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UNIVERSITY OF CALICUT

SCHOOL OF DISTANCE EDUCATION

B.COM
BA
( III SEMESTER )
POLIICAL SCIENCE

CORPORATE ACCOUNTING
(CORE COURSE : BC3B04) 329B

2017 ADMISSION
ONWARDS
CORPORATE ACCOUNTING
STUDY MATERIAL

THIRD SEMESTER

CORE COURSE : BC3B04

For
BCOM
(2017 ADMISSION ONWARDS)

UNIVERSITY OF CALICUT
SCHOOL OF DISTANCE EDUCATION
Calicut University P.O, Malappuram, Kerala, India 673635

329B
School of Distance Education

UNIVERSITY OF CALICUT
SCHOOL OF DISTANCE EDUCATION

STUDY MATERIAL
THIRD SEMESTER

BCOM
(2017 ADMISSION ONWARDS)

CORE COURSE:

BC3B04 : CORPORATE ACCOUNTING

Prepared by:

Sri. Rajan.P
Assistant Professor on Contract
School of Distance Education, University of Calicut

Layout: ‘H’ Section, SDE


©
Reserved

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CONTENTS PAGE NO.

MODULE – I 5 – 37

MODULE – II 38 – 122

MODULE – III 123 – 156

MODULE – IV 157 – 175

MODULE – V
176 – 187

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MODULE-I
ASSET BASED ACCOUNTING STANDARDS
Assets are broadly classified into two – tangible and intangible asset. Intangible asset
cannot be seen and touched. But these have value.
This chapter deals with the following assets-based accounting standards.
1. Inventories (IAS 2 & Ind AS 2)
2. Property, plant and equipment (Ind AS 16 & IAS 16)
3. Intangible assets (Ind AS 38 & IAS 38)
4. Impairment of Assets (Ind AS 36 & IAS 36)
5. Borrowing cost (IAS 23 & Ind AS 23)
6. Investment property (IAS 40 & Ind AS 40)
Accounting for inventories
Accounting for inventories is based on the matching concept. As per this concept,
inventories should be accounted for an expense in the year in which it is sold. Till that time, it
is accounted for as an asset, ie, closing stock. It is also credited in the statement of profit and
loss. Ind AS 2 & IAS 2 prescribe accounting treatment for inventories.
Objectives
The objective of this standard is to prescribe the accounting treatment for inventories.
This standard deals with determination of cost and its subsequent recognition as an expense,
including any write down to net realizable value.
Scope
This standard applies to all inventories except the following
a. Work in progress under a construction contract (dealt by Ind AS 11, construction
contracts)
b. Financial instruments, eg, share, debentures, bonds (governed by Ind AS 32, financial
instrument)
c. Biological assets related to agricultural activity and agricultural produce at the point
of harvest.
Definition of inventories
Inventories are assets that are
1. Held for sale
2. Being prepared for sale
3. Materials to be used in the production process or provision or services.
Inventory includes raw materials, production supplies, work in progress, finished goods and
goods in saleable condition(ie, ready to sell goods that have been purchased for resale.)
Accounting treatment
Measurement of inventories
Inventories must be measured at cost or net realizable value, whichever is less. Thus,
the two components are cost and net realizable value.
Cost of inventories
The cost of inventories comprises of
1. Cost of purchase
2. Cost of conversion
3. Other costs incurred in bringing the inventories to their present location and
condition.

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a) Cost of purchase
1. Purchase price
2. Import duties and other taxes
3. Transport cost
4. Handling cost
5. Other cost directly attributable to the acquisition of finished goods, materials and
services.
Malabar Textiles is a trading company dealing in textiles. It incurred the following expenses
for the purchase of textiles from New India Textiles:
Amount paid to supplies 2,25,300
Transportation charges 14,500
GST 5%
The purchase bill shows a value of 2,42,000 because New India Textiles allowed a special
trade discount of 5% of billed value to Malabar Textiles. New India Textiles also allowed a
cash discount of 2% for prompt payment. Calculate the cost of purchase. Solution
Cost of purchase as per the bill 2,42,000
Less : Trade discount 5% 12,100
2,29,900
Add : GST (5% of 2,29,900) 11,495
Add: Transportation cost 14,500
Cost of purchase 2,55,895

Note : The amount paid to the supplier * 2,25,300 is after deducting trade discount K 12,100
(5% of 2,42,000) and cash discount 4,600 (2% of net purchase price, i.e., Rs 2,29,900) To
arrive at purchase cost, only trade discount is deductible. Cash discount should not be
deducted because it is not allowed on purchase (it is allowed for prompt payment).
b) Cost of conversion: Costs of conversion of inventories include direct costs such as direct
labour, and systematic allocation of production overhead incurred in converting materials into
finished goods. Production overhead consists of fixed production overheads and variable
production overheads.
Fixed production overheads: Fixed production overheads are those indirect costs of
production that remain constant irrespective of the volume of production. Examples are
depreciation and maintenance of factory buildings and equipment, cost of factory
management and administration etc.
Fixed production overheads should be allocated on the basis of normal capacity.
Normal capacity is the production expected to be achieved on average over a number of
periods under normal circumstances. The capacity lost due to plant maintenance should be
taken into account. When production is abnormally high, the fixed production overheads
allocated to each unit will be reduced (to avoid over valuation of inventories).
Variable production overhead: variable production overheads are those indirect cost of
production that vary directly with the volume of production. Examples are indirect material
and indirect labour.
Example
Fantacy toys, manufactures toys. It has incurred the following expenses:
Cost of raw materials 600000
Rebate on purchase 30000
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Wages 110000
Depreciation of machinery 20000
Electricity charges(factory) 16500
Factory supervision charges 10500
Calculate cost of purchase and cost of conversion
solution
cost of raw material 600000
less rebate 30000
cost of purchase 570000
wages 110000
depreciation on machinery 20000
factory electricity charges 16500
factory supervision charges 10500
cost of conversion 157000
c) other cost
Other cost to be included in the cost of inventory are those which are incurred in
bringing the inventories to their present location and condition. These costs include inward
transport and storage prior to completion of production and specific design work required for
a special client.
Example
How will you value the inventory per kg. of finished goods which consisted of :
Material cost :100 per kg
Direct labour cost : 20 per kg
Direct variable production oh : 10 per kg
Fixed production charges for the year on normal capacity of 10000 kgs. Rs. 100000.
At the year end, 2000 kg. of finished goods are in stock.
Solution
The allocation of fixed production overheads is based on the normal capacity of the
production facilities. , thus cost per kg. of finished goods may be calculated as follows:
Material cost 100
Direct labor cost 20
Direct variable production oh 10
Fixed production overhead 10 40
140
Thus, the value of 2000 kgs. Of finished goods stock at the year end will be Rs.
280000(2000x140)
Cost which are excluded
a. Abnormal wastage of material, labor and overhead
b. Storage cost, if they are not necessary prior to a further production process.
c. Administrative overhead
d. Selling cost
e. Interest cost when inventories are purchased on deferred payment basis.
Cost of inventories of a service provider
To the extent that service providers have inventories, they measure them at thecosts of their
production. These costs consist primarily of the labour and other costs of personnel directly
engaged in providing the service, including supervisory personnel, and attributable
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overheads. Labour and other costs relating to sales and 5 general administrative personnel are
not included but are recognised as expenses in the period in which they are incurred. The cost
of inventories of a service provider does not include profit margins or non-attributable
overheads that are often factored into prices charged by service providers.
Example

Techniques for measurement of cost


1. Standard costing method
2. Retail costing method
Standard costing method
Standard costing involves setting costs in advance considering the normal production output.
Management usually derive standards on the basis of past experience and use this method if
cost remains fairly consistent and update the standards if situation changes.
Usually such method is used for such material or labour which is hard to trace or measure its
consumption or the benefits of such measurement are not much as compared to cost of
conducting such measurement. For example cost of glue or nails consumed in production and
entity still hold at the end of the period can be done standard costing basis.
Retail costing method
Retail method is an easy approach to determine cost by deducting profit from the sales price.
This method is employed in situations where inventory has a fairly fast turnover rate. In such
situations managing the records of costs incurred is not easy. So this retrograde approach help
ease the pressure.

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Cost formulas
An entity shall use the same cost formula for all inventories having similar nature and
use. For inventories with a different nature or use, different cost formulas may be justified.
Following are the important cost formulas for the valuation of inventories:
1. Specific identification method
Specific identification is a method of finding out ending inventory cost. It requires a
detailed physical count, so that the company knows exactly how many of each goods brought
on specific dates remained at year end inventory. When this information is found, the amount
of goods are multiplied by their purchase cost at their purchase date, to get a number for the
ending inventory cost.
2. Fifo method
This method assumes that the first items bought are the first items sold. Therefore, at the
end of the period, any items in inventory are the items purchased most recently
3. Weighted average method
The weighted average method is an inventory costing method that assigns average costs
to each piece of inventory when it is sold during the year.
Net realizable value
Estimation of net realizable value is necessary in the valuation of inventories. Net
realizable value is the estimated selling price in the ordinary course of business, less the
estimated cost of completion and the estimated costs necessary to make the sale.
Written down of inventories
The general rule is that inventories should not be carried in excess of amounts
expected to e realized from their sale or use.
In some situations, NRV is likely to be less than cost. Following are the situations
1. An increase in cost
2. Fall in selling price
3. Physical deterioration in the condition of inventory
4. Obsolescence
5. Errors in production or purchasing
Recognition as an expense
The following treatment is required when inventories are sold:
a. The carrying amount of the inventory is recognized as an expense in the period in
which the related revenue is recognized.
b. The amount of any write down of inventories to its net realizable value and all losses
of inventories are recognized as an expense in the period the write down or loss
occurs
c. If an inventory item which was written down previously, remains unsold and its NRV
has subsequently increased, then in such a case, the previous write down should
reversed and the inventory should be carried at cost.
d. Some inventories may be allocated or transferred to other assets account.
Presentation and disclosure
The financial statements should disclose the following in respect of inventories
a. Accounting policies adopted for measuring inventories and cost formula used.
b. Total carrying amount of inventories and amount per category.
c. Amount of inventory recognized as an expense during the period
d. Amount of inventory carried at fair value less costs to sell.
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e. Circumstances led to the reversal of a written down.
f. Inventory pledged as security for liabilities.
g. The amount of any written down of inventories recognized as an expense in the
period.
h. The amount of any reversal of any written down that is recognized in the period.

Example

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Example

Example

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PROPERTY, PLANT AND EQUIPMENT (Ind AS 16 and IAS 16)


Objective:
The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and
equipment. The principal issues are:-
a. the timing of recognition of asset;-
b. the determination of their carrying amounts; and-
c. the depreciation charges to be recognized.
Scope
Ind AS-16 applied to all Property, Plant & Equipment until and unless any other standard
requires or permits a different accounting treatment.
This Standard does not apply to :
a) PPE classified as held for sale in accordance with Ind AS 105
b) Biological assets related to agricultural activity other than bearer plants
c) The recognition and measurement of exploration and evaluation assets
d) Mineral rights and mineral reserves such as oil, natural gas and similar
non-regenerative resources.
Definition
:Property, Plant & Equipment are tangible items that:-
a. are held for use in the production or supply of goods or services, or-

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b. for rental to others, or


c. for administrative purposes; and
d. are expected to be used during more than one period.
Recognition:
The cost of an item or Property, Plant & Equipment shall be recognized as
an asset if, and only if:
a) it is probable that future economic benefits associated with the item will flow to the
entity; and
b) The cost of the item can be measured reliably.

Measurement at Recognition
An item of Property, Plant & Equipment that qualifies for recognition as an asset shall
be measured at its cost.
Elements of Cost:
a. Purchase price + (Import duties + Non refundable taxes) - (Trade Discounts +
Rebates)
b. Directly attributable costs.
c. Initial estimate of the cost of dismantling and removing the item and restoring the site
in which it is located.
Costs that are not Costs of Property, Plant & Equipment:
a. Costs of opening new facility;
b. Costs of introducing new product or service;
c. Costs of conducting business in new location or with new class of customer;
d. Administration and other general overhead costs;
e. Costs incurred in using or redeploying an item;
f. Amounts related to certain incidental operations
Costs that are not included in the cost of PPE
a. Cost of opening a new facility
b. New costs of introducing a new product or service
c. Cost of conducting business in a new location or with a new class of customer.
d. Administration and general overhead costs
e. Cost incurred after an asset is ready for use, but has not yet been used or is not yet
operating at full capacity
f. Initial operating losses
g. Relocation or reorganization costs
h. In case of self constructed asset, the cost of any abnormal waste related to materials,
labor or other resources
Example

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Measurement of element of cost


a. Cost : cost is the amount of cash or cash equivalents paid to acquire an asset at the
time of its acquisition or construction.
b. When the payment is deferred: if payment is deferred beyond credit terms, the
difference between the cash price equivalent and the total payment is recognized
as interest over the period of credit unless such interest is capitalized in
accordance with Ind AS 23, borrowing costs.
Subsequent expenditures
It refers to such costs which are incurred after the asset is recognized in the financial
statement and brought to the location and condition intended. Examples of such expenditures
include repair and maintenance, overhauling, upgradation, replacement costs etc.
However, not all the subsequent costs can be capitalized in the carrying amount (carrying
value or book value) of the asset in the statement of financial position.
Cost of self-constructed Assets.
Cost of these assets is determined using the same principal as for an asset acquired.
As per Ind-AS:2 if an entity make the similar asset for sale in normal course of business, the
cost of the asset is usually the same as the cost of constructing an asset for the sale. Therefore
the internal profits are eliminated and abnormal cost is not included in the cost.
subsequent measurement
When those financial assets (like cash, bank accounts, accounts and notes receivable
etc) are initially recognized, at every balance sheet date they need to be again measured. They

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need to have a true and fair value on the balance sheet and it may not be the value it was
initially recognized with.
Cost model
The cost model is used as an accounting policy to report carrying an amount of
property, plant, and equipment (fixed assets) in the balance sheet. It requires an asset to be
carried at its initial cost (also referred to as historical cost) less any accumulated depreciation
and impairment losses. The revaluation of assets is not allowed, but some accounting
standards allow recovery of impairment losses recognized in the past.
Revaluation model
under the revaluation model, an item of property, plant and equipment whose fair
value can be measured reliably is carried at a revalued amount, which is its fair value at the
date of the revaluation less any subsequent accumulated depreciation and subsequent
accumulated impairment losses.
Accounting method for revaluation under revaluation model
Revaluation increase
1. If an assets carrying amount is increased as a result of revaluation, the increased
amount is recognized in “other comprehensive income” and accumulated under equity
under the head “revaluation surplus”, unless there is a previous revaluation decrease
in respect of the same asset.
Example
A factory having the carrying value of rs. 20 million has been revalued at Rs. 23
million. Write the journal entry to record the revaluation surplus(asuem that ther is no
previous revaluation decrease in respect of the same asset)
Solution
Revaluation surplus = 23 minus 20 = 3 million
Journal entry
Property, plant and equipment Dr 3 million
To revaluation surplus 3million
2. If there is a previous revaluation decrease in respect of the same asset the increase in
revaluation (gain) shall first be recorded in the statement of profit and loss to the
extent of the previous revaluation decrease. The balance, if any, shall be recognized
“other comprehensive income” under the head “revaluation surplus”. Thus, the
revaluation gain is first used to reverse the previous revaluation los that was
previously recognized in profit or loss.

Example
A factory has a carrying value of rs. 20 million. Two years ago the company reduced
the carrying value from Rs. 22 million. This was taken as an expense in profit or loss. In the
current year the factory is now worth Rs. 23 million. Show the accounting treatment for
revaluation in the current year.

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Revaluation decrease
1. If an asset’s carrying amount is decreased as result of revaluation, then the decrease
shall be recognized in statement of profit and loss, unless there is a previous
revaluation increase in respect of the same asset.
Example
A factory has a carrying value of Rs. 20 million. It has been revalued at Rs. 19
million. How will you treat the decrease in value?
Solution
The decrease in value Rs. 1 million should be treated as expense in the statement of
profit and loss.
Profit and loss (expense) 1 million
To accumulated depreciation (to be shown in the balancesheet) 1 million.
2. If there is a previous revaluation increase in respect of the same asset, the decrease in
revaluation shall first be adjusted again the revaluation surplus to the extent of
previous revaluation increase in respect of the same asset. The balance if any, shall be
recognized in the statement of profit and loss. The decrease in revaluation reduces the
amount accumulated in equity under the head revaluation surplus.
Example
A factory has a carrying value of Rs. 22 million. Two years ago, it was revalued
upwards to rs. 23 million. The value has now fallen to Rs. 20 million. How will you
account the revaluation decrease?
Solution
The revaluation decrease is Rs. 3 million. Of this, 1million will be charged against the
previous revaluation surplus and the remaining Rs. 2 million will be charges as expenses
in the statement of profit and loss. The entry is:
Revaluation surplus Dr. 1 million
Profit or loss dr. 2 million
To property, plant and equipment 3 million
Disposal of revalued asset
when a revalued asset is disposed of, any revaluation surplus may be transferred
directly to retain earnings. This means that the transfer to retain earnings should not be
made through the statement of profit and loss.
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Example

Depreciation
Usually fixed assets are expected to be used for more than one year. Therefore, the
depreciable amount of a fixed asset is allocated over its useful life. The amount allocated
to a particular accounting period is called depreciation. Thus, depreciation is the
systematic allocation of the depreciable amount of an asset over its useful life. The
depreciable amount of an asset is the cost of an asset less its residual value.
Example
The policy of Akash Ltd. Is to keep company vehicles for 5 years. It has just bought
new equipment for Rs. 30000. Today’s market price, less selling cost, of a similar
equipment that is 5 years old is Rs. 9000, which is a reasonable estimate of the residual
value of the new equipment. Calculate
a. Depreciable amount
b. Annual depreciation charge
Solution
a. Depreciable amount 30000 minus 9000 = 21000
b. Annual depreciation 21000/5 years = 4200
Depreciation of revalued asset
In case of revaluation, the depreciation is calculated on the total revalued amount over a
period of balance useful lives assessed on the date of revaluation. New cost for the purpose of
depreciation will be gross cost less accumulated depreciation on the date of revaluation.
Along with this, the revaluation reserve is amortised to the income statement based on the
useful life of the asset to which it relates. This is done to ensure that depreciation on the
revalued amounts shouldn’t inflate/ deflate the income statement.
Example
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Shine ltd purchased an asset for Rs. 60000 at the beginning of 2014. It had a useful life of 5
years. On Ist January 2016, the asset was revalued to Rs 75000. The expected useful life has
remained unchanged. Show how revaluation is accounted. Also state the treatment for
depreciation from 2016 onwards.

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Example

example

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INTANGIBLE ASSETS (Ind AS 38 and IAS 38)


Intangible assets are assets not having any physical substance. Therefore, they cannot
be seen an touched.
Objective
The objective of this Standard is to prescribe the accounting treatment for intangible assets
that are not dealt with specifically in another Standard. This Standard requires an entity to
recognise an intangible asset if, and only if, specified criteria are met. The Standard also
specifies how to measure the carrying amount of intangible assets and requires specified
disclosures about
intangible assets.
Scope
Ind AS 38 applies to all intangible assets other than:
 financial assets
 exploration and evaluation assets
 expenditure on the development and extraction of minerals, oil, natural gas, and
similar resources intangible assets arising from insurance contracts issued by
insurance companies
 intangible assets covered by another Ind AS, such as:
 intangibles held for sale
 deferred tax assets
 lease assets
 assets arising from employee benefits plan
 Goodwill acquired under business combination.
Definition
An intangible asset is an identifiable non-monetary asset without physical substance.

Accounting treatment

Initial recognition as an asset

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c) Training costs
d) Relocating or reorganizing costs.

Initial measurement
After intangible assets have been first recognized. They are to be measured. They
should be initially measured at cost. But Subsequently, they can be carried at cost or at a
revalued amount.
Measurement of intangible assets acquired as a part of business, combinations
In this case the intangible asset is measured at fair value at the date of acquisition.
Measurement of internal project
In case of internal project, expenditure of creating an intangible asset is treated
differently. The research phase and development phase should be distinguished from one
another. Research expenditure are treated as an expense. Development expenditure qualifying
for recognition measured at cost and is capitalized.
Measurement of intangible assets acquired in exchange for equity instruments
If an intangible asset is acquired in exchange for equity instrument, the cost of the
asset is the fair value of those equity instruments.
Measurement in case of exchange of assets
An intangible asset may be acquired in exchange for a similar asset with a similar fair
value. No gain or loss is recorded on the transaction. Instead, the cost of the new asset is the
carrying amount of the asset given up.

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Example
X ltd has a franchise, which ahs carrying value of rs. 10 million. It exchanges it for a
similar franchise with a market value of Rs. 11 million. State whether there is surplus or gain.
Solution
Rs. 1 million may be treated as revaluation surplus, rather than a gain in the income
statement. The journal entry is :
Intangible asset (new) dr 11 million
Revaluation surplus 1 million
Tangible asset (old) 10 milliion

Revaluation model
Under the revaluation method, an intangible asset is carried at a revalued amount.
This is the fair value of the intangible asset at the date of revaluation, less subsequent
accumulated amortization and accumulated impairment.
Revaluation increase (upward revaluation)
When an intangible asset is revalued =upwards to a fair value, the revaluation increase
is credited directly to equity under the head revaluation surplus, unless the asset was
previously revalued downwards. If the asset was previously revalued downwards, the
revaluation increase should be first used to set off the previous revaluation decrease.
Revaluation decrease
When the carrying amount of an intangible asset is revalued downwards, the amount
of the downward revaluation should be charged as an expense in the income statement, unless
the asset was previously revalued upwards. If the asset was previously revalued upwards the
revaluation surplus in respect of that asset.
Example

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Elimination of intangible asset


An intangible asset should be eliminated from th balance sheet when it is disposed of
or when there is no further expected economic benefit from its future use. On disposal, the
gain or loss should be taken to statement of profit and loss as gain or loss on disposal, ie, it
should be treated as income or expense.
Useful life
An entity shall assess whether the useful life of an intangible asset is finite or
indefinite and, if finite, the length of, or number of production or similar units constituting,
that useful life. An intangible asset shall be regarded by the entity as having an indefinite
useful life when, based on an analysis of all of the relevant factors, there is no foreseeable
limit to the period over which the asset is expected to generate net cash inflows for the entity.
Intangible assets with finite useful lives
The depreciable amount of an intangible asset with a finite useful life shall be
allocated on a systematic basis over its useful life. Amortisation shall begin when the asset is
available for use, ie when it is in the location and condition necessary for it to be capable of
operating in the manner intended by management. Amortisation shall cease at the earlier of
the date that the asset is classified as held for sale (or included in a disposal group that is
classified as held for sale) in accordance with Ind AS 105 and the date that the asset is
derecognised. The amortisation method used shall reflect the pattern in which the asset’s
future economic benefits are expected to be consumed by the entity. If that pattern cannot be
determined reliably, the straight-line method shall be used. The amortisation charge for each
period shall be recognised in profit or loss unless this or another Standard permits or requires
it to be included in the carrying amount of another asset.
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Amortization
An intangible asset with a finite useful life should be amortised over its expected
useful life. Amortization is a systematic allocation of the cost or realued amount less any
residual value, over the asset’s useful life.
Example

Intangible asset with indefinite useful life


An intangible asset with an indefinite useful life shall not be amortised. In accordance
with Ind AS 36, an entity is required to test an intangible asset with an indefinite useful life
for impairment by comparing its recoverable amount with its carrying amount
(a) annually, and
(b) whenever there is an indication that the intangible asset may be impaired.
Residual value
The residual value of an intangible asset with a finite useful life shall be assumed to
be zero unless:
(a) there is a commitment by a third party to purchase the asset at the end of its useful
life; or
(b) there is an active market (as defined in Ind AS 113) for the asset and:
(i) residual value can be determined by reference to that market;and
(ii) it is probable that such a market will exist at the end of the asset’s useful
life.
Internally generated goodwill
Internally generated goodwill shall not be recognised as an asset. In some cases,
expenditure is incurred to generate future economic benefits, but it does not result in the
creation of an intangible asset that meets the recognition criteria in this Standard. Such
expenditure is often described as contributing to internally generated goodwill. Internally
generated goodwill is not recognised as an asset because it is not an identifiable resource (ie it
is not separable nor does it arise from contractual or other legal rights) controlled by the
entity that can be measured reliably at cost. Differences between the fair value of an entity
and the carrying amount of its identifiable net assets at any time may capture a range of

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factors that affect the fair value of the entity. However, such differences do not represent the
cost of intangible assets controlled by the entity.
Internally generated intangible asset: it may be difficult to know whether an internally
generated asset qualifies for recognition. This is because of it is often difficult to:
a. Identify whether, and when, there is identifiable asset that will generate future
benefits and
b. Determine the cost of the asset.
To assess whether an internally generated assets meet the criteria for recognition, an
enterprise splits the generation of assets into

Cost of an internally generated intangible asset:The cost of an internally generated asset is


the total costs incurred from the date when the asset first meets the recognition criteria and
that can be directly attributed or allocated to it on reasonable and consistent basis. The cost
comprises of all expenditures for creating, producing, and preparing the assets for its intended
use. Such costs include the following.

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a. Expenditure on materials and services used in generating the asset.
b. The employment costs of personnel directly engaged in producing the asset
c. Any expenditure that is directly attributable to the asset, such as fees to register a legal
right and the amortization of patents and licenses.
d. Overheads that are necessary to generate the asset.
e. Interest.

Example

IMPAIRMENT OF ASSETS (Ind AS 36 and IAS 36)


There is an established principle that assets should not be carried at more than their
recoverable amount. If the carrying value of an asset is more than its recoverable amount the
asset is described as impaired. In such a case, the company should write down the carrying
value of that asset to its recoverable amount. The amount written off is called impairment of
loss.

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Objectives
 Assets should be carried at no more than their recoverable amount, i.e. the amount
expected to be recovered through use of the asset, or its fair value less cost to sale.
 Specify procedures to be followed to ensure that assets are not carried at more than
recoverable amount
 Specify when an impairment loss should be reversed.
 Specify required disclosures.
Scope
This Standard shall be applied in accounting for the impairment of all
assets, other than:
(a) inventories (see Ind AS 2 Inventories);
(b) assets arising from construction contracts (see Ind AS 11Construction Contracts);
(c) deferred tax assets (see Ind AS 12 Income Taxes);
(d) assets arising from employee benefits (see Ind AS 19 Employee Benefits);
(e) financial assets that are within the scope of Ind AS 39 Financial Instruments:
Recognition and Measurement
(f) biological assets related to agricultural activity that are measured at
fair value less costs to sell (see Ind AS 41 Agriculture.
(g) deferred acquisition costs, and intangible assets, arising from an insurer’s contractual
rights under insurance contracts within the scope of Ind AS 104 Insurance Contracts;
and
(h) non-current assets (or disposal groups) classified as held for sale in accordance with
Ind AS 105 Non-current Assets Held for Sale and Discontinued Operations.
Definition of impairment
Impairment is the fall in the value of asset, so that its recoverable amount is less than
its carrying amount in the balance sheet.
Accounting treatment
The accounting treatment of impairment of asset involves the following steps.
Step 1 Identifying an asset that may be impaired
An entity should assess at the end of each reporting period, whether there is any
indication of impairment. For assessing the indication of impairment, a firm should consider
external sources of information and internal sources of information.
a. External sources of indication of impairment
 Market value declines.
 Negative changes in technology , markets, economy, or laws
 Increase in market interest rates.
 Company stock price is below book value
b. Internal sources of indication
 Obsolescence or physical damage
 Asset is part of a restructuring or held for disposal
 Worse economic performance than expected
 Adverse change in the use to which the asset is put.
Step 2: measuring the recoverable amount
For determining recoverable amount, it is necessary to calculate:
 Fair value less cost of disposal
An assets fair value less cost of disposal is the amount that could
obtained from the sale of the asset less selling costs. Cost of disposal
simply refers to selling expenses
 Value in use

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Value in use is the present value of the future cash flows expected to be derived from
an asset or a cash generating unit.
Step 3: recognizing and measuring impairment loss
After having determined the recoverable amount we can now determine the
impairment loss. An asset is impaired when its carrying amount exceeds its recoverable
amount. In such a case, the carrying amount should be reduced to the recoverable amount.
Step 4: recognition of impairment loss
the impairment loss should be recognized immediately in the statement of profit and
loss unless the asset has been revalued in accordance with Ind AS 16 or Ind AS 38. If the
asset is revalued, the loss is treated as revaluation decrease in accordance with Ind AS 16 or
Ind AS 38.
The journal entries are as follows:
Impairment loss account dr
To asset account
Profit or loss a/c dr
Impairment loss

Cash generating units

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Recoverable amount of an asset should be estimated individually, if possible. In most


situation, it is almost impossible to determine the recoverable amount of an individual asset.
For example, an individual asset itself without the help of other asset cannot generate the cash
flows. Hence, cash flows to be derived from individual asset cannot be calculated separately.
Therefore, for the purpose of identifying cash flows, asset should be grouped into a smallest
unit. This smallest unit is called cash generating unit.
Impairment loss for a cash generating unit
When an impairment loss is recognized for a cash generating unit, the loss should be
allocated between the assets in the following order.
a. First reduce the carrying amount of any assets that are individually destroyed
or impaired
b. Next reduce the carrying amount of any goodwill allocated to the cash
generating unit.
c. Then, reduce the carrying amount of the other assets of the cash generating
unit pro rata basis.
Allocating goodwill to cash generating units
Internally generated goodwill is not recognized in financial statements. An entity
recognizes goodwill if the purchase consideration in paid an acquisition exceeds the fair
value of the identifiable assets and liabilities acquired in the transaction. Therefore goodwill
recognized in financial statements must relate to one or more businesses acquired prior to the
balance sheet date. For the purpose of impairment test, goodwill must be allocated to each of
the acquirer cash generating units, or groups of cash generating units that are expected to
benefit from the synergies of the combination.
Example

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Example

Example

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Reversing an impaired loss


An entity should assess at the end of each reporting period whether there is any
indication that an impairment loss recognized in prior periods for an asset other than goodwill
may no longer exist or may have decreased. In such a cash, the entity should estimate the
recoverable amount of that asset.
Reversing an impairment loss for goodwill
An impairment, loss recognized for goodwill should not be reversed in a subsequent
period because Ind AS 38, intangible assets, prohibits the recognition of internally generated
goodwill. In short, impairment loss of goodwill may never be reversed.
BORROWING COST (IAS 23 & Ind AS 23)
Borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset form part of the cost of that asset. Other borrowing costs are
recognised as an expense.
Objective of IAS 23
The objective of IAS 23 is to prescribe the accounting treatment for borrowing costs.
Borrowing costs include interest on bank overdrafts and borrowings, finance charges on
finance leases and exchange differences on foreign currency borrowings where they are
regarded as an adjustment to interest costs.
Scope of IAS 23
Two types of assets that would otherwise be qualifying assets are excluded from the
scope of IAS 23:
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 qualifying assets measured at fair value, such as biological assets accounted


for under IAS 41 Agriculture
 inventories that are manufactured, or otherwise produced, in large quantities
on a repetitive basis and that take a substantial period to get ready for sale (for
example, maturing whisky)
Definition of borrowing cost
This Standard uses the following terms with the meanings specified:
a. Borrowing costs are interest and other costs that an entity incurs in connection with
the borrowing of funds.
b. A qualifying asset is an asset that necessarily takes a substantial period of time to get
ready for its intended use or sale.
Accounting treatment
Recognition
1. Borrowing cost to be capitalized
Borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset should be capitalized when it is probable that they will bring
future economic benefits to the entity and the costs can be measured reliably.
2. Borrowing cost to be charged as an expense
Other borrowing costs are recognized as expenses and written off in the
statement of profit and loss in the period in which they are incurred.
Commencement of capitalization
An entity should begin capitalizing borrowing costs on the date when all of the
following conditions are met:
a. Expenditure on qualifying asset has begun
b. Borrowing costs are being incurred
c. Activities to prepare the asset for its intended use or sale are in progress
Suspension of capitalization
Capitalization of borrowing cost is suspended during extended periods in which
active development is interrupted. This means that borrowing cost should not be capitalized
during the extended period.
It also suspended when acquisition or construction activities are suspended
intentionally. However, capitalization is not suspended in the following cases
a. Temporary delays caused by external forces
b. When substantial technical and administrative work is being carried out
c. When temporary delay is a necessary part of the process of getting an asset ready for
its intended use or sale.
Cessation of capitalization
an entity should cease capitalizing borrowing costs when :
a. Substantially all the activities necessary to prepare the qualifying asset for the
intended use or sale are complete.
b. The construction is completed in part and the completed part can be independently
used, eg, a business park comprising several buildings, each of which can be used
individually.
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Excess of the carrying amount


The amount capitalized during the period should not exceed the amount of borrowing
costs incurred during that period. If the carrying value of an asset exceeds the net realizable
value, the asset should be written down to the NRV.
Accrual basis
Borrowing cost should be calculated on a accrual basis
Example
Borrowing cost recognized as an expense are:
Interest payable:
Opening interest payable rs. 5000
Interest paid in cash during the year Rs. 78000
Closing interest payable rs. 12000
Calculate the amount of interest to be written off in the period
Solution
Interest charge for the year is calculated as below:
Opening interest 5000
Add: interest paid 78000
=====
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83000
Less closing interest 12000
======
71000
Example

INVESTMENT PROPERTY (IAS 40 and Ind AS 40)


Investment property is property (land or a building or part of a building or both) held
(by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation
or both. [IAS 40.5]
Objectives
The objective of this Standard is to prescribe the accounting treatment for investment
property and related disclosure requirements.
Scope:
The Standard applies to the measurement in a lessee’s financial statements of investment
property held under a finance lease and to the measurement in the lessor’s financial
statements of investment property leased out under an operating lease. However this Standard
does not apply to: the matter covered in Ind AS-17, Leases. biological assets related to

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agricultural activity (Ind AS-41) or, mineral rights and mineral reserves such as oil, natural
gas and similar non-regenerative resources.
Investment property:
It is a land and/or building, or part of a building, or both, held by the owner or the
lessee under a finance lease to earn rentals and/or for capital appreciation, rather than for: use
in production or supply of goods and services or use in administrative purposes or sale in the
ordinary course of business.
Owner-occupied property:
It is a property held (by the owner or by the lessee under finance lease) for use in the
production or supply of goods or services or for administrative purposes. One of the
distinguishing characteristics of investment property (compared to owner-occupied property)
is that it generates cash flows that are largely independent from other assets held by an entity.
Owner-occupied property is accounted for under Ind AS-16, Property, Plant and Equipment.
Examples of Investment Property:
 Land held for long-term capital appreciation rather than for short-term sale;
 A building owned by the entity and leased out under one or more operating leases;
 A building that is vacant but is held to be leased out under one or more operating
leases;
 Property that is being constructed or developed for future use as investment property
Partial own use.
If the owner uses part of the property for its own use, and part to earn rentals or for
capital appreciation, and the portions can be sold or leased out separately, they are accounted
for separately. Therefore the part that is rented out is investment property. If the portions
cannot be sold or leased out separately, the property is investment property only if the owner-
occupied portion is insignificant. [IAS 40.10]
Ancillary services.
If the entity provides ancillary services to the occupants of a property held by the
entity, the appropriateness of classification as investment property is determined by the
significance of the services provided. If those services are a relatively insignificant
component of the arrangement as a whole (for instance, the building owner supplies security
and maintenance services to the lessees), then the entity may treat the property as investment
property. Where the services provided are more significant (such as in the case of an owner-
managed hotel), the property should be classified as owner-occupied. [IAS 40.13]
Recognition
Investment property should be recognised as an asset when it is probable that the
future economic benefits that are associated with the property will flow to the entity, and the
cost of the property can be reliably measured. [IAS 40.16]

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Initial measurement
Investment property is initially measured at cost, including transaction costs. Such cost
should not include start-up costs, abnormal waste, or initial operating losses incurred before
the investment property achieves the planned level of occupancy. [IAS 40.20 and 40.23]
Measurement subsequent to initial recognition
IAS 40 permits entities to choose between: [IAS 40.30]
 a fair value model, and
 a cost model.
One method must be adopted for all of an entity's investment property. Change is permitted
only if this results in a more appropriate presentation. IAS 40 notes that this is highly unlikely
for a change from a fair value model to a cost model.
Disposals
An investment property is eliminated from the balance sheet on disposal, and when no
future economic benefits are expected from it. The investment property may be disposed off
by sale or by entering into a finance lease. The difference between the net sale proceeds and
the carrying amount of the property represents the gain or loss on disposals.

Example

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Example

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MODULE-II
REVENUE AND LIABILITY BASED ACCOUNTING STANDARDS

Scope
An entity shall apply this Standard to all contracts with customers, except the
following:
(a) lease contracts within the scope of Ind AS 17, Leases;
(b) insurance contracts within the scope of Ind AS 104, Insurance Contracts; 591
(c) financial instruments and other contractual rights or obligations within the scope of
Ind AS109, Financial Instruments, Ind AS110, Consolidated Financial Statements,
Ind AS111, Joint Arrangements, Ind AS 27,Separate Financial Statements and Ind AS
28, Investments in Associates and Joint Ventures; and
(d) non-monetary exchanges between entities in the same line of business to
facilitate sales to customers or potential customers. For example, this

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Standard would not apply to a contract between two oil companies that agree to an
exchange of oil to fulfill demand from their customers in different specified locations
on a timely basis
Definitions
1. contract: a contract is an agreement between two or more parties that creates
enforeale rights and obligations.
2. Revenue; revenue is the income arising in the ordinary course of an entities activities.
3. Income: income is the increase in economic benefits in the form of inflows or
enhancements of assets or decrease of liabilities that result in an increase in equity.
4. Stand along selling price: stand alone selling price is the price at which an entity
would sell a promised good or service separately to a customer.
Revenue recognition and measurement
Under Ind AS 115 (IFRS 15), revenue is recognized and measured using a five step
model.
Step 1: Identify the contract with the customer
The new standard defines a ‘contract’ as an agreement between two or more parties
that creates enforceable rights and obligations and specifies that enforceability is a matter of
law. Contracts can be written, oral or implied by an entity’s customary business practices.
Step 2: Identify the performance obligation
The new standard requires an entity to identify the performance obligations, i.e. the
unit of account for revenue recognition. A promise to deliver a good or provide a service in a
contract with a customer constitutes a performance obligation if the promised good or service
is distinct.
Step 3: Determine the transaction price
Ind AS 115 requires an entity to consider the terms of the contract and its customary
business practices to determine the transaction price. The transaction price is the amount of
consideration to which an entity expects to be entitled in exchange for transferring goods or
services to a customer.
The entity should consider the following when determining transaction price:
 Variable consideration and the constraint: If the consideration includes a variable
amount, an entity should estimate the amount of consideration to which it will be
entitled in exchange for transferring the promised goods or services to a customer.
Items such as discounts, credits, price concessions, returns and performance bonuses
may result in variable consideration.
 The existence of a significant financing component in the contract: In determining the
transaction price, an entity should adjust the promised amount of consideration for the
time value of money if significant financing components exist.
 Non-cash consideration: Non-cash consideration is measured at fair value, if that can
be reasonably estimated. If not, an entity uses the stand-alone selling price of the good
or service that was promised in exchange for non-cash consideration.
 Consideration payable to a customer: Entities need to determine whether
consideration payable to a customer represents a reduction of the transaction price, a
payment for a distinct good or service, or a combination of the two.
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Step 4: Allocating the transaction price


Under Ind AS 115, entities are required to allocate the transaction price to each
performance obligation (or distinct good or service) in proportion to its stand- alone selling
price i.e. the price at which an entity would sell the promised good or service separately to a
customer.
The best evidence of the stand-alone selling price is an observable price from stand-
alone sales of that good or service to similarly situated customers. However, if the stand -
alone selling price is not directly observable then the entity should estimate the stand-alone
selling price using the following methods:
 The adjusted market assessment approach
 Expected cost plus margin approach
 Residual approach (only in limited circumstances)
Example

Step 5: Recognise revenue


As per the new standard, revenue may be recognised either at a point in time (when
the customer obtains control over the promised service) or over a period of time (as the
customer obtains control over the promised service). For the purposes of the standard, control
refers to the customer’s ability to direct the use of and obtain necessary benefits from the
asset, i.e. the promised services.
At the end of each reporting period, for each performance obligation satisfied over
time, revenue should be recognised by measuring the progress towards complete satisfaction
of that performance obligation. An entity should use a single method consistently for such
measurement. Ind AS 115 specifies two types of methods: input method and output method,

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which an entity should consider based on the nature of the goods or services. The objective is
to use a method that depicts the transfer of control of goods or services to the customer.
If a performance obligation is not satisfied over time, then an entity recognises
revenue at the point in time at which it transfers control of the good or service to the
customer. The new standard includes indicators of when the transfer of control occurs.

Performance obligation satisfied at appoint in time

If any entity does not satisfy its performance obligation over time, it satisfies it at a
point in time. this will be the point in time at which the customer obtains control of the
promised asset and the entity satisfies a performance obligation. Revenue will, therefore, be
recognized when control is passed at a certain point in time. for this purpose, an entity has to
consider the following indicators of transfer of control:

a. The entity has a present right to payment for the asset.


b. The customer has legal title to the asset;
c. The entity has transferred physical possession of the asset;
d. The customer has the significant risks and rewards related to the ownership of the
asset; and

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e. The customer has accepted the asset.

Contract costs: Costs that would have been incurred regardless of whether the contract was
obtained are recognized as an expense as incurred. Costs incurred in fulfilling a contract,
unless within the scope of another standard are recognized as an asset if they meet all the
following criteria.

a. Cost relates directly to a contract


b. The costs generate or enhance resources of the entity that will be used in satisfying
the performance obligation in the future; and The costs are expected to be recovered.

Example

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Example

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INCOME TAX (IAS 12 and Ind AS 12)

IAS 12 Income Taxes implements a so-called 'comprehensive balance sheet method'


of accounting for income taxes which recognises both the current tax consequences of
transactions and events and the future tax consequences of the future recovery or settlement
of the carrying amount of an entity's assets and liabilities. Differences between the carrying
amount and tax base of assets and liabilities, and carried forward tax losses and credits, are
recognised, with limited exceptions, as deferred tax liabilities or deferred tax assets, with the
latter also being subject to a 'probable profits' test.

Objectives
•Calculate taxes under Ind AS 12.
•Describe the recognition criteria for deferred tax liabilities and assets.
•Explain the deferred tax effects on business combinations.
•Detail the recognition of deferred tax assets arising from unused tax
•Detail the recognition of deferred tax assets arising from unused tax losses or credits.
•Detail presentation and disclosure requirements of income taxes
Some Definitions
1. Accounting Profit– Profit or loss for a period per the books of account.
2. Taxable Profit– The profit (loss) for a period, determined in accordance with the
rules established by the taxation authorities, upon which income taxes are payable
(recoverable)
3. Tax expense–The aggregate amount included in the determination of profit or loss for
the period in respect of current tax and deferred tax
4. Current tax–The amount of income taxes payable (recoverable) in respect of the
taxable profit (tax loss) for a period
Recognition of current tax liabilities and Assets
Current tax for current and prior periods shall, to the extent unpaid, be recognised as a
liability. If the amount already paid in respect of current and prior periods exceeds the
amount due for those periods, the excess shall be recognised as an asset. The benefit relating
to a tax loss that can be carried back to recover current tax of a previous period shall be
recognised as an asset. When a tax loss is used to recover current tax of a previous period, an
entity recognises the benefit as an asset in the period in which the tax loss occurs because it is
probable that the benefit will flow to the entity and the benefit can be reliably measured.

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Example

Recognition of current tax


Current tax should be recorgnised when taxable profits are earned in the period which
it relates in the following manner.
a. A current tax expense or income item should be recognized in the income statement .
b. A current tax liability should be recognized to the extent that the amounts owing are
unpaid to tax authorities.
c. A current tax asset should recognized to the extent that the amount already paid
exceed the amount due.
Measurement of current tax
Current tax liabilities and assets are measured at the amount expected to be paid to or
recovered from the taxation authorities.
Tax base
The tax base of an asset is the amount that will be deductible for tax purposes against
any taxable economic benefits that will flow to an entity when it recovers the carrying
amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is
equal to its carrying amount.
Examples determining tax base of an Asset
1. A machine cost Rs.100. For tax purposes, depreciation of Rs.30 has already been
deducted in the current and prior periods and the remaining cost will be deductible in future
periods, either as depreciation or through a deduction on disposal. Revenue generated by
using the machine is taxable, any gain on disposal of the machine will be taxable and any loss
on disposal will be deductible for tax purposes.
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The tax base of the machine is Rs.70.


2. Interest receivable has a carrying amount of Rs.100. The related interest revenue will
be taxed on a cash basis.
The tax base of the interest receivable is nil
3. Trade receivables have a carrying amount of Rs.100. The related revenue has already
been included in taxable profit (tax loss)
. The tax base of the trade receivables is Rs.100.
4. Dividends receivable from a subsidiary have a carrying amount of Rs.100. The
dividends are not taxable.
In substance, the entire carrying amount of the asset is deductible against the economic
benefits. Consequently, the tax base of the dividends receivable is Rs.100.(a)
Examples determining tax base of a liability
The tax base of a liability is its carrying amount, less any amount that will be
deductible for tax purposes in respect of that liability in future periods. In the case of revenue
which is received in advance, the tax base of the resulting liability is its carrying amount, less
any amount of the revenue that will not be taxable in future periods.
1. Current liabilities include accrued expenses with a carrying amount of Rs.100. The
related expense will be deducted for tax purposes on a cash basis. The tax base of the
accrued expenses is nil.
2. Current liabilities include interest revenue received in advance, with a carrying
amount of Rs.100. The related interest revenue was taxed on a cash basis. The tax
base of the interest received in advance is nil.
3. Current liabilities include accrued expenses with a carrying amount of Rs.100. The
related expense has already been deducted fosr tax purposes. The tax base of the
accrued expenses is Rs.100.
4. Current liabilities include accrued fines and penalties with a carrying amount of
Rs.100. Fines and penalties are not deductible for tax purposes. The tax base of the
accrued fines and penalties is Rs.100.(a
Difference in accounting profit and taxable profit:Accounting profits form the basis for
computing taxable profit, on which the tax liability for the year is calculated. However,
accounting profits and taxable profit are different. There are two reasons for the differences,
permanent differences and temporary differences.
Permanent differences: Permanent differences occur when certain items of revenue or
expenses are excluded from the computation of taxable profit.

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Type of temporary differences

Temporary differences may be either taxable temporary differences or deductible


temporary differences.

a. Taxable temporary differences : these are temporary differences that will result in
taxable amounts in determining taxable profit of future periods when the carrying

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amount of the asset or liability is recovered or settled. The following are examples of
circumstances that give rise to taxable temporary differences.
 Transaction affecting profit or loss
 Transaction affecting balance sheet

Deferred tax
Deferred tax is difference in tax liability calculated for temporary difference between
the taxable profit and accounting profit.
Deferred tax liabilities
Deferred tax liabilities generally arise where tax relief is provided in advance of an
accounting expense/unpaid liabilities, or income is accrued but not taxed until received
Recognition of deferred tax liabilities
The general principle in IAS 12 is that a deferred tax liability is recognised for all taxable
temporary differences. There are three exceptions to the requirement to recognise a deferred
tax liability, as follows:
 liabilities arising from initial recognition of goodwill [IAS 12.15(a)]

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 liabilities arising from the initial recognition of an asset/liability other than in a


business combination which, at the time of the transaction, does not affect either the
accounting or the taxable profit [IAS 12.15(b)]
 liabilities arising from temporary differences associated with investments in
subsidiaries, branches, and associates, and interests in joint arrangements, but only
to the extent that the entity is able to control the timing of the reversal of the
differences and it is probable that the reversal will not occur in the foreseeable
future. [IAS 12.39]

example

Deferred tax assets


Deferred tax assets generally arise where tax relief is provided after an expense is deducted
for accounting purposes:
 a company may accrue an accounting expense in relation to a provision such as bad
debts, but tax relief may not be obtained until the provision is utilized
 a company may incur tax losses and be able to "carry forward" losses to reduce
taxable income in future years..
An asset on a company's balance sheet that may be used to reduce any subsequent period's
income tax expense. Deferred tax assets can arise due to net loss carryover.
Recognition of deferred tax assets
A deferred tax asset is recognised for deductible temporary differences, unused tax losses and
unused tax credits to the extent that it is probable that taxable profit will be available against
which the deductible temporary differences can be utilised, unless the deferred tax asset
arises from: [IAS 12.24]
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 the initial recognition of an asset or liability other than in a business combination


which, at the time of the transaction, does not affect accounting profit or taxable
profit.
Measurement of deferred tax
Deferred tax assets and liabilities are measured at the tax rates that are expected to apply to
the period when the asset is realised or the liability is settled, based on tax rates/laws that
have been enacted or substantively enacted by the end of the reporting period. [IAS 12.47]
The measurement reflects the entity's expectations, at the end of the reporting period, as to
the manner in which the carrying amount of its assets and liabilities will be recovered or
settled. [IAS 12.51]
IAS 12 provides the following guidance on measuring deferred taxes:
 Where the tax rate or tax base is impacted by the manner in which the entity
recovers its assets or settles its liabilities (e.g. whether an asset is sold or used), the
measurement of deferred taxes is consistent with the way in which an asset is
recovered or liability settled [IAS 12.51A]
 Where deferred taxes arise from revalued non-depreciable assets (e.g. revalued
land),
 deferred taxes reflect the tax consequences of selling the asset [IAS 12.51B]
Deferred taxes arising from investment property measured at fair value under IAS
40 Investment Property reflect the rebuttable presumption that the investment
property will be recovered through sale [IAS 12.51C-51D]
 If dividends are paid to shareholders, and this causes income taxes to be payable at
a higher or lower rate, or the entity pays additional taxes or receives a refund,
deferred taxes are measured using the tax rate applicable to undistributed profits
[IAS 12.52A]
Deferred tax assets and liabilities cannot be discounted. [IAS 12.53]
Revalued asset
Under IAS (Ind AS) 16 assets may be revalued to be shown at their fair values. The
revaluation of an asset does not affect taxable profit in the period of the revaluation. As a
result, the tax base of the asset is not adjusted.
Example

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Example

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Example

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Employee benefits (IAS 19 and Ind AS 19)


An employer provides a number of benefits to its employees for the services provided
by them. The most important one is salary or wage. In addition to this, there are some other
benefits, such as gratuity, leave encashment, maternity leaves, superannuation, medical
benefits etc.
Objectives
The objective of IAS 19 is to prescribe the accounting and disclosure for employee
benefits, requiring an entity to recognise a liability where an employee has provided service
and an expense when the entity consumes the economic benefits of employee service.
Scope
IAS 19 applies to (among other kinds of employee benefits):
 wages and salaries
 compensated absences (paid vacation and sick leave)
 profit sharing and bonuses
 medical and life insurance benefits during employment
 non-monetary benefits such as houses, cars, and free or subsidised goods or
services
 retirement benefits, including pensions and lump sum payments
 post-employment medical and life insurance benefits
 long-service or sabbatical leave
 'jubilee' benefits deferred compensation programmes termination benefits.

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Definition of employee benefit


Employee benefits are all forms of considerations given by an entity in exchange for
services rendered y employees.
Other definitions
1. Equity compensation plans: equity compensation plans are formal or informal
arrangement under which an entity provides equity compensation benefit for one or
more employees.
2. Vested employee benefits: vested employee benefits are employee benefits that are
not condition on future employment.
3. Plan asset: plan assets comprise assets held by the long term employee benefit fund
and qualifying insurance policies.
4. Return on plan assets: return on plan assets comprises interest, dividends, and other
revenue derived from the plan assets, together with realized and unrealized gains, or
losses on the plan assets, less any cost of administering the plan and less any tax
payable.
Categories of employee benefits
 Short term employee benefits
 Post employment benefits
 Other long term benefits
 Termination benefits
Short-term employee benefits
Short-term employee benefits are those expected to be settled wholly before twelve
months after the end of the annual reporting period during which employee services are
rendered, but do not include termination benefits.[IAS 19(2011).8] Examples include wages,
salaries, profit-sharing and bonuses and non-monetary benefits paid to current employees.
The undiscounted amount of the benefits expected to be paid in respect of service
rendered by employees in an accounting period is recognised in that period. [IAS
19(2011).11] The expected cost of short-term compensated absences is recognised as the
employees render service that increases their entitlement or, in the case of non-accumulating
absences, when the absences occur, and includes any additional amounts an entity expects to
pay as a result of unused entitlements at the end of the period.
Profit-sharing and bonus payments
An entity recognises the expected cost of profit-sharing and bonus payments when,
and only when, it has a legal or constructive obligation to make such payments as a result of
past events and a reliable estimate of the expected obligation can be made.
Types of post-employment benefit plans
Post-employment benefit plans are informal or formal arrangements where an entity provides
post-employment benefits to one or more employees, e.g. retirement benefits (pensions or
lump sum payments), life insurance and medical care.

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The accounting treatment for a post-employment benefit plan depends on the economic
substance of the plan and results in the plan being classified as either a defined contribution
plan or a defined benefit plan:
 Defined contribution plans. Under a defined contribution plan, the entity pays
fixed contributions into a fund but has no legal or constructive obligation to make
further payments if the fund does not have sufficient assets to pay all of the
employees' entitlements to post-employment benefits. The entity's obligation is
therefore effectively limited to the amount it agrees to contribute to the fund and
effectively place actuarial and investment risk on the employee
 Defined benefit plans These are post-employment benefit plans other than a
defined contribution plans. These plans create an obligation on the entity to provide
agreed benefits to current and past employees and effectively places actuarial and
investment risk on the entity.
Recognition and measurement of post employment benefits
Defined contribution plans
Rules for recognition measurement of defined contribution plans are given below
a. Contributions to defined contribution plan should be recognized as an expense in the
period they are payable.
b. Any liability or unpaid contribution that are due as at the end of the period should be
recognized as a liability
c. Any excess contribution paid should be recognized as an asset, but only to the extent
that prepayment will lead to a reduction in future payments or cash refund.
Other long-term benefits
 the recognition and measurement of a surplus or deficit in an other long-term
employee benefit plan is consistent with the requirements outlined above
 service cost, net interest and remeasurements are all recognised in profit or loss
(unless recognised in the cost of an asset under another IFRS), i.e. when compared
to accounting for defined benefit plans, the effects of remeasurements are not
recognised in other comprehensive income.
Recognition and measurement of other long term benefits
Unlike post employee benefits, there is only less uncertainty relating to the
recognition and measurement of other long term benefits.
The net total of the following amounts should be recognized in the statement of profit
and loss:
a. service cost
b. net interest on the net defined benefit liability (or asset)
c. remeasurements of the net defined benefit liability
d. actuarial gains and losses(should be recognized immediately)
e. past service cost.

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Termination benefits
 when the entity can no longer withdraw the offer of those benefits - additional
guidance is provided on when this date occurs in relation to an employee's decision to
accept an offer of benefits on termination, and as a result of an entity's decision to
terminate an employee's employment
 when the entity recognises costs for a restructuring under IAS 37 Provisions,
Contingent Liabilities and Contingent Assets which involves the payment of
termination benefits.
Example

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PROVISIONS, CONTINGENT LIABILITIES, AND CONTINGENT ASSETS


(IAS 37 and Ind AS 37)
The accounting standards discussed so far are based on revenue. The IAS (Ind AS) 37
is based on liabilities and provisions, contingent liabilities and contingent assets and that
sufficient information is disclosed in the notes to enable users to understand their nature,
timing and amount.
Objective
The objective of IAS 37 is to ensure that appropriate recognition criteria and measurement
bases are applied to provisions, contingent liabilities and contingent assets and that sufficient
information is disclosed in the notes to the financial statements to enable users to understand
their nature, timing and amount. The key principle established by the Standard is that a
provision should be recognised only when there is a liability i.e. a present obligation resulting
from past events. The Standard thus aims to ensure that only genuine obligations are dealt
with in the financial statements – planned future expenditure, even where authorised by the
board of directors or equivalent governing body, is excluded from recognition.
Scope
IAS 37 (Ind AS 37) shall be applied by all entities in accounting for provision,
contingent liabilities and contingent assets, except those resulting from:
1. financial instrument carried at fair value
2. Executory contract
3. insurance contract with policy holders
4. events or transactions covered by any other IAS
Definition of provision
A provision is a liability of uncertain timing or amount. Examples are:
a. income tax liability
b. product warranty
c. environment restoration
d. post employment employee benefit
e. dispute claim by customer
f. dispute claim by the revenue department
Difference between provisions and other liabilities
IAS (Ind AS ) 37 distinguishes provisions from other liabilities such as trade payables
and accruals. For a provision, there is uncertainty about the timing or amount of the future
expenditure. In the case of other liabilities the uncertainty is generally much less than for
provision.

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Relationship between provisions and contingent liabilities


All provisions are contingent because they are uncertain in timing or amount.
However, the term contingent liabilities are not recognized in the financial statements
because their existence will be confirmed only by the occurrence or non occurrence or one or
more uncertain future events. Thus, they are not liabilities. Provisions, on the other hand, are
recognized as liabilities. Thus, provisions are liabilities.
Recognition of a provision
An entity must recognise a provision if, and only if: [IAS 37.14]
 a present obligation (legal or constructive) has arisen as a result of a past event (the
obligating event),
 payment is probable ('more likely than not'), and
 the amount can be estimated reliably.
An obligating event is an event that creates a legal or constructive obligation and,
therefore, results in an entity having no realistic alternative but to settle the obligation. [IAS
37.10]
A constructive obligation arises if past practice creates a valid expectation on the part
of a third party, for example, a retail store that has a long-standing policy of allowing
customers to return merchandise within, say, a 30-day period. [IAS 37.10]
A possible obligation (a contingent liability) is disclosed but not accrued. However,
disclosure is not required if payment is remote.
Measurement of provisions
The amount recognised as a provision should be the best estimate of the expenditure required
to settle the present obligation at the balance sheet date, that is, the amount that an entity
would rationally pay to settle the obligation at the balance sheet date or to transfer it to a third
party. This means:
 Provisions for one-off events (restructuring, environmental clean-up, settlement of
a lawsuit) are measured at the most likely amount
 Provisions for large populations of events (warranties, customer refunds) are
measured at a probability-weighted expected value
 Both measurements are at discounted present value using a pre-tax discount rate
that reflects the current market assessments of the time value of money and the
risks specific to the liability
Important considerations in measuring provisions
1. Present value

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Where time value of money is important, the provision should be discounted. In other words,
the amount of provision should be the present value of the expenditures expected to be
required to settle the obligation. The discount rate should be the pre tax rate that reflects
current market assessment.
2. Reimbursement
Some or all of the expenditure required to settle an obligation is expected to be reimbursed
from a third party. If so, the reimbursement should be recognized only when it is virtually
certain that the reimbursement will be received if the entity settles the obligation.
3. Changes in provisions
Provisions should be reviewed at the end of the reporting period and adjusted to reflect the
current best estimate. If it no longer probable that an outflow of resources will e required to
settle the obligation, the provision shall be reversed.
4. Use of provisions
A provision should be used only for expenditure for which the provision was originally
recognized and not for another purpose.
5. Future operating losses
Provisions should not be recognized for future operating losses. This is because they do not
meet the definition of a liability and the general recognition criteria.
6. Onerous contact
Onerous contract is a contract in which the unavoidable costs of fulfilling the obligations
under the contract exceed the economic benefits from it.
7. Restructuring (provision for restructuring)
Restructuring is defined as a programme that is planned and controlled by management that
materially changes either the scope of business or the manner in which that business is
conducted.
Recognition of restructuring cost
A provision for restructuring costs is recognized only the general recognition criteria
for recognizing a provision are met. Besides, the following criteria should also be met:
a. An entity must have a detailed formal plan for the restructuring
b. It must have raised a valid expectation that it will carry out the restructuring, by
starting to implement that plan or announcing its main features.
A restructuring provision should include only the direct expenditures arising from the
restructuring that are both:
a. Necessitated by the restructuring, and
b. Not associated with the ongoing activities of the enterprise

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Following costs should not be included in the restructuring provisions:


a. Cost of retraining or relocating continuing staff
b. Cost of marketing
c. Cost of investment in new systems and distribution network
Examples of possible provisions
a. Warranties
b. Major repairs
c. Environmental contamination
Contingent liabilities
A contingent liability is a possible obligation that arises from past event and the
existence of which will be confirmed only by the occurrence or non occurrence of one or
more uncertain future event not wholly within the control of the enterprise.
Examples of contingent liabilities
a. Guarantees on behalf of associates and others
b. Claims against firm
c. Liabilities of case pending in the court
d. Income tax demand under appeal
e. Uncalled liability on partly paid up shares
Contingent liability:
 a possible obligation depending on whether some uncertain future event occurs, or
 a present obligation but payment is not probable or the amount cannot be measured
reliably
Recognition of contingent liability
An entity should not recognize contingent liabilities in the financial statements,
intead, an entity should disclose them by way of notes below the balance sheet. If the
possibility of an outflow of resources is remote, even the disclosure is not required.
Contingent asset:
 a possible asset that arises from past events, and
 whose existence will be confirmed only by the occurrence or non-occurrence of one
or more uncertain future events not wholly within the control of the entity.
Recognition of contingent asset
Contingent assets are not recognized in financial statements because this may result in
the recognition of income that may never be realized. However, when the realization of
income is virtually certain, then the related asset is recognized. A contingent asset is
disclosed, where an inflow of economic benefits is probable.

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Example

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IAS (Ind AS) 20, IAS (Ind AS) 17 & IFRS 2/Ind AS 102

Accounting for grants

A government grant is recognised only when there is reasonable assurance that (a) the
entity will comply with any conditions attached to the grant and (b) the grant will be
received. [IAS 20.7]

The grant is recognised as income over the period necessary to match them with the
related costs, for which they are intended to compensate, on a systematic basis. [IAS 20.12]

Non-monetary grants, such as land or other resources, are usually accounted for at fair
value, although recording both the asset and the grant at a nominal amount is also permitted.
[IAS 20.23]

Even if there are no conditions attached to the assistance specifically relating to the
operating activities of the entity (other than the requirement to operate in certain regions or
industry sectors), such grants should not be credited to equity. [SIC-10]

A grant receivable as compensation for costs already incurred or for immediate


financial support, with no future related costs, should be recognised as income in the period
in which it is receivable.

Objective of IAS 20

The objective of IAS 20 is to prescribe the accounting for, and disclosure of, government
grants and other forms of government assistance.

Scope

IAS 20 applies to all government grants and other forms of government assistance.
However, it does not cover government assistance that is provided in the form of benefits in
determining taxable income. It does not cover government grants covered by IAS 41
Agriculture, either The benefit of a government loan at a below-market rate of interest is
treated as a government grant.

Definitions

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1. Government assistance: government assistance is direct action to provide economic
benefits to a qualifying firm, or groups of firms.
2. Government grants: government grants are assistance by government in the form of
transfer of resources to an entity in return for past or future compliance with certain
conditions relating to the operating activities of the entity.

Classification of government grants

Government grants can be classified as:

1. Grants related to assets: these grants are given when tan entity purchases or constructs
long term assets. For example, govt may offer 25% grant for purchase of machinery
with a view to encourage investment in industrial machinery. Grants related to assets
are also called capital gain.
2. Grants related to income: grants related to income are government grantws other than
those related to assets. These are grants that boost income, or reduce costs, these are
also called revenue grants

Recognition of government grants

Government grants (including non monetary grants) should be recognized only when
there is reasonable assurance that:

a. The firm will comply with the condition attached to the grant, and
b. The grant will be received

Grant related to asset

a. Grants related to depreciable asset: grants related to depreciable assets are


recognized as income over the periods in which its depreciation is charged and in the
same proportion, it should treated as other income because it does not relate to any
specific item of cost
b. Grants related to non depreciable asset: in the case of grants for non depreciable
assets, certain obligations may need to fulfilled. In such cases the grant should be
recognized as income over the periods in which the cost of meeting the obligation is
incurred, for example, if piece of land is granted as condition that a building is erected
on it, then the grant should be recognized as income over the buildings life.

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Example

Grant related to income


These grants are credited to statement of profit or loss either separately or under a
general heading other income. Alternatively, it is debited against the related expense.
Non - monetary government grants
A government grant may take the form of a transfer of a non-monetary asset, such as
land or other resources, for the use of the entity. In these circumstances, it is usual to assess
the fair value of the non-monetary asset and to account for both grant and asset at that fair
value. An alternative course that is sometimes followed is to record both asset and grant at a
nominal amount.

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Presentation of grants related to assets


Government grants related to assets, including non-monetary grants at fair value, shall
be presented in the statement of financial position either by setting up the grant as deferred
income or by deducting the grant in arriving at the carrying amount of the asset.
Forgivable loans
Forgivable loans are loans which the lender undertakes to waive repayment under
certain prescribed condition, for example, cheap loans may be made available to firms that
operate in an undesirable region.
Presentation of grants related to income
Grants related to income are presented as part of profit or loss, either separately or

under a general heading such as ‘Other income’; alternatively, they are deducted in reporting
the related expense.
Repayment of government grants
A government grant that becomes repayable shall be accounted for as a change in accounting
estimate (see IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors).
Repayment of a grant related:
(a) to income shall be applied first against any unamortised deferred credit recognised in
respect of the grant. To the extent that the repayment exceeds any such deferred

credit, or when no deferred credit exists, the repayment shall be recognised


immediately in profit or loss.
(b) to an asset shall be recognised by increasing the carrying amount of the asset or
reducing the deferred income balance by the amount repayable. The cumulative
additional depreciation that would have been recognised in profit or loss to date in the
absence of the grant shall be recognised immediately in profit or loss.
Example

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ACCONTIN FOR LEASE (IAS 17 and Ind AS 17)


Leasing is a contract between the lessor and the lessee for the hire of an asset. The
lessor retains the legal ownership of the asset. He gives to the lessee the right to use the asset
for the agreed period of time in return for lease rental.
Objectives
The objective of this Standard is to prescribe, for lessees and lessors, the appropriate
accounting policies and disclosure to apply in relation to leases.
Scope
IAS 17 applies to all leases other than lease agreements for minerals, oil, natural gas, and
similar regenerative resources and licensing agreements for films, videos, plays, manuscripts,
patents, copyrights, and similar items.
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However, IAS 17 does not apply as the basis of measurement for the following leased assets:
 property held by lessees that is accounted for as investment property for which the
lessee uses the fair value model set out in IAS 40
 investment property provided by lessors under operating leases
 biological assets held by lessees under finance leases
 biological assets provided by lessors under operating leases
Definitions
Lease : a lease is an agreement whereby the lessor conveys to the lessee in return for
rent the right to use an asset for an agreed period of time.

.
Accounting treatment of finance lease in the books of lessee: At commencement date,
lessee should record financial lease as asset and liability in its balance sheet at fair value of

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the leased property or the present value of the minimum lease payments at that date,
whichever is less. Lessor and lessee should account for the transaction just like a credit sale.
In the lessee’s books, therefore, the leased asset is capitalized. The journal entry is
Asset a/c dr
To lessor (liability) a/c
The proportion of interest payable (expense) is debited in the statement of profit or loss of the
lessee. The journal entry is
Interest a/c dr
To cash
The proportion of capital cost should be debited to the lessor’s account. This reduces the
outstanding liability. The journal entry is .
Lessor’s a/c
To cash
Example

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Depreciation policy

The depreciation policy for assets held under finance lease should be consistent with

that for owned assets. The depreciation recognized shall be calculated in accordance with Ind

AS (IAS) 16 property, plant and equipment and Ind AS (IAS) 38 Intangible assets.

Disclosure requirements by lessee for finance lease

Lessee should disclose the following for the finance lease

1. the net carrying amount at the reporting date for each class of asset.

2. A reconciliation between the total minimum lease payments at the reporting date, and

their present value.

3. Contingent rents recognized as income in the period

4. Total of future minimum sublease payments, expected to be received under non

cancellable subleases at the reporting date.

5. A general description of the lessee’s material arising arrangements

Accounting treatment of finance lease in the books of Lessor: If a lessor leases out an

asset under finance lease, the asset cannot be seen in his premises. In other words, the asset

cannot be used in his business again. Hence, the lessor cannot record such an asset as a non

current asset. Interest receivable (portion of lease rental) should be credited in the statement

of profit or loss. The journal entry is

Cash a/c dr

To interest

The capital cost of lease rental should be credited in the lessee’s account. This reduces the

amount owing by the lessee. The journal entry is

Cash a/c dr

To lessee’s a/c
Example

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Disclosure requirements by lessor for finance lease


The following should be disclosed in the financial statements of lessor in respect of
finance lease:
1. A reconciliation between the total gross investment in the lease at the year end, and
the present value of minimum lease payments receivable at the year end. In addition,
an entity should disclose the total gross investment in the lease and the present value
of minimum lease payments receivable at the year end, for each of the following
periods:
 Not later than one year
 Later than one year and not later than five years.
 Later than five years
2. Unearned financial income
3. The unguaranteed residual values occurring to the benefit of the lessor
4. The accumulated allowance for uncollectible minimum lease payments receivable

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5. Contingent rents recognized in income.


6. A general description of the lessor’s material leasing arrangements
Accounting treatment of operating lease in the books of lessee
Under operating lease, the risks and rewards of ownership are not transferred to the
lessee. The lessor is responsible for the repairs and maintenance of the asset. An operating
lease is a short term rental agreement. Therefore, the accounting treatment is different. Asset
is not recognized in the balancesheet.
Operating lease is an arrangement in which the lessor gives an asset to the lessee on
rent.
The journal entries are as follows
Lease rental a/c dr
To lessor
(lease rental due)
Lessor a/c dr
Cash
(payment of lease rental)
Profit ad loss a/c dr
To lease rental
(lease rental charged to statement of profit or loss)
Disclosure requirements by lessee for operating lease
For operating leases, the disclosures are as follows
a. The total future minimum lease payments, under non cancellable operating leases for
each of the following periods:
 Not later than one year\
 Later than one year and not later than five year
 Later than five years
b. The total of any future minimum sublease payments expected to be received at the
end of the reporting period.
c. Lease and sublease payments recognized as an expense in the period
d. A general description of the lessee’s significant leasing arrangement.
Accounting treatment of operating lease in the books of lessor
The lessor presents in its balance sheet an asset as fixed asset. Lessor’s income from
operating leases shall be recognized as income on a straight line basis over the lease term
unless another basis is ore representative of asset.
Initial direct costs incurred by lessor, in negotiating and arranging an operating lease,
shall be added to the carrying amount of the leased asset, and recorded as an expense, spread
over the lease term on the same basis as the lease income.
The journal entries are as follows.
Lessee a/c dr
To lease rental (income)
(income due from lease)

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Cash a/c dr
To lease
(rental received from lessee)
Lease rental dr
To profit and loss
(income credited to statement of profit or loss)
Disclosure requirements by lessor for operating lease
Lessor should disclose the following for operating leases.
a. The furniture minimum lease payments under non cancellable operating leases in the
aggregate and for each of the following period.
 Not later than one year
 Later than one year and not later than five years,
 Later than five years
b. Total contingent rents recognized as income in the period.
c. A general description of the lessor’s leasing arrangements
Sale and leaseback transactions
In a sale and lease back transactions, an asset is sold by a vendor and then the same
asset is leased back to the same vendor.
The accounting treatment of a sale and leaseback transaction depends upon the type of
lease involved.
SHARE BASED PAYMENT
When a firm purchases goods or services from other parties it usually makes
payments in cash or through bank. Nowadays companies make payments by issuing their
shares.
Objectives
the objective of Ind AS 102 is to specify the financial reporting by an entity when it
undertake a share based payment transaction.
Scope
The concept of share-based payments is broader than employee share options. IFRS 2
encompasses the issuance of shares, or rights to shares, in return for services and goods.
Examples of items included in the scope of IFRS 2 are share appreciation rights, employee
share purchase plans, employee share ownership plans, share option plans and plans where
the issuance of shares (or rights to shares) may depend on market or non-market related
conditions.
IFRS 2 applies to all entities. There is no exemption for private or smaller entities.
Furthermore, subsidiaries using their parent's or fellow subsidiary's equity as consideration
for goods or services are within the scope of the Standard
Definition of share-based payment
A share-based payment is a transaction in which the entity receives goods or services
either as consideration for its equity instruments or by incurring liabilities for amounts based
on the price of the entity's shares or other equity instruments of the entity. The accounting

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requirements for the share-based payment depend on how the transaction will be settled, that
is, by the issuance of (a) equity, (b) cash, or (c) equity or cash.
Recognition and measurement
The issuance of shares or rights to shares requires an increase in a component of equity. IFRS
2 requires the offsetting debit entry to be expensed when the payment for goods or services
does not represent an asset. The expense should be recognised as the goods or services are
consumed. For example, the issuance of shares or rights to shares to purchase inventory
would be presented as an increase in inventory and would be expensed only once the
inventory is sold or impaired.
The issuance of fully vested shares, or rights to shares, is presumed to relate to past service,
requiring the full amount of the grant-date fair value to be expensed immediately. The
issuance of shares to employees with, say, a three-year vesting period is considered to relate
to services over the vesting period. Therefore, the fair value of the share-based payment,
determined at the grant date, should be expensed over the vesting period.
As a general principle, the total expense related to equity-settled share-based payments will
equal the multiple of the total instruments that vest and the grant-date fair value of those
instruments. In short, there is truing up to reflect what happens during the vesting period.
However, if the equity-settled share-based payment has a market related performance
condition, the expense would still be recognised if all other vesting conditions are met.
The various types of transactions may be discussed as follows
1. Equity settled share based payment transactions
For equity-settled share-based payment transactions, the entity shall measure the goods or
services received, and the corresponding increase in equity, directly, at the fair value of the
goods or services received, unless that fair value cannot be estimated reliably. If the entity
cannot estimate reliably the fair value of the goods or services received, the entity shall
measure their value, and the corresponding increase in equity, indirectly, by reference to
the fair value of the equity instruments granted.
2. Transactions in which services are received
If the equity instruments granted vest immediately, the counterparty is not required to
complete a specified period of service before becoming unconditionally entitled to those
equity instruments. In the absence of evidence to the contrary, the entity shall presume that
services rendered by the counterparty as consideration for the equity instruments have been
received. In this case, on grant date the entity shall recognise the services received in full,
with a corresponding increase in equity.
3. Cash settled share based payment transactions
For cash - settled share- based payment transactions, the entity shall measure the goods or
services acquired and the liability incurred at the fair value of the liability. Until the liability
is settled, the entity shall remeasure the fair value of the liability at the end of each reporting
period and at the date of settlement, with any changes in fair value recognised in profit or loss
for the period.

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ACCOUNTING FOR BONUS AND RIGHT ISSUE


A company sometimes issues additional shares to existing shareholders. Shares may be issued to
existing shareholders without any consideration. Such shares are called bonus shares. Similarly
shares may be issued for cash in proportion to the shares held by the existing shareholders. Such
shares are called right shares. This chapter deals with bonus issue as well as right issue.
Meaning of Bonus Shares or Bonus Issue
Bonus shares are those shares which are issued by a company free of cost to the existing
shareholders of a company out of its large reserves created out of past profits. These are shares issued
to existing equity shareholders without any consideration. Without paying cash, the existing
shareholders get additional shares. Bonus share is a bonus in kind. It is a gift on pro-data basis. In
short, bonus shares are free shares issued to the existing shareholders out of accumulated profits or
reserves.
When a company issues bonus shares out of profits or reserves, its reserves or proficts are
converted into capital. That is why bonus issue is called Capitalisation of Profits or
Capitalisation of Reserves.
Circumstances Issuing Bonus Shares
1. When the company wishes to capitalise its huge undistributed profits or reserves built.
2. When the company has not sufficient cash reserves, it issues bonus shares without ; adversely
affecting its working capital
3. When value of fixed assets of a company exceeded its capital, the difference is capitalised by
issuing bonus shares.
Circumstances under which Bonus Shares cannot be issued
1. If subscribed and paid up capital exceeds authorised capital.
2. Bonus shares can be issued only as additional or extra dividends and not as regular dividends. .
Advantages of Issuing Bonus Shares
A. To the shareholders
1. Shareholders get additional shares without paying cash for it. Partly paid shares get converted
into fully paid without giving cash.
2. No tax is to be paid on the bonus shares received by a shareholder,
3. It increases liquidity of shares.
B. To the company
1. As the bonus issue does not involve any cash payment, liquidity or working capital of the
company is not affected.
2. Workers do not create problems of demanding higher wage or bonus as there are no more
accumulated profits due to bonus issue.
Disadvantages of Issuing Bonus Shares
A. To the shareholders
1. By receiving bonus shares the shareholders do not gain actually. Because, when a company
issues bonus shares, its total profits (which do not usually increase) will have to be distributed
over a large number of shares. Hence dividend per share is reduced.

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2. If the rate of dividend cannot be maintained, the market value of shares will fall
B. To the company_
1. Market value of shares may fall if the rate of dividend is not maintained. As a result, the
company's reputation may suffer.
2. It encourages undesirable speculation.
Conditions for Issue of Bonus Shares
According to Companies Act, a company can issue bonus shares only if the
following conditions are fulfilled:
1. Issue of bonus shares should be authorized by the Articles.
2. The proposal of the Board of Directors regarding issue of bonus shares should be approved by
the members in the general meeting.
3. The company should have sufficient profits and reserves to permit the issue of bonus shares.
4. The bonus issue should satisfy the guidelines issued by SEBI.
Funds or Sources for Bonus Issue
As per Section 63 (1) of the Companies Act 2013, a company may issue fully paid up bonus
shares to its members, in any manner whatsoever, out of the following reserves:
A. Revenue Reserves/ Profits _____
1. Credit. balance in the profit and loss account.
2. General reserves.
3. Credit balance in the sinking fund account for the redemption of a liability (e.g. debentures)
after the redemption of the liability.
4. Dividend equalisation reserve.
B. Capital Reserves / Profits
1. Profit prior to incorporation.
2. Profit on sale of fixed assets or business.
3. Capital Redemption Reserve A/c created for redemption of preference share.
4. Security premium collected in cash only.
Types of Bonus Issue
1. Fully paid bonus shares : When bonus shares are distributed free of cost in proportion of holding,
it is called fully paid bonus shares.
2. Partly paid bonus shares : When bonus is applied for converting partly paid. The following are
the journal entries in respect of issue of bonus shares. A. When fully paid bonus shares are
issued. 1. When issued at par
Capital Reserve A/c Dr.
Security Premium A/c Dr.
Capital Redemption Reserve A/c Dr.
Debenture redemption reserve A/c Dr.
General Reserve A/c Dr.
' Profit and Loss Dr.
To Bonus to Shareholders A/c (On the declaration of bonus out of reserve and /or profit)

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(b) Bonus to Shareholders A/c Dr.


To Share Capital A/c
(On issue of bonus shares) 2. When issued at premium :
(a) Security Premium A/c Dr.
Capital Redemption Reserve A/c Dr.
Sinking Fund A/c ' Dr.
General Reserve A/c Dr.
Profitand Loss Dr.
To Bonus to Shareholders A/c
(On the declaration of bonus out of reserves / or profit)
(b) Bonus to Shareholders A/c Dr.
To Share Capital A/c
To Security Premium A/c
(Issue of bonus shares at premium)
B. When Bonus is given to convert partly paid shares into fully paid shares:
(a) Capital Reserve A/c Dr.
Debenture Redemption Reserve A/c
General Reserve A/c Dr.
Prof it.& Loss Dr.
To Bonus to Shareholders A/c
(On the declaration of bonus out of reserve and/or profit)
(b) Share Final Call A/c Dr.
To Share Capital A/c (
On making due the final call)
(c) Bonus to Shareholders A/c Dr.
To Share Final Call A/c
(On utilisation of bonus)

Security Premium A/c and Capital Redemption Reserve Account cannot be utilised to convert .the
partly paid shareg. into fully paid shares. When partly paid shareware converted into fully paid ones
by applying bonus, the shareholders get converted their partly paid shares into fully paid without
paying the final call money Similarly when fully paid bonus they get without aying cash. The impact
of issue of fully paid bonus shares or conversion of partly paid shares into fully paid shares on the
Balance Sheet is that the reserves and profit which are utilised for giving_ bonus, are reduced and the
share capital (and sometimes security premium also) is increased. Thus, reserves are capitalised.
Journal Entry for Cash Bonus
In case of cash bonus the required journal entries are :
1) Profit & Loss . Dr.
To Bonus Payable A/c
2) Bonus Payable A/c Dr.

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To Bank A/c
Example -1 (Bonus Shares at Par)
X Ltd. with a paid up capital of ? 5,00,000 divided into shares of f 10 each fully paid had resolved
to capitalise ? 80,000 of the accumulated reserves of f 1,25,000 by issuing bonus shares of f 10 each
fully paid. Pass necessary journal entries.
Solution:
Journal

Reserves A/c Dr. Rs. 80,000

To Bonus to Shareholders A/c Rs. 80,000


(Declaration of bonus out of reserve)

Bonus to Shareholders A/c Dr. Rs.80,000

To Share Capital A/c Rs.80,000


(Issue of fully paid bonus shares)

Example – 2 (Bonus Shares at Premium)


AB Ltd has a share capital of Rs. 20,00,000 in Equity shares of ? 10 as fully paid. The company
now declares a bonus out of its free reserves of Rs. 8,00,000. This bonus is to be paid by issue of the
equity share of Rs.10 each at a premium of Rs.2 per share for every four shares held by the
shareholders. The shares are quoted at Rs.15 on the date of allotment of bonus shares. Give journal
entries to record the above transactions.
Solution
Journal
Reserves A/c Dr. Rs. Rs.
To Bonus to Shareholders A/c 6,00,000
(Declaration of bonus out of reserves) 6,00,000
Bonus to shareholders A/c Dr. 6,00,000
' To Equity Share Capital A/c 5,00,000
To Security Premium A/c 1,00,000
(Issue of 5000 fully paid bonus shares of ? 10 each at a
premium of ? 2 per share)
Working note:
1. Amount needed for issue of bonus share at a premium of Rs. 2 per share is: . For every 4
shares held 1 bonus share issued.
For 2,00,000 shares held, 50000 shares issued.
Amount needed is 50,000 x (10 + 2) = Rs. 6,00,000
This amount is to be appropriated out of free reserves of Rs.8,00,000

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2. Price quoted in the market is not considered while writing the entries because the company
has issued the shares at face value plus premium.
Example- 3 (Conversion of Partly paid Shares)
XY Ltd. has a fully paid equity capital of ? 5,00,000 divided into shares of ? 10 each and
1,00,000 partly paid shares of ? 10 each, ? 7 paid up. It has an accumulated profit to the credit of its
profit and loss account of ? 2,00,000, free reserve of ? 1,50,000 and security premium of ? 50,000.
It has decided to convert the partly paid equity shares into fully paid by applying bonus out of
accumulated profit and free reserves. The bonus was declared at? 6 per share on the fully paid up
capital. Pass necessary journal entries.
Solution

Journal
Profit and Loss Dr. 2,00,000
Reserve A/c Dr. 1,00,000
To Bonus to Shareholders A/c 3,00,000
(Declaration of bonus out of P&L and free reserves)
Share Final Call A/c Dr. 3,00,000
To Equity Share Capital A/c 3,00,000
(Final call made on 1,00,000 shares @?3 per share)
Bonus to Shareholders A/c Dr. 3,00,000
To Share Final Call A/c 3,00,000
(Utilisation of bonus)
Working Note:
1. Amount of bonus = 50,000 fully paid shares x 6 per share = Rs. 3,00,000
2. Amount required to convert 1,00,000 partly paid shares, ? 7 paid up shares = 1,00,000 x 3 =
Rs. 3,00,000
3. The required amount is utilised out of accumulated profit of Rs. 2,00,000 and Rs. 1,00,000
out of free reserves. Security premium cannot be utilised for the purpose.
Example- 4 (Balance Sheet before Bonus Issue)
Following is the B/S of A Ltd as on 31. 3.18:
Liabilities Assets
Share Capital Sundry Assets 10,00,000
5,000 shares of Rs.100
each, Rs. 60 paid 3,00,000
Security Premium 40,000
Reserve 2,70,000
Profit and Loss 1,25,000
Sundry Creditors 2,65,000
-------------- -------------
10,00,000 10,00,000
======= =======

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The company resolves to distribute f 1,50,000 as bonus to be utilised in paying up a call of ?


30 per share. Minimum reduction is to be made from free reserves.
Working Note:
1. Since the shares are partly paid, bonus issue cannot be made unless they are made fully paid
by making a final call of Rs.40 per share.
2. Out of the call of Rs.40 bonus issue is only to the extent of Rs. 30. The balance of the amount
Rs.50,000 (i.e., 10 x 5,000) is assumed to be received in cash.
3. Since minimum reduction is to be made from the free reserves, it is assumed that entire balance
of profit and loss is utilised.
4. Security premium cannot be utilised for the purpose.
Stock Split
A share is generally split when it has a high price. Such a share is called a heavy share. This high
price may discourage small investors. Generally, retail investors prefer to buy larger number of low
priced shares. It is in this situation its shares.
Stock splitisjhe process of rgducingjhe face value of the share (or stock) of a company by
dividing one share into two or more parts. For example, if a stock has a face value Rs. 10, a two for-
one stock split will mean that there will be twice the number if shares as before with a face value of
Rs. 5 each for the new share.
RIGHT SHARES OR RIGHT ISSUES
' According to Section 62(1) of the Companies Act, 2013 when the company wants to increase the
subscribed capital by issue of further shares, such shares must be issued first of all to existing
shareholders in proportion of their existing shareholding. These shares are called Right Shares,
Meaning of Right Shares or Right Issues
In case a company wants to make a further issue of shares, the issue must first be offered to
the existing equity shareholders. Thus, an issue of shares in which existing shareholders have a pre-
emptive right to subscribe for the new shares is called 'Right Issue'.
Advantages of Right Issue
Advantages to companies
a) Issue costs are lower,
b) Issue is made at the direction of the directors,
c) It improves the image of the company,
d) Raising capital is more certain than in the case of public issue.
e) Difference between Right Issue and Public Issue
Right Issue Public Issue

1. A right issue is made to existing share 1. A public Issue is made to the public at
holders large.

2. The floatation cost is low. 2. The floatation cost Is high.

3. The price is much less than the 3. The price is generally lower than the
existing market price. expected market price.

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PRACTICAL PROBLEMS
Illustration 1
Following are the extracts from the draft B/S of Ram Ltd. as on 31-3-2018: Authorised capital:
Rs.
2,00,000 Equity shares of Rs. 10 each 20,00,000
Issued and subscribed capital:
50,000 Equity shares of Rs. 10 each ' 5,00,000
Reserve fund 1,00,000
P/L Account 80,000

A resolution was passed declaring the issue of bonus shares of 20% on equity shares, to be
provided as to f 60,000 out of P/L Account and 40,000 out of Reserve Fund. The bonus
shares were to be satisfied by issuing fully paid equity shares. Write the journal entries and
show how they would affect the Balance Sheet.
Solution
Journal
2018 Reserve Fund A/c Dr. Rs. Rs.
March Profit or Loss Dr. 40,000 1,00,000
31 To Bonus to Shareholders A/c (Declaration of bonus @ 60,000
20% on equity shares)
Bonus to Shareholders A/c Dr. 1,00,000 1,00,000
To Equity Share Capital A/c (Issue of 1,000 bonus shares)
Balance Sheet (extracts)
Particulars Note No. Rs.
Equity & Liabilities Equity
Share Capital:
60,000 shares of ? 10 each fully paid
Reserve fund (1,00,000 - 40,000) 1 6,00,000
Profit and Loss A/c (80,000 - 60,000) 60,000
20,000

Notes to Accounts
Note No. Particulars Amount Rs.
1 Share Capital
Authorised Capital 20,00,000
2.00,000 Equity shares of Rs.10 each
Issued and Subscribed capital
60,000 Equity Shares of Rs.10 each fully paid 6,00,000
(Of the above shares, 10,000 shares are allotted as
fully paid up by way of bonus shares out of Reserve
Fund and P/L a/c)

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QUESTIONS FOR PRACTICE


A. Objective Type Questions
Fill in the blanks
1. .................. shares are those shares which are issued free of cost to the existing shareholders.
2. .......... .............. shares are always fully paid
3. Generally a company issues ........... shares when the market price of shares is higher than
issue price.
Illustration 5
X Ltd, decided to make a right issue to existing shareholders in proportion of 3 shares for
every 4 held. Issue price per share is Rs. 150 and Market Price at the time of right issue is Rs.200.
Calculate the Value of Right.

Solution
Value of Right is calculated as below:
No. of New or Right Shares x (Market price - Issue price)
Total No. of all Shares (i.e., Fresh + Existing Shares)
Value of right = 3 x (200 - 150) = Rs. 21.43
4+3
or
Value of right = Market Price - Average Price
Market price of existing shares + Issue price of
proportionate right issue
Average price of share =
Total No. of Shares
4 x 200 + 3 x 150 800 + 450 1250 = f 178.57

4+3 7 7

Value of right - 200 -178.57 = 21.43

llustration 6
A Ltd. has offered right issue to its existing shareholders. The existing share capital of the
company is Rs. 25,00,000. The market price of its share is Rs. 21. The company offers to its
shareholders the right to buy 2 shares at Rs.5.50 each for every 5 shares held. You are required to
calculate:
i) Theoretical market price after rights issue
ii) The value of right
iii) Percentage increase in share capital
Solution
Average price or theoretical market price after right issue is calculated as below:

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B. Short Answer Type
1. What is cash bonus ?

2. What is capital bonus?

3. -'Define bonus share

What are free reserves ?

5. What is stock split ?

6. What are right shares ?

7. What is value of right ?

C. Short Essay Type

1. What are the different sources of bonus issues ?

2. Define bonus shares. Distinguish between bonus shares and right shares.

3. What are the advantages of issuing bonus shares?

4. What are the restrictions regarding the bonus issue in India?

5. How will you calculate value of right ?

6. What are the advantages of right issue ?

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REDEMPTION OF PREFERENCE SHARES


A company limited by shares may (if so authorised by its Articles) issue preference shares which
are liable to be redeemed within a period not exceeding 20 years from the date of their issue.
Redeemable preference shares are those shares which are repayable after a fixed period or earlier at
the discretion of the company. Section 55(i) of the Companies Act, 2013 prohibits the issue of
any preference share that is irredeemable.
Redemption of Preference Shares
Redemption means repayment of capital. Thus, redemption of preference share means repayment
of preference share capital to the preference shareholders.
Condition of Redemption of Preference Shares
According to Section 55 of the Companies Act, 2013, a company limited by shares, If authorised
by its Articles, can redeem the preference shares, subject to the following conditions:
1. The shares to be redeemed must be fully paid up.
2. The shares should redeemed either out of profits of the company available for distribution as
dividend or out of the proceeds of fresh issue of shares made for the purpose of redempE6n.
3. Any premium payable on redemption must be provided out of the profits of the company or out
of the company’s security premium account (from fresh issue r existing balance). Generally, It is
provided out of security premium, if there is existing security premium or premium on fresh
issue.
4. Where any such shares are redeemed out of profits available for dividend, an amount equal to the
nominal value of shares to be redeemed must be transferred out of the divisible profits to Capital
Redemption Reserve Account
5. The capital redemption reserve account can be utilised only for the issue of fully paid up bonus
shares. This means that partly paid up shares cannot be made fully paid up out of Capital
Redemption Reserve A/c.
Methods of Redemption
There are three methods of redemption of preference shares. They are:
(a) Redemption out of fresh issue of shares.
(b) Redemption out of Profits.
(c) Redemption partly out of fresh issue and partly out of profit.
Accounting procedure
For solving problems, the following procedure is to be followed:
1. First see whether the redeemable preference shares are fully paid up or partly paid up.
If they are partly paid up, pass the following journal entries to make them fully paid.
(a) Preference Share Final Call A/c Dr
To Preference Share Capital A/c
(b) Bank A/c Dr.

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To Preference Share Final Call A/c


2. Make journal entry for fresh issue of shares when company issues new shares:
(a) At Par
Bank A/c Dr.
To Share Capital A/c
(b) At Premium
Bank A/c Dr.
To Share Capital A/c To Security Premium A/c
(c) At Discount
Bank A/c Dr.
Discount on Issue of Share A/c Dr.
To Share Capital A/c
3. Write journal entry for redemption of preference shares
(a) When Redemption is at Par
Redeemable Preference Share Capital A/c Dr.
To Preference Shareholders A/c
(For transferring the capital to preference shareholders)
Preference Shareholders A/c Dr
To Bank A/c
(For paying the amount due to preference shareholders)
(b) When Redemption is at Premium
Security Premium A/c / Profit and Loss A/c Dr.
To Premium on Redemption of Preference Shares A/c /
(For providing premium on redemption out of security premium or profit and loss)
Redeemable Preference Share Capital A/c Dr.
Premium on Redemption of Preference Share A/c Dr.
To Preference Shareholders A/c
(For transferring the capital and premium to preference shareholders)
Preference Shareholders A/c Dr.
To Bank A/c
(For paying the amount due to preference shareholders) Note: If the preference shares are
redeemed at a premium, such premium on redemption is provided out of Security Premium Account
(existing or fresh issue) or Profit and Loss or General Reserve.
Example - 1 (Fresh Issue of Shares at Par and Redemption, at Par)
A Ltd had 10,000, 8% redeemable preference shares of Rs. 100 each, fully paid up. The company
decided to redeem these preference shares at par by issue of sufficient number of equity shares of Rs.
10 each fully paid at par. Write journal entries in the books of the company.

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Solution
Working Note:
Face value of share to be redeemed (10,000 x 100) = 10,00,000 Proceeds
per new share = Rs. 10
No.of shares to be issued = 10,00,000 = 1,00,000 shares
10
Example -2 (Fresh Issue of Shares at Premium and Redemption at Par)
B Ltd had 3,000, 9% preference shares of f 200 each fully paid up. The company
decided to redeem these preference shares at par, by issue of sufficient number of ordinary shares of f
25 each at a premium of ? 2 per share as fully paid. Write journal entries in the books of the company.

Working Note:
Value of shares to be redeemed (3,000 x 200) = 6,00,000
Proceeds per new share = Rs. 25
.-. No.of shares to be issued = 6,00,000 = 24,000 shares
25
Example - 3 (Fresh Issue of Shares at Discount and Redemption at Par)

C Ltd had 9,000,8% Redeemable Preference Shares of 20 each, fully paid up. The company decided
to redeem these shares by issue of sufficient No. of equity shares of Rs.10 each fully paid at 10%
discount. Pass necessary journal entries in company’s book.

Working Note:
Value of shares to be redeemed (9,000 x 20) = Rs. 1,80,000
When shares are issued at discount, the proceeds must be sufficient to cover the face value of
preference shares to be redeemed, i.e., Rs. 1,80,000.

Proceeds per new share = 10 -10% = Rs. 9


No.of Shares = " 1,80,000 = 20,000 shares
9
or
1,80,000 x 100 = 2,00,000 = 20,000 shares
9 90 10

Redemption of Partly Paid up Shares


If the preference shares are partly paid, they will have to be made fully paid before
redemption. The journal entries have already been given.

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In case there are two categories of redeemable preference shares (one fully paid \and another
partly paid) and there is no instruction regarding redemption, only fully /paid preference shares may
be redeemed.
Sometimes there are calls in arrears in case of redeemable preference shares. In. such a case, it
is necessary to follow the instructions given in the question. If nothing is mentioned in the question,
there are two options. They are: (a) Preference shares having calls in arrears should not be redeemed,
(b) It is presumed that calls in arrears are collected and all the preference shares are redeemed.
Note: Students are advised to give the assumption on which the problem is solved, by way of a note.
Example - 5 (Partly Paid up Shares)
E Ltd had 8,000,8% redeemable preference shares of X 25 each, f 20 called up. The company decided
to redeem the preference shares at 5% premium by the issue of sufficient number of equity shares of f
10 each fully paid up at a premium of 10%. Pass journal entries relating to redemption

In the Books of E Ltd.


Journal

Preference Shares Final Call A/c Dr. 40,000


To 8% Redeemable Preference Share Capital A/c 40,000
(Preference share final call due on 8,000 shares at ? 5 each to
make the shares
fully paid up)
Bank A/c Dr. 40,000
To Preference Share Final Call A/c 40,000
(Final call money received on 8,000 shares)
Bank A/c (20,000 x 11) Dr. 2,20,000
To Equity Share Capital A/c 2,00,000
" Security Premium A/c 20,000
(Issue of 20,000 shares of ? 10 each at 10%
premium for the purpose of redemption)
Security Premium A/c Dr. 10,000
To Premium on Redemption A/c 10,000
(Provided premium on redemp. at 5% out of security premium
A/c)
8% Redeemable Preference Share Capital A/c Dr 2,00,000
Premium on Redemption A/c Dr. 10,000
To Preference Shareholders A/c 2,10,000
(Amount including redemption premium due to preference
shareholders)
Preference Shareholders A/c Dr 2,10,000
To Bank 2,10,000
(Payment to preference shareholders)

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Working Note:
1. Nominal value of shares to be redeemed (8,000 x 25): 2,00,000 Premium on
redemption 5% 10,000
Total amount required for redemption 2,10,000
2. No.of Shares to be issued 2,00,000 = 20, 000 shares
10
3. Security Premium = 10% of 2,00,000 or (20,000 x 1) = 20,000
4. Only face value of shares issued can be used for the redemption but not premium. The
premium can be used for providing redemption premium.
Redemption out of Profits
Redeemable preference shares can be redeemed out of the divisible profits.
Divisible profits for dividend. The examples of divisible or undistributed profits include
general reserve, reserve fund, dividend equalisation reserve, investment fluctuation reserve,
insurance fund, workmen's compensation fund, workmen's accident fund, debenture
redemption reserve, reserve for contingencies, any other revenue reserve, profit and loss
account balance etc.
In the case of shares so redeemed should be transferred from divisible profits to Capital
Redemption Reseive Account.
Reasons for Creating CRR
CRR is created for the following reasons :
1) Capital maintenance: The important purpose of creating CRR is to maintain the capital
intact. By creating CRR, it is possible to protect capital structure and components of
capital as it is. If much variation is taking place in components and volume of capital,
business activities would be reduced. This causes dissatisfaction among shareholders.
2) Safeguard of creditors: The other reason for creating CRR is to protect the interest of
creditors. If CRR is not created, the directors may distribute the entire amount of
profits by way of dividend. This will adversely affect the interest of creditors.
Note: For calculating CRR, the premium on redemption and security premium are totally
ignored.
Accounting Treatment
The following journal entries are required to be passed the books of the company.
1. When Shares are Redeemed at Par
(a) On transfer to Capital Redemption Reserve Alc
Profit and Loss A/c / General Reserve A/c Dr.
To Capital Redemption Reserve A/c
(b)(On the redemption of shares
Preference Share Capital A/c Dr.
To Preference Shareholders A/c
(c) On Payment to Preference Shareholders
Pref erence Shareholders A/c Dr.
To Bank A/c
Note: First see whether the preference shares are fully paid up or partly paid up. If the shares are
partly paid up they must be made fully paid up. The journal entries have already been given.

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3. When Shares are Redeemed at Premium


a) Same entry as under 1 (a) above for transfer to Capital Redemption Reserve A/c from
divisible profits.
(b)On providing Premium Payable on Redemption
Security Premium A/c / Profit & Loss A/c / Capital Reserve A/c Dr.
To Premium on Redemption A/c
(c) On making money due to preference shareholders
Preference Share Capital A/c Dr.
Premium on Redemption A/c Dr.
To Preference Shareholders A/c
(d) On payment to Shareholders
Same entry as under 1(c) above
Example - 6 (Redemption out of Profits)
The following extract from the B/S of Sun Ltd as at 31-12-18, is given to you:
Share Capital R S.
10,000 Equity Shares of RS. 10 each 1,00,000
10,000 8% Preference Shares of F 10 each 1,00,000
Capital Reserve . 50,000
General Reserve 30,000
Profit & Loss 85,000
The company exercises its option to redeem the preference shares on 1st January 2019. Give journal
entries to record the redemption.
Redemption out of Fresh Issue of Shares and Profits
This is the most practical method of redemption. Under this method the company can redeem
the preference shares partly from the fresh issue of shares and partly out of revenue profits
(undistributed profits).
Steps ' "
1. Determine the amount payable on redemption of preference shares.
2. Decide the amount of fresh issue of shares to be made (i.e., the portion of redemption out of
fresh issue).
3. Ascertain the amount to be transferred to Capital Redemption Reserve A/c out of revenue
profits (i.e., the portion of redemption out of profit). It can be ascertained in the following
manner:
Rs.
Face value of shares redeemed xxxx
Less: Proceeds from fresh issue of share xxx
.'. Redemption out of profits (i.e., the amount to
be transferred to C.R.R. A/c xxx
4. If proceeds to be collected from fresh issue is not decided, it can be ascertained as follows:
Face value of shares redeemed xxxx
Less: Redemption out of profits (known) xxx
.'. Proceeds to be collected from fresh issue xxx

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Note: If nothing is mentioned specially in the question regarding the fund (proceeds) v/ out of which
redeemable preference shares have to be redeemed, students should always assume that the
redemption has to be made out of profits.
Example - 8 (Combination of fresh issue and profit)
X Ltd has a part of its share capital in 1000 Redeemable Preference Shares of Rs. 100 each. The
shares have now become due for redemption. It has been discovered that the company's Reserve Fund
amounts to Rs. 75,000, Rs. 50,000 out of which has been decided to be utilised in connection with the
redemption, the balance being met out of a fresh issue of sufficient number of equity shares of Rs. 20
each fully paid. You are requested to give the journal entries recording the above transactions.

Working Note:
1. Value of preference shares to be redeemed (1,000 x 100) 1,00,000
Redemption out of profit 50,000 .
Redemption out of fresh issue (balance) . 50,000
2. Value per share X 20 each
No.of shares to be issued = 50,000 = 2,500 shares
--------
20

PRACTICAL PROBLEMS
Ltd company has part of its share capital in 1,000 8% Redeemable Preference shares of ? 100 each.
The shares have now become ready for redemption. It is decided that the whole amount will be
redeemed out of fresh issue of equal amount of equity of shares of f 10 each. Show the necessary
journal entries in the company's books.
Illustration- 2
A. Ltd. has a part of its share capital in 1,000 7% redeemable preference shares of ? 100 each.
These are now redeemable out of the accumulated reserve of ? 1,50,000.

Dr.
7% Redeemable Preference Share Capital A/c 1,00,000 1,00,000

To Preference Shareholders A/c (Amount due to


preference
shareholder)
Preference Shareholders
Dr. A/c 1,00,000
1,00,000
(Payment made
Illustration - to preference shareholders)
. 3 the entries in the journal of the company
Show
A Ltd. issued 50,000 Equity shares of X10 each and 3,00010% Preference shares of
?100 each, all shares being fully called up and paid up. On 31- 03-18 Profit & Loss A/c
showed an undistributed profit of X 50,000 and General Reserve Account stood at X 1,20,000.
On 1- 04 -18 the Directors decided to issue 1,500 11% Preference Shares of X100 each for cash

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and to redeem the existing Preference Shares at X 105 utilising as much profits as would be
required for the purpose.
Show the Journal entries to record these transactions. Prepare also a summarised
Balance Sheet showing the position of the company on completion of the redemption. On 31-
03-18 cash balance amounted to X 1,85,000 and Sundry Creditors stood at X 87,000.

QUESTIONS FOR PRACTICE


A. Objective Type Questions
Fill in the blanks
1. Preference shares cannot be redeemed unless they are
2. Capital redemption reserve can be used to issue fully paid shares
3. At present, a company limited by shares cannot issue preference shares which are
..................................
4.. No company limited by shares shall issue any preference share which is redeemable
after the expiry of years from the date of issue
5. Any premium payable on the redemption of preference shares must be from the....
.....................................................account or from the divisible profits of the company.
6. The face value of preference shares redeemed from revenue reserve is transferred to
..................
7. Divisible profit means that which would otherwise be available for .......................
8. When a fresh issue of shares brought out for the purpose of redemption of preference
shares, it does not amount to ...................
9. All the profits are not available for the purpose of redemption of preference shares._
^
Ans: 1-fully paid up, 2-bonus, 3-irredeemable, 4-twenty, 5-security premium, 6-capital
redemption reserve, 7-dividend, 8-increase, 9-capital
Choose the correct answer
1. Capital redemption reserve is created (a) out of security premium account, (b) out of
share forfeited account, (c) to meet legal requirements,
(d) voluntarily.
2. Capital redemption reserve account can be utilised for (a) writing off capital losses,
(b) writing off past losses, (c) issuing partly paid bonus shares,
(d) issuing fully paid bonus shares.
3. When preference shares are redeemed, it amounts to (a) increase in share capital, (b)
decrease in share capital (c) both (a) and (b), (d) none of these.
4. Amount due to untraceable share holder may be (a) transferred to P/L account, (b)
kept as general reserve, (c) transferred to CRR, (d) shown as current liability in the
balance sheet.
5. Profit not available for dividend includes (a) CRR, (b) P/L A/c. credit balance, (c)
Security premium, (d) share forfeited account
6. Redeemable preference shares can be redeemed by (a) selling investment (b)
borrowing funds from bank (c) issue of debentures (d) issue of shares.

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7. Profit available for dividend excludes (a) P/L A/c, (b) general reserve, (c) share
forfeited account (d) dividend equalisation reserve.
Ans: 1 - c, 2 - c, 3 - d, 4 - d, 5 - b, 6 - d, 7 - c
Short Answer Type
1. Define redeemable preference shares
2. What is divisible profit?
3. What js capital redemption reserve account ?
C. C. Short Answer Type
1. What are the conditions to be fulfilled under the Companies Act for the redemption ...
of preference shares ?
2. What is divisible profit? What is not considered as divisible profit ?
3. What is capital redemption reserve account? How is it created and how is it utilised ?
4. What is capital redemption reserve account ? What is the logic of creation of capital
redemption reserve ?
5. Discuss the various methods of redemption of preference share.
6. Explain the accounting procedure on redemption of preference share.
Problems
1. Hindustan Construction Company Ltd, had 5,000 8% Redeemable Preference Shares of f
100 each, fully paid up.
The company decided to redeem these preference shares at par by the issue of sufficient
number of equity shares of ? 10 each fully paid up at par.
You are required to pass necessary journal entries including cash transactions in the
books of the company.
2. The issued and paid-up capital of XY Ltd. included 2,000,8% Preference shares of Rs.100
each. The company decided to redeem the Preference shares at par. You are required to give
journal entries separately in the following cases:
(a) When the shares are redeemed out of profits.
(b) When the shares are redeemed out of proceeds of new issue of Equity Shares
of ? 10 each at par,
3. A B C Ltd. has issued 10,000 equity shares of Rs.100 each fully paid and 6,000 redeemable
preference shares of Rs.100 each fully paid. On 31st Dec. 2018 the Profit and Loss Statement
showed undistributed profit of Rs.50,000 and the General Reserve A/c stood at Rs.2,80,00.
On 1.1.2019, the directors decided to issue 3000, 6% preference shares of Rs.100 each at
20% premium- and to redeem the existing redeemable preference shares at Rs.110 utilising as
less profit as possible for the purpose. Pass necessary journal entries to record the above
transaction. There was a bank balance of Rs. 4,00,000 on that date.
(Amount transferred to C.R.R A/c ? 3,00,000)
4. A Ltd. had issued 50,000 redeemable preference shares of Rs.10 each, Rs.8 paid. In
order to redeem these shares now being redeemable, the company issued for cash 30,000
equity shares of Rs. 10 each at a premium of Rs.2 per share. Out of the cash proceeds, the
redeemable preference shares were paid and the balance was met out of the reserve fund
which stood at Rs. 2,50,000. Show the journal entries in the books of the company.

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REDEMPTION OF DEBENTURES
Companies are allowed to issue only redeemable debentures. Redeemable debentures are
redeemed either at the expiry of the period of debentures or before the expiry.
Meaning of Redemption of Debentures
Redemption of debentures simply means repayment of debentures. It is the discharging of the
liability on account of debentures. They may be redeemed at par or at premium.
Methods of Redeeming Debentures
Following are some of the important methods of redeeming debentures:
1. Drawing lots (Lottery) and redeeming by instalment (Redemption by annual
drawings).
2. Redemption by payment in lumpsum after a specified date.
3. By converting debentures into new shares / debentures.
4. By purchase of own debentures in the open market.
Sources of Redemption of Debentures
The various sources out of which the debentures may be redeemed are:
1. Redemption out of fresh issue
2. Redemption out of capital
3. Redemption out of profit
4. Redemption by sinking fund or insurance policy fund
Redemption by Periodical Drawings
Under this method a certain portion of the debentures are redeemed periodically. This means
that the debentures are redeemed in instalments. This method is also called "Lottery Method"
of redeeming debentures (i.e., drawing by lots).
The following journal entries are passed when debentures are redeemed and interest is paid.
(a) Debentures A/c Dr.
To Debenture holders A/c
(Amount due to debenture holders)
Debenture holders A/c Dr.
To Bank A/c (Payment to debentureholders)
(b) Interest on Debentures A/c Dr.
To Bank A/c
(Payment of interest on debentures)
These entries will continue as long as debentures are repaid and the interest is paid regularly
on the balance of debentures.
Redemption in Lumpsum after a Specified Date
Sometimes debentures will not be redeemed in instalments. Instead, they will be redeemed in
one lumpsum after a certain period. They may be redeemed at; par or at premium according
to the terms of issue.
The following journal entries are passed when debentures are redeemed and interest is paid:
(a) When debentures are redeemed at par
Debentures A/c Dr.
To Debenture holders A/c
(Amount due to debentureholders)
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Debentureholders A/c Dr.To Bank A/c (Payment to


debentureholders)
(b) When debentures are redeemed at premium
Debentures A/c Dr
Premium on Redemption A/c Dr.
To Debentureholders A/c
(Amount due to debentureholders, including premium)
Security Premium/ General Reserve/ P/L Dr.
To Premium on Redemption A/c (Premium on redemption provided out of security
premium or general reserve or P/L)
Debenture holders A/c Dr.
To Bank A/c
(Payment due to debenture holders).
Note: The above entries are given on the assumption that the premium on redemption has not
been provided at the time of issue.
 Redemption out of the Proceeds of Fresh Issue
A company may issue new shares or new debentures or both for redeeming its existing
debentures. In such cases, the working capital of the company is not at all affected. The only
change is that new share capital or debentures take place in the place of the old debentures. It
may be noted that when debentures are redeemed out of the fresh issue, there is no need to
create debenture redemption reserve.
Example 5
Rani Ltd. had 10%, 5,000 debentures of X 100 each due for redemption on 1-4-2018. The
debenture trust deed provided that the company may redeem the debentures at a premium of
5% at any time before maturity. The directors decided to exercise this option and issued
40,000 equity shares of X 10 each at 10% premium and 1,000 9% debentures of f 100 each at
par for the purpose of redemption. Write journal entries.
Solution
Journal
10% Debentures A/c Premium on Redemption A/c Dr. 5,00,000
To Debenture holders A/c (10% debentures due for Dr. 25,000
redemption) 5,25,000
Bank A/c Dr. 4,40,000
To Equity Share Capital A/c 4,00,000
To Security Premium A/c (Issue of 40,000 equity shares of 40,000
Rs.10 each at 10% premium for the purpose of
redemption).
Bank A/c Dr. 1,00,000
To 9% Debentures A/c 1,00,000
(Issue of 1,000 debentures of f 100 each for the purpose of
redemption).
Security Premium A/c 25,000

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Dr. 25,000
To Premium on Redemption A/c (Premium on
redemption provided out of security premium)
Debenture holders A/c Dr. 5,25,000 5,25,000
To Bank A/c
(Payment due to debenture holders).

Note: It is assumed that the premium on redemption has not been provided at the time of
issue.
Redemption out of Capital
If profits are not utilized to redeem debentures, debentures are said to be redeemed . out of
capital. Thus, when, at the time of redemption, adequate profits are not transferred to
Debenture Redemption Reserve A/c, such type of redemption is called redemption out of
capital. Since the profits are not utilized for the redemption of debentures, the assets of the
company are reduced by the amount paid. This would affect the working capital of the
company.
Redemption out of Profit
When sufficient profits are transferred from Statement of Profit and Loss to the Debenture
Redemption Reserve Account at the time of redemption of debentures, such redemption is
said to be out of profits. This Is called redemption out of profit because it reduces the amount
of profit available for dividend. The amount thus saved because of non payment of dividends
is utilized for the redemption of debentures.
Companies Act, 2013, requires every company to create debenture redemption reserve (DRR)
every year with sufficient amount out of its profits, until such debentures are redeemed.
However, the Act does not specify the percentage or amount to be transferred to DRR. As per
the guidelines issued by SEBI, a company which wants to redeem debentures out of profit
should transfer an amount equal to 50% of the amount of debentures issued to 'Debenture
Redemption Reserve7, before the commencement of redemption of debentures (if the
debentures are for a period of more than 18 months). This provision is applicable only in case
of non-convertible debentures or for non-convertible portion of partly convertible debentures.
When an amount equal to 50% of the amount of debentures is transferred to DRR A/c, it
means that 50% of debentures is redeemed out of capital.
Infrastructure companies and company issuing debentures with maturity not more than 18
months are exempted from the guidelines of SEBI. But as per Companies Act, all companies
should create DRR. The following journal entries are required:
(1) On creation of DRR
Profit or Loss Dr.
To Debenture Redemption Reserve A/c
On Debentures becoming due (a) If redeemed at par:
Debentures A/c Dr. (with nominal value)
To Debenture holders A/c
(b) If redeemed at a Premium:
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Note: As per SEBI guidelines, creation of DRR (before redemption commences)


iscompulsory for debentures with maturity period of more than 18 months. This means that
DRR is not compulsory for debentures with maturity period of 18 months or less.
The debenture redemption reserve is shown in "Equity and Liabilities"' under the head 'Other
Equity' (i.e., Reserves and Surplus) in the Balance Sheet. On the completion of redemption of
all debentures, the debenture redemption reserve account is closed by transferring it to
general reserve. The journal entry is:
Debenture Redemption Reserve A/c Dr.
To General Reserve A/c
Difference between Debenture Redemption Fund and Debenture Redemption Reserve
If the amount appropriated from profit is invested outside the business for the purpose of
redemption, it is known as 'Debenture Redemption Fund7. If it is retained in the business (i.e.,
invested in the business itself), it is known as Debenture Redemption Reserve.
Example 6
A Ltd. issued 10,000,8% Debentures of? 10 each on April 1,2017 redeemable at par on June
30, 2018. Applications were received for 12,000 debentures and the allotment was made to all
applicants on pro-rata basis. The debentures are redeemed on due date. How much reserve is
to be created before redemption is carried out? Record necessary journal entries regarding
issue and redemption.
Date Particulars LF Amount Amount
2017 Bank A/c Dr. 1,20,000
Apr.l To Debenture Application A/c (Application money 1,20,000
received on 12,000 debentures @ 110 each)
Debentures Application A/c Dr. 1,20,000
To 8% Debenture 1,00,000
To Bank A/c 20,000
(Transfer of application money and refund of excess
application money)
2018 Profit or Loss Dr. 1,00,000
Jun30 To Debenture Redemption Reserve A/c (Creation of DRR) 1,00,000
8% Debentures A/c Dr. 1,00,000
To Debentureholders A/c (Amount due to 1,00,000
debentureholders as per redem.)
Debentureholders A/c Dr. 1,00,000
To Bank (Payment to debentureholders) 1,00,000
Debenture Redemption Reserve A/c Dr. 1,00,000
To General Reserve A/c -ffransfer of DRR to GR) 1,00,000

Note: (1) DRR has not been created before the commencement of redemption because
debentures were issued for a period of less than 18 months (as per SEBI guidelines). Here an
amount equal to the nominal value of debentures to be redeemed has been transferred from
Statement of Profit or Loss to DRR. This is done as per Companies ' Act. Since the whole

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amounts of debentures are redeemed on maturity, DRR has been created for full amount. (2)
Entries relating to interest on debentures have been ignored.
Example 7
A Ltd has issued 15,000 debentures of f 100 each payable full on application on 1-10-2016.
Applications were received for 12,000 debentures. The terms of redemption provide that one-
third of the debentures are redeemable every six months. Write necessary journal entries.
Date Particulars Debit Credit
Amount? Amount ?
2016 Bank A/c Dr. 12,00,000
Oct.l To 8% Debentures (Issue of 12,000, 8% 12,00,000
debentures of ? 100 each)
2017 Profit or Loss Dr. 4,00,000
Mar.3 To DRR A/c (Transfer of amount equal to 4,00,000
1 debentures to be redeemed to DRR)
8% Debentures A/c Dr. 4,00,000
To Debentureholders A/c 4,00,000
(Amount due to debentureholders)
Debentureholders A/c Dr. 4,00,000
To Bank A/c 4,00,000
(Payment to debentureholders)
jm.7 8% Debentures A/c Dr. 4,00,000
Sep.30 To Debentureholders A/c (Amount due to 4,00,000
debentureholders)
Debentureholders A/c Dr. 4,00,000
To Bank A/c 4,00,000
(Payment to debentureholders)
2018 Profit or Loss Dr. 8,00,000
Mar31 To DRR A/c (DRR created out of profit) 8,00,000
8% Debentures A/c Dr. 4,00,000
To Debentureholders A/c 4,00,000
(Amount due to debentureholders)

Date Particulars Debit Amt. T Credit Amt?


2016 Bank A/c Dr. 11,00,000
April To 8% Debentures A/c To Security Premium 10,00,000
A/c 1,00,000
(Issue of 1,00,000 debentures of ? 10 each at 10%
premium)
2017,. -Interest A/c Dr. 80,000
-Mar31 To Debentureholders A/c (Interest due to 80,000
debentureholders)
Debentureholders A/c Dr. 80,000
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To Bank A/c 80,000


(Payment of interest)
Profit or Loss Dr. 80,000
To Interest A/c 80,000
(Interest written off to P/L)
Note: (1) It is assumed that the "Premium payable on redemption" has been provided at the
time of issue. (2) The amount of debentures issued and period of maturity are not known.
Hence, DRR cannot be created as per SEBI guidelines;
redemption by Sinking Fund
Debentures may be redeemed by creating a sinking fund. Under this method of redemption,
every year a part of the profit (fixed installment) is set aside and sinking fund is created. The
sinking fund (also called debenture redemption fund) is invested, in outside securities (like
shares, debentures, bonds of other companies or corporations). The interest received on such
investments along with annual amount set aside from profit will again be invested as usual.
This process continues till the date of redemption of debentures. The investment will be sold
and the cash thus received will be used to repay the debentures. The working capital of the
company will not be affected as the cash is separately made available for redemption. Under
this method of redemption sinking fund account, and sinking fund investment account will be
opened. After the debentures have been redeemed, the balance of sinking fund account is
transferred to general reserve.
Merits of Sinking Fund Method
The chief merits of sinking fund method are:
(i) As the funds required for redemption accumulates outside the business, liquid
cash is available at the time of redemption. Hence debentures can be repaid without
disturbing the financial position of the company.
(ii) In the interim period, the security may be pledged or sold out to get liquid cash in case of
any emergency.
Demerits of Sinking Fund Method
The demerits of the method are:
(i) There may be losses in realising the investments .
(ii) The rate of returns on investments may be less than the earning rate of the business.
(iii) As a part of the profit is set aside for creating a sinking fund, shareholders get a
comparatively low rate of dividend during the currency of debentures.
Demerits of Sinking Fund Method
The demerits of the method are:
(i) There may be losses in realising the investments .
(ii) The rate of returns on investments may be less than the earning rate of the business.

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(iii) As a part of the profit is set aside for creating a sinking fund, shareholders get a
comparatively low rate of dividend during the currency of debentures.
Accounting Entries
The journal entries which are required to be passed under sinking fund method are
summarised as follows:
I. At the end of the First Year
(1) When annual amount is set aside
Profit or Loss Dr.
To Sinking Fund/Debenture Redemption Fund A/c
(2) When Sinking Fund is invested
Sinking Fund Investment or
Debenture Redemption Fund Investment A/c Dr.
To Bank A/c
IL At the end of Second and Subsequent Year
(3) For receiving interest on investment
Bank A/c Dr.
To Interest on Sinking Fund Investment A/c
(4) For transferring the interest to Sinking Fund
Interest on Sinking Fund Investment A/c Dr.
To Sinking Fund A/c
(5) For setting aside the amount of profit
Profit or Loss
Dr.
To Sinking Fund A/c
(6) When Sinking Fund along with interest is invested
Sinking Fund Investment A/c Dr.
To Bank A/c III. At the end of Last Year ,
(7) For receiving interest on investment
Bank A/c Dr.
To Interest on Sinking Fund Investment A/c
(8) For transferring the interest to Sinking Fund
Interest on Sinking Fund Investment A/c • Dr.
To Sinking Fund A/c
(9) For setting aside the amount of profit
Profit or Loss Dr.
To Sinking Fund A/c
(10) For sale of investment
Bank A/c Dr.

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To Sinking Fund Investment A/c (with the sale proceeds)


(11) For transferring profit on sale of investment
Sinking Fund Investment A/c Dr.
To Sinking Fund A/c In case of loss, the above entry will be reversed.
IV. For Redemption (For Making due
(a) If debentures are to be redeemed at par:
Debentures A/c Dr.
To Debentureholders A/c
(b) If debentures are to be redeemed at Premium:
Debentures A/c Dr.
Premium on Redemption A/c Dr.
To Debentureholders A/c
(13) For making payment
Debentureholders A/c Dr.
To Bank A/c
(14) For transferring the balance in Sinking Fund
Sinking Fund A/c Dr.
To General Reserve A/c
Points to Remember
1. As per SEBI guidelines, it is compulsory to create sinking fund, i.e., Debenture
Redemption Reserve equivalent to 50% of the debenture issue. A company can create the
reserve more than this minimum amount if it so desires.
2. Sinking Fund Investment A/c should always be shown at cost. However, a separate
column may be prepared to show the nominal value of investments made in securities, if
so desired.
3. Interest on investment is calculated on the opening balance of nominal value of
investments and not on the cost of investments.
4. Technically, the exact amount set aside will be invested. Therefore, the balance of
Sinking Fund A/c and Sinking Fund Investment A/c will be exactly the same. But in
practice, the amount may be invested in the multiple of ^ 10 or ^ 100. In that case,
investment will be in multiple of ^ 10 or ^ 100 as the case may be. But amount invested
should not be less than the amount set aside.
5. In the last year, annual instalment set aside together with interest will not be invested.
This is because there is no meaning in making investment in the last year and then
immediately realising the same.
6. Debenture Redemption Fund A/c shall appear under equity and liabilities in the sub head
'Reserves and Surplus' till the redemption.

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7. Debenture Redemption Fund Investment A/c shall appear under assets in the B/S under
the sub head "Investments" till redemption.
8. The amount to be set aside from the profit is ascertained with reference to "Sinking Fund
Tables"
9. The amount of profit to be set aside is to be calculated as follows:
(a) If the Debentures are to be redeemed at par Nominal Value of Debentures to be
redeemed x Present value of f 1 for given number of years at a given rate of interest
Example 10
The 1,000 9% Debentures of ? 100 each issued at par are to be redeemed after 4 years.
Investments are expected to realise 12% p.a. The table shows that ? 0.2092488 ^invested at
the end of each year at 12% compound interest will amount to ^ 1 at the end of 4 years and ?
1 p.a at 12% interest amounts to T 4.779 in 4 years.
Calculate the amount to be set aside annually from profit: (a) if Debentures are repayable at
par, (b) if Debentures are repayable at 10% premium.
Solution
(a) If Debentures are Redeemable at par :
Amount of profit to set aside 1,00,000 x 0.2092488 = Rs. 20,924.88
or
Rs. 1,00,000 / 4.779 = Rs. 20,924.88
(b) If Debentures are Redeemable at 10% premium
Amount to be set aside = (1,00,000 + 10,000) x 0.2092488 = Rs. 23017.37
or
1,10,000 = 23,017.37

4.779

Example 11

On 1- 4 - 13 A Ltd issued ? 1,00,000 8% Debentures of ? 100 each at par redeemable in 5


years. The necessary funds for redemption are to be provided by v_jCFe1iting a sinking fund
and having an annual investment to yield 5% compound interest. The sinking fund table
shows that investment of ? 0.180975 annually over 5 years fetches ? 1 at 5%. Write necessary
accounts and show the redemption of debentures.
Solution
The yearly amount of profit set aside = 1,00,000 x 0.180975 =f 18,097.50

Insurance Policy Method

This is an alternative to Sinking Fund method. Under the Sinking Fund method,
annual contribution is invested in outside securities. Under insurance policy method, an

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insurance policy is purchased by paying annual premium. Such policy will mature on the date
when the Debentures become redeemable. The total premium paid will amount to less than
the policy amount, but the policy amount will be equal to the amount required for
redemption. Thus the difference between the policy amount and premium paid will be interest
on premiums (or profit on realisation of policy). This method: (a) provides funds for
redemption, and (b) covers the risk involved in the transaction.

The following journal entries are required to be passed:

1. During all the years till the maturity of the policy

(a) For payment of premium at the beginning of the year.


Debenture Redemption Policy A/c Dr. (with annual premium)

To Bank A/c

(b) For setting aside the amount of profit at the end of the year
Profit and Loss Appropriation A/c Dr. (with the amount of profit set aside)

To Debenture Redemption Fund A/c

2. During the last year in addition to the above two entries


(c) For realising the policy amount
Bank A/c Dr. (with the amount realised)

To Debenture Redemption Policy A/c

(d) For the transfer of profit I loss, on the realisation of policy


(i) In case of profit

Debenture Redemption Policy A/c Dr.

To Debenture Redemption Fund A/c

(ii) In case of loss - Reverse of the above entry

(e) For making the amount due and for payment usual entries are to be passed.

(f) The balance of Debenture Redemption Fund Ale will be transferred to general
reserve by passing the following entry:

Debenture Redemption Fund A/c Dr.


To General Reserve A/c
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Redemption by Conversion

This is another method of redeeming debentures. Redemption by conversion means


redeeming the debentures by converting them into new debentures and/or shares within a
stipulated period at the option of the debentureholders. The new shares or debentures may be
issued either at par, or at a premium or at a discount. At the time of conversion, the following
entries are to be passed:

1. Old Debentures A/c Dr.


Premium on Redemption of Debentures A/c Dr. (If redeemed at premium)
To Debentureholders A/c (To close the old debentures)

2. (i) Debenture holders A/c Dr.


Discount on issue of Deb/Shares A/c Dr. (If new debentures/shares at discount)
To New Debentures/Share Capital A/c
(Issue of new shares / debentures at discount)
(ii) Debentureholders A/c Dr.
To New Debentures/Share Capital A/c
To Securities Premium A/c (If new debentures/shares at premium)
(Issue of new shares / debentures at premium)
In this connection, it is essential that if the debentures to be converted were originally issued
at a discount, the actual amount realised from them at the time of issue (and not the face
value) is to be taken into consideration for determining the number of shares to be issued in
exchange of the debentures to be converted. For example, if debentures of ? 5,00,000 were
originally issued at a discount of 10% and if such debentures are to be converted into shares,
the paid up value of shares to be issued for conversion should not exceed T 4,50,000. If this
rule is not applied, the provisions of the Companies Act would be violated.

Example 13

A Ltd. had issued 2000,10% debentures of ? 100 each at a discount of 10%. These debentures
were given the option to convert their debentures into equity shares of ? 100 each. The
holders of 400 debentures out of the above exercised the option. Write journal entry for
conversion if: (a) new equity shares are issued at par, (b) new equity shares are issued at 20%
premium, and (c) new equity shares are issued at 10% discount.

Solution

(a) If new equity shares are issued at par

The number of equity shares to be issued in lieu of debentures will be calculated as below:

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Face value (nominal value) of debentures to be converted X40,000
Less: Discount allowed on issue ©10% 4,000
Actual amount received on issue 36,000
The new shares to be issued = 36,000
---------- = 300
120
The journal entry for conversion is
Debentures A/c Dr. 40,000
To Equity share capital (360 x 100) 36,000
To Discount on issue of debentures 4,000
(b) If new equity shares are issued at 20% premium

The number of equity shares to be issued in lieu of debentures will be calculated as below:
The new shares to be Issued = 36,000
---------- = 400
90

The journal entry for conversion is:


Debentures A/c Dr. 40,000
To Equity share capital (360 x 100) 30,000
To Security premium 6,000
To Discount on issue of debentures 4,000
(c) If new equity shares are issued at 10% discount

The number of equity shares to be issued in lieu of debentures is calculated as below:


The new shares to be Issued = 36,000
---------- = 400
90
The journal entry for conversion is:
Debentures A/c Dr. 40,000
Discount on issue of equity shares Dr. 4,000
To Equity share capital (360 x 100) 40,000
To Discount on issue of debentures 4,000
Note: When the debentures which were originally issued at discount are converted into new shares,
‘Discount on Issue of Debentures Account’ will be credited
in the entry for conversion.
Purchase of Debentures in the Open Market
A company can buy Its own debentures if it is authorised by its Articles. A company
purchases its own debentures from the open market when the price of debentures falls below
the face value or redemption price. The debentures may be purchased either for (a) immediate
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cancellation, or for (b) investment. Debentures when purchased for investment are popularly
called Own Debentures.
When a company purchases own debentures it will amount to redemption of
debentures. This is because the old debentures are withdrawn or taken back from the
debentureholders by paying them either at par or at premium. The purchase of debentures
may be paid from sinking fund or out of profit or out of capital.
The debentures purchased for investment may be cancelled or reissued later on when
the market price is higher. When purchased for investment, the company steps into the shoes
of the general investor, and the own debentures so purchased are treated like a normal
investment. Therefore, it is shown under assets in the balance sheet.

Redemption by purchase of debenture has the following advantages:

1. The purchase is made when the market price of the debenture is the lowest. Hence, less
amount is spent for their redemption (profit on cancellation or on redemption).
2. This reduces the interest burden.
3. This avoids to pay premium on redemption.
Purchase of Debentures for Immediate Cancellation
A company may purchase its debentures for the purpose of immediate cancellation.
This results in reduction of debenture liability to the extent of par value of debentures
cancelled.

Accounting Treatment

The following journal entries are required to be passed:


(a) When Debentures are purchased at par
Debentures A/c Dr. (with nominal value)
To Bank A/c
(b) When Debentures are purchased at a discount
Debentures A/c \ Dr. (with nominal value)
To Bank A/c (with purchase price)
To Profit on Purchase (or Redemption) of Deb. A/c (profit on purchase)
'Profit on redemption/purchase of debentures' is a capital profit. It should be used to write off
any amount of capital loss given in the question such as, discount on Issue, premium on
redemption etc. The balance will be transferred to capital reserve. The entry will be:

Profit on Redemption of Debenture A/c Dr.


To Capital Loss (if any)
To Capital Reserve A/c,

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Note: When there is sinking fund, the Profit on Redemption of Debentures A/c should be credited to
Sinking Fund (and not to Capital Reserve A/c).

(c) When Debentures are purchased at a premium


If the purchase price of the debentures Is more than the face value, there will be a loss on the
purchase/redemption of such debentures and the loss will be debited to 'Loss on Redemption of
Debentures A/c'. Suppose, debentures of the face value of f 50,000 are purchased in the market at ?
52,000, the entry will be:
Debentures A/c Dr. 50,000
Loss on Redemption of Debentures A/c. Dr. 2,000
To Bank A/c. 52,000

'Loss on Redemption of Debentures A/c' (or Loss on Purchase of Debentures A/c) is a


capital loss. Therefore, it is written off against capital profits (debit Capital Reserve/ Security
Premium and credit Loss on Redemption of Debentures A/c). In the absence of capital profits, it is
written off from Statement of Profit or Loss.

Note: When there Is sinking fund, the Loss on Redemption of Debentures A/c should be debited
to Sinking Fund A/c.

It should be noted that when own debentures are purchased for immediate
cancellation, debentures account should be debited with nominal or face value (and
debentures will be cancelled). \

When, there is no sinking fund, an amount equal to the nominal value of the
debentures cancelled .(redeemed) should be transferred to Debenture Redemption
Reserve A/c. The entry is:

Profit or Loss . Dr.


To Debenture Redemption Reserve A/c
Example 14 (Purchase of debentures for cancellation)
A Ltd. purchased for cancellation 1,000 of its own 10% debentures of Rs. 100 each at Rs. 97. The
cost of purchase amounted to Rs.200 (ignore interest). Give journal entries.
Note; When there is no sinking fund, a sum equal to the cost of debentures purchased and
cancelled should be transferred from Statement of Profit or Loss to Debenture Redemption.

Ex-Interest and Cum-Interest Quotations

Generally interest on debentures is paid on fixed dates, I.e., half yearly or yearly. However,
the company can buy its own debentures from the open market at any time during the year. If
a company purchases its own debentures on the date of payment of interest, there will be no

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problem with regard to interest. This is because the interest accrued upto the date of purchase
(i.e., on the date of payment of interest) will be payable to debentureholder. If the debentures
are purchased before the due date of the interest payment, then the problem arises as to
whether the price paid includes interest for the expired period or not. Sometimes, the price
paid for debenture the expired period. Sometimes, the price paid does not include the interest
for the expired period. Expired period means the period from the date of previous payment of
interest upto the date of purchase. The interest portion included in the purchase price
constitutes revenue and the balance is capital (actual cost of debentures). The price paid for
the debentures depends on the type of quotation. There are two types of quotations - cum-
interest quotation and ex-interest quotation.

Cum-interest Quotation

If the purchase price includes interest for the period from previous date of interest to the date
of purchase, it is called cum interest price(Cnm is a Latin word which means 'with' i.e.,
cumulative or inclusive of interest). It means the price paid by the company for the
debentures includes the interest for the expired period also.

Journal Entries
S At the time of recording the purchase of own debentures, only the price paid towards the
cost of debentures must be debited to the own debentures account. The interest must be
debited to Interest account.

(a) When the debentures are purchased for immediate cancellation:


Debentures A/c Dr. (Nominal value of debentures)
Interest on Debentures A/c Dr. (Interest for the expired period)

To Bank (Amount paid)

Profit on Redemption of Debentures (Profit on redemption)

(b) When the debentures are purchased for holding as investment:


Own Debentures A/c Dr. (Cost of debentures)
Interest on Debentures A/c Dr. (Interest for the expired period)

To Bank A/c (Amount paid)

In this case, Own Debentures A/c should be debited with cost of debentures (and not nominal
value of debentures).

Cost of Own Debentures = Price paid - Interest for the expired period,

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Note: When own debentures are purchased as Investment, there will be no profit or loss on
redemption of debentures. Profit or loss on redemption will occur at the time of cancellation of
debentures.

(c). When own debentures purchased for investment are cancelled in future
Debentures A/c Dr (Nominal value)

To Own Debentures A/c (Cost, i.e., price paid minus Interest) To Profit on Redemption of
Debentures (Balance)

Ex-interest Quotation
If the purchase price excludes the interest for the expired period, it is called Ex-
interest price ('Ex'is also a Latin word which means 'without', i.e., exclusive of interest). This
means that the purchase price of debentures does not include the interest for the expired
period. This further means that the purchaser (company) has to pay, in addition, the interest
for the expired period. Thus,

Cost of Own Debentures = Price paid Journal Entries


(a) When debentures are purchased for immediate cancellation
Debentures A/c Dr. (Nominal value of debentures)

Interest on Debentures A/c Dr. (Interest for the expired period)


To Bank A/c (Total amount paid, i.e., cost of
debentures + interest)
To Profit on Redemption of Debentures (Balancing figure)
(b) When debentures are purchased as investment

Own Debentures A/c Dr. (Cost of debentures, i.e., Price paid)


Interest on Debentures A/c Dr. (Interest for the expired period)
To Bank A/c (Total)
(c) When own debentures purchased for investment are cancelled in future

Debentures A/c Dr (Nominal Value)


To Own Debentures A/c (Cost, i.e., Price Paid)
To Profit on Redemption of Debentures (Balance)
Note:
1. Interest should be calculated from the last date of payment up to the date of purchase.
2. If the price is ex-interest, the buyer (company) has to pay higher amount than under
cum-interest quotation. When own debentures are cancelled the profit on cancellation
would be more in the case of cum - interest than ex-interest quotation.

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3. In case of Govt. Securities and debentures the price quoted is Ex- interest
unless/otherwise stated and in respect of non-Govt. Securities and debentures, it is
/Cum interest unless otherwise stated.
On 1st July 2016, a company issued 1000, 6% debentures of ? 100 each (interest payable on
30th June and 31st December). The company is allowed to purchase own debentures which may
be cancelled or kept or reissued at the company's option. The company made following purchases in
the open marked for immediate cancellation.
On 31st May 2017,100 debentures at ? 98 ex-interest

On 30th September 2018, 50

Solution

Journal

2016
July 1 Bank A/c Dr. 1,00,000 1,00,000
To 6% Debentures A/c (Issue of 1000 debentures of
?100 each at par)
Dec 31 Interest on Debentures A/c Dr. 3,000 3,000
To Bank A/c (Payment of interest on
debentures)
2017 6% Debentures A/c (100 x 100) Dr 10,000
May 31 Interest on Debentures A/c(10,000 x 5/12 x 6/100) To Dr. 250 10,050
Bank A/c (price paid +interest)
To Profit on Redemption of Deb. A/c (100 x2) 200
(Purchase of 100 debentures ex-interest for cancellation)
June 30 Interest on Debentures A/c Dr. 2,700 2,700
To Bank A/c (Payment of interest on 900
debentures)
Dec 31 Interest on debentures A/c Dr. 2,700 2,700
To Bank A/c (Payment of interest on 900
debentures)
Dec 31 Profit on Redemption of Debentures A/c To Dr. 200 200
Capital Reserve A/c
(Profit on redemption transferred to capital reserve)
2018 Interest on Debentures A/c Dr. 2,700
Jun30 To Bank A/c (Payment on interest on 900 2,700
debentures)

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PRACTICAL PROBLEM
Illustration 1

On 1st January, 2017 X Ltd. issued 1,000 8% Debentures of f 100 each at a discount of 6%.

The terns of issue provided;

(a) That interest shall be payable on 30th June and 31st Dec. every year; and

(b) That on the 31st December every year, one- fifth of the debentures shall be redeemed.

Pass relevant journal entries in the books of the company including cash transactions for the years
2017 and 2018.
Illustration 3
The following balances appeared in the books of X Ltd. on 1-4-2018:
Sinking Fund A/c ? 50,000
Sinking Fund Investment A/c
(10% Govt. Securities, Nominal value X 45,000) 48,000
12% Debentures 1,00,000
The company sold X 30,000 Govt. Securities at 110% and utilised the amount to redeem part
of the Debentures at a premium of 10%. Show Debentures A/c, Sinking Fund A/c and
Sinking Fund Investment A/c.

QUESTIONS FOR PRACTICE


A, Objective Type Questions
Fill in the Blanks
1. Premium on redemption of debentures account is in the nature of ...... account.
2. Loss on issue of debentures account is...,....... asset.
3. After all the debentures are redeemed the balance in the sinking fund is transferred to
.................
4. Profit on sale of sinking fund investments is credited to account.
5. Own debenture account will appear on the side of the B/S.
6 When debentures are redeemed out of profits, an equal amount is transferred to
account.
7 From the same purchase price profit on cancellation of own debentures is more when
purchased on basis
8 If the purchase price of debentures includes interest for the expired period, the
quotation is said to be .................
9. Debenture is a document which creates a ............................

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Am: 1-personal, 2- fietiti0us,3- general reserve, 4- sinRing fund, 5- ass€ft, 6- debenture redemption
reserve, 7- cum, 8-cum interest, 9-debt
Choose the correct answer
1. Interest on debenture is (a) adjustment of profit, (b) appropriation of profit, (c) charge on
profit, (d) none of these
2. After all the debentures are redeemed, the balance in the sinking fund is transferred ■ to
(a) general reserve, (b) capital reserve, (c) profit and loss account, (d) debentures account.
3. When own debentures are cancelled, any profit on cancellation is transferred to (a) general
reserve, (b) capital reserve, (c) profit or loss (d) none of these.
4. When debentures are bought as own for the purpose of investment, the own debenture
account is debited with (a) face value, (b) cum interest price, (c) ex-interest price, (d) face
value with premium.
5. After realizing all the investments, the balance in the sinking fund account is transferred to
(a) profit and loss account, (b) debenture account, (c) capital reserve, (d) sinking fund
account.
6. Which of the following is not a source of redemption of debentures (a) redemption out of
capital, (b) redemption out of borrowings from financial institution (c) redemption out of
profit, (d) redemption by conversion
Ans: 1-c, 2- a, 3-b, 4- c, 5- d, 6-b
B Short Answer Type *
1. What do you mean by drawing by lot ?
2. What is Debenture Redemption Reserve account?
3. What are own debentures ?
4. What do you mean by sinking fund ?
C Short Essay Type
l. What are the different methods of redeeming debentures?
2. Enumerate the various sources of redemption of debentures.
3. What is the significance of Sinking Fund method of redemption of debentures?
4 . Distinguish between Sinking Fund for replacement of an asset and a Sinking Fund the
redemption of a liability.
5 . Distinguish between Sinking Fund method and Insurance Policy method.
6. How would you treat premium on redemption of debentures?
1. A company issued debentures of the face value of ? 1,00,000 at a discount of 6%. The
debentures were repayable by annual drawing of Rs. 20,000. How would you deal with
the discount on debentures? Show the discount account in the company's ledger for the
period of duration of debentures.
(Amount written off in the 1st year Rs. 2000, IInd year Rs. 1600,IIIrd year Rs. 1200, IVth
year Rs.800 and Vth year ? 400)

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2. A company has issued Rs.12,00,000, 6% debentures at a discount of 6% repayable over a


period of 10 years at par by annual drawings of X 1,20,000. Write-up the Cash Book,
Debentures Account and Discount on Debentures Account for the first three years.
3. XY Ltd. issued 2,000, 12% debentures of ? 100 each at par on 1st January 2014.
Debentures are repayable at 5% premium in 5 equal annual instalments by lottery, the 1st
redemption occurring on 31st December 2014.
Show Debentures Account, Premium on Redemption of Debentures Account, Loss on Issue
of Debentures Account, Debenture holders Account for all the years assuming that: (i) the
company's accounting year ending on 31st December, (ii) all the terms of Debenture issue are
duly complied with; (iii) no sinking fund was created.

BUY-BACK OF SHARES
Some years back buy back of shares and securities was not allowed in many developed
countries (including India), Over the years, the situation has changed. Companies in India now can
buy-back their own shares. Section 88, 69 and 70 of the Companies Act, 2013 deal with buy-back
shares,
One of the first companies to offer the buyback of shares in India in. October 2000 was
Philips India Pvt. Ltd, Later many MNCs, opted for this method to restructure capital, or avail other
benefits.
Meaning and Definition of Buy-Back of Shares
Buy-back is the reverse of issue of shares, Buy-back simply means buying of own shares, It is a
process of capital restructuring. It allows a company to buy-back its own shares, which were issued by
it earlier. It is a method of cancellation of a company's share capital It leads to reduction in the share
capital of a company
Objectives of Buy-Back
1. To improve returns on capital
2. To return surplus cash to the investors.
3. To increase the market price of the share.
4. To change the capital structure (i.e., to restructure capital base).
5. To increase the EPS.
6. To prevent hostile takeover bids.
7. To improve the financial health after buy-back
8. To achieve optimum capital structure
9. To service the equity more efficiently.
Reasons and Benefits of Buy-back
1. It helps to increase the EPS.
2. The market price of the share will go up.
3. It help to return surplus the cash to the investors

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4. It increases promoters' holding in the company.


5. It helps to restructure the capital base of the company It helps to utilise the liquid assets
to enhance the value of the company.
6. It is a reward for investors.
7. It will improve the company's image.
Damage of Buy-Back
1. It may be used as a tool of insider trading. This gives an opportunity to insiders to make
extra money
2. It may be used for manipulating the prices of shares.
3. It weakens the position of minority shareholders.
Sources of Buy-back
A company can purchase its own shares out of the following:
1. Free reserves (reserves that are free for distribution as dividend).
2. Security premium account
3. Proceeds of any shares or other securities. However, the proceeds of an earlier issu * of
same kind of shares / securities should not be used for buy-back. Thus, for example, if
equity shares are to be bought back, preference shares or debentures may be issued for
the purpose.
Methods (or Modes) of Buy-back
According to SEBI guidelines, there are three methods of buyback of shares. They are:
1. Through the tender offer.
2. From open market.
3. From odd lots.
1. Buy-back through tender offer: A company can buy back its shares from its existing equity
shareholders on a proportionate basis. Under this method the company fixes a price at which
it wishes to buy back a specified number of shares from its shareholders. If the number of
shares offered for buy back at the stated price is more than the number of shares to be bought
back, then the shares are bought back from each shareholder proportionately.
Escrow Account: A company has to open an Escrow Account if it wants to initiate the process
of buy-back of shares. The word 'escrow7 literally means a contract or bond deposited with a
third person (normally a bank) to perform its obligations under the scheme of buy-back. The
company is required to deposit an amount equal to 25% of the consideration payable for
shares to be bought upto Rs. 100 crores and 10% of the consideration in excess of Rs. 100
crores. After completion of all obligations this amount will be refunded to the company.
2. Buy-back from the open market: A company can buy back its shares from the open market
also. This may be done in any one of the following methods: (a) through stock exchange,
(b) book building process.

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(a) Through stock exchange: Under this method, a company can buy back its shares at the
prevailing quoted price in a stock exchange. The buy-back is made only on stock
exchange with electronic trading facility. This method does not require Escrow Account.
(b) Through book building process: Under book building process the shareholders offer
their shares at a price at which they are willing to sell their shares within a price band
(i.e., price range) specified by the company The company will receive the offers from the
shareholders. The merchant banker and the company shall determine the buyback price
based on the acceptances received. The final price of buy-back shall be the highest price
accepted and this price shall be /paid to all shareholders whose specified securities have
been accepted for buy / back, litis method, requires the opening of Escrow Account.
3. Buy-back of shares from odd lots : The companies may locate the odd lots of shares (i.e.,
the block of shares that is not held in multiples of 100) and purchase them back from the
odd lot holders,
Accounting Treatment
Accounting treatment of buy-back of shares is more or less similar to redemption of
preference shares. The following points may be noted:
1. Only fully paid up securities can be bought back, If the securities are partly paid, they
must be made fully paid up by making final call
2. Sufficient balance must be standing to the credit of free reserves if buy back is to be
made from free reserves.
3. If the shares are bought back out of free reserves or security premium, an amount equal
to the face value of shares so bought back must be transferred from free reserves or
security premium to Capital Redemption Reserve A/c (CRR).
4. The premium, if any paid on buy-back must be written off to security premium or free
reserves.
5. Discount on payback, if any, must be transferred to Capital Reserve.
6. CRR can be utilized for the purpose of issuing fully paid bonus shares.
It should be noted that for buy-back, security premium can be transferred to CRR.
Note: If the fresh issue of shares (for the purpose of buy back) is less than the amount of
shades to be bought back, capital redemption reserve is to be created for the balance.
Jourrnal Entries
1. If the company issues fresh securities for the purpose of buy back, appropriate
entries are passed.
2. If the company buys back shares from free reserves or security premium, an amount equal
to the nominal value of shares so bought should be transferred to Capital Redemption
Reserve A/c. The entry is:

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Profit and Loss or Other Reserves or Security Premium A/c Dr


To C.R.R. A/c
(a) For buy back at par
Share Capital A/c Dr. (with the face value of shares bought back)
To Bank A/c ■ (with amount paid)
(b) For buy back at premium
Share Capital A/c Dr. (with the face value)
. Security Premium/ Free Reserves Dr. (with the premium, i.e., excess of
purchase price over face value)
To Bank A/c (with the amount paid)
(c) For buy back at discount
Share Capital A/c Dr. (with the face value of shares)
To Bank A/c (with the amount paid)
To Capital Reserve A/c (with the discount, i.e., the excess of face value
over purchase price)
3. Write Journal entry for buyback expenses incurred in respect of buyback:
Buy-back Expense A/c Dr.
To Bank A/c
Buy back expenses account will be closed by transferring to Profit or Loss or other Reserves
Accounts. The entry is:
Profit or Loss (or Other Reserves) Dr. To Buy-back Expense A/c
Note: Instead of one entry for buy-back, two entries can be written, i.e., for transferring the
amount to shareholders account and the other for payment,
SEBI has mentioned that the companies can buy-back there own shares with or without
shareholders' resolution if the buy-back of share is upto the limit of 10% of the paid up capital
and reserves. But if the buy-back of share is upto the extent of 25% of paid-up capital and
reserves, then the sharesholders' resolution is compulsory. . J E example 1 (Buy back at par out
of fresh issue of shares)
A Ltd issued 2,00,000 equity shares of ? 10 each. It wanted to buy back 30,000 equity shares
at par. It issued 6% 3,000 preference shares of ^ 100 each, the proceeds being utilized for the
purpose of buy back. Expenses relating to the buy back amounted to ^ 18,000. Give journal
entries.

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Solution

Journal

Bank A/c (3,000x100) Dr. 3,00,000

To 6% Preference Share Capital A/c 3,00,000

(Issue of preference shares at par)

Equity Share Capital A/c (30,000 x 10) Dr. 3,00,000

To Bank A/c

3,00,000

(Buy back of 30,000 equity shares at par)

Buy back Expenses A/c Dr. 18,000

To Bank A/c 18,000

(Buy back expenses paid)

Profit or Loss Dr. 18,000

To Buy back Expenses A/c (Buy back


expenses written off to P/L) 18,000

Example 2 (Buy-back at premium out of free reserves)

A Ltd issued 4,00,000 shares of ? 10 each. The balance in the security premium account and
general reserve account were ? 40,00,000 and ? 50,00,000 respectively. The company bought back
1,00,000 shares at a price of ? 30 each and issued cheques for this purpose from its bank account.
Write journal entries.

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Example 3 (Buy back of shares at premium out of fresh issue and free reserves) The
following is the B/S of X Ltd as on 31-12-2018:

Liabilities Assets

Equity share capital Sundry Assets 14,50,000


(?10 each share)
10,00,000
General Reserve 1,00,000
Profit or Loss 70,000
Security Premium 2,20,000
Other Liabilities 60 000

. 14,50,000 14,50,000

On 1-1-2019, the company bought back 25,000 equity shares @ ? 20 each. The company
issued 2,000 8% preference shares of ? 100 each for the purpose. Give journal entries.

QUESTIONS FOR PRACTICE


A. Objective Type
Fill in the blanks

1. A company can buy-back its own shares from free...............................


2 . Buy-back of equity shares is a process of capital
3. Only paid up shares can be acquired under
buy-back
4. A company can buy-back its own shares from the
existing share holders on
.....................basis
5. For buy-back through open market operations, price
fixation is done through
auction method.
Ans: 1-reserves, 2-restructing, 3-fully, 4-proportionate,
5-dutch

IJ/ Short Answer Type 1./ What is meant by buy-back of shares ? 2 / What
are free reserves ? - 3/ What is escraw account ? 4/.What do you mean by

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tender offer method of buy-back ? 5. Is it necessary for a company to buy-


back of shares ?
QS Short Essay Type . • .
1. What are the objects of buy-back of shares ?
2. State the sources of buy-back of shares ?
3. State the conditions and limits of buy-back. ?
4. What are the various methods of buy-back of shares ?
5. The buy-back of shares is a convinent strategy for companies to avail many benefits".
Comment.
Problems
1. A Ltd. decides to buy back 50,000 equity shares of f 10 each at a premium of 20%, For this
purpose, it decides to issue 10% preference shares of f 10 each at par. To meet the
requirement of the law, the company has sufficient free reserves, i.e., General Reserves and
Securities Premium Account. You are required to pass journal entries to record the above
transactions.
A Ltd. decides to buyback 10% of ? 100 crores paid up equity capital. The face "value per
equity share is f 10, but the market price per share is f 15.A Ltd. takes the following steps for buyback
of its shares:
1. To issue 7% debentures of 100 each at par for face value of 10 crores.
2. To utilise general reserve,
3. To sell investments of 7 crores for 8 crores.
4. To buyback the shares at the market price.
5. To immediately cancel the shares boughtback. Journalise the above transactions.
Following figures have been extracted from the books of X Ltd. as on
31-3-2018:
Authorised capital:'
50,00,000 Equity shares of f 10 each 5,00,00,000
Issued and subscribed capital: •
50,00,000 equity shares of f 10 each, fully paid-up 5,00,00,000 . Reserves & Surplus:
General Reserve 80,00,000'
Profit and Loss
Following is the Balance Sheet of X Ltd as on 31-03-2018:
1
B/S of the Company as on 31-03-2018
A, Assets

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1. Non-current Assets
Fixed Assets 2,700
Non Trade Investments 300
2. Current Assets
Stock 600
Trade Receavables 360
Cash and Cash Equivalents 160
Total Assets 4,120
1. Equity and Liabilities
1. Equity
Share Capital
(a) Equity Shares off 20 each 800
(b) Other Equity (Reserves and Surplus)
General Reserve 780

Security Premium . . 100


' Surplus Account 120
2. Non-current Liabilities
10% Debentures ' 2,00,000
3. Current Liabilities
Trade Payable . 320
Total Equity and Liabilities 4420
On the above date 16,000 shares are bought by the company at f 20 per share. For his purpose,
the co. sold its all non-trade investments for ? 3,20,000. Give journal entries.

ALTERATION OF SHARE CAPITAL


A company may alter the capital clause of its memorandum only if it is authorized by
it s articles to do so.
Meaning of alteration of share capital
Increase or decrease in (or rearrangement of) the authorized share capital of a firm, as
permitted in its articles of association. Any such change requires (1) passing of a resolution to
the effect in the firm's general meeting, and (2) filing of the notice of alteration with the
appropriate governmental office such as (in the UK) the Registrar Of Companies.
Legal requirement for alteration of share capital
The main legal requirements in connection with the alteration of share capital are
summarized as under:

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a. Authorized by articles: a company may alter the capital clause of its memorandum
only if it is authorized by its articles of association to do so.
b. Ordinary resolution: an ordinary resolution must be passed at a general meeting.
c. Notice: a notice specifying alteration made must be given to the registrar within 30
days of alteration.
Methods of alteration of share capital
1. Increase its share capital by making fresh issue
If a company wants to increase its capital beyond the amount of its authorised capital, it
must increase its authorised capital by the amount of new shares. Entries for the purpose
will be the same as in the case of original issue of shares.
2. Consolidate and divide all or any of its share capital into shares of larger denomina-
tion:
Alteration in the share capital can be done by consolidating the shares of smaller amounts
into shares of larger amounts. This is possible when articles permit to do so.
Journal entry, for this purpose, will be:
(i) Share Capital (say Rs. 10) A/c Dr.
To Share Capital (say, Rs. 100) A/c
3. Subdivide all or any of its share capital into shares of smaller denomination:
Entry will be:
Share Capital (say, Rs. 100) A/c Dr.
To Share Capital (say, Rs. 10) A/c
4. Convert all or any of fully paid-up shares into stock or reconvert stock into fully
paid-up shares of any denomination:
Journal entry
Share capital a/c dr
Stock
Example
1. A ltd having 10000 equity shares o f rs. 10 each decides to convert the share capital into
equity stock. Write the journal entry.
Solution
Equity share capital a/c dr
To equity stock a/c
5. By reconverting stock into shares: tock may be reconverted into shares.
Journal entry
Stock a/c dr
Share capital a/c
Example
A ltd having equity stock of Rs. 10000 decides to convert the equity stock into equity
shares of Rs. 10 each. Write the journal entry
Equity stock a/c dr 100000
Equity share capital a/c 100000
6. By decreasing the share capital

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A company can decrease its share capital by cancelling unissued shares. The authorized
share capital gets reduced by the amount of unissued shares now cancelled. This is the
diminution of share capital. This should not be confused with the reduction of share capital.
This means that decrease in the share capital is different from reduction of share capital.
Journal entry
No accounting entry is needed for cancellation of unissued shares. Only reduced
authorized capital is to be shown in the next balance sheet.
Example
A ltd has an authorized share capital of Rs. 10,00,000 and issued capital of Rs.
800000. It decides to alter its authorized share capital to rs. 8,00,000. Show the accounting
treatment.
No journal entry is required for cancellation of unissued shares. The reduced
authorized share capital Rs. 8,00,000 is to be shown in the balance sheet.

Example

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MODULE-III
PREPARATION OF SINGLE ENTITY FINANCIAL STATEMENT
The objective of preparing general purpose financial statements of a single entity is to
provide information about the entity’s financial position, financial performance and cash
flows to users for economic decision making.
This chapter deals with the following accounting standards.
1. Accounting policies, change in accounting estimates and errors(AS 8 and Ind AS 8)
2. Events after the reporting date (AS10 and Ind AS 10)
3. Presentation of financial statement (IAS 1 AND Ind AS 1)
4. Cash flow statement (IAS7 and IndAS 7)
1. International Accounting Standard 8 Accounting Policies, Changes in Accounting
Estimates and Errors
An entity may be required to change accounting policies and accounting estimates.
Similarly, some errors might have committed in financial statements.
Objective
The objective of this Standard is to prescribe the criteria for selecting and changing
accounting policies, together with the accounting treatment and disclosure of changes in
accounting policies, changes in accounting estimates and corrections of errors.
Scope
1. Selection and application of accounting policies
2. accounting for changes in accounting policies
3. changes in accounting estimates and
4. corrections of prior period errors.
Definitions
a. Accounting policies are the specific principles, bases, conventions, rules and practices
applied by an entity in preparing and presenting financial statements.
b. A change in accounting estimate is an adjustment of the carrying amount of an asset
or a liability, or the amount of the periodic consumption of an asset, that results from
the assessment of the present status of, and expected future benefits and obligations
associated with, assets and liabilities. Changes in accounting estimates result from
new information or new developments and, accordingly, are not corrections of errors.
c. Prior period errors are omissions from, and misstatements in, the entity’s financial
statements for one or more prior periods arising from a failure to use, or misuse of,
reliable information that:
(a) was available when financial statements for those periods were authorised for
issue; and
(b) could reasonably be expected to have been obtained and taken into account in the
preparation and presentation of those financial statements. Such errors include the
effects of mathematical mistakes, mistakes in applying accounting policies, oversights
or misinterpretations of facts, and fraud.
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d. Retrospective application is applying a new accounting policy to transactions, other


events and conditions as if that policy had always been applied.
e. Retrospective restatement is correcting the recognition, measurement and disclosure
of amounts of elements of financial statements as if a prior period error had never
occurred.
Accounting policies
Selection and application of accounting policies
When a Standard or an Interpretation specifically applies to a transaction, other event
or condition, the accounting policy or policies applied to that item must be determined by
applying the Standard or Interpretation and considering any relevant Implementation
Guidance issued by the IASB for the Standard or Interpretation. [IAS 8.7]
In the absence of a Standard or an Interpretation that specifically applies to a
transaction, other event or condition, management must use its judgement in developing and
applying an accounting policy that results in information that is relevant and reliable. [IAS
8.10]. In making that judgement, management must refer to, and consider the applicability of,
the following sources in descending order:
 the requirements and guidance in IASB standards and interpretations dealing with
similar and related issues; and
 the definitions, recognition criteria and measurement concepts for assets, liabilities,
income and expenses in the Framework. [IAS 8.11]
Consistency of accounting policies
An entity shall select and apply its accounting policies consistently for similar transactions,
other events and conditions, unless a Standard or an Interpretation specifically requires or
permits categorization of items for which different policies may be appropriate. If a Standard
or an Interpretation requires or permits such categorization, an appropriate accounting policy
shall be selected and applied consistently to each category.
Changes in accounting policies
An entity is permitted to change an accounting policy only if the change:
 is required by a standard or interpretation;
 or results in the financial statements providing reliable and more relevant information
about the effects of transactions, other events or conditions on the entity's financial
position, financial performance, or cash flows.
Applying changes in accounting policies
The following rules may be followed for applying changes in accounting policies:
a. an entity shall account for a changes in accounting policy resulting from the initial
application of an Ind AS in accordance with the specific transitional provisions, if
any, in that Ind AS , and
b. if there are no specific transitional provisions applying to that change or an
accounting policy is voluntarily changed, then the change should be applied
retrospectively, unless it is impracticable to do so.

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Retrospective application
When a change in accounting policy is applied retrospectively, it requires the entity to
adjust the opening balance of each affected components of equity for the earliest prior period
presented and the other comparative amounts disclosed for each prior period presented as if
the new accounting policy had always been applied.
Limitations on retrospective application
When it is impracticable to apply retrospective application, then the entity should
apply the new accounting policy to the carrying amounts of assets and liabilities as at the
beginning of the earliest period for which retrospective application is practicable, which may
be the current period.
Changes in accounting estimates
As a result of the uncertainties inherent in business activities, many items in financial
statements cannot be measured with precision but can only be estimated. Estimation involves
judgement based on the latest available, reliable information. For example, estimates may be
required of:
(a) bad debts;
(b) inventory obsolescence;
(c) the fair value of financial assets or financial liabilities;
(d) the useful lives of, or expected pattern of consumption of the future economic benefits
embodied in, depreciable assets; and
(e) warranty obligations.
Change in measurement basis
A change in the measurement basis applied is a change in an accounting policy, and is
not a change in an accounting estimate. When it is difficult to distinguish a change in an
accounting policy from a change in an accounting estimate, the change is treated as a change
in an accounting estimate.
Difficulty in distinguishing change in policy and changes in estimate
When it is difficult to distinguish a change in an accounting policy from a change in
an accounting estimate, then the change should be treated as a change in an accounting
estimate.
Change in accounting estimate (prospective application)
The effect of change in an accounting estimate should be recognized prospectively by
including it in profit or loss in :
a. the period of the change, if the change effects that period only, for example, bad
debts;
b. the period of the change and future periods, if the change affects both, for example,
estimated useful life depreciable assets.
Errors

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Errors discovered during a current period may have arisen on account of mathematical
mistakes, incorrect application of accounting policies, misinterpretation of facts, oversights or
fraud.
Accounting treatment
An entity should correct all prior period errors retrospectively in the first set of
financial statements approved for issue after their discovery. This correction should be done
by:
a. restating the comparative amounts for the prior period(s) presented in which the error
occurred; or
b. if the error occurred before the earliest prior period presented, restating the opening
balances of assets, liabilities and equity for the earliest prior period presented.
Limitations on retrospective restatement
In case it impracticable for the entity to determine the period specific effects of an error for
one or more prior periods presented, it shall restate the opening balances of assets, liabilities
and equity for the earliest period for which retrospective restatement is practicable.
In case it is impracticable to determine the cumulative effect, at the beginning of the current
period, of an error on all prior periods, the entity shall restate the comparative information to
correct the error prospectively from the earliest date practicable.
Example

Example

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2. Events after the reporting period

Events after the end of reporting period may be classified into two types:

 Adjusting Events - Those events that provide further evidence about conditions that
existed at the end of reporting period.
 Non-Adjusting Events - Those events that reflect conditions that arose after the end of
reporting period.

Recognition and measurement

Adjusting Events

If any events occur after the end of the reporting period that provide further evidence of
conditions that existed at the end of reporting period (i.e. Adjusting Events), then the
financial statements must be adjusted accordingly.

Example

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Non adjusting events after the reporting period


The following are the examples of non adjusting event after the balance sheet date:
a. A major business combination after the balance sheet date, or disposing of a major
subsidiary.
b. Major purchases and disposals of assets, or expropriation of major assets by
government.
c. The destruction of a major production plant by a fire after the balance sheet date;
d. Announcing, or commencing the implementation of a major restructuring.
e. Major ordinary and potential share transactions, after the balance sheet date.
f. Abnormally large changes, after the balance sheet date, in asset prices, or foreign
exchange rates.
g. Changes in tax rates, or tax law enacted, or announced after the balance sheet date.
h. Commencing major litigation (law suit) arising solely out of events that occurred after
the balance sheet date.
i. Decline in the market value of investment between balance sheet date and the date of
approval of financial statements.
j. Declaration of an equity dividend.
Dividends
If dividends are declared to holders of equity instruments after the reporting period,
the entity should not recognize it as liability at the end of the reporting period because no
obligation exists at that time. Such dividends are disclosed in the notes under Ind AS 1.
Going concern
An entity should not prepare financial statements on a going concern basis if
management determines after the reporting period that it intends to either liquidate the entity

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or cease trading. For example, a fire destroyed inventory in the warehouse after the year end.
This is non adjusting event. The loss of inventory means that the entity can no longer
continue to trade. Then the going concern assumption is no longer valid.
Presentation of Financial Statements
Objective
This Standard prescribes the basis for presentation of general purpose financial statements to
ensure comparability both with the entity’s financial statements of previous periods and with
the financial statements of other entities. It sets out overall requirements for the presentation
of financial statements, guidelines for their structure and minimum requirements for their
content.
Scope

1. An entity shall apply this Standard in preparing and presenting general purpose financial
statements in accordance with Indian Accounting Standards (Ind ASs).
2. Other Ind ASs set out the recognition, measurement and disclosure requirements for
specific transactions and other events.

3. This Standard does not apply to the structure and content of condense d interim financial
statements prepared in accordance with Ind AS 34 Interim Financial Reporting. However,
paragraphs 15–35 apply to such financial statements. This Standard applies equally to all
entities, including those that present consolidated financial statements and those that present
separate financial statements as defined in Ind AS 27 Consolidated and Separate Financial
Statements .
4. This Standard uses terminology that is suitable for profit -oriented entities, including
public sector business enti ties. If entities with not-for-profit activities in the private sector or
the public sector apply this Standard, they may need to amend the descriptions used for
particular line items in the financial statements and for the financial statements themselves.

5. Similarly, entities whose share capital is not equity may need to adapt the financial
statement presentation of members’ interests.
Components of financial statement
A complete set of financial statements comprises the following
1. A balance sheet
2. A statements of profit and loss
3. Statement of changes in equity
4. A statement of cash flows,
5. Notes comprising significant accounting policies and other explanatory information
6. Comparative information in respect of preceding period, and
7. A balance sheet as at the beginning of the preceding period when an entity applies an
accounting policy retrospectively or makes a retrospective restatement or reclassifies
items in its financial statements.

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General Features of Financial Statements


1. Fair presentation and compliance with ASs
2. Going Concern
3. Accrual basis of Accounting
4. Materiality and Aggregation
5. Offsetting
6. Frequency of reporting
7. Comparative Information
8. Consistency of presentation.
Statement of Financial Position [Balance Sheet]
Statement of Financial Position, also known as the Balance Sheet, presents the financial
position of an entity at a given date. It is comprised of three main components: Assets,
liabilities and equity.
Statement of Financial Position helps users of financial statements to assess the financial
soundness of an entity in terms of liquidity risk, financial risk, credit risk and business risk.
Form of balance sheet is given below
Figures at Figures at the
the end of end of
current year previous year
A. ASSETS
Non current asset
1. Property , plant , and equipment
2. Capital work in progress
3. Investment property
4. Intangible assets
5. Other intangible assets
6. Financial assets
a. Investment
b. Trade receivable
c. Loans
d. Other to be specified
7. Biological assets
8. Deferred tax assets
9. Other non current assets
Current assets
1. Inventories
2. Financial assets
a. Investments

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b. Trade receivables
c. Cash and cash equivalents
d. Bank balances other than (1)
e. Loans
f. Other to be specified
3. Current tax assets
4. Other current assets
Total assets
B. EQUITY AND LIABILITIES
Equity
a. Share capital
b. Retained earnings(reserves and surplus)
Non current liabilities
a. Financial liabilities
i. Borrowings
ii. Trade payables
iii. Other liabilities(to be specified)
b. Provisions
c. Deferred tax liabilities
d. Other non current liabilities
Current liabilities
a. Financial liabilities
i. Borrowings
ii. Trade payable
iii. Other financial liabilities(to be specified)
b. Other current liabilities
c. Provisions
d. Current tax liabilities
Total equity and liabilities

GENERAL INSTRUCTIONS FOR PREPARATION OF BALANCE SHEET


1. An asset shall be classified as current when it satisfies any of the following criteria:—
(a) it is expected to be realised in, or is intended for sale or consumption in, the
company’s normal operating cycle;
(b) it is held primarily for the purpose of being traded;
(c) it is expected to be realised within twelve months after the reporting date; or

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(d) it is cash or cash equivalent unless it is restricted from being exchanged or


used to settle a liability for at least twelve months after the reporting date. All
other assets shall be classified as non-current.
2. An operating cycle is the time between the acquisition of assets for processing and their
realisation in cash or cash equivalents. Where the normal operating cycle cannot be
identified, it is assumed to have a duration of twelve months.
3. A liability shall be classified as current when it satisfies any of the following criteria:—

(a) it is expected to be settled in the company’s normal operating cycle;


(b) it is held primarily for the purpose of being traded;
(c) it is due to be settled within twelve months after the reporting date; or
(d) the company does not have an unconditional right to defer settlement of the
liability for at least twelve months after the reporting date. Terms of a liability that
could, at the option of the counterparty, result in its settlement by the issue of
equity instruments do not affect its classification.
All other liabilities shall be classified as non-current.
4. A receivable shall be classified as a “trade receivable” if it is in respect of the amount
due on account of goods sold or services rendered in the normal course of business.
5. A payable shall be classified as a “trade payable” if it is in respect of the amount due on
account of goods purchased or services received in the normal course of business.
6. A company shall disclose the following in the notes to accounts.
A. Share Capital
For each class of share capital (different classes of preference shares to be treated
separately):
(a) the number and amount of shares authorised;
(b) the number of shares issued, subscribed and fully paid, and subscribed but not
fully paid;
(c) par value per share;
(d) a reconciliation of the number of shares outstanding at the beginning and at
the end of the reporting period;
(e) the rights, preferences and restrictions attaching to each class of shares
including restrictions on the distribution of dividends and the repayment of
capital;
(f) shares in respect of each class in the company held by its holding company or
its ultimate holding company including shares held by or by subsidiaries or
associates of the holding company or the ultimate holding company in aggregate;
(g) shares in the company held by each shareholder holding more than 5 per cent.
shares specifying the number of shares held;

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(h) shares reserved for issue under options and contracts/commitments for the
sale of shares/disinvestment, including the terms and amounts;
(i) for the period of five years immediately preceding the date as at which the
Balance Sheet is prepared:
(A) Aggregate number and class of shares allotted as fully paid-up
pursuant to contract(s) without payment being received in cash.
(B) Aggregate number and class of shares allotted as fully paid-up by
way of bonus shares.
(C) Aggregate number and class of shares bought back.
(j) terms of any securities convertible into equity/preference shares issued along
with the earliest date of conversion in descending order starting from the farthest
such date;
(k) calls unpaid (showing aggregate value of calls unpaid by directors and
officers); (l) forfeited shares (amount originally paid-up).
B. Reserves and Surplus
(i) Reserves and Surplus shall be classified as:
(a) Capital Reserves;
(b) Capital Redemption Reserve;
(c) Securities Premium Reserve;
(d) Debenture Redemption Reserve;
(e) Revaluation Reserve;
(f) Share Options Outstanding Account;
(g) Other Reserves–(specify the nature and purpose of each reserve and the
amount in respect thereof);
(h) Surplus i.e., balance in Statement of Profit and Loss disclosing allocations and
appropriations such as dividend, bonus shares and transfer to/ from reserves, etc.;
(Additions and deductions since last balance sheet to be shown under each of the
specified heads);
(ii) A reserve specifically represented by earmarked investments shall be termed as a
“fund”.
(iii) Debit balance of statement of profit and loss shall be shown as a negative figure under
the head “Surplus”. Similarly, the balance of “Reserves and Surplus”, after adjusting
negative balance of surplus, if any, shall be shown under the head “Reserves and Surplus”
even if the resulting figure is in the negative.
C. Long-Term Borrowings
(i) Long-term borrowings shall be classified as: (a) Bonds/debentures; (b)
Term loans:
(A) from banks.

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(B) from other parties.


(c) Deferred payment liabilities;
(d) Deposits;
(e) Loans and advances from related parties;
(f) Long term maturities of finance lease obligations;
(g) Other loans and advances (specify nature).
(ii) Borrowings shall further be sub-classified as secured and unsecured. Nature
of security shall be specified separately in each case.
(iii) Where loans have been guaranteed by directors or others, the aggregate
amount of such loans under each head shall be disclosed.
(iv) Bonds/debentures (along with the rate of interest and particulars of
redemption or conversion, as the case may be) shall be stated in descending order
of maturity or conversion, starting from farthest redemption or conversion date, as
the case may be. Where bonds/debentures are redeemable by instalments, the date
of maturity for this purpose must be reckoned as the date on which the first
instalment becomes due.
(v) Particulars of any redeemed bonds/debentures which the company has power
to reissue shall be disclosed.
(vi) Terms of repayment of term loans and other loans shall be stated.
(vii) Period and amount of continuing default as on the balance sheet date in
repayment of loans and interest, shall be specified separately in each case.
D. Other Long-term Liabilities
Other Long-term Liabilities shall be classified as:
(a) Trade payables;
(b) Others.
E. Long-term provisions
The amounts shall be classified as: (a) Provision for employee benefits;
(b) Others (specify nature).
F. Short-term borrowings
(i) Short-term borrowings shall be classified as:
(a) Loans repayable on demand;
(A) from banks.
(B) from other parties.
(b) Loans and advances from related parties;
(c) Deposits;
(d) Other loans and advances (specify nature).

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(ii) Borrowings shall further be sub-classified as secured and unsecured. Nature


of security shall be specified separately in each case.
(iii) Where loans have been guaranteed by directors or others, the aggregate
amount of such loans under each head shall be disclosed.
(iv) Period and amount of default as on the balance sheet date in repayment of
loans and interest, shall be specified separately in each case.
G. Other current liabilities
The amounts shall be classified as:
(a) Current maturities of long-term debt;
(b) Current maturities of finance lease obligations;
(c) Interest accrued but not due on borrowings;
(d) Interest accrued and due on borrowings;
(e) Income received in advance;
(f) Unpaid dividends;
(g) Application money received for allotment of securities and due for refund and
interest accrued thereon. Share application money includes advances towards
allotment of share capital. The terms and conditions including the number of
shares proposed to be issued, the amount of premium, if any, and the period
before which shares shall be allotted shall be disclosed. It shall also be disclosed
whether the company has sufficient authorised capital to cover the share capital
amount resulting from allotment of shares out of such share application money.
Further, the period for which the share application money has been pending
beyond the period for allotment as mentioned in the document inviting application
for shares along with the reason for such share application money being pending
shall be disclosed. Share application money not exceeding the issued capital and
to the extent not refundable shall be shown under the head Equity and share
application money to the extent refundable, i.e., the amount in excess of
subscription or in case the requirements of minimum subscription are not met,
shall be separately shown under “Other current liabilities”;
(h) Unpaid matured deposits and interest accrued thereon; (i) Unpaid matured
debentures and interest accrued thereon;
(j) Other payables (specify nature).
H. Short-term provisions
The amounts shall be classified as:
(a) Provision for employee benefits.
(b) Others (specify nature).
I. Tangible assets
(i) Classification shall be given as:

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(a) Land;
(b) Buildings;
(c) Plant and Equipment;
(d) Furniture and Fixtures;
(e) Vehicles;
(f) Office equipment;
(g) Others (specify nature).
(ii) Assets under lease shall be separately specified under each class of asset.
(iii) A reconciliation of the gross and net carrying amounts of each class of assets
at the beginning and end of the reporting period showing additions, disposals,
acquisitions through business combinations and other adjustments and the related
depreciation and impairment losses/reversals shall be disclosed separately.
(iv) Where sums have been written-off on a reduction of capital or revaluation of
assets or where sums have been added on revaluation of assets, every balance
sheet subsequent to date of such write-off, or addition shall show the reduced or
increased figures as applicable and shall by way of a note also show the amount
of the reduction or increase as applicable together with the date thereof for the
first five years subsequent to the date of such reduction or increase.
J. Intangible assets
(i) Classification shall be given as:
(a) Goodwill;
(b) Brands /trademarks;
(c) Computer software;
(d) Mastheads and publishing titles;
(e) Mining rights;
(f) Copyrights, and patents and other intellectual property rights, services
and operating rights;
(g) Recipes, formulae, models, designs and prototypes;
(h) Licences and franchise;
(i) Others (specify nature).
(ii) A reconciliation of the gross and net carrying amounts of each class of assets
at the beginning and end of the reporting period showing additions, disposals,
acquisitions through business combinations and other adjustments and the related
amortization and impairment losses/reversals shall be disclosed separately.
(iii) Where sums have been written-off on a reduction of capital or revaluation of
assets or where sums have been added on revaluation of assets, every balance
sheet subsequent to date of such write-off, or addition shall show the reduced or
increased figures as applicable and shall by way of a note also show the amount

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of the reduction or increase as applicable together with the date thereof for the
first five years subsequent to the date of such reduction or increase.
K. Non-current investments
(i) Non-current investments shall be classified as trade investments and other
investments and further classified as:
(a) Investment property;
(b) Investments in Equity Instruments;
(c) Investments in preference shares;
(d) Investments in Government or trust securities;
(e) Investments in debentures or bonds;
(f) Investments in Mutual Funds;
(g) Investments in partnership firms;
(h) Other non-current investments (specify nature).
Under each classification, details shall be given of names of the bodies corporate indicating
separately whether such bodies are (i) subsidiaries, (ii) associates, (iii) joint ventures, or (iv)
controlled special purpose entities in whom investments have been made and the nature and
extent of the investment so made in each such body corporate (showing separately
investments which are partly-paid). In regard to investments in the capital of partnership
firms, the names of the firms (with the names of all their partners, total capital and the shares
of each partner) shall be given.
(ii) Investments carried at other than at cost should be separately stated
specifying the basis for valuation thereof;
(iii) The following shall also be disclosed:
(a) Aggregate amount of quoted investments and market value thereof;
(b) Aggregate amount of unquoted investments;
(c) Aggregate provision for diminution in value of investments.
L. Long-term loans and advances
(i) Long-term loans and advances shall be classified as:
(a) Capital Advances;
(b) Security Deposits;
(c) Loans and advances to related parties (giving details thereof);
(d) Other loans and advances (specify nature).
(ii) The above shall also be separately sub-classified as:
(a) Secured, considered good; (b) Unsecured, considered good;
(c) Doubtful.
(iii) Allowance for bad and doubtful loans and advances shall be disclosed under
the relevant heads separately.

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(iv) Loans and advances due by directors or other officers of the company or any
of them either severally or jointly with any other persons or amounts due by firms
or private companies respectively in which any director is a partner or a director
or a member should be separately stated.
M. Other non-current assets
Other non-current assets shall be classified as:
(i) Long-term Trade Receivables (including trade receivables on deferred credit
terms);
(ii) Others (specify nature);
(iii) Long term Trade Receivables, shall be sub-classified as:
(a) (A) Secured, considered good;
(B) Unsecured, considered good;
(C) Doubtful.
(b) Allowance for bad and doubtful debts shall be disclosed under the relevant
heads separately.
(c) Debts due by directors or other officers of the company or any of them either
severally or jointly with any other person or debts due by firms or private
companies respectively in which any director is a partner or a director or a
member should be separately stated.
N. Current Investments
(i) Current investments shall be classified as:
(a) Investments in Equity Instruments;
(b) Investment in Preference Shares;
(c) Investments in Government or trust securities;
(d) Investments in debentures or bonds;
(e) Investments in Mutual Funds; (f) Investments in partnership firms;
(g) Other investments (specify nature).
Under each classification, details shall be given of names of the bodies corporate [indicating
separately whether such bodies are: (i) subsidiaries, (ii) associates, (iii) joint ventures, or (iv)
controlled special purpose entities] in whom investments have been made and the nature and
extent of the investment so made in each such body corporate (showing separately
investments which are partly paid). In regard to investments in the capital of partnership
firms, the names of the firms (with the names of all their partners, total capital and the shares
of each partner) shall be given.
(ii) The following shall also be disclosed:
(a) The basis of valuation of individual investments;
(b) Aggregate amount of quoted investments and market value thereof;
(c) Aggregate amount of unquoted investments;

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(d) Aggregate provision made for diminution in value of investments.


O. Inventories
(i) Inventories shall be classified as:
(a) Raw materials;
(b) Work-in-progress;
(c) Finished goods;
(d) Stock-in-trade (in respect of goods acquired for trading);
(e) Stores and spares;
(f) Loose tools;
(g) Others (specify nature).
(ii) Goods-in-transit shall be disclosed under the relevant sub-head of
inventories.
(iii) Mode of valuation shall be stated.
P. Trade Receivables
(i) Aggregate amount of Trade Receivables outstanding for a period exceeding
six months from the date they are due for payment should be separately stated.
(ii) Trade receivables shall be sub-classified as:
(a) Secured, considered good;
(b) Unsecured, considered good;
(c) Doubtful.
(iii) Allowance for bad and doubtful debts shall be disclosed under the relevant
heads separately.
(iv) Debts due by directors or other officers of the company or any of them either
severally or jointly with any other person or debts due by firms or private
companies respectively in which any director is a partner or a director or a
member should be separately stated.
Q. Cash and cash equivalents
(i) Cash and cash equivalents shall be classified as:
(a) Balances with banks;
(b) Cheques, drafts on hand;
(c) Cash on hand;
(d) Others (specify nature).
(ii) Earmarked balances with banks (for example, for unpaid dividend) shall be
separately stated.
(iii) Balances with banks to the extent held as margin money or security against
the borrowings, guarantees, other commitments shall be disclosed separately.
(iv) Repatriation restrictions, if any, in respect of cash and bank balances shall be
separately stated.

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(v) Bank deposits with more than twelve months maturity shall be disclosed
separately.
R. Short-term loans and advances
(i) Short-term loans and advances shall be classified as:
(a) Loans and advances to related parties (giving details thereof);
(b) Others (specify nature).
(ii) The above shall also be sub-classified as:
(a) Secured, considered good; (b) Unsecured, considered good;
(c) Doubtful.
(iii) Allowance for bad and doubtful loans and advances shall be disclosed under
the relevant heads separately.
(iv) Loans and advances due by directors or other officers of the company or any
of them either severally or jointly with any other person or amounts due by firms
or private companies respectively in which any director is a partner or a director
or a member shall be separately stated.
S. Other current assets (specify nature)
This is an all-inclusive heading, which incorporates current assets that do not fit into any
other asset categories.
T. Contingent liabilities and commitments (to the extent not provided for)
(i) Contingent liabilities shall be classified as:
(a) Claims against the company not acknowledged as debt;
(b) Guarantees;
(c) Other money for which the company is contingently liable.
(ii) Commitments shall be classified as:
(a) Estimated amount of contracts remaining to be executed on capital
account and not provided for;
(b) Uncalled liability on shares and other investments partly paid;
(c) Other commitments (specify nature).
U. The amount of dividends proposed to be distributed to equity and preference shareholders
for the period and the related amount per share shall be disclosed separately. Arrears of fixed
cumulative dividends on preference shares shall also be disclosed separately.
V. Where in respect of an issue of securities made for a specific purpose, the whole or part
of the amount has not been used for the specific purpose at the balance sheet date, there shall
be indicated by way of note how such unutilised amounts have been used or invested.
W. If, in the opinion of the Board, any of the assets other than fixed assets and noncurrent
investments do not have a value on realisation in the ordinary course of business at least
equal to the amount at which they are stated, the fact that the Board is of that opinion, shall
be stated.

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Statement of profit and loss or statement of comprehensive income (income statement)


IAS 1 permit to present income and expenses either in a single statement called
“statement of profit or loss and other comprehensive income”
The following should be presented in the statement of p/l in addition to the prifit or
loss and OCI sections:
a. Profit or loss
b. Total other comprehensive income (OCI)
c. Comprehensive income for the period, beign the total of profit or loss and OCI
Information to be presented in the profit or loss section of the statement of profit and
loss
The standard lists the following as the minimum to be disclosed on the face of the
statement of profit or loss
a. Revenue
b. Finance cost
c. Share of the profit or loss associates and joint ventures accounted for using equity
method
d. Tax expenses
e. Tax gain (or loss) recorded on the disposal of assets or settlement of liabilities
attributable to discontinuing operation
f. Profit or loss
The following items shall be disclosed on the face of the income statement (statement of
profit or loss) s allocations of profit (or loss) for the period.
i. Profit (loss) attributable to minority interest, and
ii. Profit (loss) attributable to equity shareholders of the parent.
An entity should present additional line item, heading and subtotals in the
statement of profit and loss, when such presentation is relevant to an
understanding of the entity’s financial performance.
Information to be presented in the OCI section
The following shall be presented in the other comprehensive income section.
i. Actuarial gains(or loss) on defined benefit plans
ii. Share of associate’s other comprehensive income
iii. Exchange differences on translating foreign operations.
iv. Increase or decrease in revaluation of property, plant , and equipment
v. Cash flow hedges.
Information to be presented in the statement of profit and loss or in the notes
When items of income or expense are material, an entity should disclose their nature
and amount separately.

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Circumstances, that would give rise to the separate disclosure of items of income and
expenses include;
a. Write downs of inventories to net realizable value of property, plant and
equipment to recoverable amount, as well as reversals of such write down.
b. Restructuring of the activities of an entity and reversals of any provisions for
the costs of restructuring.
c. Disposals of items of property, plant and equipment
d. Disposals of investments
e. Discontinued operations,
f. Litigations settlements, and
g. Other reversals of provisions
Classification of expense
On the basis of nature of expense
Revenue xxxx
Other income xxxx
Changes in inventories of finished goods and work in progress xxxx
Raw materials and consumables used xxxx
Employee benefits cost xxxx
Depreciation and amortization expense xxx
Other expenses xxxx
Total expenses xxxx
Profit xxxx

Classification on the basis of function


Revenue xxx
Cost of sales (xxx)
Gross profit xxx
Other income xxx
Total xxxx
Distribution cost (xxx)
Administrative expenses (xxx)
Other expenses (xxx)
Profit xxx
Statement of comprehensive income
a. Single statement approach
Statement of comprehensive income of ABC ltd co. for the year ended 31st march 2018
2017.18 2016.17
Revenue Xxx Xxxx

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Cost of sales (Xxxx) Xxxx


Distribution costs (Xxxx) Xxxx
Administrative expenses (Xxx) Xxxx
Financial cost (Xxx) Xxxx
Share of profit of associates Xxxx Xxxx
Profit before tax Xxxx Xxxx
Income tax expense Xxxx Xxxx
Profit for the year from continuing operations Xxxx Xxxx
Loss for the year from discontinued operations Xxxx Xxxx
Profit for the year Xxxx Xxx
Other comprehensive income Xxxx Xxxx
Exchange differences on translating foreign operations, net of tax Xxxx Xxxx
Actuarial gains on defined benefit pension obligations, net of tax Xxxx Xxxx
Share of associates other comprehensive income Xxxx Xxxx
Other comprehensive income for the year, net of tax Xxxx Xxxx
Total comprehensive income for the year Xxxx xxxx
total comprehensive income is the change in equity during a period resulting from
transactions, other than those changes resulting from transactions with owners in their
capacity as owners. That is, total comprehensive income is the sum of profit or loss for the
period and other comprehensive income.
b. Two statement approach
Statement of profit and loss of ABC ltd com for the year ended 31st march 2018
Revenue Xxxx Xxxx
Cost of sales xxx Xxxx
Distribution costs Xxx Xxx
Administrative expenses Xxx Xxx
Financial cost Xxx Xxx
Share of profit of associates Xxx Xxx
Profit before tax Xxx Xxxx
Income tax expense Xxx Xxxx
Profit for the year from continuing operations Xxx Xxxx
Loss for the year from discontinued operations Xxxx Xxxx
Profit for the year Xxx Xxx
Profit for the year is attributable to
Owners of the parent company Xxx Xxx
Non controlling interest xxx xxx
Statement of other comprehensive income
Profit for the year Xxxx Xxxx

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Other comprehensive income


Exchange differences on translating foreign operations, net of tax Xxxx Xxxx
Actuarial gains on defined benefit pension obligations, net of tax Xxxx Xxxx
Share of associates other comprehensive income Xxx Xxx
Other comprehensive income for the year, net of tax Xxxx Xxxx
Total comprehensive income for the year Xxxx Xxxx
Total comprehensive income for the year attributable to:
Owners of the parent Xxx Xxx
Non controlling interest xxxx xxxx
Note : under Ind AS, only one statement is prepared, but in two sections
Statement of changes in equity
The statement of changes in equity show information about the increase or decrease in
net assets or wealth of an entity. IAS 1 requires preparation of a statement of changes in
equity as a separate statement. Ind AS1 requires the statement of changes in equity to be
shown as a part of the balance sheet.
1. The minimum information to be presented on the face of the statement of changes in
equity includes.
a. Total comprehensive income for the period showing separately the total amount
attributable to owners of the parent and non controlling interest.
b. The effects of retrospective applications or restatement recognized in accordance
with IAS 8 on each of the components of equity.
c. Reconciliation between the carrying amount at the beginning and end of the
period for each components of equity.
2. Following details are also to be presented on the face of the statement of changes in
equity or in the notes as other information.
a. Capital transaction with owners and distribution to owners.
b. The amount of dividend recognized as distribution to owners during the period
and the related per share information.
c. Reconciliation of the balance of accumulated profit or loss at the beginning and
end of the year.
d. Reconciliation of the carrying amount of each class of equity capital, share
premium, and each reserve at the beginning and end of the period.
Share Retaine Equity Revaluatio Tota Non Total
capita d instrumen n surplus l controllin equit
l earning ts g interest y
Balance as Xxxx Xxxx Xxx Xxx Xxx Xxx
on 1/4/16
 Correctio Xxx Xxx Xxx Xxx Xxx

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n of a xxxx xxx xxx xxx


prior
period
error
 Changes
in
accountin
g policy

Restated xxxx Xxx Xxxx Xxx Xxx Xxx


balances as
on Ist april
2016 Xxxx Xxx Xxx
Changes in
equity xxxx xxxx xxxx xxxx Xxx Xxx
Dividends
Total
comprehensi
ve income
for the year
Balance as xxxx Xxx Xxxx Xxxx Xxx Xxxx Xxx
on 31/3/17 x
Changes in
equity for the
period xxx Xxx
2017.18 Xxxx Xxx
Issue of share
capital Xxxx Xxxx Xxxx Xxx Xxxx Xxx
Dividend x
Total Xxx Xxx
comprehensi x
ve income
for the year
Transfer to
ret. Earnings
Balance on xxxx
31/3/18

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Note: 1. where there is change of accounting policy, necessitating a retrospective restatement,


the adjustment is disclosed for each period. Thus, rather than just showing an adjustment to
balance on Ist april, 2017 the balance for 2016 .17 is restated.
3. Gains and losses on cash flow hedges or on the translation of foreign operation would
be shown in additional column.

IV STATEMENT OF CASH FLOWS (IAS 7 & Ind AS 7)


The Statement of Cash Flows (also referred to as the cash flow statement) is one of the three
key financial statements that reports the cash generated and spent during a specific period of
time (i.e., a month, quarter, or year). The statement of cash flows acts as a bridge between the
income statement and balance sheet by showing how money moved in and out of the
business.
Three sections of the Statement of Cash Flows:
1. Operating Activities: The principal revenue-generating activities of an organization
and other activities that are not investing or financing; any cash flows from current
assets and current liabilities
2. Investing Activities: Any cash flows from the acquisition and disposal of long-term
assets and other investments not included in cash equivalents
3. Financing Activities: Any cash flows that result in changes in the size and
composition of the contributed equity or borrowings of the entity (i.e., bonds, stock,
cash dividends)
Cash flow definitions
Cash flows: Inflows and outflows of cash and cash equivalents
Cash: Cash on hand and demand deposits (cash balance on the balance sheet)
Cash equivalents: Cash equivalents include cash held as bank deposits, short-term
investments, and any very easily cash-convertible assets – includes overdrafts and cash
equivalents with short-term maturities (less than three months).
Cash flow classification
1. Operating Cash Flow
Operating activities are the principal revenue-producing activities of the entity. Operating
cash flows typically include the cash flows associated with sales, purchases, and other
expenses.
The company’s chief finance officer chooses between the direct and indirect presentation of
operating cash flow:
 Direct presentation: Operating cash flows are presented as a list of cash flows; cash in
from sales, cash out for purchases, etc. Simple but rarely used method, as the indirect
presentation is more common.

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 Indirect presentation: Operating cash flows are presented as a reconciliation from


profit to cash flow:
Profit P
Depreciation D
Amortization A
Impairment expense I
Change in working capital ΔWC
Change in provisions ΔP
Interest Tax (I)
Tax (T)
Operating cash flow OCF
The items in the cash flow statements are not cash flows but “reasons why cash flow is
different from profit.”
Depreciation expense reduces profit but does not impact cash flow. Hence, it is added back.
Similarly, if the starting point profit is above interest and tax in the income statement, then
interest and tax cash flows will need to be deducted if they are to be treated as operating cash
flows.
There is no specific guidance on which the profit amount should be used in the reconciliation.
Different companies use operating profit, profit before tax, profit after tax, or net
income. Clearly, the exact starting point for the reconciliation will determine the exact
adjustments made to get down to an operating cash flow number.
2. Investing Cash Flow
Investing activities are the acquisition and disposal of non-current assets and other
investments not included in cash equivalents. Investing cash flows typically include the cash
flows associated with buying or selling property, plant, and equipment (PP&E), other non-
current assets, and other financial assets.
Cash spent on purchasing PP&E is called capital expenditures (or CapEx for short).
3. Financing Cash Flow
Financing activities are activities that result in changes in the size and composition of the
equity capital or borrowings of the entity. Financing cash flows typically include cash flows
associated with borrowing and repaying bank loans, and issuing and buying back shares. The
payment of a dividend is also treated as a financing cash flow.
Calculation of cash flow from operating activities
Cash flow from operation means cash generated in the business as a result of
producing goods and services. It can be ascertained either by direct or by indirect method.
Direct method

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Under the direct method, major classes of gross cash receipts and gross payments are
disclosed. In this method, cash receipts from operating revenues and cash payments for
operating expenses are calculated to arrive at cash flows from operating activities. The
differences between the cash receipts and the payments in the net cash flow from operating
activities.
Cash flow from operating activities under direct method may be calculated in the following
manner:
Cash received from debtors xxx
Cash paid to creditors (xxx)
Cash paid to employees (xxx)
Cash operating expenses paid (xxx)
Interest paid (xxx)
Income tax paid (xxx)
Net cash flow from operating activities xxx
Indirect method
Indirect method is also known as net profit method or reconciliation method. This method
starts with net profit or net loss as per the profit and loss account. The net cash flow from
operation is determined by adjusting the net profit or loss for the effect of:
a. Non cash items such as depreciation, provision, deferred taxes, unrealized foreign
exchange gains/losses.
b. Changes during the period in inventories and receivables and payables ie, changes in
current assets and current liabilities.
c. All other items which affect cash included in investing and financing activities such
as loss/gain on sale of fixed assets and investments.
Indirect method is widely used. This method is specially used when amount of sales is not
given in the question.
Cash flow from operating activities under indirect method may be calculated in the following
manner.
Cash flow from operating activities
Net profit before tax xxxx
Add: non cash and non operating items:
Depreciation` xxx
Preliminary expenses written off xxx
Discount on issue of shares and debentures xxx
Goodwill patents etc, written off xxx
Loss on sale of fixed asset xxx
Provision for doubtful debts etc xxx
Dividend paid xxx
Under writing commission written off xxx

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Xxx
Less: items to be deducted
Rent received xxx
Interest received xxx
Dividend received xxx
Profit on sale of fixed asset, investment xxx
Operating profit before working capital changes xxx
Add: decrease in current assets(individually) xxx
Increase in current liability xxx
Less: increase in current assets (individually) xxx
Decrease in current liability xxx
Cash generated from operation xxx
Example
From the following summary of Cash Account of X Ltd., prepare Cash Flow Statement for
the year ended 31st March 2007 in accordance with AS-3 using the direct method. The
company does not have any cash equivalents.

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1. Prepare Cash Flow Statement of Suryan Ltd. from the following:

(a) During 2006, the business of a sole trader was purchased by issuing shares for
Rs. 2, 00,000. The assets acquired from him were: Goodwill Rs. 20,000, Machinery
Rs. 1, 00,000, Stock Rs. 50,000 and Debtors Rs. 30,000.
(b) Provision for tax charged in 2006 was Rs. 35,000.
(c) The debentures were issued at a premium of 5% which is included in the retained
earnings.
(d) Depreciation charged on machinery was Rs. 30,000.

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2. From the following Balance Sheets of Exe Ltd. make-out Cash Flow Statement:

Additional Information:

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(a) Depreciation of Rs. 10,000 and Rs. 20,000 have been charged on Plant and Land and
Buildings in 2004.

(b) An interim dividend of Rs. 20,000 has been paid in 2004.

(c) Rs. 35,000 Income tax was paid during 2004.

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Example

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MODULE-IV
BUSINESS COMBINATIONS AND CONSOLIDATED FINANCIAL STATMENTS
Business combination is a transaction or other event in which an entity obtains control
of one or more businesses. In short, business combination is the bringing together of separate
businesses into one reporting enterprise.
There are two parties in a business combination, acquirer and acquiree.
A business can be acquired in the following ways:
a. Acquisition of an entire entity
b. Acquisition of a group of assets and liabilities (ie, part of an entity) that constitute a
business.
c. Acquisition of controlling interest in an entity (eg. Acquisition of more than 50%
shares of an entity)
IFRS 3 and Ind AS 103 give guidance on accounting for business combinations in the
books of acquirer.
Objectives of IFRS 3 (or Ind AS 103)
The objective of IFRS 3 Business Combinations is to improve the relevance, reliability and
comparability of the information that a reporting entity provides in its financial statements
about a business combination and its effects.
Under IFRS 3, a business combination must be accounted for using a technique called the
“acquisition method”. This views the transaction from the perspective of the acquirer and
involves the following stages:
1. Identify acquirer
2. Determine acquisition date
3. Recognise and measure Assets, liabilities and NCI in acquiree at FV at the acquisition
date
4. Goodwill/Bargain purchase Difference between consideration paid and net assets
acquired
1. Identify the Acquirer
The acquirer is the entity that obtains control of the other entity or business. The concept of
control is dealt with under IFRS 10 Consolidated Financial Statements. In essence, control is
where an investor is exposed, or has rights, to variable returns from its involvement in the
investee and has the ability to effect those returns through its power over the investee.
An investor controls an investee, when all of the following are in place:
 Power over an investee
 Exposure or rights, to variable returns from its involvement with the investee, and
 The ability to use its power over the investee to affect the amount of the investors
returns

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Deciding who is the acquirer depends on judgement, and it can be useful to look out for these
indicators when deciding the acquirer:
 The entity transferring cash or assets
 The entity that issues equity interests
 The entity that is usually larger (though not always), and the relative size of the
combining units
 Voting rights in the combined entity after the combination (acquirer usually receives
more voting rights)
 The board of directors and senior management of the new combined entity (acquirer
usually controls the board)
2. Determine the acquisition date
The next step in the acquisition method is to determine the acquisition date. This is the date
the acquirer, the purchaser, obtains control of the acquiree.
If the acquisition was written down, say in contract form, the acquisition date would normally
be the closing date, when the purchaser takes legal possession of the assets and assumes the
liabilities of the acquiree. Watch out though, as the acquisition date could be earlier than this,
say if the acquirer is allowed to take possession of the acquiree early, by some agreement
between the parties.
The reason we have to ascertain the acquisition date is because it’s used when determining
the fair value of things like consideration paid, assets acquired, liabilities assumed and any
non-controlling interest. The acquisition date is also very important when considering pre and
post-acquisition dividends, as their treatment differs.
3. recognizing and measuring the identifiable assets acquired, the liabilities assumed
and any non controlling interest in the acquire.
The acquirer should identify the assets acquired and liabilities assumed. The assets
and liabilities so identified should be recognized separately from goodwill/gain from bargain
purchase. This is important for two reasons. First, disclosure of assets and liabilities
separately from goodwill adds information value to financial statements. Second, the
goodwill is not amortised but tested for impairment while assets are amortised.
Measurement of non controlling interest
Non-controlling interest (NCI), also known as minority interest, is an ownership
position whereby a shareholder owns less than 50% of outstanding shares and has no control
over decisions. Non-controlling interests are measured at the net asset value of entities and do
not account for potential voting rights.Non controlling interest should be shown as separate
non current liability in the consolidated financial statement.
Example

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Step 4 measuring the consideration transferred or paid


The consideration transferred in a business combination shall be measured at fair
value. It is calculated as sum of the acquisition date fair value of the assets transferred by the
acquirer, the liabilities incurred by the acquirer and equity interest issued by the acquirer. The
total consideration is also known as cost of combination.
Forms of consideration
The Consideration paid by parent for the shares in the subsidiary can take different
forms. Following are the forms of consideration
a. Contingent consideration
According to IFRS 3 and Ind AS 103, acquisition date fair value of contingent consideration
should be included in the consideration. The consideration the acquirer transfers in exchange

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for the acquire includes any asset or liability resulting from a contingent consideration
arrangement.
b. Deferred consideration
In some situations all of the purchase consideration shall not be paid at the date of
acquisition. Instead, a part of the payment is paid later. The payment which is paid later is
known as dererred consideration. That is, the payment of purchase consideration is deferred.
Deferred consideration shall be discounted, using the parent’s cost of capital.
c. Share exchange
Sometimes, the purchase consideration is ascertained on the basis of the ratio in which the
shares of the acquirer are to be exchanged for the shares of the acquire. The exchange ratio is
generally based on the intrinsic value of each company’s share. This method of calculating
purchase consideration is known as share exchange method or intrinsic value method.
Acquisition related costs
acquisition related costs are costs the acquirer incurs to effect a business combination.
These include:
a. Finders fees
b. Advisory, legal,valuation and other professional or consulting fees,
c. General administrative costs, including the costs of maintaining an internal
acquisition department, and
d. Cost of registering and issuing debt and equity securities.
Example

Contingent liabilities of acquiree


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As per IAS 37, a contingent liability is not recognized but only disclosed. However,
IFRS 3 and Ind AS 103 specifically provide that the acquirer should recognize a contingent
liability of the acquire if it fair value can be measured reliably.
After initial recognition and until the liability is settled, cancelled or expired, the
acquirer shall measure a contingent liability recognized in a business combination at the
higher of:
a. The mount that would be recognized in accordance with Ind AS 37, and
b. The amount initially recognized.
Step 5: recognizing and measuring goodwill (or gain from bargain purchase)
IFRS 3 or Ind AS 103 covers the accounting treatment of goodwill acquired in a
business combination. Suppose a company(acquirer) agrees to pay (consideration) for a 100%
investment in another company (acquiree) more than the tangible assets of the acquiree. Then
this would mean that the acquire must also have intangible assets. The amount paid over and
above the value of the tangible assets is goodwill arising on consideration.
Recognition and measurement of goodwill
Goodwill acquired in a business combination is recognized as an asset and is initially
measured at cost. After initial recognition, it is measured at cost less any accumulated
impairment losses. The method of calculation of goodwill varies according to situations.
Situations 1
When consideration transferred and net assets acquired are given and 100% share are
acquired by the acquirer.
Situation 2
When consideration transferred and net assets acquired are given and the acquirer
acquired less than 100% shares of subsidiary.
Situation 3
When consideration transferred, net assets acquired, assets held for sale and
contingent liabilities.
Gain from bargain purchase (negative goodwill)
in extremely rare circumstances an acquirer will make gain from bargain purchase
(negative goodwill) in a business combination. This happens when the net assets acquired is
greater than the total consideration. Before recording negative goodwill, it is necessary to
review all assets, liabilities and continent liabilities to ensure that they have been properly
accounted for. Also, the acquirer shall determine whether there exists clear evidence of the
underlying reasons for classifying the business combination as a bargain purchase.
In short bargain purchase arises when the fair value of the net assets acquired exceeds
the consideration paid for them.

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Example

Consolidated financial statement


Consolidated financial statements - are the "Financial statements of a group in which
the assets, liabilities, equity, income, expenses and cash flows of the parent company and its
subsidiaries are presented as those of a single economic entity",
Parent company:
Parent is an entity that control one or more entities. In other words, it is an enterprise
that has one or more subsidiaries. It is a company which holds the majority of equity shares
of another company, parent company is also known as holding company.
Subsidiary:
A subsidiary is a company whose majority of equity shares are hold by another
company. If the parent has purchase 100% of the outstanding equity shares, the subsidiary is
called wholly owned subsidiary.
Objective

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The objective of this Standard is to lay down principles and procedures for
preparation and presentation of consolidated financial statements. Consolidated financial
statements are presented by a parent (also known as holding enterprise) to provide financial
information about the economic activities of its group. These statements are intended to
present financial information about a parent and its subsidiary(ies) as a single economic
entity to show the economic resources controlled by the group, the obligations of the group
and results the group achieves with its resources.
Summary of consolidation process
In preparing consolidated financial statements, the financial statements of the parent and its
subsidiaries should be combined on a line by line basis by adding together like items of
assets, liabilities, income and expenses. In order that the consolidated financial statements
present financial information about the group as that of a single enterprise, the following
steps should be taken:
(a) the cost to the parent of its investment in each subsidiary and the parent’s portion of
equity of each subsidiary, at the date on which investment in each subsidiary is made, should
be eliminated;
( b ) a ny e x c e s s o f t h e c o s t t o t h e p a r e n t o f i t s i n v e s t m e n t i n a subsidiary
over the parent’s portion of equity of the subsidiary, at the date on which investment in the
subsidiary is made, should be described as goodwill to be recognised as an asset in the
consolidated financial statements;
(c) when the cost to the parent of its investment in a subsidiary is less than the parent’s
portion of equity of the subsidiary, at the date on which investment in the subsidiary is made,
the difference should be treated as a capital reserve in the consolidated financial statements;
(d) minority interests in the net income of consolidated subsidiaries for the reporting period
should be identified and adjusted against the income of the group in order to arrive at the net
income attributable to the owners of the parent; and
(e) minority interests in the net assets of consolidated subsidiaries should be identified and
presented in the consolidated balance sheet separately from liabilities and the equity of the
parent’s shareholders.
Uniform accounting policies
Consolidated financial statements should be prepared using uniform accounting
policies for like transactions and other events in similar circumstances. If it is not practicable
to use uniform accounting policies in preparing the consolidated financial statements, that
fact should be disclosed together with the proportions of the items in the consolidated
financial statements to which the different accounting policies have been applied.
Disclosure of non controlling interest in the consolidated balance sheet

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A parent presents non controlling interest in its consolidated balance sheet separately
from the equity of the owners of the parent. Clearly speaking, it is shown under non current
liabilities.
Goodwill and pre acquisition loss
On the acquisition date, the subsidiary company may have pre acquisition loss. The
pre acquisition loss should be taken into consideration while calculating net assets. Pre
acquisition loss should be deducted from equity share capital and the balance is net assets
acquired. This net asset should be compared with the consideration paid. The excess of
consideration paid over the net assets acquired represents goodwill.
Goodwill and pre acquisition profit
While acquiring the controlling shares in the subsidiary, the parent company pays not
only for the paid up value of shares acquired but also for the profits that the subsidiary has
accumulated till the date of acquisition. In such cases the total of share capital of the
subsidiary and the parent company’s share in the pre acquisition profit of the subsidiary must
be compared with the consideration paid or transferred in order to arrive at goodwill.
Post acquisition profit of the subsidiary
So far we have discussed the preparation of consolidated balance sheet immediately
after acquiring majority shareholding in a subsidiary. Hence the reserves and surplus of the
subsidiary were treated as capital profits. Now we turn our attention to the treatment profits
earned by the subsidiary after acquisition. This is called post incorporation profit.
Revaluation of fixed assets of subsidiary
Fixed assets of subsidiary company may be revalued at the time of acquisition by the
parent company. While calculating non controlling interest, the share of the non controlling
share holders in the increase in value of fixed assets should be included in the non controlling
interest. This means that the non controlling shareholders are entitled to their share in the
increase in the value of fixed assets on revaluation. Any decrease in the value of fixed assets
should be deducted along with their share in the losses or expenses not written off.
Intra group trading
There may be transactions between companies within a group. In other words, a
company may trade with another company in a group. This is known as intra group trading
and intra group transaction.
Types of intra group trading
Following are the important types of intra group trading or intra group transactions:
a. Sale and purchase of goods on credit
b. Loans held by one company in the other and interest on such loans.
c. Sale of non current assets
d. Intra group dividends
e. Intra group investment in debentures.

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Sale and purchase of goods on credit


One company may sell goods on credit to another company in the group. In other
words, one company may buy goods on credit from another company within the group.
The sale and purchase of goods on credit with the group lead to the following
potential problem areas:
a. Unrealized profit on inventory
b. Mutual indebtedness or mutual owings
Un realized profit on inventory
When goods are sold or purchased with the group at cost (ie, profit is not included),
then there will be no further problem. Suppose the goods are sold by P ltd at a profit of 20%
on selling price. This means that P ltd has made a profit of Rs. 20000 on goods sold to S ltd.
If S ltd could sell the entire goods bought from pltd, there is no further problem. This is
because S ltd could realize the entire profit on this transactions.
Mutual indebtedness or mutual owings
The intra group trading leads to mutual indebtedness or mutual owings. When one of
the members of the group sells or purchases goods on credit, mutual owings will arise.
Loans held by one company in the other and interest on such loans
Sometimes one company in the group grants loans to another in the group.
Intra group sales of non current assets
Sometimes sale on non current assets takes place between companies with the group.
The company selling the fixed asset may make profit, while the buying company would
record the fixed asset at the cost at which it purchased the fixed asset. This cost will include
the profit charged by the selling company. Following adjustments should be done in the
consolidated balance sheet.
a. Unrealized profit on sale of fixed asset: the profit recorded by the selling company
should be treated as an unrealized profit in the eyes of the group.
b. Depreciation on inflated cost: the company buying the fixed asset would provide
depreciation based on its costs. This cost is an inflated value of because this includes
the unrealized profits of the selling company.
Intra group dividend
So far we have assumed that the subsidiary company retains all of its after tax profit.
However, the subsidiary company shall distribute some of its profit as dividends. Dividend
may be received by the parent either out of pre acquisition profit or out of post acquisition
profit.
Dividends received by parent company out of pre acquisition profits of the subsidiary
a subsidiary company can pay dividends out of past profit earned before the parent
company acquired shares in the subsidiary. This usually happens when parent company buys

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shares cum dividend. It may do so in the current year or any future year. Accordingly parent
company should pass the following entry in its books on receiving dividends.
Cash a/c dr
To investment in subsidiary
Dividend received y parent company out of post acquisition profit of subsidiary
If the subsidiary has already paid dividends out of post acquisition profit, the matter
should be regarded as closed and nothing more needs to be done about this. When the
subsidiary paid dividends, it would have debited the amount to its statement of profit or loss
and credited to cash account.
Interim dividend received from subsidiary
The parent company may receive interim dividend from the subsidiary. Interim
dividend is usually declared and paid in the middle of the year. Interim dividend is to be
apportioned between the pre acquisition period and post acquisition period on the basis of
time ratio on the assumption that interim dividend is earned equally throughout the year.
Proposed dividend out of post acquisition profit
Usually dividends are proposed by the subsidiary out of post acquisition profits. The
basic rule is that if a subsidiary has not yet paid a dividend on the equity capital, this
appropriation shall be ignored in consolidation. The full amount of revenue profit attributable
to parent company’s share in the subsidiary is taken in the consolidated balance sheet as
usual. To eliminate the proposed intra group dividend in the consolidated balance sheet, the
following journal entry is to be passed
Proposed dividend a/c dr
To dividend receivable
Example

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Intra group investment in debentures


The parent company and its subsidiary may often buy each other’s debentures or
bonds. If the parent company has invested in the debentures of the subsidiary, it is shown as
investment in debentures of subsidiary in the balance sheet of the parent company.
Parent company which has two subsidiaries
Sometimes a parent company may have two subsidiaries. Then the parent and its two
subsidiaries constitute a group. In such cases, the preparation of consolidated balance sheet is
somewhat difficult.
Consolidated statement of profit or loss
In addition to the consolidated balance sheet, the group is required to prepare the
consolidated statement of profit or loss and other comprehensive income. There are two
options. One option is to prepare two separate statements:
a. Statement of profit or loss,
b. Statement of other comprehensive income.
Impact of intra group trading on consolidated statement of profit or loss
When one company in a group sells goods to another, the same amount is added to the
sales revenue of the first company and to he cost of sales to the second company. The
consolidated figures for sales revenue and cost of sales should represent sales to, and
purchase from, outsiders. Therefore, an adjustment is necessary to reduce the sales revenue
and cost of sales figures by the amount of intra group transactions. This means that such intra
group transactions should be cancelled in the consolidated statement of profit or loss.
The goods sold at a profit within the group may remain in stock of the purchasing company at
the year end. Then unrealized profit included in such inventory should be excluded from the
figure of group profits. The best way to deal with this is to calculate the unrealized profit on

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unsold stock at the yar end and add this amount back to cost of sales, thereby reducing gross
profit.
Acquisition during the accounting year
If the subsidiary is acquired during the accounting year, it is necessary to apportion its
profit for the year between pre acquisition period and post acquisition period. For this the part
year method may be used. Under this method, the entire statement of profit or loss of the
subsidiary is spelt between pre acquisition and post acquisition proportions. Only the post
acquisition figures are included in the consolidated statement of profit or loss.
Consolidated statement of profit or loss and other comprehensive income
After preparing the consolidated statement of profit or loss, it is easy to prepare
consolidated statement of profit or loss and other comprehensive income. Any item of other
comprehensive income is attributable to either the parent or a subsidiary. If it is attributable to
the subsidiary, part of it is allocated to the non controlling interest.
Fair value in acquisition accounting
Fair values are important in the accounting of acquisition of a subsidiary. To calculate
goodwill arising on consolidation, it necessary to have fair values of assets and liabilities. For
example, the market value of a freehold building may have sharply risen since it was
acquired. But the asset may appear in the balance sheet at historical cost less accumulated
depreciation.
IFRS 3 (Ind AS 103) and IFRS 13 (Ind AS 113)
IFRS 3 (Ind AS 103) business combinations gives general principles for arriving at
the fair values of subsidiary’s assets and liabilities. The acquirer should recognize the
acquiree’s identifiable assets, liabilities and contingent liabilities at the acquisition date only
if they satisfy the following conditions:
a. In the case of an asset other than an tangible asset, it is probable that any associated
future economic benefits will flow to the acquirer, and its fair value can be measured
reliably.
b. In the case of a liability other than a contingent liability, it is probable that an outflow
of resources embodying economic benefits will be required to settle the obligation,
and its fair value can be measured reliably.
c. In the case of an intangible asset or a contingent liability, its fair value can be
measured reliably.
IFRS 13 (Ind AS 113) fair value measurement provides guidance on how the fair value of
asset and liabilities should determined. The following should be considered in determining
fair value.
a. The asset or liability being measured
b. The principal market or where there is no principal market, the most advantageous
market in which an orderly transaction would take place for the asset or liability.

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c. The highest and best use of the asset or liability and whether it is used on a stand
alone basis or in conjunction with other assets or liabilities.
d. Assumptions that market participants would use when pricing the asset or liability.
Ind AS 27 separate financial statements
Separate financial statements are those presented by a parent (ie an investor with
control of a subsidiary) or an investor with joint control of, or significant influence over, an
investee, in which the investments are accounted for at cost or in accordance with Ind AS
109, Financial Instruments.
Preparation of separate financial statements
Separate financial statements shall be prepared in accordance with all applicable Ind
AS. When an entity prepares separate financial statements, it shall account for investments in
subsidiaries, joint ventures and associates either:
(a) at cost, or
(b) in accordance with IndAS 109. The entity shall apply the same accounting for each
category of investments. Investments accounted for at cost shall be accounted for in
accordance with Ind
AS 105, Non-current Assets Held for Sale and Discontinued Operations, when they are
classified as held for sale (or included in a disposal group that is classified as held for sale).
The measurement of investments accounted for in accordance with Ind AS 109 is not
changed in such circumstances.
Parent ceases to become an investment entity
When a parent ceases to be an investment entity, or becomes an investment entity, it shall
account for the change from the date when the change in status occurred, as follows:
(a)when an entity ceases to be an investment entity, the entity shall, in accordance
with paragraph 10, either:
(i) account for an investment in a subsidiary at cost. The fair value of the
subsidiary at the date of the change of status shall be used as the deemed cost at that
date; or
(ii) continue to account for an investment in a subsidiary in accordance with
Ind AS 109.
(b) when an entity becomes an investment entity, it shall account for an investment in
a subsidiary at fair value through profit or loss in accordance with Ind AS109. The difference
between the previous carrying amount of 930 the subsidiary and its fair value at the date of
the change of status of the investor shall be recognised as a gain or loss in profit or loss. The
cumulative amount of any fair value adjustment previously recognised in other
comprehensive income in respect of those subsidiaries shall be treated as if the investment
entity had disposed of those subsidiaries at the date of change in status.
Ind AS 28 investments in Associates and Joint ventures

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Ind AS 28 investment in Associates and joint ventures outlines how to apply, with
certain limited exceptions, the equity method to investments in associates and joint ventures.
Difference between associates and joint ventures
Associates are entities over which the investor has significant influence. Joint
ventures, on the other hand, are entities over which the ventures have joint control.
Significant influence
If an entity holds, directly or indirectly (eg through subsidiaries), 20 per cent or more
of the voting power of the investee, it is presumed that the entity has significant influence,
unless it
can be clearly demonstrated that this is not the case. Conversely, if the entity holds, directly
or
indirectly (eg through subsidiaries), less than 20 per cent of the voting power of the investee,
it is presumed that the entity does not have significant influence, unless such influence can be
clearly demonstrated. A substantial or majority ownership by another investor does not
necessarily preclude an entity from having significant influence.
Equity method
Under the equity method, on initial recognition the investment in an associate or a
joint venture is recognised at cost, and the carrying amount is increased or decreased to
recognise the investor’s share of the profit or loss of the investee after the date of acquisition.
The investor’s share of the investee’s profit or loss is recognised in the investor’s profit or
loss. Distributions received from an investee reduce the carrying amount of the investment.
Adjustments to the carrying amount may also be necessary for changes in the investor’s
proportionate interest in the investee arising from changes in the investee’s other
comprehensive income. Such changes include those arising from the revaluation of property,
plant and equipment and from foreign exchange translation differences.
Goodwill / capital reserve
On acquisition of the investment, an entity recognizes goodwill or a capital reserve. It
is based on the difference between the cost of the investment and an entity’s share of the
identifiable net asset of the investee as on acquisition date. If the cost of investment exceeds
the entity’s share of the identifiable net assets of the investee, and the difference is goodwill.
Investors share of post acquisition profit or loss of investee
The carrying amount of an investment in associate, after the acquisition date, is
adjusted to recognize the investor’s share of post acquisition profit or loss and OCI of
the investee entity. The investor’s share of the profit or loss and OCI of the investee are
recognized in the investor’s profit and loss and OCI respectively.
Investors share of gain or loss in respect of downstream or upstream transactions
In case of any downstream transactions or an upstream transaction, the investor’s
share of gain or losses in such transactions is eliminated.

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Adjustment of preference dividend


if the investee has any cumulative preference shares that are held by outsiders, the
investor computes its share of profits and losses after adjusting for preference dividends
whether declared or not.
Loss of associate exceeding the cost of investment
If an entity’s share of losses of an associate or a joint venture equals or exceeds its
interest in the associate or joint venture, the entity discontinues recognizing its share of
further loss. After the entity’s interest is reduced to zero, additional losses are provided for
and liability is recognized, only to the extent that the entity ahs incurred legal or constructive
obligations or made payments, on behalf of the associate or joint ventures.
Amalgamation (acquisition of entire entity)
Previously, amalgamation (including absorption and external reconstruction) was
dealt with in AS 14. But now AS 14 is replaced with IFRS 3 (or AS 103)
Example

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MODULE-V
Double account system
(Accounts of electricity companies)
Meaning of Double Account System:
The Double Account System is a method of presenting the annual final accounts/annual
financial statements of public utility undertakings, like Railways, Electricity, Gas, Water
Supply, Tramways etc.
Features of Double Account System
1. Generally, a public utility undertaking needs a large amount of capital which is invested in
the acquisition of fixed assets. Therefore, fixed assets, fixed liabilities and current assets,
current liabilities are to be separately dealt with. Fixed Assets and fixed or long-term
liabilities are recorded in Receipts and Expenditure on Capital Account. Similarly, current
assets and current liabilities are recorded in the General Balance Sheet.
2. Revenue Account and Net Revenue Account are prepared instead of Profit and Loss
Account and Profit and Loss Appropriation Account.
3. Normally, no adjustment of asset is made in the Capital Account.
4. Depreciation is not deducted from the asset concerned but the same is shown as a liability
by way of a fund. And, as such, fixed assets are recorded at book value.
5. Any kind of funds and reserve — e.g., Sinking Fund, Depreciation Fund, General Reserve,
Capital Reserve, the Balance of Revenue/Net Revenue Account — are shown in the liabilities
side of the General Balance Sheet.
6. Discount and Premiums are permanently treated as capital items.
7. Loan capital (debentures) Shares and Stocks are treated as capital items.
8. Interest on Loan and Debentures (i.e., all fixed interests) are to be charged against Net
Revenue Account.
Advantages of Double Account System
1. As Depreciation fund is compulsorily created and invested in outside securities, it helps to
replace an asset without affecting the liquid resources, viz., Cash, of the concern.
2. Revenue account represents the operating activities which expresses the operating result of
the undertaking while extraneous items are recorded on Net Revenue Account which
expresses the real operational result.
3. The capital account helps us to understand the source of capital in various forms and the
application of same in the form of various fixed assets. Thus, it can easily be followed by an
ordinary person.
4. Since these concerns enjoy almost monopoly rights given by the Govt., the Govt, may
understand whether the concern supplies the efficient service at reasonable cost or not after
analysing its prescribed format of accounting.

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5. The undertakings may compile at ease various statistical returns which reflect the service
given to the public since the accounts are published in a standardized form.
Difference between single account system and double account system.
(a) Under Single Account System, only one Balance Sheet is prepared which contains
assets and liabilities. But, under Double Account System, The Balance Sheet is split
up into two parts (i) Capital Account, and (ii) The General Balance Sheet.
(b) Under Single Account System, the purpose of preparing accounts is to show the
financial position of a firm at a particular date whereas, under Double Account
System, the purpose is to show the amount of capital received and the application of
the same in fixed assets.
(c) Under Single Account System, depreciation is deducted from the respective assets in
the Balance Sheet. Under Double Account System, however, the fixed assets are
always shown at book value, i.e. they are not written-down in the books.
(d) The revenue account is known as Profit and Loss Account and Profit and Loss
Appropriation Account, respectively, under Single Account System. But the same is
known as Revenue Account and Net Revenue Account under Double Account
System.
Final accounts under double account system
The final account under double account system consist of :
1. Revenue account
2. Net revenue account
3. Capital account
4. General balance sheet
Revenue Account
All items of expenditure appear on the debit side whereas all items of income appear
on the credit side of Revenue Account.
Revenue account for the year ended
A.Generation 1. Sale of energy for lighting
1. to fuel 2. Sale of energy for power
2. To oil, wastage , water 3. Sale of energy under special
3. salary of engineers contracts
4. to wages and gratuities 4. Public lighting
5. repairs and maintenance 5. Rental of meters
B. distribution 6. Rent receivable
1. salary of engineers 7. Transfer fees
2. wages and gratuities 8. Other items
3. repairs and maintenance 9. Miscellaneous receipts
c. public lamps 10. Sale of ashes

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1. attendants and repairs 11. Reconnection and


2. renewals reconnection fees
D. rent rates and taxes
1. rent payable
2. rates and taxes
E. management expenses
1. directors remuneration
2. management expenses
2. general establishment
3. auditors report
F. law charges
G. depreciation
1. depreciation on lease
2. depreciation on building
3. dep on plant and maint, meters
etc
H. special charges
1. bad debts
Total expenditure
Total income
Total expenditure
Balance carried to net revenue
account

Net revenue account


Net revenue account shows appropriation items. It should be noted that interest on
loan and debentures is debited to net revenue account and not in the revenue account. This
because under double system debentures and long term loan are considered as the part of the
capital.

1. Interest on security deposits 1. Balance from last year


2. Interest on fixed loans 2. Balance brought from revenue
3. Contingency reserve account
4. Dividend 3. Bank interest
5. Reserve for rebate to customers 4. Interest on calls in arrears
6. Interest on calls in advance’
7. Balance carried to general
balancesheet

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Capital Account
It is also known as Receipts and Expenditure on Capital Account. The purpose of this account
is to show the sources of total capital and the application of the same in different fixed assets.
It contains expenditure of a capital in the left hand side (or debit side) including additions to
fixed assets. Three columns are generally used for the purpose—the first column shows the
expenditure on each item at the end of last year, the second one shows the additions which
are made for the current year, and the third column represents the total capital expenditure to
date.
On the other hand, the right hand side (or credit side) reveals the receipts on capital account
including amount received from public for shares and debentures including the amount of
fixed loans, if any. Premium received on shares and debentures or any calls paid in advance
are also to be added and Calls-in-arrear is to be deducted. Three columns are also used—the
first column shows the receipts on each item at the end of last year, the second column shows
the receipts for the current year and the third column represents the total capital receipts to
date.

General Balance Sheet


This is actually the second part of the Balance Sheet which contains current assets and
current liabilities together with the balance or totals of each side (as the case may be) of
capital account. Certain other items, e.g., any kind of reserve, say, General Reserve, Capital
Reserve etc., or any kind of funds, e.g., Depreciation Fund, etc., also will appear in the

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Balance Sheet. The assets are recorded in the right hand side (asset side) and liabilities are
recorded in the left hand side (liabilities side), i.e., it is prepared in its usual form.

Prepare a Revenue Account, Net Revenue Account and the General Balance Sheet under the
Double Account System from the following Trial Balance as on 31.12.1993, of the Rural
Electric Supply Co. Ltd. A Call of Re. 1 per share was payable on 30.6.1993 and arrears are
subject to interest at 10% p.a.
Depreciation to be provided for on opening balance on Buildings 2½%, Machinery 7½%,
Main 5%, Transformer etc. 10%, Meters and Electrical Instruments 15%, Advertising has
been prepaid by Rs. 5,000 and provision of 5% to be made for doubtful debts.

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Final accounts of electricity companies


The electricity (supply)act, 1948 came into force on 10th September 1948 and was
modified by the electricity supply amendment act, 1956. The financial provision contained in
the 6th and 7th schedules to the above /act are applicable to all electricity supply companies in
india.

Annexure V of the Indian electricity Rules, 1956 presents the following statements:
Form No contents

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I : statement of share and loan capital


II : statement of capital expenditure
IIA : statement showing the written cost of fixed asset retired
III : statement of operating revenues
IV : statement of operating expenses
V : statement of provision for depreciation
VI : statement of contingencies reserve
VII : statement of tariffs and dividends control reserves
VIII : statement of consumer’s rebate reserve
IX : statement of special appropriation permitted by the state government
X : statement of net revenue and appropriation account
XI : general balancesheet
Statement of I and II resemble the receipts and expenditure on capital under double account
system stated earlier, whereas statements III and IV constitute the “revenue account” .
statement of X is the Net revenue account

Important financial provisions contained in the electricity (supply) Act


1. Reasonable Return:
The law seeks to prevent an electricity undertaking from earning too high a profit.
For this purpose, “reasonable return” has been defined as consisting of:—
(a) An yield at the standard rate, which is the Reserve Bank rate (10% w.e.f. 11th July, 1981)
plus two per cent on the capital base as defined below;
(b) Income derived from investments except investments made against Contingencies
Reserve;
(c) An amount equal to ½ per cent on loans advanced by the Electricity Board;
(d) An amount equal to ½ on the amounts borrowed from organizations or institutions
approved by the state government.
(e) An amount equal to ½ per cent on Debentures.
(f) An amount equal to ½ per cent on the balance of Development Reserve.
(g) Such other amounts as may be allowed by the control government having regard to the
pervading tax structure in the country.
2. “Capital Base” means:
(a) The original cost of fixed assets available for use and necessary for the purpose of the
undertaking less contribution, if any, made by the consumers for construction of service lines
and also amounts written off;
(b) The cost of intangible assets;

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(c) The original cost of works in progress;


(d) The amount of investments made compulsorily against Contingencies Reserve together
with the amount of such investments from contributions towards depreciation as in the
opinion of the central Electricity Authority could not be utilised for the purpose of the
business of electricity of the undertaking; and (e) the monthly average of the stores, materials,
supplies and cash and bank balances held at the end of each month.
Less:
(i) The amounts written off or set aside on account of depreciation of fixed assets and
amounts written off in respect of intangible assets in the books of the undertaking;
(ii) Loans advanced by the Board;
(iii) The amount of any loans borrowed from organisations or institutions approved by the
state government,
(iv) Debentures;
(v) Security deposits of consumers held in cash;
(vi) The amount standing to the credit of the Tariff and Dividends Control Reserve;
(vii) The amount set apart for the Development Reserve; and
(viii) The amount carried forward in the accounts of the licensee for distribution to
consumers.
3. Clear Profit:
Clear Profit means the difference between the total income and the total expenditure plus
specific appropriations. The Act defines the three terms—income, expenditure and
appropriations.
4. Disposal of Surplus:
Should the clear profit exceed the reasonable return, the surplus has to be disposed of as
under—
(a) One-third of the surplus not exceeding 5% of the reasonable return will be at the disposal
of the undertaking;
(b) Of the balance, one-half will be transferred to “Tariffs and Dividends Control Reserve”;
and
(c) The balance will be distributed among consumers by way of reduction of rates or by way
of special rebate.
An electricity undertaking must so adjust rates that the amount of clear profit in any year does
not exceed the reasonable return by more than 20% of the reasonable return.
5. Tariffs and Dividends Control Reserve:
This can be utilised whenever the clear profit is less than the reasonable return. The balance
in the Reserve must be handed over to the purchaser of the undertaking, if it changes hands.

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6. Contingencies Reserve:
A sum equal to not less than 1/4% and not more than 1/2% of the original cost of fixed assets
must be transferred from the revenue account to Contingencies Reserves until it equals 5% of
the original cost of fixed assets. The amount of the reserve must be kept invested in trust
securities.
7. Development Reserve:An amount equal to income-tax and super tax (calculated at current
rates) which would have been paid but for the development rebate allowed by income-tax
authorities on installation of new plant and machinery, has to be transferred to the
Development Reserve Account.
If, in any accounting year, the clear profit excluding the special appropriation together with
the accumulations, if any, in the Tariff and Dividends Control Reserve less the amount to be
credited to Development Reserve falls short of the reasonable return, the sum to be
appropriated to the Development Reserve in respect of such accounting year may be reduced
by the amount of the shortfall.

The following balances have been extracted from the books of an electricity company at
the end of the accounting year:

In the accounting year, the company earned a profit of Rs. 28, 00,000 after tax. Assuming the
bank rate is 10%, show how you deal with profits of the company.

Corporate Accounting Page 186


School of Distance Education

Corporate Accounting Page 187