Answers for Issues for Group Discussion

1)A company has exported goods to a party located in Singapore as on 22ndMarch, 2013 of USD 20,000 on DDP basis (Delivered Duty Paid basis). Accordingly, the company has to pay duties on behalf of that party when the goods reach the buyer's port.As at 31st March, 2013, the shipping bill is already prepared and goods are exported.The consignment reached Singapore Port on 30th April, 2013 and the company has paid duties USD 4200 on behalf of buyer on 3rd May, 2013. Will the sales be considered in financial year 2012-13 or 2013-14?

As per Para 6 of Accounting Standard 9 ‘Revenue Recognition’, the key criteria for recognizing revenue for sale of goods areas under:

a)Transferof property in the goods to the buyer for a price or transfer of significant risks and rewards of ownership and the seller retains no effective control of the goods transferred.

b)No significant uncertainty exists regarding the amount of consideration.

Hence for recognition of revenue one has to fulfill the above conditions.

In the given case recognition of revenue depends on following factors;

  • On the term of export i.e. CIF / FOB. - If the goods are exported on CIF basis risk and rewards of ownership transferred only when goods reach the port of the buyer and hence revenue will be recognised in FY 2013 -14. In case of FOB the same will be transferred as soon as goods are shipped hence revenue will be recognised in FY 2012-13.
  • There can be other factors apparent from specific terms and conditions of the contract which indicate whether or not significant rewards of ownership in the goods have been transferred.

2)PQR Ltd. (the company) purchased a ship from ABC Inc., USA, in April, 2011forRs. 38 Crores. In July, 2011, PQR Ltd. came to know that said ship was not as per the specifications provided by it and it filed a suit in an International Court against ABC Inc. For the same, the company has appointed its representative Advocate in USA. In December, 2013, ABC Inc. settled the claim out of the court and agreed to pay Rs. 8 Crores for such default.

ABC Inc. paid Rs. 3 Crores to the company’s representative Advocate in USA and issued credit note for the remaining Rs. 5 Crores which can be utilised this by the company against purchase / servicing of any spares/tools as and when required.

The company’s representative Advocate in USA deducted Rs. 1.25 Crores towards his legal & professional fees and remitted the balance Rs. 1.75 Crores to the company.

(a)What would be the accounting treatment for the above transaction?

(b)Whether the entire amount of Rs. 8 Croreswill be adjusted in 2013-14?

(c)Whether it would be reduced from the cost of ship or shown as Other Income?

(d)If reduced from the cost of ship, would accumulated depreciation also be reversed?

In case an asset fails to meet the performance standards stipulated in the contract and the supplier pays damages for the same, it would be appropriate that the damages so received by the enterprise should go towards reducing the price paid for the asset to the extent the amount of damages.is representative of reduction in the standard of performance.

That portion of damages which is in the nature of penalty should be treated as Other Income. However, if it is not possible to ascertain the extent of the amount of penalty, the entire amount should be deducted from the cost of assets concerned.

Hence,

  • The entire 8 Crores should be reduced from the cost of the asset in FY 2013-14, the year in which claim is settled.
  • The breakupof the said settlement amount specifies mode of payment to be made.
  • As recommended by Para 16 of AS 6 on ‘Depreciation Accounting’, the change in the historical cost in the above circumstances would not require recomputation of depreciation for the past years. Hence, depreciation charge for future years would require to be suitably adjusted to take account of the change in the historical cost of fixed assets.

3)Indian based Company DEF Limited has given project to construct a plant to a foreign based company XYZ. The project was for 5 years.XYZ has raised the RA bills in foreign currency and DEF Limited has capitalised the whole amount under fixed assets.At each year end, there used to be various bills outstanding for payment, the exchange differences arising out of which were capitalised every year.DEF Limited was regular in making payments against those RA Bills raised. At the end of the project, final bill was raised by XYZ and the same was capitalised in books of DEF Limited. At such time, the outstanding in INR was Rs. 50 crores.

Due to some dispute between the parties, DEF Limited stopped making payments to XYZ for some years and hence, every year end the liability was outstanding in books and the same was restated. Since there were exchange losses, this resulted in to the increase in liability to Rs. 55 crores. Subsequently, the parties decided to settle the dispute. In that settlement, foreign currency outstanding was converted into Indian Rupees and it was decided that liability will be settled as per INR outstanding to the extent of Rs. 40 croresonly, remaining amount being waived by XYZ.

How the reversal of liability of Rs 15 crores would be accounted in the books of account of

DEF Limited?

  • The reversal of liability of 15 Crores including exchange difference on reinstatement should be adjusted from the cost of the relevant assets.
  • As per the details given, company has capitalized exchange fluctuation arising on payment to vendor. However, capitalization of such exchange fluctuation is not correct since para 46A of AS 11 applies only to exchange fluctuation arising on Long Term Foreign currency monetary Assets/ Liabilities and Para 4(e) of AS 16 applies only to exchange fluctuation on borrowings. Therefore in addition to above 15 crores company needs to reverse exchange fluctuation capitalised earlier and same to be disclosed as prior period expense/income.

4)A company incorporated in June 2013, has setup a factory within a period of 6 months with borrowed funds. Whether interest on borrowings for the period prior to the date of setting up the factory should be capitalized although it has taken less than 12 months for the assets to get ready for use. This is with reference to Accounting Standard 16.

As per para 3.2 of Accounting Standard 16 on ‘Borrowing Costs’, A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.

Explanation:

What constitutes a substantial period of time primarily depends on the facts and circumstances of each case. However, ordinarily, a period of twelve months is considered as substantial period of time unless a shorter or longer period can be justified on the basis of facts and circumstances of the case. In estimating the period, time which an asset takes, technologically and commercially, to get it ready for its intended use or sale is considered.

  • There is a rebuttable presumption that a 12 month period constitutes substantial period of time.
  • Under present circumstances where construction period has reduced drastically due to technical innovation, the 12 month period should at best be looked at as a benchmark and not a conclusive yardstick. It may so happen that an asset under normal circumstances may take more than 12 months to complete. However an enterprise that completes the asset in 10 months should not be penalized for its efficiency by denying it interest capitalization and vice versa.
  • The substantial period criteria ensures that enterprises do not spend a lot of time and effort capturing immaterial interest cost for purposes of capitalization.
  • Therefore, if the factory constructed in 6 months is considered as a qualifying asset the interest on borrowings on the same can be capitalised although it has taken less than 12 months for the asset to get ready to use.

5)A company based in USA has setup a subsidiary company in India. The subsidiary has set up an office and establishment engaging about 100 employees, to render services to Head Office. In consideration thereof, the holding company has reimbursed the expenditure on salaries and other expenses amounting to Rs.400/- lacs and also allowed margin of profit at 20% being Rs.80/-lacs. Whether the accounts should show the amount of turnover at Rs.400/- lacs or Rs.480/- lacs.

  • Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and dividends.
  • In the given case subsidiary has set up an office and establishment to render services to HO and the Head Office has reimbursed the expenditure on salaries and other expenses amounting to 480/- lakhs including margin of profit of 80 lakhs, hence the turnover to be shown in the books is 480/- lakhs.

6)An Indian company is engaged by a research company based in USA to carry out research in India, in consideration of billing to be done by Indian company based on cost plus 20% markup. The Company based in USA paid a sum of Rs.10/- crores to an Indian company to acquire equipments to be used for research. The equipment is owned by the Indian company and a condition is attached in the agreement with the US company that such equipment is to be used for at least 5 years for research work of that company. How should the amount of Rs.10/- crores be accounted-as capital reserve or as credit to profit and loss account or by credit to the account of the equipments.

  • As per AS 12 in respect of ‘Government Grants’, Grants meant to subsidize or reduce expenses is taken to the Statement of Profit and loss in proportion to the savings and where the grant is related to fixed assets, the value of the fixed asset is stated net of grant and depreciation is provided accordingly.
  • Government Grants in the nature of promoters contribution is however taken to Capital reserves.

In the given case, the Company has received anamount from a research company in USA to acquire equipment’s to be used in research which is to be owned by the Company only. The same can be considered as private grant and AS 12 do not apply to private grants. Since the amount received is towards capital items, therefore it is not possible that credit arising out of a grant can be taken to statement of profit and loss. In present case, grant should be shown as Capital Reserve (not revenue reserves) with proper disclosures.

If such grant received is credited to profit and loss, profit or loss position could be easily manipulated through such private grants.

The following EAC Opinion was found of 1983 which follows the Guidance Note on 'Accounting for Capital Based Grants' issued by the Institute in 1981 which stands withdrawn with the issue of AS 12.

As per this Guidance Note, amount may either be (i) deducted from the cost of the specific fixed assets for which the gift was made available, or (ii) kept in a special reserve and a proportionate amount transferred annually to the profit and loss account with reference to the life of the machines.

7)Calculate the Revenue to be booked as per percentage completion method:

Total Saleable area / 20,000 Sq. ft.
Estimated Projected Costs -(comprises land cost of Rs. 300 lakhs & Construction costs of Rs. 300 lakhs) / Rs. 600 lakhs
Cost incurred till end of reporting period - (This includes land cost of Rs. 300 lakhs & Construction costs of Rs. 60 lakhs) / Rs. 360 lakhs
Total Area Sold till date of reporting period / 5,000 Sq. ft.
Total Sale Consideration as per Agreements of Sale executed / Rs. 200 lakhs
Amount realized till the end of the reporting period / Rs. 50 lakhs

% of completion of work -60% of total project cost including land costor20% of total construction cost

As per Para 5.3 of Guidance note on Accounting of Real Estate Transaction (Revised 2012) - there is a rebuttable presumption that the outcome of a real estate project can be estimated reliably and that revenue should be recognised under the percentage completion method only when the events in (a) to (d) below are completed.

a)All critical approvals necessary for commencement of the project have been obtained. These include, wherever applicable:

i)Environmental and other clearances.

ii)Approval of plans, designs, etc.

iii)Title to land or other rights to development/ construction.

iv)Change in land use.

b)When the stage of completion of the project reaches a reasonablelevel of development.

c)A reasonable level of development is notachieved if the expenditure incurred on construction anddevelopment costs is less than 25 % of the construction anddevelopment costs as defined in paragraph 2.2 (c) read withparagraphs 2.3 to 2.5.

d)In the Given case expenditure incurred on Construction and development is less than 25% of the total construction and development costs (i.e 60 / 300*100 = 20%) as defined in paragraph 2.2 (c) read with paragraphs 2.3 to 2.5 ( i.e excluding Land cost). Hence no revenue should be recognised.

e)If the said percentage is more than 25% then for the purpose of booking revenue percentage to be calculated inclusive of land cost.

8)A company incorporated under section 25 of the companies act having main objectives to promote the trade by organizing trade fairs/exhibitions. When the company was organizing the trade fair and exhibitions it decided to charge 5% contingency charges for the participants/outside agencies on the income received from them by the company, while in the case of fairs organized by outside agencies, 5% contingency charges are levied separately in the invoice, the contingency charges in respect of fairs organized by the company itself are inbuilt in the space rent charged from the participants. Both are credited to income & expenditure account of the company.

The intention of levying these charges is to meet any unforeseen liability, which may arise in future. The instances of such unforeseen liabilities could be on account of injury/loss of life to visitors/exhibitors etc due to fire, terrorist attack, stampede, natural calamities and other public and third party liability. The chances of occurrence of these events are high because of large crowds visit the fair. The decision to levy 5% contingency charges was based on assessment only as actual liability on this account cannot be estimated.

The following accounting treatment and disclosure was made by the company in its financial statements:

a)5% contingency charges are treated as income and matching provision for the same is also being made in accounts.

b)A suitable disclosure to this effect is also made in the notes forming part of accounts.

Required:

  1. Whether creation of provision for contingencies under the facts and circumstances of the case is in conformity with AS-29.
  2. If the answer of (I) is “No” what should be the treatment of the provision which is already created in the balance sheet with a specific reference to Schedule VI of the companies act.

As per paragraph 14 of AS 29, a provision should be recognised when:

a)an enterprise has a present obligation as a result of a past event

b)it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and

c)a reliable estimate can be made of the amount of obligation.

If these conditions are not met, no provisions should be recognised.

As per paragraph 10.4 of AS 29, a contingent liability is:

a)a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or

b)a present obligation that arises from past events but is not recognised because:

  1. it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
  2. a reliable estimate of the amount of the obligation cannot be made.
  • In this case company is required to assess the probability of occurrence of contingencies on the basis of such events taken place in earlier period.
  • Though there is a present obligation based on such past event and it is probable that an outflow of resources will be required, a reliable estimate of amount of obligation cannot be made.
  • Hence no provision for the same is to be created and the same is to be disclosed as contingent liability.
  1. Treatment of Provision already created in the Balance Sheet:
  • Reversal of provision should be netted off against the relevant expenditure and should not be shown as “Other Income”.
  • Where the reversal is greater than the current year’s expenditure, the net amount would be negative which may be reflected as other income.
  • If such provision is related to earlier year then the same should be disclosed as prior period income.
  • As required by AS 29, specific disclosure should be given for reversal of provision in the notes to accounts and reference of note should be given in the specific line item of expenditure in which reversal of provision is made.

9)During 2010, NDA corp. incurred costs to develop and produce a routine, low risk computer software product, as follows:

-Completion of detailed program designRs. 13,000

-Costs incurred for coding and testing to establish

technological feasibility Rs. 10,000

-Other coding costs after establishment of

Technological feasibilityRs. 24,000

-Other testing costs after establishment of

Technological feasibilityRs. 20,000

-Cost of Producing product masters for training materialsRs. 15,000

-Duplication of computer software and training materials

from product masters (1,000 units)Rs. 25,000

-Packaging product (500 units)

i) In NDA corp. December 31,2010 balance sheet, what amount should be capitalised as software cost, subject to amortization?

a. Rs. 54,000 b. Rs. 57,000 c. Rs. 59,000 d. Rs. 69,000

ii) In NDA corp. December 31, 2010 balance sheet, what amount should be reported in inventory?

  1. Rs. 25,000 b. Rs. 34,000 c. Rs. 40,000 d. Rs. 49,000
  1. To recognise intangible assets four important criteria’s are required to be fulfilled,
  • identifiability,
  • control over a resource,
  • expectation of future economic benefits flowing to the enterprise and
  • cost of the asset can be measured reliably.

All four conditions needs to be satisfied.

  1. An intangible asset arising from development should be recognised if the company can demonstrate:
  • the technical feasibility of completing the intangible asset so that it will be available for use or sale
  • its intention to complete the intangible asset and use or sell it
  • its ability to use or sell the intangible asset
  • how the intangible asset will generate probable future economic benefits
  • the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset
  • its ability to measure the expenditure attributable to the intangible asset during its development reliably.

The cost of an internally generated intangible asset is the sum of expenditure incurred from the time when the intangible asset first meets the recognition criteria mentioned in A above including the above conditions relating to development phase mentioned in B above.