compendium of opinions vol. xxvi - eac

ISBN : 978-81-8441-064-8 (Volume XXVI) 81-85868-05-0 (Set)

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The Institute of Chartered Accountants of India(Set up by an Act of Parliament)

New DelhiJune / 2010 (Reprint)

Volume XXVI

Expert Advisory Committee

Vo

lum

e X

XV

I

TheInstitute ofChartered

Accountantsof India

Compendium of Opinions(Volume XXVI)

of the

Expert Advisory Committee

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA(Set up by an Act of Parliament)

NEW DELHI

COPYRIGHT © THE INSTITUTE OF CHARTERED ACCOUNTANTS OFINDIA

All rights reserved. No part of this publication may be translated, reprintedor reproduced or utilised in any form either in whole or in part or by anyelectronic, mechanical or other means, including photocopying andrecording, or in any information storage and retrieval system, withoutprior permission in writing from the publisher.

(This twenty sixth volume contains opinions finalised between February2006 and January 2007. The opinions finalised upto September 1981 arecontained in Volume I. The opinions finalised thereafter upto January2006, are contained in Volumes II to XXV)

Published in 2009

Price : Rs. 200

Committee/Department : Expert Advisory Committee

ISBN : 978-81-8441-064-8 (Volume XXVI)

ISBN : 81-85868-05-0 (Set)

Published by : The Publication Department on behalf of TheInstitute of Chartered Accountants of India, ICAIBhawan, Indraprastha Marg, New Delhi-110 002

Printed at : Sahitya Bhawan Publications, Hospital Road,Agra-282 003

November/2009/1000 copies

Foreword

Today’s ever-changing economic climate is pushing enterprises toadopt new business models incorporating multiple businesstransactions, and forcing financial executives to address complexand intricate management issues. As the complexity in businessgrows, so do generally accepted accounting principles (GAAPs)as these principles attempt to measure the economic impacts ofintricate business transactions. These GAAPs cover in their ambitvarious relevant legal requirements, accounting standards, guidancenotes, and other authoritative pronouncements of the Institute ofChartered Accountants of India.

The complexities and intricacies involved in business transactionsalso sometimes make the application and implementation of theGAAPs difficult. To address these issues, the Expert AdvisoryCommittee has been constituted to provide its independent andobjective opinion on such issues. The opinions provide an insightto various accounting and auditing related real life practical problemsfaced by the industry and members in practice.

I am pleased to note that the Committee has brought out this newvolume of the Compendium of Opinions which is twenty-sixth in itsseries and contains the opinions finalised by the Committee betweenFebruary 2006 and January 2007. I am sure that like other volumes,this volume would be of great significance and use for all concerned.

New Delhi CA. T.N. ManoharanFebruary 4, 2007 President

Preface

This volume of the Compendium of Opinions, which is twenty-sixthin its series, contains opinions finalised by the Expert AdvisoryCommittee between February 2006 and January 2007. During thisperiod, the Committee provided opinions on various mattersinvolving accounting and/or auditing principles and allied aspectsas enunciated in the applicable accounting, auditing and assurancestandards and guidance notes, relevant statutory requirements,and also taking into account the international literature availableon the concerned issues.

The various subjects on which the Expert Advisory Committeeexpressed its opinion include accounting treatment in respect ofrevenue recognition, prior period items, depreciation, segmentreporting, inventory valuation, foreign exchange forward contracts,intangible assets, deferred tax assets/liabilities, borrowing costs,etc. As in the preceding volumes of the Compendium of Opinions,this volume also contains a composite index, which provides readyreference of all the opinions published in all the preceeding twenty-five volumes and this volume. The date on which the Committeefinalises its opinion is indicated as a footnote to every opinion inthe Compendium. While making a reference to an opinion, anysubsequent changes in the relevant law(s)/pronouncements, etc.,must be kept in mind.

The Advisory Service Rules, in accordance with which theCommittee expresses its opinion, is included in the Compendium.The Rules also make it clear that although the Committee hasbeen appointed by the Council, an opinion given or a viewexpressed by the Committee would represent nothing more thanthe opinion or the view of the members of the Committee and notthe official opinion of the Council of the Institute.

I would like to thank my learned colleagues on the Expert AdvisoryCommittee, namely, CA. S. Gopalakrishnan (Vice-Chairman), CA.T.N. Manoharan (President), CA. Sunil Talati (Vice-President), CA.

Anuj Goyal, CA. Charanjot Singh Nanda, CA. J.P. Gokhale, CA.Manoj Fadnis, CA. Sunil Goyal, Shri Jitesh Khosla, CA. S.C.Vasudeva, CA. H.N. Motiwalla, CA. Prem Prakash Pareek, CA.Gautam M. Mehra, CA. P.G. Sadguru Das, CA. R. Sivakumar, CA.V. Krishnan, CA. Seshagiri Rao, CA. Anil Mathur, CA. AseemChawla and Ms. Gurveen S. Chophy. I would also like to thank Dr.Avinash Chander, Technical Director, Ms. Anuradha Jain, Secretary,Expert Advisory Committee and CA. Parul Gupta, Executive Officerof the Technical Directorate for their untiring efforts and support inthe process of finalisation of the opinions.

I firmly believe that this volume will be of much significance andvalue to not only the members of the institute but also to theindustry as a whole.

CA. K.P. KhandelwalNew Delhi ChairmanFebruary 4, 2007 Expert Advisory Committee

ContentsForeword

Preface

1. Treatment of engineering fee paid to a lumpsum turnkey contractor. 1

2. Accounting treatment of expenditure incurred onlicence fee (including user licences) for SAP software. 6

3. Accounting treatment of lease premium receivedon lease of industrial plots as industrial estates. 12

4. Depreciation of Water Treatment Plant (WTP) andEffluent Treatment Plant (ETP). 22

5. Determination of net selling price of a cash generatingunit incurring losses. 28

6. Treatment of deferred tax asset in respect of excessprovision for doubtful advances and doubtful claims. 37

7. Rates of depreciation on various assets involved inmass rapid transport system. 42

8. Segment reporting for sale of power to the State grid. 49

9. Disclosure of partly secured Bonds. 55

10. Applicability of AS 3 and AS 18. 58

11. Accounting for Minimum Alternative Tax (MAT) undersection 115JB and credit available in respect thereof. 64

12. Recognition of revenue in respect of long productioncycle items. 72

13. Segment reporting by a finance company. 79

14. Booking of export sales/purchases of wheat and riceunder subsidised quota of the Government of India,purchased from another government undertaking. 88

15. Overhead allocation for the purpose of inventoryvaluation at quarter/year end. 96

16. Accounting treatment in respect of side-trackingcosts of wells. 109

17. Creation of provision for contingencies. 11918. Creation of deferred tax liability on special reserve

created u/s 36(1)(viii) of the Income-tax Act, 1961. 12419. Capitalisation of certain expenses related to

acquisition of an investment. 14020. Accounting treatment on cancellation of foreign

exchange forward contract. 14221. Accounting treatment of Duty Credit Entitlement

under the Target Plus Scheme. 14822. Treatment of spares. 16123. Disclosure of interest on shortfall in payment of

advance income-tax in the financial statements. 16624. Accounting for conversion of membership rights of

erstwhile BSE (AOP) into trading rights of BSELand shares. 172

25. Recognition of duty credit entitlement under ‘Servedfrom India Scheme’. 181

26. Accounting for expenditure on distribution ofmementos to employees during construction period. 187

27. Books of account of franchise business andaccounting implications thereof. 190

28. Capitalisation of establishment expenses ofRehabilitation & Resettlement office after commissi-oning of the project. 198

29. Accounting and reporting of interest in jointlycontrolled entity. 209

30. Accounting for fixed assets held for sale. 21731. Treatment of conversion rights for calculation of

diluted EPS. 22032. Recognition of Duty Credit Entitlement Certificates

issued under the ‘Served from India Scheme’. 225Advisory Service Rules 234Index 237

Compendium of Opinions — Vol. XXVI

1

1 Opinion finalised by the Committee on 27.3.2006

Query No. 1

Subject: Treatment of engineering fee paid to a lumpsumturn key contractor.1

A. Facts of the Case

1. A public sector undertaking is engaged in refining andmarketing of petroleum products. The company has entered into alumpsum turn key (LSTK) agreement with a contractor forprocurement, supply, commissioning, test run, etc., of apetrochemical plant at one of its refineries.

2. The querist has stated that the LSTK agreement with thecontractor provides for residual process design, detailedengineering, procurement, supply, transportation, storage,fabrication, construction, installation, testing, pre-commissioning,commissioning and performance guarantee test run, and handingover of the plant to the company in lieu of one lumpsum amountagreed to by both the parties.

3. According to the querist, in order to facilitate payments, theLSTK agreement segregates the lumpsum price in the followingcategories:

(a) Price for residual process design and detailedengineering,

(b) Price for supply portion, and

(c) Price for construction/installation portion.

4. The querist has stated that the contractor carries out all thejobs necessary to complete the project as per the agreement. Assoon as all the works have been completed in all respects to thesatisfaction of the engineer-in-charge of the company, final testsand commissioning of the complete system plant(s), equipment(s),vessels and machinery, and associated system, etc., as requiredin the specifications, are undertaken by the contractor at the riskand cost of the contractor under the overall supervision of the


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engineer-in-charge of the company. Upon satisfactory conclusionof the final tests and commissioning of the system, the engineer-in-charge issues a final tests and commissioning certificate, whichcertifies the date on which the final tests and commissioning of thesystem have been completed. As and from the date of the issue offinal tests and commissioning certificate, the company is deemedto have taken over the work(s).

5. As per the querist, advance payments are being made to thecontractor based on different stages of performance as agreed inthe LSTK contract on account of all the three categories (residualprocess design and detailed engineering, supply, and construction/installation). After completion of the contract, the contractor raisesthe final invoice and the company makes the final payment. Tillthe date of completion of the project, as mentioned in the aboveparagraph, all the advance payments made to the contractor areaccounted for as capital advance and, accordingly, disclosed ascapital work-in-progress in the financial statements. The queristhas further clarified that the payment terms, as mentioned atparagraph 3 above are only in the nature of milestones for makingpayment under the LSTK contract and the ownership of the fullproject under such LSTK contract passes to the company onlyafter satisfactory completion of the complete project.

6. On final completion of the project, capitalisation of assetsunder various heads, i.e., plant and machinery, equipments andappliances, buildings, furniture and fixtures, etc., is carried out inthe books of the company based on the information provided bythe contractor.

7. In this connection, the querist has mentioned that one of theelements of cost indicated in paragraph 3 above claimed by thecontractor relates to detailed engineering and design of the plant.The examples of such process design and detailed engineeringare designing layout of the equipments, ensuring that the length,size, thickness of equipments, pipes, etc., adheres to the safetynorms, etc.

8. The querist has also drawn the attention of the Committee toparagraphs 9.1 and 10.1 of Accounting Standard (AS) 10,


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‘Accounting for Fixed Assets’, issued by the Institute of CharteredAccountants of India, which state as under:

“9.1 The cost of an item of fixed asset comprises its purchaseprice, including import duties and other non-refundable taxesor levies and any directly attributable cost of bringing theasset to its working condition for its intended use; any tradediscounts and rebates are deducted in arriving at the purchaseprice. Examples of directly attributable costs are:

(i) site preparation;

(ii) initial delivery and handling costs;

(iii) installation cost, such as special foundations forplant; and

(iv) professional fees, for example fees of architectsand engineers.

The cost of a fixed asset may undergo changes subsequentto its acquisition or construction on account of exchangefluctuations, price adjustments, changes in duties or similarfactors.” (Emphasis supplied by the querist.)

“10.1 In arriving at the gross book value of self-constructedfixed assets, the same principles apply as those described inparagraphs 9.1 to 9.5. Included in the gross book value arecosts of construction that relate directly to the specific assetand costs that are attributable to the construction activity ingeneral and can be allocated to the specific asset. Any internalprofits are eliminated in arriving at such costs.”

According to the querist, considering the above provisions of AS10, the expenses incurred towards process design and engineeringfees under the LSTK agreement are accounted for as a componentof the cost of the fixed assets and, accordingly, apportioned amongthe various categories of the fixed assets.


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B. Query

9. The querist has sought the opinion of the Expert AdvisoryCommittee on the following issues in respect of accounting forexpenses incurred towards engineering and design of the plantunder the LSTK agreement:

(a) Whether the accounting treatment of capitalising theexpenditure incurred on process design and engineeringcost as a component of the total asset is in order.

(b) If the answer to (a) above is in the negative, whether theexpenditure incurred on process design and engineeringcost is to be separately accounted for as an intangibleasset.

(c) If the answer to (b) above is also in the negative, thesuggested accounting treatment to be followed in thisregard may be given.

C. Points Considered by the Committee

10. The Committee notes that the basic issue raised in the queryrelates to the treatment of expenditure incurred on process designand engineering cost in respect of various assets under the LSTKagreement. The Committee has, therefore, answered only thisissue and has not touched upon any other issue arising from theFacts of the Case, such as, accounting treatment of paymentsmade to contractor based on stages of completion.

11. As far as the expenditure relating to detailed engineering anddesign of the plant is concerned, the Committee notes paragraph20 of AS 10 and paragraph 10 of AS 26, which state, respectively,as follows:

AS 10

“20. The cost of a fixed asset should comprise itspurchase price and any attributable cost of bringing theasset to its working condition for its intended use.”


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AS 26

“10. In some cases, an asset may incorporate both intangibleand tangible elements that are, in practice, inseparable. Indetermining whether such an asset should be treated underAS 10, Accounting for Fixed Assets, or as an intangible assetunder this Statement, judgement is required to assess as towhich element is predominant. For example, computer softwarefor a computer controlled machine tool that cannot operatewithout that specific software is an integral part of the relatedhardware and it is treated as a fixed asset. The same appliesto the operating system of a computer. Where the software isnot an integral part of the related hardware, computer softwareis treated as an intangible asset.”

12. From the above, the Committee is of the view that theexpenditure on detailed engineering and process design consistingof layout of the equipments is an integral part of the related fixedasset and is also attributable to the cost of bringing the relatedasset to its working condition for its intended use. Hence, theexpenditure on detailed engineering and process design shouldbe allocated to various related fixed assets on the basis of benefitderived by these assets in this regard.

D. Opinion

13. On the basis of the above, the Committee is of the followingopinion on the issues raised in paragraph 9 above:

(a) Yes, the accounting treatment of capitalising theexpenditure incurred on process design and engineeringcost as a component of the total asset is correct.

(b) Since the answer to (a) above is not in the negative, thisquestion does not arise.

(c) The accounting treatment should be as stated at (a)above.


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Query No. 2

Subject: Accounting treatment of expenditure incurred onlicence fee (including user licences) for SAPsoftware.1


1. A public sector undertaking is engaged in refining andmarketing of petroleum products having its marketing networkspread throughout the country. During the year 1999-2000, thecompany decided to implement SAP ERP system in a phasedmanner so as to cover all its units spread throughout the countryover an expected period of 5 to 6 years.

2. Accordingly, the company budgeted for the estimated totalexpenditure likely to be incurred for implementation of SAP systemthroughout the company and actions were initiated in this regard.

3. Prior to Accounting Standard (AS) 26, ‘Intangible Assets’,issued by the Institute of Chartered Accountants of India, becomingmandatory w.e.f. 1.4.2003, the expenditure incurred by the companyon implementation of SAP software including user licencesseparately procured under agreement with SAP India (other thanthe hardware portion) has been charged off as expenditure in theyear of incurrence. The querist has also informed that the paymentmade to SAP India is only towards the user licence fees for theright to use the SAP software and nothing has been paid onaccount of the cost of the SAP software.

4. The company continued to incur expenditure after 1.4.2003on consultancy charges and user licences in line with its plan forimplementation of SAP system throughout the company in a phasedmanner as was envisaged at the time of deciding and initialisingthe implementation of SAP system in the company. The queristhas also informed that the payment of consultancy charges is overand above the payment made on account of user licence fees ofSAP software to the supplier company. The Annual MaintenanceCharges (AMC) being paid to the supplier company is towards



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maintenance of the software, right to use the latest version of thesoftware and minor upgradation in the software from time to time.Such expenditure incurred after 1.4.2003 was continued to becharged to revenue since the original cost incurred on SAP userlicences for the software were already charged to revenue prior to1.4.2003 as explained in paragraph 3 above. According to thequerist, this is in line with the understanding conveyed byparagraphs 58 and 59 of AS 26, which envisage that subsequentexpenditure on an intangible asset can be recognised as intangibleasset only if the original expenditure has been treated as anintangible asset subject to satisfying the conditions laid down fordetermining the test of admissibility as an intangible asset.Paragraphs 58 and 59 are reproduced by the querist as below:

“Past Expenses not to be Recognised as an Asset

58. Expenditure on an intangible item that was initiallyrecognised as an expense by a reporting enterprise inprevious annual financial statements or interim financialreports should not be recognised as part of the cost ofan intangible asset at a later date.

Subsequent Expenditure

59. Subsequent expenditure on an intangible asset afterits purchase or its completion should be recognised asan expense when it is incurred unless:

(a) it is probable that the expenditure will enablethe asset to generate future economic benefitsin excess of its originally assessed standard ofperformance; and

(b) the expenditure can be measured and attributedto the asset reliably.

If these conditions are met, the subsequent expenditureshould be added to the cost of the intangible asset.”

5. The querist has stated that in addition to the expenditurestated in paragraph 4 above, the expenditure incurred on or after


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1.4.2003 and also further expected to be incurred for totalstabilisation of SAP system in the company is mainly for procuringadditional user licences for operating the software as was originallyenvisaged by the company and the same is required to achievethe originally assessed optimal utilisation envisaged while decidingto implement the SAP system.

B. Query

6. The querist has sought the opinion of the Expert AdvisoryCommittee with respect to the expenditure incurred for acquiringthe user licences for right to use of the SAP software, on thefollowing issues:

(a) Whether the accounting treatment of charging subsequentexpenditure on SAP licence fee (including user licences)incurred on or after 1.4.2003 to the profit and loss accountis correct in view of the fact that the initial expenditureincurred on SAP software including licence fee prior to1.4.2003 (i.e., before AS 26 became mandatory) hasalready been charged to revenue in the year of incurrence.

(b) In case the answer to (a) above is in the negative, whatis the suggested accounting treatment for the following:

(i) Expenditure incurred on licence fee for SAP softwareprior to 1.4.2003 (i.e., before AS 26 becamemandatory).

(ii) Subsequent expenditure on user licence fee for theSAP software incurred on or after 1.4.2003, whichhas already been charged to revenue.

(iii) Whether the adjustments, if any, required to becarried out for the accounting periods prior to 31st

March, 2005 are to be reflected as prior yearadjustment as per Accounting Standard (AS) 5, ‘NetProfit or Loss for the Period, Prior Period Items andChanges in Accounting Policies’.


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C. Points considered by the Committee

7. The Committee notes that the issue raised in the query relatesto accounting for the expenditure incurred on purchase of userlicences for SAP software. The Committee has, therefore, restrictedthe opinion only to this issue and has not considered any otherissue arising from the Facts of the Case, for example, accountingtreatment for Annual Maintenance Contract of the software.

8. The Committee is of the view that prior to Accounting Standard(AS) 26, ‘Intangible Assets’, becoming mandatory, i.e., before01.04.2003, all fixed assets, whether tangible or intangible, werecovered by Accounting Standard (AS) 10, ‘Accounting for FixedAssets’. AS 10 dealt with assets such as know how, patents, etc.,the relevant paragraphs in respect of which were withdrawn whenAS 26 became mandatory. In this context, the definition of theterm ‘fixed asset’ as per AS 10, contained in paragraph 6.1, isreproduced below:

“6.1 Fixed asset is an asset held with the intention of beingused for the purpose of producing or providing goods orservices and is not held for sale in the normal course ofbusiness.”

9. The Committee notes from the Facts of the Case that thecompany has purchased the user licences for SAP software forthe purpose of use in the business and not for sale. Therefore, inthe view of the Committee, since the user licences have a lifelonger than one year, the expenditure on purchase of user licences,before AS 26 becoming mandatory, i.e., before 01.04.2003, shouldhave been capitalised as per AS 10 and should have beendepreciated/amortised as per the requirements of AccountingStandard (AS) 6, ‘Depreciation Accounting’, over the estimateduseful life of the user licences. Since this was not done, thisamounts to an error and, accordingly, it comes within the purviewof the definition of ‘prior period items’ under Accounting Standard(AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items andChanges in Accounting Policies’. The definition of the term ‘priorperiod items’ as contained in paragraph 4 of AS 5, is reproducedbelow:


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“Prior period items are income or expenses which arisein the current period as a result of errors or omissions inthe preparation of the financial statements of one or moreprior periods.”

10. In view of the above, if the assets (user licences) are existingon the date of the balance sheet, the company needs to capitalisethe above-said asset at a value arrived at by capitalising theexpenditure incurred with retrospective effect and amortising thesame for the past accounting years. The value of the asset soarrived at should be brought into books in the current year by acorresponding credit to the profit and loss account as a priorperiod item.

11. The Committee further notes the definition of the term‘intangible asset’, provided in paragraph 6 of Accounting Standard(AS) 26, ‘Intangible Assets’, which is reproduced below:

“An intangible asset is an indentifiable non-monetaryasset, without physical substance, held for use in theproduction or supply of goods or services, for rental toothers, or for administrative purposes.”

The Committee is of the view, on the basis of the above definition,that the user licences purchased are intangible assets. Therefore,the expenditure incurred on the purchase of user licences for SAPsoftware on or after 01.04.2003, should have been capitalised andamortised over their estimated useful life as per AS 26. Since thiswas not done as above, the company is required to makeadjustments as suggested in paragraph 10 above.

12. The Committee does not agree with the contention of thequerist that previous expenditure which should have beencapitalised but which was expensed can not be capitalised in viewof the requirements of paragraph 58 of AS 26 reproduced inparagraph 4 of the Facts of the Case. In the view of the Committee,paragraph 58 of AS 26 is related only to that expenditure whichcould not qualify to be recognised as an intangible asset as perthe requirements of the said Standard, at the time of incurrenceand, therefore, was charged as an expense, but later it qualified to


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be recognised as an intangible asset. Paragraph 58 of AS 26provides that the expenditure so expensed can not be capitalisedas an intangible asset in a later year. Thus, this paragraph doesnot relate to an expenditure which fulfilled all the conditions forrecognition as an intangible asset but was erroneously expensed.Therefore, in the view of the Committee, paragraph 58 is notrelevant in the present case.

13. The Committee also does not agree with the contention of thequerist that as per paragraph 59 of AS 26, reproduced in paragraph4 of the Facts of the Case, the subsequent expenditure can not becapitalised as the original expenditure on acquisition was notcapitalised. In the view of the Committee, the subsequentexpenditure dealt with in paragraph 59 is that expenditure which isincurred on those items which were recognised as assets as perAS 10 or AS 26 in earlier years. Thus, simply because theexpenditure incurred initially on acquisition of user licences forSAP software was not capitalised, cannot be an argument for notcapitalising user licences acquired subsequently as they meet therecognition criteria for capitalising the user licences as an intangibleasset. Accordingly, the Committee is of the view that the furtherpurchase of user licences does not amount to be a subsequentexpenditure as contemplated in paragraph 59, as this expenditureamounts to creation of an intangible asset.

14. The Committee notes paragraph 4.3 of the ‘Preface to theStatements of Accounting Standards’ which states that “TheAccounting Standards are intended to apply only to items whichare material….”. Therefore, the above suggestions are onlyapplicable if the amounts involved are material.

D. Opinion

15. On the basis of the above, the Committee is of the followingopinion on the issues raised in paragraph 6 above, subject to theconsideration of materiality stated in paragraph 14 above:

(a) The accounting treatment of charging expenditure, onpurchase of user licences on or after 1.4.2003, to theprofit and loss account is not correct.


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(b) Subject to the condition that the user licences exist onthe date of the balance sheet, i.e., the user licenceshave a useful life on the balance sheet date,

(i) expenditure incurred on purchase of SAP softwareuser licences prior to 1.4.2003 should be capitalisedas suggested in paragraph 10 above;

(ii) expenditure incurred on SAP user licences, on orafter 1.4.2003, should be recognised as an intangibleasset as suggested in paragraph 11 above; and

(iii) adjustments required to be carried out for theaccounting periods prior to 31st March, 2005, shouldbe reflected as prior period item as suggested inparagraph 10 above.

Query No. 3

Subject: Accounting treatment of lease premium receivedon lease of industrial plots as industrial estates.1


1. A government company, registered under the Companies Act,1956, is engaged in the business of developing industrial plots,leasing them to industrial units and meeting their financial needs.

2. The company has developed various industrial plots, whichwere acquired through the Government. The company providesadequate infrastructure facilities like construction of roads, drainagesystem, sewerage system, water distribution network, maintenanceof the plots, etc. The said plots are then leased out to variousindustrial units who construct buildings/sheds etc. The lease isgiven for a period of 99 years and a non-refundable lease premium



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amount is collected towards 100% of the estimated developmentexpenditure besides a yearly rental of Re 1/-.

3. The querist has stated that till 1988-89, the following accountingpractice was followed:

(i) the acquisition cost of land as well as the developmentexpenditure of the industrial estates were shown as‘Current Assets’ and the lease premium received onallotment of the corresponding developed plots was shownas “Current Liabilities” in the balance sheet.

(ii) The resultant profit or loss on such activity wasascertained on completion of the development of theindustrial complex.

4. According to the querist, the above accounting treatment waschanged in the financial year 1988-89, as per the advice of theAccountant General (Commercial), to the understated method,which has been followed upto and including the year 2005-06:

(a) accounting for the cost of land as well as the developmentexpenditure of the industrial estates as ‘Fixed Assets’,

(b) proportionate amount of the lease premium is accountedfor as income of the concerned financial year,

(c) the balance of the lease premium is presented under‘current liabilities’, and

(d) depreciation is charged to the profit and loss account atthe relevant rates on the concerned assets.

5. During the supplementary audit for the financial year 2002-03, the Accountant General (Commercial) commented that thecompany was not following the accounting practice as per anOpinion given by the Expert Advisory Committee of the Institute ofChartered Accountants of India (Query No. 22 of Compendium ofOpinions – Volume No. XX), wherein it was opined that in suchcases, the cost of acquisition of land and the relevant developmentexpenditure should be treated as current assets till the plots areleased and after leasing of the plots, the lease premium received


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should be recognised as income in the profit and loss account inthe year in which the recognition conditions as laid down inAccounting Standard (AS) 9, ‘Revenue Recognition’, issued by theInstitute of Chartered Accountants of India are fulfilled and thecosts of acquisition of land and the development expenditurethereon should also be expensed in the same year.

6. The Accountant General (Commercial) had commented onthe same issue for the accounting year 2003-04 and had statedthat the current liabilities and fixed assets were being overstated.

7. The Board of Directors of the company has discussed theissue and decided as below:

(i) That the matter regarding accounting treatment to begiven in the books of account in respect of the plots/landallotted by the corporation under the lease premiumscheme for the period of 99 years be referred to theExpert Advisory Committee of the Institute of CharteredAccountants of India for expert opinion.

(ii) That the matter be brought to the Board after receipt ofthe expert opinion.

(iii) That till such time, the present accounting treatment becontinued in order to have consistency.

8. The querist has reproduced below the gist of the Opinion ofthe Expert Advisory Committee referred to in paragraph 5 above,for immediate reference:

(a) The query was regarding a government company, whichwas in the business of developing industrial estates andhousing plots, including provision of amenities andinfrastructure just like the company under consideration.The developed industrial estates were given out on leasefor 60 years for which the company was receiving alease premium at the beginning of the lease period. Thelease premium was not refundable during the period oflease. However, the lease was transferable to any otherentrepreneur with the consent of the company. A nominal


15

lease rent of Re. 1/- per annum was charged from thelessees besides recovery of service and maintenancecharges towards maintenance of the industrial estate.

(b) The lease premium was accounted as income at 1/60th

each year and the balance lease premium was shown as‘lease premium received in advance’ under the head‘current liabilities’. The leasehold land, and the landdevelopment expenditure were shown as ‘Fixed Assets’.On objections raised by statutory auditors, the companystarted amortising the proportionate land developmentexpenditure during the operative period of lease andincluded the same under the head ‘Depreciation’.

(c) Considering the above basic facts, the Expert AdvisoryCommittee was of the view that in respect of the leaseagreements for long periods, e.g., 60 years and 99 years,it is generally expected that on the expiry of the leaseterm, either the lease period would be extended or thetitle will pass to the lessee at some agreed amount. Thisamounts to passing of the significant rights of ownershipin the land to the lessee. Thus, it would be in the natureof sale of plots and should be accounted for, accordingly.This requirement, according to the Committee, isrecognition of the principle of ‘substance over form’.

(d) The cost of land along with development expenditureshould be reflected as a current asset and should beexpensed in the same year in which the revenue fromthe lease of plots is recognised as income keeping inview the matching principle.

(e) Also, as per Accounting Standard (AS) 9, ‘RevenueRecognition’, issued by the Institute of CharteredAccountants of India (ICAI), the following three conditionsare laid down for recognition of revenue:

(i) Performance of the act giving rise to revenue

(ii) Measurability of the revenue

(iii) Collectability of the revenue


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(f) In the light of the above considerations, the ExpertAdvisory Committee opined that the lease of land shouldbe treated as sale. Thus, whole of the lease premiumshould be recognised as revenue in the year in whichthe three conditions as laid down in AS 9 are fulfilled andthe related costs of acquisition of land and developmentexpenditure thereon should be expensed in the sameperiod.

9. The querist has further stated that perusal of the lease deedof the company reveals certain important provisions which areenumerated below (a copy of the deed has been separatelyprovided by the querist for the perusal of the Committee):

(i) In fulfillment of one of its principal objects, the companyhas laid out the land into various plots, drains and forother commercial betterment schemes for the benefit ofthe occupants of the plots so laid out. The companyproposes to have control over the amenities so created,such as roads, water supply, drainage, etc., so that theseare distributed to the industrialists in a reasonable andequitable manner. The company also proposes to allotthe land on long lease for 99 years inasmuch as it is feltthat the characteristic and homogeneity of the industrialestate should not be destroyed. Also, the intention of thecompany is that the leased land should be put to theexclusive use for industrial purposes and therebyfacilitating the implementation of the pattern ofindustrialisation that was envisaged. (Emphasis suppliedby the querist.)

(ii) The lessee shall pay 100% of the estimated developmentexpenditure as non-refundable premium in addition topaying rent of Rs. 100/- for 99 years (Re. 1 p.a. for 98years and Rs. 2 for 99th year) and service andmaintenance charges as may be intimated on a monthlybasis.

(iii) In case the lessee violates any conditions of the leasedeed, the company may determine the lease during the


17

period of lease and take possession of the said allottedplot together with the factory buildings and other buildingslocated on the same and the lessee shall not be entitledto any compensation for any of the construction on theallotted plot or any refund of any amount paid by thelessee by virtue of this deed. (Emphasis supplied by thequerist.)

(iv) If the lessee, by any of his action, causes the land to besold or attached, then the company may determine thelease and take possession of the said property alongwith the buildings thereon as mentioned in the aboveparagraph. (Emphasis supplied by the querist.)

(v) If any portion of land allotted to the lessee is foundunutilised or in excess of the lessee’s requirements, thenthe company may take over the unutilised or excessland and the proportionate non-refundable premium paidby the lessee for such land shall be refunded to thelessee. (Emphasis supplied by the querist.)

(vi) On expiry of the lease term laid down in the lease deed,the new lease of the said plot for a similar period of 99years shall be entered into on such covenants andprovisions, as contained in the original lease deed.

10. The querist has stated that the above clauses reveal theintention of the company to hold the said plots as its own fixedassets and the agreement reveals that no significant rights ofownership pass on to the lessee, inasmuch as that the companyretains the right to take over the land with its buildings thereon,upon certain events taking place, even without compensation beingpayable to the lessee.

11. According to the querist, the condition, “performance of theact giving rise to revenue” is not absolutely fulfilled in this instance,as the company retains the right of ownership and even evictionand repossession, and also the company retains the power toextend the lease for another 99 years. Hence, in substance, itcannot be said that the significant rights of ownership have passedon to the lessee.


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12. Besides, as per the querist, if the cost of acquisition of landand development cost thereon, are treated as current assets andexpensed in the same year in which the revenue from sale of plotsis recognised, it leads to the anomaly that the fixed assets of thecompany are written off, while the company retains the ownershiprights on such assets which are only leased. According to thequerist, this is not in accordance with Accounting Standard (AS)10, ‘Accounting for Fixed Assets’, issued by the Institute ofChartered Accountants of India, or generally accepted accountingprinciples. This accounting treatment will not reflect a true and fairview of the financial statements and would invite a qualificationthereon by the auditors.

13. The querist has further stated that accounting of the leaseincome fully in the year of receipt will also not be in accordancewith the principles of recognition of revenue laid down in AS 9,viz., measurability of revenue, as the lease income is paid inadvance for 99 years and if accounted in one year, will lead tolopsided presentation of income and non-matching of income withrelevant expenditure like depreciation on amenities and otherinfrastructure. In the view of the querist, this accounting treatmentwill not reflect a true and fair view of the financial statements andwould invite a qualification thereon by the auditors.

14. The querist has reproduced the professional opinion of thestatutory auditors on this issue which is as follows:

“(i) … we are of the professional opinion that the accountingsystem followed by the company, i.e., accounting for the costof acquisition of land and development costs thereon andother infrastructure costs as fixed assets and accounting forthe lease premium received in advance as current liabilitiesand proportionate lease premium (1/99th) as income for thefinancial year and charging off depreciation for the relevantassets to profit and loss account, is as per the generallyaccepted accounting principles and relevant accountingstandards.

(ii) Besides, we are of the professional opinion, that theopinion of the Expert Advisory Committee of the ICAI should


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be taken into consideration with all other relevant factors andthat it is specifically mentioned that the opinion of the ExpertAdvisory Committee is only that of the Expert AdvisoryCommittee and does not necessarily represent the opinion ofthe Council of the Institute of Chartered Accountants of India,which is binding on all institutions and members of the ICAI.”

B. Query

15. Considering the above factors, the querist has sought theopinion of the Expert Advisory Committee as to whether, onconsideration of the facts and circumstances of the case concerned,it is right for the company to continue its accounting practice of:

(a) recognising the cost of land as well as the developmentexpenditure of the industrial estates as ‘Fixed Assets’,

(b) recognising the lease premium under ‘Current Liabilities’,

(c) recognising the proportionate amount of lease premiumas income of the concerned financial year, and

(d) charging the depreciation to the profit and loss accountat the relevant rates on the concerned assets.


16. The Committee notes paragraph 17(b) of Accounting Standard(AS) 1, ‘Disclosure of Accounting Policies’, issued by the ICAI,which states as follows:

“17(b) Substance over Form

The accounting treatment and presentation in financialstatements of transactions and events should be governed bytheir substance and not merely by the legal form.”

17. The Committee notes from the above that the transactionsand events are accounted for and presented in accordance withtheir substance, i.e., the economic reality of events and transactionsand not merely with their legal form. The Committee notes fromthe ‘Facts of the Case’ that the plots of land are given by thecompany on lease for a period of 99 years, which is renewable for


20

a similar period. The Committee is of the view that taking intoaccount the long period of lease with renewability clause, and theprevalent commercial practices in India in this regard, in substance,the lease of land in this case amounts to passing of significantrights of ownership to the parties concerned. Thus, such a leasewould be in the nature of sale of plots and should be accountedfor accordingly. In this regard, the Committee notes that the principleof substance over form is also recognised in Schedule VI to theCompanies Act, 1956, which requires leaseholds to be shown asfixed assets of the lessee and not of the lessor. The Committeefurther notes from the ‘Facts of the Case’ that the leasing ofindustrial plots constitutes an ordinary activity of the company;hence, land along with the development expenditure incurredthereon should be accounted for as ‘Current Assets’ rather than‘Fixed Assets’. Accordingly, no depreciation should be charged onsuch assets. These current assets should be expensed in the yearin which revenue from the leasehold premium is recognised, asdiscussed in the following paragraphs.

18. The Committee also notes that the querist has argued inparagraph 9(iii) above that the company can take back thepossession of the leased land, in case the lessee violates theconditions of the lease deed, or causes the land to be sold orattached, or keeps the land unutilised, etc. The Committee is ofthe view that such terms and conditions under the lease deed aregenerally inserted so as to regulate the use of industrial plots forspecified purposes only and for their optimum utilisation. TheCommittee also notes that the company also reserves the right oftaking the possession of factory buildings and other constructionon land, which are not even owned by the lessors. In the view ofthe Committee, this does not represent the intention of the companyto hold them as its fixed assets. Similarly, the Committee is of theview that the above-mentioned conditions in case of lease of land,in no way, represent the intention of the company to hold the plotsas its own fixed assets as defined in Accounting Standard (AS)10, Accounting for Fixed Assets, issued by the Institute of CharteredAccountants of India. Accordingly, the contentions of the querist,as stated in paragraphs 11 and 12 above are also not tenable as


21

the significant rights of economic ownership of the land leased fora long period of 99 years, do not vest with the company.19. Regarding the recognition of revenue, the Committee notesfrom the lease deed supplied by the querist, separately that theupfront lease premium comprises upfront leasehold premium onaccount of the acquisition of land and on account of developmentexpenditure, which is collectively referred to as ‘estimateddevelopment expenditure’. As far as premium in respect of land isconcerned, it should be recognised as revenue in the profit andloss account in the year in which the recognition conditions laiddown in paragraph 11 of AS 9 are met. The revenue fromdevelopment expenditure such as expenditure on construction ofroads, drainage system, sewerage system, etc., should berecognised proportionately over the term during which thedevelopment activity is carried on, on the basis of stage ofcompletion, every year. The Committee is of the view that thismanner of recognition of revenue on account of upfront leasepremiums related to estimated development expenditure wouldlead to matching of revenue with the cost. As far as the expenditureincurred in future on services and maintenance of land is concerned,the same will be matched with the services and maintenancecharges obtained by the company.D. Opinion20. On the basis of the above, the Committee is of the opinionthat it is not right for the company to continue its accountingpractice of:

(a) recognising the cost of land as well as the developmentexpenditure of the industrial estates as ‘Fixed Assets’,

(b) recognising the lease premium under ‘Current Liabilities’,(c) recognising the proportionate amount of lease premium

as income of the concerned financial year, and(d) charging the depreciation to the profit and loss account

at the relevant rates on the concerned assets.The company should follow the accounting policy as suggested bythe Committee in paragraphs 17 and 19 above.


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Query No.4

Subject: Depreciation of Water Treatment Plant (WTP) andEffluent Treatment Plant (ETP).1


1. A public sector company with majority shareholding by a stategovernment, manufactures paper for newsprint, printing and writing.The company has a water treatment plant and an effluent treatmentplant.

Water Treatment Plant (WTP)

2. The company constructed a WTP in 1985 to treat raw waterdrawn from a river to carry out various production activities. Thecapacity of WTP was augmented in 1995. WTP consists of thefollowing:

(i) Clarifiers

(ii) De-mineralisation plants (DM plants)

(iii) Neutralisation pit and drain

(iv) Pipelines

3. The querist has stated that the machineries installed in theWTP, including civil foundation works to install the machinery,were capitalised as ‘plant and machinery’. The other civil workswere capitalised as ‘Factory Buildings’. The assets are still in use.

4. The querist has further stated that the company hasconstructed three water storage reservoirs during the years 2000,2003 and 2005 to store water pumped from a river and use thesame for the requirements of the factory. The life of these storagereservoirs is expected to be very long. These water storagereservoirs and connected pipelines have been capitalised as‘Factory Buildings’ by considering the nature of works.



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Effluent Treatment Plant (ETP)

5. The company constructed ETP to treat the effluent in 1985and augmented the capacity in 1995. ETP consists of the following:

(i) Effluent clarifiers (primary and secondary clarifiers)

(ii) Effluent filter house and clarifiers

(iii) Drains

(iv) Effluent/anaerobic lagoon

6. According to the querist, the machineries installed in theeffluent clarifiers, effluent filter house and clarifiers, and lagoonincluding civil foundation works to install the machineries werecapitalised as ‘Plant and Machinery’. The other civil works werecapitalised as ‘Factory Buildings’. These assets are still under use.

7. The querist has provided the following tables containing theprocesses/activities carried on by using various civil works involvedin WTP and ETP, respectively, along with the remarks of thecompany:

CIVIL WORKS IN WATER TREATMENT PLANT (WTP)

S. DescriptionNo.1 Intake well

sumps

2 Clariflocula-tor 1 and 2(Clarifiers)

Nature of civilwork involved

Reinforced ce-ment concrete(RCC) structureat ground level.

RCC circulartank at groundlevel.

Processactivity

Water is beingpumped from thesump for entireplant.

To treat waterwith chemicalsfor clarifying thewater.

Remarks

Not directly in-volved in treat-ment.

Directly involvedin pre-treatmentof water.


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S. DescriptionNo.1 Primary

clarifiers

2 Anaerobiclagoon

3 Aerationpond

4 Secondaryclarifier anddrains

5 Sludgethickener

6 Filter Housebuilding

Nature of civilwork involved

RCC circular tankat ground level.

R e c t a n g u l a rearth-en lagoonwith stone pitch-ing.

Rectangular pondwith RCC liningand walkways atground level.



RCC framedstructure building.

Processactivity

To clarify theeffluent withchemicals.

For anaerobictreatment forreducing COD.

For treatment ofeffluent withaerobic action.

For settlement ofsludge.

For removal ofsludge.

To house ETPfilters for sludgeremoval.

Remarks

Directly involvedin treatment.





Not directlyinvolved intreatment.

3 Reservoirsat WTP(Reservoir 1and 2)

4 De-minerali-sation plant

5 Neutralisa-tion Pit anddrains

6 Softeningplant



RCC rectangularground level tank.


For storing clari-fied water beingpumped for plantuse.

To house equip-ments involved inde-mineralisationactivity.

Water is beingneutralised byadding chemi-cals.

To house equip-ments involved insoftening activity.


Not directly in-volved in treat-ment of water


Not directly in-volved in treat-ment of water

CIVIL WORKS IN EFFLUENT TREATMENT PLANT (ETP)


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B. Query

8. The querist has sought the opinion of the Expert AdvisoryCommittee on the following issues:

(i) Whether the capitalisation of civil works in WaterTreatment Plant (WTP) and Effluent Treatment Plant(ETP) as ‘Factory Buildings’ is correct? If not, what shouldbe the treatment for the above civil works?

(ii) Whether the capitalisation of raw water storage reservoiras ‘Factory Buildings’ is correct? If not, what should bethe treatment?

(iii) If the above items are to be capitalised as ‘Plant andMachinery’, whether the revised depreciation rates areapplicable prospectively or retrospectively.

(iv) If the revised depreciation rates are to be appliedretrospectively, whether the depreciation pertaining to priorperiods should be presented under ‘prior period items’.


9. The Committee is of the view that in the absence of thedefinitions of the terms ‘Factory Buildings’ and ‘Plant andMachinery’, under the Companies Act, 1956, a functional test hasto be applied to determine whether a structure is ‘plant’ or not. Thefunctional test requires to examine various aspects of the structureto determine whether it is an apparatus with which the activity oractivities is/are carried on or it is a mere setting of or part of thepremises in which the activity is/activities are carried on.

10. The Committee notes from the Facts of the Case that the civilworks of WTP and ETP consisting of reservoirs, drains, lagoons,various clarifiers, neutralisation pit, aeration pond, and sludgethickener are directly involved in the process of treatment of waterand effluent. On this basis, the Committee is of the view that thecivil works involved in the Water Treatment Plant and EffluentTreatment Plant, excluding intake well sumps, de-mineralisationplant, softening plant and filter house building, are not merely the


26

premises in which the work is carried on; these are rather themeans with which and through which the activities of treatment ofwater and effluent are carried on. Hence, in the view of theCommittee, the civil works directly involved in the treatment ofwater and effluent should be capitalised as ‘Plant and Machinery’instead of ‘Factory Buildings’ and accordingly, depreciation as perthe rates applicable to ‘Plant and Machinery’ should be providedon these items, taking into account the rates given in ScheduleXIV to the Companies Act, 1956.

11. As far as depreciation on other civil works, i.e., which are notdirectly involved in the process of treatment of water and effluent,such as, intake well sumps, de-mineralisation plant, softening plantand filter house building is concerned, the Committee notes fromthe Facts of the Case that these civil works only act as the settingor structure containing various equipments and are not directlyinvolved in the process of water treatment and effluent treatment.Hence, the Committee is of the view that these civil works shouldbe classified as ‘Factory Buildings’ and accordingly, depreciationon these items should be provided as per the rates applicable to‘Factory Buildings’ under Schedule XIV.

12. The Committee notes that the information provided by thequerist in tables (paragraph 7 above), explaining the nature of civilworks involved and the process activities carried on by them, doesnot specifically mention raw water storage reservoir. Hence, if thenature of the reservoir is such that it is not directly involved in thetreatment of water and effluent, it should be treated as ‘FactoryBuilding’.

13. Regarding the revision of the rates of depreciation to be appliedon civil works directly involved in WTP and ETP, the Committee isof the view that the practice followed by the company of providingdepreciation on these civil works, at the rates applicable to ‘FactoryBuildings’, is an error as depreciation on these items should havebeen provided as per the rates applicable to ‘Plant and Machinery’,from the very beginning. In view of this, depreciation on the saiditems should now be provided with retrospective effect. Thedeficiency or surplus arising from retrospective recomputation of


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depreciation in accordance with the changed rates due to changein classification of assets should be adjusted in the accounts in theyear in which change is given effect to as a prior period item asdiscussed in the following paragraphs.

14. The Committee notes the definition of the term ‘prior perioditems’ and paragraphs 15 and 19 of Accounting Standard (AS) 5,‘Net Profit or Loss for the Period, Prior Period Items and Changesin Accounting Policies’, issued by the Institute of CharteredAccountants of India, which state as follows:


“15. The nature and amount of prior period items shouldbe separately disclosed in the statement of profit andloss in a manner that their impact on the current profit orloss can be perceived.”

“19. Prior period items are normally included in thedetermination of net profit or loss for the current period. Analternative approach is to show such items in the statement ofprofit and loss after determination of current net profit or loss.In either case, the objective is to indicate the effect of suchitems on the current profit or loss.”

15. From the above, the Committee is of the view that the changein the depreciation rates due to change in the classification ofassets arising from an error, as discussed in paragraph 13 above,is a prior period item and, therefore, excess/short depreciationcharge pertaining to prior periods should be disclosed separatelyin the current year’s profit and loss account in a manner that itsimpact on the current year’s profit or loss can be perceived.

D. Opinion



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(i) No, capitalisation of civil works directly involved in watertreatment and effluent treatment, as ‘Factory Buildings’is not correct. These civil works should be treated as‘Plant and Machinery’.

(ii) Capitalisation of raw water storage reservoir as ‘FactoryBuildings’ would be correct only if it is not directly involvedin the process of treatment of water and effluent asdiscussed in paragraph 12 above.

(iii) The revised depreciation rates are applicableretrospectively.

(iv) Depreciation pertaining to prior period due to retrospectiveapplication of depreciation rates is a prior period item,which should be separately disclosed.

Query No. 5

Subject: Determination of net selling price of a cashgenerating unit incurring losses.1


1. The accounts of a public sector company are audited by theOffice of the Principal Director of Commercial Audit & Ex- OfficioMember, Audit Board. During the audit of the accounts of thecompany for the financial year 2004-05, certain differences ofopinion had arisen in respect of Accounting Standard (AS) 28,‘Impairment of Assets’, issued by the Institute of CharteredAccountants of India. The auditors, however, had cleared theaccounts for the year 2004-05, on the commitment made by thecompany to take opinion from the Expert Advisory Committee ofthe Institute of Chartered Accountants of India.



29

2. The querist has stated that the company has mainly threedifferent businesses controlled by three separate business groupsas under:

(i) Business Group (Petroleum) – It is engaged in storageand distribution of high speed diesel, motor spirit (petrol),kerosene oil, naphtha, aviation turbine fuel, etc., andmanufacture and marketing of automotive lubes andgrease, etc. Turnover of this business group (B.G.) inthe financial year 2004-05 was Rs. 13,364 crore. Underthe B.G. (Petroleum), there are 3,272 petrol pumps ason 31.03.2005, 17 depot terminals (for storing anddistribution of petroleum products), 27 divisional offices,4 regional offices, one marketing head office at Mumbaiand one corporate head office at Kolkata. For budgetand MIS reporting purpose, B.G. (Petroleum) as a wholehas been considered as a separate unit and budgetedprofitability is being prepared for the B.G. (Petroleum)separately.

For the purpose of accounting, all transactions (cash/bank/journal) at the divisional office level and depot levelare consolidated at the concerned region. Except somemajor adjustments pertaining to margin updation,Government subsidy is being controlled and accountedfor at marketing head office for petroleum at Mumbai.Considering 4 regional final accounts and separate finalaccounts for LPG business, marketing head office forpetroleum prepares consolidated final accounts for thepetroleum business which is ultimately consolidated atcorporate head office at Kolkata along with the finalaccounts of B.G. (Explosives) and B.G. (Cryogenics).

Considering various provisions of AS 28 and the industrypractice on the issue, the company has consideredbusiness group (petroleum) as ‘cash generating unit(CGU)’ instead of considering each regional offices andLPG business as separate CGUs. Reason being thatindividual regions and LPG business are not independent


30

of cash inflows from the other assets or group of assetsof the B.G. (Petroleum). The statutory auditors of thecompany and C&AG have agreed to consider the B.G.(Petroleum) as a separate CGU.

(ii) Business Group (Explosives) – It is engaged inmanufacture and marketing of site mixed explosives, re-pumpable bulk emulsion explosives, cartridged explosives,detonating fuses, cast boosters, etc. Turnover of thisgroup in the financial year 2004-05 was Rs. 92 crore.Under B.G. (Explosives), there are 14 manufacturingplants, two marketing offices at Delhi and Nagpur andone divisional head office at Kolkata. Individual plantsare maintaining accounts and making all payments exceptfor majority of the raw material payment which is procuredcentrally from the divisional head office (DHO) at Kolkata.Sundry creditors for raw material and debtors are alsobeing maintained centrally at divisional head office.

For the purpose of Budget and MIS, overall profitabilityof the B.G. (Explosives) is being prepared. However,plant-wise profitability is also prepared as per therequirement of the management from time to time. Trialbalances of each plant, after getting audited, are sent toDHO for consolidation and preparation of final accountsof B.G (Explosives) which subsequently get consolidatedat corporate head office, Kolkata along with B.G.(Cryogenics) and B.G. (Petroleum) accounts. The finalaccounts get audited at regional level, Mumbai Headoffice level for B.G. (Petroleum) and at DHO level forB.G. (Cryogenics) and B.G. (Explosives).

Considering various provisions of AS 28, the companyhas considered the Business Group (Explosives) as aseparate ‘cash generating unit’ (CGU). Reasons being:(a) The sales allocation of principal customer of B.G.(Explosives) is being made from DHO, Kolkata. (b) Allthe major raw materials are being procured centrally atDHO and then placed with the plants as per therequirements. (c) The overall control of the plants with


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respect to finance, human resource, marketing issuesare being centrally controlled at DHO. The statutoryauditors of the company and C&AG have agreed toconsider the B.G. (Explosives) as a separate CGU.

(iii) Business Group (Cryogenics) - It is engaged inmanufacture and marketing of aluminium cryogeniccontainers, stainless steel industrial cryovessels, etc.Turnover of this group in the financial year 2004-05 wasRs. 23 crore. Under B.G. (Cryogenics), there is one plantat Nasik and one cryogenics head office at Mumbai.Final accounts of B.G. (Cryogenics) are prepared atMumbai and finally consolidated at Kolkata corporateoffice along with B.G. (Petroleum) and B.G. (Explosives)accounts. For the purpose of budget and MIS, overallprofitability of the B.G. (Cryogenics) is being prepared.Considering various provisions of AS 28, the companyhas considered Business Group (Cryogenics) as aseparate ‘Cash Generating Unit’.

3. According to the querist, as stated above, in line with thevarious paragraphs of AS 28, the company has identified threecash generating units (CGUs), i.e., B.G. (Petroleum), B.G.(Explosives) and B.G. (Cryogenics). For the purpose of testing theimpairment of the three CGUs of the company, while calculatingthe recoverable amount, value in use has been considered for B.G. (Petroleum) as it was possible to forecast the future cash flowsfor the next 10 years (emphasis supplied by the querist). However,according to the querist, to calculate the recoverable amount ofB.G. (Explosives) and B.G. (Cryogenics), assets’ net selling pricehas been considered in line with paragraph 15 of AS 28 as it wasnot possible to forecast the future cash flows nearest to actual dueto volatile conditions in the market. The querist has also mentionedthat these two business groups have been suffering losses for thelast five years. While calculating the net selling price of the abovetwo business groups, since the company was unable to makereliable estimate of the amount obtainable from the sale of theassets in an arm’s length transaction between knowledgeable andwilling parties, the company had appointed chartered valuers to


32

arrive at the net realisable value of the assets. On the basis of thevaluers’ reports, the company had tested the impairment of assetsof the B.G. (Explosives) and B.G. (Cryogenics) and found that thecarrying amounts of the assets are less than the recoverableamount (net realisable value) of the assets. Hence, as per thequerist, no impairment of assets was warranted.

4. The querist has further stated that while considering the netselling price as recoverable amount of the above two businessgroups, the company has placed reliance on the following: (a)definition of recoverable amount as per paragraph 4 of AS 28 –since these two business groups are making losses, net sellingprice of the assets will always be higher than the value in use. (b)paragraph 15 of AS 28, which, inter alia, states that it is notalways necessary to determine both assets’ net selling price andvalue in use.

B. Query


(a) In the absence of a binding sale agreement in an arm’slength transaction, or if the assets are not traded in theactive market, or in the absence of the current bid pricesof the assets, or if the prices of the most recenttransaction are not available,

(i) Whether the assets can be valued by a charteredvaluer for accounting at net selling price/ netrealisable value, and

(ii) If yes, whether such value can be considered forthe purpose of testing impairment.

(b) If a CGU is incurring losses, whether the carrying amountshould not be more than its value in use.


6. The Committee notes that the basic issue raised in the queryrelates to the calculation of impairment loss in case of B.G.


33

(Explosives) and B.G. (Cryogenics). The Committee has, therefore,considered only this issue and has not touched upon any otherissue arising from the Facts of the Case, such as, identification ofCGUs, testing of impairment in case of B.G. (Petroleum), etc.

7. The Committee notes that the basic objective of providingimpairment loss is to ensure that the assets of an enterprise arecarried at no more than their recoverable amount. Recoverableamount, according to AS 28, “is the higher of an asset’s net sellingprice and its value in use.” Hence, the company has to comparethe net selling price and value in use of an asset and the higher ofthese two, which is the recoverable amount, is then compared withthe carrying amount of the asset, and if an asset is carried at morethan its recoverable amount, i.e., the asset is impaired, then theimpairment loss is recognised.

8. Insofar as the calculation of value in use is concerned, theCommittee notes the definition of the term ‘value in use’, ascontained in paragraph 4 of AS 28 and paragraphs 26 to 30 of AS28, which state as follows:

“Value in use is the present value of estimated futurecash flows expected to arise from the continuing use ofan asset and from its disposal at the end of its usefullife.”

“26. In measuring value in use:

(a) cash flow projections should be based onreasonable and supportable assumptions thatrepresent management’s best estimate of theset of economic con ditions that will exist overthe remaining useful life of the asset. Greaterweight should be given to external evidence;

(b) cash flow projections should be based on themost recent financial budgets/forecasts that havebeen approved by management. Projectionsbased on these budgets/forecasts should covera maximum period of five years, unless a longerperiod can be justified; and


34

(c) cash flow projections beyond the period coveredby the most recent budgets/forecasts should beestimated by extrapolating the projections basedon the budgets/forecasts using a steady ordeclining growth rate for subsequent years,unless an increasing rate can be justified. Thisgrowth rate should not exceed the long-termaverage growth rate for the products, industries,or country or countries in which the enterpriseoperates, or for the market in which the asset isused, unless a higher rate can be justified.

27. Detailed, explicit and reliable financial budgets/forecastsof future cash flows for periods longer than five years aregenerally not available. For this reason, management’sestimates of future cash flows are based on the most recentbudgets/forecasts for a maximum of five years. Managementmay use cash flow projections based on financial budgets/forecasts over a period longer than five years if managementis confident that these projections are reliable and it candemonstrate its ability, based on past experience, to forecastcash flows accurately over that longer period.

28. Cash flow projections until the end of an asset’s usefullife are estimated by extrapolating the cash flow projectionsbased on the financial budgets/ forecasts using a growth ratefor subsequent years. This rate is steady or declining, unlessan increase in the rate matches objective information aboutpatterns over a product or industry lifecycle. If appropriate,the growth rate is zero or negative.

29. Where conditions are very favourable, competitors arelikely to enter the market and restrict growth. Therefore,enterprises will have difficulty in exceeding the averagehistorical growth rate over the long term (say, twenty years)for the products, industries, or country or countries in whichthe enterprise operates, or for the market in which the assetis used.


35

30. In using information from financial budgets/forecasts, anenterprise considers whether the information reflectsreasonable and supportable assumptions and representsmanagement’s best estimate of the set of economic conditionsthat will exist over the remaining useful life of the asset.”

9. Regarding the determination of net selling price of the twobusiness groups, the Committee notes the definition of the term‘net selling price’ as contained in paragraph 4 of AS 28, andparagraphs 16 and 20 to 22 of AS 28, which, state as follows:

“Net selling price is the amount obtainable from the saleof an asset in an arm’s length transaction betweenknowledgeable, willing parties, less the costs of disposal.”

“16. It may be possible to determine net selling price, even ifan asset is not traded in an active market. However, sometimesit will not be possible to determine net selling price becausethere is no basis for making a reliable estimate of the amountobtainable from the sale of the asset in an arm’s lengthtransaction between knowledgeable and willing parties. In thiscase, the recoverable amount of the asset may be taken tobe its value in use.”

“20. The best evidence of an asset’s net selling price is aprice in a binding sale agreement in an arm’s lengthtransaction, adjusted for incremental costs that would bedirectly attributable to the disposal of the asset.

21. If there is no binding sale agreement but an asset istraded in an active market, net selling price is the asset’smarket price less the costs of disposal. The appropriate marketprice is usually the current bid price. When current bid pricesare unavailable, the price of the most recent transaction mayprovide a basis from which to estimate net selling price,provided that there has not been a significant change ineconomic circumstances between the transaction date andthe date at which the estimate is made.

22. If there is no binding sale agreement or active marketfor an asset, net selling price is based on the best information


36

available to reflect the amount that an enterprise could obtain,at the balance sheet date, for the disposal of the asset in anarm’s length transaction between knowledgeable, willingparties, after deducting the costs of disposal. In determiningthis amount, an enterprise considers the outcome of recenttransactions for similar assets within the same industry. Netselling price does not reflect a forced sale, unless managementis compelled to sell immediately.”

10. The Committee notes from the above that while AS 28 doesnot exempt any enterprise from calculating value in use under anycondition, it exempts calculation of net selling price under paragraph16 reproduced above, where net selling price cannot be arrived atin accordance with the requirements of the Standard. The Standarddoes not contemplate that in case the net selling price cannot bearrived at as per its requirements, such a price can be arrived aton the basis of the valuation made by a chartered valuer. The saidparagraph provides that in such a case the enterprise should,instead, use the value in use. Thus, in the view of the Committee,the company should compute its value in use even though thereare volatile conditions in the market, on the basis of the reasonableprojections supported by the existing conditions and assumptionsover the remaining useful life of the asset as stated in paragraphs26 to 30 of AS 28. The Committee does not agree with theconclusion given by the querist that in case a CGU is incurringlosses, its value in use will always be lower than that of its netselling price. In any case, as stated in paragraph 16 of AS 28, incase the net selling price cannot be computed, the value in use isto be considered by the company. The underlying reason for thisrequirement is that the fixed assets are held by the company foruse in the business rather than for the purpose of their sale. Thus,computation of value in use is paramount.

D. Opinion

11. The Committee is of the following opinion on the issues raisedin paragraph 5 above:

(a) In the absence of a binding sale agreement in an arm’slength transaction, or if the assets are not traded in the


37

active market, or in the absence of the current bid pricesof the assets, or if the prices of the most recenttransaction are not available,

(i) the values provided by a chartered valuer can notform basis for determining the net selling price/netrealisable value of the assets.

(ii) No, such value can also not be considered for thepurpose of testing impairment.

(b) For the purpose of testing impairment, the carryingamount has to be compared with the recoverable amount(higher of an asset’s net selling price and its value inuse). In case net selling price cannot be determined inaccordance with principles of AS 28, value in use maybe taken as recoverable amount, which then should becompared with the carrying amount of the asset. In sucha case, carrying amount of the asset should not be morethan its value in use, irrespective of the fact that CGU isincurring losses.

Query No. 6

Subject: Treatment of deferred tax asset in respect of excessprovision for doubtful advances and doubtfulclaims.1


1. The accounts of a public sector company are audited by theoffice of the Principal Director of Commercial Audit and Ex-officioMember, Audit Board. During the audit of the accounts of thecompany for the financial year 2004-05, certain differences ofopinion had arisen between the company and the auditors in respect



38

of Accounting Standard (AS) 22, ‘Accounting for Taxes on Income’,issued by the Institute of Chartered Accountants of India. Theauditors, however, cleared the accounts for the year 2004-05,giving the benefit of doubt and on the commitment made by thecompany to take opinion of the Expert Advisory Committee of theInstitute of Chartered Accountants of India.

2. The company has mainly three different businesses controlledby three separate business groups, namely, Petroleum, Explosivesand Cryogenics.

3. The querist has separately provided detailed calculation ofdeferred tax assets/liabilities of the company for the last two yearsand a copy of the balance sheet as on 31.03.2005 for the perusalof the Committee. According to the querist, the computations showthat the company has considered only the provision for doubtfuldebts against sundry debtors for the purpose of creating deferredtax assets and has not considered provision for doubtful advances,provision for doubtful claims and provision for doubtful deposits forthis purpose. The reason given by the querist for the aforesaidtreatment is that, from its past experience, the company isreasonably certain in respect of provisions for doubtful advancesand doubtful claims that there are remote chances of these resultinginto bad debts. The querist has also emphasised that there wereno bad debts against these two provisions for the years 2001-02to 2003-04. As per the querist, the company is consistently followingthe same method while calculating the deferred tax assets/liability.

B. Query

4. The querist has sought the opinion of the Expert AdvisoryCommittee as to whether while calculating deferred tax assets/liability for the company as a whole, provision for doubtful advancesand provision for doubtful claims need to be considered forcalculation of deferred tax assets.


5. The Committee notes that the basic issue raised by the queristrelates to creation of deferred tax asset/liability in respect ofprovision for doubtful advances and doubtful claims. Hence, the


39

Committee has considered only this issue and has not examinedany other issue arising from the Facts of the Case, for example,creation of provision in respect of doubtful debts against sundrydebtors and treatment of deferred tax assets/liabilities in respectthereof, etc.

6. The Committee notes that Part III of Schedule VI to theCompanies Act, 1956 states in paragraph 7(2) as below:

“(2) Where –

(a) any amount written off or retained by way ofproviding for depreciation, renewals or diminution invalue of assets, not being an amount written off inrelation to fixed assets before the commencementof this Act; or

(b) any amount retained by way of providing for anyknown liability;

is in excess of the amount which in the opinion of the directorsis reasonably necessary for the purpose, the excess shall betreated for the purposes of this Schedule as a reserve andnot as a provision.”

7. The Committee also notes that Schedule VI to the CompaniesAct, 1956, under ‘Instructions in accordance with which assetsshould be made out’ in respect of ‘sundry debtors’ provides that“The provisions to be shown under this head should not exceedthe amount of debts stated to be considered doubtful or bad andany surplus of such provision, if already created, should be shownat every closing under “Reserves and Surplus” (in the Liabilitiesside) under a separate sub-head “Reserve for Doubtful or BadDebts”.”

8. The Committee further notes that the provision for bad anddoubtful claims and advances represents impairment of receivableswhich is covered by Accounting Standard (AS) 4, ‘Contingenciesand Events Occurring After the Balance Sheet Date’, issued bythe Institute of Chartered Accountants of India. In this context, theCommittee notes paragraph 10 of AS 4, which states as follows:


40

“10. The amount of a contingent loss should be providedfor by a charge in the statement of profit and loss if:

(a) it is probable that future events will confirm that,after taking into account any related probablerecovery, an asset has been impaired or aliability has been incurred as at the balance sheetdate, and

(b) a reasonable estimate of the amount of theresulting loss can be made.”

The Committee notes that an event is regarded as ‘probable’ if theevent is more likely than not to occur, i.e., the probability that theevent will occur is greater than the probability that it will not.

9. The Committee notes that the querist has stated in paragraph3 of the Facts of the Case that the chances of advances/claims(against which provisions have been created) becoming bad arevery remote and from its past experience, the company isreasonably certain that these debts will be recovered in the future.The Committee also notes from the said paragraph that therewere no bad debts against these two provisions during the last twoyears.

10. From the above paragraphs, the Committee is of the viewthat creation of provision by the company against advances/claimsthat are considered to be recoverable is an error in view of therequirements of the Companies Act, 1956, and AS 4. Hence, theexcess amount of provision should be written-back in the financialstatements as a ‘prior period item’. In this regard, the Committeenotes the definition of the term ‘prior period items’ and paragraphs15 and 19 of Accounting Standard (AS) 5, ‘Net Profit or Loss forthe Period, Prior Period Items and Changes in Accounting Policies’,issued by the Institute of Chartered Accountants of India, whichstate as follows:



41


“19. Prior period items are normally included in thedetermination of net profit or loss for the current period. Analternative approach is to show such items in the statement ofprofit and loss after determination of current net profit or loss.In either case, the objective is to indicate the effect of suchitems on the current profit or loss.”

11. On the basis of the above, the Committee is of the view thatsince the creation of provision for doubtful claims and advanceswas on account of an error in the past years, as discussed inparagraphs 9 and 10 above, it should be written-back in the financialstatements of the year in which such a correction is made andshould be shown separately in a manner that its impact on thecurrent profit or loss can be perceived. Accordingly, the questionof creation of deferred tax assets/liability in respect of provision fordoubtful claims and advances would not arise. The Committee is,however, of the view that if the company so desires, the companymay create reserve for doubtful claims and doubtful advances asan appropriation of profits.

D. Opinion

12. On the basis of the above, the Committee is of the opinion,on the issue raised in paragraph 4, that in the present case, theprovision for doubtful advances and provision for doubtful claimsshould be written back in the financial statements as a ‘prior perioditem’ as explained in paragraph 11 above and hence, the questionof treatment of deferred tax asset/liability against such provisionsdoes not arise.


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Query No. 7

Subject: Rates of depreciation on various assets involved inmass rapid transport system.1

A Facts of the Case

1. A government company has been incorporated to constructand operate a mass rapid transport system (i.e., metro trains) inthe National Capital Region. While some phases of the systemhave already become operational, others are at various stages ofconstruction or conceptualisation. The construction of a mass rapidtransport system involves incurrence of huge capital expenditure.Consequently, depreciation constitutes a significant element of costof operations.

2. According to the querist, three major types of fixed assets,each of which accounts for a substantial capital expenditure andare quite unique to the company in the Indian context are asfollows:

(a) Rolling stock

(b) Escalators and elevators

(c) Track work

3. The querist has stated that Schedule XIV to the CompaniesAct, 1956, does not specifically lay down any rates of depreciationin respect of the above categories of fixed assets. In the absenceof a specific rate, if the company applies the general rate applicableto plant and machinery, it would be totally un-representative of theuseful lives of these assets. According to the querist, this generalrate applicable to plant and machinery (i.e., 4.75 percent onstraightline basis) assumes that the useful life of general items ofplant and machinery is 20 years whereas, the estimated lives ofRolling Stock, Escalators and Elevators, and Trackwork are muchlonger than 20 years. The special features of these items are asbelow:



43

(i) Rolling Stock – The trains are of modern design and arelight weight made of stainless steel with three phase ACdrive having VVVF control regenerative braking andsuitable for automatic train protection and operationsystem. The coaches are provided with automatic doorclosing mechanism to ensure passenger safety. Thecoaches have been built, meeting international standardsof safety, reliability and maintainability. They are designedand constructed for a service life of at least 30 years ofnormal usage, without major repair.

(ii) Escalators and elevators – They are provided at elevatedand underground stations for passenger transportation.These heavy duty public escalators comply withinternational and national standards. The design,manufacture, supply, installation, testing andcommissioning of the escalators meet the state of thetechnology in the area. The life of these escalators andelevators is estimated at a minimum of 30 years.

(iii) Trackwork – With a view to obtain optimum life for variouscomponents, a sturdy track structure has been selected,such as 60 kg. head hardened rails, ballast less track onviaduct/tunnel and structurally strong turnouts. A life of58 years is estimated for the same.

4. As per the querist, the estimates made by the company arebased on technical evaluation and suppliers’ assertions. Theseestimates are prudent and would represent true and fair commercialdepreciation. The querist has separately provided technicalevaluation reports of suppliers in this regard for the perusal of theCommittee. Comparative depreciation rates/lives of assets adoptedby the companies carrying similar operations, along with thecorresponding lives under the Companies Act, 1956 and that asestimated by the company, are also provided separately by thequerist for the perusal of the Committee. According to the querist,a perusal of the comparative analysis of depreciation rates/usefullives highlights the following in respect of the said assets:


44

(a) Rolling stock: All the companies carrying similaroperations have estimated life of Rolling Stock muchhigher (at 35-40 years) than 20 years which is the lifeworked out on the basis of the general rate applicable toplant and machinery as per the Companies Act, 1956.According to the data given by the management, thesuppliers of the company have estimated the life at 30years. The life of 30 years, according to the querist,therefore, seems a prudent estimate.

(b) Escalators and elevators: The useful life has beenestimated around 30 years by various other companies(except one company). However, the general rate asprescribed in Schedule XIV to the Companies Act, 1956envisages a life of 20 years. The life of 30 years asestimated by the management may, therefore, beadopted.

(c) Trackwork: The management’s estimate of 58 years issupported by the estimates of other railway companies.

5. The querist has stated that the company applied forconcurrence to the aforesaid special rates of depreciation to theMinistry of Urban Development (Administrative Ministry) and theMinistry of Company Affairs. In response, the Ministry of UrbanDevelopment, vide its Office Memorandum No. 14011/73/2003/MRTS dated 22.3.2004, communicated its concurrence. TheMinistry of Company Affairs vide its letter dated 22.8.2005 askedthe company to seek the expert opinion from the Institute ofChartered Accountants of India.

6. The querist has stated that as per Accounting Standard (AS)6, ‘Depreciation Accounting’ issued by the Institute of CharteredAccountants of India, useful life is “…the period over which adepreciable asset is expected to be used by the enterprise…”(emphasis supplied by the querist). Further, paragraph 8 of AS 6,inter alia, states that “determination of the useful life of a depreciableasset is a matter of estimation and is normally based on variousfactors including experience with similar types of assets” (emphasis


45

supplied by the querist). The querist has also drawn the attentionof the Committee to paragraph 22 of AS 6, which states as follows:

“22. The useful life of a depreciable asset should beestimated after considering the following factors:

(i) expected physical wear and tear;

(ii) obsolescence;

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

7. The querist has further stated that AS 6 also recognises inparagraph 13 that “the statute governing an enterprise may providethe basis for computation of the depreciation. For example, theCompanies Act, 1956 lays down the rates of depreciation in respectof various assets. Where the management’s estimate of the usefullife of an asset of the enterprise is shorter than that envisagedunder the provisions of the relevant statute, the depreciationprovision is appropriately computed by applying a higher rate. Ifthe management’s estimate of the useful life of the asset is longerthan that envisaged under the statute, depreciation rate lower thanthat envisaged by the statute can be applied only in accordancewith requirements of the statute.” (Emphasis supplied by thequerist.) According to the querist, it is clear from the aforementionedprovisions that one has to:

(a) estimate the useful life of the specified categories offixed assets, and

(b) consider the position under the Companies Act, 1956.

8. According to the querist, as far as the estimate of the usefullife is concerned, technical estimates and past experience areimportant indicators. The practice followed by the companies usingsimilar assets is another useful indicator (provided those companiesare not covered by any specific legal stipulations). As per thequerist, in the present case,

(a) the technical specifications agreed to between thecompany and the suppliers of rolling stock, escalators


46

and elevators clearly stipulate a life of a minimum of 30years;

(b) other entities using similar assets are also chargingdepreciation at rates based on estimates of useful liveswhich are generally higher than those estimated by thecompany; and

(c) the Ministry of Urban Development has independentlyconcurred with the useful life as envisaged above.

9. On the basis of the above, the querist has argued that thereis a strong logic for the Ministry of Company Affairs to specificallyallow ‘rolling stock’ and ‘escalators and elevators’ of the companybeing depreciated at 3.17% (SLM) and trackwork being depreciatedat 1.63% (SLM) based on technical life of the relevant assets.Also, since the above estimates already take into account theextent of likely usage of the assets (which will be almost on acontinuous basis round the clock except for a few hours aroundmid-night), it may also be specifically provided that there would beno extra shift depreciation on those assets.

B. Query


(a) Assuming that (i) it can be demonstrated that the usefullife of rolling stock and escalators and elevators is 30years and that of track work is 58 years and (ii) there areno legal stipulations as to rate of depreciation, whethercharging depreciation at 3.17% and 1.63% (respectively)per annum as per straight line method (SLM) would resultin a true and fair view.

(b) Since the company, as per the querist, has been able toadduce sufficient evidence regarding the above estimatesof useful life, whether depreciation at 3.17% and 1.63%(SLM) per annum would be a proper charge, if this rateis allowed by the Ministry of Company Affairs undersection 205(2) of the Companies Act, 1956.


47


11. The Committee notes that the basic objective of providingdepreciation is to allocate the depreciable amount of an asset overits useful life so as to exhibit a true and fair view of the financialstatements of an enterprise. In this regard, the Committee notesthe definition of the term ‘useful life’ as contained in paragraph 3.3of AS 6 and paragraph 20 of AS 6, which state as follows:

“Useful life is either (i) the period over which a depreciableasset is expected to be used by the enterprise; or (ii) thenumber of production or similar units expected to beobtained from the use of the asset by the enterprise.”

“20. The depreciable amount of a depreciable assetshould be allocated on a systematic basis to eachaccounting period during the useful life of the asset.”

12. The Committee further notes paragraphs 7 and 8 of AS 6,explaining the term ‘useful life’, as follows:

“7. The useful life of a depreciable asset is shorter than itsphysical life and is:

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

(ii) directly governed by extraction or consumption;

(iii) dependent on the extent of use and physicaldeterioration on account of wear and tear whichagain depends on operational factors, such as, thenumber of shifts for which the asset is to be used,repair and maintenance policy of the enterprise etc.;and

(iv) reduced by obsolescence arising from such factorsas:

(a) technological changes;

(b) improvement in production methods;


48

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

(d) legal or other restrictions.

8. Determination of the useful life of a depreciable asset isa matter of estimation and is normally based on various factorsincluding experience with similar types of assets. Suchestimation is more difficult for an asset using new technologyor used in the production of a new product or in the provisionof a new service but is nevertheless required on somereasonable basis.”

13. The Committee also notes paragraph 13 of AS 6, whichrecognises the linkage between charge of depreciation under astatute and that as per the generally accepted accounting principles,as reproduced in paragraph 7 above.

14. On the basis of the above, the Committee is of the view thatin arriving at the rates at which depreciation should be provided,the company should consider the true commercial depreciation,i.e., the rate which is adequate to write off the asset over its usefullife based on the technological estimates of the management. Incase the useful life so worked out is less than the life arrived at asper the rates prescribed in Schedule XIV to the Companies Act,1956 (in case of companies), the higher rate of depreciation, soarrived at is applied. However, in case the useful life works out tobe longer, i.e., the rate so arrived at is lower than the rate prescribedby the statute, the rates prescribed in the relevant statute (ScheduleXIV in case of companies) should be applied. In the concernedcase, since Schedule XIV prescribes no specific rates ofdepreciation in respect of rolling stock, escalators and elevators,and track work involved in mass rapid transport system, the generalrates applicable to ‘plant and machinery’ would be relevant.Accordingly, the useful life of 20 years (as arrived at from thegeneral rate of depreciation as per Schedule XIV to the CompaniesAct, 1956), which is much shorter than the lives of the assets, asestimated by the management, should be considered for thepurpose of calculating depreciation in the present case.


49

D. Opinion


(a) Assuming that (i) the useful life of rolling stock andescalators and elevators is 30 years and that of trackwork is 58 years determined in accordance with theprovisions of AS 6 and (ii) there are no legal stipulationsas to the rate of depreciation, charging depreciation asper SLM at the rates determined on the basis of theafore-mentioned lives of the respective assets would resultin a true and fair view, provided provisions of section205(2) of the Companies Act, 1956 are complied with.

(b) Charging of depreciation as per the SLM rates, based onestimated useful lives of the assets as per the provisionsof AS 6 would be a proper charge, provided such ratesare allowed by the Ministry of Company Affairs undersection 205(2).

Query No. 8

Subject: Segment reporting for sale of power to the Stategrid.1


1. A listed company is engaged in the business of manufacturingpaper for newsprint, printing and writing. The turnover from thesale of newsprint, printing and writing paper during 2004-05 wasRs. 671.29 crore.

2. The querist has stated that the company has installed fourturbo generators. The entire power requirement is met throughcaptive generation. Surplus power is sold to the State grid. In



50

addition, the company is having a wind farm. The wind power isalso sold to the State grid. The proceeds from sale of powerduring the financial year 2004-05 were Rs. 29.27 crore.

3. The querist has reproduced paragraph 27 of AccountingStandard (AS) 17, ‘Segment Reporting’, issued by the Institute ofChartered Accountants of India, which states as follows:

“27. A business segment or geographical segment shouldbe identified as a reportable segment if:

(a) its revenue from sales to external customersand from transactions with other segments is10 per cent or more of the total revenue, externaland internal, of all segments; or

(b) its segment result, whether profit or loss, is 10per cent or more of-

(i) the combined result of all segments inprofit, or

(ii) the combined result of all segments in loss,

whichever is greater in absolute amount; or

(c) its segment assets are 10 per cent or more ofthe total assets of all segments.”

4. According to the querist, sale from power works out to 4.36 %of the total turnover. The profit from sale of power is less than10% of the combined result of the manufacturing activities andsale of power. The segment assets are also less than10% of thetotal assets of the company.

5. The querist has stated that in the above circumstances, thecompany has considered that sale of power is not a reportablesegment. However, during the audit, the statutory auditors haveopined as below:

“Segment Reporting vis-à-vis, the company, after applyingthe above norms, we are of the opinion that the company hastwo business segments viz. 1) paper and Paper products and


51

2) wind farm or power sector. Both are subject to differentrisks and returns and further have different organisationalstructure and internal reporting.

As far as reportable segment is concerned, paper and paperproducts individually meet the criteria laid down in AS 17(paragraph 27) (i.e., more than 10%) and hence to be reportedas a separate business segment.

As wind farm or power sector is regarded as a differentundertaking for the purpose of claiming deduction u/s 80-IA ofthe Income-tax Act, for reckoning the threshold limits ‘internaltransfer/utilisation’ (i.e., the transaction with other segments)shall also be taken into account as AS 17 (paragraph 27) isvery clear in this regard.

Therefore, disclosing of the power sector as a reportablesegment has to be arrived at by taking into consideration thetransactions with other segments. In case the threshold limitsare lower than the percentage stipulated, it is the discretion ofthe management to consider it as a separate ‘reportablesegment’ or as a ‘residual segment’ (as ‘others’).”

B. Query

6. The querist has sought the opinion of the Expert AdvisoryCommittee as to whether the sale of power to the State gridshould be considered as a separate reportable segment eventhough the activity does not fall within the threshold limits stipulatedunder paragraph 27 of AS 17.


7. The Committee notes from paragraph 6 above that the queristhas raised the query only in the context of ‘power’ segment. In theabsence of the relevant information, the Committee presumes thatthere is only one segment other than ‘power’, viz., ‘paper’.

8. The Committee notes that as per the provisions of AccountingStandard (AS) 17, ‘Segment Reporting’, issued by the Institute ofChartered Accountants of India, the components of an enterprise


52

have to first fall within the definitions of the term ‘business segment’or ‘geographical segment’ before being considered as ‘reportablesegment’. In this context, the Committee notes the definitions ofthe terms ‘business segment’ and ‘geographical segment’ as perparagraph 5 of AS 17, which are reproduced below:

“A business segment is a distinguishable component ofan enterprise that is engaged in providing an individualproduct or service or a group of related products orservices and that is subject to risks and returns that aredifferent from those of other business segments. Factorsthat should be considered in determining whetherproducts or services are related include:

(a) the nature of the products or services;

(b) the nature of the production processes;

(c) the type or class of customers for the productsor services;

(d) the methods used to distribute the products orprovide the services; and

(e) if applicable, the nature of the regulatoryenvironment, for example, banking, insurance,or public utilities.

A geographical segment is a distinguishable componentof an enterprise that is engaged in providing products orservices within a particular economic environment andthat is subject to risks and returns that are different fromthose of components operating in other economicenvironments. Factors that should be considered inidentifying geographical segments include:

(a) similarity of economic and political conditions;

(b) relationships between operations in differentgeographical areas;

(c) proximity of operations;


53

(d) special risks associated with operations in aparticular area;

(e) exchange control regulations; and

(f) the underlying current risks.”

9. The Committee further notes paragraphs 7 and 12 of AS 17which provide as below:

“7. A single business segment does not include productsand services with significantly differing risks and returns. Whilethere may be dissimilarities with respect to one or several ofthe factors listed in the definition of business segment, theproducts and services included in a single business segmentare expected to be similar with respect to a majority of thefactors.”

“12. The predominant sources of risks affect how mostenterprises are organised and managed. Therefore, theorganisational structure of an enterprise and its internalfinancial reporting system are normally the basis for identifyingits segments.”

10. The Committee notes from the above that to identify businessand geographical segments, the undertaking needs to evaluatewhether the risks and returns of various components of anenterprise are different as per the factors stated in the definitionsof the terms ‘business segment’ and ‘geographical segment’. Wherethe organisational structure and internal financial reporting systemof various components are different, it suggests that the risks andreturns are different. The Committee presumes from the Facts ofthe Case that the company has two business segments, viz., paperand power, as the two have different risks and returns particularly,in view of the fact that they have different organisational structureand internal financial reporting systems.

11. The Committee also notes the requirements of paragraph 27of AS 17 reproduced in paragraph 3 above with respect toidentification of a reportable segment that for the purpose ofdetermination of the threshold limit of 10% with regard to revenue,


54

the revenue from sales to external customers and from transactionswith other segments is to be taken into account. Accordingly, theCommittee is of the view that for the purpose of determining whetherpaper and power qualify as reportable segments, the revenuefrom external sales as well as internal sales should be taken intoaccount. In case the segment revenue so determined, is equal toor exceeds 10% of the total revenue of the company, external andinternal, that segment would qualify as a separate reportablesegment. The Committee further notes that for the purpose ofidentification of reportable segments, not only the threshold limitwith respect to segment revenue, but also with respect to segmentresult and segment assets should be considered as stipulated inparagraph 27 of AS 17.

12. In the above context, the Committee notes paragraph 28 ofAS 17, reproduced as below:

“28. A business segment or a geographical segmentwhich is not a reportable segment as per paragraph 27,may be designated as a reportable segment despite itssize at the discretion of the management of the enterprise.If that segment is not designated as a reportable segment,it should be included as an unallocated reconciling item.”

Therefore, if the segment is not designated as a reportable segmenteither on the basis of the consideration of paragraph 27 of AS 17,or the management’s discretion as per paragraph 28 of AS 17, itshould be included as an unallocated reconciling item. In otherwords, in the context of the company under consideration even ifone of the segments does not qualify as a reportable segment asper the threshold requirements of paragraph 27 of AS 17, thesame would have to be reported separately as a residual segment.

D. Opinion

13. On the basis of the above, the Committee is of the opinionthat the company needs to recalculate the threshold limits inaccordance with paragraph 27 of AS 17 as stated in paragraph 11above. In case the threshold limit is not met, it is the discretion ofthe management to consider power as a separate ‘reportable


55

segment’. However, in case the management does not do so, ithas to be reported as a ‘residual segment’.

Query No. 9

Subject: Disclosure of partly secured Bonds.1


1. A company is a wholly-owned, Government of India enterpriseunder the Ministry of Power. The company is a public financialinstitution and is also registered as a non-banking financial company(NBFC) with the Reserve Bank of India (RBI). The main activity ofthe company is to fund the various power sector projects in thecountry.

2. The querist has stated that the company, for meeting itsfinancial needs, has been raising money through various sources.One of them is bonds. Some of the bonds raised by the companyare guaranteed by the Government of India, some bonds aresecured by mortgage of immovable property and hypothecation ofbook debts, and some are unsecured against which no securityhas been provided.

3. The company, for meeting its financial requirements, has alsobeen permitted to raise Capital Gains Tax Exemption Bonds andInfrastructure Bonds under section 54EC and section 88 of theIncome-tax Act, 1961. These bonds have a lock-in period as perthe requirements of the Income-tax Act, 1961 and have beensecured by providing mortgage of immovable properties, the valueof which is less than the funds borrowed. As per the practiceadopted by various companies, the company has been disclosingthese bonds as ‘secured borrowings’ with a disclosure of the extentof the security provided. A point has arisen that since the value ofthe security provided is not commensurate to quantum raised,



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whether these borrowings should be disclosed as ‘unsecured loan’or ‘secured loans’. Prima facie, the borrowings are neither fullysecured nor unsecured. A copy of the annual report of the companyfor the financial year 2004-05 has also been provided by the queristfor the perusal of the Committee. The querist has stated thatSchedule ‘C’ on page 52 of the annual report indicates disclosurebeing made by the company in the balance sheet about factualposition. The querist has provided the following extracts from thesaid Schedule:

“Capital Gains Tax Exemption Bonds are issued for a tenureof 5/7 years at different interest rates varying from 5.15% to8.70% payable with 3 options, viz., semi-annual, annual andcumulative. These bonds have put option at par at any timeand in case of Capital Gains Tax Exemption Bonds – Series-IV at the end of 3/5 years. Infrastructure Bonds are issued fora tenure of 3/5 years at different interest rates varying between5.60% to 9.00% payable annually. These Bonds have putoption at par at the end of 36 months from the date of allotmentand in case of Infrastructure Bonds – Series-IV at par at theend of 3/5 years. The Capital Gains Tax Exemption Bondsand Infrastructure Bonds are secured by a legal mortgagerespectively over the company’s immovable properties andreceivable to the satisfaction of the trustees. The book valueof these immovable properties and receivables is Rs.38.50lakh. However, charge to the extent of amount borrowed hasbeen created with the Registrar of Companies (ROC ) infavour of trustees.”

4. According to the querist, the company has raised Capital GainsTax Exemption Bonds to the extent of Rs. 7,750 crore as on31.03.2005.

B. Query

5. The querist has sought the opinion of the Expert AdvisoryCommittee as to whether such borrowings should be disclosed as‘secured’ or ‘unsecured’ in the balance sheet of the company.


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6. The Committee notes that the basic issue raised in the queryrelates to the disclosure of partly secured Capital Gains TaxExemption Bonds as ‘secured’ or ‘unsecured’ loans as per therequirements of Schedule VI to the Companies Act, 1956, in thefinancial statements of the company. The Committee has, therefore,considered only this issue and has not examined any other issuethat may arise from the ‘Facts of the Case’, for example, disclosurerequired by NBFC Prudential Norms (Reserve Bank) Directions,1998.

7. The Committee notes the definition of the term ‘secured loan’,as provided by paragraph 15.02 of the Guidance Note on TermsUsed in Financial Statements, issued by the Institute of CharteredAccountants of India, which states as follows:

“15.02 Secured Loan

Loan secured wholly or partly against an asset.”

8. The Committee further notes from paragraph 3 of the Factsof the Case that the Capital Gains Tax Exemption Bonds havebeen partly secured by mortgage of immovable properties. Hence,the Committee is of the view that these bonds should be classifiedunder ‘secured loans’, for the purpose of disclosure in the balancesheet as per the requirements of Schedule VI to the CompaniesAct, 1956. However, the nature of security should be clearlyspecified, as required by ‘Instructions in accordance with whichliabilities should be made out’ of the said Schedule.

D. Opinion

9. On the basis of the above, the Committee is of the opinion,read with paragraph 6 above, that partly secured Capital GainsTax Exemption Bonds should be disclosed under ‘secured loans’along with a proper disclosure of the nature of security, as statedin paragraph 8 above.


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Query No. 10

Subject: Applicability of AS 3 and AS 18.1


1. A not-for-profit company was incorporated on 13th January,1992 under section 25 of the Companies Act, 1956. Its authorisedcapital is Rs.700 crore and paid up capital is Rs. 425.35 crore ason 31st March, 2005. It is a Government company within themeaning of section 617 of the Companies Act, 1956. Its sharesare not listed and its turnover (interest income) during the year2004-05 was Rs. 20.39 crore. The company is exempted frompayment of income-tax under section 10(26 B) of the Income-taxAct, 1961.

2. The main objects to be pursued by the company, as per itsmemorandum and articles of association, are reproducedhereunder:

(i) To promote economic and developmental activities forthe benefit of backward classes;

(ii) To assist, subject to such income and/or economic criteriaas may be prescribed by the Government from time totime, individuals or groups of individuals belonging tobackward classes by way of loans and advances foreconomically and financially viable schemes and projects.Under micro-financing schemes, self help groups havingmembers of target groups to the extent of at least 75%could be considered for financial support. The groups ofthe individuals belonging to the backward classes willinclude such groups in which predominantly (75% andabove) members belong to backward classes providedother members belong to weaker sections (as per incomeand/or economic criteria prescribed by the Government)including scheduled castes/scheduled tribes, minoritiesand disabled persons;



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(iii) To promote self-employment and other ventures for thebenefit of backward classes;

(iv) To grant concessional financial assistance in selectedcases for persons belonging to backward classes belowthe poverty line in the country in collaboration withGovernment Ministries/Departments at the national andstate level to the extent of the budgetary assistancegranted by the Government of India to the company;

(v) To extend loans to the backward classes for pursuinggeneral /professional/technical education or training atgraduate and higher levels;

(vi) To assist in the upgradation of technical andentrepreneurial skills of backward classes for proper andefficient management of production units;

(vii) To assist the state level organisations dealing with thedevelopment of the backward classes by way of providingfinancial assistance and in obtaining commercial fundingor by way of refinancing;

(viii) To work as an apex institution for coordinating andmonitoring the work of all corporations/Boards set up bythe State Government/Union Territory Administrations forschedule castes, schedule tribes, backward classes andminorities insofar as it relates to the economicdevelopment of the backward classes;

(ix) To help in furthering the Government policies andprogrammes for the development of backward classes.

3. In order to achieve its objects as outlined above, the companyis providing finances at concessional rate of interest (4% p.a. to6% p.a.) to persons belonging to backward classes (OBCs - notifiedby the State Government/Central Government) living below thepoverty line/double the poverty line in the country. The loans areprovided to the eligible target groups through state level companies/corporations/cooperatives (wholly owned/controlled by the StateGovernments). These are referred to as state channelising agencies


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(SCAs). The loans are provided to the SCAs after obtainingguarantee from the State Government. The individual borrowersobtain financial assistance from SCAs. The loans are provided forsetting-up small business, agricultural activities, viz. STD, PCOshop, electric repair shop, barber shop, minor irrigation, tailoringshop, carpentry, blacksmithy shop, pottery, general store, vegetablevendors or other self employment ventures etc. The loan limit perbeneficiary is Rs. 5 lakh, out of which generally 85% to 95% isfinanced by the company and the balance by the SCAs/individualborrowers. The company also provides educational loans atconcessional rates, to the target group for pursuing higher studies.As part of its developmental activities, the company is also providinggrants-in-aid to the target group for the upgradation of their technicaland entrepreneurial skills.

4. The querist has informed that the company was initiallyclassified as an investment company (Industrial Classification CodeNo. 803.1) by the Registrar of Companies. Therefore, the ReserveBank of India had initially directed the company to file ‘FirstSchedule’ returns, which are applicable to non-banking financialcompanies. Consequent to the company’s representation dated8th January 1996, on the basis of its objects and nature of activities,the Department of Company Affairs, vide its letter dated 1st

February, 1996, decided to change the Industrial Activity Codenumber of the company from 803.1 to 94 (Community Services).Thereafter, on submission of the revised industrial classificationcode on 20th August, 1998, the Reserve Bank of India, vide itsletter dated 2nd September, 1998, informed that it has deleted thename of the company from the mailing list w.e.f. 15th February,1996. Further, vide the company’s representation to the ReserveBank of India on 7th April, 1999, the company sought a clarificationfrom the RBI, as to whether RBI directives and prudential normsetc., applicable to NBFCs, are applicable to the company. On July23, 1999, the RBI informed and “certified that the company is notan NBFC and as such no RBI directives and prudential norms etc.are applicable to the company”. Copies of the relevantcorrespondence have been provided by the querist separately forthe perusal of the Committee. The querist has also drawn the


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attention of the Committee to the fact that the company is also notcovered under the definition of ‘Public Financial Institution’ as perthe Companies Act, 1956.

5. The querist has reiterated that the main objects of thecompany, as mentioned in paragraph 2 above, are to promoteeconomic and developmental activities to help the poor personsbelonging to other backward classes. The query pertains to theapplicability of Accounting Standard (AS) 3, ‘Cash Flow Statements’and Accounting Standard (AS) 18, ‘Related Party Disclosures’,issued by the Institute of Chartered Accountants of India. AS 3and AS 18 are applicable to ‘financial institutions’ and certain otherinstitutions/organisations. The querist has stated that in view ofthe objects of the company and the background note given above,in the opinion of the company, it is neither a financial institutionnor falls under any category of the other institutions/organisationswithin the scope of AS 3 and AS 18. Therefore, the company didnot make disclosures required as per AS 3 and AS 18 in theannual accounts for the year ending 31st March, 2005. However,the government auditors representing the Office of the C&AG,during the course of the supplementary audit u/s 619(4) of theCompanies Act, 1956, for the said year had issued two half margins(copies supplied separately for the perusal of the Committee) tothe company stating that though being a financial institution, it hasnot complied with the aforesaid accounting standards. The companyin its reply (copy supplied separately for the perusal of theCommittee) had submitted the aforesaid facts and had also givenan assurance to the government auditors that it shall seekclarification/ opinion from the Institute of Chartered Accountants ofIndia on this subject. Consequently, the Office of the C&AG agreedto drop the half margins issued to the company and therefore, noaudit qualification was issued by them on this account.

B. Query


(a) Whether AS 3 and AS 18 are applicable to the company.


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(b) If yes, whether the company can claim exemption fromthe applicability of AS 3 and AS 18 and how.


7. The Committee notes that the term ‘financial institution’ is notdefined in the applicability paragraphs of Accounting Standard(AS) 3, ‘Cash Flow Statements’, and Accounting Standard (AS)18, ‘Related Party Disclosures’, issued by the Institute of CharteredAccountants of India (ICAI). The Committee is, therefore, of theview that the term ‘financial institutions’ for the purpose ofapplicability of Accounting Standards, in the absence of a specificdefinition thereof in the Accounting Standards, should be construedto have its meaning in the general commercial parlance, whichmay be different from that given in various legislations. In the viewof the Committee, any enterprise engaged in the activities ofproviding loans and advances and/or providing financial servicesand/or engaged in financial transactions involving financial products,etc., is considered to be a financial institution in terms of thegeneral commercial parlance. Keeping in view the aforesaid, thecompany in question should be considered as a financial institution.Accordingly, AS 3 and AS 18 apply to the company.

8. The Committee notes the contention of the querist stated inparagraph 5 of the ‘Facts of the Case’ that in view of the objects ofthe company being primarily for the development of backwardclasses, AS 3 and AS 18 should not be applied to it. In thiscontext, the Committee notes paragraph 3.3 of the ‘Preface to theStatements of Accounting Standards’, issued by the ICAI,reproduced below:

“3.3 Accounting Standards are designed to apply to thegeneral purpose financial statements and other financialreporting, which are subject to the attest function of themembers of the ICAI. Accounting Standards apply in respectof any enterprise (whether organised in corporate, co-operativeor other forms) engaged in commercial, industrial or businessactivities, irrespective of whether it is profit oriented or it isestablished for charitable or religious purposes. Accounting


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Standards will not, however, apply to enterprises only carryingon the activities which are not of commercial, industrial orbusiness nature, (e.g., an activity of collecting donations andgiving them to flood affected people). Exclusion of an enterprisefrom the applicability of the Accounting Standards would bepermissible only if no part of the activity of such enterprise iscommercial, industrial or business in nature. Even if a verysmall proportion of the activities of an enterprise is consideredto be commercial, industrial or business in nature, theAccounting Standards would apply to all its activities includingthose which are not commercial, industrial or business innature”.

9. On the basis of the above, the Committee is of the view thatfor the purpose of applicability of the Accounting Standards to anenterprise, the objective of setting up the enterprise is not relevant;what is of relevance is the nature of the activities carried on by it.Since the company in question is carrying on the activities ofproviding loans and advances on which it earns income by way ofinterest, in the view of the Committee, the activities carried on bythe company are of commercial nature. Accordingly, AccountingStandards issued by the Institute of Chartered Accountants ofIndia are applicable to the company, subject to specific exemptions/relaxations available in the Standards.

10. With regard to disclosure of related party information by thecompany, the Committee notes paragraph 9 of AS 18, reproducedbelow:

“9. No disclosure is required in the financial statementsof state-controlled enterprises as regards related partyrelationships with other state-controlled enterprises andtransactions with such enterprises.”

11. The Committee notes from the Facts of the Case that thecompany in question is a state controlled enterprise. In view ofthis, no disclosure is required in its financial statements in respectof related party relationships and related party transactions withother state controlled enterprises.


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D. Opinion


(a) AS 3 and AS 18 are applicable to the company.

(b) The company is exempted from disclosures under AS 18only to the extent stated in paragraph 11 above. Thereare no exemptions from AS 3.

Query No. 11

Subject: Accounting for Minimum Alternative Tax (MAT)under section 115JB and credit available in respectthereof.1


1. A company is a public sector undertaking engaged in refiningof crude oil. The company was earning profits till the financial year1998-99. Due to withdrawal of Administrative Pricing Mechanism(APM), additional interest, and depreciation burden on account ofsubstantial capacity expansion of the refinery from 3 million metricton per annum (MMTPA) to 9 MMTPA in April 2001, coupled withdrop in refinery margins, the company incurred losses till thefinancial year ending 31st March, 2003. This has resulted intosubstantial carried forward losses and unabsorbed depreciationunder the Income-tax Act, 1961.

2. The querist has stated that another public sector undertakingacquired 52% stake in the company through acquisition of 37.50%stake of one of the private promoter group company and infusionof additional equity capital. Further, it acquired equity shares allottedto banks and financial institutions on debt restructuring, therebyincreasing its stake to 72%. The company’s debts were restructured,



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which has resulted into substantial reduction in the interest cost ofthe company.

3. According to the querist, the company made a turn-around inthe year 2003-04, earned substantial profit in the year 2004-05and declared maiden dividend. This has resulted in wiping-off ofthe entire carried forward business loss and substantial reductionin unabsorbed depreciation.

4. The company had paid Minimum Alternative Tax (MAT) forthe year 2004-05 and as the company is earning profit for the year2005-06 also, the company is liable to pay MAT under section115JB of the Income-tax Act, 1961.

5. The querist has mentioned that with effect from assessmentyear commencing on 1st April, 2006, by virtue of insertion of sub-section (1A) in section 115JAA of the Income-tax Act, tax credit inrespect of tax paid under provisions of section 115JB of the Act isallowable. The sub-section (1A) of section 115JAA of the Income-tax Act provides that “where any amount of tax is paid under sub-section (1) of section 115JB by an assessee, being a company forthe assessment year commencing on the 1st day of April, 2006and any subsequent assessment year, then, credit in respect oftax so paid shall be allowed to him in accordance with the provisionsof this section”. Further, sub-section (4) of section 115JAA providesas under:

“The tax credit shall be allowed set-off in a year when taxbecomes payable on the total income computed in accordancewith the provisions of this Act other than section 115JA orsection 115JB, as the case may be.”

6. This position, according to the querist, implies that the MATpaid in the financial year 2005-06 is eligible for set-off by reductionin the tax liability of subsequent year(s) where the companybecomes liable to pay tax under regular computation provisions. Inother words, the company needs to pay lower tax in a subsequentyear, in which the credit is available for MAT paid in the currentyear. As per the querist, in view of the company’s present/projectedlevels of profits, the company is virtually certain that taxes paid


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under MAT will be available for set-off against tax liability insubsequent year(s).

7. The querist has given the following options in respect ofaccounting for MAT paid in the year 2005-06:

(a) Tax paid under MAT to be accounted for as advance taxinstead of tax expense of the year; or

(b) Treat MAT paid as a timing difference resulting in deferredtax asset and reduce the same from the deferred taxliability, to the extent of credit available; or

(c) Treat MAT paid as current tax and also provide deferredtax without considering such MAT paid as timingdifference, for the purpose of deferred tax calculation, inthe year.

8. The querist has further stated that Accounting Standard (AS)22, ‘Accounting for Taxes on Income’, issued by the Institute ofChartered Accountants of India, does not specifically provide fortiming differences arising out of tax credits. However, this standardenvisages recognition of tax on the book profit. The current taxprovision and deferred tax provision shall be equal to tax computedon book profit (excluding permanent difference) at the enacted taxrates. Hence, according to the querist, in case of virtual certaintyof absorption of tax credit, if either of the accounting treatments(a) or (b) stated in paragraph 7 above, is not followed, it mayresult in excess provision to the extent of MAT paid in the currentyear and also under provision to the extent of set-off/absorption oftax credit in the subsequent year(s). The querist has also statedthat Accounting Standards Interpretation (ASI) 6, ‘Accounting forTaxes on Income in the context of Section 115JB of the Income-tax Act, 1961’ was issued by the Institute before the introduction ofsub-section (1A) of section 115JAA with effect from 1st April, 2005,i.e., when credit in respect of MAT paid was not available, meaningthereby that tax paid under MAT was not allowed to be set-offagainst regular tax payable in later years.


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B. Query

9. Considering the Facts of the Case as explained above, thequerist has sought the opinion of the Expert Advisory Committeeon the following issues:

(i) Whether MAT paid under section 115JB of the Act forthe year ending 31st March, 2006, is to be considered ascurrent tax to be absorbed as tax expense in the profitand loss account for the year or treat the same asadvance tax under current assets.

(ii) Whether MAT paid under section 115JB of the Act is tobe considered as timing difference resulting in deferredtax asset for deferred tax computation purposes underAS 22 and reduce the same from the deferred tax liabilityin the current year, to the extent of tax credit available.

(iii) Whether MAT payable under section 115JB of the Actneeds to be considered as current tax but should not beconsidered for the purpose of deferred tax calculationinspite of it being eligible for carry forward and set-off inthe subsequent year.


10. The Committee notes that the basic issue raised in the queryrelates to the accounting treatment of MAT paid under section115JB of the Income-tax Act, 1961 and credit available in respectthereof. The Committee has, therefore, considered only this issueand has not touched upon any other issue arising from the Factsof the Case.

11. The Committee notes that the issue raised by the querist hasbeen dealt with in the Guidance Note on Accounting for CreditAvailable in respect of Minimum Alternative Tax under the Income-tax Act, 1961, issued recently by the Institute of CharteredAccountants of India. Paragraphs 4 to 15 of the said GuidanceNote suggest the accounting treatment in respect of MAT andcredit available in respect of MAT, as follows:


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“Whether MAT credit is a deferred tax asset

4. An issue has been raised whether the MAT credit canbe considered as a deferred tax asset within the meaning ofAccounting Standard (AS) 22, Accounting for Taxes on Income,issued by the Institute of Chartered Accountants of India. Inthis context, the following definitions given in AS 22 are noted:

“Timing differences are the differences between taxableincome and accounting income for a period that originatein one period and are capable of reversal in one or moresubsequent periods.”

“Accounting income (loss) is the net profit or loss for aperiod, as reported in the statement of profit and loss,before deducting income tax expense or adding incometax saving.”

“Taxable income (tax loss) is the amount of the income(loss) for a period, determined in accordance with the taxlaws, based upon which income tax payable (recoverable)is determined.”

5. From the above, it is noted that payment of MAT, doesnot by itself, result in any timing difference since it does notgive rise to any difference between the accounting incomeand the taxable income which are arrived at before adjustingthe tax expense, namely, MAT. In other words, under AS 22,deferred tax asset and deferred tax liability arise on accountof differences in the items of income and expenses creditedor charged in the profit and loss account as compared to theitems of income that are taxed or items of expense that areallowed as deduction, for the purposes of the Act. Thus,deferred tax assets and deferred tax liabilities do not arise onaccount of the amount of the tax expense itself. In view ofthis, it is not appropriate to consider MAT credit as a deferredtax asset for the purposes of AS 22.

Whether MAT credit can be considered as an ‘asset’

6. Although MAT credit is not a deferred tax asset underAS 22 as discussed above, yet it gives rise to expected futureeconomic benefit in the form of adjustment of future income


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tax liability arising within the specified period. A question,therefore, arises whether the MAT credit can be consideredas an ‘asset’ and in case it can be considered as an assetwhether it should be so recognised in the financial statements.

7. The Framework for the Preparation and Presentation ofFinancial Statements, issued by the Institute of CharteredAccountants of India, defines the term ‘asset’ as follows:

“An asset is a resource controlled by the enterprise as aresult of past events from which future economic benefitsare expected to flow to the enterprise.”

8. MAT paid in a year in respect of which the credit isallowed during the specified period under the Act is a resourcecontrolled by the company as a result of past event, namely,the payment of MAT. MAT credit has expected future economicbenefits in the form of its adjustment against the discharge ofthe normal tax liability if the same arises during the specifiedperiod. Accordingly, MAT credit is an ‘asset’.

9. According to the Framework, once an item meets thedefinition of the term ‘asset’, it has to meet the criteria forrecognition of an asset so that it may be recognised as suchin the financial statements. Paragraph 88 of the Frameworkprovides the following criteria for recognition of an asset:

“88. An asset is recognised in the balance sheet whenit is probable that the future economic benefits associatedwith it will flow to the enterprise and the asset has a costor value that can be measured reliably.”

10. In order to decide when it is ‘probable’ that the futureeconomic benefits associated with the asset will flow to theenterprise, paragraph 84 of the Framework, inter alia, providesas below:

“84. The concept of probability is used in the recognitioncriteria to refer to the degree of uncertainty that thefuture economic benefits associated with the item willflow to or from the enterprise. The concept is in keepingwith the uncertainty that characterises the environment


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in which an enterprise operates. Assessments of thedegree of uncertainty attaching to the flow of futureeconomic benefits are made on the basis of the evidenceavailable when the financial statements are prepared.”

11. The concept of probability as contemplated in paragraph84 of the Framework relates to both items of assets andliabilities and, therefore, the degree of uncertainty forrecognition of assets and liabilities may vary keeping in viewthe consideration of ‘prudence’. Accordingly, while forrecognition of a liability the degree of uncertainty to beconsidered ‘probable’ can be ‘more likely than not’ (as inparagraph 22 of Accounting Standard (AS) 29, ‘Provisions,Contingent Liabilities and Contingent Assets’) for recognitionof an asset, in appropriate conditions, the degree may haveto be higher than that. Thus, for the purpose of considerationof the probability of expected future economic benefits inrespect of MAT credit, the fact that a company is paying MATand not the normal income tax, provides a prima facie evidencethat normal income tax liability may not arise within thespecified period to avail MAT credit. In view of this, MATcredit should be recognised as an asset only when and to theextent there is convincing evidence that the company will paynormal income tax during the specified period. Such evidencemay exist, for example, where a company has, in the currentyear, a deferred tax liability because its depreciation for theincome-tax purposes is higher than the depreciation foraccounting purposes, but from the next year onwards, thedepreciation for accounting purposes would be higher thanthe depreciation for income-tax purposes, thereby resulting inthe reversal of the deferred tax liability to an extent that thecompany becomes liable to pay normal income tax.

12. Where MAT credit is recognised as an asset inaccordance with paragraph 11 above, the same should bereviewed at each balance sheet date. A company should writedown the carrying amount of the MAT credit asset to theextent there is no longer a convincing evidence to the effectthat the company will pay normal income tax during the


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specified period.

Presentation of MAT credit in the financial statements

Balance Sheet

13. Where a company recognises MAT credit as an asseton the basis of the considerations specified in paragraph 11above, the same should be presented under the head ‘Loansand Advances’ since, there being a convincing evidence ofrealisation of the asset, it is of the nature of a pre-paid taxwhich would be adjusted against the normal income tax duringthe specified period. The asset may be reflected as ‘MATcredit entitlement’.

14. In the year of set-off of credit, the amount of creditavailed should be shown as a deduction from the ‘Provisionfor Taxation’ on the liabilities side of the balance sheet. Theunavailed amount of MAT credit entitlement , if any, shouldcontinue to be presented under the head ‘Loans and Advances’if it continues to meet the considerations stated in paragraph11 above.

Profit and Loss Account

15. According to paragraph 6 of Accounting StandardsInterpretation (ASI) 6, ‘Accounting for Taxes on Income in thecontext of Section 115JB of the Income-tax Act, 1961’, issuedby the Institute of Chartered Accountants of India, MAT is thecurrent tax. Accordingly, the tax expense arising on accountof payment of MAT should be charged at the gross amount,in the normal way, to the profit and loss account in the year ofpayment of MAT. In the year in which the MAT credit becomeseligible to be recognised as an asset in accordance with therecommendations contained in this Guidance Note, the saidasset should be created by way of a credit to the profit andloss account and presented as a separate line item therein.”

D. Opinion



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(i) MAT paid under section 115JB of the Income-tax Act,1961 should be considered as current tax for the year inwhich it arises. MAT Credit should, however, be treatedas an asset to be shown under the head ‘Loans andAdvances’ in the year in which it becomes eligible to berecognised as an asset as discussed in paragraph 11 ofthe Guidance Note.

(ii) No, MAT should not be considered as ‘timing difference’,as stated in paragraph 5 of the Guidance Note.

(iii) MAT should be considered as current tax but should notbe considered for the purpose of deferred tax calculation.Instead, MAT credit can be recognised as an asset, incase it meets the requirements of paragraph 11 of theGuidance Note.

Query No. 12

Subject: Recognition of revenue in respect of long productioncycle items.1


1. A company is a leading engineering product company cateringto the vital sectors of the economy such as infrastructure, surfacetransportation, mining and defence. The company is a public sectorenterprise under the administrative control of the Ministry ofDefence. With a turnover of Rs.1857 crore for the financial year2004-05, the company is the market leader in earthmoving andmining products. The company is making profits consistently rightfrom its inception. For the year 2004-05, the profit before tax ofRs. 272.80 crore registered a growth of 444% compared to theprevious year. The shares of the company are listed on Mumbaiand Bangalore Stock Exchanges and are actively traded scripswith a market price of Rs. 1473 per share (as on date) with face1 Opinion finalised by the Committee on 27.3.2006


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value of Rs. 10. The company is a fast growing engineering productcompany with export presence in as many as ten countries spanningover Asia, Africa and South American continents. For the year2004-05, the export turnover of the company was Rs. 59 croreand according to the querist, it is expected to increase manifold inthe future.

2. The company has three manufacturing units located at KolarGold Fields (KGF), Bangalore and Mysore. It has marketing andservice centres spread all over India. The KGF unit manufacturesdozers, excavators, loaders, walking draglines, rope shovels andsophisticated aggregates catering to the needs of the mining anddefence sectors. The Bangalore unit manufactures rail coaches,EMU’s, wagons, overhead inspection vehicles for Indian Railwaysand also logistics vehicles (Tatra variants) for usage by the Ministryof Defence. In addition, Bangalore unit is manufacturing, for thefirst time in India, metro rail coaches under license from M/s Rotemof Korea. The Mysore unit manufactures highly sophisticateddumpers, graders, aircraft towing tractors, weapon loading systemsand high powered internal combustion engines. All these productsare highly technology intensive and call for an array ofmanufacturing technologies. Some of these products have a longproduction cycle time extending beyond one accounting year.

3. The querist has stated that the accounting policy of thecompany, as far as revenue recognition is concerned, is as under:

“(i) Sales set up for products, viz., equipments, aggregates,attachments and ancillary products is made when theseare unconditionally appropriated to the valid sales contractafter pre-despatch inspection by the specified authority.

(ii) Sales setup for long production cycle items, is reckonedbased on technical estimates when the percentage ofcompletion of each identifiable unit of contract includingdespatches with customers is 30% or more of the totalrealisable value of such contract or estimate. Suchrevenue recognition is restricted to 97.5% of the reckonedrealisable value and the balance 2.5% is accounted oncompletion of the contract.”


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According to the querist, these policies are being consistentlyfollowed by the company. Further, these policies have beenvalidated by both the statutory auditors and the Comptroller andAuditor General of India (C&AG) (government auditors). However,during the meeting of the Audit Committee held on 06.01.06, thestatutory auditors were of the opinion that the accounting policypropounded in paragraph 3 (ii) is not in line with AccountingStandard (AS) 9, ‘Revenue Recognition’, issued by the Institute ofChartered Accountants of India (ICAI). As per the querist, as theviews of the statutory auditors are at variance with the statedpolicy of the company regarding revenue recognition, a need is feltto seek the opinion of the Expert Advisory Committee of the ICAI.

4. The querist has further stated that the marketing policy of thecompany is in line with the accounting policies being pursued. Forinstance, the revenue from sale of equipments, aggregates,components and attachments are recognised based on valid salescontracts. Further, the revenue is recognised in respect of theseproducts only on the basis of pre-despatch inspection. This isapplicable in the case of products and aggregates having aproduction cycle time of less than one year. Some of the products,like Walking Draglines are highly import intensive coupled withmultiple manufacturing technologies. Further, the manufacturingof these equipments warrant fabrication and manufacture of heavyduty steel structures, integrating the multiple electrical and electronicassemblies, sub-assemblies and transporting them in dis-aggregated structures to customer site for erection andcommissioning. All these activities, right from commencement ofproduction to final erection take more than one year. Recognisingthe long production cycle time as well as assembling the structuresat site, the company has evolved a specific marketing policy inrespect of such products. The policy calls for production of thesegoods only on firm sale orders. Further, in case of these products,invariably advances are received from the customers before thecommencement of production. In addition, the customer orderprovides for billing details, with respect to pre-identified and mutuallyagreed modules, assemblies and structures. Based on the billingdetails, invoices are raised as and when the modules, assemblies,


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structures, as the case may be, are despatched as per the termsof the sale order and payments are also received as agreed.

5. According to the querist, it may be seen from paragraph 4above, that revenue is recognised based on reliable data regardingphysical completion. Both the parties to the contract agree to theterms of sale and also payment in respect of modules despatched.Further, both the parties are clear in understanding the rights,obligations, risks and rewards as well as the terms of payment. Infact, in many of the transactions of this kind, the buyer pays notonly advance but also to the extent of agreed percentage of valueof invoices raised at the point of delivery at site or ex-works, asthe case may be.

6. The querist has stated that considering the nature of business,the type of product and the long production cycle time involved,the method adopted by the company is in order. This alsosynchronizes the revenue recognition with occurrence ofperformance or event and is well within the realm of the principleof matching concept (emphasis supplied by the querist). Accordingto the querist, US GAAPs also recognise revenue on the basis ofpercentage of completion method in respect of long productioncycle items/products (the querist has referred to US GAAP 2002by Siegel, Levine, Qureshi and Shim published by Prentice Hall).On the other hand, if revenue is recognised only after the finaldelivery of such equipment, it will lead to distortion of the financialperformance and position of the company for earlier years.

7. The querist has further stated that AS 9 recognises revenueboth from the sale of products and rendering of services. However,in the case of services, it reckons the applicability of percentage ofcompletion method but not so in the case of sale of goods. Thequerist has further stated that in this regard, it may be worthwhileto note that revenue recognition irrespective of the fact whether itis revenue generation from rendering of service or from sale ofgoods, is well within the purview of the framework of matchingconcept of revenue with expenditure. Therefore, what is explicitlystated as applicable to rendering of services will be equallyapplicable for sale of goods. Further, as per the querist, in the


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case of goods having long production cycle time, as long as thereis a valid contract and the parties to the contract agree regardingbilling details, contractual obligations and payment terms, there isno need to apply the rule of explicit statement in the Standard. Onthe other hand, the strict interpretation of the Standard based onthe literal meaning instead of the spirit behind it would adverselyaffect the financial performance of the companies having suchproducts (emphasis supplied by the querist). This, in turn, accordingto the querist, would have significant impact on the perception ofeconomic agencies, like stock exchanges, creditors, bankers,investors and other stakeholders.

8. The querist has also mentioned that an attempt was made bythe company to find out the accounting policies pursued by othercompanies manufacturing engineering products having longproduction cycle time. The querist has observed that anothercompany, having similar product profile as that of the companyunder construction in respect of products having long productioncycle time, has similar accounting policy in respect of these items.It is requested by the querist that the Committee may also takecognizance of the other company’s accounting policy whileexpressing its considered opinion.

B. Query

9. The querist has sought the opinion of the Committee as towhether the accounting policy of the company, particularly, withregard to sale of products having long production cycle time is inline with AS 9. If not, what modifications, in the opinion of theCommittee are desirable to conform to AS 9?


10. The Committee notes that the basic issue raised in the queryrelates to whether as per the provisions of AS 9, the revenue fromsale of products having long production cycle time, produced undera contract with the customer, can be recognised following theprinciples of percentage of completion method. The Committeehas, therefore, considered only this issue and has not touchedupon any other issue arising from the Facts of the Case, such as


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accounting treatment of products having production cycle timeless than a year, etc.

11. With regard to long production cycle items taking more than ayear to complete, the Committee notes the ‘Objective’ paragraph,definition of the term ‘construction contract’, and paragraph 3 ofAccounting Standard (AS) 7 (revised 2002), ‘ConstructionContracts’, issued by the Institute of Chartered Accountants ofIndia, which inter alia, state as follows:

“Objective

The objective of this Statement is to prescribe the accountingtreatment of revenue and costs associated with constructioncontracts. Because of the nature of the activity undertaken inconstruction contracts, the date at which the contract activityis entered into and the date when the activity is completedusually fall into different accounting periods.”

“A construction contract is a contract specificallynegotiated for the construction of an asset or acombination of assets that are closely interrelated orinterdependent in terms of their design, technology andfunction or their ultimate purpose or use.”

“3. A construction contract may be negotiated for theconstruction of a single asset such as a bridge, building, dam,pipeline, road, ship or tunnel. A construction contract mayalso deal with the construction of a number of assets which areclosely interrelated or interdependent in terms of their design,technology and function or their ultimate purpose or use;examples of such contracts include those for the constructionof refineries and other complex pieces of plant or equipment.”

12. On the basis of the above, the Committee is of the view thatin case of contracts of manufacture and supply of long productioncycle items which are complex pieces of equipment and which aremanufactured under a contract with the customer, AS 7 (revised2002) is applicable because the date on which the contract issecured and the date when the contract activity is completed fallinto different accounting periods. In view of this, the principles of


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recognition of revenue in respect of sale of goods, as enunciatedin AS 9, as being argued by the statutory auditor, are not applicablein this case. In this regard, the Committee also notes paragraph 2of AS 9, which, inter alia, states as follows:

“2. This Statement does not deal with the following aspectsof revenue recognition to which special considerations apply:

(i) Revenue arising from construction contracts”.

13. With regard to method of recognition of revenue prescribed inAS 7, the Committee notes paragraph 21 of the Standard asreproduced below:

“21. When the outcome of a construction contract can beestimated reliably, contract revenue and contract costsassociated with the construction contract should berecognised as revenue and expenses respectively byreference to the stage of completion of the contract activityat the reporting date. An expected loss on the constructioncontract should be recognised as an expense immediatelyin accordance with paragraph 35.”

14. On the basis of the above, the Committee is of the opinionthat in the present case, the company should recognise revenuefrom sale of long production cycle items manufactured under acontract with the customer, on the basis of stage of completion ofthe product, i.e., percentage of completion method, provided otherconditions and provisions of AS 7 (revised 2002) are also compliedwith.

D. Opinion

15. The Committee is of the opinion on the issues raised inparagraph 9 above that in the present case, AS 7 (revised 2002)is applicable rather than AS 9. Accordingly, the revenue of thecompany from sale of products having long production cycle time,i.e., more than a year, that are manufactured under a contract withthe customer, should be recognised following the percentage ofcompletion method as per the provisions of AS 7 (revised 2002).


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Query No. 13

Subject: Segment reporting by a finance company.1


1. A public sector undertaking is registered under the CompaniesAct, 1956. The Government has also recognised it as a publicfinancial institution under section 4A of the Companies Act, 1956.

2. The main operational activity of the company is financing ofhousing and infrastructure projects. The other activities includeconstruction, consultancy, conducting management developmentprogrammes, etc., which revolve around the main activity offinancing. A break-up of the activity-wise revenue is as under:

S. Particulars % of (Rs. inNo. total crore)

revenue1 Income from financing activities 94.15 2,661.38*

(interest on housing, infrastructureloans and investment in bonds/fixed deposits)

2 Other income on loans (i.e., 2.40 67.75advisory income and other fees)

3 Closing-work-in-progress (constru- 2.94 83.20ction activity)

4 Other income (balance) 0.51 14.38

Grand Total 100.00 2826.71

* Includes income of Rs. 374.74 crore from loan under retail financescheme, i.e., Rs. 328.75 crore on account of bulk loans and Rs. 45.99 croreon account of direct loan to individuals.

3. The querist has informed that the financing activity, i.e., housingand infrastructure financing business, is shown as a single segmentsince the rates of interest at which loans are advanced, the



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securities taken against the loans and the recovery mechanismare absolutely the same for both the businesses. Also, the rate ofinterest as well as the security aspect of both types of projects areregulated through ‘Financing Pattern’ (a copy of which has beenprovided by the querist for the perusal of the Committee) which isapproved by the company’s board of directors. Further, the loanagreement with the borrowing agencies is common for housing aswell as infrastructure projects. The securities demanded for variousprojects are taken based on the common circular, according towhich, there is a basket of securities from which available securityis picked up. Thus, the types of security accepted are also samefor both the types of projects. Moreover, in most of the cases, asper the querist, the loans are advanced to a single agency both forhousing and infrastructure purposes. In this context, the queristhas informed that the total loan outstanding in respect of loansadvanced by the company as on 31.3.2005 was Rs. 21,583.90crore (provisional). The loan outstanding in respect of the sameagencies in housing as well as infrastructure loans is Rs. 7,263.11crore.

4. The querist has stated that as per Accounting Standard (AS)17, ‘Segment Reporting’, issued by the Institute of CharteredAccountants of India, “a business segment is a distinguishablecomponent of an enterprise that is engaged in providing anindividual product or service or a group of related productsor services and that is subject to risks and returns that aredifferent from those of other business segments. Factors thatshould be considered in determining whether products orservices are related include:

(a) the nature of the products or services;

(b) the nature of the production processes;

(c) the type and class of customers for the products orservices;

(d) the methods used to distribute the products orprovide the services; and


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(e) if applicable, the nature of the regulatory environment,for example, banking, insurance, or public utilities.”

According to the querist, since the risks and returns in housingand infrastructure businesses are considered the same, no separatesegments are required to be recognised for the purposes of AS 17.

5. In view of the above, a disclosure in the notes forming part ofaccounts is given by the company which is as under:

“The main business of the company is to provide finance forhousing/infrastructure projects. All other activities of thecompany revolve around the main business and, therefore,there are no separate reportable segments as per AS 17”.

6. The querist has further mentioned that during the course ofaudit of accounts for the year 2003-2004 by the Comptroller andAuditor General of India (C&AG), a query was raised that sincethe company has classified its business into ‘housing’ and ‘non-housing business’ as required under NHB directions, the housingloans and infrastructure project loans should be reported asseparate segments as per the requirements of AS 17, since therevenue generation from these activities are 41.21% and 46.40%,respectively of the total revenue of the company.

7. In this connection, the querist has further clarified that thecompany’s main business is long term financing for housing andurban infrastructure projects and is not undertaking housing andinfrastructure activities as such. Therefore, the company’s mainproduct/activity is long term financing – housing and infrastructureare the areas for which finances are provided.

8. The querist has also furnished the following information relatingto the risk profile of financing of housing and infrastructure activities:

(i) (a) The profile of borrowers for housing loans includesvarious State Government agencies, e.g. HousingBoards, Rural Housing Boards, DevelopmentAuthorities, City Improvement Trusts, MunicipalCorporations, Public Sector Undertakings, StateGovernment Undertakings, NGOs, Co-operative


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Societies, viz., Primary Level Cooperative HousingSocieties and State Level Apex Cooperative HousingSocieties and Private Builders, Developers,Corporate Sector Agencies. Besides this, thecompany also provides loans to individuals underits retail finance scheme.

(b) The profile of borrowers for infrastructure loansincludes State Level Financing Institutions/Corporations, Water Supply & Sewerage Boards,Development Authorities, State Functional Agenciesfor Housing and Urban Development, New TownDevelopment Agencies, Regional Planning Boards,Improvement Trusts, Municipal Corporations/Councils, Joint Sector Companies, CooperativeSocieties/Trusts, NGOs, Private Companies/Agencies including BOT Operators, Concessionaires.

(c) The profile of borrowers under the Niwas schemeof the company includes individuals and StateGovernment bodies/HFCs for lending to individualsfor housing purpose.

(ii) As per the guidelines of the company, any agency whichis undertaking housing and urban developmentprogramme in the country can avail finance from thecompany both for housing as well as urban infrastructureschemes. Further, the housing and urban infrastructureschemes are supplementary to each other and most ofthe state borrowers undertake complete activity/development, which includes housing as well as urbaninfrastructure programmes.

(iii) Housing and infrastructure loans are provided afterappraising the project with respect to two aspects, viz.,(i) scheme based appraisal, and (ii) agency basedappraisal. Under the scheme based appraisal, the projectsubmitted by the agency is evaluated from legal, technicaland financial point of view, keeping in view the objectiveof each scheme and the respective guidelines. The


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agency based appraisal focuses on (i) the agency’sfinancial soundness, (ii) the organisational strength ofthe agency, and (iii) the track record of the agency interms of execution and delivery of similar products in thepast. Accordingly, risk profile of common borrowers ofthe housing loans and infrastructure loans is same.Further, the process of providing loans, extent of financingfor housing and infrastructure loans, etc., is the same asstated above.

(iv) The borrowing agencies for housing loan are involved invarious types of activities depending upon theirconstitution, regulatory framework, e.g., housing boardfor development of land, providing developed plots andhousing, etc.

(v) The borrowing agencies for infrastructure loans areinvolved in various housing and urban developmentactivities depending on their constitution, Memorandumand Articles of Association, etc.

9. According to the querist, being a housing finance company, itis regulated by the National Housing Bank (NHB). Sub-paragraph(2) of paragraph 25 of the Housing Finance Companies (NHB)Directions, 2001 requires that the principal provisions made shallbe distinctly indicated under separate heads of accounts separatelyfor ‘housing’ and ‘non-housing finance business’ and individuallyfor each type of assets as under:

(a) Provisions for sub-standard, doubtful and loss assets;and

(b) Provisions for depreciation in investments.

10. The querist has informed that since the above disclosure inthe balance sheet is required to be given by every housing financecompany (HFC), the principal outstanding and provision as on thedate of the balance sheet for housing business and non-housingbusiness were classified under standard, sub-standard, doubtfuland loss assets in the notes to accounts (note no. 27 of annualaccounts for 2003-2004).


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11. Regarding the internal reporting system prevalent in thecompany, the querist has informed that the reporting of performanceof housing and infrastructure business is done through MIS Report(a copy of which has been provided by the querist for the perusalof the Committee) which comprises data on releases, sanctions,schemes in pipelines and progress of the schemes for regionaloffices and all India level. This report is forwarded to the Ministryand is also used for replying to parliament questions and queries,etc. from the Ministry. It is further clarified by the querist thatalthough the performance of housing and infrastructure activitiesalongwith their sub-heads is intimated to board of directorsseparately, yet its purpose is to achieve better internal control andeffective monitoring and not for arriving at the profit/loss from bothtypes of activities. The querist has also stated that there is onlyone department which is looking after entire sanctions of all typesof schemes, i.e., housing, urban infrastructure, commercial, Ministrygrant related schemes, etc. Similarly, there is only one departmentwhich is responsible for all issues relating to releases and postreleases, i.e., recoveries, default, monitoring of defaults, etc.Similarly, delegation of powers does not specify any different criteriapertaining to housing, urban infrastructure or any other type ofschemes.

12. As regards making decisions about future allocations ofresources, the querist has stated that the resource progamme isplaced before the board for its approval for the full year in thebeginning of the financial year and there is no bifurcation betweenresource generation for different types of schemes, i.e., housing,urban infrastructure, etc. and the resources are raised subsequentlyby considering overall fund requirement for all types of schemes.

13. The querist has also informed that the NHB norms dealingwith the provisions for Non-Performing Assets (NPA) etc., are thesame for housing and infrastructure loans. The main business ofthe company is to make available finances for housing as well asfor infrastructure projects. Maintenance of account books/variousrecords and calculation of profit and loss account of the companyis made in a consolidated manner irrespective of the type ofschemes.


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B. Query

14. The opinion of the Expert Advisory Committee has been soughton the issue as to whether financing for housing and infrastructureactivities are to be shown as separate business segments asobserved by C&AG for the purposes of AS 17, ignoring the factthat risks and returns for financing, i.e., interest rate, security,agency, treatment of the defaults with reference to provisioningnorms of NHB guidelines are the same for both the products.


15. The Committee restricts its opinion to the issue raised by thequerist in paragraph 14 above, viz., whether financing for housingand infrastructure activities should be shown as separate businesssegments. Accordingly, the Committee has not addressed anyother issue that may arise from the Facts of the Case, e.g., whetherthere can be business segments other than the housing loans andinfrastructure loans activities.

16. The Committee notes the definition of the term ‘businesssegment’ reproduced in paragraph 4 above and paragraphs 11,12 and 24 of AS 17 as below:

“11. Determining the composition of a business orgeographical segment involves a certain amount of judgement.In making that judgement, enterprise management takes intoaccount the objective of reporting financial information bysegment as set forth in this Statement and the qualitativecharacteristics of financial statements as identified in theFramework for the Preparation and Presentation of FinancialStatements issued by the Institute of Chartered Accountantsof India. The qualitative characteristics include the relevance,reliability, and comparability over time of financial informationthat is reported about the different groups of products andservices of an enterprise and about its operations in particulargeographical areas, and the usefulness of that information forassessing the risks and returns of the enterprise as a whole.

12. The predominant sources of risks affect how mostenterprises are organised and managed. Therefore, the


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organisational structure of an enterprise and its internalfinancial reporting system are normally the basis for identifyingits segments.”

“24. Business and geographical segments of anenterprise for external reporting purposes should be thoseorganisational units for which information is reported tothe board of directors and to the chief executive officerfor the purpose of evaluating the unit’s performance andfor making decisions about future allocations ofresources…”

17. On the basis of the above, the Committee is of the view thatidentification of a business segment involves consideration as towhether different components of an enterprise meet the definitionof the term ‘business segment’ as reproduced in paragraph 4above. Further, the factors specified in the definition, which needto be considered in determining whether product or services arerelated involves a certain amount of judgement. In the presentcase, in making the judgement with regard to the factors stated inthe definition, apart from the information which is stated in theFacts of the Case, the management may have to consider otherrelevant factors since the list of the said factors is inclusive andnot exhaustive. On the basis of the information which is furnishedby the querist, the Committee notes as below:

(i) The returns from the housing loans and infrastructureloans are the same except in case of certain housingloans such as EWS housing projects and LIG housingprojects in respect of which interest rates are differentfrom the other housing loans and the infrastructure loans.In other words, the returns are different in a few caseseven within the housing loans component.

(ii) The risk profile of the common borrowers of the housingloans and infrastructure loans is the same. TheCommittee, however, notes that only about 30% of theborrowers were common (paragraph 3 of the Facts ofthe Case) in the year ending 31.3.2005.


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(iii) While the internal reporting system within the organisationreports the performance of housing and infrastructureactivities to the board of directors separately, as perparagraph 12 of the Facts of the Case, there is nobifurcation between housing loans and infrastructure loansfor making decisions about the future allocation ofresources.

(iv) The organisation structure of the company also does notappear to differentiate between the housing loans andinfrastructure loans as it is stated in paragraph 11 of theFacts of the Case that there is only one departmentwhich is responsible for various issues of releases andrecoveries of both housing and infrastructure loans.

18. On the basis of the above observations based on the factsfurnished by the querist, the Committee feels that the risks andreturns from housing loans do not appear to be different from therisks and returns pertaining to infrastructure loans, even thoughfor prudential norms purposes, the management has to makeseparate disclosures for housing loans and infrastructure loans.Further, the internal reporting system and organisation structure ofthe company is not structured in a manner that the managementmakes various resource allocation decisions between housing loansand infrastructure loans based on their respective performance.

D. Opinion

19. On the basis of the above, the opinion of the Committee onthe issue raised by the querist in paragraph 14 above is that onthe basis of the facts, the financing of housing and infrastructureactivities need not be shown as separate business segments forthe purposes of AS 17.


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Query No. 14

Subject: Booking of export sales/purchases of wheat andrice under subsidised quota of the Government ofIndia, purchased from another governmentundertaking.1

A Facts of the Case

1. A company is a central public sector undertaking (hereinafterreferred to as ‘the company’) under the administrative control ofthe Ministry of Commerce, Government of India, and is engagedin trading activities by way of export, import and domestic trade. Itis purely a trading house. The company was a governmentcanalised agency upto decanalisation era. Total turnover of thecompany during financial year 2003-04 was Rs. 8348.76 crore.The company, in addition to many other items, also exported wheat/rice under the Government allocation from another governmentundertaking (hereinafter referred to as ‘the undertaking’) onsubsidised rates during financial years 2003-04 and 2004-05. Noprivate party was entitled to export these items directly from theundertaking.

2. The querist has summarised certain basic facts of the case,which are as below:

(i) Allocation of wheat and rice is done by the Ministry tothe company from the undertaking at the specific rates.

(ii) Accordingly, the undertaking sells wheat and rice only tothe company.

(iii) Purchase price is paid by the company to the undertakingthrough demand draft (DD).

(iv) Release order is given by the undertaking in the name ofthe company.

(v) RR/LR are in the name of the company.



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(vi) Export order is in the name of the company thougharranged by business associates.

(vii) The company issues sales tax declaration Form-H to theundertaking.

(viii) Letter of credit is opened by the importer in favour of thecompany.

(ix) Export documents are in the name of the company.

(x) Export packing credit (EPC) from the banker is availedby the company.

(xi) Bills are negotiated through the company’s banker andthe proceeds are used to discharge the EPC availed.

(xii) Stock is hypothecated to the company’s banker and thebank has lien over the goods towards the EPC given tothe company.

(xiii) The port trust holds the stock for the company.

(xiv) The company is the beneficiary of the insurance policy.

(xv) Risks and rewards of ownership of goods, as per thequerist, are always with the company. In other words, atno point of time, risks and rewards of ownership of goodsare transferred to business associates.

3. The querist has stated that to execute the export commitmentand trading operations, the company is having an arrangementwith its business associates to undertake the following activities:

(i) Lifting the material from the godown of the governmentundertaking to port towns by road or rail.

(ii) Receiving the material at the port town and moving themto the godown/transit port area.

(iii) Segregation, if necessary, as per the requirement of thebuyers.

(iv) Arranging shipments as and when vessels take berth.


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(v) Fumigation of stock.

(vi) Quality analysis.

(vii) Arranging necessary documents for negotiations by thecompany.

4. The querist has stated that the company is primarily a tradingentity and contracting party. It procures and sells goods as requiredby its associates on their behalf. It is one of the intermediaries inthe process of trading. The procurement and supply is undertakenfor and on behalf of business associates by the company. Thecompany is having a fixed trade margin on export quantity, i.e., onBill of Lading quantity. It takes 15% of the procurement price as amargin from the associates. Wherever the company is availingEPC/PCFC from its bank, interest cost is also being recoveredfrom the associates. The agreement with the associates has clausesfor indemnity to the company and recourse on the associate forany damages that may arise to the company under the contract.All the consideration for procurement and disposal flow throughthe company. The company remits the net cash flows less its fixedmargin and the expenses incurred, to the associate.

5. According to the querist, the company records the purchasesand sales against the above contracts based on the legal andcontractual obligations assumed by the company and transfer oftitle to the goods passing through it under the contract. TheGovernment Audit Party (GAP) is of the view that there is a violationof Accounting Standard (AS) 9, ‘Revenue Recognition’, issued bythe Institute of Chartered Accountants of India, in recognising thepurchase and sales since,

(a) the company is trading only with a fixed margin;

(b) all the activities from lifting of the material to the shipmentare carried out by the associate; and

(c) the contract provides for indemnity to the company andallows the company to recover losses, if any, ultimatelyfrom the associate.


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According to the GAP, “the risks and rewards are with the associateand there is an assignment of the contract to the associate”.

6. As per the querist, the company is of the view that AS 9 dealsonly with the timing of recognition of revenue and does not dealwith the question of ownership which is more fundamental. Also,AS 9 does not deal with accounting for purchases. The ownershipin the goods is passed on by the government undertaking to thecompany and the company has to book the purchases. Accordingto the querist, the ownership rests throughout with the companyuntil it is transferred by the company to the foreign buyer and itwould be wrong if the company does not recognise the purchaseand sale. Restricting its trade margin, is the company’s decisionbased on commercial considerations. The clauses for indemnity,etc., in the contract only provide for recourse to the company incase of loss but at first, the risk falls only on the company. AS 9requires consideration of risks and rewards of ownership (emphasissupplied by the querist). Risks and rewards cannot be separatedfrom ownership and AS 9 does not anywhere state that if there isanybody who has been made responsible for the risks, he willbecome the owner. The querist has argued that it should beappreciated that if such be the case, since all the risks are coveredby insurance, the insurance companies would become the owner.According to the querist, all the documents and the events as peritems (i) to (xv) of paragraph 2 above, confirm that the ownershipof the goods rests with the company and, accordingly, purchasesshould be booked by the company.

7. The querist has also brought to the notice of the ExpertAdvisory Committee, two opinions issued by the Committee onbooking of purchases and sales made through business associatesvide Queries No. 1.17 and 1.18 of Compendium of Opinions,Volume XVI, wherein, as per the querist, the Committee has clearlyopined that the fact to be seen is whether the ownership in thegoods passes on to the company or not. Although, as per thequerist, the present query is addressed by the above opinions, theMember, Audit Board (MAB) has desired that a fresh opinion maybe sought.


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B. Query

8. The opinion of the Expert Advisory Committee is sought onthe following issues:

(i) Whether booking of the purchases and sales by thecompany is in order.

(ii) If not, what should be the correct accounting treatment?

(iii) Whether the company is required to disclose suchpurchases and sales in the notes to accounts as acontravention of AS 9.

(iv) Whether AS 9 is applicable for booking of suchpurchases.

(v) Whether such purchases and sales are to be treated asassignment.


9. The Committee notes paragraph 17(b) of Accounting Standard(AS) 1, ‘Disclosure of Accounting Policies’, issued by the Instituteof Chartered Accountants of India, which states as follows:

“17(b) Substance over Form


10. The Committee notes from the above that the transactionsand events are accounted for and presented in accordance withtheir substance, i.e., the economic reality of events and transactions,and not merely in accordance with their legal form. In other words,it is the ‘economic reality’ that is important in accounting and notonly the ‘legal reality’. In the context of revenue recognition, theprinciple of ‘substance over form’ is recognised by paragraph 6.1of AS 9 as reproduced below:

“6.1 A key criterion for determining when to recognise revenuefrom a transaction involving the sale of goods is that the seller


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has transferred the property in the goods to the buyer for aconsideration. The transfer of property in goods, in most cases,results in or coincides with the transfer of significant risks andrewards of ownership to the buyer. However, there may besituations where transfer of property in goods does not coincidewith the transfer of significant risks and rewards of ownership.Revenue in such situations is recognised at the time of transferof significant risks and rewards of ownership to the buyer.Such cases may arise where delivery has been delayedthrough the fault of either the buyer or the seller and thegoods are at the risk of the party at fault as regards any losswhich might not have occurred but for such fault. Further,sometimes the parties may agree that the risk will pass at atime different from the time when ownership passes.”(Emphasis supplied by the Committee.)

11. In the context of the query, the Committee notes that whilethe legal form is that the title to the goods passes on to thecompany, the substance of the transaction is that the company inquestion is only an agent of the business associates because ofthe following factors:

(a) The querist has specifically stated in paragraph 4 abovethat the company undertakes procurement and supplyfor and on behalf of business associates.

(b) The company is getting only a fixed percentage of trademargin as its service charges. It is specifically stated inparagraph 4 above that the company remits the net cashflows less its fixed margin and the expenses incurred, tothe associate, which means that the risk of profit or lossarising out of the whole transaction is borne by thebusiness associate and not by the company. Thecompany is assured of its fixed margin and, therefore, itdoes not bear the risk of loss on this account.

(c) The agreement between the company and associates (acopy of which has been separately provided by the queristfor the perusal of the Committee) clearly states that the


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business associate will indemnify the company againstall claims/liabilities, if any, under the export contract.

(d) It is clear from the agreement with the business associatethat most of the expenses such as letter of credit charges,amendment and negotiation fees, export duties/fares,survey/inspection charges, etc. are to be borne by thebusiness associate. Also, the risk of inspection and qualityis to be borne by the business associate.

(e) It is clearly mentioned in the above-said agreement thatthe business associate is fully responsible as to thecorrectness of the export price etc. and role of thecompany is limited to arranging EPC funds etc. andfacilitating release of allocations for rice from thegovernment undertaking.

12. With regard to the arguments advanced by the querist inparagraph 6 above, the Committee notes that the principle ofsubstance over form does separate legal ownership from significantrisks and rewards of ownership. In other words, while AS 9 doesnot state that if the buyer is made responsible for the risks he willbecome the owner, it does provide that in case significant risksand rewards in the goods are transferred to the buyer then onlythe sale should be booked by the seller. With regard to theargument advanced by the querist that if risks be the determiningfactor for becoming an owner, the insurance company will be theowner of all the goods, the Committee is of the view that thisargument is fallacious since AS 9 nowhere states that the transferof significant risks and rewards of ownership results into thetransferee becoming the owner of the goods. Further, the insurancecompany may assume the risks yet it does not get the rewardsfrom the goods and for recognition of revenue, it is the transfer ofboth significant risks and significant rewards that is of paramountimportance. In other words, as per paragraph 6.1 of AS 9 (asreproduced in paragraph 10 above), in a situation where significantrisks and rewards of ownership are transferred, it is not necessarythat the property in the goods, i.e., the legal ownership is alsotransferred. On the transfer of significant risks and rewards of


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ownership, the buyer becomes the ‘economic owner’ of the goodseven though he is not the legal owner of the goods. This principlehas been recognised in many other accounting standards, forexample, Accounting Standard (AS) 19, ‘Leases’, issued by theInstitute of Chartered Accountants of India, recognises that in thesituation of a finance lease, the lessee should show the assetsacquired under such a lease in his balance sheet, even though heis not the legal owner of the assets.

13. The Committee agrees with the querist that AS 9 does notdeal with recognition of purchases by a buyer. The Committee is,however, of the view that the principle of recognition of revenuestated in AS 9 can be extended to recognition of purchases by thebuyer. The Committee is, therefore, of the view that just as theseller should recognise sale on the transfer of significant risks andrewards of ownership in the goods, the buyer should recognisethe purchases when he assumes significant risks and rewards ofownership in the goods. Accordingly, in the view of the Committee,the buyer can recognise purchases, only when he has acquiredsignificant risks and rewards of ownership in the goods.

14. The Committee also notes that the opinions of the ExpertAdvisory Committee on Queries No. 1.17 and 1.18 contained inVolume XVI of the Compendium of Opinions are based on theconsideration of transfer of ‘significant risks and rewards ofownership’ and not on whether the ‘ownership’ in the goods ispassed on as claimed by the querist in paragraph 7 above. On thisconsideration, the Committee had opined that since the significantrisks and rewards in the goods do not pass on to the concernedtrading company, it cannot book the purchases/sales made onbehalf of the business associates as its own purchases and sales.

15. On the basis of the above, the Committee is of the view thatalthough the ownership of goods vests with the company, thesignificant risks and rewards from the ownership of goods vestwith the business associates. Hence, in the present case, thecompany is merely an agent of the business associate andtherefore, it should not recognise sale and purchase of goods inits books of account, but should recognise only the service chargesas its revenue.


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D. Opinion


(i) No, booking of the purchases and sales by the companyis not in order.

(ii) The correct accounting treatment would be to recogniseonly service charges as its revenue.

(iii) Since the company should not recognise such purchasesand sales in its books of account, the question to disclosethe same as purchases and sales in the notes to accountsdoes not arise. However, the company may, if it sodesires, disclose the gross amounts of the transactionsin the notes to accounts, but not as purchases and sales.

(iv) No, AS 9 is applicable in respect of revenue recognitiononly. However, its principles can be extended torecognition of purchases, as stated in paragraph 13above.

(v) Since purchases and sales are made on behalf of thebusiness associates, the company in question is acting,in substance, only as an agent.

Query No. 15

Subject: Overhead allocation for the purpose of inventoryvaluation at quarter/year end.1


1. A company is having a “Continuous Process Plant” producinga single product. The installed capacity, which has been reportedin the annual accounts, is 2,000 MT per annum. The actual



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production has been higher for the past few years, the quantitiesproduced have been in the range of 2,400 MT to 2,500 MT.

2. According to the querist, the company has been consistentlyfollowing the method of valuation of inventories, viz., finished goodsand work-in-progress, by arriving at the cost of production (COP).In arriving at the cost, all the direct costs are considered and thefixed factory overheads are allocated on the basis of actualproduction. It is also considered whether the cost is greater thannet realisable value (NRV) or not.

3. During the 1st quarter ended June 2005, the plant was shutdown for 21 days for planned maintenance and later during thequarter due to a break-down for a period of 6 days, thereby theeffective working days during the quarter were 64. The actualproduction during the 1st quarter was 340 MT.

4. The querist has stated that during the course of the company’sinternal review, a view was expressed that since the plant hasproduced 340 MT during the 1st quarter, and the normal quantityproduced over the past few years is about 2,400 MT, andrecognising that the quarterly accounts must follow the sameprinciples followed as at the year-end, there is a need to quantifythe production capacity on a quarterly basis. The suggestion wasto do the pro-rating of the capacity over 4 quarters. The basefigure so arrived is 600 MT per quarter. Considering the quantityactually produced, i.e., 340 MT, a view was that the fixed overheadsto be inventorised on the closing stock should only be to theextent of 56% (340/600) as per Accounting Standard (AS) 2,‘Valuation of Inventories’, issued by the Institute of CharteredAccountants of India, and the balance 44% should be charged offas an expense and should not be inventorised. In this connection,the querist has drawn the attention of the Committee to paragraph9 of AS 2, as given hereunder:

“9. The allocation of fixed production overheads for thepurpose of their inclusion in the costs of conversion is basedon the normal capacity of the production facilities. Normalcapacity is the production expected to be achieved on an


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average over a number of periods or seasons under normalcircumstances, taking into account the loss of capacity resultingfrom planned maintenance. The actual level of productionmay be used if it approximates normal capacity. The amountof fixed production overheads allocated to each unit ofproduction is not increased as a consequence of low productionor idle plant. Unallocated overheads are recognised as anexpense in the period in which they are incurred. In periods ofabnormally high production, the amount of fixed productionoverheads allocated to each unit of production is decreasedso that inventories are not measured above cost. Variableproduction overheads are assigned to each unit of productionon the basis of the actual use of the production facilities.”

5. The querist has interpretated from the above paragraph of AS2 that the period of planned maintenance is to be excluded inarriving at normal level of production. Accordingly, the actual daysof planned maintenance have been excluded (21 days), therebyreducing the “base” quantity from 600 MT to 461 MT (600*70/91days). Thus, allowable overheads for inventory valuation based onavailable capacity utilisation works out to 74% (340/461).

6. The querist has further expressed his view that in arriving atthe normal level of production, if the period of break-down is alsoto be excluded as per cost accounting principles where allowanceis given for unavoidable interruptions, like time lost for repairs,inefficiencies, breakdown, inventory taking, etc., the period to beconsidered reduces to 64 days. As per the querist, the base quantityof 600 MT will get reduced to 422 MT (600*64/91 days). Allowableoverheads for inventory valuation based on available capacityutilisation works out to 81% (340/422).

7. The querist has stated that the company in question hasnever followed this method of identifying the actual productionagainst the rated production for the purpose of inventory valuationand while the company might have been producing about 600 MTper quarter, a so-called “normal production” had never been bench-marked by the company – definitely not quarter-wise.


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8. According to the querist, there was also a view that this issuegets highlighted where there is a shortfall in quarter 1. In quarter 2and quarter 3, the cumulative throughput normally brings theaverage to an acceptable norm. As per the querist, the questionthat needs to be addressed is whether this rule is to be for aparticular quarter or for the cumulative period.

9. As per the querist, financial impact of the treatmentrecommended as above would have a bearing in the particularquarter where there is a reduced production as the overhead costthat is normally inventorised would be lower, thereby impacting thebottom line. The next quarter’s opening stock would, to that extent,have a lower carried forward unit rate. This inventory when soldwould generate a higher margin. However, if the under-absorbedoverheads for a quarter are frozen and not to be considered forthe year-end valuation and unallocated overheads are recognisedas an expense in the period in which they are incurred, then theyear-end stock valuation process will not consider this amount andto that extent the year-end value of stock will be lower. The queristhas stated that since the year-end carry forward stock levels arehigh, this also impacts the year-end profitability.

B. Query

10. The querist has sought the opinion of the Expert AdvisoryCommittee on the following issues arising from the above:

(a) Paragraph 9 of AS 2, inter alia, states “actual level ofproduction may be used if it approximates normalcapacity”. At what percentage of production over eachquarter would trigger the application of this Standard? Isit 50%, 60%, 75%, 80% or 95%?

(b) Whether the normal level of production for each quarteris to be arrived at on the basis of equal production for 4quarters. Is this a reasonable method for determiningthe capacity utilisation (refer paragraph 4 of the ‘Facts ofthe Case’)? In the case of the company underconsideration, the main demand will be during the 3rd

and 4th quarters and it is expected that the normal


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production level of about 2,400 MT will be achieved inthe current year. If this be the case, what is the treatmentto be given for the first quarter’s lower production?

(c) Whether this rule is to be for a particular quarter or for acumulative period?

In case the actual production in the 1st and 2nd quartersare assumed at 600 MT and there is a fall in the 3rd

quarter to 340 MT as illustrated below what would be thetreatment:

Expected Annual Production – 2,400 MT

Pro-rated production per quarter – 600 MT

Actual Production – 1st and 2nd

quarters – 1,200 MT(600 MT each)

Actual Production – 3rd quarter – 340 MT

Cumulative total of all the 3 quarters – 1,540 MT

In the above instance, in the 3rd quarter accounts as on31st December, the Production:

• for the 3rd quarter is 340 MT or 56% utilisation

• for the cumulative period, the utilisation is 86%(1540/1800)

(d) If the answer to (c) above is to consider the cumulativeproduction and not the production quarter-wise, whetherit should be recommended to the management to planfor maintenance in the later quarters. Is the intention ofthe Accounting Standard to split hair? Whether this, inconjunction with the query, implies that the AccountingStandards should be considered for production planning.

(e) Since the undertaking is a continuous process plant,inspite of annual maintenance, there could be a majorbreak-down of a critical machinery. In such instances,


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what should be the treatment of absorption of fixedoverheads?

In the instant case, if the annual production is 2,400 MT,the average production per day would be 6.98 MT foreffective working days of 344 days (365days - 21 daysfor planned maintenance) and the normal production for70 days would be 461 MT - thereby achieving 74%capacity utilisation on production of 340 MT. Alternatively,if the break-down days of 6 days are also excluded, thenormal production for 64 days would be 422 MT –achieving 81% capacity utilisation on production of 340MT.

(f) If the answer to (c) above is to consider cumulativeproduction and not the quarter-wise production, in caseof fall in demand of the product or for whatever reasons,the plant is shut down in the 3rd quarter with nil production,what should be the treatment of absorption of fixedoverheads in such instances? The cumulative productionin such instance would be 1,200 MT, which will be 66%of cumulative pro-rated production of 1,800 MT.

(g) If the overheads are disallowed for inventorisation in the1st quarter, whether the expenditure to be considered forthe year-end inventory valuation excludes the overheadsdisallowed in quarter 1 as it is frozen and charged-off asexpenditure in the 1st quarter, or the disallowed figure isto be reinstated for the year-end working of inventoryvaluation.


11. The Committee notes paragraph 9 of AS 2 reproduced by thequerist in paragraph 4 of the Facts of the Case. The said paragraphis reproduced below again for ready reference:

“9. The allocation of fixed production overheads for thepurpose of their inclusion in the costs of conversion is basedon the normal capacity of the production facilities. Normalcapacity is the production expected to be achieved on an


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average over a number of periods or seasons under normalcircumstances, taking into account the loss of capacity resultingfrom planned maintenance. The actual level of productionmay be used if it approximates normal capacity. The amountof fixed production overheads allocated to each unit ofproduction is not increased as a consequence of low productionor idle plant. Unallocated overheads are recognised as anexpense in the period in which they are incurred. In periods ofabnormally high production, the amount of fixed productionoverheads allocated to each unit of production is decreasedso that inventories are not measured above cost. Variableproduction overheads are assigned to each unit of productionon the basis of the actual use of the production facilities.”

12. On the basis of the above, the Committee is of the view thatthe first step for allocation of fixed production overheads is toarrive at the quantum of normal capacity of the production facilities.As per the above paragraph, the normal capacity is the productionexpected to be achieved on an average over a number of periodsunder normal circumstances, taking into account the loss of capacityresulting from planned maintenance. In other words, in the view ofthe Committee, the enterprise estimates the level of productionwhich will be achieved during a period, say a year, after consideringthe planned maintenance and other normal wastages in theutilisation of the facilities. For example, an enterprise may have aninstalled capacity of say 10,000 MT a year, but after consideringthe planned maintenance and other normal wastages in capacityutilisation, the management may estimate on the basis of the pastaverage of 3 years and the demand of the product over the next 3years, that the normal capacity per year would be 8,000 MT. It isthis quantity of 8,000 MT which will be considered as normalcapacity for the purpose of allocation of fixed overheads. Accordingto the Standard, the actual production capacity can be consideredonly if it approximates the normal capacity. The Committee notesthat the Accounting Standard does not lay down any hard and fastrule as to what should be considered as an approximation of thenormal capacity. The Committee is of the view that an enterprisewill have to consider under the facts and circumstances of each


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case as to what can constitute an approximation keeping in viewthe considerations of materiality and other factors, such as thefluctuations in the actual production, vis-a-vis, the normal production.For instance, in the aforesaid example, the enterprise may decidethat compared to the normal capacity of 8,000 MT, theapproximation should be within the range of, say, plus/minus 2%.Thus, in the view of the Committee, the starting point is always thenormal level of production which is considered for allocation offixed overheads. It may be noted that the normal level of productionis not changed every time there is a change in actual productionas has been suggested by the querist. The normal level ofproduction remains the same. The allocation of the fixed overheadsto the actual production attained based on the allocation rate workedout on the basis of the normal production gives rise to an under orover allocation. The fixed production overheads that cannot beallocated on the basis of normal level of production are required tobe charged to the profit and loss account as per paragraph 9 ofAS 2 reproduced above.

13. With regard to allocation of fixed production overheads for thepurpose of valuation of inventories for the financial results pertainingto the interim periods, the Committee notes the following extractsfrom Accounting Standard (AS) 25, ‘Interim Financial Reporting’,issued by the Institute of Chartered Accountants of India:

“27. An enterprise should apply the same accountingpolicies in its interim financial statements as are appliedin its annual financial statements, except for accountingpolicy changes made after the date of the most recentannual financial statements that are to be reflected in thenext annual financial statements. However, the frequencyof an enterprise’s reporting (annual, half-yearly, orquarterly) should not affect the measurement of its annualresults. To achieve that objective, measurements forinterim reporting purposes should be made on a year-to-date basis.

28. Requiring that an enterprise apply the same accountingpolicies in its interim financial statements as in its annual


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financial statements may seem to suggest that interim periodmeasurements are made as if each interim period standsalone as an independent reporting period. However, byproviding that the frequency of an enterprise’s reporting shouldnot affect the measurement of its annual results, paragraph27 acknowledges that an interim period is a part of a financialyear. Year-to-date measurements may involve changes inestimates of amounts reported in prior interim periods of thecurrent financial year. But the principles for recognising assets,liabilities, income, and expenses for interim periods are thesame as in annual financial statements.

29. To illustrate:

(a) the principles for recognising and measuring lossesfrom inventory write-downs, restructurings, orimpairments in an interim period are the same asthose that an enterprise would follow if it preparedonly annual financial statements. However, if suchitems are recognised and measured in one interimperiod and the estimate changes in a subsequentinterim period of that financial year, the originalestimate is changed in the subsequent interim periodeither by accrual of an additional amount of loss orby reversal of the previously recognised amount…”

14. The Committee also notes paragraph 19 of Appendix 3,‘Examples of Applying the Recognition and MeasurementPrinciples’, of AS 25, which is reproduced below:

“19. Inventories are measured for interim financial reportingby the same principles as at financial year end. AS 2 onValuation of Inventories, establishes standards for recognisingand measuring inventories. Inventories pose particularproblems at any financial reporting date because of the needto determine inventory quantities, costs, and net realisablevalues. Nonetheless, the same measurement principles areapplied for interim inventories. To save cost and time,enterprises often use estimates to measure inventories at


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interim dates to a greater extent than at annual reportingdates…”

15. On the basis of the above, the Committee is of the view thatfor the purpose of allocation of fixed production overheads, theenterprise will have to apply the same accounting policies in itsinterim financial results that are followed for annual financialstatements. However, as mentioned in paragraph 19 of Appendix3 of AS 25, reproduced above, the enterprise may rely on estimatesto a greater degree. Thus, in case an enterprise estimates itsnormal production on an annual basis, and if there are no quarterly/seasonal variations, it can pro-rate the same appropriately, sayequally, over the 4 quarters, in case the enterprise is preparingquarterly financial reports. In case there are quarterly/seasonalvariations, the enterprise will have to estimate its normal capacityon the basis of the average of the relevant quarters/seasons ofpast few years, say, 3 to 5 years, also considering the demand ofthe product during the season. For example, where a company ishaving seasonal variations say, in the 3rd quarter of the year, thenit should estimate the normal capacity for the 3rd quarter based onthe capacity utilisation of the 3rd quarter for the past few years, say3 to 5 years, also keeping in view the future demand of the productduring the quarter. Once the normal capacity for a quarter isdetermined, as aforesaid, the quarter should be considered formeasurement purposes, as per paragraph 27 of AS 25 on year-to-date basis, i.e., on cumulative basis. If there is an abnormalbreakdown during a period, as per AS 2, the amount of fixedproduction overheads not allocated to units of production is chargedto the profit and loss account. However, the result of under allocationof overheads or over allocation of overheads should not affect themeasurement of its annual results since interim periods are partsof a financial year. This process is illustrated by way of an exampleas given in Annexure A.

D. Opinion

16. On the basis of the above, the Committee is of the followingopinion on the issues raised by the querist in paragraph 10 above:


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(a) As explained in paragraph 12 above, the approximationto normal capacity should be based on the facts andcircumstances of each case.

(b) and (c) It is not always necessary to arrive at the normal levelof production for each quarter based on equal productionfor all the quarters. Such a situation may arise only whereit is expected that there are no seasonal or quarterlyvariations in production. In cases where quarterly/seasonal variations in production are expected, the normallevel for the quarter(s) should be estimated based on theaverage of past 3 to 5 years of that quarter(s). This maybe necessary in case of seasonal variations or whereotherwise the quarterly production is expected to be lower,for example, the enterprise estimates that it will have toshut down the plant for normal maintenance during thequarter. In the case of the company in question, if themain demand and, therefore, the production, is expectedin the 3

rd and 4th quarters, normal production should bedetermined separately for the 3

rd and the 4

th quarters as

explained above. Moreover, the above principles, as perparagraph 27 of AS 25, will have to be applied on year-to-date basis, i.e., cumulatively, as explained in paragraph15 above.

(d) Normal level of production as per AS 2 and AS 25 shouldbe determined based on the expected maintenance andnot the other way round as indicated by the querist that itshould be used for production planning. The intention ofAS 25 is to inventorise fixed production overheadsmeasured on year-to-date basis so that the annual resultsare not affected.

(e) In case of a major breakdown for a critical machinery, ina particular quarter, as per paragraph 9 of AS 2, theunder allocation of overheads, if arrived at on year-to-date basis, should be charged to the profit and lossaccount for that quarter.


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(f) In case there is nil production in a quarter because ofabnormal reasons, i.e., it was not factored in whileestimating normal level of production for the quarter,and, if it results in under allocation of overheads on year-to-date basis, it should be expensed in that quarter.

(g) Since the fixed production overheads are absorbed atthe normal level of production, the rate should remainthe same for year-end inventory valuation purposes.

Annexure A

Example:

Fixed production overheads for the financial year = Rs. 9,600.

Normal expected production for the year, after consideringplanned maintenance and normal breakdown, also consideringthe future demand of the product = 2,400 MT. In this example,it is considered that there are no quarterly/seasonal variations.Therefore, the normal expected production for each quarter is600 MT and the fixed production overheads for the quarterare Rs. 2,400.

Actual production achieved

First quarter 500 MTSecond quarter 700 MTThird quarter 400 MTFourth quarter 700 MT

Fixed production overheads to be allocated per unit ofproduction in every quarter will be Rs. 4 per MT (Fixedoverheads/Normal production).

First quarter

Actual production overheads = Rs. 2,400

Fixed production overheads based on the allocation rate ofRs. 4 per unit allocated to actual production = Rs. 4x500=Rs. 2,000


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Unallocated fixed production overheads to be charged asexpense as per paragraph 9 of AS 2 and consequently as perAS 25 = Rs. 400

Second quarter

Actual fixed production overheads on year-to-date basis Rs.4,800

Fixed production overheads to be absorbed on year-to-datebasis 1200x4 = Rs. 4,800

Rs. 400 were not allocated to production in the Ist quarter. Togive effect to the entire Rs. 4,800 to be allocated in the secondquarter, as per paragraph 29(a) of AS 25, Rs. 400 are reversedby way of a credit to the profit and loss account of the 2

nd

quarter.

Third quarter

Actual production overheads on year-to-date basis = Rs. 7,200

Fixed production overheads to be allocated on year-to-datebasis 1,600x4 = Rs. 6,400

Under allocated overheads Rs. 800 to be expensed as perparagraph 9 of AS 2 and consequently as per AS 25

Fourth quarter/Annual

Actual fixed production overheads on year-to-date basis Rs.9,600

Fixed production overheads to be allocated on year-to-datebasis 2,300x4 = Rs. 9,200

Rs. 400, i.e., [2,800(i.e., Rs.4x700) - 2,400] over allocable inthe 4

th quarter, are to be reversed as per paragraph 29(a) of

AS 25 by way of a credit to the profit and loss account.

Unallocated overheads for the year Rs. 400 are expensed inthe profit and loss account as per paragraph 9 of AS 2.


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The cumulative result of all the quarters would also result inunallocated overheads of Rs. 400, thus, meeting therequirements of paragraph 27 of AS 25 that the quarterlyresults should not affect the measurement of the annual results.

This example presumes that there are no quarterly/seasonalvariations. In a case where there are quarterly/seasonalvariations, the estimates of normal capacity would have to bemade on the quarterly/seasonal basis as discussed inparagraph 15 of the Opinion, which would then be added upto determine the normal capacity for the year on the basis ofwhich the absorption rate will be determined. The variationsbetween the seasons would thus be considered normal andtreated accordingly.

Query No. 16

Subject: Accounting treatment in respect of side-trackingcosts of wells.1


1. An Exploration & Production (E&P) company established underthe Companies Act, 1956, has the core activities of exploration,development and production of hydrocarbons in inland as well asin offshore areas.

2. The company had generally been following the SuccessfulEfforts Method of accounting as contained in Statement of FinancialAccounting Standard (FAS) 19, ‘Financial Accounting and Reportingby Oil and Gas Producing Companies’, issued by the FinancialAccounting Standards Board (FASB) of USA. The Institute ofChartered Accountants of India issued the ‘Guidance Note onAccounting for Oil and Gas Producing Activities’ in March 2003,which lays down the accounting treatment for costs incurred on



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acquisition of mineral interests in properties, exploration,development and production activities. According to the querist,the company implemented the above Guidance Note from theaccounting year 2003-04 onwards and has been compiling itsfinancial statements as per the provisions of the Guidance Note.

3. As oil fields mature, sustenance of production levels andtechno-economics of hydrocarbon exploitation necessitate drillingof development wells and work-over in tandem for gas shut-offs,water shut-offs, layer transfer, inter-conversions between injectorsand producers, etc. Also, with recently introduced technologyinduction, previously drilled well bores which are no longer producingor producing below economic levels, are ‘side-tracked’. This isaccomplished by cutting a window in casing at appropriate depthand drilling a side-tracked hole at different angle and terminatingthem at the target depth within the same or different layer of thereservoir, with a purpose to utilise the same well to reach a differenttarget to produce more oil and gas and at the same time to reducewell cost.

4. Drilling of wells is an integral part of exploration activity.Sometimes, due to complications in the drilled hole, the originalhole is side-tracked to drill further to achieve the target depth.Side-tracking techniques are broadly covered under the applicationof directional drilling technology. In case of an exploratory ordevelopment well, side-tracking is carried out when an objective/target could not be reached due to drilling complications like stuckpipe, loss of cementation, etc. In the process, certain portion ofthe drilled depth of the well or the entire well may have to beabandoned, in order to achieve the objective of drilling the well.

5. The querist has stated that the Guidance Note on Accountingfor Oil and Gas Producing Activities does not specifically addressthe issue of accounting treatment of side-tracking costs.

6. The querist has also mentioned that there is no specificreference to the accounting treatment in the Significant AccountingPolicies of the company. There are also no specific guidelinesfrom any bodies like the Financial Accounting Standards Board,USA (FAS 19 does not deal specifically with the issue). The


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company, at present, is following the accounting treatment in thisregard, as given below:

(i) In case of exploratory wells, the cost of abandoned portionof the well is considered as a part of the cost of the wellconsidering the well as a single unit and capitalised asexploratory wells-in-progress.

(ii) In case of development wells, the cost of abandonedportion of the well is considered as a part of the cost ofthe well and capitalised under producing property.

(iii) In case of existing producing wells, the expenditure onside-tracking is classified as workover expenditure, i.e.,repair of the well, and, accordingly, charged to the profitand loss account.

7. According to the querist, during the course of audit, a differentview, based on the internationally accepted accounting practicesgiven in (i) Fundamentals of Oil and Gas Accounting by RebeccaGallun and others, (ii) Petroleum Accounting – Principles,Procedures and Issues – 4th Edition by Horace R Brock and othersand (iii) Council of Petroleum Accountants Society (COPAS) BulletinNo. 10 and on the basis of treatment recommended under theGuidance Note on Accounting for Oil and Gas Producing Activities,issued by the Institute of Chartered Accountants of India (ICAI),emerged as follows:

(i) Exploratory wells

As per paragraph 39 of the Guidance Note, under thesuccessful efforts method, costs incurred on exploratory drywells are to be expensed. On the same analogy, as the costof abandoned portion of the side-tracked exploratory well, i.e.,from the point of side-tracking to the bottom of incompletewell does not add to the value of side-tracked well, such costsare to be expensed.

(ii) Development wells

Under successful efforts method, the costs incurred in drillingdevelopment dry wells as well as development successful


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wells are to be capitalised. Since the costs incurred on boththe successful and unsuccessful development wells drilled inproved area are capitalised, the cost of abandoned portion ofthe side-tracked well should also be capitalised.

(iii) Producing wells

In case of existing producing wells, the expenditure on portionof side-tracking or portion of well drilled deeper below theproducing horizon, which is proved successful, should becapitalised as its benefits will accrue over a number of years.However, unsuccessful side-tracked portion(s) or portion ofwell drilled deeper below the producing horizon (as mentionedin COPAS Bulletin No. 10) should be expensed as it does notadd any value to the well. In case of side-tracking, if theportion below the point of side-tracking is abandoned/plugged,the cost should be expensed.

8. The querist has stated that if the accounting treatmentproposed in paragraph 7 above is followed and in case, it is decidedthat abandoned portion of the side-tracked well adds no utility /value to the well actually completed then the proportionate portionof the well costs will have to be charged to expense either onmeterage basis or per drilling day basis or allocated costs on anyother reasonable basis which will have to be decided. On thesame principles, the side-tracking in respect of a producing well(which proved successful) would have to be capitalised.

9. The querist has drawn the attention of the Committee to thefollowing references taken from two of the petroleum accountingbooks on the Industry, which broadly incorporate the accountingpractices prevalent in the US:

(i) As per The Fundamentals of Oil & Gas Accounting byRebecca Gallun and Others,

“Costs of sidetracking are generally considered a part of drillingcosts and are capitalised or expensed, depending uponwhether the well is a development well or an exploratory welland whether proved reserves are found. However, if the well


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is an exploratory well, expensing the costs of the abandonedportion of the well regardless of whether proved reserves arefound (emphasis provided by the querist) appears moreconsistent with the theory of successful efforts because thatportion of well obviously has no future economic benefit”.

(ii) As per Petroleum Accounting-Principles, Procedures &Issues, 4th Edition, by Horace R Brock and others

“Sometimes in the drilling of an exploratory well with a specificformation or trap as an objective, difficult drilling conditionsmay be encountered, making it necessary to abandon thehole already drilled and to start a new well nearby. If thesecond hole is completed as a producer, the question arisesfor successful efforts as to whether the costs incurred on theabandoned hole should be charged to expense or should becapitalised as part of the cost of the completed well thatfound proved reserves.

It appears that the former treatment is preferable and that thecosts applicable to the abandoned hole should be charged asan exploratory dry-hole expense because the abandoned holeadded nothing to the utility or value of the well actuallycompleted. If the well originally being drilled were classifiedas a development well, all costs involved would be capitalised.If in drilling a well, difficulties are encountered and it isnecessary to abandon the lower portion of the well in order toplug-back and side-track to reach the same objective throughdirectional drilling, the cost of abandoned portion shouldlikewise be charged to expense as dry-hole cost. (Emphasisprovided by the querist.)

Some companies do, however, capitalise costs of anabandoned well if the target of the second well (or the side-tracking) is the same as that of the abandoned well. Thesecond well (or the twin well) and the side-tracking are simplyunexpected additional costs, like fishing for stuck drill pipe, toget a well drilled to the target.”


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10. The querist has stated that there is no uniform standardisedpractice as far as the accounting treatment of such cost isconcerned. A survey published in the Journal of Extractive IndustriesAccounting, reported how companies are handling similar situationsin practice (Survey of Successful Efforts Accounting Techniques –Summer 1982). In most of the situations, there appears to be littleagreement as to whether to expense or capitalise the cost of suchwells.

B. Query


(i) The appropriate accounting treatment in respect of costincurred on side-tracking and the abandoned portion ofwell due to side-tracking of exploratory wells, developmentwells and producing wells.

(ii) In case it is decided that the abandoned portion of theside-tracked well adds no utility to the well actuallycompleted then the basis on which the costs will have tobe charged to the expenses may also be advised, i.e.,whether on the basis of meterage or drilling days or anyother reasonable basis.

C. Points Considered by the Committee

12. The Committee is of the view that although the GuidanceNote on Accounting for Oil and Gas Producing Activities, issuedby the Institute of Chartered Accountants of India, does notspecifically deal with the accounting treatment in respect of costsincurred on side-tracking and abandoned portion of oil well due toside-tracking of exploratory wells, development wells and producingwells, the treatment in respect thereof can be derived from thetreatment given in respect of the exploratory costs, developmentcosts and production costs given in the Guidance Note.

13. With regard to accounting treatment in respect of costs incurredon side-tracking and the abandoned portions of the wells due to


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side-tracking of exploratory wells, the Committee notes paragraph39 of the Guidance Note which recommends as below:

“39. If the cost of drilling exploratory well relates to a well thatis determined to have no proved reserves, then such costsnet of any salvage value are transferred from capital work-in-progress and charged as expense as and when its status isdecided as dry or of no further use. Costs of exploratorywells-in-progress should not be carried over for more than aperiod of two years from the date of completion of drillingunless it could be reasonably demonstrated that the well hasproved reserves and development of the field in which thewell is located has been planned with required capitalinvestment such as development wells, pipelines, etc., in whichcase the costs of the exploratory well can be carried forwardwithout any time limit.”

14. On the basis of the above, the Committee is of the view thatin case of side-tracking of an exploratory well, the abandonedportion of the exploratory well is similar to that of an exploratorywell that is determined to have no proved reserves. Accordingly,the treatment thereof should be the same as that of an exploratorywell that is determined to have no proved reserves, i.e., the costsin respect of the abandoned portion of the exploratory well shouldbe transferred from capital work-in-progress and charged asexpense as and when its status is decided as dry or of no furtheruse. Further, the costs incurred on drilling of side-trackedexploratory well is similar to the costs of drilling and equippingexploratory wells (paragraph 9(iv) of the Guidance Note) and,therefore, should be capitalised as recommended in paragraph 36of the Guidance Note (reproduced in paragraph 16 below) as partof the capital work-in-progress when incurred.

15. With regard to the treatment in respect of costs incurred onside-tracking and the abandoned portion of the well due to side-tracking of development wells, the Committee notes the definitionof the term ‘development wells’, as per paragraph 4 of the GuidanceNote which is reproduced below:


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“Development Well: A well drilled, deepened, completed orrecompleted within the proved area of an oil or gas reservoirto the depth of a stratigraphic horizon known to be productive.”

16. The Committee further notes paragraph 36 of the GuidanceNote as below:

“36. Under the successful efforts method, in respect of a costcenter, the following costs should be treated as capital work-in-progress when incurred:

(i) All acquisition costs;

(ii) Exploration costs referred to in paragraph 9(iv) and(v); and

(iii) All development costs.”

17. From the definition of the term ‘development well’, theCommittee notes that the said wells are drilled and developed inan area within the area of proved oil or gas reserves and, therefore,are different from the exploration wells in respect of which it is stillto be determined whether the area has proved oil reserves. TheCommittee is of the view that expenditure incurred on developingdry wells is like a normal loss/expenditure during construction orcreation of an asset and, therefore, should be capitalised. TheCommittee is of the view that side-tracking of a developed well isalso like a normal loss/expenditure on the developing well and,accordingly, the costs incurred on side-tracking as well as thecosts related to the abandoned portion of well due to side-trackingof developing well should be capitalised as part of the capitalwork-in-progress.

18. With regard to accounting treatment in respect of costs incurredon side-tracking and the abandoned portion of wells due to side-tracking of producing wells, the Committee notes that the GuidanceNote contemplates charging-off of the capitalised cost to the profitand loss account by way of depreciation over the period of itseconomic use. In this context, the Committee notes the definitionof ‘proved developed oil and gas reserves’ and paragraphs 42 and


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44 of the Guidance Note, related to charging-off of the depreciationon the producing wells as reproduced below:

“Proved Developed Oil and Gas Reserves: Proved developedoil and gas reserves are reserves that can be expected to berecovered through existing wells with existing equipment andoperating methods. Additional oil and gas expected to beobtained through the application of advanced recoverytechniques for supplementing the natural forces andmechanisms of primary recovery should be included as proveddeveloped reserves only after testing by a pilot project or afterthe operation of an installed programme has confirmed throughproduction response that increased recovery will be achieved.”

“42. The depreciation charge or the Unit of Production (UOP)charge for all capitalised costs excluding acquisition cost withina cost center is calculated as under:

UOP charge for the period = UOP rate x Production forthe period

UOP rate = Depreciation base of the cost center/ ProvedDeveloped Oil and Gas Reserves”

“44. ‘Proved Oil and Gas Reserves’ for the purpose ofparagraph 41 comprise proved oil and gas reserves estimatedat the end of the period as increased by the production duringthe period. ‘Proved Developed Oil and Gas Reserves’ for thepurpose of paragraph 42 comprise proved developed oil andgas reserves estimated at the end of the period as increasedby the production during the period. Additional reserves fromadvanced recovery techniques are to be considered as proveddeveloped oil and gas reserves only after the requiredinvestments have been capitalised.”

19. On the basis of the above, the Committee is of the view thatin case of side-tracking of producing wells, if the proved developedoil reserves do not increase because of side-tracking, the cost ofside-tracking the producing wells is of the nature of ‘work-over’which is defined in Clause 15 of the Appendix to the GuidanceNote as “Remedial work to the equipment within a well, the well


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pipework or relating to attempts to increase the rate of flow”.Accordingly, such cost of side-tracking should be expensed in theyear in which it is incurred. The depreciation charge on the cost ofthe original producing well would continue to be charged as before.However, in case the side-tracking results in additional proveddeveloped oil reserves, the side-tracking should be treated in thesame manner as advanced recovery techniques and the additionalcost should be capitalised in respect thereof. Consequently, thedepreciation charge would also have to be revised as indicated inparagraph 44 of the Guidance Note reproduced above.

20. With regard to measurement of expenditure regardingabandoned portion of the side-tracked well for the purpose ofaccounting treatment given above, i.e., whether it should be onthe basis of the meterage or drilling days, the Committee is of theview that the company in question should assess the relationshipof the costs with the basis and select the appropriate method inthis regard.

D. Opinion

21. On the basis of the above, the opinion of the Committee onthe issues raised by the querist in paragraph 11 above are asbelow:

(i) The appropriate accounting treatment should be asbelow:

(a) Exploratory wells

Costs incurred on side-tracking should be treated ascapital work-in-progress and the abandoned portion dueto side-tracking should be expensed.

(b) Development wells

Costs incurred on the side-tracking should be capitalisedand the cost related to abandoned portion due to side-tracking of development wells should continue to becapitalised.


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(c) Producing wells

• In case the side-tracking does not result in increasein proved developed oil and gas reserves, the costof side-tracking should be charged to expense andthe cost of abandoned portion should be depreciatedin the normal way.

• In case the side-tracking results in additional proveddeveloped oil and gas reserves, the cost of side-tracking should be capitalised and the cost relatedto the abandoned portion of well due to side-trackingshould be expensed.

(ii) The basis on which the costs have to be charged asexpense in respect of the abandoned portion should bedetermined on a rational basis according to which thecosts relate best to the basis selected.

Query No. 17

Subject: Creation of provision for contingencies.1


1. A company was incorporated in March 1977 under section 25of the Companies Act, 1956. The main objective of the companyis to promote India’s trade. One of the medium of promoting thetrade is organising trade fairs and exhibitions in various parts ofthe country, as well as in other countries. The fairs/exhibitionsorganised by the company as also by outside agencies attractlarge crowds.

2. The querist has stated that from the year 2000-01, it wasdecided to charge 5% contingency charges from the participants/outside agencies on the income received from them by the



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company. While, in the case of fairs organised by outside agencies,5% contingency charges are levied separately in the invoice, thecontingency charges in respect of fairs organised by the companyare inbuilt in the space rent charged from the participants. Bothare credited to the income and expenditure account of the company.The intention of levying these charges is to meet any unforeseenliability which may arise in future. The instances of such unforeseenliabilities could be on account of injury/loss of life of visitors/exhibitors, etc., due to fire, terrorist attack, stampede, electrocution,natural calamities and other public/third party liability, statutoryliabilities, etc. The chances of occurrence of these events are highdue to visit of large crowds to the fairs/exhibitions. Besides, thelikelihood of damage to participant’s exhibits due to any of thereasons indicated above also exists.

3. According to the querist, as the recovery on account ofcontingency charges is being made to meet such unforeseenliability, as a prudent policy, a matching provision for the same isalso being made by the company in the accounts to reflect a trueand fair view of the state of affairs of the company. A suitabledisclosure to this effect is also made in the notes forming part ofaccounts. The decision to levy the 5% contingency charges wasbased on an assessment only as the actual liability on this accountcannot be estimated.

4. During the audit of accounts for the year 2002-03, the statutoryauditors of the company felt that provision against unknown liabilitiesand the expenses of contingent nature, which are contingent/unknown, is violative of the provisions of the Companies Act, 1956.In other words, the statutory auditors were of the view that noliability can be provided in the books of account unless the quantumof the liability and the details of the payee are known.

5. The querist had drawn the attention of the auditors toAccounting Standard (AS) 4, ‘Contingencies and Events OccurringAfter the Balance Sheet Date’, issued by the Institute of CharteredAccountants of India (ICAI), wherein the word ‘contingency’ hadbeen defined as a “condition or situation, the ultimate outcome ofwhich, gain or loss, will be known or determined only on the


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occurrence, or non-occurrence, of one or more uncertain futureevents.” In the opinion of the management, some events mightoccur in future which might affect the profitability of the company,and as a safeguard, a provision to meet unforeseen liability couldbe made in the books of account. The company’s contention thatthe matching provision was being made against the amounts beingrecovered to discharge any future liability, which might or mightnot occur, was however not accepted by the auditors and theaccounts of the organisation were qualified by the statutory auditorson this aspect.

6. In order to sort out the issue, the querist had earlier referredthe matter to the Expert Advisory Committee of the Institute ofChartered Accountants of India for the expert opinion as to whethercreation of provision for contingencies as detailed above was inconformity with AS 4 issued by the ICAI. The Committee hadopined2 that under the facts and circumstances of the case, thecreation of the provision for contingencies was not in conformitywith AS 4 and Accounting Standard (AS) 29, ‘Provisions, ContingentLiabilities and Contingent Assets’, issued by the ICAI and ScheduleVI to the Companies Act, 1956.

7. Accordingly, on the basis of the opinion received and afterdiscussion with the statutory auditors, the provision for contingencies(balance sheet) standing in the books of account from 2000-01 to2003-04 was reversed and credited as prior period income in theincome and expenditure account for the accounts of theorganisation for the year 2004-05. The Member Audit Board (MAB)[Comptroller and Auditor General of India (C&AG)], while reviewingthe accounts, was, however, of the view that the provision forcontingencies should be transferred to a special reserve account.This, according to the querist, was presumably on the basis of thewording of paragraph 13 of the opinion of the Expert AdvisoryCommittee which, inter alia, states that “the Committee is of theview that since the contingencies stipulated by the company arenot known at the balance sheet date, the provision in this regardcannot be created. Accordingly, the provision for contingencies

2 Query No. 12 of Compendium of Opinions — Vol. XXIV.


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created by the company is of the nature of a reserve.” (A copy ofthe observation of the C&AG auditors and management reply hasbeen separately provided by the querist for the perusal of theCommittee).

B. Query


(i) Whether the accounting treatment given by the companyis in conformity with the earlier opinion of the ExpertAdvisory Committee.

(ii) Whether the view of the MAB office on the above issuethat the provision for contingencies should be transferredto a special reserve account is correct.

(iii) If the answer to (ii) above is in the affirmative, then whatentry is required to be passed by the company for creatingthe special reserve in the books of account, i.e., whetherthe entry should be passed through the income andexpenditure account or through general reserve accountto the special reserve account.


9. The Committee notes from the Facts of the Case that thequerist had earlier sought its opinion on the issue as to whethercreation of provision for contingencies not known at the balancesheet date is appropriate, and that the Committee had opined thatsuch a creation of provision for contingencies is not in conformitywith AS 4, AS 29 and Schedule VI to the Companies Act, 1956.Accordingly, the Committee has not touched upon this issue againand has considered only the issue regarding accounting treatmentof the provision erroneously created in the books of account inpast.

10. With regard to the treatment of the provision for contingencieswrongly created in the books of account, the Committee notes thedefinition of the term ‘prior period items’ and paragraph 15 of


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Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period,Prior Period Items and Changes in Accounting Policies’, issued bythe Institute of Chartered Accountants of India, which state asfollows:



11. On the basis of the above, the Committee is of the view thatthe provision for contingencies wrongly created in the financialstatements of prior periods is a prior period item and hence, shouldbe written back in the statement of profit and loss for the currentperiod for determining the profit or loss for the period and shouldbe shown separately. Thus, the question of transfer of suchprovision to ‘reserve’ account, as argued by the governmentauditors, does not arise. Regarding the expression used by theCommittee, in its earlier opinion, based on the definitions of theterms, ‘provision’ and ‘reserve’ as per Schedule VI to the CompaniesAct, 1956 that such a provision is of the nature of reserve, theCommittee is of the view that the aforesaid expression refers onlyto the nature of an item rather than recommending the accountingtreatment. The company may, however, if it so desires, create aspecial reserve account in this regard by way of appropriation ofprofits.

D. Opinion


(i) Yes, the accounting treatment given by the company isin conformity with the earlier opinion of the Expert AdvisoryCommittee.


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(ii) No, the view taken by MAB office on the issue that theprovision for contingencies should be transferred to aspecial reserve account is not correct.

(iii) Answer to this question does not arise as the answer toquery (ii) above is not in the affirmative.

Query No. 18

Subject: Creation of deferred tax liability on special reservecreated u/s 36(1)(viii) of the Income-tax Act, 1961.1


1. A wholly owned Government of India undertaking, registeredunder the Companies Act, 1956, is engaged in financing the powergeneration projects, transmission and distribution works andrenovation and modernisation of power plants etc., in India. Thecompany is also notified as a ‘Public Financial Institution’ undersection 4A of the Companies Act, 1956. The company is givingterm loans, working capital loans, bridge loans etc., to finance thepower projects. The company is also engaged in leasing activitiesand has leased out equipments to power producing companies onwhich it is charging lease rent from the lessees.

2. The Institute of Chartered Accountants of India has issuedAccounting Standard (AS) 22, ‘Accounting for Taxes on Income’,which is applicable from 1.4.2001 to all listed enterprises. Thequerist has stated that since the bonds issued by the company arelisted on the National Stock Exchange (NSE), the company is alisted company, and therefore, AS 22 became applicable to thecompany w.e.f. 1.4.2001.

3. The querist has stated that AS 22 requires the recognition ofdeferred tax asset or liability for the timing differences. As per theStandard, “Timing differences are the differences between1 Opinion finalised by the Committee on 15.5.2006


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taxable income and accounting income for a period thatoriginate in one period and are capable of reversal in one ormore subsequent periods”. “Permanent differences are thedifferences between taxable income and accounting incomefor a period that originate in one period and do not reversesubsequently.” The Standard also provides that permanentdifferences do not result in deferred tax assets or deferred taxliability.

4. According to the querist, at the time of implementation of AS22, the following timing differences between accounting incomeand taxable income were identified by the company:

(i) Accrual of expenses and short term income.

(ii) Translation loss on foreign currency loans.

(iii) Lease equalisation amount

(iv) Depreciation on leased assets and owned assets

As per the querist, the tax effect on the above items was ascertainedand dealt with in accordance with the Standard in the books ofaccount by creation of deferred tax asset or liability.

5. The querist has reproduced extracts from section 36(1) of theIncome-tax Act, 1961, which provides as under:

“36. (1) The deductions provided for in the following clausesshall be allowed in respect of the matters dealt with therein, incomputing the income referred to in section 28 –

...

(viii) in respect of any special reserve created andmaintained (emphasis supplied by the querist) by afinancial corporation which is engaged in providing long-term finance for industrial or agricultural development ordevelopment of infrastructure facility in India or by apublic company formed and registered in India with themain object of carrying on the business of providing long-term finance for construction or purchase of houses in


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India for residential purposes, an amount not exceedingforty percent of the profits derived from such business ofproviding long-term finance (computed under the head“Profits and gains of business or profession” beforemaking any deduction under this clause) carried to suchreserve account:

Provided that where the aggregate of the amountscarried to such reserve account from time to time exceedstwice the amount of the paid-up share capital and of thegeneral reserves of the corporation or, as the case maybe, the company, no allowance under this clause shallbe made in respect of such excess.”

The querist has stated that the company has been claiming adeduction under section 36(1)(viii) on account of special reservecreated and maintained (emphasis supplied by the querist) @40% of profits derived from the business of long-term finance fromthe taxable income every year.

6. Further, the querist has mentioned that section 41(4A) of theIncome-tax Act, 1961, provides that in case the special reserve isutilised/withdrawn the same will become taxable in the year inwhich it is so utilised/withdrawn. Hence, the deduction claimed inthe year of creation of special reserve becomes taxable in theyear of utilisation/withdrawal of special reserve.

7. The querist has also intimated that the special reserve isappropriated out of the profits available for appropriation everyyear. It is not charged to profit and loss account, while the same isdeducted from the taxable income. The company is treating specialreserve as permanent difference and is not creating deferred taxliability on it.

8. Besides the above, as per the querist, the company has alsoexamined the matter and noted that in the various examples givenin the Standard, the items identified as timing differences arecapable of reversal subsequently themselves (emphasis suppliedby the querist), such as the difference in the method of depreciationin case a company charges depreciation on straight-line method


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(SLM) basis in its books, which is different from the written downvalue (WDV) method acceptable under the Income-tax Act. Thisresults in timing difference. In the books, the depreciation on SLMbasis would be spread evenly over the life of the asset while onWDV basis under the Income-tax Act, depreciation would be morein initial years and would reduce in the later years of life of theasset. The total amount of depreciation would be the same underboth the methods and differences and tax effects on the timingdifferences would square up themselves over the life of the asset.Whereas, in case of special reserve, the difference would squareup only when the company utilises/withdraws the special reserve,otherwise not. Till the time the company utilises the special reserve,section 41(4A) of Income-tax Act does not become operative; thus,the difference remains of permanent nature. It is not squared upitself as in the case of revenue items.

9. During the course of audit, however, a view has arisen thatdeferred tax liability should be created on the special reserve u/s36(1)(viii) of the Income-tax Act, 1961. The view expressed wasthat such reserves are created under the relevant sections of theIncome-tax Act and are not free reserves as any withdrawalstherefrom are subject to tax liability at prevalent rates. The taximplications of the reserves of aforesaid type stand deferred tillwithdrawal from such reserves. The creation of special reservecreates a difference between taxable income and accountingincome, which is not a permanent timing difference.

10. The querist has informed that as on 31.3.2004, the balancesheet of the company carries the special reserve of Rs. 2636.29crore and the deferred tax liability, if created on it, would amountRs. 500 crore (approximately). Further, the paid-up share capitaland general reserve of the company as at 31st March, 2004 stoodat Rs. 3578.74 crore; and as per section 36(1)(viii) of the Income-tax Act, the company can create special reserve to the extent oftwice its paid-up capital and general reserve (i.e. upto Rs.7157.48crore) against which the special reserves so far created are Rs.2636.29 crore. As there is a big gap between the paid-up capitaland general reserve and the special reserve, need for withdrawalfrom special reserve may never arise. The deferred tax liability, if


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created on special reserve, would be carried forward in the balancesheet of the company for a number of years (and may be, duringthe entire life of the company) which would create an imbalanceand distort the solvency ratios (emphasis supplied by the querist).Also, keeping in view the concept of going concern, the companymay not utilise the special reserve for a sufficiently long time.

11. The querist had earlier sought the opinion of the ExpertAdvisory Committee on the issue as to whether the company isrequired to create the deferred tax liability on the special reservecreated and maintained under section 36(1)(viii) of the Income-taxAct, 1961 as of now, which will become chargeable to tax as persection 41(4A) of the Act, only in the event of withdrawal therefromand which may or may not happen (emphasis supplied by thequerist). In response to the aforesaid query, the Committee hadexpressed the following opinion:

“The Committee is of the opinion that the company is requiredto create deferred tax liability on the special reserve createdand maintained under section 36(1)(viii) of the Income-taxAct, 1961, irrespective of the fact that withdrawal of the reservemay or may not happen since the company is capable towithdraw the reserve resulting into reversal of the differencebetween accounting income and taxable income (i.e., timingdifference).”

12. The querist has now submitted the following additional facts/arguments in favour of not creating a deferred tax liability:

(i) The company has no intention whatsoever of makingany withdrawal from the reserve. It has been earning ahealthy profit, a large part of which has been retainedresulting in a healthy net worth, which act as a cushionfor any unforeseen losses. In this context, select datarelating to the performance of the company has beensubmitted by the querist. The querist has also submittedthe Board Resolution to the effect that the company doesnot have any intention of withdrawing from the reserve inquestion.


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To be a liability, the obligation must be probable

(ii) The querist strongly feels that the provisions of AS 22relating to creation of a deferred tax liability need to beinterpreted harmoniously with the definition of the term‘liability’ as generally accepted in accounting. The queristbelieves that the following definitions of ‘liability’ have auniversal application:

(a) “The financial obligation of an enterprise other thanowners’ funds” (Guidance Note on Terms Used inFinancial Statements).

(b) “A liability is a present obligation of the enterprisearising from past events, the settlement of which isexpected to result in an outflow from the enterpriseof resources embodying economic benefits.”(Accounting Standard (AS) 29, ‘Provisions,Contingent Liabilities and Contingent Assets’ andthe Framework for the Presentation of FinancialStatements).

The querist has stated that he is firmly of the view thatsince the chances of a future withdrawal from the specialreserve are remote, it does not give rise to a ‘liability’.Generally accepted accounting principles requireobligations of an enterprise to be classified into twocategories:

(a) ‘Probable’ obligations (i.e., it is more likely than notthat an obligation exists on the balance sheet date).

(b) ‘Possible but not probable’ obligations (i.e., it is notmore likely than not that an obligation exists on thebalance sheet date).

Even though AS 22 does not state so specifically, thetiming differences contemplated (and illustrated) in AS22 are only those that must be probable of reversal in afuture period, though the reversal may take place at apoint of time considerably distant in future. In the view ofthe querist, the term ‘capable of reversal’ used in the


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definition of ‘timing differences’ should be interpreted as‘probable of reversal’. If this is not done, it will result inan item being recognised as a liability even though itdoes not meet the definition of ‘liability’. To take anextreme case, it will result in creation of a deferred taxliability the chances of whose settlement are one in amillion. This would result in making the balance sheetnot “true and fair”. The querist is of the view that thepresent case clearly does not fall in the category ofobligations which are probable. The amount of deferredtax liability of Rs. 888.02 crore due to transfer to specialreserve does not represent a liability since the chance ofits having to be settled is remote. To the extent theliability is recognised, the balance sheet wouldmisrepresent the reality.

(iii) In the view of the querist, the fact that a deferred taxliability is required to be recognised only when the outflowon account of the relevant obligation is probable isunequivocally recognised in Accounting StandardsInterpretation (ASI) 3, ‘Accounting for Taxes on Incomein the situations of Tax Holiday under Sections 80-IAand 80-IB of the Income-tax Act, 1961’, and AccountingStandards Interpretation (ASI) 5, ‘Accounting for Taxeson Income in the situations of Tax Holiday under Sections10A and 10B of the Income-tax Act, 1961’. Relevantexcerpts from ASI 3 are reproduced below (the positionunder ASI 5 is identical):

“In the situation of tax holiday under Sections 80-IA and80-IB of the Act, it is probable that deferred tax assetsand liabilities in respect of timing differences whichreverse during the tax holiday period, whether originatedin the tax holiday period or before that (refer provisionsof section 80-IA (2) of the Act), will not be realised orsettled. Accordingly, a deferred tax asset or a liability fortiming differences which reverse during the tax holidayperiod does not meet the above criteria for recognition ofasset or liability, as the case may be, and therefore isnot recognised to the extent the gross total income of


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the enterprise is subject to the deduction during the taxholiday period.”

Thus, ASIs 3 and 5 clearly provide, in the view of thequerist, that a deferred tax liability should be recognisedonly if it is probable that it will be settled. If it is possiblebut not probable that the obligation will need to be settled,the obligation does not meet the criteria for recognitionas a liability. The querist has also emphasised that theapplicability of the above principle is not restricted to taxholiday situations; it is all-pervasive.

(iv) Whether a possible obligation is ‘probable’ or ‘possiblebut not probable’ of crystallisation depends on the factsand circumstances of each case. In this case, in theview of the querist, the utilisation of special reserve impliesa higher tax liability for the company. It is obvious thatthe company would not make a transfer from the abovereserve except in the remotest circumstances making itinescapable. The company has been earning a healthyprofit and is in sound financial health. Thus, the possibilityof its having to withdraw from the special reserve is notmore than remote. The querist has stated that he isaware that AS 29 does not deal with recognition ofdeferred tax liabilities. However, the querist also believesthat the principles for recognition of liabilities laid downin AS 29 have, more or less, a universal application –other standards primarily apply these principles to specifictypes of transactions or situations. This fact is clearlyrecognised in ASIs 3 and 5 referred to above. In anycase, the gulf between AS 29 (and the Frameworkreferred to earlier) on the one hand and AS 22 on theother cannot be so wide that an item that is consideredno more than a remote obligation under AS 29 has to beconsidered a probable obligation under AS 22.

(v) There are many other provisions in the Income-tax Actwhereby the deductions/exemptions given to the assesseeare withdrawn if the assessee does not fulfill theprescribed conditions. The withdrawals of the deductionsare only contingent on the happening of a certain event


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and act more as a preventive penalty than anything else.In view of this, a distinction needs to be made betweenautomatically reversible tax concessions/deductions andconditionally reversible tax concessions/deductions. In thelatter case, reversibility of the tax concessions/deductionsis often within the control of the assessee. In such cases,a deferred tax liability should be required to be recognisedonly when it becomes probable – due to the intent of theassessee or due to attendant circumstances – that thetax concessions/exemptions would get reversed. Untilthis happens, the situation remains one of a contingentliability, which should be disclosed on the basis of theprinciples laid down in AS 29.

Is it a timing difference

(vi) Apart from the above, the querist has also requested theCommittee to consider whether such a transfer reallyconstitutes a timing difference. The opinion of theCommittee that transfer to special reserve results in atiming difference is based on the following definition of‘timing differences’ given in AS 22:

“Timing differences are the differences betweentaxable income and accounting income for a periodthat originate in one period and are capable ofreversal in one or more subsequent periods.”

The earlier opinion of the Committee has observed asfollows:

“14. From the above, the Committee is of the view thatthere are two essentialities for timing differences to arise:

(i) There should be difference between taxableincome and accounting income originating inone period; and

(ii) The difference so originated should be capableof reversal in one or more subsequent periods.

The Committee notes that there is no condition of anylimitation of the period for reversal of such differences,


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i.e., as per the definition quoted above, the reversal ofthe difference can take place at any time in future.

15. The Committee notes that in the period in whichspecial reserve is created, the accounting income remainsunaffected as the same is created below the line.However, the taxable income for the same year getsreduced by the amount of the special reserve thusresulting into lesser tax liability. Thus, a difference arisesbetween the accounting income and the taxable incomefor that period. The Committee also notes that thisdifference is capable of reversal in the period in whichthe special reserve is utilised or withdrawn as in the yearof utilisation or withdrawal, the amount of special reservewould be added to taxable income thus resulting into ahigher taxable income than the accounting income ofthat period. Therefore, the Committee is of the view thatthe creation of special reserve results into timingdifferences as per AS 22.”

The querist has expressed his views on the aboveobservations of the Committee as follows:

The definition of ‘timing differences’ given in the Standardand explanation of the nature of timing differences givenin paragraph 7 of the Standard need to be given aharmonious interpretation. Paragraph 7 specifically notesthat:

“… Timing differences arise because the period inwhich some items of revenue and expenses are includedin taxable income do not coincide with the period inwhich such items of revenue and expenses are includedor considered in arriving at accounting income…”

In the view of the querist, the above statement isabsolutely unequivocal – a timing difference arises (andarises only) if an item of revenue or expense enters thecomputation of both accounting income and taxableincome in different periods. The various examples given


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in the Standard (paragraph 7 and Appendix 1) fullysupport this view. Nothing else can give rise to a timingdifference. If an item enters the computation of onlyaccounting income but not taxable income (or vice versa),it does not result in a timing difference. This view isstrongly supported by the fact that the Standard containsspecific deeming provisions for unabsorbed depreciationand carried forward losses. These items do not arisefrom the same items of revenues or expenses enteringthe computation of accounting income and taxable incomein different periods and, in the absence of the specificdispensation in paragraph 8 of the Standard, would nothave been covered in AS 22. It is, therefore, the view ofthe querist that special reserve under discussion doesnot constitute a timing difference. While both the creationand the utilization of Special Reserve affect taxableincome, neither affects accounting income.

Other reasons

(vii) The querist has also submitted that the industry practiceis also such that no deferred tax liability is created onsuch transfer to reserves.

(viii) The querist has also pointed out that the concessionunder the Income-tax Act is aimed at encouraginginfrastructure financing and providing a basis for higherearnings to such companies. The concession is not aimedat deferring or postponing the income-tax liability but atproviding a relief from tax liability. The provision regardingtaxability of withdrawal is meant only to ensure that thisconcession is not abused – it is only a penal measure.Thus, the relevant provisions have the effect of providinga permanent relief as a rule and a mere postponementonly as an exception. Accounting, which is aimed atreflecting the economic substance, should be guided bythe general rule; it should reflect the exception only whenthe circumstances so warrant – it cannot reflect theexception as a rule. If one has to create an income-taxprovision (by way of deferred tax liability) for transfer tospecial reserve also, the very purpose of law is defeated


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since the profits after tax would be the same whetherthis concession exists or not.

(ix) There is very little economic justification for the companyto make a withdrawal from the special reserve. As longas the company is making profits, there is no reason forit to withdraw from the reserve. Even hypothetically if itmakes losses, why should it lose further by paying taxeson withdrawals specifically when it has substantial otherreserves to cushion its losses.

B. Query

13. The querist has sought the opinion of the Committee whetherit is necessary to create deferred tax liability on the special reservecreated and maintained under section 36(1)(viii) of the Income-taxAct, 1961.


14. The Committee notes the definition of the term ‘timingdifferences’ contained in the Accounting Standard (AS) 22,‘Accounting for Taxes on Income’, issued by the Institute ofChartered Accountants of India, reproduced below:

“Timing differences are the differences between taxableincome and accounting income for a period that originatein one period and are capable of reversal in one or moresubsequent periods.”

15. From the above, the Committee is of the view that there aretwo essentialities for timing differences to arise:

(i) There should be difference between taxable income andaccounting income originating in one period; and

(ii) The difference so originated should be capable of reversalin one or more subsequent periods.

The Committee notes that there is no condition of any limitation ofthe period for reversal of such differences, i.e., as per the definitionquoted above, the reversal of the difference can take place at anytime in future.


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16. The Committee notes that in the period in which special reserveis created, the accounting income remains unaffected as the sameis created below the line. However, the taxable income for thesame year gets reduced by the amount of the special reserve thusresulting into lesser tax liability. Thus, a difference arises betweenthe accounting income and the taxable income for that period. TheCommittee also notes that this difference is capable of reversal inthe period in which the special reserve is utilised or withdrawn asin the year of utilisation or withdrawal, the amount of special reservewould be added to taxable income thus resulting into a highertaxable income than the accounting income of that period.Therefore, the Committee is of the view that the creation of specialreserve results into timing differences as per AS 22.

17. The Committee also notes paragraph 14 of AS 22 whichstates as below:

“14. This Statement requires recognition of deferred tax forall the timing differences. This is based on the principle thatthe financial statements for a period should recognise the taxeffect, whether current or deferred, of all the transactionsoccurring in that period.” (Emphasis supplied by theCommittee.)

18. The Committee further notes paragraph 8 of AccountingStandards Interpretation (ASI) 6, ‘Accounting for Taxes on Incomein the context of Section 115JB of the Income-tax Act, 1961’,which, inter alia, describes one of the principal conceptual basesof AS 22 as below:

“8. There are two methods for recognition and measurementof tax effects of timing differences, viz., the ‘full provisionmethod’ and ‘partial provision method’. Under the ‘full provisionmethod’, the deferred tax is recognised and measured inrespect of all timing differences (subject to consideration ofprudence in case of deferred tax assets) without consideringassumptions regarding future profitability, future capitalexpenditure etc. On the other hand, the ‘partial provisionmethod’ excludes the tax effects of certain timing differences


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which will not reverse for some considerable period ahead.Thus, this method is based on many subjective judgementsinvolving assumptions regarding future profitability, futurecapital expenditure etc. In other words, partial provision methodis based on an assessment of what would be the position infuture. Keeping in view the elements of subjectivity, the ‘partialprovision method’ under which deferred tax is recognised onthe basis of assessment as to what would be the expectedposition, has generally been discarded the world-over. AS 22also does not consider the above assumptions and, therefore,is based on ‘full provision method’.”

19. From the above, the Committee notes that even if an enterpriseexpects that a difference between accounting and taxable incomewill not reverse (partial provision approach), the difference shouldbe recognised as timing difference if it is capable of reversal atany time in future (full provision approach). Thus, deferred tax isto be provided for all timing differences. Accordingly, the Committeeis of the view that in the present case, the eventuality of utilisation/withdrawal of special reserve is not of relevance. So long as theutilisation/withdrawal is capable of taking place, the creation ofspecial reserve results into timing differences for which deferredtax should be provided.

20. With regard to the other arguments advanced by the queristin paragraph 12 above, the views of the Committee are as follows:

(i) Passing of a Board resolution that the company will notutilise the special reserve is only a voluntary action andis capable of reversal. Accordingly, the capability ofreversal of the timing differences is not affected.

(ii) to (v) Had the intention in AS 22 been to consider thegeneral requirements of creating a provision in terms ofprobability of incurrence of a liability, e.g., as laid downin AS 29, ‘Provisions, Contingent Liabilities and ContingentAssets’, the Standard would have laid down the probabilityrequirements similar to those provided in that Standardor the Standard prevailing at the time of the issuance of


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AS 22, i.e., Accounting Standard (AS) 4, ‘Contingenciesand Events Occurring After the Balance Sheet Date’.This was not done in view of the fact that the accountingstandards on deferred taxation all over the World arebased on the ‘full provision method’ rather than the ‘partialprovision method’ as discussed in paragraph 17 to 19above. Adoption of the criteria for creation of provisionas per AS 4/AS 29 would have resulted in creation ofdeferred tax liability in accordance with the partialprovision method. In any case, the specific requirementsprescribed in a standard override the generalrequirements as has been recognised in the ‘Frameworkfor the Preparation and Presentation of FinancialStatements’, issued by the Institute of CharteredAccountants of India. Paragraph 3 of the Frameworkstates as follows:

“3. The Accounting Standards Board recognisesthat in a limited number of cases there may be aconflict between the Framework and an AccountingStandard. In those cases where there is a conflict,the requirements of the Accounting Standard prevailover those of the Framework. As, however, theAccounting Standards Board will be guided by theFramework in the development of future Standardsand in its review of existing Standards, the numberof cases of conflict between the Framework andAccounting Standards will diminish through time.”

Further, ASI 3 and ASI 5 consider the probability ofreversal of timing differences in the sense that, duringthe tax holiday period, the timing differences are notcapable of reversal.

(vi) Whether creation of special reserve results in ‘timingdifferences’ or not has been dealt with in paragraphs 14to 19 above. The Committee also does not agree withthe contention that paragraph 7 of AS 22 requires thatan item of revenue and expense must necessarily appear


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in the computation of accounting income as well as inthe computation of taxable income. In the view of theCommittee, paragraph 7 should be read along with thedefinition of the term ‘timing differences’ which does notstipulate that an item should affect both the accountingincome as well as the taxable income.

(vii) An industry-practice, if it is not in accordance with anaccounting standard, does not imply that the accountingtreatment is correct.

(viii) The opinion is based on the requirements of AS 22 withthe specific objective that accounts give a true and fairview. There are various instances where the treatmentof items of income and expenses is different foraccounting purposes than that under the Income-tax Actbecause the objectives of the two are different.

(ix) The argument is conjectural in nature as it presupposes‘as long as the company is making profits there is noreason for it to withdraw from reserve’. Further, acompany may have many other reasons to withdraw fromreserve even at the expense of paying taxes, e.g., issueof bonus shares.

D. Opinion

21. On the basis of the above, the Committee reiterates its earlieropinion that the company is required to create deferred tax liabilityon the special reserve created and maintained under section36(1)(viii) of the Income-tax Act, 1961, irrespective of the fact thatwithdrawal of the reserve may or may not happen since thecompany is capable to withdraw the reserve resulting into reversalof the difference between accounting income and taxable income(i.e., timing difference).


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Query No. 19

Subject: Capitalisation of certain expenses related toacquisition of an investment.1


1. A public limited company (hereinafter referred to as ‘the Indiancompany’) whose shares are listed on the Bombay Stock Exchangeis engaged in the business of manufacture and sale of electricaland electronic items. During the financial year 2005–06, thecompany acquired a company in Europe carrying on similarbusiness. The European company’s shares were acquired througha subsidiary of the Indian company in the Netherlands.

2. The acquisition was completed in May 2005 and the Indiancompany has incurred the following expenses upto May 2005, forthe acquisition of the European company:

INR in Lakh(a) Travelling 200(b) Legal 100(c) Due Diligence 100(d) Other Expenses 50

––––––Total 450

––––––

3. The Indian company has remitted an amount of US$ “x” to itssubsidiary in the Netherlands for acquiring the shares. TheNetherlands subsidiary actually incurred only US$ “y” for theacquisition of the shares of the European company and remittedback the balance US$ (x-y) to the Indian company. On account ofthis excess money returned, the Indian company has incurred anexchange loss of Indian Rupees 200 lakh (approx).

B. Query




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(a) Whether the amount of expenditure incurred by the Indiancompany can be treated as part of the cost of investment.

(b) Whether the exchange loss incurred by the Indiancompany on account of sending and receiving backexcess US$ from its Netherlands subsidiary can betreated as part of the cost of investment.

(c) Any another points/issues which, in the opinion of theCommittee, should be taken care of under any Law orAccounting Standards.


5. The Committee presumes from the Facts of the Case assupplied by the querist, that the subsidiary of the Indian companyin the Netherlands acted only as an agent of the Indian companyin the acquisition of shares of the European company.

6. The Committee notes paragraph 9 of Accounting Standard(AS) 13, ‘Accounting for Investments’, issued by the Institute ofChartered Accountants of India, which states that “the cost of aninvestment includes acquisition charges such as brokerage, feesand duties”. Keeping in view the nature of the items of acquisitioncharges mentioned in AS 13, the Committee is of the view that thecost of acquisition should include only those direct charges whichare incurred ‘on’ acquisition of investment, i.e., the expenses,without the incurrence of which, the transaction could not havetaken place such as share transfer fees, stamp duty, registrationfees, and duties and levies by regulatory agencies and stockexchanges. The expenses incurred ‘before’ the acquisition, eventhough directly attributable to acquisition should not be added tothe cost of acquisition of shares as these do not represent theworth of the shares acquired.

7. Keeping in view the above principles, the Committee is of theview that in the present case, the exchange loss incurred by theIndian company on sending and receiving back of foreign currency,travelling cost and due diligence cost should not form part of thecost of acquisition, rather, these should be expensed in the periodin which these are incurred. The legal costs and ‘other expenses’


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should form part of the cost of investment only if and only to theextent these costs meet the considerations for inclusion in the costof investment as stated in paragraph 6 above.

8. The Committee answers only specific queries raised by thequerist on accounting and/or auditing principles and allied mattersand as a general rule, the Committee does not answer open-ended queries. Accordingly, the Committee has not examined theFacts of the Case in the light of any Law or other AccountingStandards.

D. Opinion

9. On the basis of the above, the Committee is of the followingopinion on the issues raised by the querist in paragraph 4:

(a) The various items of expenses incurred by the Indiancompany as mentioned in paragraph 2 above, should betreated in the manner described in paragraphs 6 and 7above.

(b) The exchange loss incurred by the Indian company onaccount of sending and receiving back excess US$ fromits Netherlands subsidiary cannot be treated as part ofthe cost of the investment.

(c) This is not answered in view of paragraph 8 above.

Query No. 20

Subject: Accounting treatment on cancellation of foreignexchange forward contract.1


1. An Indian shipping company has placed an order for a newship with a company based in Singapore and payments are to be



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made on the completion of various stages in Singapore Dollar(SGD). The company has entered into foreign exchange forwardcontract for buying SGD against the equivalent US Dollar (USD)with a maturity date as 31st March, 2006 (the company has anatural hedge as most of its revenue is USD denominated/based).This was done to cover exposure in terms of SGD/USD fluctuationsat the time of installment payments becoming due to the vendor inSingapore for the new vessel, during the period vessel constructionis in progress.

2. The company has cancelled the forward contract before thematurity date and the cancellation has resulted in a gain/loss. Thequerist has given various arguments for different accountingtreatments for such gain/loss as below:

Arguments for treating the same as profit/loss:

(i) Paragraph 36 of Accounting Standard (AS) 11, ‘Changesin Foreign Exchange Rates’, issued by the Institute ofChartered Accountants of India, inter alia, states that“profit or loss arising on cancellation or renewal of aforward contract should be recognised as income or asexpense for the period.

(ii) The Announcement of the Institute of CharteredAccountants of India on Treatment of exchangedifferences under Accounting Standard (AS) 11 (revised2003), The Effects of Changes in Foreign ExchangeRates vis-à-vis Schedule VI to the Companies Act, 1956and the requirement to capitalise the foreign exchangedifferences do not deal with paragraphs 36 to 39 of AS11 which deal with forward contracts. The Announcementdeals with paragraph 13 of AS 11 which prescribesrequirements in respect of normal exchange differences.

(iii) The recent Announcement of the Institute of CharteredAccountants of India on ‘Accounting for exchangedifferences arising on a forward exchange contractentered into to hedge the foreign currency risk of a firmcommitment or a highly probable forecast transaction’


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(published in ‘The Chartered Accountant’, January 2006(pp.1090)), also, inter alia, states, “exchange differencesarising on the forward exchange contracts entered intoto hedge the foreign currency risks of a firm commitmentor a highly probable forecast transaction should berecognised in the statement of profit and loss in thereporting period in which the exchange rate changes.Any profit or loss arising on renewal or cancellation ofsuch contracts should be recognised as income orexpense for the period.”

(iv) The Announcement (referred in clause (iii) above) alsodoes not distinguish between any liabilities for capitalexpenditure (imports) and others.

(v) The requirement of Schedule VI relating to capitalisationof foreign exchange differences could not havecontemplated such matters when it was drawn up andhence, cannot be extended to cover forward exchangetransactions, etc., even if related to capital expenditureliabilities and loans.

(vi) The Exposure Draft of the proposed Accounting Standardon Financial Instruments: Presentation, also inter aliastates in paragraph 56 that gains related to financialinstruments should be recognised as income in thestatement of profit and loss, and in the ‘definitions’paragraph of the said Exposure Draft, derivatives areincluded in the definition of the term ‘financial instruments’.

(vii) Also, as the company has an Indian loan on which interestat 8.5% is paid, the requirement of Accounting Standard(AS) 16, ‘Borrowing Costs’, issued by the Institute ofChartered Accountants of India, regarding considerationof the foreign exchange differences on foreign currencyloan to the extent of difference between the interest onIndian loan and interest on foreign currency loan is notrelevant in the present case. Hence, interest capitalisationis not affected (if such an issue arises).


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(viii) Hence, the gain, which arises because the foreigncurrency liability in Singapore dollars was covered for aUS dollar amount (in view of natural hedge of thecompany) and the forward contract to hedge the loanwas cancelled, should be taken to the statement of profitand loss only. Similarly, premia paid, if any, or lossesincurred should also be taken to the profit and lossaccount only and not capitalised.

Arguments for capitalising the gain on cancellation of the forwardcontract:

(i) Schedule VI to the Companies Act, 1956, under the‘Instructions in accordance with which assets should bemade out’ for the head ‘Fixed Assets’, inter alia, states:“where the original cost aforesaid and additions anddeductions thereto, relate to any fixed asset which hasbeen acquired from a country outside India, and inconsequence of a change in the rate of exchange at anytime after the acquisition of such asset, there has beenan increase or reduction in the liability of the company,as expressed in Indian currency, for making paymenttowards the whole or a part of the cost of the asset or forrepayment of the whole or a part of moneys borrowed bythe company from any person, directly or indirectly, inany foreign currency specifically for the purpose ofacquiring the assets (being in either case the liabilityexisting immediately before the date on which the changein the rate of exchange takes effect), the amount bywhich the liability is so increased or reduced during theyear, shall be added to, or, as the case may be, deductedfrom the cost, and the amount arrived at after suchaddition or deduction shall be taken to be the cost of thefixed asset.”

(ii) The asset in the present case is acquired from Singapore,a country outside India.

(iii) The liability is in Singapore dollars.


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(iv) The cover is taken to protect against any adversemovement of Singapore dollars, e.g., in case itappreciates and the company needs to pay more.

(v) The cover protects the company against future liabilities;liability can be interpreted to mean future liability also;after all, it is a commitment which would have beendisclosed as per Schedule VI, Part I anyway.

(vi) When the company makes the payment, it is going tocapitalise the payment made actually. Hence, any suchcancellation is part and parcel of the same thing andhence, whether plus or minus, is a part of cost; hence,as per Schedule VI, the amount of gain should be reducedfrom the cost of capital work-in-progress (WIP).

(vii) AS 11 (revised 2003) does not deal with this aspect inparagraph 36 inadvertently. If a cost is incurred to freezethe liability in Indian rupee, then that cost would logicallybe part of the cost of fixed assets only as these two areinseparable.

B. Query

3. In the light of the above, the opinion of the Expert AdvisoryCommittee has been sought on how the gain/loss on cancellationof the forward contract is to be accounted for in the books ofaccount of the company, i.e., (a) whether to be shown as anincome or an expense for the period, or (b) to be deducted from/added to the capital work-in-progress for new ship.


4. The Committee, while answering the query, has restricteditself to the query raised in paragraph 3 above and has notconsidered any other issue arising from the Facts of the Case.

5. The Committee notes from the Facts of the Case that thecompany has placed an order for purchase of a ship, the paymentsfor which are to be made in future on completion of various stagesof construction of the ship and the transaction was hedged against


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the foreign exchange fluctuations by entering into a forward contractby the company.

6. In this context, the Committee notes the definition of the term‘firm commitment’, as provided in the footnote to the Announcementon ‘Accounting for exchange differences arising on a forwardexchange contract entered into to hedge the foreign currency riskof a firm commitment or a highly probable forecast transaction’,issued by the Institute of Chartered Accountants of India, whichstates as follows:

“A firm commitment is a binding agreement for the exchangeof a specified quantity of resources at a specified price on aspecified future date or dates.”

On the basis of the above, the Committee is of the view that in thepresent case, a forward exchange contract was entered into tohedge the foreign currency risk of a firm commitment andaccordingly, the accounting treatment prescribed by the saidAnnouncement is applicable in the present case.

7. The Committee further notes paragraph 3 of the aforesaidAnnouncement, which inter alia, states as follows:

“3. ... Any profit or loss arising on renewal or cancellation ofsuch contracts should be recognised as income or expensefor the period”.

The Committee also notes that the Institute of CharteredAccountants of India, through its Announcement published in ‘TheChartered Accountant’, June 2006 (pp. 1774), deferred theapplicability of its Announcement on ‘Accounting for exchangedifferences arising on a forward exchange contract entered into tohedge the foreign currency risk of a firm commitment or a highlyprobable forecast transaction’ upto April 1, 2007 and hence, thisAnnouncement would now be applicable in respect of accountingperiod(s) commencing on or after April 1, 2007. Since it representsthe present view of the Council of the Institute in respect of suchtransactions, in the view of the Committee, the treatment prescribedby the said Announcement should be followed for such transactions.


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8. Regarding the arguments set out in favour of capitalising/deducting to/from the cost of the fixed asset as required bySchedule VI to the Companies Act, 1956, the Committee notesthat the requirement of Schedule VI is in respect of capitalisationof foreign exchange variations to the cost of the fixed asset. Thesaid requirement deals only with the increase/decrease in foreignexchange liability related to the acquisition of fixed asset fromabroad and can not be extended to the profit or loss arising oncancellation of forward contract entered into to hedge a firmcommitment for purchase of a fixed asset. Hence, the saidrequirement of Schedule VI is not applicable in the present case.

D. Opinion

9. On the basis of the above, the Committee is of the opinion onthe query raised in paragraph 3 above that the gain/loss oncancellation of the forward contract should be recognised as incomeor expense in the statement of profit and loss for the period ratherthan deducting/adding the same from/to capital work-in-progressfor new ship.

Query No. 21

Subject: Accounting treatment of Duty Credit Entitlementunder the Target Plus Scheme.1


1. The querist has stated that the Ministry of Commerce andIndustry introduced the Target Plus Scheme (TPS) as part of itsforeign trade policy 2004-09. The objective of the scheme is toaccelerate growth in exports by rewarding Star Export Houses. Allhigh performing Star Export Houses are entitled to a duty creditbased on incremental exports substantially higher than the generalannual export target fixed. The TPS credit can be subsequently



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utilised towards payment of customs duty on specified importsunder this scheme.

2. The querist has mentioned certain important features of thescheme, which are as follows:

(i) All Star Export Houses, which have achieved a minimumexport turnover in free foreign exchange of Rs. 10 crorein the previous licensing year, are eligible for considerationunder the Target Plus Scheme. (Emphasis supplied bythe querist.)

(ii) An exporter is eligible to claim duty credit as a specificpercentage of the incremental growth in FOB value ofthe export in the current licensing year over the previouslicensing year, as follows (emphasis supplied by thequerist):

% Incremental growth Duty credit entitlementas a % of incrementalgrowth

20% & above but less than25% 5%

25% & above but less than100% 10%

100% & above 15% (maximum upto100% growth)

(iii) A company has to apply for TPS credit on post-exportbasis on realisation of export proceeds. The TPS creditcan be subsequently utilised towards payment of customsduty on import of specified inputs and capital goods foreither own use or use by supporting manufacturer.(Emphasis supplied by the querist.)

(iv) There are some restrictions for the utilisation of TPScredit, which are as follows:

(a) the duty credit certificate cannot be sold ortransferred to a third party; and


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(b) the duty credit certificate is valid for a period of 24months from the date of issue.

3. The querist has stated that a company is in the business ofmanufacturing colour televisions for sale in the domestic and exportmarket, with the turnover of Rs. 1,145 million for the year ended31st March, 2005. The shares of the company are listed on theBombay Stock Exchange and the National Stock Exchange.According to the querist, the company was eligible under thescheme for duty credit against exports made in the financial year2004-05 as it had achieved a minimum export turnover of Rs. 100million in the previous year, i.e., 2003-04 and had been awarded astatus of ‘Star Export House’. The company applied under thescheme to the Director General Foreign Trade (DGFT) on 9th

September, 2005. Since the company had achieved a 114%increase in exports for the year 2004-2005 over 2003-2004, thecompany was given a duty credit entitlement @ 15% and wasgranted 12 duty credit entitlements worth Rs. 36 million of whichRs. 3 million has been utilised by the company till 31st March,2006.

4. The company has achieved incremental growth of 26% ofexports in the year 2005-2006 as compared to the year 2004-2005and would be applying for the duty credit on realisation of theforeign exchange from export sales and after completion of thestatutory audit for the year ended 31st March, 2006. The dutycredit accruing to the company is estimated at Rs. 13 million. Asper the querist, as regards recognition of TPS credit, following arethe two possible views:

A. Credit should be recognised on utilisation basis, i.e., inthe period when the TPS credit is used to pay duty onimports.

B. TPS credit should be recognised in the period whenrelevant exports are made provided recovery isreasonably certain.

5. The querist has advanced the following arguments in favourof the first view, viz., credit should be recognised on utilisation


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basis, i.e., in the period when the TPS credit is used to pay dutyon imports:

(i) Accounting Standard (AS) 9, ‘Revenue Recognition’,issued by the Institute of Chartered Accountants of India,lays down the principle that revenue should not berecognised until its realisation is reasonably certain. Eventhough TPS credit may not strictly fall within the definitionof ‘revenue’, the querist believes that the above principlewould still be applicable. The basic argument forrecognising TPS credit only at the time of utilisation isthat until its actual utilisation, there may not be areasonable certainty as to whether or not the companywould be able to utilise the aforesaid credit. This is onaccount of the following factors:

(a) The Target Plus Scheme does not allow the sale/transfer of the duty credit entitlement.

(b) TPS credit certificate is valid for a period of 24months from the date of issue. The certificatesremaining unutilised at the end of the 24 monthperiod would lapse.

(c) The Government reserves the right in public interest,to specify from time to time, the category of exportsand export products which shall not be eligible forcalculation of incremental growth/entitlement.Similarly, the Government may from time to timealso notify the list of goods, which shall not beallowed for import under the duty credit entitlementcertificate issued under the scheme. In this regard,the querist has drawn the attention of the Committeeto the following two recent notifications:

• Notification No. 57 (RE-2005)/2004-2009 dated31st March, 2006 abolished the Target PlusScheme for exports from 1st April, 2006 onwards.

• Vide Notification No. 48 (RE-2005)/2004-2009dated 20.02.2006, the Government has


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withdrawn the benefit of Target Plus scheme inrespect of certain items, like ores andconcentrates, sugar, cereals and crude/petroleum products with retrospective effect from1st April, 2005.

It may be noted that the above mentionednotification does not have any direct impact onthe target plus incentive to be received by thecompany since the company does not fall in theabove mentioned categories of exporters.However, it serves to highlight the uncertaintyattached to TPS credit.

(ii) There is already a view taken by the Expert AdvisoryCommittee on the accounting treatment of advancelicenses wherein the Committee has stated as follows(Vol. XVI of Compendium of Opinions, p. 53):

“4. With regard to entitlements of advance licenses,the Committee is of the view that the cost of suchentitlements is not reliably ascertainable, and theirnet realisable values may fluctuate considerablysince they would also depend on many uncertainfactors such as demand for imported goods, changein prices of domestic goods, rate of custom dutyprevailing at the relevant point of time etc.”

(iii) According to Accounting Standard (AS) 1, ‘Disclosure ofAccounting Policies’, issued by the Institute of CharteredAccountants of India, ‘prudence’ is one of the majorconsiderations in selection of accounting policies. TheStandard explains ‘prudence’ as follows:

“In view of the uncertainty attached to future events,profits are not anticipated but recognised only whenrealised though not necessarily in cash. Provision ismade for all known liabilities and losses even thoughthe amount cannot be determined with certainty andrepresents only a best estimate in the light ofavailable information.”


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In its opinion on treatment of advance licenses referredto above, the Expert Advisory Committee has explicitlyrecognised the role of prudence in determining theappropriate accounting treatment of advance licenses.

(iv) There is a specific provision in the scheme as per whichthe Government has the power to withdraw the categoryof export and also the list of goods, which shall not beallowed for import at any point of time. The same isreproduced below:

“3.7.8

Government reserves the right in public interest, tospecify from time to time the category of exportsand export products, which shall not be eligible forcalculation of incremental growth/entitlement.

Similarly, Government may from time to time alsonotify the list of goods, which shall not be allowedfor import under the duty credit entitlement certificateissued under the scheme.”

(v) There is a difference between Duty Entitlement PassBook (DEPB) Scheme and the TPS in the sense thatwhereas the credit under DEPB Scheme can be sold /transferred to a third party, the duty credit under TPSscheme can only be utilised for settling import for ownuse or for the use of supporting manufacturers whichaffect the realisability of the entitlement especially in viewof the fact that the Government has withdrawn the TPSvide notification No. 48(RE 2005)/2004-2009 dated20.02.2006 in respect of certain items retrospectively from1st April, 2005, as mentioned above. The entitlement ofDEPB is on shipping bill basis whereas TPS eligibility isdecided on annual basis based on the incremental growthin exports. Therefore, both the schemes are entirelydifferent from each other.

Based on the above, it may be ascertained that the TPSand DEPB schemes are designed with different


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perspectives by the Ministry of Commerce. DEPB is tocompensate the tax, infrastructure and other constraintsto exporter on regular basis. Whereas TPS is to boostfuture growth of exports to enable the exporters to survivein global competition.

(vi) Moreover, if the example of a company is taken, which ismaking local procurement and getting the target plusincentive, since the license is not transferable, theutilisation is impossible for such a company. Therefore,the accounting treatment of Target Plus incentive cannotbe the same as that for the DEPB.

6. In addition to the above, the querist has also mentioned thefollowing points for the consideration of the Committee:

(a) Apart from the above mentioned restrictions for theutilisation of TPS, the market is very sensitive in terms ofprice war, which may force the company to switchoverfrom import component to domestic component. In suchcases, the certainty of utilisation of TPS is doubtful asthe period during which it can be utilised is 24 monthsfrom the date of issue. Further, if there is any change inTPS scheme, the company may opt for ‘Advance License’,and in that case, TPS cannot be used.

(b) As per the generally accepted accounting principles(GAAP), accounting or recording of transactions is notappropriate on signing a contract or agreement. SinceTPS is like a contract under which duty credit is awardedon post-export basis, but the actual realisation is madelater, i.e., as and when the entity utilises this benefit,TPS accounting, in the view of the querist, should be onutilisation basis as per the GAAP.

7. The querist has also submitted the arguments for the otheralternative, viz., TPS credit should be recognised in the periodwhen relevant exports are made provided recovery is reasonablycertain, which are as follows:

(i) The basic argument in support of recognition of TPS


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credit in the year in which the exports giving rise to thecredit take place is that this treatment results in a propermatching of efforts and accomplishments.

(ii) It is the activity of export which results into entitlement ofduty credit and accordingly, this credit can not be relatedto duty payable at the time of subsequent imports. At thetime of subsequent imports, the full duty payable onsuch imports should form part of the cost which is metpartly or fully by way of adjustment of TPS creditdepending on the policy of the Government of India atthat time.

(iii) The utilisation of duty credit is a mode of payment ofduty. In other words, it is not an exemption from duty inthe year of import but is a benefit/right arising out of theearlier export performance. Thus, the duty earnedrepresents an asset in the nature of advance payment ofduty to be utilised towards subsequent payment ofcustoms duty on specified imports.

(iv) The decision as to when the credit under the TPS shouldbe recognised as income should broadly be based onthe principles similar to those applicable to recognition ofrevenue. Performance related to TPS credit should beconsidered to be complete when the exports which giverise to the credit have been made, provided the othercriteria for recognition of revenue are fulfilled, viz., thoselaid down in AS 9. However, according to the querist, AS9 provides that revenue should be recognised only whenthere is no significant uncertainty regarding the amountof the consideration that will be derived and when thereis no significant uncertainty as to its ultimate collection.Where such uncertainties exist, the recognition of revenueshould be postponed.

(v) There is also an opinion of the Expert Advisory Committeeon the accounting treatment of DEPB benefit, wherein ithas been opined that the credit under DEPB Schemeshould be recognised as income when the exports


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(against which the credit has been granted) are madeprovided the criteria for recognition of revenue under AS9 have been fulfilled (query No. 28 of Vol. XX ofCompendium of Opinions, page 96). In the said opinion,the Committee has stated, inter alia, the following:

“Under the facts and circumstances of the query,the DEPB credit should be recognised in the booksof account when no significant uncertainties as tothe amount of consideration that would be derivedand as to its ultimate collection exist. In the case ofDEPB credit on post-export basis when the companyapplies for the credit on realisation of exportproceeds and the credit is to be utilised for importsby the company, there seems to be no suchsignificant uncertainty and, therefore, the DEPBcredit should be recognised in the year in which theexport was made in accordance with paragraph 6above.”

According to the querist, the incentive under TPS is similarto that under the Duty Entitlement Pass Book (DEPB)Scheme except that the credit under DEPB can be sold/transferred to a third party. This difference only affectsthe assessment as to the realisation of the entitlement.Due to transferability, there may be greater assurance ofrealisation of DEPB credit than that of TPS credit. Thus,if there is a reasonable assurance of utilisation of TPScredit, it should be treated at par with DEPB credit and,accordingly, recognised in the year in which the exportsgiving rise to the credit take place.

(vi) The opinion of the Committee on treatment of DEPBcredit is later in time than its opinion on treatment ofadvance license. Accordingly, it is only logical to concludethat in formulating its opinion on treatment of DEPB credit,the Committee would have considered non-recognitionof credit on account of advance licenses, viz., cost of theentitlement being not reliably ascertainable and


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uncertainty as to realisation and realisable value of theentitlement, etc.

(vii) It is also noteworthy that as per the Update onCompendium of Opinions Volumes I – XX, theCommittee’s opinion on advance license needs to beviewed in the light of subsequent issuance of AS 26.However, there is no such mention in respect of theopinion on DEPB credit.

8. Based on the above, the querist has argued that if there isreasonable certainty that the company has satisfied all the stipulatedconditions and it will be entitled to credit of duty if it imports rawmaterial, spares or capital goods as per the scheme, duty creditunder the TPS should be accounted for in the year of relevantexports to the extent there is reasonable certainty that the companywould be able to utilise it in accordance with the terms of thescheme. In assessing whether there exists a reasonable certaintyof utilisation of the duty credit, all relevant factors should be takeninto consideration including the documented plans of the companyshowing the likely imports of the relevant items. In case of capitalgoods, the detailed plans of the company should be considered.

9. The querist has further provided the following facts:

(i) The amount of incentive for the financial year 2004-2005of Rs. 36 million has already been received in the formof duty credit entitlement in the month of January 2006,out of which Rs. 3 million has been utilised. Thus, thereis no uncertainty to the extent of only Rs. 3 million.

(ii) The incentive for the financial year 2005-2006 can bederived based on the incremental exports made duringthe year 2005-2006, which is Rs. 13 million.

(iii) As mentioned earlier, the company is yet to makeapplication to DGFT for grant of TPS credit for thefinancial year 2005-06. The application will be made afterthe statutory audit for the year is over and the exportproceeds have been realised.


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(iv) The company imported major raw material items for theproduction of colour TV in the year 2005-2006. The importduty expense of the company is approximately Rs. 10-15 million per month.

(v) It may also be mentioned that the company has beenreceiving DEPB benefit and recognising it as incomewhen the exports (against which the credit has beengranted) are made.

10. The querist has stated that the Bank Realisation Certificatenot having been obtained by 31st March, 2006 and the applicationnot being made to DGFT by that date are not significant enough toconclude that inflow of TPS benefit is not probable. Due to thetime factor, the aforesaid certificate cannot be obtained, andapplication to DGFT cannot be made, before the close of financialyear. The issuance of these licenses depends on the policy of theGovernment of India at the time when these are actually issued,which is uncertain based on the above facts. The querist has alsomentioned that the Government notification regarding withdrawalof the scheme is effective prospectively from 1st April, 2006 butthe Government has the power to withdraw the scheme asmentioned above retrospectively.

11. The querist has also brought to the notice of the Committeethat vide DGFT notification No. 8(RE2006)/2004-2009 dated12.06.2006, the Central Government has recently made anamendment to the Target Plus Scheme for the period April 1,2005 to March 31, 2006 which states as follows:

“The entitlement under this scheme would be contingent onthe minimum percentage incremental growth of 20% in theFOB value of exports in the current licensing year over theprevious licensing year, and the rate of entitlement shall be5% of the incremental growth”.

“This will take effect from 01.04.2005”.

With this notification, the Central Government has restricted thebenefit of Target Plus Scheme to a maximum of 5% of incremental


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growth which was earlier at 15% of the incremental growth andthis has been effected retrospectively from April 1, 2005. This hasresulted in the loss of revenue in the case of the companies whichhad recognised revenue at 15% earlier. These companies wouldnow have to adjust their accounts for entitlement of 5% and thiswill affect the revenues of the current year or they will have toreopen the accounts for the earlier years to provide for this situation.

B. Query


(i) Whether TPS credit should be recognised in the periodwhen the exports which give rise to the credit have beenmade or whether it should be recognised on utilisation,i.e., in the period when the TPS credit is used to payduty on imports.

(ii) In case credit is required to be recognised in the periodof exports, whether it would make any difference, if thetarget has been achieved but the application is still to befiled with the DGFT.


13. The Committee, while giving its opinion, has answered onlythe issues raised in paragraph 12 above, and has not touchedupon any other issue arising from the Facts of the Case, such as,accounting treatment of DEPB credit being availed by the company,valuation of subsequent imports, etc.

14. The Committee notes that the basic issue raised in the queryrelates to recognition of the benefit of duty credit under TargetPlus Scheme, i.e., when should this benefit be recognised in booksof account – whether at the time when relevant exports are madeor at the time TPS credit is utilised to pay duty on subsequentimports.

15. Keeping in view the recognition principles laid down in AS 9,the Committee is of the view that the TPS credit should be


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recognised at the time when and to the extent there is no significantuncertainty as to its measurability and ultimate realisation, i.e.,utilisation of the TPS credit. The assessment of the level ofuncertainty is a matter of judgement based on the facts andcircumstances of each case on considering factors, such as,utilisation of duty credit within the specified period as evidenced bythe existence of a binding contract for purchase of inputs withinthe specified period against which the duty credit can be utilised,the expected cost of purchase of the imported inputs vis-à-vis thecost of the inputs available within the domestic market, expectationof future amendments in the scheme, realisability of export proceedsin convertible foreign exchange, etc. Events occurring after thebalance sheet date may remove the uncertainty about the utilisationof the duty credit. For example, imports are made after the balancesheet date but before the approval of accounts by the governingauthority, against which the duty credit has been utilised. TheCommittee is, therefore, of the view that it is not necessary thatuncertainty regarding measurement and utilisation of duty credit isremoved only on actual utilisation of the credit, i.e., at the timewhen the import of specified goods is made.

D. Opinion


(i) TPS credit should be recognised in the period whenthere is no significant uncertainty about the measurabilityand ultimate realisation of TPS credit, i.e., utilisation ofthe duty credit, after considering the factors, such asthose indicated in paragraph 15 above.

(ii) The basis for recognition of TPS credit is indicated at(i) above.


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Query No. 22

Subject: Treatment of spares.1


1. A public sector company is in the business of refining andmarketing of petroleum products. The company’s books of accountare subjected to audit by both the statutory auditors and theComptroller and Auditor General of India (C&AG). According tothe querist, accounting policy of the company as disclosed in theNotes to Accounts is in conformity with the Accounting Standards/Guidance Notes issued by the Institute of Chartered Accountantsof India.

2. The querist has referred to an earlier opinion sought by himfrom the Expert Advisory Committee on a similar subject (publishedin Volume XXV of the Compendium of Opinions, Query No. 16).The querist has stated that although he agrees with the views ofthe Committee, it is observed that there are certain practicaldifficulties in implementing the same retrospectively. In order toexplain the issues to the Committee, the querist has elaboratedthe case in the following paragraphs.

3. The querist has mentioned that as per Accounting Standard(AS) 10, ‘Accounting for Fixed Assets’, issued by the Institute ofChartered Accountants of India (paragraph 8.2), “machinery sparesare usually charged to the profit and loss statement as and whenconsumed. However, if such spares can be used only in connectionwith an item of fixed asset and their use is expected to be irregular,it may be appropriate to allocate the total cost on a systematicbasis over a period not exceeding the useful life of the principalitem”. Further, as per paragraph 4 of Accounting StandardsInterpretation (ASI) 2, ‘Accounting for Machinery Spares’,“machinery spares of the nature of capital spares/insurance sparesshould be capitalised separately at the time of their purchasewhether procured at the time of purchase of the fixed assetconcerned or subsequently. The total cost of such capital spares/



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insurance spares should be allocated on a systematic basis over aperiod not exceeding the useful life of the principal item, i.e., thefixed asset to which they relate”.

4. The querist has stated that the earlier opinion of the Committeementioned above, states that “the new spare purchased to replacethe capital spare so used should be capitalised separately anddepreciated over the remaining useful life of the principal asset”(paragraph 18 of the Opinion). According to the querist, in order toimplement the views of the Committee, it is essential that theoriginal spares are capitalised separately, independent of the mainequipment and depreciated over the life of the parent asset.However, the practice followed consistently over the years by thecompany is that the main equipment, in combination with severalmachinery spares together is treated as a single unit. Accordingly,it is capitalised and depreciated as one unit. When some sparesof this main equipment need to be replaced, taking out the wornout parts and replacing the same with a new spare is while possiblephysically, dropping the spare from the fixed asset register is notpossible in view of the absence of separate identity for the individualspares. In these circumstances, charging-off the carrying value ofthese replaced spares (hitherto, held in warehouse) to the profitand loss account is not feasible and consequently, replacementspares (new spares) are being charged to revenue in the year ofpurchase. Original spares not being dropped from the gross block,continue to be depreciated even after replacement.

5. Accordingly, the querist has stated that the significantaccounting policy published by the company includes the followingclause:

“Machinery spares which could be used only in connectionwith an item of fixed asset and their use is expected to beirregular are depreciated over a period not exceeding theuseful life of the principal item of fixed asset. Replacement ofsuch spares is charged to revenue”.

6. The querist has further stated that the Accounting StandardsBoard of the Institute of Chartered Accountants of India has recentlyissued an Exposure Draft of Revised AS 10, ‘Tangible Fixed Assets’,


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which upon coming into effect would supercede, among others,the existing Accounting Standard (AS) 10, ‘Accounting for FixedAssets’ and Accounting Standards Interpretation (ASI) 2,‘Accounting for Machinery Spares’. The said exposure draft,according to the querist, has considered the practical aspects ofsome of the issues faced by the industry and, in the context ofwhat is discussed above, provides companies an option either tocapitalise the cost of replacement spares with the consequentderecognition of the replaced parts or to recognise such costs inthe statement of profit and loss (refer paragraph v, Appendix B tothe draft). As per the querist, the policy of the company is in linewith the relevant paragraph of the exposure draft. In refineries,most of the assets are such that the main equipment, in combinationwith several machinery spares, together form a single unit. Beingso, the cost of replacement is charged to revenue in view of thedifficulties of derecognising the carrying value of original spares.As per the querist, the draft visualises these situations wheremajor parts of a tangible fixed asset are not capitalised separatelyand for replacement of such spare parts, suggests as one of thetreatment that the enterprise should recognise the cost of replacinga major part of an asset in the statement of profit and loss asincurred (paragraph 14 and 14(b) of the exposure draft) (emphasissupplied by the querist).

B. Query

7. In the light of the problems/difficulties faced by the companyas described in the above paragraphs and the treatment suggestedin the exposure draft as discussed by the querist above, the queristhas sought the opinion of the Expert Advisory Committee on thefollowing issues:

(i) It is expected that the exposure draft would be finalisedsoon and its implementation date would be notified. It isthe standard practice that on notification of the Standard,earlier adoption by the companies would be encouragedthough the Standard could come into effect at a laterdate. In view of the accounting policy of the companybeing in consonance with the treatment permitted in the


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exposure draft, the company desires to continue itsaccounting policy, viz., “machinery spares which couldbe used only in connection with an item of fixed assetand whose use is expected to be irregular, aredepreciated over a period not exceeding the useful lifeof the principal item of fixed asset. Replacement of suchspares is charged to revenue”. The quantum of themachinery spares so charged to the profit and lossaccount in the year of purchase will be disclosed suitablyby way of a note. The querist has sought the opinion ofthe Expert Advisory Committee as to whether this will bein order.

(ii) Otherwise, if the company has to implement the earlieropinion of the Expert Advisory Committee, whether it willbe correct to implement the opinion prospectively for theassets (main equipment) that are to be commissionedfrom the current financial year onwards.


8. The Committee notes that the querist has relied upon thetreatment prescribed in the exposure draft of Revised AS 10, whileinsisting upon the charging-off of replacement of capital spares torevenue. The Committee notes that the said exposure draftdistinguishes between the accounting for major spare parts andaccounting for major components forming part of the fixed asset.As per paragraph 8 of the exposure draft, the major spare partswhich are expected to be used during more than one period asalso the spare parts that can be used only in connection with atangible fixed asset, have to be capitalised separately as a tangiblefixed asset. The exposure draft does not provide any alternativetreatment for such spare parts. The paragraphs referred to by thequerist, viz., paragraphs 14 and 14(b) of the exposure draft, andparagraph (v) of Appendix B to the exposure draft deal with theaccounting treatment of components forming part of the fixed asset.Paragraph 14(b) of the exposure draft provides that where anenterprise is not following the components approach of capitalisingfixed assets, the cost of replacement of any major part should be


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charged to revenue. Similarly, if the component part in such asituation is replaced by an existing spare part (which is separatelycapitalised by virtue of paragraph 8 of the exposure draft), thecarrying amount of such spare part should be charged to revenue.Paragraph 14(b) does not deal with the spare parts that arepurchased to replace an existing spare part (which replaces acomponent part of the tangible fixed asset). In any case, theCommittee is of the view that the exposure drafts are the proposedguidelines which are subject to amendments/changes based onthe comments received thereon and hence, cannot form the basisfor determination of accounting treatment before the final accountingstandard comes into force.

9. As far as the accounting treatment in respect of replacementof a major part of a fixed asset with a spare is concerned, theCommittee notes from the Facts of the Case that the company istreating the main asset and its several machinery spares as asingle unit. However, as per paragraph 4 of ASI 2 (reproduced inparagraph 3 above), capital spares have to be capitalised separatelyfrom the principal fixed asset. Hence, in the present case, thecompany should apportion the carrying amount of the fixed assetto various machinery spares, which hitherto were being treated asa part of the value of fixed asset. At the time of replacement of thecomponent part of the fixed asset by a spare part, the carryingamount of the spare should be charged to the profit and lossaccount and the new spare which is purchased to be kept in thestore for replacement of the capital spare so used should becapitalised separately and be depreciated over the remaining usefullife of the principal asset. With regard to the practical difficulties indetermining the carrying amount of the replaced part, the Committeeis of the view that the Accounting Standard does not envisage anyrelaxation on this ground. The company should estimate the carryingamount of the replaced spare part on a reasonable basis, e.g., thecost of replacement may be used as an indicator of what the costof the replaced part was at the time it was acquired.

10. The Committee is also of the view that the principles ofaccounting for spare parts are contained in Accounting Standard(AS) 10, ‘Accounting for Fixed Assets’ which has been in existence


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since 1985. If the company has not followed the principles containedtherein, it should rectify the error for the existing assets and accountfor accordingly. In the view of the Committee, it would be incorrectto apply the said principles prospectively, only for the assets thatare to be commissioned from the current financial year onwards,as stated by the querist.

D. Opinion


(i) No, the charging-off of the capital spares to the profitand loss account in the year of purchase is not in orderin the light of accounting treatment prescribed in theapplicable Accounting Standard. Please refer toparagraphs 8 and 9 above.

(ii) No, the company should implement the above-saidopinion for all the existing assets.

Query No. 23

Subject: Disclosure of interest on shortfall in payment ofadvance income-tax in the financial statements.1


1. A company is a premier electronics company under the Ministryof Defence, Government of India, having its shares listed at themajor stock exchanges in India. The turnover of the company forthe year 2005-06 was Rs. 3,536 crore.

2. The querist has stated that as per an earlier opinion issued bythe Expert Advisory Committee (published in the Compendium ofOpinions, Volume XXIV, Query No.21), the interest payable under



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section 234B and section 234C of the Income-tax Act, 1961, shouldnot be considered as a part of tax expense. The Opinion furtherstates that this may, however, be separately provided for inaccordance with the requirements of Accounting Standard (AS)29, ‘Provisions, Contingent Liabilities and Contingent Assets’, issuedby the Institute of Chartered Accountants of India. As per thequerist, the Opinion of the Expert Advisory Committee does notindicate as to where the interest expenditure under section 234Band section 234C should be disclosed in the profit and loss account,i.e., whether as a part of ‘interest costs’, or as a separate itemabove the line (i.e., before profit before tax (PBT)), or whether itcan be included in ‘other expenses’.

3. The querist has stated that the company has been includingthis amount as a part of tax expense in the profit and loss accountafter profit before tax and indicating the same as part of ‘Provisionfor Income-tax’ and grouping the same under the head ‘Provisions’in the balance sheet. The company is of the view that the interestin question does not fall under the purview of AS 29 since AS 29defines a provision as “a liability which can be measured ‘onlyby using a substantial degree of estimation’.” As per the querist,calculation of interest on the shortfall of advance income tax doesnot call for a substantial degree of estimation.

4. According to the querist, interest costs generally reflect theefficiency or otherwise with which an organisation is able to meetits financing requirements. The expenditure on interest undersection 234B and section 234C does not reflect the above. On theother hand, this amount is to be paid to the income tax departmentat predetermined rates of interest, irrespective of the position ofthe funds availability with the company. Moreover, this interestamount is not in the nature of ‘borrowing costs’ as defined underAccounting Standard (AS) 16, ‘Borrowing Costs’, issued by theInstitute of Chartered Accountants of India. The querist has statedthat the company is of the view that the ‘interest cost under section234B and section 234C’ reflects the efficiency or otherwise withwhich the company is able to estimate its taxable income, andhence, should ideally form part of the ‘tax expense’. If required, aseparate disclosure can be made of the element of interest cost


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included in the ‘tax expense’, in the same manner as the currenttax and deferred tax expense/income in the schedules to the profitand loss account. The liability aspect of the same can be shownunder the head ‘Provisions’ in the balance sheet as a part of‘Provision for Income-tax’.

B. Query


(i) Whether the accounting treatment adopted by thecompany, i.e., accounting for the interest under section234B and section 234C of the Income-tax Act, 1961, aspart of tax expense in the profit and loss account,disclosing the interest amount in the Schedule on‘Provision for Taxation’ and grouping the same (Provisionfor Taxation) as part of ‘Provisions’ in the balance sheet,is in order.

(ii) If not, what should be the treatment/disclosure to bemade in the profit and loss account and the balancesheet for the same.


6. The Committee notes that section 234B and section 234C ofthe Income-tax Act, 1961, appear under ‘Part F – InterestChargeable in Certain Cases’ of Chapter XVII – ‘Collection andRecovery of Tax’. The Committee further notes that the sectionsprescribe payment of interest where advance tax is not paid inaccordance with the requirements of the said sections. TheCommittee thereby concludes that the nature of income-tax isdifferent from that of interest chargeable under these sectionseven though the levy of interest is automatic. In this context, theCommittee notes the definition of the term ‘tax’ as per section2(43) of the Income-tax Act, 1961, as reproduced below:

“ “tax” in relation to the assessment year commencing on the1

st day of April, 1965, and any subsequent assessment year


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means income-tax chargeable under the provisions of thisAct, and in relation to any other assessment year income-taxand super-tax chargeable under the provisions of this Actprior to the aforesaid date and in relation to the assessmentyear commencing on the 1

st day of April, 2006, and any

subsequent assessment year includes the fringe benefit taxpayable under section 115WA”.

On the basis of the above, the Committee is of the view thatinterest chargeable under section 234B and section 234C cannotbe considered as ‘income-tax’ within the meaning of the provisionsof the Income-tax Act, since the said sections do not deal withcomputation of income-tax but deal with payment of interest onthe lower amount paid as advance tax in specified cases. TheCommittee notes that the above conclusion had also been drawnin the earlier opinion issued by the Expert Advisory Committee(mentioned in paragraph 2 above). The Committee feels that thesaid interest can be viewed as of the nature of interest since it ispaid as a compensation for the amount used by the assesseewhich, otherwise would have been paid by him to the Governmentas income-tax.

7. The Committee further notes that the earlier opinion of theCommittee did not deal in detail with the aspect of disclosure ofthe interest under section 234B and section 234C of the Income-tax Act, 1961, in the profit and loss account since the matter wasnot specifically raised by the querist in that query. The opinion ofthe Committee stated that a provision for such interest should bemade separately as per the requirements of AS 29 provided thecompany considers the payment of interest probable on the dateof the balance sheet and the amount of interest can be estimatedreliably, presuming that a substantial degree of estimation wouldbe required. The Committee is of the view that even in case thecalculation of the interest under section 234B and section 234C ofthe Income-tax Act, 1961, does not call for a substantial degree ofestimation as argued by the querist, it could still not be consideredas ‘income-tax’. The Committee is of the view that in case theamount of such interest is certain, it would then be considered as


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a crystallised ‘liability’, as defined in paragraph 10 of AS 29 andparagraph 49 of the Framework for the Preparation andPresentation of Financial Statements, issued by the Institute ofChartered Accountants of India, as below:

“A liability is a present obligation of the enterprise arising frompast events, the settlement of which is expected to result inan outflow from the enterprise of resources embodyingeconomic benefits.”

8. On the basis of the above, the Committee is of the view that acrystallised liability should be recognised as an expense in theprofit and loss account. Accordingly, the interest under section234B and section 234C of the Income-tax Act, 1961, is required tobe recognised as an expense in the profit and loss account, evenif it is a crystallised liability and substantial degree of estimation isnot involved in its estimation.

9. As regards the disclosure of the expense on account of interestunder section 234B and section 234C in the profit and loss account,the Committee notes the provisions of Part II of Schedule VI to theCompanies Act, 1956, as reproduced below:

“2. The profit and loss account –

(a) shall be so made out as clearly to disclose theresult of the working of the company during theperiod covered by the account; and

(b) shall disclose every material feature, including creditsor receipts and debits or expenses in respect ofnon-recurring transactions or transactions of anexceptional nature.”

From the above, the Committee is of the view that the interest inquestion should be disclosed as a separate sub-item under thehead ‘interest’ with a proper disclosure of its nature or as a separateline item in the profit and loss account. It can be clubbed withother items, if any, under the head ‘interest and penalties’, in caseit meets the requirements of paragraph 3(x)(i) of Part II of ScheduleVI to the Companies Act, 1956, as reproduced below:


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“(i) Miscellaneous expenses:

Provided that any item under which the expenses exceed1 per cent of the total revenue of the company orRs.5,000, whichever is higher, shall be shown as aseparate and distinct item against an appropriate accounthead in the Profit and Loss Account and shall not becombined with any other item to be shown under‘Miscellaneous expenses’.”

10. With respect to disclosure in the balance sheet, the Committeeis of the view that the interest expense under section 234B andsection 234C, under the circumstances of the query, is a ‘currentliability’ and should be disclosed accordingly. Such interest expensecannot be disclosed as a ‘provision for income-tax’.

D. Opinion

11. On the basis of the above the Committee is of the followingopinion on the issues raised in paragraph 5 above:

(i) No, the treatment given by the company is not correct.

(ii) If the interest in question is a crystallised liability and nosubstantial degree of estimation is required for estimationof interest under section 234B and section 234C of theIncome-tax Act, 1961, the same should be accrued andrecognised as an expense in the profit and loss accountand disclosed as discussed in paragraphs 8 and 9 above.The liability for such interest should be disclosed in thebalance sheet under the head ‘Current Liabilities’ (andnot as a ‘provision’).


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Query No. 24

Subject: Accounting for conversion of membership rights oferstwhile BSE (AOP) into trading rights of BSELand shares.1


1. The querist has stated that the BSE had till recently beenfunctioning as an Association of Persons (AOP). Brokers/membersof the erstwhile BSE (a recognised stock exchange registered asan association of persons) had been holding membership cardwhich gave them (a) the ownership rights in the AOP and (b)exclusive rights to carry on business as a stock broker.

2. In the past, one could trade in this membership card with thevalue being in the range of Rs. 7 million to Rs. 40 million. Accordingto the querist, before the introduction of Accounting Standard (AS)26, ‘Intangible Assets’, issued by the Institute of CharteredAccountants of India, as no specific guidance was available, thismembership card was classified as a fixed asset or as aninvestment. In case it was classified as an investment, it wasevaluated for diminution other than temporary. Similarly, if it wasclassified as a fixed asset, the same might or might not have beendepreciated as it was considered to have perpetual life.

3. With the introduction of AS 26, this membership right wasconsidered to fall under the purview of the Standard. Accordingly,the same was classified as part of intangible assets (disclosed asfixed asset). The membership right was considered to haveperpetual existence and there was no defined useful life. As thereis a presumption in AS 26 that the useful life of an intangible assetis 10 years (unless substantiated otherwise), the stockbrokers wereamortising this intangible asset over a period of 10 years. Thistreatment had been confirmed by an earlier opinion of the ExpertAdvisory Committee of the Institute of Chartered Accountants ofIndia (published in the Compendium of Opinions – Volume XXIV,Query No. 2).



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4. The BSE (Corporatisation and Demutualisation) Scheme 2005seeks to convert BSE from association of persons to a corporatebody, ‘Bombay Stock Exchange Limited’ (BSEL), with effect fromthe due date. This scheme, subject to certain conditions andmodifications, had been approved by the Securities and ExchangeBoard of India (SEBI) on 29th May, 2005. The scheme has beeneffective from 19th August, 2005 (due date). The objective of thescheme is to separate the ownership of BSE from the right totrade. Thus, as per the scheme, owners would no longer necessarilybe traders and vice versa.

5. As per this scheme, all the existing members of the AOP shallbe entitled to 10,000 fully paid-up equity shares of face value ofRe.1/- each for cash at par of the corporate entity, BSEL. Thescheme also mentions that BSEL may list its securities at any timeon a recognised stock exchange. The net book value of eachshare, according to the querist, is over Rs. 1,000. In the view ofthe querist, the intention seems to be that the owners of the AOPshould be compensated for the loss in the value of exclusivetrading right and proportionate ownership of AOP up to the date ofthe scheme.

6. An existing member of AOP who is registered with SEBI hasthe trading rights with BSEL with effect from the due date. Afterthe due date, a person (other than the existing member of AOP)desirous of carrying stock brokerage business of any segment ofBombay Stock Exchange Limited can also be admitted if hecomplies with the requirements and brings in specified fees anddeposits as specified in the rules, bye-laws and regulations ofBSEL. SEBI has allowed a provision for additional privileges to theexisting members with its prior approval. The querist has informedthat currently no such privileges have yet been given.

7. With regard to the transfer/surrender of the BSEL tradingrights given to the existing members of AOP, the scheme does notspecify as to whether any money would be received by the erstwhileAOP member on his surrendering the trading right. For tradingmembers having deposit-based membership rights, the deposit isrefundable. The Scheme also does not specify as to whether this


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trading right given to the erstwhile AOP members can be transferredto any other person. However, a deposit-based trading membershipright of BSEL is available to any person who satisfies the requisiteconditions.

8. The scheme clearly mentions that:

• Trading right holder may or may not be a shareholder.

• A shareholder may or may not be a trading right holder.

As per the querist, all the assets and liabilities of the erstwhileBSE would be transferred to BSEL.

9. The querist has summarised the benefits accruing to themembers of the erstwhile BSE as follows:

• They would continue to have the trading rights on theBSEL similar to the new deposit-based membership rightswithout making the deposit.

• They have received 10,000 shares for a totalconsideration of Rs. 10,000, i.e., at Re. 1/- per share.However, the fair value of BSEL’s shares is expected tobe significantly higher than the value at which thecorresponding shares have been issued. This is basedon the expected book value of the net assets and theearnings per share of the erstwhile BSE to be transferredto BSEL.

10. The querist has stated that in case an old member intends tosurrender the trading right, he may not get any value for the rightas there may not be any willing buyers for this right when there isa refundable deposit-based right available. However, by virtue ofbeing a shareholder of BSEL and the fact that the book value isexpected to be significantly higher than the cost of acquisition ofsuch shares, the old members are expected to benefit from theshares allotted to them.

11. The querist has given two views for the above mentionedtransactions and also the possible accounting treatments thereofwhich are as follows:


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(i) View 1

As far as the trading right is concerned, there is no exchangeof assets and this should be continued to be carried forwardas an intangible asset. The shares of the BSEL receivedunder the corporatisation scheme of the BSE should be shownas an investment at acquisition cost, i.e., Rs. 10,000. Thisview is based on the premise that as a result of corporatisationand demutualisation, the trading rights of a member of theerstwhile BSE (AOP) remain unaffected, while he additionallygets 10,000 shares at a price of Re. 1 each.

Proposed accounting treatment:

The WDV of the membership card of AOP in the books at theeffective date should continue to be carried forward as anintangible asset and written off over its balance useful life outof the original ten years (and not 10 years counted afresh).The 10,000 shares of BSE should be shown as an investmentat Rs. 10,000, i.e., acquisition cost.

(ii) View 2

A cardholder of the erstwhile BSE (AOP) gets shares in BSELwhich is an entity totally separate and distinct from BSE (AOP).He also gets trading rights which are otherwise availableagainst deposit. Thus, from a legal angle, the transactioninvolves giving up the rights of one legal entity [BSE (AOP)]and acquiring trading rights and shares of another legal entity(BSEL). The membership card of BSE and shares of the newcompany are two distinct and separate legal instruments andholding thereof gives to the holder separate and distinctivelegal rights. From the angle of economic substance also, themembership card of the erstwhile AOP now results in twoseparate assets, viz., the trading right and the equity shares.The new trading right and issue of shares are part of a singlepackage given to the existing members of the BSE (AOP) inexchange of their old trading right. Acknowledging the factthat the new trading right received by the existing membermay have a lower fair value (because there is no market for


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this trading right and the fair value will primarily reflect thecost savings, i.e., the present value of the cost of deposit), itappears that the loss in the value of the old right due tocorporatisation of BSE has been compensated through issueof equity shares at a nominal price. Thus, the fair value of theold trading right (before corporatisation) will now be availableto the member as gain through the fair value of the equityshares so received. If this were not the business rationale,the equity shares would not have been issued at a nominalprice. The present situation is one where the membershipcard of the AOP was an intangible asset. Against this intangibleasset, two assets have been acquired. The first is the right oftrading which is no longer an exclusive right. The second isan investment in the new company. As far as the shares ofBSEL are concerned, their allotment to members of AOPrecognises the fact that earnings of the AOP till date belongto the members of the AOP. It is also evident that thearrangement is such that the existing members arecompensated through the shares for the loss of their exclusivityof trading rights. It is clear that allotment of shares at Re. 1each is not representative of the economic reality. Thus, itwould not be proper to record these shares at Re. 1 each.

Proposed accounting treatment:

In this case, one needs to apply paragraph 29 of AccountingStandard (AS) 13 ‘Accounting for Investments’, paragraphs11.1 and 22 of Accounting Standard (AS) 10, ‘Accounting forFixed Assets’, paragraph 34 of AS 26 and the concept ofprudence as per Accounting Standard (AS) 1, ‘Disclosure ofAccounting Policies’, issued by the Institute of CharteredAccountants of India. The card of BSE (AOP) entitles theholder to two distinct rights described above. Therefore, theexisting carrying amount of the card plus Rs. 10,000 needs tobe allocated to the two rights on the basis of their fair valuesat the date of their acquisition (emphasis supplied by thequerist).


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The fair value of 10,000 shares of BSEL can be determinedon the basis of any one of the several widely used sharevaluation models, e.g., on the basis of book value per share,or earnings per share. In valuing the shares, one would, ofcourse, need to also consider whether the earnings of BSELwould be distributable to members or not (it seems that atleast the assets acquired from BSE (AOP) are not distributable;the position regarding distributability of earnings of newlyformed BSEL is not clear).

The fair value of new trading right should reflect the differentialadvantage that the BSE (AOP) holder has over a new tradingmember, e.g., the erstwhile cardholder of BSE (AOP) doesnot have to pay the required deposit. This value would beascribable to the present value of the cost of deposit, i.e., thenet interest payable plus other costs of the funds. In case theaggregate fair value of shares and new trading right exceedsthe carrying amount of the card, excess should not berecognised (effectively not recording any gain). If, on the otherhand, the carrying amount of the card exceeds the above-mentioned aggregate, the excess would need an immediatewrite-off. As far as the value of the shares is concerned, theircarrying amount and disclosure would depend upon the intentwhether they are being held as long term investments orcurrent investments.

B. Query

12. The querist has sought the opinion of the Expert AdvisoryCommittee as to which of the two views stated above should befollowed.


13. The Committee notes from the Facts of the Case that underthe BSE corporatisation and Demutualisation Scheme 2005, amember of the erstwhile BSE (AOP) receives two assets, namely,10,000 shares in the BSEL for a nominal value of Rs. 10,000 anda trading right in the BSEL. Thus, a member of the AOP gets aninvestment in the form of shares in BSEL and an intangible asset


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in the form of trading rights in BSEL in exchange of his existingintangible asset, i.e., membership card.

14. As far as the value at which the shares in the BSEL should berecorded, is concerned, the Committee notes paragraph 11 of AS13, which states as follows:

“11. If an investment is acquired in exchange, or partexchange, for another asset, the acquisition cost of theinvestment is determined by reference to the fair value of theasset given up. It may be appropriate to consider the fairvalue of the investment acquired if it is more clearly evident.”

15. The Committee further notes paragraph 34 of AS 26 andparagraphs 11.1 and 22 of AS 10 which state as follows:

AS 26

“34. An intangible asset may be acquired in exchange orpart exchange for another asset. In such a case, the cost ofthe asset acquired is determined in accordance with theprinciples laid down in this regard in AS 10, Accounting forFixed Assets.”

AS 10

“11.1 When a fixed asset is acquired in exchange for anotherasset, its cost is usually determined by reference to the fairmarket value of the consideration given. It may be appropriateto consider also the fair market value of the asset acquired ifthis is more clearly evident. An alternative accounting treatmentthat is sometimes used for an exchange of assets, particularlywhen the assets exchanged are similar, is to record the assetacquired at the net book value of the asset given up; in eachcase an adjustment is made for any balancing receipt orpayment of cash or other consideration.”

“22. When a fixed asset is acquired in exchange or inpart exchange for another asset, the cost of the assetacquired should be recorded either at fair market valueor at the net book value of the asset given up, adjusted


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for any balancing payment or receipt of cash or otherconsideration. For these purposes fair market value maybe determined by reference either to the asset given upor to the asset acquired, whichever is more clearly evident.Fixed asset acquired in exchange for shares or othersecurities in the enterprise should be recorded at its fairmarket value, or the fair market value of the securitiesissued, whichever is more clearly evident.”

16. On the basis of the above, the Committee is of the view that,in the present case, the assets exchanged are dissimilar – theasset given up is a membership card which is an intangible assetand the assets acquired are an investment and an intangible asset,which entitle the holder separate and distinct legal rights. In viewof this, the alternative accounting treatment provided in paragraph11.1 of AS 10 would not be appropriate. Accordingly, the fair valueapproach prescribed in that paragraph should be followed fordetermining the value at which the assets acquired should berecorded, i.e., fair value of the asset given up or fair value of theasset acquired, whichever is more clearly evident. Also, in view ofthe requirements of paragraph 11 of AS 13, the Committee is ofthe view that it would be appropriate to adopt fair value approachfor valuing investment in the shares of BSEL. Further, since thequerist has stated in paragraph 10 above that in the present casethere may not be potential buyers for the existing card (the assetgiven up), in the view of the Committee, the fair value of the assetgiven up is not clearly evident. Accordingly, as per the abovereproduced provisions of AS 10 and AS 13, investment in theshares of BSEL and trading rights in the BSEL should be recordedat their respective fair values. The resultant gain or loss should betransferred to the profit and loss account. This view is differentfrom the View 2 suggested by the querist in paragraph 11 aboveas in this approach the shares and the new trading rights acquiredhave to be recorded at their respective values rather than thecarrying amount of the existing card being allocated to the twoassets on the basis of their fair values.

17. The Committee is of the view that the accounting treatmentsuggested by the querist as View 1 of paragraph 11 above, which


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is based on the historical approach should not be followed in thepresent case as the Accounting Standards do not envisage historicalcost based accounting treatment in case of transactions involvingexchange of assets.

18. Regarding the amortisation of trading right, the Committee isof the view that, as discussed in paragraph 16 above, the tradingright in the BSEL is an altogether different asset from the erstwhiletrading and membership right in the BSE (AOP). Accordingly, itshould be amortised afresh over the best estimate of its useful lifesubject to the rebuttable presumption of 10 years, in accordancewith the requirements of paragraphs 63 and 72 of AS 26 asreproduced below:

“63. The depreciable amount of an intangible asset shouldbe allocated on a systematic basis over the best estimateof its useful life. There is a rebuttable presumption thatthe useful life of an intangible asset will not exceed tenyears from the date when the asset is available for use.Amortisation should commence when the asset isavailable for use.”

“72. The amortisation method used should reflect thepattern in which the asset’s economic benefits areconsumed by the enterprise. If that pattern connot bedetermined reliably, the straight-line method should beused. The amortisation charge for each period should berecognised as an expense unless another AccountingStandard permits or requires it to be included in thecarrying amount of another asset.”

D. Opinion

19. On the basis of the above, the Committee is of the opinionthat the querist should not follow either of the views suggested inparagraph 11 above; rather, the accounting treatment suggestedin paragraphs 16 and 18 above should be followed.


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Query No. 25

Subject: Recognition of duty credit entitlement under ‘Servedfrom India Scheme’.1


1. A multinational company has the main object, as per theMemorandum of Association and as approved by ForeignInvestment Promotion Board (FIPB), to carry on the business ofresearch and development of products, processes, systems,investigation and experiments on drugs, pharmaceuticals andchemicals of any nature and kind whatsoever and production ofbulk pharmaceuticals and chemicals.

2. The objective of process research and development is todesign practical, efficient, environmentally responsible andeconomically viable chemical synthesis for existing bulkpharmaceuticals and chemicals.

3. The company undertakes process research and developmentwork on existing bulk pharmaceuticals and chemicals identified bygroup companies and works exclusively for the group companies.For providing the services to its group companies, the companyearns income in foreign exchange.

4. As the company earns foreign exchange from its activities, itis eligible to avail the benefits under the “Served from India Scheme”(hereinafter referred to as ‘the Scheme’) as provided under theForeign Trade Policy 2004-2009. The querist has stated that asper the Scheme, the company received a license dated January15, 2006, granting a duty credit entitlement of Rs. 50,00,000 foruse in the import of capital goods including spares, office equipmentand professional equipment, office furniture and consumables,related to the main line of business of the applicant. The licenseissued under the Scheme is valid for a period of 24 months fromthe date of issue.

5. According to the querist, as per the Scheme, the Indian



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Customs Assessing Officer, based on the assessable value, arrivesat the import duty payable and adjusts the said import duty againstthe license amount. In effect, the company is provided the saidbenefit as part of the Scheme (emphasis supplied by the querist).

6. During the financial year 2005-06, the company has utilisedthe duty credit entitlement of Rs. 10,00,000 towards the import ofcapital equipments, Rs. 3,00,000 towards the import of spares andRs. 2,00,000 towards the import of consumables. The followingaccounting entries were passed in the books of the company forthe financial year 2005-06:

Fixed assets Dr. 10,00,000

Other income Cr. 10,00,000

(being the amount of duty entitlement utilised)

Cost of spares Dr. 3,00,000



Consumables Dr. 2,00,0000



B. Query

7. Under the given facts and circumstances of the case, thequerist has sought the opinion of the Expert Advisory Committeeon the following issues:

(i) Whether the amount of duty credit entitlement is requiredto be accounted for as income in the books of accountas per the applicable Accounting Standards, GuidanceNotes, Opinions, etc.

(ii) Whether the value of fixed assets/spares/consumablesis to be increased by the value of duty credit entitlement


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utilised as per the applicable Accounting Standards,Guidance Notes, Opinions, etc.

(iii) If the value of fixed assets is to be increased by thevalue of duty credit entitlement utilised, then whether itwill be allowed to claim depreciation on such addition.

(iv) In case the duty credit entitlement is required to berecognised as income, whether the same is to berecognised in the year of export of services, receipt oflicense or at the time of actual utilisation of such creditor some other event.


8. The Committee notes that the basic issues raised in the queryrelate to recognition of benefit under the ‘Served from IndiaScheme’, i.e., how should this benefit be recognised in the booksof account and whether this benefit should be recognised at thetime of export of services, or on receipt of license, or at the time ofactual utilisation of such credit. The Committee has, therefore,considered only these issues and has not touched upon any otherissue arising from the Facts of the Case.

9. The Committee notes that even though the benefit receivedunder the Scheme does not strictly fall within the definition of theterm ‘revenue’, as defined under Accounting Standard (AS) 9,‘Revenue Recognition’, such credit is of the nature of revenue andaccordingly, the principles enunciated under AS 9 would beapplicable in the present case. In this context, as far as timing ofrecognition of duty credit is concerned, the Committee notesparagraph 9.1 of AS 9, which states as follows:

“9.1 Recognition of revenue requires that revenue ismeasurable and that at the time of sale or the rendering ofthe service it would not be unreasonable to expect ultimatecollection.”

10. The Committee further notes from the Served from IndiaScheme that the duty credit entitlement under the Scheme shallbe non-transferable. It signifies that there are certain uncertainties


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associated with the utilisation of duty credit entitlement since if thiscredit is not utilised within the specified time period, i.e., 24 months,the credit shall lapse. Hence, keeping in view the above-mentionedrecognition principle of AS 9, the Committee is of the view that thecredit under the Scheme should be recognised only at the timewhen and to the extent there is no significant uncertainty as to itsmeasurability and ultimate realisation, i.e., utilisation of the creditunder the Scheme. The assessment of the level of uncertainty is amatter of judgement based on the facts and circumstances ofeach case on considering factors, such as, utilisation of duty creditwithin the specified period as evidenced by the existence of abinding contract for purchase of allowable capital goods includingspares, office equipment and professional equipment, officefurniture and consumables against which the duty credit can beutilised; the expected cost of purchase of the imported allowablespecified goods vis-à-vis the cost thereof in the domestic market;etc. Events occurring between the balance sheet date and thedate on which the financial statements are approved by the Boardof Directors, may remove the uncertainty about the utilisation ofthe duty credit, e.g., imports are made after the balance sheetdate but before the approval of the financial statements by theBoard of Directors, against which the duty credit has been utilised.The Committee is, therefore, of the view that it is not necessarythat uncertainty regarding measurement and utilisation of dutycredit is removed only on actual utilisation of the credit, i.e., at thetime when the import of specified goods is made.

11. As far as the question regarding how this duty credit entitlementshould be recognised in the books of account is concerned, theCommittee notes from the entries passed by the company asindicated in paragraph 6 above that the company has increasedthe value of fixed assets, spares, consumables, etc. with the amountof duty credit utilised. It appears that at the time of purchase ofthese items, the company is recording these at the cost incurrednet of duty. In this regard, the Committee notes paragraph 9.1 ofAccounting Standard (AS) 10, ‘Accounting for Fixed Assets’, andparagraphs 6 and 7 of Accounting Standard (AS) 2, ‘Valuation ofInventories’, issued by the Institute of Chartered Accountants ofIndia, which state as follows:


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AS 10






The cost of a fixed asset may undergo changes subsequentto its acquisition or construction on account of exchangefluctuations, price adjustments, changes in duties or similarfactors.”

AS 2

“6. The cost of inventories should comprise all costsof purchase, costs of conversion and other costs incurredin bringing the inventories to their present location andcondition.

7. The costs of purchase consist of the purchase priceincluding duties and taxes (other than those subsequentlyrecoverable by the enterprise from the taxing authorities),freight inwards and other expenditure directly attributable tothe acquisition. Trade discounts, rebates, duty drawbacks andother similar items are deducted in determining the costs ofpurchase.”

From the above, the Committee is of the view that the cost ofpurchase of fixed assets, consumables, spares, etc. should berecorded at their full value inclusive of the import duties payable


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thereon whether by way of payment in cash or whether by way ofutilisation of duty credit, with a view to provide the fairest possibleapproximation to the costs incurred in bringing these items to theirpresent location and working condition. Hence, the question ofseparately increasing the value of fixed assets, consumables, etc.by the duty amount does not arise, as is being presumably doneby the company. Further, the Committee is of the view that asmentioned in paragraph 10 above, when and to the extent thesignificant uncertainty as to measurability and ultimate realisationof the duty credit is removed, the company should recognise theduty credit entitlement as its ‘other income’ by debiting the ‘dutycredit entitlement account’ and crediting the profit and loss accountand further, at the time of purchase of fixed assets, spares,consumables, etc., such credit entitlement is adjusted against theduty payable on the import thereof.

D. Opinion

12. On the basis of the above, the Committee is of the followingopinion on issues raised in paragraph 7 above:

(i) The benefit of duty credit entitlement should berecognised as ‘other income’ at the time and to the extentthere is no significant uncertainty as to its measurabilityand ultimate realisation as discussed hereinbefore.

(ii) The value of fixed assets/spares/consumables should beinclusive of the duty payable whether by way of paymentin cash or by way of utilisation of duty credit entitlement.Hence, there is no question of increasing the value offixed assets/spares/consumables separately by theamount of duty credit entitlement utilised, as discussedin paragraph 11 above.

(iii) The cost of the fixed asset (inclusive of duty payablewhether by way of payment in cash or by way of utilisationof duty credit entitlement) is eligible for depreciation.

(iv) The duty credit should be recognised when and to theextent there is no significant uncertainty about themeasurability and ultimate realisation of the duty credit


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available under the ‘Served from India Scheme’, afterconsidering the factors such as those indicated inparagraph 10 above.

Query No. 26

Subject: Accounting for expenditure on distribution ofmementos to employees during constructionperiod.1


1. A company is a Government of India undertaking, incorporatedin 1975 under the Companies Act, 1956. One of its objectives is toset up thermal/hydro-power plants in the country for supply of bulkpower to various State Electricity Boards / successor entities.

2. The querist has stated that during the construction stage of aproject, the company accounts for the expenditure on employeeremuneration and benefits as incidental expenditure duringconstruction. In case of projects which are partially under operationand partially under construction, the expenditure on employeeremuneration and benefits is analysed and as far as possible,identified with operation or construction activities and accountedfor accordingly. Further, such expenses that are common to revenueand capital activities are allocated in the proportion of sales toaccretion to capital work-in-progress and charged to the profit andloss account or the statement of incidental expenditure duringconstruction, as the case may be. In the case of expansion projects,only the expenditure directly attributable to the construction/expansion activities is capitalised, keeping in view the provisionsof paragraph 16.2 (b) of the Guidance Note on Treatment ofExpenditure during Construction Period, issued by the Institute ofChartered Accountants of India.



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3. At one of the projects where new units are being set up forexpansion of generating capacity, mementos were distributed toall the employees, whether engaged in operations, construction orother common services/functions, on the occasion ofsynchronisation of a new generating unit ahead of the schedule.Synchronisation is a major milestone preceding the readiness forcommercial operations. The expenditure on the mementos wascapitalised as incidental expenditure during construction. Thegovernment auditor while reviewing the accounts observed thatthe expenditure is not directly attributable to the construction ofthe unit and should have been charged to revenue.

4. The company is of the view that the expenditure on distributionof mementos on the occasion of synchronisation ahead of scheduleis an additional expenditure directly related to the construction ofthe unit. Synchronisation before schedule results in significantbenefits to the company in terms of cost reduction and shorterproject construction schedule. The mementos were distributed tothe employees to enhance employee morale and team spirit.

B. Query

5. The querist has sought the opinion of the Expert AdvisoryCommittee on the issue as to whether capitalisation of theexpenditure on the mementos distributed to all the employees ofthe project on synchronisation of unit, as indirect expenditure relatedto construction activity, is in accordance with the Guidance Noteon Treatment of Expenditure during Construction Period.


6. The Committee, while expressing its opinion, has consideredonly the issue raised in paragraph 5 above and has not touchedupon any other issue arising from the Facts of the Case, such as,accounting policy of the company in respect of expenditure duringconstruction period, as indicated by the querist in paragraph 2above.

7. The Committee notes that the Guidance Note on Treatmentof Expenditure during Construction Period allows the capitalisationof only those expenses which are incurred during the construction


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period and which are related to or are incidental to constructionactivities directly or indirectly. The Committee notes that the natureof these expenses is such that these are generally incurred inconnection with the construction activity and had these expensesnot been incurred, construction activity would not have proceeded/accomplished. In this regard, the Committee notes that paragraph5.2 of the said Guidance Note, which deals with ‘indirect expenditureincidental and related to construction’, inter alia states as follows:

“5.2 The following list of some of the possible items ofexpenditure which would qualify for inclusion under this headingis by no means exhaustive but is merely illustrative of the typeof expenditures which are discussed in this paragraph:—

(a) Expenditure on employees who are either assignedto construction work or to supervision overconstruction work including salaries, provident fundand other benefits, staff welfare expenses, etc.”

8. The Committee notes from the above, particularly, theexpenditure on employees as contained in clause (a) of paragraph5.2 of the Guidance Note as reproduced above that the nature ofthe expenses to be capitalised, is such that these expenses aregenerally part of a formal plan or an informal practice of theorganisation to provide such benefits to its employees and arerelatable to the construction activity, i.e., these expenses directlyor indirectly benefit the construction activity and are responsiblefor bringing the asset to its working condition. Accordingly, in theview of the Committee, if the giving of mementos to the employeesis pursuant to a formal plan or an informal practice of the companyto provide incentive to the employees for early completion of theconstruction activity, or the expenditure directly or indirectly benefitsthe construction activity, the cost of these mementos should becapitalised as then, these would be attributable to the cost ofbringing the asset under construction to its working condition forits intended use. However, if these mementos are not a part ofany formal plan or an informal practice as stated above, and aregiven only as an after-thought, i.e., as an award/reward to theemployees for meeting the target, i.e., synchronisation of the unitahead of schedule, the cost thereof cannot be attributed to bringing


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the asset under construction to its working condition for its intendeduse, and hence, the same should not be capitalised. Further, incase the cost of the mementos is to be capitalised on theaforementioned basis, it should be capitalised only to the extent ofsuch benefit given to the employees who are engaged in theconstruction activity. In this regard, the Committee notes from theFacts of the Case that the company has distributed the mementosto all employees, whether engaged in operations, construction orother common services/functions.

D. Opinion

9. On the basis of the above, the Committee is of the opinionthat the capitalisation of the expenditure incurred on mementosdistributed to the employees would be in accordance with theGuidance Note on Expenditure during Construction Period only ifit is part of a formal plan/informal practice of the organisation toprovide incentives to the employees for achieving certainconstruction activity ahead of schedule, or it directly or indirectlybenefits the construction activity. In case it is to be so capitalised,it should be capitalised only to the extent such expenditure isrelated to the employees engaged in the construction/expansionactivity, as discussed in paragraph 8 above.

Query No. 27

Subject: Books of account of franchise business andaccounting implications thereof.1


1. A public limited company is engaged in the business ofmanufacturing and marketing of country liquor, spirit and IMFL(Indian Made Foreign Liquor). It is engaged in the business ofmanufacturing of IMFL products of certain brand owners under anarrangement with them.1 Opinion finalised by the Committee on 17.1.2007


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2. The querist has stated that the liquor is subject to state excise.It involves import duty on purchase of goods from another stateand export duty implication on the sale of goods to the buyerslocated in another state (within India). Such duties on purchasesand sales are called as import duty and export duty, respectively.Hence, the brand owners are getting their products manufacturedand sold through manufacturing entities located in respective states.Further, being non-excise licensees for the concerned states, thebrand owners are not allowed to do business in their name.

3. The products are being manufactured and sold in the nameof the company. Being the permit based business, excise licencesare also in the name of the company. Import permits for thepurchase of finished goods by out of the state buyers are beingobtained in favour of the company from the concerned state excisedepartment and the export permit in respect of the same are beingreleased in the name of the company by Madhya Pradesh ExciseDepartment (for each consignment). The purchase invoices inrespect of raw material, packing material and consumables arebeing issued in the name of the company (inspite of the fact thatthe purchases of the same are in absolute control of the brandowners). The sales invoices for the finished goods are also beingissued in the name of the company (strictly in accordance with thespecifications and instructions of the brand owners). The specialbank account for the operation of the said business is also operatedin the name of the company.

4. The necessary compliances under sales tax (filing of returns,necessary declarations/‘C’ Forms, assessments etc.), income tax(TDS, TCS under section 206C, etc.) and service tax on GoodsTransport Agency (GTA) (registration, return, payment etc.) arealso being done in the name of the company.

5. According to the querist, the business is under the control ofthe brand owners; they decide purchases (price, parties, qualityand other terms/conditions) and sales (price, parties and otherterms/conditions). The company is acting under the instructions/specifications of the brand owners in accordance with theagreement executed between the parties.


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6. The business is funded by the brand owners. The assets ofthe business (consisting of inventory, debtors/other current assets)and liabilities (creditors for supply of raw material, packing materialsand consumables) are appearing in the name of the company butthe company is under the obligation to deal with the assets inaccordance with the instructions of the brand owners and is havingright to recover/indemnify itself against the liabilities/losses arising,if any, in the said business.

7. The company is working for a fixed charge/ margin per caseby using its factory/other infrastructure (irrespective of profits andlosses of the business). The separate set of books of account,including inventory records are maintained by the company inrespect of the arrangement with each concerned brand owner forthe said business. The surplus in the business is being withdrawnby the brand owners as “brand owners entitlement” and in case ofdeficit (losses), the same will be funded/borne by the brand owners.

8. The querist has also referred the following issues for theconsideration of the Expert Advisory Committee in the givensituations:

(i) When the books of the business are considered to beforming part of the books of account of the company

(a) The documents of the transactions of the business(purchase/sales invoices, licence, permits relatedTCS certificates under section 206C, TDScertificates in respect of the payments/expenses)are in the name of the company. On the basis ofsupportings vis-a-vis the provisions of section 209(1)of the Companies Act, 1956, if the books of accountof the business are treated to be forming part of thebusiness of the company, the issue of implication ofTDS on the brand owners entitlement vis-à-visaccounting implication on presentation of the samein the profit and loss account needs to be analysed.

(b) According to the brand owners, since they areresponsible for the profit/ loss of the business,


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including the liabilities of the business, if any, (inspite of holding the same in the name of thecompany in view of technical requirements of exciselaws) the said withdrawal is basically the surplusfrom the business. Hence, no implication of TDSwould arise under any of the provisions of part B ofChapter XVII of the Income-tax Act, 1961. Thequerist has requested the Committee to considerthe situation of treating books of account of thesaid business as forming part of books of accountof the querist company in view of the provisions ofsection 209 (1) of the Companies Act, 1956alongwith the relevant documents and at the sametime, non-implication of TDS on the debit to theprofit and loss account as the brand ownersentitlement.

(ii) When books of the business are not considered to beforming part of the books of account of the company

Alternatively, if the company decides about non-inclusion ofthe said business in the financial statements of the company(in spite of sales/purchases etc., lying in the name of thecompany), the querist has referred the following issues:

(a) Differences in the details of TDS/TCS certificatesissued vis-a-vis income-tax return filed and the booksof account considered for the purpose of financialstatements (as TDS/TCS pertaining to the divisionwill not be included in the financial statements ofthe company). What would be the implication ofdelay/default in respect of the same vis-à-visprovisions of section 40 (a) and (ia) of the Income-tax Act, 1961 in the assessment of the company?

(b) Further, since the supporting documents are not inthe name of the brand owners (inspite of the control,risks/rewards of the business), they are not in aposition to consider the said transactions in theirfinancial statements. In case of non-inclusion of the


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same in the financial statements of the company,what would be the implication?

(c) Further, in case of non-inclusion of the said business,in the financial statements, how the company isgoing to justify itself for issuance of TDS/TCScertificates and payments of service tax in respectof the said business?

(iii) Accounting treatment alongwith implication of the TDSon the brand owners entitlement.

B. Query


(i) What is the correct accounting treatment of the saidtransactions?

(ii) Whether the books of account of the business shall beforming part of books of account of the company or ofthe brand owner.


10. The Committee notes from the Facts of the Case that basicallythere are three issues raised by the querist, viz., (i) accountingtreatment of the transactions carried on by the company in respectof the business of IMFL products on behalf of the brand owners,(ii) whether books of account of the said business shall form partof the books of account of the company or of the brand ownersand (iii) Income-tax, TDS/TCS and other legal implications of thesaid transactions. Regarding the third issue, the Committee hasnot expressed any opinion since as per Rule 2 of the AdvisoryService Rules of the Expert Advisory Committee, the Committeedoes not answer queries involving legal interpretation of variousenactments. The opinion of the Committee, expressed hereinafter,is therefore, only from the accounting point of view.

11. The Committee notes paragraph 17(b) of Accounting Standard(AS) 1, ‘Disclosure of Accounting Policies’, which states as follows:


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“b. Substance over Form


12. The Committee notes from the above that the transactionsand events are accounted for and presented in accordance withtheir substance, i.e., the economic reality of events and transactions,and not merely in accordance with their legal from. In other words,it is the ‘economic reality’ that is important in accounting and notonly the ‘legal reality’. From the Facts of the Case, the Committeenotes that while the legal form is that all the documents such asexcise licenses, import permits, purchase invoices in respect ofraw material and packing material, sales invoices in respect offinished goods, special bank account for the operation of the saidbusiness, etc., are in the name of the company, the substance ofthe transaction is that the company is acting only as an agent ofthe brand owners as the significant risks and rewards of thebusiness vest with the brand owners which is clear from thefollowing facts:

(a) The querist has specifically stated in paragraph 5 abovethat the business is under the control of brand ownersand the company is just acting under the instructions/specifications of the brand owners.

(b) The company is getting only a fixed charge/margin percase irrespective of the profits or losses of the saidbusiness. The surplus of the business is being withdrawnby the brand owners and in case of deficit (losses), thesame will be funded/borne by the brand owners.

(c) The company has the right to recover/indemnify itselfagainst the liabilities/losses, if any, arising during thecourse of business. Thus, all significant risks related tothe business are assumed by the brand owners.

(d) The control over the assets vest with the brand ownersas the company is under obligation to deal with the assetsin accordance with the instructions of the brand owners.


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The liabilities of the business are also assumed by thebrand owners.

(e) The terms and conditions related to purchases and salessuch as price, parties, quality, etc. are decided by thebrand owners.

13. On the basis of the above, the Committee is of the view thatsince the significant risks and rewards related to the ownership ofIMFL products do not vest with the company, the sales andpurchases of the said products should not be recognised in thebooks of account of the company; instead these should berecognised in the books of account of the brand owners. Similarly,the assets and liabilities of the said business should also not berecorded in the books of account of the company as these arebeing controlled by the brand owners, even though the supportingdocuments in respect of the same are being maintained by thecompany. The company should recognise its fixed charge/marginas its income in its financial statements. Regarding the accountingtreatment of the brand owners’ entitlement, the Committee is ofthe view that surplus from the business which is the brand owners’entitlement and withdrawn by the brand owners, is merely a cashoutflow for the company and should, therefore be recorded assuch in the books of the company. Hence, any such entitlementdue to the brand owners should be credited to their respectiveaccounts in the books of the company.

14. As far as the books of account to be kept by the company isconcerned, the Committee notes that section 209(1) of theCompanies Act, 1956, provides as follows:

“209.(1) Every company shall keep at its registered officeproper books of account with respect to –

(a) all sums of money received and expended by thecompany and the matters in respect of which thereceipt and expenditure take place;

(b) all sales and purchases of goods by the company;

(c) the assets and liabilities of the company; and


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(d) in the case of a company pertaining to any class ofcompanies engaged in production, processing,manufacturing or mining activities, such particularsrelating to utilisation of material or labour or to otheritems of cost as may be prescribed, if such class ofcompanies is required by the Central Governmentto include such particulars in the books of account

...”

On the basis of the above and considering the fact that sales,purchases, assets and liabilities in respect of the business of IMFLproducts should not be recognised in the financial statements ofthe company, the Committee is of the view that for the purposesof Companies Act, 1956, the books of account maintained thatenable the company to reflect various items of income (e.g. fixedcharge per case) and expense in the financial statements of thecompany should be deemed to be the books of account of thecompany. In this regard, the Committee also wishes to again pointout that the opinion expressed by the Committee is purely fromthe accounting point of view without consideration of anyimplications thereof, from the point of view of the provisions ofTDS/TCS, Income-tax Act, 1961, or any other legal/statutoryrequirement.

D. Opinion


(i) The correct accounting treatment of the said transactionsin the books of account of the company would be torecognise only the fixed margin/charge received by itrather than to recognise sales and purchases of thebusiness of IMFL products as discussed in paragraphs12 and 13 above. The company should also not recogniseany asset or liability of the said business in this regard inits books of account. The brand owners entitlement paidby the company should be booked as a mere cashoutflow. On the other hand, the brand owners should


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recognise the sales, purchases, assets and liabilities ofthe said business as their own, in their books of account.

(ii) Books of account of the company for the purposes ofthe Companies Act, 1956, should be the books of accountmaintained that enable the company to reflect variousitems of its income (e.g., fixed charge per case) andexpense in the financial statements of the company.Sales, purchases, assets and liabilities relating to thebusiness controlled by the brand owners should not berecorded in the books of account of the company eventhough supporting vouchers are in the name of companyand are maintained by it.

Query No. 28

Subject: Capitalisation of establishment expenses ofRehabilitation & Resettlement office aftercommissioning of the project.1


1. A joint venture between a Government of India enterprise andthe Government of Madhya Pradesh was incorporated as acompany on 01.08.2000, with 51% stake being held by the formerand the rest by the latter, to exploit the hydroelectric potential ofthe Narmada Basin. The company, having its headquarters atBhopal, Madhya Pradesh (M.P.), presently has two projects, viz.,Indira Sagar Project (ISP) of 1,000 MW under operation andOmkareshwar Project (OSP) of 520 MW under construction. Boththese projects are situated in the state of M. P.

2. The querist has stated that ISP is the mother project of theNarmada Basin. It supplies water to three major downstreamhydroelectric projects, viz., Omkareshwar & Maheshwar Projects



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(both in M.P.) and Sardar Sarovar Project in Gujarat. The installedcapacity of the project is 1,000 MW, i.e., 8 units of 125 MW each.The project cost of ISP is Rs. 4,277.03 crore.

3. ISP is a multipurpose project, having both power generationand irrigation components. It has a catchment area of 61,642 sq.km. and its reservoir of 913 sq. km. will be the largest reservoir inIndia. Besides generation of electricity, the project would irrigatean area of 2.70 lakh hectares covering 564 villages, provide drinkingwater to downstream areas and enable production of an additional4.00 lakh tons of food grains and 10.55 lakh tons of other crops.Other benefits of the project include annual production ofapproximately 1,500 tons of fish from the reservoir, creation ofjobs through development of tourism and establishment of IndustrialTraining Institute (ITI), etc.

4. The queist has further stated that the work of Rehabilitation &Resettlement (henceforth referred to as R&R) of the ProjectAffected Families (PAFs) of the project is being carried out by theR&R office situated at Khandwa. The work of R&R office includes,inter alia, land acquisition, preparation and payment of landcompensation awards, development of infrastructure at variousresettlement sites and transportation of PAFs to these sites. Asper the approved cost estimate of ISP, the entire expenditureincurred on the R&R activities is chargeable to the dam of ISP andis to be capitalised therewith. A total number of 249 villages arecovered in the submergence area of the project, out of which 75villages are being fully submerged and the balance 174 villagesare being partially submerged. In addition to these, some morevillages being submerged / families affected by the back waters ofthe reservoir are also to be resettled. The original cost estimatefor R&R was Rs. 1,160 crore which was later revised to Rs. 1,570crore vide the Cabinet Committee on Economic Affairs (CCEA)clearance dated 28.03.2002. The total proportionate establishmentexpenditure pertaining to R&R works of ISP incurred on R&Roffice from 24.08.2005 to 31.03.2006 works out to Rs. 6.43 crorewhich has been transferred to Incidental Expenditure DuringConstruction (IEDC) and thus got capitalised in the annual accountsof 2005-06 of ISP, as the project is fully operational.


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5. The first unit of ISP was commissioned on 13.01.2004 andthe remaining seven units were commissioned on different datesthereafter. Though the first unit was commissioned on 13.01.2004,a substantial amount of civil, electrical and hydro-mechanical work,apart from R&R work was yet to be completed. Even after thecommissioning of the last unit (i.e., 8th unit) on 30.03.2005, someof these works were still incomplete. Accordingly, the companyhas been preparing both profit and loss account and IEDC accountsince 2003-04 because the construction activities of the projectwere being carried out simultaneously with the operation of thecommissioned units. The capitalisation of the project expenditurehas been carried out in stages and at different times. All the unitsof ISP were commissioned by 30.03.2005 and the rated capacityof 1,000 MW was achieved on 24.08.2005.

6. The querist has stated that though the rated capacity of 1,000MW was achieved on 24.08.2005, the total expenditure incurredtill that date was only Rs. 3,786.89 crore as against the estimatedproject cost of Rs. 4,277.03 crore. The unspent amount of Rs.490.14 crore is on account of balance civil, electrical and finishingworks of dam and power house, pending claims of variouscontractors and remaining R&R works as well as the balanceexpenditure on compensatory afforestation and catchment areatreatment.

7. Though the dam has been raised to its maximum height of EL262.13 M, the Hon’ble High Court, Jabalpur has ordered that thewater level may be maintained at or below EL 255 M, due to thefact that R&R work of many villages in submergence area has notyet been completed.

8. The querist has stated that the comments of the Comptrollerand Auditor General of India (C&AG) on this issue during the auditof the company for the year ended 31.03.2006 were as follows:

“All the generating units of ISP were commissioned by30.03.2005 and the rated capacity of 1,000 MW was achievedon 25.08.2005. As the project was complete and fullyoperational by this date, all the revenue expenditure andincome should have been booked in the Profit and Loss


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Account. However, net revenue expenditure of Rs. 642.53lakh incurred by R&R Division, Khandwa, in respect of ISPfrom 25.08.2005 to 31.03.2006 were transferred to IEDC andcapitalised instead of charging to Profit & Loss Account.

This has resulted in understatement of revenue expenditureand overstatement of profit for the year by Rs. 642.53 lakh.”

9. As per the querist, the company’s reply to the above commentsof C&AG was as follows:

“The office of R&R Division, Khandwa is doing only the workof land acquisition and related activities and is not engaged inany Operation & Maintenance Work of the project. All itsexpenses are therefore charged to IEDC. Even after24.08.2005, the work of land acquisition, etc., continued whichis a direct capital expenditure. This practice is continuing sincelast two years as per Accounting Policy no. 17 which is asfollows:

“Payments made provisionally towards compensation andother expenses relatable to land, which is going to besubmerged, are treated as Rehabilitation & ResettlementExpenses to be capitalised as Dam Cost.”

In view of the above, expenses pertaining to R&R activitieshave been correctly booked to IEDC and capitalisedaccordingly.”

10. The querist has stated that the reply of the company wasfurther elaborated upon in the supplementary reply to the C&AGcomments as follows:

“The office of R&R Division, Khandwa is engaged in balanceR&R activities including land acquisition and payment ofcompensation to oustees falling between EL 255 M to EL 261M or Maximum Water Level (MWL). This particular elevationis essential for the filling of reservoir to its maximum capacityfor its maximum economic use. It is again for the informationof audit that although the project has started commercialgeneration since 25.08.2005, but its complete commercial


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benefit as projected in the detailed project report will only bepossible once the balance R&R works are completed. Wehave not yet fully spent the projected capital expenditure.Payment of compensation and incidental expenses are metout of the projected capital expenditure and charging of sameto O&M expenses will be beyond the norms of CentralElectricity Regulatory Commission (CERC).”

11. According to the querist, the following are the supporting factsfor the reply:

(a) The land acquisition and R&R work of a few villages,which come under submergence of back waters of ISPdam at Full Reservoir Level (FRL) to Maximum WaterLevel (MWL) are still in progress and shifting of PAFs isalso in progress.

(b) Apart from this, 8 villages have been totally surroundedby the back waters of ISP dam at FRL to MWL and havebecome islands. Land acquisition, R&R work and shiftingof PAFs are still in progress.

(c) In view of the above, the Hon’ble High Court, Jabalpurhas permitted the company to raise the water level ofISP upto EL 255 M only against the FRL of EL 262.13M. The rated capacity of 1,000 MW was achieved on24.08.2005 at the water level of EL 255 M and not at EL262.13 M.

(d) The work of dam will be completed only after thecompletion of all land acquisition, R&R work, shifting ofall PAFs and getting the permission of the Hon’ble HighCourt to raise the water level up to EL 262.13 M, i.e.FRL. The work of the project can only be considered tobe completed when the dam along with all R&R activitiesis complete and is filled up to MWL of EL 262.13 M. Untilthen, the expenditure incurred on project related activities,including establishment expenditure will be included inIEDC and capitalised subsequently. Further, the fullbenefits of the project, as envisaged in the approved


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detailed project report and referred to in the company’sreply to C&AG’s comments, can only be exploited afterthe filling of reservoir up to the MWL of EL 262.13 M.

(e) As per the CERC guidelines no. 34.4 for tariff fixation,capital expenditure incurred after the completion of theproject is also to be considered for the fixation of tariff.The generating company can file two revised tariffpetitions, apart from the original tariff petition, within atariff period, i.e., five years of the completion of the project,to include the capital expenditure incurred after thecommissioning of the project in the total project cost andconsider the same towards tariff fixation of the project.

(f) Accordingly, the company is of the view that the treatmentof the expenditure of Rs. 6.43 crore incurred on R&Rworks from 24.08.2005 to 31.03.2006 as IEDC andcapitalisation of the same is correct and as per theprovisions of Accounting Standard (AS) 10, ‘Accountingfor Fixed Assets’, the company’s accounting policy andCERC guidelines.

B. Query

12. In view of the facts of the case, the querist has sought theopinion of the Expert Advisory Committee on the following issues:

(i) Whether the treatment given to R&R expenditure for theperiod from 24.08.2005 to 31.03.2006 is correct and asper the relevant Accounting Standards and practices.

(ii) If not, the corrective steps to be taken.


13. The Committee notes from a comprehensive reading ofparagraphs 4 and 8 that the query relates to the issue ofappropriateness of capitalisation of establishment expenses ofRehabilitation and Resettlement (‘R&R’) office incurred from24.08.2005 till the end of the accounting year though, in paragraph12, the querist has raised the issue with respect to R&R expenditure


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in general. Therefore, the Committee has not touched upon anyother issue that may be contained in the Facts of the Case, suchas the asset to which the R&R expenditure is to be capitalised within case capitalisation criteria are met, treatment of R&R expenditurefrom the date of commissioning to the date of achieving 100 percent rated capacity, etc.

14. The Committee further notes that the querist has mentionedtwo dates as the date of reaching 100 percent rated capacity, viz.,24.08.2005 and 25.08.2005. Also, at one place it is mentioned thatFull Reservoir Level and Maximum Water Level are one and thesame while at another place, they are stated to be different.However, such matters do not affect the accounting treatment forthe issue involved.

15. The Committee notes that the last unit (i.e., 8th unit) of themother project (ISP) was commissioned on 30.03.2005 itself whilethe rated capacity of 1,000 MW was achieved on 24.08.2005(25.08.2005). There is huge unspent amount on account of balancecivil, electrical and finishing works of dam and power house, pendingclaims of various contractors and remaining R&R works as well asthe balance expenditure on compensatory afforestation andcatchment area treatment. Further, the rated capacity is reachedagainst the water level of EL 255 M and not at the maximum level,i.e., EL 262.13 M.

16. In the context of the comments of the C&AG contained inparagraph 8 above, the Committee notes the following portions ofthe Guidance Note on Treatment of Expenditure during ConstructionPeriod, issued by the Institute of Chartered Accountants of India:

“…from the moment the plant is completed and commissionedand is ready for commercial production, all expenditures ofrevenue nature must be charged to the profit and loss account.”[Paragraph 12.3]

“The term “commercial production” refers to production incommercially feasible quantities and in a commerciallypracticable manner.” [Paragraph 12.2]


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From the above, the Committee is of the view that it is thecommissioning date that signifies readiness for commercialproduction and not the date of achieving 100 per cent rated capacityso far as power plant units are concerned. Accordingly, in respectof commissioned units, revenue expenditure related to post-commissioning period should be charged to profit and loss account.

17. With respect to capitalisation of expenses, the Committeenotes the following paragraphs from Accounting Standard (AS)10, ‘Accounting for Fixed Assets’:





(iv) professional fees, for example fees for architectsand engineers.


“9.3 Administration and other general overhead expenses areusually excluded from the cost of fixed assets because theydo not relate to a specific fixed asset. However, in somecircumstances, such expenses as are specifically attributableto construction of a project or to the acquisition of a fixedasset or bringing it to its working condition, may be includedas part of the cost of the construction project or as a part ofthe cost of the fixed asset.”


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18. The Committee also notes that paragraph 23 of AS 10 statesas below:

“23. Subsequent expenditures related to an item of fixedasset should be added to its book value only if theyincrease the future benefits from the existing asset beyondits previously assessed standard of performance.”

The Committee is of the view that the ‘subsequent expenditure’mentioned above can be capitalised, only if:

(a) it is a directly attributable cost;

(b) it is probable that the expenditure will increase the futurebenefits from the relevant asset beyond the previouslyassessed standard of performance; and

(c) such expenditure can be measured reliably.

The expression ‘subsequent expenditure’ indicates that expenditureincurred after the initial recognition of a fixed asset or completionof a project is also eligible for capitalisation, subject to meeting theaforesaid three conditions.

19. The Committee is of the view that for determining whether thesubsequent expenditure is a ‘directly attributable cost’, factors,such as, whether the concerned expenditure directly benefits or isrelated to the relevant asset may be considered. In establishingwhether the expenditure directly benefits or is related to an asset,a nexus between the expenditure and the benefit/relationship withthe asset can be established technologically.

20. The Committee notes that R&R expenditure, including theestablishment expenditure, is incurred as a direct consequence ofthe project. The R&R office is doing only the work of land acquisitionand related activities and is not engaged in any operation andmaintenance work. Though the R&R office expenditure isadministrative in nature, it is specifically attributable to the projectand not general in nature. Thus, it is a directly attributable cost.

21. The querist has not stated what incremental benefits will flow


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from raising the existing water level to the maximum level. However,the querist has indicated in paragraphs 10 and 11(d) above that itis probable that future benefits from the relevant asset will increasebeyond the previously assessed standard of performance. Thus, itseems that the R&R expenditure is continued with a view toexploiting the commercial benefits of the project fully by raisingthe water level from the existing level of EL 255 M to the maximumlevel of EL 262.13 M, after obtaining the Court’s approval. Thoughthe dam has already been raised to the maximum height of 262.13M, to raise the water level to this height, Court’s permission isnecessary. It seems that for getting the Court’s permission, R&Rwork must be complete, for which the R&R office is to bemaintained.

22. The Committee notes that R&R office is exclusively devotedto R&R activities only. Hence, the expenditure incurred by theR&R office can be reliably measured.

23. In view of the above, all the three conditions mentioned inparagraph 18 above appear to be satisfied. Though the capacityof the dam is not going to be increased further, the standard ofperformance so far assessed in terms of benefits is related toexisting level of water only. Since it is probable that the raising ofexisting water level to the maximum level will increase the futurebenefits and the expenditure thereon can be measured reliably,continued incurrence of the R&R expenditure, including R&R officeexpenditure, which is a directly attributable cost in the case of thequerist, is eligible for capitalisation as part of cost of the relevantasset.

24. The Committee is of the view that even if the continuedincurrence of R&R expenditure is to be capitalised on theconsiderations mentioned in paragraph 23 read with paragraph 18above, incidental expenditure, such as, establishment expenses ofR&R office should not be capitalised if no activity is in progress orthe delay in the progress of R&R activities is avoidable. In thisconnection, the Committee notes the following paragraphs fromAccounting Standard (AS) 16, ‘Borrowing Costs’:


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“17. Capitalisation of borrowing costs should besuspended during extended periods in which activedevelopment is interrupted.

18. Borrowing costs may be incurred during an extendedperiod in which the activities necessary to prepare an assetfor its intended use or sale are interrupted. Such costs arecosts of holding partially completed assets and do not qualifyfor capitalisation. However, capitalisation of borrowing costsis not normally suspended during a period when substantialtechnical and administrative work is being carried out.Capitalisation of borrowing costs is also not suspended whena temporary delay is a necessary part of the process of gettingan asset ready for its intended use or sale. For example,capitalisation continues during the extended period neededfor inventories to mature or the extended period during whichhigh water levels delay construction of a bridge, if such highwater levels are common during the construction period in thegeographic region involved.”

The Committee is of the view that the above principle can beapplied to other expenditure also.

D. Opinion


(i) The treatment of R&R expenditure, so far as it relates toestablishment expenses of R&R office for the period from24.08.2005 to 31.03.2006, is correct, provided R&Ractivities are in progress during this period and delay, ifany, is unavoidable.

(ii) In view of (i) above, this question does not arise. However,in case R&R activities are not in progress or the delay inR&R activities is avoidable, capitalisation of establishmentexpenditure of R&R office is an error, the correction ofwhich should be accounted for as a prior period item inaccordance with Accounting Standard (AS) 5, ‘Net Profit


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or Loss for the Period, Prior Period Items and Changesin Accounting Policies’.

Query No. 29

Subject: Accounting and reporting of interest in jointlycontrolled entity.1


1. A company, which is a Government of India enterprise, havinga 3 MMTPA refinery, desires to purchase natural gas from M/s.XYZ Limited and has already entered into an agreement with it forthe supply of natural gas for a period of 15 years for its use in therefinery, with a provision to further extend the term of the agreementby another 5 years by mutual consent.

2. The company has entered into an agreement with anothercompany, ABC Ltd., a State Government enterprise, on 27th June,2005. According to the querist, there was an advantage availablein entering into this agreement with ABC Ltd., having a network ofgas pipeline and presently, operating in the business of gastransportation in the State and other near-by areas. Under theagreement, ABC Ltd. agreed to set up gas transportation systemto transport gas from XYZ Ltd.’s off-take point to the company’srefinery for the use of the company in its refinery as per the termsand conditions of the agreement. The tenure of this agreementwas initially meant for 15 years from the date of commencementof gas transportation and renewal for a further period of 5 yearson terms and conditions mutually agreed to.

3. The above agreement with ABC Ltd. was entered into toconstruct a gas transportation system with 2.00 MMSCMD of gas(1.00 MMSCMD for the company and other 1.00 MMSCMD for theconsumers other than the company). The transmission charges


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etc. were also calculated based on the revenue to be generatedfrom 2.00 MMSCMD of gas. Consequent upon signing of thememorandum of understanding (MOU) as referred to above, itwas spelt out by XYZ Ltd., that it would not be able to supply 2.00MMSCMD of gas and instead settle for 1.00 MMSCMD of gas ascommitted to the company. Accordingly, in a meeting held on 23/06/06, it was decided to reconfigure the project as follows:

(i) The pipeline diameter will be changed to be adequate totransport 1.00 MMSCMD of gas to the company.

(ii) Instead of 6 compressors initially planned, ABC Ltd. willinstall only 3 compressors in the system.

(iii) Provision will be made in the pipeline for augmentationof capacity in future to transport additional quantity ofgas in case it is available.

(iv) The project cost will be reworked with the newconfiguration and the company’s transmission chargeswill be revised based on the parameters of the agreementand finalised on mutually agreed terms.

(v) Necessary changes shall be made to the agreementalready signed on 27/6/05.

4. In view of the above developments and considering that thepipelines would only be for the dedicated use of the company, itwas felt that an unincorporated joint venture (JV) would be formedto carry out the project. Salient features of the JV are as under:

(i) The company shall be co-investor in the JV on 1:1 basiswith ABC Ltd. as the partner/co-venturer.

(ii) The JV unit will have the status of unincorporated jointlycontrolled entity.

(iii) The estimated cost of the project is Rs. 320 crore andthe same will be shared by the two venturers on anagreed debt/equity basis.


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B. Query

5. Having regard to the above facts and probability of thecompany entering into an agreement with ABC Ltd. to be partner/co-venturer in a JV under special purpose vehicle (S.P.V.)arrangement, the querist has sought the opinion of the ExpertAdvisory Committee with regard to accounting in the separatefinancial statements of the company on the following matters, inthe context of the requirements of Accounting Standard (AS) 27‘Financial Reporting of Interests in Joint Ventures’, issued by theInstitute of Chartered Accountants of India:

(i) Treatment in the books of account of contribution by thecompany towards JV equity, and the borrowings andliability taken by the company for funding the JV.

(ii) Basis of recognition of share of jointly controlled assetsin the books of account of the company during the projectperiod as well as after commissioning.

(iii) Basis of recognition of share of any liability incurred jointlywith other venturers in relation to the JV.

(iv) Basis of recognition of any income from the sale or useof its share of the output of the JV, together with itsshare of any expenses incurred by the JV or by thecompany in respect of the JV.

(v) Availment of benefit on account of excise benefit oncapital procurements of the JV, cenvatable service taxand modality of billing of TC charges.

(vi) Requirement of maintaining separate records for the JVor S.P.V.


6. The Committee notes from the Facts of the Case that a jointventure (JV) or a special purpose vehicle (S.P.V.) arrangement isproposed to be entered into by the company with another company.It is also mentioned in the Facts of the Case that the JV unit willhave the status of unincorporated jointly controlled entity. The


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Committee further notes paragraph 1 and the definitions of theterms ‘joint venture’ and ‘joint control’ as contained in paragraph 3of Accounting Standard (AS) 27, ‘Financial Reporting of Interestsin Joint Ventures’, issued by the Institute of Chartered Accountantsof India, which state as below:

“1. This Statement should be applied in accounting forinterests in joint ventures and the reporting of joint ventureassets, liabilities, income and expenses in the financialstatements of venturers and investors, regardless of thestructures or forms under which the joint venture activitiestake place.”

“A joint venture is a contractual arrangement wherebytwo or more parties undertake an economic activity, whichis subject to joint control.

Joint control is the contractually agreed sharing of controlover an economic activity.”

7. On the basis of the above, the Committee is of the view thatirrespective of the form in which the joint venture activity is enteredinto by the company, i.e., irrespective of the fact whether it istermed as a JV or an S.P.V. arrangement, if the above-mentionedconditions are met, the provisions of AS 27 would be applicablefor determining the accounting treatment for interests of thecompany in the entity. Further, since in the present case, the J.V.activity shall be carried on as an unincorporated jointly controlledentity and there is a joint control over that entity, in the view of theCommittee, the provisions related to ‘jointly controlled entities’ ascontained in AS 27 would be applicable as against jointly controlledoperations and jointly controlled assets. In this context, theCommittee also notes paragraph 22 of AS 27, which states asfollows:

“22. A jointly controlled entity is a joint venture which involvesthe establishment of a corporation, partnership or other entityin which each venturer has an interest. The entity operates inthe same way as other enterprises, except that a contractualarrangement between the venturers establishes joint controlover the economic activity of the entity.”


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8. The Committee further notes that the querist has raised thequery only in respect of accounting and reporting of financial interestin the jointly controlled entity in the separate financial statementsof the company. Accordingly, the opinion of the Committee is onlyon this aspect. In this context, the Committee notes the provisionsrelated to ‘separate financial statements’ as contained in paragraphs27 and 28 of AS 27 reproduced as below:

“27. In a venturer’s separate financial statements, interestin a jointly controlled entity should be accounted for asan investment in accordance with Accounting Standard(AS) 13, Accounting for Investments.

28. Each venturer usually contributes cash or other resourcesto the jointly controlled entity. These contributions are includedin the accounting records of the venturer and are recognisedin its separate financial statements as an investment in thejointly controlled entity.”

9. On the basis of the above, the Committee is of the view thatthe contribution made by the company towards the JV equity shouldbe accounted for as an investment in accordance with AccountingStandard (AS) 13, ‘Accounting for Investments’, issued by theInstitute of Chartered Accountants of India. Further, since thisinvestment is intended to be held by the company for more thanone year, it should be accounted for as ‘long-term investment’ inthe books of the company. This investment should be carried inthe financial statements at cost in accordance with paragraph 32of AS 13 which sates as follows:

“32. Investments classified as long term investmentsshould be carried in the financial statements at cost.However, provision for diminution shall be made torecognise a decline, other than temporary, in the value ofthe investments, such reduction being determined andmade for each investment individually.”

10. The Committee is also of the view that borrowings made andthe liabilities assumed by the company for funding the JV,presumably by contributing to the equity of the JV will appear as


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the borrowings and liabilities of the company. However, if thecompany undertakes to repay the borrowings and liabilities of theJV, the same should be considered as a part of investment andtreated as suggested in paragraphs 8 and 9 above.

11. The Committee notes that the querist has also raised anissue with respect to the use or sale of the output of the JV entityby the company in question in paragraph 5(iv) above. TheCommittee is of the view that such transactions constitute thetransaction of sale by the JV to the venturer (i.e., the company inquestion) and, therefore, should be accounted for accordingly inthe books of both the venturer and the JV. In this context, theCommittee notes paragraph 45 of AS 27 reproduced below:

“45. In the separate financial statements of the venturer, thefull amount of gain or loss on the transactions taking placebetween the venturer and the jointly controlled entity isrecognised. However, while preparing the consolidated financialstatements, the venturer’s share of the unrealised gain or lossis eliminated. Unrealised losses are not eliminated, if and tothe extent they represent a reduction in the net realisablevalue of current assets or an impairment loss. The venturer,in effect, recognises, in consolidated financial statements, onlythat portion of gain or loss which is attributable to the interestsof other venturers.”

Accordingly, if any of the output of jointly controlled entity ispurchased or used by the venturer, it should be recognised in theseparate financial statements of the venturer in its full respect, asif the transaction has taken place with an independent party.

12. With regard to the maintenance of separate records for thejoint venture, the Committee notes that paragraph 26 of AS 27provides as below:

“26. A jointly controlled entity maintains its own accountingrecords and prepares and presents financial statements inthe same way as other enterprises in conformity with therequirements applicable to that jointly controlled entity.”


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Accordingly, the Committee is of the view that the JV shouldmaintain separate books of account in accordance with the lawsapplicable to the entity.

13. As far as recognition of the share of the company in theassets, liabilities, income and expenditure of the jointly controlledentity in the separate financial statements of the company isconcerned, the Committee is of the view that a jointly controlledentity has a separate identity different from that of its venturersand accordingly, the assets, liabilities, income and expenditure ofthe jointly controlled entity should be recognised in its own booksof account rather than in the separate financial statements of theventurers. However, the venturer should disclose in its notes toaccounts, the aggregate amounts of each of the assets, liabilities,income and expenses related to its interest in the jointly controlledentities, as required by paragraph 54 of AS 27 reproduced belowand should also disclose other information as required byparagraphs 51, 52, and 53 of AS 27.

“54. A venturer should disclose, in its separate financialstatements, the aggregate amounts of each of the assets,liabilities, income and expenses related to its interests inthe jointly controlled entities.”

14. With respect to recognition of share in the assets of jointlycontrolled entity during the project period and after commissioning,in the separate financial statements of the company as raised bythe querist in paragraph 5(ii) above, the Committee is of the viewthat there will be no difference in the accounting treatment assuggested in the above paragraph.

15. Regarding the issue raised by the querist in paragraph 5(v)above, with respect to the availment of benefit on account ofexcise benefit on capital procurements of the JV, cenvatable servicetax and modality of billing of TC charges, the Committee notesthat it involves pure interpretation of the concerned laws. In viewof Rule 2 of the Advisory Service Rules of the Committee, theCommittee does not answer issues that involve pure interpretationof the legal enactments. Accordingly, this issue is not answered bythe Committee.


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D. Opinion

16. On the basis of the above, the Committee is of the followingopinion in respect of the issues raised in paragraph 5 above:

(i) The contribution made by the company towards the JVequity should be accounted for as an investment in theseparate financial statements of the company assuggested in paragraphs 8 and 9 above. The borrowingsmade and the liabilities assumed by the company forfunding the JV, presumably by contributing to the equityof the JV should appear as the borrowings and liabilitiesof the company. However, if the company undertakes torepay the borrowings and liabilities of the JV, the sameshould be considered as a part of investment and treatedas suggested in paragraph 10 above.

(ii) The company should not account for such a share in theassets of JV in its separate financial statements, only adisclosure is required as discussed in paragraph 13above. Further, the recognition principles will remain thesame for both, during the project period as well as aftercommissioning, as discussed in paragraph 14 above.

(iii) Any share in the liabilities of the jointly controlled entityshould not be recognised in the separate financialstatements of the company, however, a disclosure inrespect thereof is required in the notes to accounts asdiscussed in paragraph 13 above.

(iv) Any expense incurred by the company on behalf of thejointly controlled entity should be accounted for as aninvestment as per the requirements of AS 13. As far asany transaction of sale and purchase between thecompany and jointly controlled entity is concerned, itshould be recognised as a normal sale or purchasetransaction as discussed in paragraph 11 above.However, any share in the income earned or expensesincurred by the jointly controlled entity should not berecognised by the company but only disclosed as per


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the requirements of AS 27, as discussed in paragraph13 above.

(v) This issue has not been answered by the Committee asdiscussed in paragraph 15 above.

(vi) The jointly controlled entity should maintain its ownrecords and books of account as mentioned in paragraph12 above.

Query No. 30

Subject: Accounting for fixed assets held for sale.1


1. The querist has stated that the question on which the opinionof the Expert Advisory Committee is sought relates to fixed assetswith reference to Accounting Standard (AS) 10, ‘Accounting forFixed Assets’, issued by the Institute of Chartered Accountants ofIndia and more particularly with reference to paragraph 27 of AS10 reproduced below:

“27. When a fixed asset is revalued in financialstatements, an entire class of assets should be revalued,or the selection of assets for revaluation should bemade on a systematic basis. This basis should bedisclosed.”

2. According to the querist, the above provision permits a selectiverevaluation, provided it is on a systematic basis. The querist hasstated that the dictionary meaning of systematic is as under:

“pertaining to, or consisting of, for the purpose of, observing,or according to system:methodical: habitual: intentional”

3. The querist has further stated that a company is engaged in


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manufacturing, namely, textiles, engineering precision tools;investment; and business automation, shipping and allied services.The querist has further clarified that the company is not in realestate business. The company has properties (land and buildings)at several places in India, in various business segments, comprisingmanufacturing plants, offices, residential quarters as well as non-operational assets. The company has identified three of itsproperties as the properties held for sale and has revalued thesethree properties, which are held for sale. Apart from these threeproperties, there are other properties which are not held for saleand which are not revalued. Thus, in revaluing the properties, thecompany has adopted a system, namely, properties held for saleare revalued and the properties not held for sale are not revalued.

B. Query

4. The querist has sought the opinion of the Committee as towhether the principle followed, namely, revaluation of all properties,i.e., land and buildings held for sale, and continuing other land andbuildings not held for sale at historical cost, amounts to a systematicbasis and whether such systematic revaluation is within therequirements of the above referred paragraph 27 of AS 10, i.e.,whether AS 10 is complied with.


5. The Committee notes from the Facts of the Case that thequerist has stated that the company in question is not in the realestate business. It can be inferred from the aforesaid that thequery does not relate to assets which are held for sale in theordinary course of business, i.e., inventories.

6. The Committee further notes that when an entity identifies afixed asset as ‘held for sale’, it expects that carrying amount ofthat asset will be primarily recovered through its sale rather thanfrom its continuing use in the production of goods or rendering ofservices. Thus, these assets will no more be of the nature of fixedassets, rather these will be of the nature of current assets.Accordingly, valuation principles applicable to current assets shouldbe applied in the present case. The Committee notes that as per


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the generally accepted accounting principles, current assets arevalued at the lower of the net book value and net realisable value.

7. The Committee notes that AS 10 also prescribes similar typeof treatment in case of fixed assets retired from active use andheld for disposal. In this context, the Committee notes paragraphs24 and 26 of AS 10, which state as follows:

“24. Material items retired from active use and held fordisposal should be stated at the lower of their net bookvalue and net realisable value and shown separately inthe financial statements.”

“26. Losses arising from the retirement or gains or lossesarising from disposal of fixed asset which is carried atcost should be recognised in the profit and lossstatement.”

8. On the basis of the above, the Committee is of the view thatthe company should ascertain the net realisable value of the threeproperties (land and buildings) held by the company for sale andshould value the same at the lower of their net book value and netrealisable value. The resultant loss, if any, should be transferredto the statement of profit and loss. Hence, in the view of theCommittee, the question of revaluation does not arise in the presentcase. Accordingly, paragraph 27 of AS 10 is not applicable here.

D. Opinion

9. On the basis of the above, the Committee is of the opinionthat the land and buildings held by the company for sale should bevalued at the lower of their net book value and net realisable valueand, accordingly, the question of systematic revaluation of theseassets does not arise in the present case as discussed inparagraphs 6 to 8 above.


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Query No. 31

Subject: Treatment of conversion rights for calculation ofdiluted EPS.1


1. A flagship company of a major group is manufacturing textiles.The group is one of the largest textile houses in the country with aturnover of about Rs. 2200 crore and employs around 18,000people. The group has sizeable presence in spinning, weaving,sewing threads, textile processing, acrylic fibre manufacturing andalloy steels.

2. The querist has stated that the company funds its variousexpansions and modernisations through long-term debt. The lenderbanks usually have certain covenants (financial and non-financial),which the company is required to adhere to for the tenure of theloan. One of the clauses in the loan agreement of certain banks(the querist has separately provided a copy of a loan agreementwith the lender for the perusal of the Committee) is conversionright in case of default (emphasis supplied by the querist). Theessence of the said clause is that, in case the company commitsdefault in interest payments and/or repayments due to the bankunder the loan facility, it would give the bank the right to convertthe whole or part of the outstanding amount of the facility into fullypaid-up equity shares of the company at par.

3. The querist has further stated that the Institute of CharteredAccountants of India (ICAI) issued Accounting Standard (AS) 20,‘Earnings Per Share’, which is applicable to the accounting periodscommencing on or after April 1, 2001 and is mandatory in natureto all the companies that are required to give information underPart IV of Schedule VI to the Companies Act, 1956. According tothe querist, AS 20 requires disclosure of the basic and dilutedearnings per share (EPS) on the face of the profit and loss accountin the annual report of the company. As per the querist, for thecalculation of diluted EPS, net profit or loss for the period attributableto equity shareholders and the weighted average number of equity


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shares outstanding during the period should be adjusted for theeffects of all dilutive potential equity shares (emphasis supplied bythe querist). A potential equity share has been defined under AS20 as “a financial instrument or other contract that entitles, ormay entitle, its holder to equity shares”. Further, the examplesof potential equity shares, inter alia, include “shares which wouldbe issued upon the satisfaction of certain conditions resulting fromcontractual arrangements (contingently issuable shares), such asthe acquisition of a business or other assets, or shares issuableunder a loan contract upon default of payment of principal orinterest, if the contract so provides.”

4. The querist has also stated that although this dilution isconditional, still, in order to comply with the requirements of AS20, at the time of calculation of the diluted EPS of the company,the company assumes that the entire loan outstanding with thebank for the relevant period is converted into equity shares at par[in accordance with the definition of potential equity shares, “afinancial instrument or other contract that entitles, or mayentitle, its holder to equity shares”(emphasis supplied by thequerist)].

5. According to the querist, disclosure of diluted EPS dilutes theequity and creates a confusion in the minds of investors that eitherthe company has defaulted or has given a commitment to a lenderto convert the loan into equity at par. The basic and diluted EPS ofthe company for the last 2 years is as follows:

Particulars As on 31.03.05 As on 31.03.06

Basic EPS 20.90 33.98

Diluted EPS 9.47 16.50

Thus, in the view of the querist, EPS gets deteriorated on thedilution basis and does not represent the clear and fair portrayal ofthe company’s performance, even though the contingent eventhas not occurred and is not likely to occur, going by the past trackrecord of the company which has never defaulted on a singlepayment to a financial institution. But, in order to adhere to therequirements of AS 20 (i.e., disclosure of diluted EPS), the company


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has to calculate and disclose the diluted EPS also. It creates anegative impression about the company’s performance to theexisting investors or potential investors. It is not possible for thecompany to explain this phenomenon to each and everyshareholder.

6. Considering the above, as per the querist, disclosing a dilutedEPS under the said conversion clause of the lender gives a distortedpicture about the company and the company feels that non-incorporation of this clause for the calculation of diluted EPS maynot be misleading. Furthermore, this conversion clause is a part ofthe standard documentation of a few of the major term lenders inthe market and every industry would be availing loans from them.However, the querist has noted from the results of these companiesthat none of such companies appear to reflect the impact of thisparticular clause in their diluted EPS. The querist, therefore, believesthat the interpretation made by the company with regard to thisclause may not be correct.

B. Query

7. On the basis of the above, the querist has requested theExpert Advisory Committee to give its interpretation of this clausevis a vis the covenant of conversion clause in the loandocumentation and give its opinion on inclusion of this covenantfor calculation of diluted EPS. Also, since the company has neverdefaulted, the querist has argued that this condition of conversionbecomes superfluous for the company and has requested that thestipulation regarding the disclosure of the diluted EPS be interpretedin a manner that only companies which have defaulted in paymentof debt are required to disclose the same.


8. The Committee while answering the query has consideredonly the issues raised in paragraph 7 above and has not touchedupon any other issue arising from the Facts of the Case, such as,whether the potential equity shares under conversion clause aredilutive or anti-dilutive, etc.

9. The Committee notes from clause (b) of Section 8.3, ‘Other


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Consequences of Default’ of the agreement of the company withthe lender that it provides for the conversion right to the lenderand specifically states that if the borrower commits a default inpayment or repayment of three consecutive instalments of principalamounts of the loan(s) or interest thereon or any combinationthereof, then, the lenders shall have the right to convert at theiroption the whole of the outstanding amount of the loans into fullypaid-up equity shares of the borrower, at par, in the mannerspecified in the notice of conversion to be given by the lenders tothe borrower. The Committee notes the examples of potentialequity shares, as given by paragraph 7 of AS 20, which are asfollows:

“7. Examples of potential equity shares are:

(a) …

(d) shares which would be issued upon the satisfactionof certain conditions resulting from contractualarrangements (contingently issuable shares), suchas the acquisition of a business or other assets, orshares issuable under a loan contract upon defaultof payment of principal or interest, if the contract soprovides.”

10. The Committee further notes paragraphs 26, 27(b) and 34 ofAS 20, which provide as follows:

“26. For the purpose of calculating diluted earnings pershare, the net profit or loss for the period attributable toequity shareholders and the weighted average number ofshares outstanding during the period should be adjustedfor the effects of all dilutive potential equity shares.

27. In calculating diluted earnings per share, effect is givento all dilutive potential equity shares that were outstandingduring the period, that is:

(a) …

(b) the weighted average number of equity sharesoutstanding during the period is increased by the


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weighted average number of additional equity shareswhich would have been outstanding assuming theconversion of all dilutive potential equity shares.”

“34. Equity shares which are issuable upon the satisfactionof certain conditions resulting from contractual arrangements(contingently issuable shares) are considered outstanding andincluded in the computation of both the basic earnings pershare and diluted earnings per share from the date when theconditions under a contract are met. If the conditions have notbeen met, for computing the diluted earnings per share,contingently issuable shares are included as of the beginningof the period (or as of the date of the contingent shareagreement, if later). The number of contingently issuableshares included in this case in computing the diluted earningsper share is based on the number of shares that would beissuable if the end of the reporting period was the end of thecontingency period. Restatement is not permitted if theconditions are not met when the contingency period actuallyexpires subsequent to the end of the reporting period. Theprovisions of this paragraph apply equally to potential equityshares that are issuable upon the satisfaction of certainconditions (contingently issuable potential equity shares).”

11. The Committee notes from the definition of ‘potential equityshare’ (as reproduced in paragraph 3 above) and the abovereproduced paragraphs of AS 20 that AS 20 requires adjustmentof the net profit attributable to equity shareholders and the weightedaverage number of shares, for the effects of all dilutive potentialequity shares for the purpose of calculating diluted EPS. TheStandard does not exempt a dilutive potential equity share frominclusion in the computation of diluted EPS on any ground, e.g.,as argued by the querist in paragraph 4 above that the dilution isconditional. In the view of the Committee, the objective of disclosingthe diluted EPS is to give an idea to the readers/users of thefinancial statements about the potential equity shares that maydilute the earnings attributable to the equity shareholders, eventhough the dilution is conditional and contingent. Moreover, thecontingently issuable shares mean those potential equity shares,


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where there is a possibility of issuance of these shares on fulfillmentof certain conditions, even though such circumstances do not existat present and are not even experienced in the past. Had therebeen no contingency and the conditions had been met, then thesewould have been included in the calculation of basic EPS as well.Accordingly, in the view of the Committee, the contingently issuableshares on default of payment of loan or interest, under theconversion clause of the loan agreement, should be included forcalculation of diluted EPS. The fact that some other companiesare not including the aforesaid conversion rights for the purpose ofcomputing ‘potential equity shares’ is no argument for notconsidering such shares as ‘potential equity shares’.

D. Opinion

12. On the basis of the above, the Committee is of the opinionthat the disclosure of diluted EPS can not be interpreted in themanner to include only those potential equity shares under theconversion clause where the companies have either defaulted inthe past or will default in future, in the computation of diluted EPS.Accordingly, the company should include all dilutive potential equityshares, including those shares, which are issuable upon default ofpayment of loan or interest under a loan agreement, in thecalculation of diluted EPS.

Query No. 32

Subject: Recognition of Duty Credit Entitlement Certificatesissued under the ‘Served from India Scheme’.1


1. An enterprise was formed by merger of two enterprises on 1stApril, 1995 by an Act of Parliament. The enterprise is notincorporated under the Companies Act. It is governed by the



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Airports Authority of India (AAI) Act, 1994. Its mission is to progressthrough excellence and customer satisfaction with world-classairport and air traffic services fostering economic development. Itsmain functions are to build, operate and maintain airports andairstrips; and provide air-traffic services to airlines.

2. The enterprise maintains 127 airports throughout India, viz.,15 international airports, 86 domestic airports and 26 civil enclaves.It earns foreign exchange by providing air-traffic services and otherairport services to foreign airlines in India. It also provides enrouteair traffic services to foreign airlines passing through/over India.

3. The querist has stated that the accounts of the enterprise aredrawn up in the format approved by the Government under section41 of the AAI Act, 1994 and the AAI (Annual Report and AnnualStatement of Accounts) Rules, 2003. The enterprise is broadlyfollowing Accounting Standards prescribed by the Institute ofChartered Accountants of India. The Comptroller and AuditorGeneral of India (C&AG) is the sole auditor of the enterprise.

4. The querist has further stated that the Government of Indiahas introduced many schemes for promotion of exports, like exportincentives under Duty Entitlement Pass Book (DEPB) scheme,EPCG scheme, etc. The enterprise is entitled to import goodsspecified in list 20 appended to Notification No. 21 / 2002-Customsdated 01.03.2002, required for development of airports atconcessional customs duty of 10%.

5. According to the querist, the Director General of Foreign Trade(DGFT), Government of India, has announced a ‘Served fromIndia Scheme’. Under the Scheme, all service providers (otherthan hotels and restaurants) shall be entitled to duty creditequivalent to 10% of the foreign exchange earned by them in thepreceding financial year. During March 2005, the enterprise obtainedduty credit certificates (duty credit entitlement) from the DGFTunder the ‘Served from India Scheme’ amounting to Rs.70.84crore. The certificates were issued on 30th March, 2005.

6. The salient features of the duty credit certificates as per thequerist are as under:


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(a) These certificates are valid for 2 years from the date ofissue.

(b) Duty credit entitlement may be used for import of anycapital goods including spares, office equipment andprofessional equipment, office furniture and consumables,provided it is part of the main line of business.

(c) The entitlement and the goods imported shall be non-transferable (emphasis supplied by the querist.)

7. The querist has stated that during the year 2005-06, theenterprise utilised duty credit certificates amounting to Rs.11.25crore for use in the import of capital goods and Rs.7.21 crore forimport of spares, totalling Rs.18.46 crore. As the enterprise hadnot paid any customs duty for capital items imported during theyear 2005-06 for its operation, only the cost paid by the enterprise(i.e., without customs duty) was capitalised in the books of account.Similarly, as no customs duty was paid for import of spares, thecost actually paid by the enterprise was charged to the profit andloss account without customs duty.

8. The querist has further informed that the enterprise hasappointed a consultant for liaisoning with the customs department,who is paid service charges based on duty credit certificates utilisedon import of any consignment for its operations.

9. The querist has also stated that before getting duty creditcertificates, the enterprise used to get concessional duty benefitson certain items and used to account for such items on cost basisand customs duty (concessional) actually paid.

10. In the view of the querist, as the enterprise has not paid anycustoms duty for capital items imported during 2005-06 for itsoperation, only the cost paid by the enterprise (without customsduty) should be taken as the cost for capitalisation of assets in itsbooks of account on the basis of requirement of AccountingStandard (AS) 10, ‘Accounting for Fixed Assets’, issued by theInstitute of Chartered Accountants of India, which states that thecost of an item of fixed asset comprises its purchase price, includingimport duties and other non-refundable taxes or levies and any


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directly attributable cost of bringing the asset to its working conditionfor its intended use; any trade discounts and rebates are deductedin arriving at the purchase price. Similarly, no customs duty waspaid for import of spares, accordingly, the cost paid by the enterprisewas charged to the profit and loss account without customs duty.

B. Query

11. During audit of annual accounts of the enterprise for thefinancial year 2005-06, the following issues came up for decision,on which the querist has sought the opinion of the Expert AdvisoryCommittee:

(i) Whether the amount of Rs. 70.84 crore being the valueof duty credit entitlement certificates obtained from DGFTunder the ‘Served from India Scheme’ is required to beconsidered as income of the enterprise and booked asincome in the books of account.

(ii) Whether the duty credit entitlement certificates utilisedfor payment of customs duty in respect of capital itemsprocured should be added to the cost of such items.

(iii) Whether the value of duty credit entitlement certificatesutilised for purchase of stores and spares should beincluded in the cost of such spares.

(iv) Whether the commission/service charges payable toconsultant for utilising the duty credit entitlementcertificates is to be added to the cost of the items importedby the enterprise for its use or to be charged off.

(v) Whether the balance value of duty credit certificates (Rs.70.84 crore minus Rs. 18.46 crore = Rs. 52.38 crore)lying unutilised at the end of the year, i.e., 31

st March,

2006, is to be treated as a current asset and accountedfor as such.


12. The Committee notes that the basic issue raised in the queryrelates to the recognition of duty credit entitlement certificates


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issued under the ‘Served from India Scheme’, i.e., how this benefitshould be recognised in the books of account, and whether thebalance of duty credit entitlement certificates lying unutilised at theend of the year should be recognised as ‘current assets’, i.e., thetiming of recognition of the duty credit entitlement and presentationthereof. In this regard, the Committee notes that even though theentitlement received under the Scheme does not strictly fall withinthe definition of the term ‘revenue’, as defined under AccountingStandard (AS) 9, ‘Revenue Recognition’, issued by the Institute ofChartered Accountants of India, such duty credit entitlement is ofthe nature of revenue and accordingly, it should be recognised as‘other income’ in the books of account of the enterprise providedthe conditions for recognition of revenue as discussed in paragraph14 below are satisfied.

13. As far as the question regarding whether the duty creditentitlement certificates, i.e., duty credit entitlement utilised forpayment of customs duty in respect of capital items and storesand spares should be added/included in the cost of such items isconcerned, the Committee notes from paragraph 7 above that atthe time of purchase of these items, the enterprise is recording thecapital items, and stores and spares at the cost incurred net ofduty. In this regard, the Committee notes paragraph 9.1 ofAccounting Standard (AS) 10, ‘Accounting for Fixed Assets’, andparagraphs 6 and 7 of Accounting Standard (AS) 2, ‘Valuation ofInventories’, issued by the Institute of Chartered Accountants ofIndia, which state as follows:

AS 10





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AS 2

“6. The cost of inventories should comprise all costsof purchase, costs of conversion and other costs incurredin bringing the inventories to their present location andcondition.

7. The costs of purchase consist of the purchase priceincluding duties and taxes (other than those subsequentlyrecoverable by the enterprise from the taxing authorities),freight inwards and other expenditure directly attributable tothe acquisition. Trade discounts, rebates, duty drawbacks andother similar items are deducted in determining the costs ofpurchase.”

From the above, the Committee is of the view that the cost ofpurchase of fixed assets, consumables, spares, etc. should berecorded at their full value inclusive of the customs duties payablethereon whether by way of payment in cash or whether by way ofutilisation of duty credit entitlement, with a view to provide thefairest possible approximation to the costs incurred in bringingthese items to their present location and working condition. Forthe errors in the preparation of financial statements of prior periods,necessary adjustments should be made. Any income or expensearising as a consequence of making such adjustments should bedisclosed as ‘prior period item’ in the determination of net profit orloss for the current period as per the provisions of AccountingStandard (AS) 5, ‘Net Profit or Loss for the Period, Prior PeriodItems and Changes in Accounting Policies’, issued by the Instituteof Chartered Accountants of India.


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14. With regard to the issue raised by the querist in paragraph11(v) above, relating to accounting treatment of the balance valueof duty credit entitlement certificates lying unutilised at the end ofthe year, the Committee notes that it depends on when the revenuein respect of the duty credit entitlement certificates is recognised.As far as the timing of recognition of the revenue in respect thereofis concerned, the Committee is of the view that since there arecertain uncertainties involved with respect to the utilisation of dutycredit as these certificates are non-transferable and are valid onlyfor 2 years from the date of issue, as stated by the querist inparagraph 6 above; and since this benefit is of the nature ofrevenue, as discussed in paragraph 12 above, the principlesenunciated under paragraph 9.1 of AS 9 regarding timing ofrecognition would be applicable, which states as follows:

“9.1 Recognition of revenue requires that revenue ismeasurable and that at the time of sale or the rendering ofthe service it would not be unreasonable to expect ultimatecollection.”

Keeping in view the above-mentioned revenue recognition principleof AS 9, the Committee is of the view that the credit under theScheme should be recognised only at the time when and to theextent there is no significant uncertainty as to its measurability andultimate realisation, i.e., utilisation of the credit under the Scheme.The assessment of the level of uncertainty is a matter of judgementbased on the facts and circumstances of each case on consideringfactors, such as, utilisation of duty credit within the specified periodas evidenced by the existence of a binding contract for purchaseof allowable specified goods against which the duty credit can beutilised; the expected cost of purchase of the imported allowablespecified goods vis-à-vis the cost thereof in the domestic market;etc. Events occurring between the balance sheet date and thedate on which the financial statements are approved by thegoverning authority may also remove the uncertainty about theutilisation of the duty credit, e.g., imports are made after the balancesheet date but before the approval of the financial statements bythe governing authority, against which the duty credit has beenutilised. Thus, in the view of the Committee, the enterprise should


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recognise the duty credit entitlement in the profit and loss accountas its ‘other income’ on the above basis, by debiting the ‘dutycredit entitlement account’ and crediting the profit and loss account.At the time of purchase of fixed asset or spares, etc., such creditentitlement should be adjusted against the duty payable on theimport of these items. The balance of duty credit entitlementstanding in the books of account, remaining unutilised, if any, atthe end of the year should be disclosed under the head ‘Loansand Advances’, on the ‘Assets’ side of the balance sheet since, itis of the nature of pre-paid expenses which would be adjustedagainst the customs duty expenses in future period.

15. As regards the commission/service charges payable toconsultant for utilising the duty credit entitlement certificates, theCommittee is of the view that these charges do not add any valueto the items so imported and are not directly attributable expenses,i.e., the costs without the incurrence of which the transaction wouldnot have taken place. Accordingly, these should not be added tothe cost of the items; instead, these should be charged to theprofit and loss account when incurred.

D. Opinion


(i) The revenue in respect of the duty credit entitlementcertificates should be recognised as income in the booksof account when and to the extent there is no significantuncertainty as to their ultimate realisation, i.e., utilisationof the credit under the Scheme as discussed in paragraph14 above.

(ii) The capital items procured should be recorded at thevalue inclusive of the customs duty payable thereonwhether by way of cash or by way of adjustment of theduty credit entitlement. Please refer to paragraph 13above.

(iii) The stores and spares should be recorded at the value


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inclusive of the customs duty payable thereon whetherby way of cash or by way of adjustment of the duty creditentitlement. Please refer to paragraph 13 above.

(iv) The commission/service charges payable to consultantfor utilising the duty credit entitlement certificates shouldnot be added to the cost of the items imported by theenterprise. These expenses should be charged to theprofit and loss account as discussed in paragraph 15above.

(v) The balance value of duty credit entitlement certificateslying unutilised at the year-end should be disclosed underthe head ‘Loans and Advances’ on the ‘Assets’ side ofthe balance sheet provided they have been recognisedas revenue on the basis of considerations discussed inparagraph 14 above.


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ADVISORY SERVICE RULES OFTHE EXPERT ADVISORY COMMITTEE

1. Queries should be stated in clear and unambiguous language.Each query should be self-contained. The querist shouldprovide complete facts and in particular give the nature andthe background of the industry or the business to which thequery relates. The querist may also list the alternative solutionsor viewpoints though the Committee will not be restricted bythe alternatives so stated.

2. The Committee would deal with queries relating to accountingand/or auditing principles and allied matters and as a generalrule, it will not answer queries which involve only legalinterpretation of various enactments and matters involvingprofessional misconduct.

3. Hypothetical cases will not be considered by the Committee.It is not necessary to reveal the identity of the client to whomthe query relates.

4. Only queries received from the members of the Institute ofChartered Accountants of India will be answered by the ExpertAdvisory Committee. The membership number should bementioned while sending the query.

5. The fee charged for each query is as follows:

(i) Rs. 25,000/- per query where the query relates to:

(a) an enterprise whose equity or debt securities are listedon a recognised stock exchange, or

(b) an enterprise having an annual turnover exceedingRs.50 crore based on the annual accounts of theaccounting year ending on a date immediatelypreceding the date of sending the query.

(ii) Rs. 10,000/- per query in any other case.

The fee is payable in advance to cover the incidental expenses.Payments should be made by crossed Demand Draft or chequeor Postal Order payable at Delhi or New Delhi drawn in favour


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of the Secretary, The Institute of Chartered Accountants ofIndia.

6. Where a query concerns a matter which is before the Boardof Discipline or the Disciplinary Committee of the Institute, itshall not be answered by the Committee. Matters before anappropriate department of the government or the Income-taxauthorities may not be answered by the Committee onappropriate consideration of the facts.

7. The querist should give a declaration in respect of the followingas to whether to the best of his knowledge:

(i) the equity or debt securities of the enterprise to which thequery relates are listed on a recognised stock exchange;

(ii) the annual turnover of the enterprise to which the queryrelates, based on the annual accounts of the accountingyear immediately preceding the date of sending the query,exceeds Rs. 50 crore;

(iii) the issues involved in the query are pending before theBoard of Discipline or the Disciplinary Committee of theInstitute, any court of law, the Income-tax authorities orany other appropriate department of the government.

8. Each query should be on a separate sheet and five copiesthereof, typed in double space, should be sent. The Committeereserves the right to call for more copies of the query. Whilesending the hard copies of the query is necessary, a copy ofthe query can also be sent on a floppy or through E-mail [email protected]

9. The Committee reserves its right to decline to answer anyquery on an appropriate consideration of facts. If theCommittee feels that it would not be in a position to, or shouldnot reply to a query, the amount will be refunded to the querist.

10. The right of reproduction of the query and the opinion of theCommittee thereon will rest with the Committee. TheCommittee reserves the right to publish the query togetherwith its opinion thereon in such form as it may deem proper.

The identity of the querist and/or the client will, however, notbe disclosed, as far as possible.

11. It should be understood clearly that although the Committeehas been appointed by the Council, an opinion given or aview expressed by the Committee would represent nothingmore than the opinion or view of the members of theCommittee and not the official opinion of the Council.

12. It must be appreciated that sufficient time is necessary for theCommittee to formulate its opinion.

13. The queries conforming to above Rules should be addressedto the Secretary, Expert Advisory Committee, The Institute ofChartered Accountants of India, ‘ICAI Bhawan’, IndraprasthaMarg, New Delhi-110 002.


236

INDEX Vols. I to XXVI*

*Prefix ‘I’, ‘II’, ‘III’, ‘IV’, ‘V’, ‘VI’, ‘VII’, ‘VIII’, ‘IX’, ‘X’, ‘XI’, ‘XII’, ‘XIII’, ‘XIV’, ‘XV’, ‘XVI’, ‘XVII’, ‘XVIII’, ‘XIX’,

‘XX’, ‘XXI’, ‘XXII’, ‘XXIII’, ‘XXIV’, ‘XXV’ and ‘XXVI’ before the page numbers indicate the respectivevolumes of Compendium of Opinions.

A

Abnormal losses in naturedemurrage XX-20

Above the line I-29, I-60 to 61,I-108

Absorption costing VII – 62Account books lost / damaged /

destroyed 1-252 to 253Accounting

basis of, for Income taxpurpose XVII-50

estimates XXI - 72for additional costs expected

due to pay scale revisionunder a cost plus contractXVIII-13

for additional interest cost tohedge foreign exchangerisk XXI-181

for advance training fees andregistration fees XXI-177

for amount received ontransfer of right to receivepower XXII-86

for amount received undertatkal scheme fromcustomers XIX-102

for assets whose title is sub-judice XI-48

for cash rebate for promptpayment XXII-169

for change in treatment ofcurrent assets as fixedassets XI-95

for changes in foreignexchange rates, effects ofX-6; XIII-11, XIII-28,XIII-56; XIV–56; XVIII-1,XVIII-71; XIX-56; XXI-15(See also under “Foreign”and “Foreign exchangerate fluctuations,accounting for”)

for cheques received afterbalance sheet date XXIV-71

for costs in a serviceorganisation XVI-24

for credit card reward pointschemes XXI-129

for customs duty and exciseduty X-23; XI-157; XII-19;XXI-57

for deduction from invoiceprice XIX-71; XXI-61

for deferred entitlement ofLTC/LLTC XXII-16

for development and leasingof industrial estate XX-71;XXVI-12

for disputed telephone billsXV-58; XIX-71

for duty credit entitlementunder Served from IndiaScheme XXVI-181, 225

for duty credit entitlementunder Target PlusScheme XXVI-148

for duty free import underDEPB scheme (see also

Compendium of Opinions – Vol. XXVI

238

‘DEPB scheme’) XX-96;XXIV-12

for excess provision for badand doubtful debts XI-39

for expenditure during shut –down period XVI-19

for expenditure incurred aftercapitalisation date XI-33

for expenditure ondistribution of mementosto employees duringconstruction period XXVI-187

for exports by businessassociates XVI-43, XVI-47; XXVI-88

for export credit receivableunder DEPB Scheme(see also ‘DEPB scheme’)XVIII-40; XX-96

for factored debts XXI-202for gain arising on account of

foreign exchangefluctuations XVIII-1; XX-64

for goods sent for customer’sapproval XIV-32

for incidental expenditure ontransmission lines readyfor use but not inoperation XXIII-58

for income and expenditureincurred duringdevelopment of ore bodyof the existing mine XXII-129

for initial issue expenses byopen-ended mutual fundschemes XX-115

for interest earned on fundsreceived from governmentfor acquisition of fixedassets XVIII-29

for interest on overdue out-standings XV-2; XIX-159

for interest wrongly receivedXVI-36

for internally manufacturedspares IX-87

for land development IX-2,IX-9, IX-56; X-49; XX-71

for lease rentals XIX-17; XX-30

for left over materials XIV-39for licence fee payable to

DoT XVI-1for loan arranged by

contractor through atripartite agreement XIX-9

for loan transactionsinvolving petroleumproducts XV-31;XVI-14

for loss incurred on the saleof non-convertibledebentures XIII-89

for loss of fixed asset IX-92;X-39

for mandatory refurbishmentcost XXIV-128

for MODVAT credit on capitalgoods XVI-2; XXI-190

for moulds and dies XX-4for notional loss/premium on

sales XIII-107for operating lease by manu-

facturers XIII-103for orchid plants XXI-35for premium received on land

XII-71for professional fees paid to

directors I-200for profit on settlement of

insurance claim XI-89for profit arising from a sale

& lease back transactionXIII-101


239

for provisions made in earlieryears XII-92

for renunciation of rightssharesXI-41

for replacement cost of a partof fixed asset XVIII-66

for revision in pay scalesretrospectively XII-102;XVIII-13

for rolls used in a mill XIV-87for sales and purchases

made by businessassociates XVI-43,XVI-47, XVI-73

for sales tax concession XI-51; XX-14

for salvaged fixed assets X-84

for service charges forrepairs/replacement ofgoods in transit XI-70

for settlement allowance paidto employees onretirement XVIII-60; XXII-183

for share issue expensesand interest earned onsurplus funds, pendingcommence-ment ofcommercial productionXIII-75

for software developmentcostXI-146; XVI-11

for special tools, jigs andfixtures XVIII-53

for stores MODVAT A/cadjusted to Excise Dutypaid A/c XXI-190

for subsidy received fromstate government for

repayment of loan takenfor fixed assets andcapitalised interest XVIII-36

for surcharge in the nature ofinterest on overdueoutstandings XVIII-6

for taxes on income VII-73;XI-171

for technical know-how XVIII-20

for unclaimed amount ofbondsXII-61

for unencashable leave XIX-124; XX-90

for unsold site XVI-9for waiver of interest

capitalised as part of thecost of fixed assets priorto commencement ofcommercial productionXXIII-131

for waiver of loan andinterest thereon XVIII-47;XIX-99

for waiver of penal interestXI-27; XXII-70

hybrid system 1-91, 1-96;XIV-70

of additional interest payableafter repayment ofprincipalXXI-220

of import duty and voyageexpenses on import ofdredger XXI-231

of penalty & interest payableunder the Income TaxAct, 1961 XIII-48

in a not-for-profitorganisationVII-67

method, change in I-54 to 55,I-91 to 93; VII-47; XII-38,


240

XII-111; XIII-93; XIX-66;XX-121; XXI-13

period/year I-96 to 98; III-36to 37

policies I-115, I-144; IV – 11;VII-47, VII-87; XII-38;XVIII-72; XXI-13; XXIII-157

real estate IX-2, IX-9; XXVI-12

standard 2, applicability inpower sector companiesXXV-148, XXV-182

standard 2, regardingMODVAT credit on inputsXV-11

standard 3, applicability tosection 25, Govt. unlistedcompany XXVI-58

standard 4, applicability inincome-tax demandsXIV-64

standard 7, applicability todredging contracts XIV-71applicability to an unsoldsite XVI-9applicability toconsultancy businessXXV-140applicability to turnkeyprojects XXI-109percentage of completionmethod XX-100; XXI-103,109; XXV-140applicability to enterprisesundertaking constructionactivities on their ownaccount as a venture ofcommercial nature XXIII-95

standard 7, valuation ofequipment to be used in

ship under constructionXXI-187

standard 9, applicability todredging contracts XV-65

standard 9, increase inrevenue because of salestax exemption XX-14

standard 10, spares (seealso ‘machinery spares’)XX-40;XXIII-14

standard 11, applicability totransactions entered intobefore 1-4-2004 XXIV-36

standard 11, gain/loss fromcancellation of foreignexchange forwardcontract XXVI-142

standard 12, Sales Taxexemption XX-14

standard 17, identification ofreportable segment XXVI-49, 79

standard 18, applicabilityXXIII-174; XXVI-58

standard 19, applicability forassets leased before 1-4-2001 XXIV-28

standard 20, computation ofweighted average no. ofshares in case of bonusissue XXV-113

standard 20, treatment ofconversion rights forcalculation of Diluted EPSXXVI-220

standard 21, applicabilityXXI-193; XXII-172

standard 22, XXV-135, XXV-201

standard 23, applicability inthe preparation ofseparate financialstatements XXV-57


241

standard 27, accounting andreporting of interest injointly controlled entityXXVI-209

standard 28, applicability topetroleum industry XXIV-105applicability to telecomindustry XXV-131

standards interpretation 6,MAT resulting into timingdifferences XXV-145

standards interpretation 9,virtual certainty XXIV-54

system for an advertisingcompany VII-33

year different from uniformaccounting year VIII-101

Accountsadoption of accounts by a

special committee III-40amendment in VII-36 (see

also ‘reopening’ and‘revision’ under this head)

annual general meeting andIII-18 to 20

annual, where managementtaken over X-18

authentication / approval ofII-42; III-5; VI-34; XIII-121

certification of I-80finalisation of previous years’

accounts XIV-115not adopted (use in

subsequent years’) I-256not approved by board IX –

15of Public Provident Fund

Trust XI-6re-opening of I-78receivable/payables, write-

off/ back XIV-90recertification of VI-23reconstruction of I-252rectification of XVI-5; XX-1

revision of V-30; VI-23unaudited III-18 to 20

Accrual of LTC payable XIV-84;XXII-16

Accrual system/basis ofaccountingIX-42; X-16; XI-180; XIII-93; XV-3; XVI-85; XX-80;XXI-211, 220; XXII-16, 45,169; XXIII-29

Accrued income, share inundistributed surplus ofan AOP XIX-90

Accumulated deferred taxliability XXII-45

Actuarial valuation XXI-72;XXIII-99

Admission of partner in CA firmIX-106

Advance licence VII-4; X-46, X-58; XII-48; XIV-52; XVI-51

Advance training fees,accounting XXI-177

Advance tax I-249, XXIV-96;XXVI-166

Advancesagainst depreciation to be

recovered through tariffXVII-98; XXV-37

against purchase of fixedassets VIII-52

bridge loans, whether XII-67on capital account IV-15partly secured bank

advancesI-5

received for export XIX-49received under Tatkal

scheme for LPG cylindersXIX-102

Adverse opinion (‘See Negativeopinion’)

Advertisement cost on purchaseof investments XIX-94

Advertisement expenses VII-9


242

Advertising companyaccounting system for VII-33disclosure of turnover by an

X-88Agency fee XX-150Agency relationship, revenue

recognition XXVI-88, 190Agent I-6, I-116, I-154 to 156;

XXVI-88, 190Agricultural operations I-233; III-

12 to 15; XXI-35Agricultural company, land

development expenditureby X-49

Air conditioning plant XVII-79Aircraft XXV-62, XXV-80Allocable surplus I-259, I-272Allotment of shares by holding

company to its subsidiaryXIV-139

Allotment of shares topromoters XXI-124

Amalgamationaccounting treatment of

reserves XXIII-109accounting treatment of

revaluation reserve in V-1approval of Central

Government forappointment of directors,in case of VIII-103

in the nature of merger V-4;XXIII-109

in the nature of purchase V-5transfer of Reconstruction

reserve to Generalreserve XV-23

Amortisation of goodwill,trademarks andcopyrights XVII-86

Amortisation of right to use ofland not having futureeconomic benefits XXV-170

Annual General Meeting VI-1

Annual maintenance contractsX-32

Appointment of Auditors (seealso ‘Auditors’)

as internal auditors aftercompletion of tenure asstatutory auditors XXI-217

as internal auditors of a bankwhere a partner of thefirm is a guarantor of aloan exceeding Rs. 1000VIII-65

as statutory auditors, whenone of the firm’s partnersis a director in holdingcompany XVII-84

brother of director’s wife, forXIV-137

by a non-operator for audit ofthe operator’s accountsXXII-1

disqualifications, for IX-1in an adjourned General

Meeting VI-1in case of Extraordinary

General Meeting VII-81in case of voluntary

liquidationVII-80

in place of retiring auditorXIII-128

of a relative of a director VI-58

of a sole proprietor in acompany in which apartner of the soleproprietor in another firmof Chartered Accountantshas interest VII-50

of an employee CharteredAccountant V-50

of an erstwhile director VIII-64

of government company XI-1


243

of statutory auditor asinternal auditor XXII-1

of the same firm by bothoperator and non-operatorof a venture separatelyXXII-1

through memorandum andarticles of association I-189

Apportionment, basis foroverheads XI-38; XXII-72,132

Apportionment of amountreceived betweenprincipal and interest XIX-159

Apportionment of product costXXI-28

Arbitration award XXV-1Arrears of preference dividend

XI-219Assets (See also ‘Fixed Assets’)

constructed on behalf ofothersVII-75

disclosure in the balancesheet of lessor IV-2

disclosure where purchasedfor a consolidated price X-11

exchange of IX-50 to 56in use but completely written

off VI-71; IX-18location of, under

MAOCARO X-78loss of IX-92; X-39, X-147non-depreciable XXV-170not belonging to the

company XV-8provided to an outside

agency XXV-157revalued I-4, I-39 to 41, I-51,

I-162 to 172; X-172right of use of XIX-119; XIX-

128; XXV-170

salvaged, used for otherfixed assets X-84

self constructed III-7sold after completion of

construction project XII-4taken over I-22; X-18title sub-judice XI-48total, meaning thereof as per

schedule VI of CompaniesAct, 1956 XXIV-146

used in foreign projects X-140

valuation from incompleterecords IX-50

valuation of BSE tradingrights acquired inexchange of BSEmembership cards XXVI-172

valuation, treatment ofliquidated damages XI-177

valuation where all costsdebited to a compositeaccount IX – 61

with outside agency XXV-157

written off without priorauthority VI-18

written off valuing below Rs.10,000 IX-18

Associates, valuation ofinvestments in XXV-57

Association of persons,investments in XIV-109

Association of persons, share inundistributed surplus XIX-90

Auditauthentication of documents

during XIV-122based on duplicate books I-

81; IX-32


244

branch I-9,I-10, I-236by C&AG XXIV-101change in the name of firm

VII-24; IX-106compliance with accounting

standards XXIII-14confirmation of debtors’

balances VIII-48damaged books of account I-

252evidence VIII-44, VIII-62; IX-

27, IX-32; XI-60; XXI-55,215; XXIII-117

fees I-175, I-176, I-178, I-181; XI-223

of banks II-29 to 30; VI-58of consolidated financial

statements XXIV-101of co-venturer by the

statutory auditor XXII-1of expenditure incurred by a

director on foreign tripsXXIII-117

of gifts VIII-62of government company

XXIV-101of provident fund trust XI-6of subsequent period’s

accounts when precedingperiod’s accounts notconsidered by the generalbody XII-100

of previous years’ accountsin current year XIV-115

of quarterly / half-yearlycomplete set of financialstatements XXII-149

supplementary III-34 to 36under Income Tax Act, by

statutory auditor XVII-50where firm reconstructed

VIII-24; IX-106where opening balances not

available VIII-43

where relatives holding placeof profit I-77; V-13; VI-58,VI-60

where supporting vouchers/records seized by I.T.authorities IV-28; IX-27,IX-32

working papers, period ofmaintenance XVII-74

Audit materiality XXI-211; XXIII-105

Audit reportadverse opinion in VII-17; X-

109; XXV-225amendment / suppression of

I-51; IV-30branch auditors’ comments

in VII-50 to 53consolidated financial

statements XXII-172disclaimer in VIII-46, VIII-63;

IX-28; XXV-225in the context of S. 227(2) &

227(3)(d) XXI-11, 20, 72,98, 227

in the context of S. 295 II-43;VI-14

manner of qualificationwhere AS 22 not compliedwith XXII-45

MAOCARO-VII-37 [See also‘Manufacturing and OtherCompanies (Auditor’sReport) Order’]

negative opinion in VII-17;X-109; XXV-225

‘nil’ comments in CAG’s XI-24

on accounts not approved bythe board of directors IX-15

on quarterly / half-yearlycomplete set of financialstatements XXII-149


245

qualifications regardingcapitalisation ofRevaluation Reservepertaining to an earlieryear XVII-1

qualifications regarding initialissue expenses XX-115

qualifications, manner ofmaking in XII-107

qualification on accrual basisof accounting regardingpre-paid expenses XXI-211

qualifications on revisedaccounts XVI-91

qualifications regardingcontra-vention of statutesVI-13, VI-78; VII-1

qualifications regardinginventory valuation XI-65;XXI-98

qualifications regarding non-genuine commissionpayments XII-50

regarding matter contained inthe Directors’ Report VI-80

revised V-30; VI-24stock V-11where deemed public

company becomes privatecompany X-177

when evidence is notsufficient appropriateaudit evidence XXI-215

Auditors (See also ‘Appointmentof Auditor’)

as tax and other consultantsIII-44 to 45; VII-31

authentication of documentsby XIV-122

branch I-299; VI-24; VII-50brother of director’s wife,

whether can be appointedas XIV-137

consent of previous auditorsI-177

disqualifications IX-1in place of retiring auditor

XIII-128independence of I-180; V-54;

VII-33; IX-1; XXI-217internal I-2, I-9, I-273; V-12;

VII-36; VIII-84joint I-213of a relative of a director VI-

58reappointment of existing

auditors’, where newauditors’ appointment isnot as per law XIV-117

reappointment, where thenew auditor’s appointmentis not as per law XIV-117

relationship betweenstatutory auditors andlimited purpose auditor V-10

relationship betweenstatutory main auditor andbranch auditor VII-50

removal of XIII-129retiring III-18 to 20; VI-1shareholders enquiries from

VII-64tax VIII-84; XI-197; XVII-50tenure of I-206; III-18written letter of appointment

not given to XV-2Auditors’ duties and

responsibilities I-58, I-70,I-95, I-236, I-251; VI-80;VII-64; XVI-67; XXI-11,20, 72

Auditors’ expenses I-104, I-190Award

accounting treatment ofperformance V-33

arbitration XXV-1


246

for enhanced compensationand interest thereon XXV-159

B

Bad and doubtful debtsaccounting for deferred tax

on provision for XXIV-75accounting for excess

provision of XI-39created pursuant to provision

u/s (36(I) (viia) of ITA,accounting for XV-50

of a bank VI-67Badla I-189; XI-16Balance sheet date, cheques

received thereafter XXIV-71

Balance sheet of a ProvidentFund Trust XI-9

Balance sheet Abstract andCompany’s GeneralBusiness Profile XXIV-146

Balance sheets, preparation oftwo XXV-28

Bank advancesagainst book debts I-32against hire purchase

hundiesI-33

against motor receipts I-32against usance bills

discounted I-125Bank audit II-29 to 30; III-5;

V-20; VI-58; VIII-65Bank balance I-57; III-28 to 30,

III-31 to 33; XXIV-93Bank charges XIII-41Bank deposits, against site

restoration fund,disclosure XXIV-95.

Bank deposits, doubtful XIX-25Bank deposits, whether

investment u/s 292(1)(d)XXII-191

Bank guarantees I-155 to 156;II-18 to 19, II-35 to 36; III-3; XIX-31

Bank, payment of salariesthroughVII-10

Bank, provision on NPA inQuarterly Accounts XIX-88

Bank scheduled I-253Bankers acceptance facility XII-

33Banking company I-5Banking Regulation Act I-274;

III-6; VI-58, VI-67Base stock method X-159Basis of accounting for tax

purposes XVII-50Below the line (see Profit & Loss

Appropriation Account)Bill of lading I-261, I-263 to 264‘Billed’ meaning under Schedule

XIII X-172Bills discounted I-125, I-243; II-

12 to 15; III-3; XIII-54;XIX-109

Bills discounting charges XIII-41Bills paid, disclosure in profit

and loss account I-1 to 2Bonded warehouse I-64; V-18,

V-26; XIV-112Bonds VIII-67; XII-61; XIX-31;

XXVI-55Bonds, partly secured XXVI-55Bonds, unclaimed XVII-73Bonus issue I-46, I-69, I-79;

XXIII-109; XXV-113Bonus, payment of I-79; V-61Books, depreciation on V-39Books of account


247

damage I-253closure in case of retirement

of partner X-146duplicate I-81; IX-32of franchise business XXVI-

190of jointly controlled entity

XXVI-209preservation of I-187retained by CBI I-81

Borrowing costsinclusion of interest on land

acquisition XXV-16increase in foreign currency

liability XXIV-17 (see alsounder ‘interest’)

Borrowing power of a companyI-197 to 198; VII-I; XII -120; XIX-1

Borrowings, utilisation of XXII-177; XXIII-164

Branch audit I-9, I-10, I-236 to238; V-20

Branch Audit Exemption RulesI-84, I-188

Branch auditor I-273; III-5; VII-50

Branch returns / statements,incor-poration of I-73

Branch, foreign I-253; XII-75;XIV-132

Bridge loan XII-67Broker (stock)

applicability of section 44ABX-166

membership rights XXIV-4;XXVI-172

prepayment fees XXIV-80Brokerage I-7, I-207Builders, revenue recognition

XXIII-25Buildings

classification into freeholdand leasehold XXIII-34

factory, meaning thereofXXIV-119

Bullet proof jackets XXV-157

C

Call money on notice XIX-109C&AG’s audit applicability to

govt. company XXIV-101C&AG’s audit report, ‘nil’

comments in XI-24C&AG’s directive I-192Capacity, normal XX-45; XX-

108Capacity utilization,

measurement of VII-61 to62

Capitalaccount VII-70commitments I-109, I-186;

VII-9contributions from

consumers, whether partof net worth XXI-223

employed I-247expenditure I-28; III-7; IX-14,

IX-81; XI-52; XV-8; XIX-120

fund VII-67 to 71gains I-59, I-90; X-160goods, MODVAT credit on

XVI-2; XXI-190paid–up VIII – 98profits VI-49; VII-20reorganisation account XIV –

80


248

reserve I-163, VIII-41 to 43,XI-161; XIX-61; XX-17;XXIII-109

spares (see also ‘Insurancespares’ and ‘Machineryspares’) XIV-102; XVII-8;XVII-95; XX-40; XX-50;XXI-196; XXIII-14; XXIV-168; XXV-62, XXV-80,XXV-90, XXV-95; XXVI-161

work-in-progress I-150, I-186IV-15; VII-9

Capitalisation ofawards during construction

period XXV-1completed parts of project

XXII-160construction cost, cut-off

date for XX-139cost of plantations (see

under ‘Plantation’)cost before issuance of

certificate of completionXX-140

construction cost, cut-offdate for XX-139

engineering overheads XI-165; XXII-132

expenditure incurred aftercut-off date XI-33

expenditure incurred ondeveloping ore body ofexisting mine, whetherappropriate XXII-129

expenditure incurred onexpansion of a project XI-52

expenditure incurred onreplacement/improvements inmachines XIV-75; XXV-80

expenditure on catchmentarea XXIV-40

expenditure on distribution ofmementos to employeesduring construction periodXXVI-187

expenses related toacquisition of aninvestment XXVI-140

foreign exchange differenceson loan amount XXI-151,164

future interest on unpaidlease premium XXV-19

insurance spares held instock XXIII-153

interest on borrowings VI-35;VIII-70, VIII-78; X-8, X-39to 45; XI-168; XII-95,XVIII-36; XIX-106; XXI-114; XXII-93, 177; XXIII-164; XXV-16

interest on enhancedcompensation awardedXXV-159

interest on unpaid leasepremium XXV-18

loan processing fee XXV-19materials produced in an

expansion project III-7operational support credit

XXI-160plant where commercial

production delayed XVII-63

premium on leasehold landXXV-19

provisions for final mineclosure expenses XXV-185

rent XXV-19stamp duty XXV-19

Capital grants (See under‘grants’)

Carting agent I-154


249

Cash against cheques bymangers whether a loanII-43 to 44

Cash and cash equivalentsXXIV-93

Cash assistance received in lieuof customs duty drawbackI-135

Cash basis, from accrual to XIII-93; XV-3

Cash book VI-78Cash credit I-12; VII-24; XIX-1Cash discount XXIII-29“Cash” for section 297 VII-85Cash generating units,

determination of netselling price thereof XXVI-28

Cash generating units,identification of XXIV-105;XXV-131

Cash incentives I-15; I-135; III-8;VIII-97

Cash instead of cheques,payments by VI-78

Cash rebates XXII-169Cash securities VII-22Casual vacancy VIII-24Catchment area, expenditure

thereon XXIV-40Central Excise Rules, 1944,

Rule 57 R (8) XXI-190CENVAT credit treatment

consequent to changes inCentral Excise Act,whether change inaccounting policy XXIV-174

CENVAT scheme, inventoryvaluation XX-106

Certificate by a CharteredAccountant V-51

Certificate of deposits XVI-111;XIX-109

Change in accounting policyXXI-13; XXIV-174

Change in the name of firm ofCAs VIII-24; IX-106

Change in method of accountingfrom accrual to cash basisin respect of interestincome XIII-93; XV-3

Chartered Accountantemployee I-80; V-50, V-51in full-time employment XI-

216minimum fee for audit by XI-

223whether competent to

comment on draftrehabilitation scheme andimpact of qualifications inthe auditor’s report onprofitability of companyXXI-208

Chequespayments by VI-78received after balance sheet

date, accounting of XXIV-71

CIF contracts I-269; XI-56; XX-9City development IX-3, IX-9

(See also ‘Colonies,development of’)

Claimestimation of outstanding

liability XXII-188; XXIII-145

for export incentive,assessment of uncertaintyregarding XI-60

for interest from the due dateto date of repayment XVI-88

insurance VII-2; XI-89; XX-54; XXII-188; XXIII-145

not certified or accepted bythe clients XXV-13


250

profit on settlement ofinsurance XI-89

self insurance VII-2; XI-88treatment of unsettled I-55

Classification of subordinatedsecurities held by theoriginator in asecuritisation transactionXXIII-149

Clause 7(2) of Part III ofSchedule VI XXI-129

Clause 32 of Listing AgreementXXII-172

Clause 41 of Listing AgreementXX-84; XXII-149

Closed jobs XXV-13Club, whether covered by

MAOCARO XI-124Clubbing of expenses XIII-41Coaching assignment by a

Chartered Accountant I-179

Coal stock used as fuel XXI-80Code of conduct, assignments

allowed XXI-208Coins I-128Colonies, development of I-239

(See also ‘Citydevelopment’)

Commencement of commercialproduction, gross block offixed assets XXIII-40

Commencement of operations,timing XVII-63, XVII-75;XXII-160

Commercial paper XII-65; XIX-18

Commercial production delayedXVII-63

Commission I-5, I-8 to 9 I-113,I-255; VI-33; VII-34; XII-3;XXIII-29

Commission/service charges forduty credit entitlement

under served from Indiascheme XXVI-225

Committee of Board, approval ofmodified accounts by aIII-40 to 42

Companies (Acceptance ofDeposit) Rules, 1975

capital contributions fromconsumers XXI-223

deposits in the form of shareapplication IX-104

deposits from a director whowas a shareholder VII-83

deposits from firm whose allpartners are directors VII-84

deposits from partnershipunder same managementI-238; VIII-101

maintenance of liquid assets(Rule 3A) IV-36

treatment of developmentrebate reserve I-75

treatment of un-provideddepreciation VIII-98

treatment of un-providedgratuity VIII-98

Companies Deposits(Surcharge on Incometax) Scheme, 1976II-22

Companies under the samemanagement, disclosureof loans and advancesXXI-237

Company secretary, signing ofaccounts by VI-34

Compensationfor certain losses and

interest thereon XXV-1for loss of revenue and

interest due to delay indelivery of asset XXI-160


251

for waiting time in respect ofrelocation of unit to analternate place XVII-107

interest paid on enhancedXXV-159

taxability of X-154Compliance with Accounting

Standards XXIII-14, 34,83

Components, allocation of costof fixed assets into XXV-80

Components, manufactured III-1, III-22 to 24; V-43; VI-51

Components, worn-out andreplaced by spares XXV-90

Comprehensive inter-period taxallocation VII-74

Computation of weightedaverage shares on bonusissue XXV-113

Confirmation of debtors’balancesVIII-48

Concessional duty XI-157Consent of previous auditors I-

177Consignment purchase XII-1Consignment sales VI-33; XII-1Consolidated financial

statementsapplicability to listed Govt.

company XXIV-101applicability of Segment

Reporting XXII-12audit by C&AG XXIV-101format of audit report XXII-

149, 172provision of losses of

subsidiaries I-88

whether mandatory XXI-193;XXII-172

Consolidated purchase ofassets X-10

Construction project,development of industrialestate XX-71

Construction contracts (Seealso ‘contract(s)’)

advances against materialXV-54

billable pay revision, revenuerecognition XVIII-13

contribution received fromstate government towardsXIX-82

design engineering XXI-85equipment used after

completion of VIII-19for supply of material XX-156foreseeable losses XIX-4godowns on behalf of others

VII-75housing projects XXIII-95indirect costs included in cost

XIX-4in foreign countries,

accounting for XIV-20long production cycle items,

revenue recognition X-98;XXVI-72

loss from damage of assetduring construction XVII-68

meaning of ‘total turnover’XXIV-84

percentage of completionmethod XX-100; XXI-103;XXIV-84; XXV-14; XXVI-72

procurement projects XXI-85project management XXI-85provision for foreseeable

losses XXI-103, 187retention money XX-33


252

recognition of revenue atearly stages XX-100; XXI-103

sale of fixed assets aftercompletion of XII-4

sales and inventories underXII-27

staff salaries paid for idleperiod awaiting transfersVIII-21

surplus material, accountingand disclosure XXI-126

unconsumed materials XVII-17

valuation of equipment to beused in specific contractXXI-187

valuation of work-in-progressXXI-187; XXV-13

Construction costs borne bylessee in lieu of leasepremium XIX-27

Construction cost, cut-off datefor capitalisation of XX-140; XXII-160

Construction material, treatmentof surplus XXI-126

Construction periodaccounting for income tax

liability during XVI-53allocation of incidental

expenses to packagesXXII-160

capitalisation of depreciationduring X-121; XXIII-40

capitalisation ofestablishment expensesof rehabilitation andresettlement office aftercommissioning of theproject XXVI-198

capitalisation of expenditureon catchment area XXIV-40

capitalisation of expenditureon distribution ofmementos to employeesXXVI-187

capitalisation of ground rentX-8

capitalisation of interest X-8,X-118; XXIII-58 (see alsounder ‘Capitalisation ofinterest on borrowings’)

capitalisation of know – howfees X-39 to 45; XXIII-19

capitalisation of trial runexpenditure X-39 to 45;XXI-114

cut-off date XX-139; XXII-160

depreciation on powerprojects XIX-76

expenditure during XII-9;XIV-66, XIV-91

interest earned, during XIII-64; XVIII-31; XX-18

loss from damage /obsolescence XVII-68

preparation of profit and lossaccount during XI-128

sales of intermediary productin VIII-76

Consultancy III-44 to 45; VII-32;XI-17; XXV-140

Consultancy fee XXI-85Containers

income from completelogistic services XXIV-138

income from freight andhandling XXII-114

income from ground rentXXII-138


253

Contingency XXI-71Contingency, creation of

provision in respectthereof XXVI-119

Contingency reserve XXIV-88Contingent gain III-9Contingent liability

additional power tariff XXI-78bank guarantees/indemnity

bonds XIX-31classification and definition

I-10; XIX-40defamation case XIX-79disputed payments of earlier

years XV-58disputed tax liability /

demandsI-172; III-11; XIV-64; XXV-53

gratuity net-of-tax, whether aVII-74

in respect of show causenotices VII-21

investments partly paid I-6outstanding reward points

XXI-129payment as per Bonus Act

I-259tax liability under

investigation IX-82under Form 3CD of Income-

tax Rules XIX-38under tripartite agreement

XIX-9unknown liability at the

balance sheet date XXIV-50; XXVI-119

zero based debentures XII-114

Contingent loss VII-58; XIII-105Continuous process plant XIV-

124, XIV-125; XV-20;XVII-30, XVII-46, XVII-79

Contract(s) (see also‘construction contract(s)’)

accounting I-93; VI-62; VII-12,VII-44, VII-54; X-98, X-111; XII-86

annual maintenance X-32commencement of

operations XVII-63, XVII-75

composite III-3 to 5contribution received from

state government towardscost of construction XIX-82

costs, inclusion of indirectcosts XIX-4

dredging XIV-71for supply of materials XX-

150, XX-156foreign XIV-20fully completed VI-62lumpsum turnkey, for

process design, detailedengineering, etc. XXVI-1

materials supplied under XX-150, XX-156

manufacturing units X- 1performance of III-3 to 5retention money in the books

of contractee XX-33revenue, disclosure of XXV-

13revenue recognition by

builders XXIII-95sales and inventories under

XII-27service XIII-113treatment of foreseeable

losses in V-17; VII-54; XII-105; XIX-4

unexecuted I-186, I-199, I-245


254

valuation of work-in-progressin IX-23, IX-35, IX-76;XXI-187; XXV-13

Control, determination forpreparation ofconsolidated financialstatements XXI-193

Conversion of partnership intocompany, revaluation offixed assets XIX-117

Converion rights for calculationof EPS XXVI-220

Conveyor belts replacement I-106; XVI-100; XVIII-66;XXI-42

Cooley loan I-49Cooperative banks I-24Cooperatives I-77; XII-15Cooperative Societies,

applicability of TaxationLaws (Amend-ment) Act,1991 to XIII-117

Copyrights, amortisation ofXVII-86

Corporate office overheads,allocation to units XXII-72

Corresponding figures for theprevious year, disclosureof IV-10

Cost XX-5Cost allocation to joint products

XXI-25Cost, directly attributable –

whether or not XXVI-198Cost inefficiencies III-7Cost of conversion III-15; XX-24Cost of plots given on lease XX-

30Cost of purchase, contribution to

Gas Pool Account XXV-164

Costs on side-tracking andabandoned portion ofwells XXVI-109

Counter guarantee I-10 to 11

Credit card, provisioning ofreward points XXI-129

Creditors VIII-50; IX-63 (Seealso ‘Sundry Creditors’)

Crude oil stock in pipelines andtanks XXI-93

Cumulative Interest SchemeVIII-18

Current assets I-129, I-142 to145; III-14; VI-41; VIII-55;X-140; XI-95; XII-64;XXI-126; XXII-35; XXVI-12

Current Investments, valuationof XI-11

Current liabilityclassification I-41; VII-22;

VIII-50dues to employees XVI-57financing facility against

purchase of raw materialsIX-63

for deferred payments I-13interest accrued but not due

VIII-18Current rate VI-51Customs bonded warehouse I-

64; V-18, V-26; X-36; XIV-112

Customs duty creditServed from India Scheme

XXVI-181, 225Target Plus Scheme XXVI-

148Customs duty drawback, cash

assistance in lieu of I-135Customs duty, provision for

exempted goods XXI-57Customs duty, provision for

goods in bondedwarehouse X-36; XIV-112; XXI-57

Cut-off date, expenditureincurred after XI-33


255

Cut-off date, determination forcapitalisation of cost XX-139

D

Damaged books of account I-253

Damaged stores II-34 to 35Damages (see ‘Liquidated

damages’)Dam, capitalisation of


Dearness allowance, interimrelief of VIII-23

Debenture RedemptionReserve, creation of XI-212; XV-83

Debentures guaranteed byGovt. of India, whethersecured or unsecured IV-1

Debentures premium receivableon maturity in case ofMutual Fund XVII-103

Debentures, unclaimed XVII-73Debentures, zero based XII-115Debt, long-term VIII-8Debts factored XXI-202Debt-Equity Ratio VIII-7Debt outstanding, translation of

foreign currency XVIII-1Debtors (See also ‘sundry

debtors’)capacity to repay debt XXII-

35Debtors balances, confirmation

for VIII-48Debts, write-off of suit filed

XII-70Deemed public company,

conversion to privatelimited company X-177

Defamation case XIX-79

Defaulted interest payments X-106

Deferral of revenue due todifferent rates ofdepreciation XXIV-123

Deferred credit I-13 to 15, I-42,I-76, I-141, I-243; VIII-7,VIII-16, VIII-70

Deferred foreign currencyfluctuation asset XXV-206, XXV-216

Deferred payment liabilities(See ‘deferred credit’)

Deferred revenue expenditureI-28; VI-26; VII-9; XXI-42;XXIII-29, 58

Deferred taxes VII-73; XI-171Deferred tax asset, brought

forward depreciationXXIV-54

Deferred tax asset in respect ofMAT credit XXV-145;XXVI-64

Deferred tax asset in respect ofprovision for doubtfuladvances and claimsXXVI-37

Deferred tax asset in respect ofprovision for final mineclosure expenditure XXV-185

Deferred tax asset/liability underTonnage tax schemeXXV-43, XXV-72

Deferred tax effect of adjustingimpairment loss directlyagainst revenue reservepursuant to transitionalprovisions XXV-22

Deferred tax liability XXII-45;XXIII-83; XXIV-64; XXV-135, XXV-201; XXVI-124

Deferred tax liability on creationof special reserve u/s


256

36(1)(viii) of IT Act XXV-135, XXV-201; XXVI-124

Deferred tax on provision fordoubtful debts XXIV-75

Deferred tax reserve XXIII-83Delayed commercial production

XVII-63Delegation of powers by

directors III-40 to 42Demurrage paid whether part of

inventory cost XX-20Deodani kayars I-103DEPB Scheme XVII-20, XVII-

93; XVIII-40; XX-96;XXIV-12

Deposit investment IX-95Deposits

acceptance of money ofcurrent account I-238

along with share applicationmoney IX-104

applicability of Companies(Acceptance of Deposits)Rules VII-83; VII-84; VIII-101

for using office space VIII-25lease payment IX – 80long-term u/s 33 ABA of I.T.

Act XXIV-93short-term, whether

investment u/s 292(1)(d)XXII-191

with scheduled bank I-253Depreciable amount XX-6; XXV-

62Depreciable asset XX-5Depreciation

additions to fixed assets I-196; II-8 to 12; XV-25;XXV-199

advance against, recoveredthrough tariff XVII-98;XXV-37

applicability of schedule XIVX-69, X-79, X-128; XI-73;XI-80; XV-30; XIX-76; XX-69; XXI-234; XXV-62,XXV-80, XXV-153; XXVI-42

arrears of XI-82; XX-68as a special reserve I-3, I-

183as prescribed by Bureau of

Public Enterprises V-36asset-wise disclosure of VIII-

57based on technical

assessmentV-36; VI-23, VI-71; XIX-66; XXV-62; XXVI-42

block concept IX-58brought forward, deferred tax

in respect of XXIV-54capitalisation of assets used

during construction periodX-21; XXIII-40

change in cost due to foreigncurrency fluctuations XIII-61, XIII-66; XIV-48; XV-68

change in method I-19, I-99;I-196; V-47; VII-87; XII-38;XII-111; XIX-66; XX-121

change in previous year IV-21

construction period XIX-76cost changed due to foreign

currency fluctuations XIII-61, XIII-66; XIV-48;XV-68

creation of InvestmentAllowance Reserve onwrite-back of VII-87

crushing plant situated withinmining lease area XX-67

customs duty capitalised insub-sequent year XVI-65

differential depreciationrates, deferred tax effect


257

in respect thereof XXV-216

different methods for sameclass of assets VIII-72;XXI-234

disclosure, asset-wise VIII-57extra shift depreciation X-

174; XIII-69; XIII-83; XIII-85; XV-25; XVII-57; XX-69; XXV-153

for computing divisible profitsI-19 to 20

for computing net worth I-99for computing work-in-

progress I-93for section II5J IX-30; X-129in absence of legal

requirement in leases XX-80

in absence of specific rateunder Schedule XIV ofCompanies Act XXV-153;XXVI-42

in accordance with IncomeTax Act I-82; I-157; II-8 to12

on additions during the yearI-196; II-8 to 12; XV-25;XXIII-126

on assets developed onleasehold land XVI-108

on assets leased out XI-93,XI-98; XX-80

on assets not used II-31 to32; V-7

on assets not owned buthaving right of use XIX-119; XIX-128

on assets taken over I-122on assets used during cons-

truction period I-151 to154;II-6 to 8; VIII-28; X-121;XXIII-40

on assets between dateproject ready tocommence commercialproduction and the dateon which productionactually commencesXXIII-58

on bullet proof jackets XXV-157

on capital spares XXI-196;XXIII-14, 153; XXIV-168;XXV-62

on continuous process plantXIV-124; XIV-125; XV-20

on energy-saving devices IV-24; V-48

on foreign exchangefluctuationXIII-61; XIII-66; XIV-48;XV-68

on helicopter XVII-87on jetties and handling

equipments used at sea-ports XXV-153

on land having limited usefullife XXV-170

on leased out assets XI-93,XI-98; XX-80

on leasehold building XXIII-34

on library books V-39on low cost items XIX-114;

XXIII-105on mass rapid transport

system XXVI-42on moulds & dies used in

manufacture of acomponent XX-4

on pump trucks XIX-136on revalued assets I-5, I-34,

I-163on ‘rolls’ used in rolling mill

XIV-87on rolling stock, escalators

and elevators, and tract


258

works used in mass rapidtransport system XXVI-42

on spares when capitalisedXX-40, XX-128; XXV-62

on surface machinery XX-87on water treatment and

sewage treatment plantXXIV-119; XXVI-22

prior period adjustment XX-67; XXVI-22

pro-rata IX-58, IX-68, IX-70;X-79; XI-73; XII-24;XV-25

rates applicable to assets V-35;X-12; IX-58; XV-30; XIX-136

rates higher than thoseprescribed VI-21, VI-71;IX-30; IX-68; XIII-63; XIX-66

revision of rates XIX-66selection of method XXI-234subsequent to recognition of

impairment loss XXIV-113u/s 115 J of Income Tax Act

IX-30u/s 350 in relation to section

205 (2) I-82; IV-21; IX-30;IX-70

under Electricity (Supply)Act, 1948 V-36; XIX-76;XXIV-123

under industries(Development andRegulation) Act, 1951 I-194

under MAOCARO II- 1 to 2unprovided VII-98; IX-11useful life XIX-66

Detachable warrants XIII-89Development expenditure on

landX-49; XVI-105; XX-71

Development of IndustrialEstateXX-71

Development of new towns,accounting for IX-3, IX-9(See also ‘coloniesdevelopment of’)

Development of ore body ofexisting mine XXII-129

Development of property I-145;III-14

Development of prototypes XIV-1; XXV-3

Development of surplus funds –presentation in balancesheetXVI-110

Development Rebate Reserve I-22 to 24, I-59 to 61, I-66;IV-17; VII-88

Diamondsnet realisable value of XXIV-

22valuation of WIP of XI-143

Direct taxes, notional I-272Directives of C& AG I-192 to

193Director (s)

appointment as auditor of aformer VIII-64

appointment of a relative ofIII-38 to 39

delegation of powers by III-40 to 42

fees I-200, I-213, I-217; III-42to 43

interest I-204interpretation of the term II-

42 to 43payment of guarantee

commission to I-209remuneration (see ‘Director,

fees’)report, comments on

qualifications in auditor’s


259

report / under MAOCAROVI-80; XI-76

report, where deemed publiccompany becomes privatecompany X-177

working II-42 to 43Disclaimer of opinion VIII-46,

VIII-63; IX-28; XXV-225Disclosure

in company balance sheet, ofreceivables I-141

in consolidated financialstatements, of differentaccounting policies XXI-193

of accounting policy inrespect of export salesXVIII-63

of amount due towardssubscription of sharesXI-222

of bank guarantees /indemnity bonds XIX-31

of buildings into freehold andleasehold XXIII-34

of buildings purchasedalongwith land X-10

of cash securities receivedfrom borrowers VII-22

of class ‘B’ PTCs held by theOriginator XXIII-149

of discounted pre-payment ofdeferrable sales-taxliability XXIII-122

of doubtful bank deposits,provision for XIX-25

of dues to employees VIII-51;XVI-57

of factored debts XXI-202of fixed assets given on

operating lease XVI-32of funds invested in

Certificates of DepositsXVI-111

of funds invested in shortterm deposits XVI-110

of gains arising fromtranslation of foreigncurrency debts, on thebalance sheet date XVIII-4

of gross block of fixed assetsused for constructionactivities duringconstruction period XXIII-40

of interest accrued but notdue on loans X-144

of interest on shortfall inpayment of advanceincome-tax XXVI-166

of leasehold buildings XXIII-34

of loan and advances fromcompanies under thesame management XXI-237

of loan arranged bycontractor throughtripartite agreementXIX-9

of loss on translation of work-in-progress on severedevaluation XIX-21

of particulars of options onunissued shares XV-73

of provision for incompleteassignments XXV-175

of provision of loss in currentasset XIX-25

of provision of outstandingreward points XXI-129

of provisions in respect ofexpenses XIX-41

of related party transactionsXXIII-174

of sale/lease of houses/landXXII-20

of special items I-128


260

of stocks of inter-unittransfersXI-133

of surplus constructionmaterial XXI-126

of unutilised monies out ofequity issue XXI-124

regarding revalued fixedassetsXV-16; XX-163

Discount charges of bills XIII-41Discount on issue of shares

XXV-121Discounting factor in actuarial

valuation XXI-72Discounts VI-56; XIII-39; XXII-

169; XXIII-29Disputed liabilities, provision for

XXV-53Dissolution of firm, withdrawal of

Investment Allowance incase of VII-86

Distance discount VI-56Distributable incomes as per

Income-tax Act I-90Disposal of flats by a

cooperative housingsociety XII-15

Dividendaccounting for XIX-44from reserve created on

amalgamation XXIII-109preference VI-44; XI-214,

XI-219unclaimed IV-34warrants I-221, I-19 to 29,

I-43, I-116, I-195, I-220declaration of, u/s 205 XII-

123Divisible profits I-19; III-12;

VI-49, VI-87; VII-88 to 90;XII-123

Documentary proof of DA/TA toBoard members I-70

Documents, to self I-155

Doubtful debts XVII-90Doubtful deposits, provision for

XIX-25Draft rehabilitation scheme,

comments of charteredaccountant XXI-208

Dredging contracts XIV-71;XV-65

Dredger, capitalisation cost ofXXI-231

Drum discounts VI-56Duplicate books of account I-81Duty credit entitlement XXVI-

148, 181, 225

E

Earnings Per Sharecomputation of weightedaverage number of shares incase of bonus shares XXV-113treatment of conversionrights for calculation ofdiluted EPS XXVI-220

Electric arc furnace - whether acontinuous process plantXIV-124

Electricity company (See under‘Power sector’)

Empties, valuation anddisclosure of IV-8

Energy - saving devices IV-24Engineering overheads,

capitalisation of XI-155;XXII-132

Entertainment tax VI-83Entry tax XIX-41Equipments

manufactured againstcustomers’ orders VI-53

owned by an enterpriseinstalled with another


261

enterprise for use by thelatter XXIII-53

used after completion ofconstruction VIII-19

Equity VIII-8Equity issue, disclosure of

unutilised monies XXI-124Equity method I-89; XXV-57Equity pending allotment I-118;

II-27 to 29; XV-34Errors (see ‘Mistakes’)Escalation claims, treatment of

V-24Escalation clause I-55, I-177Escalation cost I-75Events occurring after balance

sheet date II-28; III-9, III-11, III-32; XI-62; XII-89;XIX-71; XXI-61, 79, 148

Evidence, audit VIII-44, VIII-62;IX-27, IX-32

Evidence of salaries paid VIII-10Excess provisions, writing back

ofXIV-95

Exchange rate (see under‘Foreign exchange’ and‘Foreign exchange ratefluctuations, accountingfor’)

Excise duty I-109; III-8, III-22 to24; VI-53; VII-15; X-23;XI-2, XI-55; XII-19; XX-106, XX-118; XXI-11, 20,67

Exemption from branch auditI-184, I-188

Exemption, sales tax XX-15Exim policy XVII-20; XVII-93Expansion project, capitalisation

in case of III-7; XI-52Expendable wells in upstream

oil industry, accounting ofXXV-193

Expenditure, capital I-28; III-7;IX-14, IX-81; XI-52; XII-9

Expenditure during constructionperiod (see under‘Construction period’)

Expenditure on catchment areaXXIV-40

Expenditure on development ofore body of existing mineXXII-129

Expenditure on land notrepresented by tangibleassets IX-81; XII-10 to 19

Expenditure on moulds & diesused XX-4

Expenditure on removal ofoverburden fromlimestone quarries X-26

Expenditure on renewal ofsleepers and rails forrailway sidings IX-14

Expenditure on replacement/improvements inmachines, capitalisationof XIV-75; XXIII-126

Expensesclassification of I-29 to 130;

VII-77clubbing of XIII-41current I-110during construction period I-

147, I-149; II-6 to 8; X-8,X-118; XII-9; XIV-66, XIV-91 XVIII-32 (see alsounder ‘Constructionperiod, expenditureduring’)

recognition of IX-44sharing of VII-72

Exploration expenditure IV-12;VI-25

Exploratory wells XXX-193Export credit receivable under

DEPB Scheme XVII-


262

20,XVII-93; XVIII- 40; XX-96

Export House VIII-93Export incentive III-8; VI-43; VII-

4; XI-60; XII-48; XVII-20,XVII-93; XVIII-40; XX-96

Export marketing expenses,grant for VIII-96

Export sales, disclosure ofXVIII-70

Exports made by businessassociates XVI-43, XVI-47, XVI-73

Extraordinary items VIII-74; XX-32; XXIII-122; XXIV-96

Extraordinary meeting held atplace other thanregistered office VII-81

Extrashift depreciation (Seeunder ‘Depreciation’)

Extractive industry IX-78, XXIV-22, 93, 156; XXV-193;XXVI-109

F

Face value, defined V-23Face value of capital investment

V-21Factored debts, accounting for

XXI-202Fee, agency XX-150Fees, market XII-89Fees paid to SEBI in respect of

purchase of investmentsXIX-94

Fees paid to merchant bankersfor purchase ofinvestments XIX-94

Fertiliser industry, segmentreporting XXIII-1

Fictitious asset/liability XXII-121Film industry

accrual of costs inIX-42

revenue recognition in VIII-5Final accounts

authentication / approval of I-190; II-42 to 43; III-5, III-40 to 42

certification of I-80preparation after take over

X-20Finance business, applicability

of section 44AB to XI-184Finance company, segment

reporting XXVI-79Finance income from lease XI-

101Financial year III-36 to 37Fire

loss of fixed assets in XIV-98loss of stock in I-241

Firm commitment, meaningthereof XXVI-142

Firm of chartered accountants,appointment as statutoryauditors when one offirm’s partners is adirector in holdingcompany XVII-84

Firm, reconstruction of auditVIII-24

Fixed assets (see also ‘Assets’)additional interest incurred to

hedge foreign exchangerisk XXI-181

addition to, depreciation inrespect thereof XXV-199

adjustment of differencebetween swap rate andexchange rate XXI-181

advance against purchase ofVIII-24

acquired on lease XIX-17allocation of cost into

components XXV-80


263

building whose title issubjudice XI-48

bullet proof jackets providedto outside securitypersonnel XXV-157

capitalisation of arbitrationaward in respect ofcertain losses and interestthereon XXV-1

capitalisation of interest onborrowings VI-35; XI-168;XII-95; XVIII-29; XXI-114

capitalisation of interest oncompensation for landacquired XXV-159

charge-off of small valueitems XXIII-105

classification into freeholdsand leaseholds XXIII-34

depreciation (see under‘Depreciation’)

discarded or surplus,valuation of XXI-148

disclosure of special items inbalance sheet I-128; VIII-57

disclosure under MAOCAROII-1; X-78

expenditure incurred onraising plantations III-12

expenditure on acquiringright of use XIX-119; XIX-128

expenditure on constructionof VII-75

expenditure on detailedengineering and processdesign XXVI-1

expenditure on renewal ofmining lease XIX-46

expenditure on user licencefee for SAP softwareXXVI-6

fixtures XVIII-53

for projects outside India X-140

foreign currency fluctuation(see under ‘Foreignexchange ratefluctuations, accountingfor’)

gross block where assetsused for Capital ProjectXXIII-40

held for sale XXVI-217inclusion of import duty and

initial delivery costs XXI-231

installed with anotherenterprise XXIII-53

jigs XVIII-53land having limited useful life

XXV-170leasehold land (See under

‘Lease’)loss of IX-92; X-39; X-147;

XIV-98; XVII-68;machinery spares (see also

‘capital spares’) XVII-95;XX-40, XX-50, XX-112,XX-128; XXI-42, 196;XXV-62, XXV-80, XXV-90, XXV-95

operating lease XVI-32operational support credit

treatment XXI-160profit on sale of XIX-61ready but not in operation

XXIII-58renovation/overhauling XXIII-

126replacement cost XV-37retired XIV-94retired from active use XXVI-

217revaluation of XIV-19; XV-36;

XIX-117; XX-121, XX-163right of use of land XIX-119,

XIX-128; XXV-170


264

sale proceeds in excess ofcost XIX-61

salvaged material fromdismantled fixed assetused in construction ofotherX-84

spares XVII-95;XX-40, XX-50, XX-112, XX-128;XXIII-14; XXV-62, XXV-80, XXV-90, XXV-95

subsequent expenditureXXIII-126; XXVI-198

subsidy for acquiring XVIII-36

tools XVIII-46trademark, accounting for

XXIII-135used in other construction

activities after completionof construction of aproject VIII-19

utilisation of loan foracquisition of XXI-151,164

valuation in case ofincomplete records IX-50;XI-177

waiver of interest capitalisedXXIII-131

water and effluent treatmentplants XXVI-22

when ready to commenceoperation XXIII-58

write off VI-18Fixed Deposits VII-24; X-86; X-

155; XIX-109Fixed overheads XX-45; XXVI-

96Fixtures XVIII-53Flats, disposal of XII-15Float, interest on XIII-21Flood, loss of stock in I-241

FOB/FOR contracts I-269; VII-28; VIII-46; X-98; XI-117;XX-9; XXI-52; XXII-27

Foreseeable loss in contractsXIX-4

Foreignbranches I-253; XII-75; XXII-

121company, liaison office of a

XII-125currency loan, forward cover

XVII-112exchange rate XX-146, XX-

160; XXI-15project sites, whether

branches under theCompanies Act, 1956,XIV-132

projects, accounting of fixedassets X-140

travel, audit of XXIII-117Foreign exchange rate

fluctuations, accountingfor

swap transaction XXI-181advance for export of goods

XIX-49currency/bank account

abroad III-20; XIII-28;XVII-5; XIX-138; XX-64,XX-143; XXI-20

date of transaction for importof material XXII-7

date of transaction for importof natural gas XXIII-89

difference between date oftransaction and date ofsettlement XXII-7; XXIII-89

difference between prevailingexchange rate and swaprate XXI-181

disclosure under Schedule VIII-19; XI-127


265

expenses incurred at foreignliaison office XIX-138

fixed assets acquired withinIndia XXIV-32

gain XX-64gain/loss on cancellation of

forward contract XXVI-142

gain/loss recoverable underpower purchaseagreement XXV-206

in case of life insurancebusiness XXII-121

interest income XIX-59; XXI-20

long term liability not relatingto fixed asset I-161

long term liability relating tofixed asset VIII-3, VIII-27;XI-28; XII-52, XII-58, XII-82; XIII-56; XIV-56; XXI-151, 164; XXIV-17, 32

severe devaluation XIX-21transactions for the benefit of

the subsidiaries I-112translating current assets /

current liabilities VI-38;VIII-53; X-6; XII-33; XIII-11; XIV-12; XVI-75; XIX-21; XIX-49; XX-64, XX-146

translating financialstatements of foreignbranches XXII-121

translating fixed assets / longterm liability VIII-3, VIII-27; VIII-53; X-6; XII-33,XII-82; XIII-11; XIV-12;XVI-75; XX-9, XX-160

translating items of incomeand revenue expenditureVIII-53; XIII-11; XIV-12;XVI-75; XX-160

translating work-in-progressXIX-21

translation of debtoutstandingXVIII-1

Forest (see ‘Timber’)Form 3CD, clause 9(c) XIX-38Forward cover IX-47; XI-106;

XIV-74; XVII-112; XXVI-142 (see also under ‘Roll-over contract’)

Forward exchange contracts(see also ‘ForwardCover’) XIV-74; XVII-112;XXVI-142

Framework for the Preparationand Presentation ofFinancial StatementsXXIII-8, 122, 135; XXIV-71

Free Reserve IV-29; VIII-98;XXIII-171

Freight and handling incomeXXII-114

Freight, inclusion in cost ofinventory XXIII-49; 157

Full Costing Approach IV-12; VI-25

Fund II-3 to 6; IV-7; VII-67 to 71Future profit, treatment of I-85

G

Gas Pool Account, contributionto XXV-164

Gifts, audit of VIII-62Global method for stock

valuationI-140

Going concern assumption XVI-61; XX-124


266

Goodwill, valuation andamortisation X-135; XVII-86

Goods sent for customer’sapprovalXIV-32

Govt. companies, audit of I-129Grading and levelling of land I-

53Grants

definition XX-16for acquisition of fixed assets

I-103; III-16, III-24; IX-19;XI-161; XVI-20

for control & distribution ofessential commoditiesXX-76; XXIV-164

for meeting revenueexpenses VI-31; VIII-86

interest on XV-76of the nature of promoters

contribution XI-137, XI-140; XIII-99

unspecified XI-140; XIV-27unspent XIV-46

Gratuity liability I-110; VII-38;VIII-98; XI-180; XV-40;XVII-22; XXI-72; XXIII-69,99

Gratuity trust fundwhether interest earned on

investments included toarrive at contributionXXIII-69

accrued amount of liabilityXXIII-99

Gross receipts u/s 44 AB VI-83Ground rent X-8; XXII-138Guarantee

bank XIX-31bills discounted III-3commission paid to directors

I-209counter guarantees I-10

debentures guaranteed bygovernment of India IV-1

debtors backed by II-18; II-35disputed performance VII-81margin money on account of

XVII-71revenue recognition on

completion ofperformance XV-60

Guaranteed business XXV-121Guidance Note on Accounting

for Credit Available inrespect of MinimumAlternative Tax under theIncome-tax Act, 1961XXVI-64

Guidance Note on Accountingfor Depreciation inCompanies XXI-234;XXV-62

Guidance Note on Accountingfor Oil and Gas ProducingActivities XXIV-156; XXV-193; XXVI-109

Guidance Note on accountingfor securitisation XXIII-149

Guidance Note on Accrual Basisof Accounting XXI-227;XXII-45, 114

Guidance Note on Audit ofExpenses XXII-7

Guidance Note on audit reportsand certificates for specialpurposes XXII-149

Guidance Note on Clause 9 ofPart I of the CharteredAccountants Act VI-3

Guidance Note onIndependence of AuditorsXXI-217

Guidance Note on terms used infinancial statements XXI-223; XXIII-8


267

Guidance Note on treatment ofexpenditure duringconstruction period XXIII-8,19, 40, 58; XXV-1; XXVI-187, 198

H

Half-pay leave encashment XX-90

Handling expenditures, inclusionin cost of inventory XXIII-157

Head office accounts I-73Hedging foreign exchange risk

XXI-181High sea sales and purchases I-

262Hire purchase VII-45; IX-1; X-

106; XIX-18; XIX-154Housing projects, applicability of

standard 7 XXIII-95Housing society, co-operative

XII-15Hybrid system I-19, I-96; XIV-70Hydro electric power project,


I

IDA credit I-135Idle capacity costs VII-58; XX-

108Idle project funds, interest on

XX-18Impairment loss

basis of depreciation afterrecognition of XXIV-113

deferred tax effect onadjustment againstrevenue reserve as a

transitional provisionXXV-22

Impairment of assetsapplicability to petroleum

industry XXIV-105applicability to telecom

industry XXV-131determination of net selling

price of cash generatingunit XXVI-28

intangible XXIV-4Import duty payable, adjustment

against license amountunder Served from IndiaScheme XXVI-181, 225

Import duty payable, provisionfor I-64

Import duty and voyageexpenses, capitalisationof XXI-231

Import entitlement I-99; VII-4VIII-97; XVI-51

Import licence terms, verificationof compliance with I-251

Imported commodities I-260,I-263; XX-7; XXIII-89

Imported goods-in-transit,valuation XV-11

Improvements XV-39Incentives

cash I-15 to 19cash compensatory support

III-8customs duty drawback I-16,

I-18, I-135 to 137export I-16, III-8; VI-43on purchase of investments

XIX-64Income from installation charges

collected XXV-29Income from sale of ore mined

during development workXXII-129


268

Income recognition from mutualfund XIX-44

Income recognition on assetsleased out XI-31; XXVI-12

Income recognition oninvestments in an AOPXIV-109

Income and ExpenditureAccount of a PublicProvident Fund Trust XI-10

Income-tax Act, accounting forpenalty & interest payableunder XIII-48

Income-tax – basis ofaccountingXVII-50

Income-tax deducted at sourcefrom interest paidoverseas IX-99

Income-tax demands, whethercontingency XIV-64; XIX-38

Income-tax liability duringconstruction period,accounting for XVI-53

Income-tax recovery fromcustomers XXI-47

Incomplete assignments,provision for XXV-175

Incomplete records, valuation ofassets from IX-50

Income-tax Rules, Form 3CDXIX-38

Indemnity bond XIX-18Indian Stamp Act I-95Indirect expenditure during

construction I-149; XIX-4Industrial estate, development

and leasing XX-71Industries (Development and

Regulation) Act I-194 to219

Initial issue expenses by openended mutual fundschemes XX-115

Injection moulding machine -whether a continuousprocess plant XIV-125

Instalment payments I-13 to 15,I-41 to 43, I-75 to 76;VII-45; VIII-16, VIII-59

Installation charges collected bya telephone companyXXV-29

Installation cost II-23 to 24Installed capacity XIV-119; XX-

45Insurance business VII-2; XI-70;

XXII-188; XXIII-145Insurance claims VII-2; XI-89;

XX-54; XXII-188; XXIII-145

Insurance spares (see also‘Machinery spares’) XVII-95; XX-128; XXI-196;XXIII-153; XXIV-168;XXV-62, XXV-80, XXV-90, XXV-95

Intangible assetsacquisition through exchange

of another asset,valuation thereof XXVI-172

amortisation XVII-86; XXV-121; XXVI-172

expenditure duringconstruction period XXIII-58

expenditure on user licencefee for SAP softwareXXVI-6

know – how costs XXIII-19prototypes, development

thereof XXV-4right to guaranteed business

XXV-121


269

sale of right to receive powerXXII-86

stock exchangecards/membership rightsXXIV-4; XXVI-172

trademark XXIII-135Intended use, meaning thereof

XXIV-40Inter-division transfer IX-87Interest

accrued but not due I-12; X-16,X-144

additional, payable afterrepayment of loan XXI-220

and principal, apportionmentof amount between XIX-159

as an element of cost IX-23bills of exchange I-243; XIII-

41capitalisation of XXII-93;

XXIII-164; XXV-16change of method XIII-93deductibility under Income

Tax Act IX-99; X-154deduction of notional saving

XX-149demands from Income-tax

authorities XXV-53during construction period X-

8;XIII-64; XVIII-31; XXIII-58

during period asset ready butnot in operation XXIII-58

earned on idle project fundsXX-18

earned on fixed deposit X-86earned, whether to include in

gratuity trust fund balanceXXIII-69

for construction of propertyfor sale XIX-106

for usance period X-16; XV-70

from bank deposit prior totheir use in constructionactivities of a company I-147; X-118; XIII-75

from due date to date ofrepayment XVI-85; XIX-159

in jointly controlled entity,accounting and reportingin separate financialstatement of venturerXXVI-209

incidence VI-45incurred to hedge foreign

exchange risk XXI-181liability for deferred

payments I-13notional saving of XX-148on borrowings for purchase

of fixed assets VI-35; VII-75 XI-168; XII-95; XXII-93

on borrowings during trial runXXI-114

on cash credit taken againstfixed deposit VII-24

on compensation paid onland acquired XXV-159

on credit available againstpurchase of raw materialsIX-63

on deposits made out ofgrants in aid fromgovernment of India XV-76

on funds borrowed generallyXIX-106; XXII-93, 177;XXIII-164

on hire purchase/instalmentX-106; XIX-154

on investments againstspecific funds XXIV-61


270

on loans from Governmentfor acquisition of fixedassets XVIII-29

on outstanding borrowingsXXII-177

on overdue outstanding XV-2on shortfall in payment of

advance tax XXIV-96;XXVI-166

on unpaid lease premiumXXV-18

on working capital relating toinventories held in stockXXI-1, 4, 7, 31, 98

recognition of revenue fromXIX-113, XIX-159

penal interest XIII-48penal interest on hire

purchase XIX-154provision for goods held in

custom warehouse (seeunder ‘Customs bondedwarehouse’)

subsidy on capitalised XVIII-36

surcharge in the nature ofwaiver of XI-27; XVIII-47;XXII-70

waiver on loan XIX-99; XXIII-131

wrongly received XVI-36Interim financial statements,

audit of XXII-149Interim financial statements,

overhead allocation forinventory valuation XXVI-96

Interim relief VIII-23Intermediary components (see

‘Components, manufact-ured’)

Intermediate product, valuationof stock of XVIII-25; XXI-137

Intermediary products soldduring construction periodVIII-76

Internal audit I-2, 9, 273; VII-36;VIII-65, 84; XXII-1

Internal auditor (see ‘Internalaudit’)

Internal transfers, inclusion inturnover XV-18

Internally manufactured spares,accounting for IX-87

Internet ticketing, recognition ofrevenue & costs XXIV-43

Inter-period tax allocation VII-74; XI-171

Inter-related transactions XIX-49Inter-unit transfers of stock,

disclosure XI-133Inventory of internal transfers

XI-137Inventory, inclusion of goods in

transit XII-46Inventory valuation

administrative cost inclusioninIX-37, IX-64; XII-41, XII-45; XIII-77; XX-24, XX-136

at cost XI-63, XXIV-12at lower of cost and net

realisable value XXI-137,143, XXIV-22; XXV-148

at market price as on thedate of signing ofaccounts II-36

at raw materials cost III-15by builders XXIII-95catalyst XX-47change in the method of I-72;

XI-63coal XXI-80construction contract XII-27cost of purchase, inclusion of

contribution to ‘Gas PoolAccount’ XXV-164


271

crude oil XXI-93demurrage XX-20depreciation unprovided, for

inclusion in IX-11divisional head-quarter

expense XX-24duty credit under Served

from India Scheme XXVI-181, 225

excise duty in XI-55; XX-11,XX-106, XX-119; XXI-11,20, 67

factory administrationoverheads inclusion XII-41; XIII-77; XX-136

fixed production overheadXX-45, XX-106; XXVI-96

FIFO XX-93for internal use XX-37gas in pipelines XX-37headquarter expenses XX-24housing projects XXIII-95grouping of items for I-140held in field godowns XXIII-

49, 157idle capacity costs VII-58;

XX-106in bonded warehouse V-18;

XI-55in case finished products are

expected to be sold at orabove cost XXV-145;XXV-182

in case of buffer stocks heldin godown XX-76

in extractive industry IX-78;XI-143; XX-37; XXIV-22

in petroleum industry XXI-93in power industry XXI-80;

XXV-148, XXV-182in rubber industry X-77in software development

industry XVI-11

in sugar industry XXI-1, 4, 7,31

in tea industry VIII-14; X-75in textile industry IX-46in-transit V-11; XVII-12in-warehouse XVII-12; XX-

20, XX-118inclusion of handling

expenditure XXIII-157inter-division transfers XI-133interest cost inclusion IX-21,

IX-23, IX-37, IX-64; X-124; XIX-106, XIX-132;XXI-1, 4, 7, 31, 98

intermediate product XVIII-25; XX-49; XXI-137

located at different pointshaving different realisablevalue XX-76

left-over materials XIV-39MODVAT, inclusion in VIII-

29, VIII-32, VIII-35; XX-11, XX-118; XXI-190

negative realisable valueVIII-1

net realisable valuedetermination for I-86; II-36; IV-26; IX-46; XX-76,XX-132; XXI-137, 143

non-moving XIV-36normal capacity XX-45, XX-

108obsolete XIV-36; XX-50of books by a publishing

company XVI-41of capital stores (see also

‘Machinery spares’) XX-50

of components usedinternally, sold V-43

of cotton bales, seeds etc.XI-68

of gold jewellery, for taxpurposes X-157

of hedged materials XX-93


272

of imported goods againstadvance licence XVI-51;XXIV-12

of imported goods underDEPB scheme (see also‘DEPB Scheme’) XX-96

of in-process material incontinuous process XVII-46

of intervening waste productsXVI-34

of items handled on behalf ofgovernment VI-29

of joint products XXI-25of machinery spares XVII-95;

XX-40, XX-50, XX-112,XX-128; XXI-42, 196

of natural gas in pipelinesXX-38

of oil stock in pipelines andtanks XXI-93

of orchid plants XXI-35of raw materials XX-49, XX-

93; XXI-137of raw materials purchased

in exchange of steam IX-21

of raw materials where set-off of excise duty underCENVAT XX-106

of salt XV-48of samples VIII-11of stores XX-50of spares XIV-35; XX-40;

XX-50, XX-112, XX-128;XXIII-153; XXV-148

of work-in-progress, bybuilders XXIII-95

qualification with regard toXI-64

R & D cost, inclusion in IX-37; IX-64; XXV-3

specific identification methodXX-94

selling prices, different XX-76

tax implications of change inmethod of IX-41

transportation cost inclusionXXIII-49, 157

used for internalconsumption as well asdirect sale XX-37

waste products I-53; XI-22;XVI- 117

work-in-process XVIII-25Investigation, special III-34 to 36Investment

allowance reserve V-57; VII-87, VII-88; X-151; X-162;XVI-113; XVI-117

allowance, withdrawal of VII-86

capital store (see also‘machinery spares’) XX-50

company VII-66deposit IX-95in an AOP, recognition of its

income XIV-109; XIX-90invoices, composite charge I-

62u/s 292(1)(d) XIII-124; XXII-

191Investments

advertisement, travelling,legal cost etc., part ofXIX-94; XXVI-140

against specific funds,interest thereon XXIV-61

amount deposited with abank in a fixed deposit III-31

call money XIX-109certificate of deposits XVI-

111; XIX-109commercial paper XII-65;

XIX-109cost of XXVI-140


273

determination of carryingamount of lot sold XXIII-112

disclosure of unutilisedmonies under ScheduleVI XXI-124

fair value XXII-39in associates XXV-57incentive on direct purchase

XIX-64interest in jointly controlled

entity XXVI-209long-term, determination of

carrying amount XXIII-112long-term, recognition of

interest in jointlycontrolled entity XXVI-209

long-term, valuation XXV-57;XXVI-140

of surplus funds, duringconstruction period XVIII-31

profit/loss on sale VII-17;VIII-39; XXIII-112

provision for shortfall in valueof VII-17; XXII-3, 39, 145

Schedule-VI (disclosure)I-206; XVI-110

section 372 (5) ofCompanies Act I-189

valuation in case ofacquisition to obtainsynergies XXI-51

valuation in case ofacquisition throughexchange of BSEmembership cards XXVI-172

valuation in case of banksXVI-39

valuation of long-term XXV-57

valuation of unquotedinvestments for NBFC’sXV-15

verification and treatment inaccounts I-6

Invoiced amount, deductionallowed XIX-66; XXI-61

Irrigation sector, expenditure onXIX-82

Issue expenses, initial XX-115Issue price, difference with the

market price of shareXXV-121

J

Jewellery, valuation of inventoryof X-157

Jigs XVIII-53Job work XX-59Joint

auditors I-213products cost allocation XXI-

25Joint venture

as a separate segment XXII-76

audit of operator’s accountsXXII-1

interest in jointly controlledentity XXVI-209

treatment of a future profitunexecuted rights I-85

K

Know how, expenditure on VI-68; X-39 to 45; XV-45;XVII-108; XVIII-20; XXIII-19

L

Land


274

acquired on long-term leaseXXV-16

interest on compensationpaid on acquired XXV-159

deposit with state/centralgovt. agencies foracquisition of XII-45;XXIII-8

development company,application of Schedule VIand MAOCARO to IX-56

development expenditure I-146; X-49; XVI-105; XX-71; XXVI-12

having limited useful lifeXXV-170

leased XXII-20; XXVI-12purchased along with

building X-10reclamation contracts XIV-71right of use XIX-119, XIX-

128; XXV-170Lease

99 years XIX-17; XX-31, XX-71; XXII-20; XXVI-12

accounting for lumpsumpayments in respect of I-26; XXII-20

asset bought by a leasingcompany for letting out IV-2; XXIV-29

asset installed with anotherenterprise XXIII-53

back IX-72; X-132; XIII-101classification XIV-106; XXIII-

53construction cost borne by

lessee in lieu of premiumXIX-27

depreciation on leasedassetsXI-93; XX-80; XXIII-34

equalisation charge/credit,XIV-130; XX-80

financial X-133; XI-98; XXII-20; XXIII-53; XXIV-29

hold land expenditure XVI-105;XXIII-8

holds, disclosure XXIII-34housing project XX-71; XXII-

20industrial estate XX-71;

XXVI-12land acquired on perpetual

lease VIII-56; XI-164long-term XXV-16; XXVI-12office space XIX-17operating XIII-103period closure XI-164permium on XII-71; XIX-27rentals, XIII-42; XIX-17; XX-

80rentals received on

premature closure ofprimary period ofXI-164

rights, capitalized value of I-60

rights, surrender of XIII-34security deposit, for XIX-17;

XXIII-8stamp duty & registration fee

on renewal XIX-46; XXV-13

taxability of leaseequalisation charge XIV-130

where sum paid by lessee atinception is repaid bylessor at the expiry of thelease term IX-80; XIX-17,XIX-42

Leave encashment XI-180; XV-42; XVI-81; XVI-94; XVI-97; XVII-51; XVII-59; XIX-38; XX-26; XXI-72, 227

Leave travel concession VI-84;XIV-84


275

Leave unencashable XIX-124;XX-90

Left-over materials, accountingfor XIV-39

Letter of credit I-260; I-262; III-3;VII-85; IX-63; XVII-71

Letter of commitment for issuingdebt guarantees XIV-62

Levy quota obligation, treatmentof shortfall in IV-3

Liaison office of a foreigncompany XII-125

Liabilities subject toperformance tests VII-8

Liabilities, classification I-74,VIII-50

Liability, estimation ofoutstanding claims XXII-188; XXIII-145

Liabilities, time barred VI-47Liability on contribution to Gas

Pool Account XXV-164Liability on account of deferred

entitlement towardsLTC/LLTC XXII-16

Liability on account of intereston shortfall in payment ofadvance income-taxXXVI-166

Liability on account of marketfees XII-89

Liability taken over VIII-101Liability under outstanding credit

card reward point schemeXXI-129

Liability under voluntaryretirement scheme XVII-81

Liability, long term VI-41; VIII-27Liability, short term (see also

‘Current liability’) VI-41Library books, depreciation on

V-39Licence

advance VIII-4; X-46, X-58;XII-48; XIV-52

capitalisation of fee XXIII-19Licence fee for radio paging

business XVI-1Life insurance premium I-110Life insurance business,

applicability of AS 11XXII-121

Limestone quarries X-26Limited Review under clause-41

of Listed Agreement XX-84

Liquidated damages I-117;XI-177; XIII-49; XV-55;XVI-58

Liquidation of a companyappointment of auditors in

case of VII-80dues recoverable from XXII-

35Listed company, definition

XXIV-101Listing agreement, clause 32

XXIV-101Livestock, valuation of I-97Loan of petroleum products

amongst oil companiesXV-31

Loansagainst receivables due on

sales on deferred creditterms I-141

against usance billsdiscounted I-125

applicability of section 293XIX-1

applicability of S.295 II-43;VI-14

applicability of S.370 (I B) toGovt. Companies II - 39

application of S.269 of I.T.Act XII-118

arranged by a contractee forcontractor XIX-9


276

cash securities received inrespect of VII-23

classification of interestaccrued but not due on I-12; VIII-18

companies under the samemanagement XXI-237

deferred payment,classification as I-15, I-42;VIII-17

demand loan XIX-1disclosure of I-49; VI-50; X-

144; XII-67guaranteed by banks/Fls/

Govt., etc. I-74; II-18; IV-1instalments repaid before

due date VIII-59materials given as XII-44;

XV-31; XVI-14secured, disclosure of partly

secured bonds XXVI-55temporary XIX-1tripartite XIX-9waiver of XVIII-47; XXII-70working capital demand loan

XIX-1write off when suits have

been filed XII-70utilisation for acquisition of

fixed assets XXI-151, 164Long production cycle items V-

24; X-98; XVII-35; XXVI-72

Long - term debt VIII-7Long term investments,

valuation of XXI-51; XXII-3, 39, 145; XXIII-112

Long term settlement withemployees VIII-74

Loss accumulated VIII-100;XVII-115

during construction periodXVII-68

for the purpose of section115J XI- 183, XI-195

in valuation of work-in-progress V-15

notional V-41; XIII-110of stock in flood / fire I-241of subsidiary companies,

provision for I-88; II-15 to16

on abondment of expansionscheme XX-168

on fixed assets, in fire X-39;X-147; XIV-98

on exchange rate XII-33, XII-58 (see also ‘Foreignexchange ratefluctuations, accountingfor,’)

on sale of non-convertibledebentures XIII-89

setting off I-52 to 53surcharge waived XXII-70treatment in construction

contracts VII-54; XII-105

M

Machinery and equipment, heldfor use in specificcontracts XXI-187

Machinery spares (see also‘Capital spares’) valuationXVII-95; XX-40, XX-50XX-112, XX-128; XXI-42,196; XXIII-14; XXIV-168;XXV-62, XXV-80, XXV-90,XXV-95, XXV-103; XXVI-161

Maintenance cost reserve, writeback XI-91

Maintenance spares under anO&M agreement XXV-103

Management consultancyservices VII-32; XXI-208

Management fee, portfolio XI-44


277

Management fees, disclosure ofXIII-41

Management taken over byGovt., of a textile unit X-18

Manager III-38 to 39Managerial remuneration (see

‘Remuneration’)Managing director’s

appointment in case ofamalgamation VIII-103

Managing director’s fees I-255;II-17 to 18

Managing director’s,contribution to providentfund of IX-105

Mandatory costs of share issueIX-208

Mandatory refurbishment costXXIV-128

Manufactured componentsclassification of III-1for internal use V-43for sister units V-43valuation of V-43

ManufacturecontractX-1defined X-4

Manufacturers, supporting(section 80 HHC) VIII-93

Manufacturing and OtherCompanies (Auditor’sReport) Order

club registered as acompany XI-124

company engaged inagricultural operations I-233


depreciation of fixed assetsunder II-1

directors’ comments onobser-vations made inauditor’s report XI-76

engaged in growing andexport of flowers XVI-7

engaged in researchactivities VII-82

form of auditor’s report VII-37frequency of physical

verification of stores andspare parts II-32

interpretation I-239investment company VII-66land development company

IX-56location of fixed Assets X-78service company X-32valuation of inventories XI-63

Market fees XII-89Market value, derived I-31 to 33Matching concept XXIII-29MAT credit, creation of deferred

tax asset in respectthereof XXV-145; XXVI-64

Materialconsumed VI-51in-transit I-138; XII-46left-over XIV-39loaned XII-44packing IX-86produced, used in expansion

project III-7rejected I-138unconsumed in case of cost

plus contracts XVII-17under inspection I-138

Materiality XXI-211; XXIII-105;XXV-36, XXV-140

Mehta Sukhdi I-7Mementos distributed among

employees duringconstruction period,accounting thereof XXVI-187


278

Memorandum amounts duefrom subscribers to XI-222

Mercantile system I-7, I-92 to93, I-96 to 98

Mine closure expenditure,provision for XXV-185

Minimum fee for audit by CAsXI-223

Mining contract work-in-progress X-111

Mining industry, development ofore body XXII-129

Miscellaneous expenditure IV-14; XV-79

Mistakes I-25, I-26, I-129 to 130;XX-1

Mistakes in billing XXI-61MODVAT for inputs VIII-29, VIII-

32, VIII-35; XI-12; XIII-44,XIII-110; XX-11, XX-118;XXI-190

MODVAT for capital goods XVI-2; XXI-190

MOU arrangements XX-59Molasses II-3 to 6Monetary item XIX-49Money market instruments XIX-

109Motor Car Accident Tribunal

award X-154Moulds and dies used in

manufacture of acomponent XX-4; XXIV-150

MRTP Act, treatment ofrevalued assets X-172

Mutual Funds, initial issueexpenses XX-115

N

Name of CA firm, change in VIII-24; IX-106

NBFC’s disclosure of partlysecured bonds XXVI-55

NBFC’s presentation of NPAprovision in the balancesheet XXV-26

NBFCs’ valuation of unquotedinvestments XV-15

Negative opinion VII-17; X-109;XXV-225

Negative realisable value VIII-1;XX-76

Net-of-tax VII-73Net realisable value XXI-137

materials and other suppliesXXI-143

of assets discarded/declaredsurplus XXI-148

Net worthcomputation of I-99, I-158,

I-161inclusion of capital

contribution fromconsumers XXI-223

Nominee 1-6Non-current asset VI-41Non-convertible debentures XIII-

89Normal capacity utilisation for

the purpose of fixedproduction overhead XX-45, XX-108; XXII-132;XXVI-96

Not-for-profit organisation VI-67Not-for-profit organisation –

applicability of AS 3 andAS 18 XXVI-58

Notional direct taxes I-272Notional income VII-79; XVI-9;

XX-148Notional loss/premium off sales

XIII-107Notional loss, adjustment

against notional premiumV-41; XIII-107


279

NPA provision in quarterlyaccounts XIX-89

NPA Provision, Presentationthereof in the balancesheet of an NBFC XXV-26

O

Obligation, constructive XXIV-128

Office space, deposit made forusing VIII-25

Officer, for Part I of Schedule VIof the Companies Act XV-81

Oil and gas industryexpendable wells,

accounting for XXV-193foreign currency transactions

XXIII-89producing properties,

exploratory wells anddevelopment dry wells,accounting for XXIV-156

segment reporting XXII-76side-tracking and abandoned

portion costs of wellsXXVI-109

Opening balances not available,audit where VIII-43

Opening balance of inventory,restatement XXI-13

Operating lease, disclosure offixed assets XVI-32

Operational support credit,accounting for XXI-160

Opinion, disagreement withmanagement XIX-79

Opinion, disclaimer of VIII-46,VIII-63 and 64; IX-28

Opinion, adverse/negative VII-17; X-109 (see under‘Negative Opinion’)

Options on unissued shares,disclosure XV-73

Orchid plants, accounting forXXI-35

Ordinary activities XX-32; XXII-70

Ore body, development of XXII-129

Outgoings II-40 to 42Overburden, removal of II-16;

X-26Outstanding amounts I-41; XV-

2;XVIII-6

Outstanding claims in insurancebusiness, estimation ofXXII-188; XXIII-145

Overdue outstandings XVIII-6Overhead rates I-72Overheads, allocation for

inventory valuation XXVI-96

Overheads, basis ofapportionmentXI-38, XI-155; XX-136;XXII-72, 132

P

Packing materials supplied bycustomers XIII-52

Packing materials, disclosureunder Schedule VI IX-86

Paid-up capital VIII-98Partner’s retirement, issues

involved X-146Partly secured advances I-5Pass book credit XVII-20; XVII-

93Patent development cost XIV-10Pay scales

revision, retrospectivelyXII-102; XVIII-13


280

Payments of Bonus Act I-259,I-272; V-61

Penalty, accounting for XIII-48Percentage of completion

method VI-62 to 65; VIII-48; XX-100; XXI-103, 109;XXIV-84; XXV-112, XXV-140; XXVI-72

Performance award, accountingtreatment of V-33

Performance guarantees VIII-81; XV-60

Performance of a guarantee I-111

Performance tests VII-8; VIII-81Performance, when complete in

a service contract XXII-114

Petroleum industrycash generating unit XXIV-

105segment reporting XXII-12side-teaching and

abandoned portion costsof wells XXVI-109

valuation of crude oil XXI-93valuation of inventories XXI-

137Petroleum products - accounting

of loan transactions XV-31

Physical verification of storesetc. II-32 to 34

Physical verification of work-in-progress I-118

Physician’s samples, valuationofVIII-11

Pisciculture I-96Plant & equipment, write-off

small value items XXIII-105

Plant & Machinery, bullet proofjackets XXV-157

Plant & machinery, meaningthereof XXIV-119; XXVI-22

Plant & machinery, retired XIV-94 (see also under‘Retired Assets’)

Plant II-24Plantation (see also ‘Timber’)

VII-72; VIII-14; VIII-60;XIII-35, XIII-96; XXI-35

Pond, tailing XXV-170Portfolio management services

fees, recognition of XI-43Portfolio management services,

disclosure in financialstatements XIV-100

Ports trusts Act, 1963, intereston investments againstspecific funds XXIV-61

Post-retirement medical facilitiesXVII-51; XIX-150

Post-shipment packing credit I-141

Potential equity share XXVI-220Power sector

advance against depreciationXVII-98; XXV-37

applicability of AS 11(1994)for transactions before1-4-2004 XXIV-36

asset ready but not inoperation XXIII-58

capital contributions receivedfrom consumers XXI-223

catchment area, expenditurethereon XXIV-40

deferred tax liability onspecial reserve XXIV-64

deferred tax reserve XXIII-83electicity supply annual

account rules, 1985 XXII-86

exchange differences inrespect of fixed assets


281

acquired within India inforeign currency XXIV-32

foreign exchange gain/lossXXV-206

machinery spares XXIII-14segment reporting XXVI-49

Power purchase agreement,foreign exchangedifference XXV-206

Power purchase agreement,revenue recognition inrespect of deferred taxliability recoverable onactual payment XXV-216

provisions for mandatoryrefurbishment cost XXIV-128

recovery of income tax fromcustomers XXI-47

revenue recognition, deferraldue to different rates ofdepreciation XXIV-123

sale of right to receive powerXXII-86

valuation of coal XXI-80valuation of inventories XXV-148; XXV-182

Power tariff, additionaldemanded byGovernment XXI-78

Pre-acquisition profit IV-17Preference capital, redemption

of VI-44; XI-219; XVII-26Preference dividend VI-44;

XI-214, XI-219Premium payable on

investmentsVIII-69; XIII-41

Premium receivable on maturityof debentures XVII-103

Premium received on land XII-71

Premium, notional VI-41; XIII-107

Prepaid expenses I-110

Prepayment fees on borrowingXXIV-80

Previous auditor’s consent I-177Previous years’ accounts I- 1 to

2, I-58 to 59; III-18 to 20;XIV - 115; XVI-5

Previous year’s figures,disclosure ofcorresponding IV-10

Price escalation clause I-55 to57, I-117

Price revision with retrospectiveeffect VIII-75

Primary period of lease closureXI-164

Principal and interest,apportionment betweenXIX-159

Prior period item I-28 to 29, I-84to 85; VI-71, VI-75; VII-47to 50; XI-27, XI-77; XX-1,XX-67; XX-71; XXI-13, 98;XXII-121; XXIII-153; XXV-34; XXVI-6, 22, 37, 119

Prior year accounts (see‘Previous years’accounts’)

Pro-rata depreciation IX-58,IX-68, IX-70; X-79; XI-73;XII-24 ; XV-25

Process wastes I-53 to 55Processing industries I-234 to

236Processors, TDS on charges

paid VIII-88Production, third party X-1Profession XI-193, XI-200Profit and Loss account debit

balance, whether part offree reserve XXIII-171

Profit and Loss Account duringconstruction period XI-128

Profit and Loss Account whengoing concern assumptioninappropriate XX-124


282

Profit and Loss AppropriationAccount I-29, I-60 to 61,I-108

Profit determinationfor section 32 AB VIII-91for section 80 HHC VIII-89,

VIII-97Profit on cancellation of roll-over

contract XIII-1, XIII-30Profit on sale of investments

VIII-39Profit on sale of machine VIII-86Profit on surrender of leasehold

rights XIII-34Profit arising from a sale & lease

- back XIII-101Progress payment II-24 to 27;

VII-44Proportionate completion

method (see ‘percentageof completion method’)

Prototype development costsXIV-1; XXV-3

Provident fund I-60 to 61; IX-104;XI-6

Provision for contingent liabilityXIX-31; XXIV-50; XXVI-119

Provision for contingent loss,writing back of XIII-105

Provision for credit card rewardpoints scheme XXI-129

Provision for customs duty XXI-57

Provision for deferredentitlement of LTC/LLTCXXII-16

Provision for diminution in valueof investments XXII-3, 39,145

Provision for disputed income-tax demands XXV-53

Provision for doubtful advancesand claims, consideredrecoverable XXVI-37

Provision for doubtful bankdeposits XIX-25

Provision for doubtful debtsXXIV-75

Provision for excise duty XXI-67Provision for expected

expenditure in respect ofalterations/amendmentsXXV-175

Provision for final mine closureexpenditure XXV-185

Provision for gratuity liabilityXXI-72; XXIII-69, 99

Provision for incompleteassignments anddisclosure thereof XXV-175

Provision for interest onadvance tax XXIV-96;XXVI-166

Provision for losses on contractsXIII-105; XXI-187

Provision for leave encashment(see also ‘Leaveencashment’) XX-27; XXI-72, 227

Provision for losses on currentassets XIX-25

Provision for mandatoryrefurbish-ment cost XXIV-128

Provision for NPA XIX-88; XXV-26

Provision for obsolescence ofstores and spares XXV-62

Provision for outstanding claimsXXII-188; XXIII-145

Provision for redundancy, non-moving and slow movingitems XXI-143

Provision for scheduledmaintenance under an


283

O&M Management XXV-103

Provision for stamp duty XXIII-8Provision for wear and tear of

stores, presentation XXIV-172; XXV-148

Provision of earlier years nolonger required XII-92

Provision of market fees XII-89Provisions’ adjustment for

section 32AB purposesVIII-91

Provisions for expensesdisclosure of XIX-41

Provision whether required,when dues recoverablefrom company underliquidation XXII-35

Purchase consignment XII-1Purchase, consolidated X-10Purchase cost, inclusion of

contribution to ‘Gas PoolAccount’ XXV-164

Purchases, determination oftime to recognise XX-9;XXII-7

Purchases, high sea I-262Purchases, MOU arrangements

XX-59

Q

Qualification in audit report re.non-genuine commissionpayments XII-50

Qualification in auditor’s reportin case of statutoryviolations VI-13, VI-78;VII-1, VII-18 to 20, VII-38

Qualifications in auditor’s reportin case of revisedaccounts XVI-91

Qualifications in auditor’s report,comments in director’sreport on VI-80

Qualifications in auditor’s report,manner of making XII-107; XXI-11, 20, 72, 98

Qualifications regardingcapitalisation ofrevaluation reservepertaining to an earlieryear XVII-1

Qualifying assetacquisition of land XXV-16use of borrowed funds or

equity inflow XXII-93use of borrowed funds or

internal accruals XXIII-164

Quantity discount VI-56; XIII-39Quarterly results, provision for

NPAs in XIX-88Quota obligation treatment of

shortfall in levy IV-3

R

Railways siding IX-14Railway receipts, accounting for

sales XXII-27Raw materials consumed VI-51;

IX-86Real estate accounting IX-2; IX-

9Rebates (see also ‘Discounts’)

XIII-39; XXII-169Receipts, gross VI-83Recognition of duty credit

entitlement underserved from India scheme

XXVI-181, 225target plus scheme XXVI-148

Reconstitution of audit firm VIII-24; IX-106


284

Reconstruction Reserve,transfer to GeneralReserve on amalgamationXV-23

Recovery of amount received,apportionment betweenprincipal and interest XIX-159

Recovery of income tax fromcustomers XXI-47

Redemption of borrowings,sinking fund for IV-6

Redemption of builders’ loanXVII-75

Redemption of preferencecapital VI-44; XI-219;XVII-26

Redemption Reserve I-51; I-163; V-1; XIV-80; XVII-1;XVII-115

Refurbishment cost, accountingfor XXIV-128

Registration fee onexecution/renewal oflease XIX-46; XXV-16

Regrouping of previous year’sfigures IV-10

Rehabilitation and resettlementoffice, accounting forestablishment expensesthereof XXVI-198

Related party XXIII-174Relative I-77 to 78; III-38 to 39;

V-13; VI-58, VI-60; VII-41Reliance on the work of internal

auditor V-12Relocation of a unit-

compensation toemployees XVII-107

Remunerationdirectors (see ‘Director’s

fees’)managerial I-8, I-209 to 212,

I-214 to 217; II- 40 to 42;VII-47

managing director (see‘Managing director’sfees’)

set-off of previous years’losses, for managerialXI-217

to employees of subsidiariesI-113 to 114

Renewal of sleepers and rails,expenditure on IX-14

Rent I-27 to 28; XX-71Renunciation of rights shares,

accounting for XI-41Rephasement of builder loans

XVII-75Replacements IX-14; XIV-75;

XV-37; XVI-100; XVIII-66;XXIII-126

Research and developmentcosts XIV-1; XXV-3

Research and DevelopmentFund III-31 to 33

Research institution,applicability ofMAOCARO to VII-82

Reserve, arising inamalgamation in thenature of merger XXIII-109

Reserve, creation and utilisationXXIV-88

Reserve, definition XX-17; XXIII-171; XXIV-75; XXVI-37

Reserve fund II-3 to 6; VII-70;XXIV-61

Reserves no longer required,write back of XI-88, XI-91

Residual reserve for bonusissue I-48 to 49

Retainership basis, appointmentof auditors for otherservices on VII-31

Retention money, in the booksof contractee XX-33

Retired assets VIII-21; XIV-94


285

Retirement benefits (see also‘Voluntary retirementscheme’) XVII-51, XVII-59; XVIII-60; XIX-145,XIX-150; XX-90; XXI-72;XXII-183; XXIII-69, 99

Retirement of partner X-146Retirement scheme, voluntary

X-81; XVII-81; XIX-145Retrenchment benefits,

treatment of VI-27Revaluation reserve I-51, I-163;

V-1, XIV-80; XVII-1, XVII-115; XX-163

Revalued assets I-4, I-34 to 41,I-51, I-162 to 172; X-172;XIV-19; XV-36; XX-163

Revenue recognition (see also‘Sales’)

against FOR destinationcontracts VII-28; VIII-46;X-98; XXI-52; XXII-27

arising from freight andhandling of containersXXII-114; XXIV-138

before delivery of goodsXVII-35; XXII-98

by builders XXIII-95credit arising on pre-mature

repayment of sales taxliability otherwisedeferrable XXIII-122

customs duty credit underServed from IndiaScheme XXVI-181, 225

customs duty credit underTarget Plus SchemeXXVI-148

deduction allowed frominvoiced amount XXI-61

deferral due to different ratesof depreciation XXV-123,XXV-216

design engineering XXI-85dredging contracts XV-65

export on CIF basis XI-56for a service organisation

XVI-24; XXII-114; XXV-140

from internet ticketing XXIV-43

from lease of housing /industrial projects XX-71;XXII-20; XXVI-12

from unmanned PCOs XXIV-1

ground rent XXII-138housing projects XXIII-95in an advertising company

VII-33in case of insurance claims

(see also ‘Insuranceclaims’) XX-54

in case of constructioncontracts VII-12

in case of lease XX-71; XXII-20; XXVI-12

increase in revenue due tosales tax exemption XX-14

in respect of moulds sold, butretained for furtherproduction XXIV-150

of amounts receivable oncompletion ofperformance guaranteesXV-60

of billable, retrospectiverevision of pay scalesXVIII-19

of gain on conversion offoreign currency intoIndian currency XX-64

of gains arising fromtranslation of foreigncurrency debts onbalance sheet date XVIII-4; XX-64


286

of goods manufacturedagainst customers’ ordersVI-53

of goods delivered to thetransporter for despatchto the customer’s godownand issue of sales invoicebut delivery on paymentXXII-98

of income from consultancyfees XXI-85; XXV-175

of income from units XIX-44of income from interest XIX-

109: XXIV-61of income from interest on

idle project funds XX-18of income tax recovery from

customers XXI-47of insurance claims XX-54of interest on investments

against specific fundsXXIV-61

of non-refundable depositXIX-102

of proceeds from leasing ofland XX-30; XXII-20

of sales made by businessassociates of a companyXVI-43, XVI-47, XVI-70;XXVI-88

of sales made by afranchisee XXVI-190

of surcharge on outstandingdues XVIII-6

of training fees andregistration fees XXI-177

of undistributed surplus inAOP XIX-90

on contracts at early stagesXX-100; XXI-103

on long production cycleitems XVII-35; XXVI-72

on sale of goods ondocuments against

payment basisXVII-42

on sale of natural gas,inclusive of amountcontributed to ‘Gas PoolAccount’ XXV-164

on time proportion basis XXI-177; XXII-138

percentage of completionmethod XXI-103; XXV-140

power sector XVII-98; XXIV-123; XXV-37, XXV-216

premium on maturity ofdebentures XVII-103

procurement projects XXI-85project management XXI-85rendering portfolio

management services XI-43

sale of sub-distribution rightsof a film VIII-5

sales effected by documentsthrough bank by acompany and not clearedby parties withinstipulated time, whetheramounts to XVI-17

service contracts XIII-113;XX-156; XXI-109; XXII-114, 138

transfer of rights notbelonging to companyXVI-93

waiver of interest XIX-99where rates of depreciation

are different for financialstatements and tarifffixation XXIV-123; XXV-216

Revenue reserve, adjustment ofimpairment loss XXV-22


287

Revenue stamps I-95Review, limited XX-84Revision of accounts V-30; XVI-

67, XVI-89, XVI-113Revision of prices with

retrospective effect VIII-75Revision of pay scales with

retrospective effect XII-102; XVIII-13

Right of use of land XIX-119,XIX-128; XX-30;XXV-170

Right to use the trademarkXXIII-135

Right of shares renunciation,accounting for XI-41

Risks and rewards, transfer ofXXI-52; XXII-7, 27, 98;XXIV-150; XXVI-190

‘Rolls’ used in a rolling mill,accounting of XIV-87

Roll-over contract IX-47; XVI-106

for long term liabilities IX-47XI-106

for liabilities for purchasingraw materials XIII-19

interest on float arising inXIII-21

profit on cancellation of XIII-1; XIII-30; XIV-74

treatment of estimatedcharges payable in futureunder XIII-24

Royalty I-59, I-105Rule 3A of the Companies

(Acceptance of Deposits)Rules IV-36

Rule 57R(8) of the CentralExcise Rules, 1944 XXI-190

S

Sale of Goods Act I-269; XXII-98

Sales (see also ‘Revenuerecognition’)

and leaseback IX-72; X-132;XIII-101

before delivery of goodsXVII-35; XXII-98

consignment VI-33; XII-1contract I-117; IV-27export XVIII-70high sea I-262in case of advertising

company X-88in case of franchise business

XXVI-190intangible asset XXII-86notional loss/premium on

XIII-107MOU arrangements XX-59of intermediary product

during construction periodVIII-76

of wheat and rice under theGovernment allocation,purchased from anothergovernment undertakingXXVI-88

on documents againstpayment basis XVII-42

recognition of I-154 to 157;VIII-46; XI-56, XI-117;XXII-98

sub-distribution rights of filmsVIII-5

tax I-62, I-109, I-263 to 269;XI-51; XX-14

value variation X-91where variation between

loading port anddischarge port X-91

Sales tax


288

credit arising on pre-maturerepayment ofaccumulated liabilityotherwise deferrableXXIII-122

Samples VIII-11Schedule VI

change in basis ofaccounting XXIV-174


current liability, interest onshortfall in payment ofadvance tax XXVI-166

disclosure of partly securedbonds XXVI-55

format of balance sheetXXIII-171

information provided underpart IV XXIV-146

provision for wear and tear ofstores and spares,disclosure XXIV-172

Schedule XIII X-172Schedule XIV XXIII-126; XXVI-

42Scheduled Bank I-253Seasonal business stock held

XXI-1, 4, 7, 31Secretary, signing of accounts

by VI-34Section 32 AB of Income-tax

Act, 1961 VIII-91; IX-95;XI-186, XI-190, XI-201,XI-204

Section 33 ABA of Income-taxAct, 1961, Disclosure oflong-term deposit XXIV-93

Section 36(1)(viii) of Income-taxAct, 1961, deferred taxliability on special reserveXXIV-64;XXV-135, XXV-201; XXVI-124

Section 43 B of Income-tax Act,1961, VII-15; X-165; XI-4

Section 44AB of Income-tax Act,1961

applicability to a financebusiness XI-184

applicability to a hospital XI-193

applicability to a stock brokerX-166

applicability to a travel agentXI-198

audit under clause II of form3CD IX-95

appointment of auditors XI-197

exempted institution V-56provisions under clause 9(c)

of Form 3CD XIX-38Section 80A of Companies Act,

1956, arrears ofpreference dividend XI-219

Section 80 HHC of Income-taxAct, 1961, VIII-89, VIII-93,VIII-97

Section 115J of Income-tax Act,1961, XI-183, XI-194

Section 115JAA(IA) of Income-tax Act, 1961, XXV-145;XXVI-64

Section 209 (3)(b) ofCompanies Act, 1956,XXI-211; XXII-45, 114

Section 211 of Companies Act,1956, XXII-45; XXIII-83

Section 212 of Companies Act,1956, particulars requiredto be attached under XIII-21

Section 221 and 227 ofCompanies Act, 1956,applicability to a liaisonoffice of a foreigncompany XII-125


289

Section 227(1A) of CompaniesAct, 1956, XXIII-117

Section 227(2) of CompaniesAct, 1956, XXII-45

Section 227(3) of CompaniesAct, 1956, XXI-215; XXII-45

Section 224 (I-B) of CompaniesAct, 1956, application toCA in full-timeemployment XI-216

Section 225 of Companies Act,1956, compliance withXIII-128

Section 234B and 234C ofIncome-tax Act, 1961,disclosure of interestXXIV-96; XXVI-166

Section 269T of Income-tax Act,1961, application to loanssquared up by means ofbook entries XIII-118

Section 292 (1) (d) ofCompanies Act, 1956,applicability of XIII-124;XXII-191

Section 293(1) (d) ofCompanies Act, 1956

clarification of borrowing limitXII-120; XIX-1

inclusion of debit balance ofprofit and loss account infree reserves XXIII-171

Section 295 of Companies Act,1956, contravention of VI-13

Section 297 of Companies Act,1956, VII-85

Section 370(1B) of CompaniesAct, 1956, applicability forMAOCARO 1988 andSchedule VI XXI-237

Section 372 (A) of CompaniesAct, 1956, XIX-142

Section 619(2) of CompaniesAct, 1956, appointment ofauditor XXI-217

Securitisation, disclosure ofclass ‘B’ PTCs held byOriginator XXIII-149

Security VI-50Segment Reporting XXII-12, 76;

XXIII-1; XXIII-75; XXVI-49, 79

Self-insurance claims VII-2; XI-70

Self insurance reserve, write-back of XI-88

Served from India Scheme,accounting for duty creditentitlement XXVI-181, 225

Service charges for repairs intransit XI-70

Service company, applicabilityof MAOCARO to VII-82;X-32

Service contracts, revenuerecognition in XIII-113;XXI-109; XXIV-43

Servicing equipment, definedXX-40

Setting off losses I-52 to 53Settlement allowance, whether

retirement benefit XVIII-60; XXII-183

Share application money asdepositIX-104

Share application moneypending allotment I-118;II-27 to 29;XV-34

Share applications rejected,whether part ofsubscribed share capitalXII-121

Shareholders’ enquires fromauditors VII-64


290

Share in undistributed surplus inan AOP XIX-90

Share issue expenses,classification of XI-208;XIII-75

Share premium XXV-121Shares allotted against cash

XVI-114Shares allotted against debt

XVI-114Shares issued against cash and

intangible asset XXV-121Sheera Niyantran Adhiniyam II-

3 to 6Shipping industry

deferred tax asset/liabilityupon adoption of tonnagetax scheme XXV-43,XXV-72

interest earned oninvestments againstspecific funds XXV-61

Short-fall in the payment ofadvance income-tax,disclosure of interestthereon XXVI-166

Short-fall in the value ofinvestments VII-17

Short production cycle itemsXI-117

Show-cause notices VII-21Shut-down period, expenditure

during XVI-19Significant accounting policy

XVIII-72Silver rupee coins I-128Sick Industrial Companies Act,

treatment of BondRedemption Reserve andmiscellaneousexpenditure XV-79

Side-tracking costs of wells,accounting thereof XXVI-109

Sinking fund for redemption ofborrowings IV-6

Societies Registration Act,appointment and tenure ofauditor XV-1

Society, co-operative XII-15, XII-117

Software development costXI-146; XVI-11

Software use licence cost XXVI-6

Spares, allocation of total costXXIV-168; XXV-62

Spares capital/insurance XVII-95; XXI-196; XXIII-153;XXV-162, XXV-80, XXV-90, XXV-95; XXVI-161

Spares for resale VI-51Spares, high value XXV-95Spares, initial pack procured

with plant XXI-196Spares, mandatory XIV-102;

XVII-8Spares, replacement of worn-

out components XXV-90,XXV-95; XXVI-161

Spares sold along withequipments, treatment ofVI-12; XIV-102

Spares, valuation of XXI-42Spares, where principal item of

fixed asset fullydepreciated XXIII-14;XXV-62, XXV-90, XXV-95

Special rebates allowed bysuppliers XIII-39

Special reserve, deferred taxliability thereon XXIV-64;XXV-135, XXV-201

Special tools, nature of XVIII-57Specified period I-123 to 124,

I-157, I-158; XXV-62,XXV-80

Spin - off XIV-80Stamp duty


291

on registration of land XXV-19

on renewal of lease XIX-46payable on execution of

lease, provision for XXIII-8

Stand by equipment, whetherfixed asset XI-85; X-40;XXI-196; XXV-95

State-controlled enterprise,applicability of AS 18XXIII-174; XXVI-58

Statement on Qualifications inAuditor’s Report XXII-45;XXIII-12, 117

Statutory auditorsappointment for special

purpose assignment XXII-1

appointment of firm when apartner is director inholding company XVII-84

Statutory reserve fund II-3 to 6Statutory reserve, interest on

investments there againstXXIV–61

Staff loans X-144Stock broker

applicability of section 44ABX-166

membership rights XXIV-4;XXVI-172

Stock exchange cards XXIV-4;XXVI-172

Stock lost in flood / fire I-241Stores & spares, provision for

XXIV-172Stores & spares replacement I-

106Stores repairs I-29 to 30Sub-distribution rights from films

VIII-5Subscription shares, amounts

due towards XI-222

Subsequent years’ accounts I-256

Subsidiaries, expenses incurredfor the benefit of I-112 to114; XIX-94

Subsidiary company losses,provision for I-88; II-15 to16

Subsidiary company, loan sub-lent by parent XXIV-17

Subsidiary company underliquidation, duesrecoverable from XXII-35

Subsidiary, wholly owned XIX-142

Subsidy I-102; I-135; IV-30; XI-161; XVII-12; XVIII-36;XX-79; XXIV-164

Substantial interest V-14; VI-59,VI-60; VII-40 to 41

Successful costing approach IV-12

Sugar industry, inclusion ofinterest cost in inventoryvaluation XXI-1, 4, 7, 31

Sundry creditors I-21, I-74, I-111; VIII-50; XVI-57; XIX-102

Sundry debtors I-111 to 112; I-142 to 144; II-35 to 36; III-3 to 5; XVII - 90; XXII-35

Supplementary cash assistanceI-135

Surcharge in the nature ofinterest on outstandingdues XVIII-9, XVIII-11

Surplus funds deployment,disclosure of XVI-110

Surplus, undistributed XIX-90Sur-tax Act X-51Swap transaction

additional interest cost forXXI-181

difference in exchange rateand swap rate XXI-181


292

T

Tailing pond XXV-170Tangible security VI-50Target Plus Scheme,

accounting for duty creditentitlement XXVI-148

Tatkal scheme XIX-102Tax audit (see also ‘Section 44

AB’)clause 9(c) XIX-38fees, disclosure of VII-64of exempted institutions V-56of stock broker X-166report, accounts not audited

under any other statueX-147

under clause II of Form 3 CDIX-95

where accounting year isdifferent from previousyear XIV-128

Tax auditor, appointment ofinternal auditors as VIII-86

Tax consultants, appointment ofauditors as III-44 to 45

Tax deduction at source I-244;VIII-88; IX-99

Tax expense, whether intereston shortfall in payment ofadvance tax includedXXIV-96; XXVI-166

Tax implications of profit on saleof machine VIII-86

Tax implications of assetsdestroyed in fire X-39;X-147

Tax liability, disputed I-173,I-250; III-11; XXV-53

Taxability

of grant for meeting exportmarketing expenses VIII-96

of interest accrued X-16, X-165

of lease equalisation charge/credit XIV-130

Taxation, provision for I-43,I-172, I-248 to 249

Taxation, deferred VII-74Taxes on income, accounting

for VII-73; XI-171; XXII-45; XXV-22, XXV-43,XXV-72, XXV-135, XXV-185, XXV-193, XXV-201;XXVI-124

Tea industry, valuation ofinventories in VIII-14; X-75

Telecom industryapplicability of AS 28 XXV-

131equipments - whether

continuous process plantXVII-79

revenue from PCOs XXIV-1installation charges collected

from customers XXV-29Telegraphic transfers

adjustment against cashcredit accountV-28

Telephone Bills, disputedamountsXV-58

Telephone company, installationcharges collected byXXV-29

Temporary construction I-151 to153

Temporary loan IX-1Termination benefits, treatment

ofVI-26; X-81


293

Textile unit, management takenover by Govt. X-18

Third parties, goods producedbyX-1

Timber, expenditure on raisingIII-12

Time barred liabilities VI-47Timing differences VIII-74 to 75;

XI-171; XXIV-64; XXVI-124

Title of an asset sub-judice XI-48

Tonnage tax scheme, deferredtax assets/liabilities underXXV-43, XXV-72

Tools XVIII-53Town development IX-3, IX-9

(See also ‘Colonies,development of’)

Trade discount VI-57; XIX-71;XXI-63

Trade investments VII-17Trade marks

accounting for XXIII-135amoritisation of XVII-86

Trading receipts VIII-15Transfer pricing XI-133Transfer of rights not belonging

to the company XVI-93Translation of financial

statements of foreignbranches XII-75

Travel agentapplicability of section 44AB

XI-198revenue from internet-

ticketing XXIV-43Travel expenditure liability XVIII-

60; XIX-38, 41; XXII-16,183

Trial runcapitalisation of borrowing

costs XXI-114

underutilisation of capacityXXII-160

Trust I-21, I-82 to 83, I-116,I-180; XI-6

Turnoverin case of advertising

company X-88in case of construction

company XXIV-84inclusion of internal transfers

inXV-18

U

Unclaimed bonds/debenturesXII-61; XVII-73

Unclaimed credit balance,writing back of I-104; XIV-95

Unclaimed dividends, treatmentof IV-34

Uncommitted reserve I-66 to 70Undercutting of audit fees I-175,

I-176, I-180, I-181Underwriting commission I-207

to 209Undistributed surplus in AOP

XIX-90Unencashable leave XIX-124;

XX-90Unexecuted contracts I-186, I-

199, I-209Unexecuted rights I-85Uniform accounting year VIII-

101Unissued shares, options on

XV-73Units VIII-67; XIX-44Unpaid dividends I-220Unpaid wages / salary / bonus,

writing back of XIV-95


294

Unquoted investments,valuation of XV-15

Unsecured loan XXII-86Unserviceable stores II-34 to 35Unsettled claims I-55Unsold or unutilised DEPB

credit XVIII-42Unsold site, accounting for XVI-

9Unspent capital based grant,

disclosure XIV-46Unutilised duty credit certificates

under Served from IndiaScheme at the year endXXVI-225

Unutilised MODVAT credit XIII-113

Unutilised monies, disclosureunder Schedule VI XXI-124

Urban development IX-3, IX-9US 64 of UTI XIX-44Usance bills I-244Usance period, interest during XV-70Useful life

construction plant/equipmentVIII-19

determinatin thereof XXVI-42intangible assets XXIV-4revision of XXV-62whether same as that of

principal asset XXV-80Usual working charges II-40 to

42Utilisation of borrowed funds

XXII-93, 177; XXIII-164Utilisation of contingency

reserve XXIV-88

V

Vacancy, casual VIII-24

Valuation balance sheet XXII-121

Valuation ofempties IV-8fixed assets, duty credit

under Served from IndiaScheme XXVI-181, 225

fixed assets held for saleXXVI-217

fixed assets retired fromactive life XXI-148

inventories (See ‘InventoryValuation’)

intermediate products XX-49;XXI-137

investments (see‘Investments’)

wastes (see ‘Wastes’)Value in use of cash generating

unit, determination on thebasis of valuer XXVI-28

Voluntary retirement schemeX-81; XV-40; XVII-81;XIX-145

Vouchers, ownership and placeof maintenance of XII-98

W

Waiting time in respect ofrelocation of unit,compensation toemployees XVII-107

Waiver of loan and interestthereon XVIII-47

Waiver of interest XI-27; XIX-99;XXIII-131

Waiver of surcharge XXII-70Warehouse charges VIII-15Warehousing Corporation VI-71;

XXIII-75Warranties XI-180Warrants, detachable XIII-89


295

Wastes I-53 to 55; XI-22; XVI-34Weighted average cost of stock

I-87Weighted average no. of

shares, computation incase of bonus issue XXV-113

Wells, expendable XXV-193Whole time directors,

appointment in case ofamalgamation VIII-103

Wholly-owned subsidiary XIX-142

Winding up petition XVII-90Windmill, continuous process

plant XVII-30Work-in-progress,

capital I-150, I-186; VII-9;VIII-61

classification III-1construction contract,

valuation of XXI-187;XXV-13

construction, of buildersXXIII-95

depreciation as an elementof cost I-93

disclosure II-24; VI-61; VII-42exploratory wells XXV-193in case of consultancy

organisation XXV-140in case of mining contract X-

IIIinclusion of amount

receivable against extrawork and other claims notcertified or accepted bythe clients XXV-13

losses in valuation V-15of consultancy projects XI-17valuation I-119; III-15; IX-35;

IX-76; XI-143; XIV-20;XVI-11; XVII-46; XIX-21;XXI-103; XXV-13

in foreign country whereforeign currency devaluedXIX-21

Working capital, borrowing forVIII-16; XIX-1

Working charges II-40Working papers XVII-74Works contracts I-115; II-24 to

27 III-3, III-14Write-back of provision for a

contingent loss XIII-105Write-back of reserves XI-88;

XI-91Write-back of time-barred

liabilities VI-47Write-back of unclaimed credit

balances, excessprovision and unpaidwages / salary / bonus etcXIV-95

Write-off ofassets IV-18debts XXII-70investments XXI-51small value items XXIII-105suit-filed debts XII-70

Write-off/write-back of accountsreceivable and payable inprofit & loss accountXIV-90

Y

Year, uniform accounting VIII-101

YTM method XVI-40

Z

Zero based debentures XII-115