Deferred Tax Liability and Deferred Tax Asset---Diferred Charges and Prepaid Expenses

Lots of students of Accounting have the problem relating to these four terms; here is my small endeavor to make them understand these concepts and clear their doubts.

DEFERRED TAX LIABALITY:

Taxing authority generally determine the profit of the enterprises according to the cash basis,  that is, expensed which are paid in the current year and income which are received in the current year. Suppose we have paid prepaid expenses in this year. Now according to the GAAP, this expense will not be deducted from the profit of the current year, but this will be deducted in deriving profit according to the income tax. At this point of time, an enterprise knows that in current year, profit according to the income tax is less therefore, favors the enterprise to pay less tax but when this prepaid expense will be expensed in the next year by the enterprise, the taxation authority will not allow this as expense because they had already recognized this in last year so the profit in the next year will be less according to the enterprise and high according to the income tax, so the enterprise has to pay more tax in next year.  Thus, it creates deferred tax liability for enterprise in current year.

Now if the expenses related to the deferred tax liability are expensed in the one year, it’s a current liability and if the expenses are expensed in more than 1 year (example advance payment for the insurance for next three year) the liability is non-current liability.

It should be noted that DTL is not only related with prepaid expenses but with all those expenses that creates the difference between profit according to tax and profit according to the GAAP. For example—Tax laws allow full depreciation in the first year after a company acquires certain assets; however, a company may actually write off the depreciation over several years on its financial statements. The company may charge depreciation at lower rates than allowed under tax laws. Or it may use a different method of charging depreciation. So in all these cases differed tax liability should be created.

Deferred tax asset:

In the similar way, Tax laws may not recognize some of the expenses that the company has accounted for in its financial statement in the current year say (2013-14). For example-provision for bad debt, which are not fully recognized by tax authorities –in such case, the company is paying the tax for future year so in the future year the profit for tax will be less and thus, it is having differed tax asset in the current year that is (2013-14).

Accounting treatment for both differed tax liability and assets:

DTL should be debited to p/l Account and will come on the liability side of the balance sheet.

DTA should be credited to p/l Account and will come on the asset side of the balance sheet.

 

 

Difference between Deferred charges and prepaid expenses:

 Students sometimes get confused about these two concepts because they look almost similar to each other, but there is a major difference. Here it is….

Prepaid expenses mean expenses paid in advance by the enterprise to receive the service in future.(it will come in the Asset side of the B/S)

Deferred charges mean charges paid by the enterprises the benefit for which is expected to receive in future years also.(it will come in the asset side of B/S and write off accordingly in the P/L account)

In the case of prepaid expenses the enterprise has the legal right to receive the service but in case of deferred charges there is no such right.

Suppose an enterprise paid rent of the building Rs 50000 in advance for the next two year, here the enterprise’s got the legal right to receive the service of building for the next two year this is called pre-paid expenses. Now the same enterprise has paid 25000 to move its all equipment from old building to this new building, here the enterprise will get the benefit of this 25000 as long as it stays in that building so the enterprise has to write off this expenditure accordingly to the estimated years it will stay in that building.  

 

So this was all how I explained about these terms, hope you all like it-I'm coming soon with one more important Accounting topic.

 

 

 

Substance Over Form

Many students have the problem in understanding the meaning of this term "substance over form"--Here is my little endeavor to make them understand its meaning, hope you all will like it.

Substance over form:

Here SUBSTANCE means truth; in other words “financial reality”.

FORM means shape, you can say giving transaction a legal shape; in other words “legal status”

This principal says that while recording the transaction in the financial statement we need to consider on the financial reality of that transaction not on its legal status.

1)      Suppose, we have sold a building to the buyer for RS100000, and the risk and reward relating to that building has been transferred to the buyer; only the legal formalities are pending. Here this principle says that neither we nor buyer; can postponed recording of this transaction in our financial statements just because the legal formalities are pending. Here the substance is “building has been sold” form is “legal formalities pending”, as substance should be preferred over form so both the parties are bound to record this transaction in their books of account.

2)      We can see this case in the financial lease where we all know that the seller transfers the risk and reward of the related asset to the buyer at the time of initial payments but the legal ownership remains with seller. Here again this principle is being applied that the buyer has to record that lease asset as ASSET in its balance sheet even though the legal ownership remains with seller.

The word “risk and reward transferred” means-- buyer enjoys all the benefits and rights as if he is an owner of the asset or goods and on the same hand he is responsible for any damages or liability exists on that goods or asset”

3)      Suppose, I have sold goods for Rs 200000 to you, and after 2 months, I have purchased it back from you in an inflated price; here legally it’s a sale and purchase transaction-- it is called form of the transaction but reality is that I have used this transaction as loan and this inflated price is the interest of that loan, this is called the substance of the transaction. So according to this principle, we can’t record this transaction as sale or purchase.

The final important example is,

If two parties exchanged their goods of similar nature and with same price, it would not be called sales transaction according to this principle (because the financial reality is only the exchange of goods; no gain no loss) although both the parties entered into a legal contract to exchanged their goods.

Conclusion:

 This principle came into existence to avoid or to control the window dressing done by the enterprise. It says that financial statements should reflect true and fair view of the company so all the transaction should be considered by its substance not by its form. Here we should keep in mind that form of transaction can be changed in its favor by any enterprise but its financial reality can’t be changed and that’s why this principle is important in accounting.

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AS 10- Accounting For Fixed Assets

Definition of fixed assets:

It is an assets held with the intention of being used for the purpose of producing goods or rendering services and is not held for sale in the normal course of business.

Standby equipment and service equipment are normally capitalized.

Machinery spares are usually charged to profit and loss account as and when consumed. However if they are used only in connection with fixed assets they should be capitalized.

Component of cost:

1)      Gross book value of fixed assets is its historical cost or amount substituted for historical cost in the financial statements. Net book value is the amount left after deducting accumulated depreciation.

2)      Cost of fixed assets include purchase price (plus) duties and taxes that are non refundable(plus)cost of bringing the asset into working condition (minus) any trade discounts and rebates.

3)      The cost of fixed assets undergo change due to factors like exchange fluctuation, change in the duties, price adjustments etc.

4)      The expenditure incurred on start up of the project or on the experimental production is usually capitalized.

5)      Depreciation of the other assets used to construct the main assets should also be included in its cost.

Non monetary assets:

When fixed assets are acquired in exchange of other assets, the fair market value of the assets given up or book value of the asset given up, whichever is low, is considered and recorded in the financial statements(plus/minus any cash given or taken).

Suppose, WDV/book value of the machine =50000, on the same hand, Net Realizable Value of that machine= 80000. This machine is exchanged with other asset costing 110000 along with cash 10000. Here FMV of old machine =110000-10000=100000 thus book value is lower than FMV so the cost of new asset will be 50000. If the FMV were 40000, the loss of 10000 would be charge to the profit and loss account and the cost of new asset would be 40000.

If the shares are given in exchange of assets, the above work will be done with shares and assets.

Improvements and repairs:

If the expenditure on improvements and repairs; increase the efficiency of the existing assets to give extra future benefits, it will be included in the gross book value of the assets.

Revaluation of fixed assets:

If there is a revaluation in fixed assets, it should be adjusted with net book value directly and depreciation will be changed accordingly.

Suppose, the historical cost of fixed asset = Rs 100,000 as gross book value, estimated life 10 years, residual value zero, accumulated depreciation (straight line) after 4 years= 40,000, and net book value= 60,000. Now the value of fixed asset is increased by 10000. In this case, remaining life=6, NBV=70000, depreciation= 70000/6=11666. So we can either write directly the value of NBV 70000. This increase in the NBV of 10000 is directly credited to the revaluation reserve account and if there were a decrease in the NBV because of revaluation it would be charge to profit and loss account, but if the decrease of revaluation is because of increment of the same asset made earlier it will be adjusted from revaluation reserve.

 If this asset is sold later, the loss on sale of this asset will be adjusted to the revaluation reserve account and if the amount still remains in the revaluation reserve account after adjusting losses, the balance amount will be transferred to general reserve, here is the example..

Suppose the above asset is sold at Rs 65000, The net loss is 5000 (70000-65000) now this amount will be adjusted with revaluation  reserve balance that is 10000, after adjusting loss we got still 5000 in revaluation reserve account this amount will be transferred to general reserve account.

Disposal --

On the normal disposal of fixed assets the loss or profit will be debited or credited to profit and loss account respectively.

JOINT OWNERSHIP--

Where any asset is held jointly by an enterprise, the extent of share in such asset and the proportionate cost, depreciation and net book value is recorded in the balance sheet. If this jointly owned asset is grouped together with fully owned assets, they are to be separately indicated in the fixed assets register.

Goodwill--

Goodwill is recorded in the book only when the consideration in the money has been paid by the enterprises. As a matter of prudence it should be write off over a period of years but many enterprises retain it as asset. 

Patent--

They are acquired in two ways either by purchasing or by developing. When patents are purchased, the purchase price, incidental expenses and stamp duty, etc are recorded in the balance sheet and when patent is developed; the development cost are recorded and capitalized. Patents are normally written off over their legal life or useful life whichever is lower.

Know-how—

Know- how is recorded only when some consideration in the money or money’s worth has been paid by the enterprise. Know how is of two types 1) relating to the manufacturing process and 2) relating to the plans, designs, on the building, plants and equipments etc.

Know- how relating to the manufacturing process is charged as an expensed during the year in which it is incurred. Know how relating to plans, design of building, plant and equipments, are capitalized under the relevant assets heads.

Assets retired:

When fixed assets are retire from active use and held for disposal they will be recorded in the financial statements, lower of NRV and book value.

The revaluation reserve relating to that asset will be transferred to general reserve. Expected loss will be recorded immediately after adjusting with revaluation reserve.

Self- constructed assets ---

It should not include any internal profits. Suppose a company constructed an asset for 100,000 rupess, the lowest estimate given by the other contractor is 150,000. The company can’t write its constructed assets at 150,000 rupess because if they did so that would be the inclusion internal profit.

Assets acquired under hire purchase: such assets are recorded in the balance sheet at its cash price but stating full ownership doesn’t exists.

Disclosure—

1).Gross and net book value of assets in the beginning and at the end of the year showing addition, disposals , acquisition, etc during the year

2) Expenditure incurred on fixed assets in the course of construction and acquisition.

3) Revalued amount substituted for historical costs of fixed assets.

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Introduction of the Accounting Standards

Before 1977 Accounting system of the Indian enterprises was pathetic, their profits were not reliable, they could modify their Balance sheet in their favor as a result of this the confusion was increasing and the users of the financial statements were losing faith in the accounting data and thus the fragile condition of commerce was there in India.

Then the experts Accounting body of India named ICAI first time took the initiative in 1977 to standardize the process of Accounting and for this they formed Accounting Standard Board (ASB).

The work of ASB, which was an independent body was to form and draft Accounting Standards and submit to the ICAI for issuance and if ICAI found it necessary to modify the draft, they after taking the consultation with ASB modify it, and finally ICAI issued that Accounting Standards.

And this process is being carried now also.

So this was how the Accounting Standards came in to existence in India. Currently there are 31 Accounting Standards.

This was in short the necessary idea that every students pursuing professional examination should know. Hope you all will like it.

Benefits of Accounting Standards  

Now what Accounting Standards does?

Accounting Standards gives Accounting principles and the method of applying those principals in the preparation of financial statements.

Accounting principals like separate entity concept (business and owners are two separate entity), materiality concept(all the items which have a significant effect in the business of an enterprise need to be disclose)conservatism concept(to anticipate all future loss but not future gains)going concern concept(that enterprise has the intention to carry on the business for long period)etc etc.

1)      Thus by applying those principals Accounting Standards provides true and fair view of the financial statements.

2)      Financial statements are now reliable

3)      Confusions which existed earlier that is all the accountants were following their own accounting system are eliminated now after issuance of AS.

4)      Earlier the enterprises were not disclosing the important information if that was not mandatory by statutory law and so users were not getting full information but now after issuance of AS they are bound to disclose all the financial items which has material effect on the business of an enterprises.

These are some of the main benefits of Accounting Standards.

 Applicability of Accounting Standards:

General idea

Accounting Standards are applicable in respect of every enterprises engage in commercial and business activity whether or not enterprise are corporate or co-operative even in the non profit organizations the accounting standards will be applicable.

Important point:

Now very important point to be noted ”For the applicability of AS, earlier ICAI divided all the enterprises in to 3 categories viz level 1, level 2, level 3.level 2 and level 3 were called SMEs(small and medium enterprise )and level 1 called NON SME, but in the meanwhile Government has given notification about the applicability of Accounting Standards for companies and thus divide the companies(that is only corporate entities not non corporate entities) into two levels viz SMCs and Non SMCs after this notification lots of criteria in the levels of the enterprises were contradicting  so     lastly it was decided that levels recommended by the ICAI for the applicability of AS would be applicable only for non corporate entities and levels as per government notification would remain applicable  for corporate entities”

Government in that notification notified that ALL the Accounting standards issued by ICAI will be applicable for Non- SMCs and give some exemption and relaxation to the SMCs for few accounting standards.

Criteria for SMCs:

        1)A company whose equity or debt securities are not listed in any stock exchange whether in india  

         Or outside india        

2)Whose turnover does not exists Rs 50 crore in the immediately preceding year.

3)Which is not bank ,financial institution or insurance company

4)Whose borrowings do not increases 10 crore in the immediate preceding year.

5)Which is not holding company or subsidiary company of Non Smcs.

Companies which are not falling in the definition of SMCs are Non SMCs.

Criteria for the level 1 enterprises according to the ICAI for non corporate entities:

These criteria’s are just the opposite of what have been stated above for SMCs that is ,

1) if the turnover of the non corporate entities exceeds 50 crore or

2) if its borrowings increases 10 crore or

3)if its equity or debt securities are listed in stock exchange  whether in India or outside India or

4)Banks financial instutiuion or entities carry on the insurance business.

Criteria for level two according to ICAI for non corporate entities are:

1)Entities whose turnoever exceeds 40 lakhs but does not exceed 50 crore or

2)Entities whose borrowings exceeds 1 core but does not exceeds 10 crore in the immediately preceding year.

 

This was all about applicability of AS and when you will read each AS you will know clearly which AS is applicable for which level.

All I stated till now is the basic and important idea that every student should know before starting the journey of learning each AS in details.

AS 1 --Disclosure of Accounting Policies

Introduction:

      Although the standardizing of accounting has reduced the possibilities of different alternatives of profit which could be reflected in a single transaction, it is not possible to control all the possible ways. Because of the diversity in the business a single set of policy will not apply to all the enterprises that’s why accounting standards permits more than one policy and thus the enterprise of the same industry are using different policies and the net effect is that the users of financial statements are finding difficulty in comparing both company, and here comes the need of AS 1. This standard says that all the enterprises should disclose his accounting policies in its financial statements so that the users are aware of that and compare accordingly.

First, what are the accounting policies?

Every enterprises have some rules and principals for how the transaction should be recoded in their books of accounts and once they create their rules, they follow this every time when the same transaction takes place--these rules and principals are called the accounting policies,  like whether inventories are valued at weighted average method or LIFO method, Depreciation is charged on WDV method or straight line method, assets are charged on historical cost method or in releasable value, revenue is recognized on the transfer of property or immediately after the sale, etc etc ..so these are some of the accounting policies that every enterprise state in its financial statements in the heading “significant accounting policies” 

Commencement:

This AS was first issued in 1979 and came into effect in respect of accounting period commencing on or after 1 April 1991.

Applicability:

This standard applies to all the enterprises.

Fundamental Accounting Assumption:

AS 1 gives three accounting assumptions viz Going concern, Accrual basis and consistency.

Going concern-

This assumption has a very deep meaning students generally learn the first line and think they understand the whole meaning.

Its says that an Enterprise prepares its financial statements on the assumption that it will carry on its business for longer period and neither it has intention nor need to shut the business or reduce the business operation.

It is because of this going concern assumption that we keep some amount out of profit as depreciation so that when  the value of fixed assets will nil the depreciation money will be accumulated enough to purchase that asset…

Its because of going concern that we keep the some amount separate as provision for liability..so that when liability exists enterprise suffers no problem in paying them from their provisions.

Consistency-

 Assumption of consistency says that the enterprise should maintain the same accounting policy for recording the transaction in every year i.e if inventories are valued at LIFO  method then in every year LIFO  method will be carried on. If depreciation in WDV method, then every year depreciation will be calculated on WDV --they can’t change different accounting policy in different year consistency should be maintain. it will change when require especially by AS OR GOVERNMENT OR other STAUTORY LAW.

Accrual basis –

 Its says that all the transactions are recognized(written) in the financial statements as soon as it occurred whether or not real cash is paid/received.Thus the accrual basis says that how much business company has done during the accounting year not how much cash company has earn..so  the accrual basis gives the clear idea of the workings of the business.

  DISCLOSURE REQUIREMENT OF THESE ASSUMPTION IN THE FINANCIAL STATEMENT:

Actually these are the assumption and not required to be disclose it will require only if these assumption are not followed by an enterprise in any accounting year and on that case it will disclose in the auditors report which is a part of the financial statement.

Selection of accounting policy:

This standard require that while selecting accounting policies the following points should be care

1) prudence:

 It says that as the future is uncertain all the probable loss is to be considered but not probable gain. it means while choosing the accounting policy enterprise should consider the point of prudence..example..creation of provision for the liability is normally an accounting policy and whether to create the provision for the particular liability in the balance sheet is a matter of prudence

But the applying prudence doesn’t mean that enterprise can create an unnecessary provisions for losses and understate the profit,… they will record the losses only when the chances of happening loss in future is more than chances of not happening loss.

2) Materiality:

It says all the significant items that can influence the decisions of the user of financial statement, will be disclosed in the financial statements by the way of notes to accounts. while choosing the accounting policies enterprise should take in to consideration about the materiality of the financial items.

Rememberàrevised provisions of the company act has made mandatory for the company to  disclose separately the expenses which is equal or more than 1%of total revenue or 100000 whichever is higher, in its financial statements by the way of notes to accounts …(here the provision is called accounting policy and while deciding policy we took in consideration the concept of materiality……this is the exact process the AS 1 is requiring from the entity..)

Manner of disclosure:

This AS tells that all the significant accounting policies will be disclosed in one place in the financial statements.

Disclosure for change in the accounting policy:

This AS says that the when the enterprises change the accounting policies which have a material effect on the financial statement or will have the material (significant)effect on future they should  disclosed that policy in the financial statement in the year in which the changes takes place and in such way that the effect is noticeable by a users. For example:

If an entity changed its policy from straight line to WDV, it should disclose clearly the amount by which  current year profit is effected from such change. It should determine the amount of depreciation as per straight line and as per WDV, so that users have clear idea about that.

This AS  says that just by only stating (say for example) “current year we have changed the depreciation valuation from WDV to straight line "--is not enough.

Important point:

Contradiction of consistency and AS 1

Student should note that the AS 1 says, Fundamental Accounting Assumption if followed, It should not be disclosed--- if not followed, it should be disclosed in the financial statements.One of the accounting assumption is consistency which says that enterprise should use same accounting policy in all the accounting period for a same transaction.

One can ask that”it means when in any year enterprise change its accounting policy it can disclosed that…’ fundamental accounting assumption are not followed’… since it has broken the consistency”….answer is …consistency would be broken if the enterprises changed the accounting policies frequently year after year and it was not mandatory for the enterprise to do this.

Here this AS 1 is talking about the changes which enterprises are bound to do in order to bring the true and fair view of their balance sheet. So for this they need to disclose the effect of change in their financial statements as per rule ,and no relation with FAA.  

So this was all about AS 2 soon I'm coming with the next important concept of Accounting.

Accounting Standard 2--Valuation of Inventories

Introduction:

This AS is talking about how to value the inventories lying as closing stock in the balance sheet date. Value of this closing stock is directly related to the profit, any unnecessary increase in value of closing stock leads to an increase in false profit. So the care should be taken in determining the cost of inventories. According to the principal of prudence the stock should be value at lower of cost or net realizable value. This AS tells about how to determine the *cost and **Net Realizable value of stock.

Inventories: Inventories are the assets(economic benefits are expected to flow)held by an enterprise: a)for sale in the ordinary course of business (finished goods)b)which are in process of production(wip) and c) which are to be consumed in the production process.(raw-material)

*Cost of closing stock:

This include cost of purchase(of raw material), 2)cost of conversion(of raw-material into finished good)and 3)other cost.

Cost of purchase:

This cost include purchase price +duties and taxes +freight inward +other cost attributable directly to purchase, from this derived amount, deduction will be made for taxes and duties that are received by the enterprises from taxing authority, trade discount and reabate.

Cost of conversion:

This include cost directly related to production like direct labor and overhead cost(both fixed and variable).variable cost are easily allocatable to the closing inventories but for fixed cost we need to consider normal capacity of production:

If the actual production is more than normal capacity production, overhead costs are allocated on the basis of actual production.

If the actual production is less than normal capacity production, overhead costs are allocated on the basis of normal capacity production.

Other costs:

These are some rare costs that are incurred in bringing the material in its present condition. A) like cost of design in custom made unit may be taken as cost of inventories.

b) borrowing cost and interest costs are normally not included in cost of inventories but in case where inventories get longer period to get ready for sale the interests and borrowing costs will include in cost of inventories, like making of wine.

c) Amortization of intangibles(like patent ,trademarks,etc) are also taken as part on inventories cost.

**Net realizable value..NRV=selling price of the product-further costs require to bring the product in selling condition. thus if a material present cost=1000 and it require further cost of 500 to make it in selling condition and the selling price of the product in the market is 2500..Net realizable value will be 2000(I,e 2500-500)..NRV of each item should be determined separately not at whole finshed products. Only sometimes when the products are very similar then are recognized in group while determining NRV.

Measurement basis..this AS says that inventories are measured either by FIFO or weighted average method

Important points for AS 2 valuation of inventories:

1)      The by-product will be valued at net realizable value and it will be deducted from the cost.

2)      Borrowing cost and interest cost will only be include in the cost of inventory when production require substantial period of time to bring the material into the saleable condition like in wine and spirites that require time to mature..otherwise no interest and borrowing cost will be included in cost of inventories. For example sugar produce seasonally and being sold throughout the year here bringing the sugar in saleable condition doesn’t require time only its seasonal that’s why stocks are kept and sold throughout the year so in this case the interest will not add in closing stock.

3)      An enterprise should follow only one cost formula at a time for its inventory ..either FIFO or weighted average formula method, one branch in FIFO and other branch in weighted average is not permissible.

4)      Storage and advertisement cost are not to be included in cost of inventories.

5)      Exchange fluctuation will not be added in the cost of inventories.

6)      For service provider only WIP will not be included in determining cost of inventory.

7)      AS 2 does not apply for the inventory of livestock, mineral oils, forest products,shares debentures and other financial instruments held as stock-in-trade, wor-in-progress under construction contract.

8)      Inventories do not include spares of machineries used only in connection with the item of fixed assets.

9)      Abnormal gains/losses should be recognized (written) as separate line items in the profit and loss account.

10)  Enterprise should disclose a) Accounting policies adopted in measuring inventories including cost formula used b) carrying amount of inventories and its classification appropriate to the enterprise.

This was all about this Accounting Standards; hope you all will like it.

Accounting Standard 9- Revenue Recognition.

Conceptual Idea:

To understand this standard first we need to understand the meaning of revenue.

Revenue is the gross inflow of cash, receivables or other consideration arising in the course of ordinary activities of an enterprise from the sale of goods, or from rendering of service, or from use by others of enterprise resources yielding interest, dividends and royalties.

Revenue is the gross inflow,(that is without deducting any expenses)

Of cash, receivables,

 or other consideration (that is, giving same value of goods or providing services)

Arises from,

The sale of goods, or from rendering of services, or from enterprise resources used by others

1^st case..sale of goods..when we sold 5 shirts @1000 per shirts we will get Rs 5000. This Rs 5000 is revenue derived from sale of goods.

2^nd case..rendering of service… in above example, if we charge 5000 to make design on that shirt, that Rs 5000 would be our revenue from rendering of services.

3^rd case..when we purchase the shares of company , it uses our cash resource in its business and gives us dividend. This dividend is the revenue derived from the use of our resources by others. Apart from this, the royalty payment for the use of patent, trademarks, etc have also been included in this category.

The agency company; get commission for their service, this commission is their revenue.

From the above definitions it is clear that revenue is not always in cash. Suppose the company sold 1 lakh shirts during the year @of 500 per shirt. The party paid 3 crore during the year, and remained due 2 crore. Here the revenue will be 5 crore NOT 3 crore--cash we received during the year; it will also include receivables increased during the year. That’s why the definition says “Revenue is the gross inflow of cash, receivables and other consideration arising either from the sale of goods, rendering of services or use of enterprise resources by other”.

Now certain items are excluded from the definition of revenue for the purpose of this standard; they are:

1)      Gains from the disposal of non-current assets.

2)      Gains from the holding of non-current assets. Example appreciation in the value of fixed assets.

3)      Gains resulting from the change in the foreign exchange rates and adjustments arise in translation in foreign currency in financial statements.

4)      Gains resulting from the restatement of the carrying amount of obligation.(suppose in the beginning of the year the obligation to be discharged is Rs 2 lakh, in the mid year this obligation is restated to Rs 180,000. Here gains of 20,000 will not be revenue of that enterprise)

5)      Gains resulting from the discharge of obligation at less than its carrying amount.(in the above example suppose at the time of discharging the obligation at the end of the year the company is required to pay 150,000, here gains of 30,000 will not be revenue)

This standard will not be applicable in the following situation:

1)      Revenue under construction contract.

2)      Revenue from govt. grant

3)      Revenue of insurance companies from insurance contract.

4)      Revenue from lease, hire purchase.

Now the main reason why this standard has been introduced is to explain the timings of recognition of revenue in the statement of profit and loss account. This is stated below:

  As we know there are 3 category from which the revenues are expected to derive:

1)sale of goods, 2) rendering of services and 3) use of enterprise resources by others. we will learn the timing of these three category in detail.

Sale of goods:

There are 3 criteria to regard the transaction as sale of goods.

1)      When the CONSIDERATION is involved in the transfer of goods between two parties (that is when the goods are transferred to other company as gift it will not be called sale).

2)      There is no UNCERTAINTY exists regarding the amount of this consideration(that is if there is a doubt regarding the price or the negotiation is going on between the buyer and seller, the seller can’t recognize the sale in the statement of account until negotiation is completed and final amount is derived) . And,

3)      When the RISK AND REWARD related with the goods are transferred to the buyer (suppose the sale of the goods are agreed, but there is a delay in delivering goods because of the fault of seller, here the seller can’t recognize the sale until the goods are delivered to the buyer because the undelivered goods lying in the warehouse is at the risk of seller. However, if the delay was the buyer’s fault then seller can recognize that sale on the same date).

Some special cases to consider for recognizing revenue for sale of goods:

1)      Sales against advance payment—

When the full or partial payment is received in advance for the goods not in stock that is they are not available currently but will be manufactured later, then the revenue from that sale will be recognized when the goods are manufactured and ready for delivery.

2)      Barter transaction—

       When the goods and services are exchanged for goods and services of similar nature and value; then it will not be recognized as revenue but if they are dissimilar then it will be regarded as transaction generating revenue and should be recognized at fair value.  

3) Sale depends upon condition:

Sometimes sales depend upon the installation and inspection process in this case when the customer is satisfied after the installation; at that time revenue should be recognized. But if the installation process is simple no chance of rejection, it can be recognized then.

4) Guaranteed sale—

In the guaranteed sale, when seller gives the guarantee “for money back if don’t like the product” then the company can recognize the sale after taking the proper provisions according to the past experience for return.

5) Consignment sale—

Revenue is not recognized until the goods are sold to the third party.

6) Repurchase of goods—

When the seller agrees to repurchase the goods, it will not be regarded as sale hence not to be recognized.

7) Installment sales----

When the consideration is receivable in installment; the revenue exclusive of interests is recognized at the time of sales and the interest elements to be recognized as revenue proportionate to unbalance amount due to seller.

8) Effect of uncertainties in the revenue recognition:

At the time of sale when there is uncertainty about the realization of amount then the revenue recognition of that sale must be postponed, and will be recognized in the year in which certainty exists. Sometimes uncertainty exists after the sale in that situation proper provision is made in the profit and loss account regarding the expected loss.

9) Rendering of services:

Revenue from the service transaction is recognized when the service is performed, either from the proportionate completion method or completed service contract method.

In the proportionate completion method, revenue is recognized proportionately with the degree of completion of service under contract. This method is used when the whole service contract can be segregated into number of stages and it’s possible to determine the cost and revenue of each stage and there is certainty about the recovery of revenue.

Under CSCM revenue is recognized when the whole service contract is completed. This method is applied when the work is in such a way that each and every stage is dependent on other stage and recovery of revenue depends on the completion of whole service contract.

10) Cases to be considered in recognizing revenue under rendering of service:

Installation fees: Revenue from installation; other than incidental to the sale of a product, are recognized  when the equipment is installed and accepted by the customer.

11) Commission of insurance agency and advertising agencies:

Insurance agency will recognize the commission as revenue when that insurance policy commence.

For advertising agency, media commission will be recognized when information appeared before public.

Production commission will be recognized as revenue when the project is completed.

12) Financial service commission:

A financial service may be rendered as a single set or may be provided over a period of time. Similarly the charges for such services may be recognized as a single amount or in stages over the period of service or the life of transaction to which it relates.

13) Processing fees:

Processing fees are received under various conditions, for example housing finance company receives it for the sanction of loan, or a lessor receives lease management fees to grant the lease. These fees are recognized in three ways: a) recognize the entire fees upfront on the sanction of loan or lease. B) recognize the fees equally over period of loan or lease. c) recognize the fees upfront to the extent of cost incurred for processing the loan or lease arrangements which will then be followed by equal distribution of the remainder of fees over the life of loan or lease.

14) Admission fees:

Revenues from artistic performances, banquets and other special events should be recognized when the events takes place.

15) Use by others of enterprise resources yielding interests, royalty, and dividends:

Interests…it is the charges for the use of cash resources or for outstanding amount.

Recognize…it should be recognized on time proportionate basis taking into an account the amount outstanding and the rate applicable.

Royalty…it is the charges for the use of assets such as patent, trademark, know-how, etc.

Recognized..on accrual basis in accordance with the terms of the agreement.

Dividends…it is the rewards for the holding of investments in shares.

Recognized…it is recognized when the owner’s right to receive the payment is established.

Basic criteria…the basic criteria to recognize revenue is that the amount receivable is determinable. If there is doubt regarding the determination of amount, revenue recognition must be postponed.

DISCLOSURE:

In addition to the disclosure required under AS 1, the enterprise is also required to disclose the circumstances in which revenue recognition has been postponed pending the resolution of significant uncertainties.