“PREFACE”
There has been a long-standing demand from students & teachers to write a
separate “Hand book” which will contain brief explanation of Topics, Terms, and
Important formulas, Format. I am very happy to introduce this “Hand book” for
the benefits of students & teachers
This done keeping in mind that this is the 1
styear (FYJC) for the study of this
subject, which will lay the foundation for vast & practical subject for the future.
It strictly follows a “Student – friendly” approach and has been written purely in
a “Teach- yourself “style. Thus, it would essentially serve as a Tutor at Home.
As I discussed the topic in brief & in simple. Straightforward & easy language to
make it easy for students to understand & remember. I express the hope that the
teachers as well as the students will welcome this “Hand Book”.
Any criticism or suggestion for further improvement of the book will be gratefully
acknowledged & highly appreciated.
Author
Prof. Jha Nishikant (“Nishi Sir”)
I.Sc., DCA, B.Com.,ICWA
What is Book –Keeping?
“Book” means “Books of Accounts” & “ Keeping” means “ Maintaining the books of Accounts.”
It is a Scientific Method to record day-to-day “ BUSINESS TRANSACTION” in books of Accounts in such a manner that it gives us a correct and clear picture of financial position of the business.
Classification of Accounts:
As we are knowing that, in every transaction at least two aspects / amount are affected, this two fold
of every transaction in two Accounts is know as Double Entry System of Book – Keeping.
Three Golden rules for Book – Keeping & Accountancy are a follows:
For Personal A/c: “DEBIT THE RECEIVERCREDIT THE GIVER” e.g. .1. Nihikant Pays Rs3000/- to M/s Nishi & Co.
Ans: DEBIT M/s Nishi & Co. A/c (As receiver) &
CREDIT Nishikant’s A/c (As giver)
For Real A/c : “DEBIT WHAT COMES IN ;CREDIT WHAT GOES OUT” e.g. 2. Purchase goods for Cash Rs
3000/-Ans; DEBIT Goods A/c (As comes in)
CREDIT Cash A/c (As goes out)
For Nominal A/c: “ DEBIT ALL LOSSES & EXPENSESCREDIT ALL INCOME &* GAINS” e.g.3. Paid Salary Rs
3000/-Ans: DEBIT Salary A/c (As expenses)
CREDIT Cash A/c (As goes out)
JOURNAL: It is a book of Prime Entry, in which daily transactions are recorded for the first time. JOURNALIZE: it means record the transactions by passing Journal Entry; i.e. giving effects of every
transaction in terms of debit and credit by applying rules of Debit & Credit of different types of Account
Real A/c
Related with Tangible & Intangible Assets or Things
(e.g. Cash A/c, Goods A/c, Goodwill A/c, Land Building A/c, Plant & Machinery A/c)
Nominal A/c
Related to Expenses / Losses & Income /
Gains (e.g. Wages / Salary A/c, Rent A/c,
Loss by fire / Theft A/c etc)
Personal A/c
Name of the person / Institution;
Outstanding & prepaid Expenses
(e.g. Nitin’s A/c, Thakur College A/c, O/s
salary A/c etc)
Journal of ………..
Date Particulars L/F Debit
Amt
Credit Amt DD/MM/YY Name of the A/c Debit………Dr.
To Name of A/c Credited. (Narration / Explanation)
** **
e.g. 1. Nishi & Co A/c…………...Dr. To Nishikant’s A/c
(Being Nishikant Pays to Nishi & Co.)
3000
3000 2. Good A/c………..Dr.
To Cash A/c
(Being Purchase goods for Cash)
3000
3000 3. Salary A/c……….…Dr.
To Cash A/c
(Being Salary paid)
3000
3000 LEDGER:
“A Ledger A/c contains Summary statement of all the transactions to a Person, Asset, Expenses, and Incomes etc. which have taken place during a given period of time and show their Net Effect.”
LEDGER POSTING:
“An act of recording the transaction in the Ledger A/c on the basis of the entry made in Journal.”
RULE OF POSTING:
Same Sides, Same Amount, but Opposite A/c
LEDGER of…….
Dr. Name of A/c Cr.
Date Particulars J/F Amt. Date Particulars J/F Amt DD/MM/YY To Name of the
A/c Credited ** DD/MM/YY By Name of the A/c Debited ** Ledger posting of above three e.g.
Dr. M/s Nishi & Co. A/c Cr.
Date Particulars J/F Amt. Date Particulars J/F Amt DD/MM/YY To Nishikant’s A/c 3000 DD/MM/YY
Dr. Nishikant’s A/c Cr.
Date Particulars J/F Amt. Date Particulars J/F Amt
DD/MM/YY DD/MM/YY By Nishi & Co. A/c 3000
Dr. Goods A/c Cr.
Date Particulars J/F Amt. Date Particulars J/F Amt DD/MM/YY To Cash A/c 3000
Dr. Salary A/c Cr.
Date Particulars J/F Amt. Date Particulars J/F Amt DD/MM/YY To Cash A/c 3000
Dr. Cash A/c Cr.
DD/MM/YY By Goods A/c
By Salary A/c 30003000 Notes:
i. In a specific ledger that A/c can never be Debited on Credited
ii.
If ledger A/c is having an opening balance then it will start with the word “ Balance b/d” (i.e.brought down). However if the ledger A/c is having a closing balance then it will close with the
word “Balance c/d” (i.e. carried down)
iii.
All closing balance of ledger A/c is transfer to “Trail Balance” at the end of every Financial Year.iv. TRIAL Balance:
v. If a statement showing the list of A/c with they’re closing balance i.e. either Debit or Credit balance.
It shows “ ARITHMETICAL ACCURACY” of ledger Posting. It should be tallied. If there is any difference, for time being it should be transferred to “SUSPENSE A/c.”
There are two types of “Trial Balance “. They are as follows:
Journal Form / Statement Form of Trail Balance:
Trail Balance of………as on ………..
Sr. No Particulars L/F Debit bl. Credit bl. Capital Assets Total ** ** ** **
Ledger From of Trail Balance:
Trail Balance of………as on ………..
Sr. Particulars J/F Debit Sr. Particulars J/F Credit 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Purchase Sales Return / Return Inward Expenses / Loss Bad Debts Stock Drawings Debtors Bills Receivable Cash / Bank Balance Prepaid Expenses Outstanding Incomes Loan given Depreciation All Assets ** ** ** ** ** ** ** ** ** ** ** ** ** ** 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Sales Purchase Return / Return Outward Incomes/ Gain Bad Debts Recovery Gross Profit Capital Creditors Bills payable Bank Overdraft Outstanding Expenses Advance income Loan taken Reserve / Funds All liabilities ** ** ** ** ** ** ** ** ** ** ** ** ** ** Total ** Total **
FINAL ACCOUNT OF SOLE TRADER:
Final Account and Statement are prepared by a Trader at the end of financial year in order to find out Profit or Loss and the position of total Assets & Liabilities of the Business.
What will be given in the Problem?
a) Trial Balance & b) Adjustments
We are required to prepare final account, which consist of the following: a. Trading Account
b. Profit & Loss Account c. Proprietor’s Capital Account d. Balance Sheet
Trading A/c for the year ended……….
Particulars Rs Particulars Rs
To Opening Stock
To Purchase Less: Purchase Returns To Exp related to Purchase Carriage Inward Octroi Duty Freight To Manufacturing Exp
To Wages To Power & Fuel
To All Factory Expenses To Gross Profit c/d (Bal Fig)
** ** ** ** ** ** ** By Sales ** Less: Sales Return ** By Closing Stock
By Goods Loss by fire or theft By goods donated or withdrawn by Proprietor
By goods distributed as free sample
By Gross Loss c/d (Bal. Fig)
** ** ** ** ** ** *** ***
Profit & LOSS ACCOUNT
Profit and Loss Account for the year ended………..
To Gross Loss b/d Office Adm Exp: To Salaries To Office Rent
To Print & Stationery To Sundry Expenses Selling & Dist Exp:
To Commission to Salesman To Advertisement To Packing Charges To Carriage Outward To financial Expenses To Interest on Loan To Bad Debts
To Loss on Sale of Asset To Discount Allowed Depreciation:
To Plant & Machinery To Land & Building To Furniture To Net Profit c/d ** ** ** ** ** ** ** ** ** ** ** ** ** ** ** ** ** ** By Gross Profit b/d By Discount Recd. By Commission Recd By Dividend Recd
By Bad Debts Recovered By Interest Recd
By Apprenticeship Prem. By Sundry Income
By Profit on Sale of Asset
By Net Loss c/d ** ** ** ** ** ** ** ** ** ** *** ***
Proprietor’s Capital Account
Particulars Rs. Particulars Rs.
To Net Loss To Drawings
To Interest on Drawings To Balance c/d
(Trans. To B/s Liability Side)
** ** ** ** *** By Balance B/d By Net Profit By Interest on Capital By Balance c/d
(Trans. To B/s Assets Side)
** ** ** ** *** OR
Proprietor’s Capital Account
Opening Balance ****
Add: Net Profit **
Less: Drawings **
Add: Interest on Capital ** Less: Interest on Drawings **
****
Balance Sheet as on ………….
Liability Rs Assets Rs
Proprietor’s Capital A/c Loans from Bank
Loans from others Current Liabilities: Sundry Creditors Bills Payable Outstanding Expenses Advance Income Bank Overdraft ** ** ** ** ** ** ** ** Fixed Asset: Goodwill
Land & building Plant & Machinery Furniture Current Assets: Closing Assets: Closing Stock Loose Tolls Bills Receivable Cash at Bank Cash at Hand Outstanding Income Prepaid Expenses
Deferred Revenue Expense
** ** ** ** ** ** ** ** ** ** ** ** **
Suspense A/c ** ***
Advertisement Suspense A/c
Miscellaneous Expenses (Fictious) **** ** *** IMPORTANT NOTES FOR FINAL ACCOUNTS:
a.
All items of Trial balance will have ONLY ONE EFFECT b. Items on the Debit side of the Trail Balance will appearEITHER on Trading Account DEBIT SIDE
OR on Profit & Loss Account DEBIT SIDE
OR on Balance Sheet ASSET SIDE
c. Items on the Credit side of the Trading Balance will appear
EITHER on Trading Account CREDIT SIDE
OR on Profit & Loss A/c CREDIT SIDE
OR on Balance Sheet LIABLITIES SIDE
d. All adjustment will have two effects.
e. Generally speaking, all items relating to the goods and direct Expenses like Freight, Wages, Custom Duties, Fuel & Power etc. will be shown under Trading Account.
f. All items of Incomes & Expenses (other than above direct expenses) will be shown under Profit & Loss Account
g. Items of Assets and Liabilities will be shown in Balance Sheet.
ADJUSTMENTS:
Certain transactions came to our notice after Trail Balance is prepared, however have to be considered while preparing Trading A/c, Profit & Loss A/c, Balance Sheet are know as adjustment. An item in adjustments will appear at two places while item in Trial Balance at only one place.
No Adjustments One Effect (Debit) Second Effect (Credit)
1 Closing Stock Trading a/c. Credit Side Balance Sheet Asst Side
2 Outstanding Expenses Trading a/c OR P/L a/c Balance Sheet – Liabilities Side Debit Side add to Expenses
3 Prepaid Expenses Trading a/c OR P/L a/c Balance Sheet Asset Side
Debit Side less from Expenses
4 Outstanding Income P/L a/c Credit Side add to Income Balance Sheet Asset Side 5 Pre Received Income P/L a/c Credit Side less from Income Balance Sheet – Liabilities
6 Depreciation P/L a/c Debit Side Balance Sheet less from Assets
7 Further Bad Debts P/L a/c Debit Side Add to Bad Debts Balance Sheet less from Debtors 8 R.B.D P/L a/c Debit Side add to Bad Debts Balance Sheet less from Debtors 9 R.D.D P/L a/c Debit Side add to Discount allowed Balance Sheet less from Debtors (Net)
Note: If old RBD / RDD is more than total of B>D / Discount allowed and new RBD /RDD the whole thing will come on
the credit side of P/L a/c 10 Goods distributed as
Samples Trading a/c Credit Side P/L Debit Side as Advt Expense
11 Goods Withdrawn by
Proprietor Trading a/c Credit Side Balance Sheet – Add to Drawings OR Less from Capital i.e.. Capital a/c Debit Side
12 Goods destroyed by fire
Trading a/c Credit Side P/L a/c Debit Side as loss by fire (our share of loss) Balance Sheet Asset Side (for Insurance Claim receivable)
13 Goods lost by theft Trading a/c Credit Side P/L a/c Debit Side 14 Credit purchase left
out to be recorded
Trading a/c add to purchase Balance Sheet add to Creditors liabilities Side
15 Credit sales left out to
be recorded Trading a/c add to Sales Balance Sheet add to Debtors Asset side
16 R.D.C P/L a/c credit side add Balance Sheet – liabilities to Discount
recd & less from Creditors
Subsidiary book are the division & sub – division of journal, so that time & labor could be saved by grouping similar transactions together & providing a separate book.
The subsidiary book maintain by business organization are:
a.
Purchase book: to record all credit purchases of goods onlyb.
Sales book: to record all credit sales of goods onlyc.
Purchase Returns Book: to record goods returned to suppliers out of credit purchased.
Sales Returns Book: to record goods returned by customers out of credit sales of goods.e.
Cash Book: to record all cash transactions onlyf.
Analytical Petty Cash Book: to record Petty Paymentsg.
Bills Receivable Book: To record all bills of exchange which are received from Debtorsh.
Bills Payable book: to record all Bills of exchange accepted & given to Creditorsi.
Journal Proper: it is used to record only those business transactions which cannot be entered in any of above eight booksIt will record following transactions: a. Opening Entries
b. Adjustments Entries c. Transfer Entries d. Closing Entries e. Rectification Entries
f. Dishonor of bills & Promissory note entries g. Credit Purchase of assets
h. Credit Sales Assets i. Bad Debts Entries
Format of Purchase Book
Date Name of Supplier L/F Inward Invoice No. Amt
Format of Sales Book
Date Name of Customer L/F Outward Invoice No. Amt
Format of Purchase Return Book
Date Name of the suppliers to whom goods are returned L/F Debit Note No.
Amt
Format of Sales Return Book
Date Name of the Customer who returns the goods L/F Credit Note No.
Amt
Rules to record a Transaction in Subsidiary Book:
Sr
No Transactions In ledger Reasons
1. 2. 3. 4. 5. 6.
Sales / Purchase Return Purchase / Sales Return Total of Purchase Book Total of Sales Book
Total of Purchase Return Book Total of Sales Return Book
Party’s A/c Party’s A/c Purchase A/c Sales A/c
Purchase Return A/c Sales Return A/c
Debit Receiver Credit Giver Debit Good comes in Credit Goods goes out Debit Goods comes in
CASH BOOK: The cashbook is a book of original entry. Where all cash & bank Transactions relating to
receipt & payments are recorded. It serves the purpose of journal as well as ledger.
Since the cashbook enables the trader to find out the daily cash & bank balance, there is no need to open separate Cash A/c & Bank A/c
Different Types of Cash Book:
i. Simple Cash Book is single column cashbook with one cash column on each side. ii. Double column cash book viz. Cash & Discount column on each side
iii. Triple column cash book viz. Cash, Discount & Bank column on each side
Dr. Format of three columns Cash Book Cr.
Date Receipts Discount Cash Bank Date Receipts Discount Cash bank
PETTY CASH BOOK:
Petty Cashbook is a separate cashbook where we record small or Petty Cash expenses of routine nature. It is of two Types:
i. Simple Petty Cashbook
ii. Analytical or columnar Petty Cashbook
Specimen Form
Bank Reconciliation Statement as on:
Rs Rs
Bank Balance as per Cash Book Add: 1) ………..
2) ……….. Less: 1) ………... 2) ………
Bank Balance as per Pass Book
** ** ** ** ** ** ** **
Transactions for the preparation of Bank Reconciliation Statement
Cash Book Pass Book
i. Cheques issued but not presented (not encashed, or dishonored or lost)
ii. Cheques drawn but not actually issued to parties iii. Cheque issued but not credited in cash book iv. Direct payment by the bank or transfer to other
accounts
v. Cheques deposited but not cleared (not realized, not collected, not credited or dishonored)
vi. Cheques discounted but dishonored
vii. Cheques debited in cash book but not deposited viii. Cheques or cash directly paid in bank by others or
transfer from others a/c
ix. Cheques deposited but not deposited in cash book x. Interest on deposits / investment, dividends credited
in pass book
xi. Wrong credit in pass book for deposit of Cheque, interest
xii. Interest on overdraft, bank charges, commission etc debited in pass book
xiii. Wrong Debit in passbook for issue of cheque, bank changes etc.
xiv. Wrong on excess credit in cashbook on payment side
Less Less NO NO Add Add Add NO NO NO NO NO NO NO Less Less NO NO NO Add Add Add Add Less
of cashbook has been overcast.
xv. Short credit in cashbook or payment side of cashbook has been under cast.
xvi. Short debit in cashbook or Receipt side of cashbooks has been under cast
xvii.Wrong on excess debit in cashbook on Receipt side of cash book has been overcast
NO Less Add Add Add Less NO NO NO NO RECTIFICATION of ERRORS
Errors mean “Mistake” to rectify means “to correct or make right what is wrong.” Therefore, rectification of errors is the process of correcting a mistake or mistakes made.
Different types of Errors and their rectification:
i. One side Errors: such errors can be rectified by giving only the rectification effect, rectification entry is not necessary. E.g.
Error of partial omission
Debit or Credit entries are not posted art all or posted more than once Debits are wrongly posted as credits and vice versa
Wrong totally of subsidiary books.
Difference in the amount posted to the Debit and Credit of the concerned account of an entry
Error in calculation of balance of an account
Balance of an account wrongly recorded while preparing Trail Balance Error in taking total of any items on both the columns of a Trail Balance E.g., A credit sale of Rs. 1000 from Nihikant’s has not been posted to his account Solution: Nishikant’s a/c should be credited.
ii. Two Side Errors: following steps are used in order to rectify the two side errors. 1st Step: Write wrong entry
2nd Step: Write Reverse Wrong Entry
3rd Step: wirte Correct Entry
From reverse wrong entry & correct entry. We will have to pass “Rectification Entry” which will nullify & cancel the wrong effect which is already caused due to some errors & will give correct effect. They are:
Error of Principle Compensating errors
Writing wrong amount in Journal or subsidiary book
Debiting or Crediting wrong A/c in Journal or subsidiary books or Ledger Recording transaction in wrong Subsidiary book
Posting of wrong amount. Posting to wrong side of an A/c. Posting of wrong amount to wrong A/c
Posting of wrong amount to wrong side of an A/c Posting to wrong A/c on wrong side
Double posting.
Solution:
Entry Dr Cr
Wrong Entry
M/s Nishi & co A/c Dr. To Sales A/c
Reverse Entry
Sales A/c Dr. To M/s Nishi & Co A/c
Correct Entry
Nishikant’s A/c Dr. To Sales A/c
Rectification Entry
Nishikant’s A/c Dr. To M/s Nishi & Co A/c
3000 3000 3000 3000 3000 3000 3000 3000 E.g.2. a credit purchase of Rs 3,000 from Nishikant is posted to his A/c as Rs. 30,000
Solution: Entry Dr Cr Wrong Entry Purchase a/c Dr. To Nihikant’s A/c Reverse Entry Nishikant’s A/c Dr. To Purchase A/c Correct Entry Purchase A/c Dr. To Nishikant’s A/c Rectification Entry Nishikant’s A/c Dr. To Purchase A/c 3000 30000 3000 3000 30000 3000 3000 3000 E.g. 3. A credit purchase from Nishi & Co has been wrongly recorded in sales book Rs. 3000/-Solution:
Entry Dr Cr
Wrong Entry
M/s Nishi & co A/c Dr. To Sales A/c
Reverse Entry
Sales A/c Dr. To M/s Nishi & Co A/c
Correct Entry
Purchase A/c Dr. To M/s Nishi & co A/c
Rectification Entry Purchase A/c Dr. Sales A/c Dr. 3000 3000 3000 3000 3000 3000 3000 3000
To M/s Nishi & Co A/c 6000
RECTIFICATION of Suspense A/c:
Suspense A/c is an artificial A/c, which is used to put difference of Trial balance. In order to avoid delay in the preparation of Final A/c.
When errors are detected after preparing Trail Balance & Balance of Suspense A/c is given in the problem then it is necessary to pass the rectification entry & post them in suspense A/c that must tally after making all rectification & post them into suspense ledger.
Session 2 Chapter II Accounting Standards
“The changing economic trend of the world requires balance sheet and accounts to be comparable and one that would reflect the common picture. Bringing Indian Accounting Standards on par with
international standards is a step which will help the investor community and the entire corporate world” –(Arun Jaitley, Former Law Minister)
Format of each standard contains:
1. A statement of concepts and fundamental accounting principles relating to the standards. 2. Definition of the terms used in standard.
3. The manner in which the accounting principles have been applied for formulating the standard 4. Presentation and disclosure requirements.
5. Class of enterprise to which it applies 6. Effective date.
Accounting Standards apply only to material items.
The Accounting Standard Board (ASB) of the Institute of Chartered Accountants of India has issued the following Accounting Standards that are to be followed but its members.
Accounting standards are collection of generally followed accounting principles, policies and practices. These help to ensure a common basis for financial statements different originations. This means that people can understand these more easily and make useful comparisons
Financial Statements are at the centre of business reporting. Financial statements usually provide users with essential information that heavily influence their decisions. The US is the leader in financial reporting, and US Securities and Exchange Commission is respected for it role in formulating and implementing US GAAP despite the general vote of confidence. In India the Statements on Accounting Standards are issued by the Institute of Chartered Accountants of India (ICAI) to establish standards that have to be complied with to ensure that financial statements are prepared with generally
accepted accounting standards in India (India GAAP)
The Council of ICAI constituted the Accounting Standards Board (ASB) in April 1977 to formulate Accounting Standards. While formulating the Accounting Standards, ASB takes into consideration the
applicable laws, usages and business environment. However, users were strongly critical about certain aspects of financial statements and they offered or supported many substantive ideas for
improvement. Standard setters, regulators, and many others devote considerate resources in maintaining and improving the standards.
The new accounting norms are aimed at protecting share / holders interest and recommending ways of improving corporate governance
AS-1: Disclosure of Accounting Policies. Effective date April 1993
This statements deal with the disclosures of significant accounting policies followed in preparing and presenting financial statements. The purpose of this statement is to promote preparing and presenting financial statements by instituting the disclosure of significant accounting policies in the financial statements and the manner of doing it.
The emphasis in AS-1 is on disclosure of accounting policies in the presentation of financial statements. These are normally to be disclosed at one place. All the companies now follow this
practice. Accounting Polices refer to the specified accounting principles, adopted by the enterprise and methods of applying these principles in the preparation and presentation of financial statements. Some of the areas in which such disclosure is to be made are as under:
1. Methods of depreciation, depletion, and amortization. 2. Treatment of expenditure during construction
3. Valuation of inventories
4. Conversion or translation of foreign currency items’ 5. Treatment of goodwill
6. Valuation of investments 7. Valuation of fixed asset
8. Recognition of profits on long term contracts 9. Treatment of retirement benefits
10. Treatment of contingent liabilities
It is for the management to select the accounting policy to be followed by the enterprise. However, while making this selection, it is necessary to ensure that the financial statements present a true and fair view of the state of affairs. The major considerations to be followed during the selection of accounting policies are stated in AS-1 as under.
Prudence: this is a world of uncertainty. Profits are recognized only when realized. At the same time, provisions for all known liabilities and losses are made though the amount represents only the best estimate.
Substance over form: the accounting treatment and presentation of transactions and events in the financial statements should be governed by their substance and not just by the legal form. For example, the accounting of finance leases is based on the substance rather than the form of transaction. The lessee capitalizes the lease equipment as fixed assets being the owner in the substance, whereas the lessor records the investment made as debtor
Materiality: financial statements disclose all material facts. The IASC audit materiality as under.
“Information is material if its omission or misstatement could influence the economic decision of users taken on the basis of financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or mist statements. Thus materiality provides a
threshold or cut-off point rather than being a primary qualitative characteristic whose information should be there to be useful.”
There are no hard and fast rules for determining materiality. Materiality is a matter of judgment. For instance, what is material to the financial statements of one firm may not be material to the financial statements of another firm of a different nature or size.
Fundamental Accounting Assumptions
As we discussed in the 1st sessions the fundamental accounting concepts underlie the preparation of
financial statements. Their use is not specifically stated in the financial statements because their use is assumed. If they are not accepted and used a disclosure of such facts should be made. The following are generally accepted fundamental accounting concepts.
Going concern Consistency
Accrual
AS-2 Valuation of Inventories
How to value and account for stocks? This standards was revised in June -99. Effective date: 1- Apr
-99
The standard deals with the principles of valuing inventories for financial statements including the ascertainment of cost of inventories and any write – down thereof to net realizable value.
Requirements:
1. Inventories should be valued at lower of cost and net realizable value.
2. The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to the present location and condition. Administrative, selling and distribution expenses, abnormal wastages should not be included in the cost of inventories 3. The cost of inventories of items that are not ordinarily interchanged, goods, and services produced
and segregated for specific projects should be assigned by specific identification of their individual costs.
4. the costs of inventories, other than those dealt with (3) above, should be assigned by using the first – in- first out (FIFO) or weighted average cost formula.
5. Under the weighted average formula, the cost of each item is determined from the weighted average of the cost of similar items at the beginning of the period and the cost of similar items purchased or produced during the year.
6. Generally, inventories are written down to net realizable value on an item-by-item basis. However, similar items can be grouped wherever it is appropriate.
Disclosure:
The financial statements should disclose the following:
The accounting policies adopted in measuring inventories, including the cost formula The total carrying amount of inventories and its classification.
AS – 3: Cash flow Statements
Preparing and presenting cash flow statements. Revised in March – 1997. Effective date: 1- Apr-2001 The statements deals with the provisions of information about the historical changes in cash and cash equivalents of an enterprise by means of cash flow statements which classifies cash flow during the period from operating, investing and financial activities.
AS-4: Contingencies and events occurring after Balance Sheet date. Revised in April-1995.
Effective date: 1-Apr-1995.
This standard deals with Contingencies, and
Events occurring after Balance Sheet date, financial statements.
This statements deal with the accounting treatment of contingencies and events occurring after Balance Sheet date. The standard does not apply to the following contingencies.
Liabilities of life insurance and general insurance enterprises arising from policies issued Obligations under retirement benefit plans.
Commitments arising from long term lease contracts.
Accounting
The amount of contingent loss should be provided for by a change in the profit and loss account if:
• It is probable that future events will confirm that, after taking into account any related probable recovery, an asset has been impaired or a liability has been incurred as at the Balance Sheet.
• A reasonable estimate of the amount of the resulting loss can be made.
• The existence of the contingent loss should be disclosed in the financial statements if either of condition in the above paragraph is not met, unless the possibility of loss is remote.
• The existence and amount of guarantees, obligations arising from discounted bills of exchange and similar obligations undertaken by an enterprise are generally disclosed in financial
statement by way of note, even though the possibility that a loss will occur to the enterprise is remote.
• Provisions and contingencies are not made in respect of general or unspecified business risks since they do not relate to conditions or situation existing at the balance sheet date.]
• Contingent gains should not be recognized in the financial statements
• Assets and liabilities should be adjusted for events occurring after the balance sheet date that provide additional evidence to assist the estimation of amounts relating to conditions existing at the balance sheet date or that indicate the fundamental accounting assumption of going concern.
• Dividends that are stated to be in respect of the period covered by the financial statements, which are proposed or declared by the firm after the balance sheet but before approval of the financial statements, should be adjusted.
Disclosure Requirements:
Disclosure should be made in the report of the approving authority of those events occurring after the balance sheet date represent material changes and commitments affecting the financial position of the firm. The following information has to be provided:
The nature of the event
An estimate of the financial effect or statement that such an estimate cannot be made.
AS-5: Net Profit or Loss for the period, prior period items and changes in Accounting Policies. Revised in Feb-1997. Effective date: 1 Apr-1996
The objective of this statement is to prescribe the classification and disclosures of certain items in the statement of profit and loss so that all enterprises prepare and present such statement on a uniform basis
Accounting
Net profit or Loss for the period, prior period items and changes in accounting policies. All items of income and expenses, which are recognized in a period, should be included in the determination of net profits or loss.
1. The net profit or loss for the period comprises the following components; Profits or Loss from ordinary activities
Extraordinary items
The above components should be disclosed on the face of the profit and loss statement.
2. Extraordinary items should be disclosed in the statement of profit and loss as a part of net profit or loss for the period. The nature and the amount of extraordinary item should be separately disclosed in the statement of profit and loss in a manner that its impact on current profit and loss can be perceived.
3. When items of income and expenses within profits and loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise foe the period, the nature and amount of such items should be disclosed separately.
Disclosure:
In the financial statements, there should be disclosure of i. The amount of construction work-in-progress
ii. Progress payments received and advances and retentions on account of contracts included in construction work-in-progress; and
iii. The amount receivable in respect of income accrued under cost, plus contracts not included in construction work-in-progress
iv. Disclosure of changes in an accounting policy used for construction contracts should be made in the financial statements giving the effect of the change and its amount.
AS-6: Depreciation Accounting. Revised in Aug-1994. Effective date: 1 Apr – 1995. Depreciation
should be charged on assets. Related information should be disclosed. Different enterprises adopt different accounting policies for depreciation. Disclosure of accounting polices for depreciation that are followed by an enterprises is necessary to appreciate the view presented in the financial statements of the enterprise
AS-7: Accounting for Construction Contracts. Effective date: 1 Arp-1993.
This standard deals with the determination of construction cost and its disclosure in accounts. A construction contract is a contract for the construction of an asset or a combination of asset, which
together constitute a single project. Examples of activity covered by such contracts include the construction of bridges, dams, ships, buildings and complex pieces of equipment
Types of construction contracts: construction contracts are formulated in a variety of ways but generally fall into two basic types:
Fixed price contracts: the contractor agrees to fixed contract price, or rate, in some cases subject to cost escalation clauses.
Cost plus contracts: the contractor is reimbursed for allowable or otherwise defined costs, and is allowed a percentage of these costs or a fixed fee.
Accounting Treatment of Construction Contract Costs and Revenue
The methods of accounting for contracts commonly followed by contractors are as under: Percentage of completion method
Completed contract method
Percentage of Completion Method: Revenue is recognized based on the stage of completion
reached as the contract activity progresses. The costs incurred in reaching the stage of completion are matched with the revenue, resulting in the reporting of results, which can be attributed to the
proportion of work completed. Although (as per the principle of prudence) revenue is recognized only when realized, under this method the revenue is recognized with the progress of the activity even though in certain circumstances it may not be realized.
Completed Contract Method: Revenue is recognized only when the contract is completed or
substantially completed, that is when only minor work is expected other than warranty obligation. Costs and progress payments received are accumulated during the course of the contract but revenue is not recognized until the contract activity is substantially completed.
Under both methods, provision is made for losses for the stage of completion reached on the contract. In addition, provision is usually made for losses on the reminder of the contract.
It may be necessary for accounting purpose to combine contracts made with a single customer or to combine contracts made with several customers if the contracts are negotiated as a package or if the contracts are for single project. Conversely, if a contract covers a number of projects and if the costs and revenue of such individual projects can be identified within terms of the overall contract, each such project may be treated as equivalent to a separate contract.
AS-8: Accounting for Research and Development: Effective date: 1 –Apr- 1993
This standard deals with the treatment of costs of research and development in the financial statements. The standard identifies items cost which compromise R&D costs lays down conditions under which R&D costs may be defined and requires specific disclosures to be made regarding R&D costs.
AS-9: Revenue recognition. Effective date: 1-Apr-1993
This statement deals with the basis to recognize revenue in the statement of profits and loss of an enterprise. The statement is concerned with the recognition of revenue arising in the course of ordinary activities of the enterprises
AS-10.Accounting for Fixed Assets: Effective Date: 1 Apr-1993.
Financial statements disclose certain information relating to fixed assets. In many enterprises these assets are grouped into various categories, such as land, building, plant and machinery, vehicles, furniture and fitting goodwill, patents, trade marks designs. This statement deals with the accounting for such fixed assets.
AS-11: Accounting for effects of changes in Foreign Exchange Rates. Effective date: 1-
Apr-1995
Objective: an enterprise may have transactions in foreign currencies or it may have foreign branches. Foreign currency transactions should be expressed in the enterprise’s reporting currency and the financial statements of foreign branches should be translated into the enterprise’s reporting currency in order to include financial statements of the enterprise the principle issues in accounting for foreign currency transactions and foreign branches are to take decision on the exchange rate to use and how to recognize the financial effect of changes in exchange rates in the financial statements.
Scope: This statement should be applied by an enterprise:
ii. In translating the financial statements of foreign branches for inclusion in the financial statements of the enterprise.
Disclosures: An enterprise should
disclose-1. The amount of exchange differences included in the net profit or loss for the period.
2. The amount of exchange differences adjusted in the carrying amount of fixed assets during the accounting period; and
3. The amount of exchange differences in respect of forward exchange contracts to be recognized in the profit or loss for one or more subsequent accounting periods.
AS-12: Accounting for Government Grants. Effective Date: 1 Apr- 1994.
These statements deal with the accounting for government grants. Government grants are sometimes called by other names such as Subsidies, Cash incentives, Duty drawbacks etc. this statement does not deal with:
1. The special problems arising in accounting for government grants in financial statements reflecting the effects of changing prices or in supplementary information of a similar nature.
2. Government assistance other than in the form of government grants; 3. Government participation in the ownership of the enterprise.
Definition:
“Government” refers to government agencies and similar bodies whether local, national or international
“Government Grants” are assistance by government in cash or kind to an enterprise for past or
future compliance with certain conditions. They exclude those forms of government assistance which cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading and transactions of the enterprise.
Disclosure:
The following disclosures are appropriate
1. The accounting policies adopted for government grants, including the methods of presentation in the financial statements;
2. The nature and extend of governments grants recognized in the financial statements, including grants of non – monetary assets given at a concessional rate or free of cost.
AS-13: Accounting for investments. Effective Date: 1-Apr-1995.
This statement deals with accounting for investments in the financial statements of the enterprises and related disclosure requirements.
AS-14: Accounting for Amalgamations: Effective date: 1-Apr-1995.
Introduction: These statements deals with accounting for amalgamation and the treatment of any
resultant goodwill or reserves. This statement is directed principally at the companies although some of its requirements also apply to financial statements of other enterprises.
Definitions:
Amalgamation: it means an amalgamation pursuant to the provisions of the companies Act, 1956 or
any other statute, which may be applicable to companies.
Transferor Company: It means the company, which is amalgamated into another company. Transferee Company: It means the company into which a transferor company is amalgamated.
Amalgamation in the nature of merger: an amalgamation has to satisfy all the following conditions. 1. All the assets and liabilities of the transferor company become, after amalgamation, the assets
and liabilities of the transferee company.
2. Shareholders holding not less than 90% of the face value of the equity shares of the transferor company (other than the equity shares already held therein, immediately before the
amalgamation, by transferee company or its subsidiaries or their nominees) will become equity shareholders of the transferee company by virtue of the amalgamation.
3. The transferee company discharges the consideration for the amalgamation receivable by those equity shareholders of the transferor company who agree to become equity shareholders of the transferee company, except that cash may be paid in respect of any fractional shares.
4. The business of the transferor company is intended to be carried on, after amalgamation, by Transferee Company.
5. No adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated in the financial statements of the transferee company except to ensure uniformity of accounting policies.
Amalgamation in the nature of purchase: it is amalgamation, which does not satisfy any one more of the condition specified in sub-paragraph above.
Consideration: consideration for the amalgamation means the aggregate of the shares, other securities issued, and the payment made in the form of cash or other assets by the transferee company to the shareholders of the transferor company.
Fair value: An asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length transaction for the amount.
Explanation
Types of Amalgamation
Amalgamations fall into two broad categories. In the first category are those amalgamations where there is a genuine pooling not merely of the assets and liabilities of the amalgamations companies but also of the shareholders interest and of the business of these companies. Such amalgamations are in the nature of merger and their accounting treatment should ensure that the resultant figures of Assets, liabilities, capital and reserves more or less represent the sum of the relevant figures of the amalgamation companies.
In the second category are those amalgamations, which are in effect a mode by which one company acquires another company and as a consequence, the shareholders of the company which is acquired normally do not continue to have a proportionate share in the equity of the combined company, or the business of the company which is acquired is not intended to be continued. Such amalgamations are in the nature of purchase.
Methods of Accounting for Amalgamations: there are two main methods of accounting for amalgamation:
The pooling of interests method; and The purchase method
The use of the pooling of interests method is confirmed to circumstances, which meet the criteria for an amalgamation in the nature of a merger.
The object of the purchase method is to account for the amalgamation by applying the same principles as are applied in the normal purchase of assets. This method is used in accounting for amalgamation in the nature of purchase.
The pooling of interest method
Under the pooling of interests method, the assets, liabilities and reserves of the transferor company are recorded by the transferee company at their existing carrying amounts.
The Purchase Method:
Under the purchase method, the transferee company accounts for the amalgamation either by incorporating the assets and liabilities at their existing carrying amounts or by allocating the
consideration to individual identifiable assets and liabilities of the transferor company based on their fair values at the date of amalgamation. The identifiable assets and liabilities may include assets and liabilities not recorded in the financial statements of the transferor company.
Where assets and liabilities are restated based on their fair values, the determination of fair values may be influenced by the intentions of the transferee company. For example to other potential may have specialized use for an asset, which is not available to other potential buyers. The transferee company may intend to effect changes in the activities of the transferor company which necessitate the creation of specific provisions for the expected costs, e.g. planned employee termination and plant relocation costs.
Consideration
The consideration for the amalgamation may consist of securities, cash or other assets. In determining the value of the consideration, an assessment is made of the fair value of its elements. A variety of techniques is applied in arriving at fair value. For example, when the consideration includes securities, the value fixed by the statutory authorities may be taken to be the fair value. In case of other assets, the fair value may be determined by reference to the market value of the asset given up. Where the
market value of the assets given up cannot be reliably assessed, such asset may be valued at their respective net book values.
Balance of Profit & Loss Account:
In the case of an Amalgamation in the nature of merger, the Balance of the Profit & Loss Account appearing in the financial statement of the transferor company is aggregated with the corresponding balance appearing in the financial statements of the transferee company. Alternatively, it is transferred to the general reserve, if any. In the case of an Amalgamation in the nature of purchase the Balance of Profit & Loss Account appearing in the financial statements of the transferor company, whether debit or credit, loses its identity.
Disclosure:
For all amalgamations, the following disclosures are considered appropriate in the first financial statements following the amalgamation:
Names and General nature of business of the amalgamation companies; Effective date of amalgamation for accounting purposes.
The method of accounting used to reflect the amalgamation; and Particulars of the scheme sanctioned under a statue.
For all amalgamation accounted for under the pooling f interest method, the following additional disclosure are considered appropriate in the first financial statements following the amalgamation.
Description and number of shares issued, together with the percentage of each company’s equity shares exchanged to effect the amalgamation.
The amount of any difference between the consideration and the value of net identifiable assets acquired and the treatment thereof.
For amalgamation accounted for under the purchase method, the following additional disclosures are considered appropriate in the first financial statements following the amalgamation:
Consideration for the amalgamation and a description of the consideration paid or contingently payable; and
The amount of any difference between the consideration and the value of net identifiable assets acquired, and the treatment thereof including the period of amortization of any goodwill arising on amalgamation.
AS-15: Accounting for retirement benefits in the Financial statements of Employers 1.
Effective date: 1 Arp-1995.
This statement deals with accounting for retirement benefits in the financial statements of the employers. Retirement benefits usually consist of;
a. Provident fund.
b. Superannuating / Pension. c. Gratuity
d. Leave encashment benefits on retirement e. Post-retirement health and welfare schemes and f. Other retirement benefits.
Accounting
In respect of retirement benefits in the form of provident fund and other defined contribution
schemes, the contribution payable by the employer for a year is charged to the statement of profit and loss for the year. Thus, besides the amount of contribution paid, a shortfall of the amount of
contribution paid compared to the amount payable for the year is also charged to the statement of profit and loss for the year. On the other hand, if contribution paid is in excess of the amount payable for the year, the excess is treated as a pre-payment. The accounting treatment for gratuity and other schemes will depends upon the type of arrangement that the employee has chosen to make.
i. If the employer has chosen to make payment for retirement benefits out of his own funds, an appropriate charge to the statement of profit & loss for the year is made through a provision for the accruing liability. The accruing liability is calculated according to actuarial valuation. However many enterprises which employ only few persons do not calculate the accrued liability by using actuarial methods. They calculate the accrued liability by using other rational methods. E.g. a method based on the assumption that such benefits are payable to all employees at the end of the accounting year.
ii. In case, the liability for retirement benefits is funded through creation of a trust, the cost incurred for the year is determined actuarially. Many employers undertake such valuations every year while others undertake them less frequently, usually once in every years. Where
the contribution paid during the year is lower than the amount required to be contributed during the year to meet the accrued liability as certified by the actuary, the shortfall is charged to the statement of profit and loss for the year. Where the contribution paid during the year is in excess of the amount required to be contributed during the year to meet the accrued liability as certified by the actuary, the excess is treated as a pre-payment.
iii. In case the liability for retirement benefits is funded through a scheme administered by an insurer, it is usually considered necessary to obtain an actuarial certificate or a confirmation from the insurer that the contribution payable to the insurer is the appropriate accrual of the liability for the year. Where the contribution during a year is lower than the amount required to be contributed during the year to meet the accrued liability as certified by the actuary or confirmed by the insurer, as the case may be, the shortfall is charged to the statement of profit and loss for the year. Where the contribution paid during the year is in excess of the amount required be contributed during the year to meet the accrued liability as certified by the actuary or confirmed by the insurer, as the case may be, the excess is treated as a pre- payment.
Disclosures:
The financial statements should disclose the method by which retirement benefit costs for the period have been determined. In case the costs related to gratuity and other defined benefit schemes are based on an actuarial valuation, the financial statements should also disclose whether the actuarial valuation was made at end of the period or at an earlier date. In the latter case, the date of the actuarial valuation should be specified and the method by which the accrual for the period has been determined should also be briefly described, if the same is not based on the report of the actuary.
AS-16: Borrowing Costs . Effective date: 1-Apr-2000.
The objective of this statement is to prescribe the accounting treatment of borrowing costs meaning thereby interest and other costs incurred by an enterprise in connection with borrowing of funds, briefly stated, it lays down that borrowing costs that are directly attributable to the acquisition, construction or production of an asset should be capitalized as a part of the cost of that asset. This statement does not deal with the actual or imputed cost of owners equity, including preference share capital not classified as a liability.
Borrowing costs:
Borrowing cost are interest and other costs incurred by an enterprise in connection with the borrowing of funds. Borrowing costs may include:
Interest and commitment charges on bank borrowings and other short term and long term borrowings.
Amortization of discounts or premiums relating to borrowings.
Amortization of ancillary costs incurred in connection with the arrangement of borrowings. Finance charges in respect of assets acquired under finance leases or under other similar
arrangements; and
Exchange differences arising from foreign currency borrowings to the extend that they are regarded as an adjustment to interest costs.
Qualifying Asset: it is an asset that necessarily takes a substantial period of time to get ready for its
intended use or sale.
Examples of qualifying assets are manufacturing plants, power generation facilities, inventories that require a substantial period of time to bring then to a saleable condition, and investment proprieties. Other investments, and those inventories that are routinely manufactured or otherwise produced in large quantities on a repetitive basis over a short period of time, are not qualified assets. Assets that are ready for their intended use or sale when acquired are also not qualified assets.
Recognition:
Borrowings costs that are directly attributed to the acquisition, construction or production of a
qualifying asset should be capitalized as part of the cost of that asset. The amount of borrowings costs eligible for capitalized as part of the cost of that asset. The amount of borrowing costs eligible for capitalization should be determined in accordance with this statement. Other borrowings costs should be recognized as an expense in the period in which they are incurred.
Borrowing costs are capitalized as part of the cost of qualifying asset when it is probable that they will result in future economic benefits to the enterprise and the costs can be measured reliably. Other borrowing costs are recognized as an expense in the period in which they are incurred.
Disclosure:
The financial statements should disclose:
a. The accounting policy adopted for borrowing costs, and b. The amount of borrowing costs capitalized during the period.
AS-17: Segment Reporting. Effective Date: 1-Apr-2001
This Standard applies to
Enterprises, whose equity or debt securities are listed on a recognized stock exchange in India, and to enterprises that are in the process of issuing equity or debt securities that will be listed on recognized stock exchange in India as evidence by the board of directors’ resolution in this regard.
All other commercial, industrial and business reporting enterprises, whose turnover for the accounting period exceeds Rs. 50 crore.
The objective of this statement is to establish principles for reporting, financial information, about the different types of products and services an enterprise produces and the different geographical areas in which it operates. Such information helps users of financial statements to:
a. Understand better the performance of the enterprises; b. Assess better the risks and returns of the enterprise; and c. Make more informed judgments about the enterprise as a whole
Many enterprises provide groups of products and services or operate in geographical areas that are subject to differing rates of profitability, opportunities for growth, future prospects, and risks. Information about different types of products and services of an enterprise and its operations in different geographical areas- often called segment information – is relevant in assessing the risks and returns of a diversified or multi- location enterprise but may not be determinable from the aggregated data. Therefore, reporting of segment information is widely regarded as necessary for meeting the needs of users of financial statements.
AS-18: related Party Disclosures. Effective Date: 1- Apr-2001.
The objective of this statement is to establish requirements for disclosure of: a. Related party relationships; and
b. Transactions between a reporting enterprise and its related parties
This statement should be applied in reporting related party relationships and transactions between a reporting enterprise and its related parties. The requirements of this statement apply to the financial statements of each reporting enterprise as also to consolidate financial statements presented by holding company.
This statement applies only to related party relationship described as under:
a. Enterprises that directly, or indirectly through one or more intermediaries, control, or are controlled by, or are under common control with, the reporting enterprise (this includes holding companies, subsidiaries and fellow subsidiaries);
b. Associates and joint venture of the reporting enterprise and the investing party or venture in respect of which the reporting enterprise is an associate or a joint venture;
c. Individual owning, directly or indirectly; an interest in the voting power of the reporting enterprises that gives them control or significant influence over the enterprise, and relatives of any such individual;
d. Key management personnel and relatives of such personnel, and
e. Enterprise over which any person described in © or (d) is able to exercise significant influence. This includes enterprise owned by directors or major shareholders of the reporting enterprise /s that have a member of key management in common with the reporting enterprise.
Disclosure:
The statues governing enterprise often require disclosure in financial statements of transactions with certain categories of related parties. In particular, attention is focused on transactions with the directors or similar key management personnel of an enterprise, especially their remuneration and borrowings, because of the fiduciary nature of their relationship with the enterprise.
Name of the related party and nature of the related party relationship where control exists should be disclosed irrespective of whether or not there have been transactions between the related parties.
Where the reporting enterprise controls or is controlled by, another party, this information is relevant to the users of financial statements irrespective of whether or not transactions have taken
place with that party. This is because the existence of control relationship may prevent the
reporting enterprise from being independent in making its financial and /or operating decision. The disclosure of the name of the related party and the nature of the related party relationship where control exists may sometimes be at least as relevant in appraising an enterprise’s prospects as are the operating results and the financial position presented in its financial statements. Such a related party may establish the enterprise’s credit standing, determine the source and price of its raw materials, and determine to whom and at what price the product is sold.
If there have been transactions between related parties, during the existence of a related party relationship, the reporting enterprise should disclose the following.
1. The name of the transacting related party;
2. a description of the relationship between the parties; 3. a description of the nature of transactions;
4. Volume of the transactions either as an amount or as an appropriate proportion;
5. Any other elements of the related party transactions necessary for an understanding of the financial statements;
6. The amounts or appropriate proportions of outstanding items pertaining to related parties at the balance sheet date and provisions for doubtful debts due from such parties at that date; and
7. Amounts written off or written back in the period in respect of debts due from or to related parties.
The following are examples of the related party transactions in respect of which disclosures may be made by a reporting enterprise:
Purchases or sales of goods (finished or unfinished); Purchases or sales of fixed asset;
Rendering or receiving of services; Agency arrangements;
Leasing or hire purchase arrangements; Transfer of research and development; License agreement;
Finance (including loans and equity contributions in cash or kind); Guarantees and collaterals; and
Management contracts including deputation of employees.
AS - 19: Leases. Effective date: 1-Apr-2001.
Objective: the objective of this statement is to prescribe, for lessees and lessor, the appropriate accounting policies and disclosures in relation to finance leases and operating leases. A lease is an agreement whereby by the lessor conveys to the lessee in return for a payment or series of payment the right to use an asset for an agreed period of time.
Financial lease: A financial lease is a lease that transfers substantially all risks and rewards incident
to ownership of an asset.
Operating lease: it is a lease other than a financial lease.
Lease term: It is the non- cancelable period for which the lessee has agreed to take on lease the
asset together with any further periods for which the lessee has option to continue the lease of the asset, with or without further payment, which option it is reasonably certain that the lessee will exercise at the inception of the lease.
Fair value: It is the amount for which an asset could be exchanged or a liability settled between
knowledgeable, willing parties in an arm’s length transaction.
Residual value: it is estimated fair value of the asset at the end of the lease term.
Classification of Leases:
The classification of leases adopted in this statement is based on the extend to which risks and reward incident to ownership of a leased asset; lie with the lessor or the lessee. Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in returns due to changing economic conditions. Rewards may be represented by expectation of profitable operation over the economic life of the asset and of gain from appreciation in value or realization of residual value.
A lease is classified as a finance lease if it transfers substantially all risks and rewards incident to ownership. Title may or may not eventually be transferred. A lease is classified as an operating lease if it does not transfer substantially all risks and rewards incident to ownership.
Whether a lease is finance or an operating lease depends on the substance of the transaction rather than its form.
Examples of situations, which would normally lead to a lease being classified as a finance lease, are: a. The lease transfers ownership of the asset to the lessee by end of the lease term;
b. The lessee has option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception of the lease, it is reasonably certain that the option will be exercised;
c. The lease term is for the major part of the economic life of an asset even if title is not transferred;
d. At the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and
e. The leased asset is of a specialized nature such that only the lessee can use it without major modification being made.
Leases in the Financial Statements of lessees: Finance Leases:
At the inception of a finance lease, the lessee should be recognized the lease as an asset and a liability. Such recognition should be at an amount equal to the fair value of the leased asset at the inception of the lease. However, if the fair value of the leased asset exceeds the present value of the minimum lease payments from the standpoint of the lessee, the amount recorded as an asset and a liability should be the present value of the minimum lease payments from the standpoint of the lessee. In calculating the present value of the minimum lease payments, the discount rate is the interest implicit in the lease, if this is practicable to determine, if not the lessee’s incremental borrowing rate should be used. The lessee should, in addition to the requirements of AS 10, accounting for Fixed Asset, AS 6, and Depreciation Accounting and governing statute, make the following disclosure for finance leases:
a. Assets acquired under finance lease as segregated from the asset owned. b. For each class of assets, the net carrying amount at the balance sheet date;
c. Reconciliation between the total of minimum lease payments at the balance sheet date and their present value. In addition, an enterprise should disclose the total of minimum lease payments at the balance sheet date, and their present value, 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;
d. Contingent rents recognized as income in the statement of profit and loss for the period; e. The total of future minimum sublease payments expected to be received under non-cancelable
sublease at the balance sheet date, and;
f. A general description of the lessee’s significant leasing arrangements including but not limited to, the following:
The basis on which contingent rent payable are determined;
The existence and term of renewal or purchase options and escalation clauses; and Restrictions imposed by lease arrangements, such as those concerning dividends,
additional debt, and future leasing.
Operating leases:
Lease payments under an operating lease should be recognized as an expense in the statement of profit and loss on a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern of the user’s benefit.
The lessee should make the following disclosures for operational leases:
a. The total of future minimum lease payments under non-cancelable operating leases fro each of the following periods:
Not later than one year;
Later than one year and not later than five year; Later than five years;
