@cmalogics Paper 12 CAA

INDIGOLEARN
CMA (Inter)
Paper 12 – Company Accounts & Audit
1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 1

Table of Contents
SECTION A: ACCOUNTS OF JOINT STOCK COMPANIES [50 MARKS] ............................... 5
Study Note | Accounting of Shares and Debentures ................................................ 5
1.1 Introduction .......................................................................................... 5
1.2 Issue of Share ....................................................................................... 10
1.3 Right Issue........................................................................................... 34
1.4 Bonus Issue .......................................................................................... 37
1.6 Forfeiture of Shares ............................................................................... 42
1.7 Buy Back of Shares ................................................................................. 48
1.8 Issue and Redemption of Preference Shares and Debentures ............................... 59
1.9 Underwriting of Shares and Debentures .......................................................107
Study Note – 2 | Preparation of Financial Statements (As per Schedule III) ................ 121
2.1 Introduction ........................................................................................121
2.2 Balance Sheet......................................................................................122
2.3 Statement of Profit and Loss Account..........................................................143
Study Note – 3 | Cash Flow Statement ............................................................. 170
3.1 Introduction ........................................................................................170
3.2 Meaning of Cash and Cash Equivalent ..........................................................173
3.3 Types Of Cash Flow ...............................................................................173
Study Note – 4 | Accounting of Banking, Electricity and Insurance Company .............. 188
4.1 Accounts of Banking Company .................................................................188
4.2 Accounts for Insurance Companies ............................................................216
Study Note – 5 | Accounting Standards ............................................................ 248
5.1 AS 11: Accounting for the Changes in Foreign Exchange Rates .............................248
5.2 AS 12: Accounting for Government Grants ....................................................265
5.3 AS 15: Accounting for Employee Benefits .....................................................279
5.4 AS 16: Borrowing Costs ...........................................................................318
5.5 AS 17: Segment Reporting .......................................................................337
5.6 AS 18: Related Party Disclosures ................................................................373
5.7 AS 19: Accounting for Leases ....................................................................387

SECTION B: AUDITING (50 MARKS) ................................................................... 405
Study Note – 6 | Auditing Concepts ................................................................. 405
6.1 Nature, Scope and Significance of Auditing ...................................................405
6.2 Audit Engagement, Audit Programme, Audit Wroking Papers, Audit Notebook, Audit
Evidence and Audit Report ...........................................................................431
6.3 Internal Check, Internal Control, Internal Audit - Industry Specific .......................454
Study Note – 7 | Provision relating to Audit under Companies Act ........................... 486
7.1 Auditor’s qualifications, disqualifications, appointment, remuneration removal, powers
and duties...............................................................................................486
7.4 Miscellaneous Audit ...............................................................................518

SECTION A: ACCOUNTS OF JOINT STOCK COMPANIES [50
MARKS]
Study Note | Accounting of Shares and Debentures
1.1 Introduction
Company
A Company is a separate legal entity registered

under Companies Act, 2013
Company consists of individuals, called

shareholders by virtue of holding the shares of a
company,
Shareholders are authorised by law to elect a

board of directors
Through Board of Directors , the Companyt

performs its activities as an artificial person.
SALIENT FEATURES
▪ Incorporated Association – Invisible/ Intangible / Existing only in the eyes

of law
- A company comes into existence only through registration under
Companies Act. It is regarded as an artificial legal person.
▪ Separate Legal Entity

A company can contract, sue and be sued in its incorporated name

and capacity.
▪ Perpetual Existence
- Existence independent of its members. It continues to be in existence
despite the death, insolvency or change of members
▪ Common Seal
- Company is not a natural person. In order to enable the company to sign its
documents, it is provided with a legal tool called ‘Common Seal’.
▪ Limited Liability
- The liability of every shareholder is limited to the amount he has agreed to pay
(fully paid up value of shares) to the company on the shares allotted to him.
▪ Distinction between ownership and management

- Ownership – Shareholders.
- Management: Board of Directors, appointed by the shareholders
Why ‘Company’ form of organisation?
Large amount of money, modern technology, large human contribution etc. is

required to increase the scale of operations so as to provide goods and services to the
ever-increasing needs of the growing population of consumers, which is not possible
to arrange under partnership or proprietorship. This led to the inception of the
concept of ‘Company’ or ‘Corporation’.
TYPES OF COMPANIES
1. Government Company - Section 2(45) of the Companies Act, 2013

➢ Any Company in which not less than fifty-one per cent of the paid-up share
capital is held by
❖ the Central Government, or
❖ any State Government or Governments, or
❖ partly by the Central Government and partly by one or more State
Governments,
➢ and includes a company which is a subsidiary company of such a
Government company.
2. Foreign Company - Section 2 (42) of the Companies Act, 2013,
Any company or body corporate incorporated outside India which –
✓ Has a place of business in India whether by itself or through an agent
physically or through electronic mode; and
✓ Conducts any business activity in India in any other manner.
3. Private Company - Section 2(68) of the Companies Act, 2013

A company which by its articles,
➢ restricts the right to transfer its shares;
➢ Prohibits any invitation to the public to subscribe for any securities
of the company.
➢ Shares of a Private Company are not listed on Stock Exchange.
➢ Exception
❖ One Person Company limits the number of its members to two
hundred. Joint membership will be considered as single member
❖ Employees – Present & past holding shares are not considered as
members
4. Public Company - Section 2(71) of the Companies Act, 2013

➢ A company which is not a private company;
➢ Subsidiary of company which is not a private company shall also be
considered as public company even where such subsidiary company
continues to be a private company in its articles.
➢ A unlisted public company.
➢ No Minimum Paid-up Share Capital
Note:The minimum paid-up share capital requirement of INR 1,00,000

(in case of a private company) and INR 5,00,000 (in case of a public
company) has been done away with under Companies Act, 2013.

5. One Person Company - Section 2 (62) of the Companies Act, 2013
A company which has only one person as a member.
6. Small Company - Section 2(85) of the Companies Act, 2013

➢ A company, other than a public company
➢ paid-up share capital
▪ does not exceed Rs.50 lakhs or
▪ such higher amount as may be prescribed which shall not be
more than Rs.5 Crores; or
➢ turnover (as per its last profit and loss account)
▪ does not exceed Rs.2 Crores or
▪ such higher amount as may be prescribed which shall not be
more than Rs.20 crores
Note: The status of a company as a Small Company may change from year to year.
7. Listed Company - Section 2 (52) of the Companies Act, 2013

A company which has any of its securities listed on any recognised stock
exchange.
8. Unlisted Company
The company, whose shares are not listed on any recognised stock
exchange. An unlisted company can be a public company or a private
company.
9. Company limited by Shares - Section 2(22) of the Companies Act, 2013
Liability of its members is limited by the memorandum to the amount, if
any, unpaid on the shares respectively held by them.
10. Company limited by Guarantee - Section 2(21) of the Companies Act, 2013
Liability of its members limited by the memorandum to such amount as
the members may respectively undertake to contribute to the assets of
the company in the event of its being wound up.
11. Unlimited Company - Section 2 (92) of the Companies Act, 2013

A company not having any limit on the liability of its members.
12. Holding Company - Section 2 (46) of the Companies Act, 2103

A company of which one or more other companies companies are subsidiary
companies.
13. Subsidiary Company - Section 2(87) of the Companies Act, 2013

➢ A company in which the holding company:
▪ Controls the composition of the Board of Directors (i.e.
power to appoint or remove all or a majority of the directors);
or
▪ Exercises or controls > ½ of the total share capital either on
its
• own or
• together with one or more of its subsidiary companies.
➢ Deemed Subsidiary Company - indirect control through the
subsidiary company (ies).
MAINTENANCE OF BOOKS OF ACCOUNTS – Section 128
➢ Who should maintan : Every company

➢ Where to maintain : Registered office
o What to maintain : Books of accounts and other relevant books and
papers and financial statement for every financial year which give a
true and fair view of the state of the affairs of the company
➢ Whose books : Company’s, Branch office’s or Company’s other offices,
explaining the transactions effected both at the registered office and its
branches
➢ How to maintain :
o Method of Accounting- Accrual basis and according to the double
entry system of accounting
o Mode – Physical or electronic

1.2 Issue of Share
Procedure for raising funds through equity
COMPANY
(1) PROSPECTUS
APPLICATION &
CALL MONEY
(4)
(3)
SHARE SHARE
APPLICATION HOLDER
S
(2)
(5) Shares Allotted

Issue of prospectus
inviting applications for
shares from the public
Applications
received & Share
application
money received
Under subscription
Full subscription Over subscription
(Issued >
(Issued = Subscribed) (Issued < Subscribed)
Subscribed)
Minimum Minimum
subscription subscription NOT
received received
Directors make Pro-rata

All application
allotment for allotment made
money returned
shares applied by Directors
Allotment money
received
Further calls
made and call
money received
Note: Section 53 of Companies Act,

2013 a company cannot issue Shares issued
shares at discount except for in for cash
case of sweat equity shares and
therefore any issue on discount by
the company will be void with
company being punishable with At face value At Premium
fine.
“Securities Premium
Account” is credited
with the entry for
“Share Capital
Account”

INTRODUCTION
Capital
Funds provided by the owners.
Business Organization Ownership Type of Capital Liability of Owners

Sole - Proprietorship Proprietor Capital Unlimited
Partnership Partners Partners' Capital Unlimited

Company Shareholders Share Capital Limited to issue price of
shares held
SHARE CAPITAL
❖ Share
Total capital of the company is divided into a number of small indivisible units of a
fixed amount called shares. The capital of the company is called ‘Share Capital’
❖ Face / Nominal Value of Share

The fixed value of a share printed on the share certificate.
❖ Share Price
Issue price – The value at which the share is issued [Face (+) Premium, if any
(–) Discount, if any]
Book building - Process through which company determines it's share prices.
Under this method company determines a price band of its shares and on the basis
of bids received from potential investors at various prices within the price band
finally fixes its issue price
Market Price – The value at which the share is traded on the stock exchange

SHARE CAPITAL - Categories
Authorised Share Issued Share Capital Subscribed Share

Capital or Nominal Capital
Capital •It is the portion of the
authorised capital issued
by the company •It is part of Issued Share
•It is the maximum limit of Capital
capital which a company is •subscribed by the public
authorised to raise during •It includes the nominal
value of shares issued for •allotted by the company
its lifetime
•Cash
•Consideration other than •It also includes face value
•It is mentioned in 'Capital of shares issued by
Clause' of the Cash to
company for consideration
"Memorandum of • Promoters
other than cash.
Association" • Others
•It is disclosed on the face •The remaining portion of

of the Balance Sheet at the Authorised Share
face value capital which is not issued
either in cash or
consideration may be
termed as ‘Un-issued
Capital’

SHARE CAPITAL - Categories
Called-up Paid-up Share Subscribed Reserve Share

Share Capital Capital Share Capital capital
•It is the portion •It is the portion •It is part of •It is the portion
of the issue price of called up Issued Share of the uncalled
of shares which a capital which is Capital capital which a
company has paid by the company has
demanded or shareholders. •subscribed by decided to call
called from the public only in case of
shareholders •allotted by the liquidation of the
• A particular company
amount called by company
•The balance, the company and
which the not paid by the •It also includes •As per Section 65
company has shareholder(s), face value of of the Companies
decided to fully or partially, shares issued by Act, 2013, a
demand in future is known as company for Company may
may be referred ‘unpaid calls’ or consideration decide by passing
to as Uncalled ‘installments (or other than cash. a resolution
Capital." Calls) in Arrears’
• Paid up Capital =
Called up Capital
– Installments in
Arrears
•In balance sheet,

Called -up and
Paid-up share
capital are
showin together
1. Authorised Capital = Issued Capital + Unissued Capital.

2. Subscribed Capital differs based on subscription type
• Fully Subscribed: Subscribed Capital = Issued Capital
• Over Subscribed: Subscribed Capital > Issued Capital
• Under Subscribed: Subscribed Capital < Issued Capital
3. Called up Capital = Paid up Capital + Calls in arrears if any – Calls in
advance if any
4. Uncalled capital = Issued Share Capital – Called up Share Capital
❖ Calls in advance
been paid by shareholder. It is shown separately, in the Balance Sheet as liability
of the company under the heading ‘Current Liabilities’ until the calls are made and
the amount actually becomes payable by the shareholder.
Types of Shares
SHARES
Preference
Equity
Preference Shares
As per Section 43 of the Companies Act, 2013, Preference shareholders
➢ are assured of a preferential dividend at a fixed rate during the life of the
company.
➢ carry a preferential right over other shareholders to be paid first in case
of winding up of the company.

Type of Preference Shares
Based on "Right to • Cumulative

accumulate dividends" • Non-Cumulative
Based on "Right to • Participating

participate in surplus • Non-Participating
• Redeembable
Based on Redemption
• Non-Redeemable
Based on Conversion • Convertible

into equity • Non-Convertible
(a) Cumulative Preference Shares

➢ It carries the right to a fixed amount of dividend or dividend at a
fixed rate.
➢ Dividend on these shares accumulates unless it is paid in full
➢ The arrears of dividend are then shown in the balance sheet as a
contingent liability.
➢ In India, a preference share is considered cumulative unless
otherwise stated.
➢ If arrears of dividend are outstanding for a period more than two
years, holders of such shares can vote on every resolution on every
matter in the general body meeting of the shareholders.
(b) Non-cumulative Preference Shares:

➢ It carries with it the right to a fixed amount of dividend.
➢ Dividend on these shares does not accumulate in the year with no
profits
➢ The right to dividend expires every year.
(c) Participating Preference Shares

➢ These shares give the right to participate in the surplus profits, if
any, after the equity shareholders
o Every year for dividend at a stipulated rate
o At the time of winding up for distribution of profits (a pre-
determined proportion)

(d) Non-participating Preference Shares
➢ No additional rights in profits and in the surplus on winding-
up,
➢ Unless otherwise specified, the preference shares are
generally non-participating.
(e) Redeemable Preference Shares

➢ The company will repay after the fixed period or even earlier
at company’s discretion.
➢ The repayment on these shares is called redemption and is
governed by Section 55 of the Companies Act, 2013.
(f) Non-redeemable Preference Shares

➢ No redemption arrangement agreed upon.
➢ According to Section 55, no company limited by shares shall
issue irredeemable preference shares or preference shares
redeemable after the expiry of 20 years from the date of issue.
➢ A Company may issue preference shares redeemable after 20
years for such infrastructure projects as may be specified,
under the Companies Act, 2013.
(g) Convertible Preference Shares

➢ These shares give the right to get converted into equity shares
at the shareholder’s option.
(h) Non-convertible Preference Shares

➢ No right to get his holding converted into equity share
➢ Preference shares are non-convertible unless otherwise stated.
Special Points related to Preference Shares:
➢ They enjoy preferential rights in the matter of :
o Payment of dividend, and
o Repayment of capital
➢ Generally, holders of these shares do not get voting rights
➢ The cost of raising preference share capital is cheaper than raising debt
➢ The Companies Act, 2013 prohibits the issue of any preference share
which is irredeemable.
➢ Preference shares are cumulative and non-participating unless
expressly stated otherwise.
➢ Unless mentioned otherwise Preference Shares are Non-Cumulative, Non
Participating, Non- Convertible and Redeemable in nature.
➢ Dividend is generally cumulative.

Equity Shares
Those shares, which are not preference shares are called Equity Shares.
Special Points for Equity Shares

➢ These shares carry voting rights.
➢ No preferential rights in the matter of payment of dividend or repayment
of capital
➢ Dividend on equity shares is recommended by the Board of Directors and
may vary from year to year.
➢ Rate of dividend depends upon the dividend policy and the availability of
profits after satisfying the rights of preference shareholders.
➢ Companies Act, 2013 permits issue of equity share capital with differential
rights as to dividend.
Types of Equity Shares
Equity Equity
Shares Shares
Issued for
Issued for Cash consideration
other than Cash

ISSUE OF SHARES FOR CASH
Private Companies Public Companies
• Private Placement • Issue Prospectus

• Invite General Public to subscribe for
Shares
• Receive Share applications and
Application money (Section 39
Application money ≥ 5% of nominal
value)
• Allot Shares to subscribers as per SEBI
guidelines (A company cannot
proceed to allot shares unless
minimum subscription is received by
the company
❖ Minimum Subscription
A public limited company cannot make any allotment of shares unless
➢ minimum subscription stated in the prospectus has been subscribed and
➢ application money for such shares has been paid to and received by the
company.
The amount of minimum subscription to be disclosed in prospectus by the

Board of Directors should consider the following
(a) Preliminary expenses,
(b) Commission payable on issue of shares,
(c) Cost of fixed assets purchased or to be purchased,
(d) Working capital requirements, and
(e) Any other expenditure for the day to day operation of the business.
Guidelines of the Securities Exchange Board of India (SEBI)

➢ Minimum subscription to be received in an issue shall not be less than 90%
of the offer through offer document.
➢ Non receipt of the minimum subscription of 90% of the issue, all
application moneys received shall be refunded:
o Non-underwritten Issue – within 15 days of the closure of the issue; and
o Underwritten Issue – within 7 days of the closure of the issue
o Underwritten issue where minimum subscription including devolvement
obligations paid by the underwriters is not received – within 60 days of
the closure of the issue.
➢ The company has the right to reject or accept an application fully or partially.
o Accepted applications – Shareholders have to pay “Allotment Money”
o Rejected applications – Application money is refunded by the Company
(delayed refunds shall be paid with interest)
➢ ‘Calls’ (subsequent instalments of the issue price) made by company as given in
prospectus.
Note: The issue price of shares is generally received by the company in

instalments:
First instalment Application Money
Second Instalment Allotment Money
Third Instalment First Call Money
Fourth Instalment Second Call Money and so on.
Last Instalment Final Call Money
Application money
Companies Act,
SEBI Regulations
2013 - Section 39
≥ 5% of Face ≥ 25% of Issue

Value Price
Section 24 of the Companies Act, 2013 - Matters related to issue and transfer of
securities will be administered by the SEBI and not by the Company Law Board.
Thus the application money has to be minimum of 25% of Issue price.

SUBSCRIPTION OF SHARES
❖ Full Subscription
Number of shares offered for subscription = Number of shares actually subscribed
by the public
❖ Under Subscription
Number of shares offered for subscription > Number of shares actually subscribed
by the public.
Important Note: shares can be allotted, in this case, only when the minimum
subscription is received.
➢ Minimum subscription received ➔ Proceed for allotment
➢ Minimum subscription not received ➔ Refund the amount received on
application, as per guidelines
❖ Over Subscription
Number of shares offered (Public issue) < Number of shares actually subscribed
by the public.
➢ Applications rejected ➔ application money refunded
➢ Applications accepted
o All shares applied are allotted ➔ No refund
o Part of the shares applied are allotted ➔ excess amount received
can be used for allotment or call money

JOURNAL ENTRIES – ISSUE OF SHARES
Event Entry Debit Credit Remarks
(Rs.) (Rs.)
Bank A/c Dr. xxxx Actual amount

(1) Receipt of
Application received.
Money
To Share Application Money A/c xxxxx Actual amount
received.
(Being application money received)
(1a) Refund of Share Application A/c Dr. xx Actual amount

Application refunded
money to To Bank A/c xx
applicants) (Being application money refunded)
(2) Allotment Share Allotment A/c Dr. xxxx Amount due on

of Share allotment
Share Application A/c Dr. xxxx Application amount

received on allotted
shares
To Share Capital A/c xxxxxx Amount due on

allotment and
application
(Being the sum due on allotment and

application money transferred to
capital account)
(2a) A part of Share Application A/c Dr. xxxx

shares applied
for are allotted
To Share Allotment A/c ** xxxx Application money
accepted for
allotment

To Shares Calls in advance A/c xxx Amount from
application money
adjusted for future
calls
To Bank A/c xx Excess amount to be

refunded
(Being application money adjusted)
** Credited to Share Capital A/c

subsequently
(3) Receipt of Bank A/c Dr. xxxx Amount actually

allotment received on
money allotment.
To Share Allotment A/c xxxx
(Being money received on

allotment)
(4) Call being Share Call A/c Dr. xxx Amount due on the
made call
To Share Capital A/c xxx
(Being share call made due at Rs……)
(5) Receipt of Bank A/c Dr. xxxx Amount called

Call Money actually received
To Share Call A/c xxxx
(Being share call money received)
Note: Sometimes separate Application and Allotment Accounts are not prepared
and entries relating to application and allotment monies are passed through a
combined account “Share Application & Allotment Account”.

SHARES ISSUED AT DISCOUNT
Shares are issued at DISCOUNT, if Issue Price < Nominal or Par Value
Discount = Nominal Value – Issue Price
Example:
Nominal Issue Price Discount (Rs.) Discount %

Value
(b) (c) = (a-b) (d)= [(c) ÷ (a)
(a) ]100
100 100 0 N.A
100 98 2 2%
100 110 N.A N.A
250 200 50 20%
Important Note: As per Section 53 of the Companies Act, 2013, a Company cannot
issue shares at a discount except in the case of issue of sweat equity shares (issued
to employees and directors). Thus, any issue of shares at discount shall be void (if
issued to general public).
SHARES ISSUED AT PREMIUM

Shares are issued at PREMIUM, if Issue Price > Nominal or Par Value
Premium = Issue Price -Nominal Value
Example:
Nominal Issue Price Premium Premium %

Value (Rs.)
(b) (d)= [(c) ÷ (a)
(a) (c) = (b-a) ]100
100 100 0 N.A

100 120 20 20%
100 90 N.A N.A
250 350 100 40%
Premium is generally called with the amount due on allotment, sometimes with the
application of money and rarely with the call money
❖ Securities Premium Account

➢ Premium amount is credited to a separate account called Securities
Premium Account.
➢ It is not a part of share capital. Rather, it represents a gain of a capital
nature to the company.
➢ It is shown under the heading, “Reserves and Surplus”, which is further
shown as “Shareholders’ Funds” in the Balance Sheet as per Schedule III.
❖ Utilisation of Securities Premium Account

It may be used by the company as given under Section 52 of the Companies Act,
2013:
(a) Towards issue of un-issued shares of the company to be issued to members
of the company as fully paid bonus securities.
(b) To write off preliminary expenses of the company.
(c) To write off the expenses of, or commission paid, or discount allowed on
any of the securities or debentures of the company.
(d) To provide for premium on the redemption of redeemable preference shares
or debentures of the company.
(e) For the purchase of own shares or other securities i.e. Buy back of shares.
Note Companies whose financial statements comply with the accounting
standards prescribed for them under Section 133 of the Companies Act, 2013.

JOURNAL ENTRIES – ISSUE OF SHARES AT PREMIUM
(1) Premium amount called with Application Money
(Rs.) (Rs.)
Bank A/c Dr. Xxxx Total application

(1) Receipt of
Application money + Premium
Money amount
To Share Application Money A/c xxxxx Actual amount

received.
(Being application money received

for _____ shares @ Rs._____ per
share including premium)
(2) Allotment Share Application A/c Dr. Xxxx No. of shares x

of Share Application money
per share
To Share Premium A/c Dr. xxxx No. of shares

allotted x Premium
per share
To Share Capital A/c xxxxxx No. of shares

allotted x Nominal
Value per share
(Being the application money

transferred to capital account)
(2) Premium amount called with Allotment Money

(Rs.) (Rs.)
Bank A/c Dr. Xxxx Total application

(1) Receipt of
Application money + Premium
Money amount

To Share Application A/c xxxxx Actual amount
received.
(Being application money received

for _____ shares @ Rs._____ per
share including premium)
(2) Allotment Share Application A/c Dr. Xxxx No. of shares x

of Share Application money
per share
Share Allotment A/c Dr. Xxxx No. of shares

allotted x Allotment
& Premium amount
per share
To Share Capital A/c xxxxxx No. of shares

allotted x
Application &
allotment amount
per share
To Share Premium A/c Dr. xxxx No. of shares

allotted x Premium
per share
(Being Amount due on allotment of

shares @ Rs.____per share including
premium )
(3) Allotment Bank A/c Dr. Xxxx Actual amt received

money
received To Share Allotment Money A/c xxxxx Total allotment
money + Premium
amount
(Being money received including

premium consequent upon
allotment)

OVER SUBSCRIPTION AND PRO-RATA ALLOTMENT
Number of shares offered (Public Issue) < Number of shares actually subscribed
by the public.
Reasons for oversubscription
➢ investors’ confidence in the company,

➢ previous performance of the company
➢ general economic conditions,
➢ pricing of the issue etc
Allotment for oversubscription
✓ Shares can be allotted to the applicants by a company in any manner it thinks

proper.
➢ Some Applicants rejected in full and remaining accepted in full➔
application money refunded to such applicants
➢ Multiple applications by the same person not considered ➔ application
money refunded for applications
➢ All Applications accepted ➔ allotment done on pro-rata basis i.e. ‘Pro-
rata allotment’ means allotment in proportion of shares applied for.
Example
Shares offered to public 10,000
Applications received 12,000
Ratio 12,000:10,000 i.e. 6:5
For every 6 shares applied, 5 shares are allotted
✓ Excess amount received is treated as an advance against allotment and

calls and thereby adjusted against the amount due on allotment or calls.
✓ Surplus money after making adjustment against future calls is returned to
the applicants.
✓ The applicants are informed about the allotment procedure through an
advertisement in leading newspapers.

JOURNAL ENTRIES – OVER SUBSCRIPTION (PRO-RATA ALLOTMENT)
(Rs.) (Rs.)
Share Application A/c Dr. xxxx Application money x

(1) Rejected
applications no. of shares rejected
To Bank A/c xxxxx Actual amount received.
(Being application money refunded

for rejected applications as per
Board’s Resolution No….dated….)
(2) Pro-rata Share Application A/c Dr. xxxx Total money received –
Allotment (No. of shares allotted x
Application money per
share)
To Share Allotment A/c xxxxxx No. of shares allotted x

Allotment money per
share
(Being excess application money

adjusted against allotment money
as per Board’s Resolution
No….dated….)

CALLS IN ADVANCE & CALLS IN ARREARS
Calls made
Scenario I Scenario II Scenario III
Calls paid = Calls paid < Calls paid >

Calls made Calls made Calls made
Calls in
All Dues paid Calls in Arrears
Advance
❖ Calls in Arrears
➢ The total unpaid amount on one or more instalments called but shareholder
failed to pay is known as Calls-in-Arrears or Unpaid Calls.
➢ It is the uncollected amount of capital from the shareholders;
➢ It is shown by way of deduction from ‘called-up capital’ to arrive at paid-up value
of the share capital.
❖ Calls in Advance
➢ Amount not yet called up but paid by shareholders is known as Calls-in-advance.

➢ Interest at a rate not exceeding 12 % p.a. is to be paid on such advance call
money.
➢ This amount is credited in Calls-in-Advance Account and shown separately under
Current Liabilities
❖ Interest on Calls in Arrears & Calls in Advance

Interest on Calls in Arrears Interest on Calls in Advance
Receivable by the Compay Payable by the Company to
from the Shareholders Shareholders
Maximum Rate (Table F Maximum Rate (Table F
prescribed) is 10% prescribed) is 12%
Interest period = Call due date Inerest period = Actual money
to actual money receipt date receipt date to Call due date
Directors have right to waive Shareholders are not entitled
off such interest on their to dividend on calls in advance
discretion Expense - debited to P&L A/c
Income - credited to P&L A/c
as a nominal account
JOURNAL ENTRIES – CALLS IN ADVANCE & CALLS IN ARREARS
(Rs.) (Rs.)
Calls in arrears A/c Dr. xx Amount of Unpaid Calls

(1a) Calls in
Arrears after call Bank A/c Dr. xxxx Amount received
made
To Share Allotment A/c xxx Total allotment money
due
To Share Calls A/c xxxx Total allotment money

due
( Being call money/ allotment

money received on .... shares at `
per share.)
(1b) Calls in Bank A/c Dr. xx Amount of Unpaid calls

Arrears received received
To Calls in Arrears A/c xx
(Being unpaid calls received)

(2a) Calls in Bank A/c Dr. xxx Call amount received in
Advance received advance
To Calls in Advance A/c xxx
(Being excess application money

received)
(2b) Call made Calls in Advance A/c Dr. xxx Call amount received
in advance
Bank A/c Dr. xx Remaining call money

received, if any
To Particulars Call A/c xxxx Call money due
(Being call in advance adjusted

and call money due received)
Shareholder’s A/c Dr. xxx

(3a) For interest
receivable on To Interest on Calls in arrears A/c xxx
Calls-in-Arrears
(Being interest on calls in arrears
at the rate of _____% due)
(3b) For receipt of Bank A/c Dr. xxx

interest
To Shareholder’s A/c Xxx
(Being interest money received)
(4a) For interest Interest on Calls-in-AdvanceA/c Dr. xxx Amount of interest due
payable on Calls- for payment
in-Advance due To Shareholder’s A/c xxx
(Being interest on calls in advance

due)
(4b) For payment Shareholder’s A/c Dr. xxx Amount of interest

of interest paid
To Bank A/c xxx
(Being interest money received)

Illustrations
Illustration – 1
A company had an authorised capital of Rs.10,00,000 divided into 1,00,000 equity

shares of Rs.10 each. It decided to issue 60,000 shares for subscription and received
applications for 70,000 shares. It allotted 60,000 shares and rejected remaining
applications. Up to 31-3 -2017, it has demanded or called Rs.9 per share. All
shareholders have duly paid the amount called, except one shareholder, holding 5,000
shares who has paid only Rs.7 per share.
Prepare a balance sheet assuming there are no other details.
Illustration – 2
A company invited applications for 10,000 equity shares of Rs.50 each payable on:
1. Application Rs.15;
2. Allotment Rs.20,
3. on first and final call Rs.15.
Applications are received for 10,000 shares and all the applicants are allotted the
number of shares they have applied for and instalment money was duly received by
the company.
Show Journal entries in the books of the company.
Illustration – 3
On 1st April 2017, A Ltd. issued 43,000 shares of Rs. 100 each payable as follows:
• Rs.20 on application;
• Rs.30 on allotment;
• Rs.25 on 1st October 2017; and
• Rs. 25 on 1st February 2018
By 20th May, 40,000 shares were applied for and all applications were accepted.
Allotment was made on 1st June. All sums due on allotment were received on 15th
July; those on 1st call was received on 20th October.
Journalise the transactions when accounts were closed on 31st March 2018.
Illustration – 4
Pant Ltd. invited applications for 50,000 equity shares at Rs.50 each, which are
payable as on application Rs.20, on allotment Rs.10 and on first and final call Rs.20.
The company received applications for 60,000 shares. The directors accepted
application for 50,000 shares and rejected the rest.
Show Journal entries if company refunded the application money to rejected
applicants and allotment money was received for 45,000 shares.

1.3 Right Issue
RIGHT ISSUE
 Right issue is an issue of rights to a company's existing shareholders that entitles
them to buy additional shares directly from the company in proportion to their
existing holdings, within a fixed time period.
 This way the voting and governance rights of the existing shareholders is not
diluted.
 In a right offering, the subscription price at which each share may be purchased is
generally at a discount to the current market price.
 Rights are often transferable, allowing the holder to sell them in the open market.
 They have an implicit right to renounce this right in favor of someone else (unless
the articles restrict such a right), or even reject it completely. When the existing
shareholder charges for the renouncement, it is called the value of right.
 The difference between the cum-right and ex-right value of the share is the value
of the right.
PROVISIONS UNDER COMPANIES ACT, 2013
 Sec 62(1) - Conditions for issuing letter of offer

The offer is made by a notice to shareholder which consists the following:
➢ The number of shares offered
➢ The time limit not being less than fifteen days and not exceeding thirty days
from the date of the offer within which the offer should be accepted.
➢ If time limit expires, the offer is deemed to be declined
➢ Unless the articles otherwise provide, the offer aforesaid shall be deemed to
include a right exercisable by the person concerned to renounce the shares
offered to him or any of them in favor of any other person.
➢ After the expiry of the time specified in the notice or on receipt of earlier
intimation of rejection from the shareholder the Board of Directors may dispose
of them in a manner which is not disadvantageous to the shareholders.
 Exceptions to Sec 62 –Cases where shares are issued by a company, but not be
offered to the existing shareholders –
1) To employees under a scheme of employees’ stock option subject to certain
specified conditions
2) To any persons, either for cash or for a consideration other than cash, if the

price of such shares is determined by the valuation report of a registered valuer
subject to certain specified conditions.
3) When companies borrow money through debentures / loans and give their lender
an option to convert them into equity shares.
4) In a special situation where the loan has been obtained from the government,
and government in public interest, directs the debentures / loan to be converted
into equity shares.
COMPUTATION OF VALUE OF RIGHT
Book value of a share = Net worth (as per books) ÷ Number of shares
Market price, which exists before the rights issue, is termed as Cum-right
Market Price of the share.
The market price of the shares after further issue of shares (right issue) is
termed as Ex- right Market Price of the shares.
This price is going to prevail after the further issue of shares is executed
Ex-right value of the shares = [Cum-right value of the existing shares +

(Rights shares X Issue Price)] ÷ (Existing Number of shares + Number of
right shares)
Value of right = Cum-right value of share – Ex-right value of share
Market value of a company's shares represents the present value of future cash flows
expected to be earned from the share in the form of dividends and capital gains from
expected future share price appreciation.
The Ex-right value of the share is also known as the average price.
The accounting treatment of rights share is the same as that of issue of ordinary
shares.

Journal entries
Upon the issue of Right shares
Bank A/c Dr.
To Equity Share Capital A/c
In case shares are offered at premium
Bank A/c Dr.
To Equity Share Capital A/c
To Securities premium A/c
RIGHT OF RENUNCIATION
 Right of renunciation refers to the right of the shareholder to surrender his right to
buy the securities and transfer such right to any other person.
 Shareholders that have received right shares have three choices

➢ They can act on the rights and buy more shares as per the particulars of the
rights issue;
➢ They can sell them in the market; or
➢ They can pass on taking advantage of their rights (i.e., reject the right offer).
 The renunciation of the right is valuable and can be monetized by the existing
shareholders in well-functioning capital market which is known as ‘value of right’.
 Value of right = Cum-right value of share – Ex-right value of share
ADVANTAGES OF RIGHT ISSUE
1) Enables the existing shareholders to maintain their proportional holding in the

company and retain their financial and governance rights.
2) It works as a deterrent to the management, which may like to issue shares to
known persons with a view to have a better control over the company’s affairs.
▪ The existing shareholders are not affected by the dilution because getting
new shares at a discounted value from their cum-right value will
compensate decrease in the value of shares.
3) Right issue is a natural hedge against the issue expenses normally incurred by

the company in relation to public issue.
4) Right issue has an image enhancement effect, as public and shareholders view it
positively.
5) The chance of success of a right issue is better than that of a general public issue
and is logistically much easier to handle.
DISADVANTAGES OF RIGHT ISSUE
1) The right issue invariably leads to dilution in the market value of the share of
the company.
2) The attractive price of the right issue should be objectively assessed against its
true worth to ensure that you get a bargained deal.
1.4 Bonus Issue
BONUS ISSUE
 Bonus issue means an issue of free additional shares to existing shareholders,

without the additional inflow of cash.
 It is based upon the number of shares that the shareholder already owns.
 With bonus issue
➢ The number of shares increases
➢ There is no change in net worth of the company
➢ There is no change in ratio of number of shares held.
 Also known as Capitalization of profits, as it involves converting free reserves into
paid up capital. {Free reserves are those which are otherwise available for
distribution as dividends}
 If it exceeds the authorized share capital, then a resolution is passed in General
meeting for increasing the authorized capital.
PROVISIONS UNDER COMPANIES ACT, 2013
 Sec 63(1) - a company may issue fully paid-up bonus shares to its members, in any
manner out of –
➢ its free reserves.
➢ the securities premium account; or
➢ the capital redemption reserve account.

 However, no issue of bonus shares shall be made by capitalizing reserves created
by the revaluation of assets. [Also provided in Regulation 94 of SEBI (Issue of
Capital and Disclosure Requirements) Regulations,2009:
 Sec 63(2) - No company shall capitalise its profits or reserves for the purpose of
issuing fully paid-up bonus shares unless –
1) It is authorised by its articles.
2) It has, on the recommendation of the Board, been authorised in the general
meeting of the company.
3) It has not defaulted in payment of interest or principal in respect of fixed deposits
or debt securities issued by it.
4) It has not defaulted in respect of the payment of statutory dues of the employees,
such as, contribution to provident fund, gratuity and bonus.
5) The partly paid-up shares, if any outstanding on the date of allotment, are made
fully paid-up;
 Free reserves may be used for paying up amounts unpaid on shares held by
existing shareholders, though securities premium account and capital redemption
reserve cannot be used.
 The company which has once announced the decision of its Board recommending a
bonus issue, shall not subsequently withdraw the same. [Rule 14 of Companies (Share
Capital and Debentures) Rules, 2014]
 Sec 63(3) - The bonus shares shall not be issued in lieu of dividend. [Also provided
in Regulation 94 of SEBI (Issue of Capital and Disclosure Requirements)
Regulations, 2009
PROVISIONS UNDER SEBI REGULATIONS
A listed company, while issuing bonus shares to its members, must comply with the
following requirements under the SEBI (Issue of Capital and Disclosure Requirements)
Regulations, 2009:
 Regulation 92- Conditions for Bonus Issue

➢ Points 1, 3, 4 and 5 provided in Sec 63(2) (mentioned above) are also provided
in regulation 92.

 Regulation 93 - Restriction on bonus issue
➢ Every listed company must make reservation of same class equity shares in favor
of the holders of outstanding compulsorily convertible debt instruments, if any,
in proportion to the convertible part thereof.
➢ Such reserved shares shall be issued at the time of conversion of such
convertible debt instruments on the same terms or same proportion at which
the bonus shares were issued.
 Regulation 94 – Bonus shares provision

➢ The bonus issue shall be made from
▪ free reserves built out of the genuine profits or
▪ securities premium collected in cash only
➢ The bonus issue shall not be made from reserves created by revaluation of fixed
assets
➢ The bonus share shall not be issued in lieu of dividend.
 Regulation 95 - Completion of bonus issue

➢ Implementation of bonus issue
▪ Within 15 days from the date of approval of the issue by its board – when
bonus issue is announced after the approval of its board of directors and
not requiring shareholders’ approval
▪ within 2 months from the date of the meeting of its board - where the
issuer is required to seek shareholders’ approval.
➢ Once the decision to make a bonus issue is announced, the issue cannot be
withdrawn.
Journal entries
Upon the sanction of an issue of bonus shares
Capital Redemption Reserve A/c Dr.
Securities Premium A/c Dr.
General Reserve A/c Dr.
Profit & Loss A/c Dr.
To Bonus to Shareholders A/c

Upon issue of bonus shares
Bonus to Shareholders A/c Dr.
To Share Capital A/c
Upon the sanction of bonus by converting partly paid shares into fully
paid shares
Profit & Loss A/c Dr.
To Bonus to Shareholders A/c
On making the final call due
Share Final Call A/c Dr.
On adjustment of final call
Bonus to Shareholders A/c Dr.
To Share Final Call A/c
Illustrations
Illustration – 1
Particulars Amount
(Rs.)
40,000 Equity shares of Rs. 10 each 4,00,000
Capital Redemption Reserve 55,000
Securities Premium (collected in cash) 30,000
General Reserve 1,05,000
Surplus i.e. credit balance of Profit and Loss Account 50,000
The company decided to issue to equity shareholders bonus shares at the rate of 1
share for every 4 shares held and for this purpose, it decided that there should be the
minimum reduction in free reserves. Pass necessary journal entries.

Illustration – 2
Following is the extract of the Balance Sheet of Solid Ltd. as at 31st March, 20X1:
Particulars Amount
(Rs.)
Authorised capital:
10,000 12% Preference shares of Rs. 10 each 1,00,000
1,00,000 Equity shares of Rs. 10 each 10,00,000
11,00,000
Issued and Subscribed capital:
8,000 12% Preference shares of Rs. 10 each fully paid 80,000
90,000 Equity shares of Rs. 10 each, Rs. 8 paid up 7,20,000
Reserves and Surplus:
General reserve 1,60,000
Revaluation reserve 35,000
Securities premium (collected in cash) 20,000
Profit and Loss Account 2,05,000
Secured Loan:
12% Debentures @ Rs. 100 each 5,00,000
On 1st April, 20X1 the Company has made final call @ Rs. 2 each on 90,000 equity
shares. The call money was received by 20th April, 20X1.
Thereafter the company decided to capitalize its reserves by way of bonus at the
rate of one share for every four shares held. Show necessary entries in the books of
the company and prepare the extract of the Balance Sheet immediately after bonus
issue if the company has passed necessary resolution at its general body meeting for
increasing the authorized capital.
Illustration – 3
A company offers new shares of Rs. 100 each at 25% premium to existing shareholders
on one for four bases. The cum-right market price of a share is Rs. 150. Calculate the
value of a right. What should be the ex-right market price of a share?

1.6 Forfeiture of Shares
FORFEITURE OF SHARES
➢ Forfeiture of shares is the action taken by a company to cancel the shares,

WHEN shareholders fail to pay their allotment and/or calls on the due dates
➢ The directors are usually empowered by the Articles of Association to

forfeit those shares by strictly following the rules and regulations in the
Articles of Association
➢ Proper notice to the defaulting shareholder(s) should be served.

➢ Directors also have the right to cancel such forfeiture before the forfeited
shares are re-allotted.
➢ When shares are forfeited, the title of such shareholder is extinguished

but the amount paid to date is not refunded to him.
➢ The shareholder then has no further claim on the company.
Forfeiture of Shares
Scenario I Scenario II
Scenario III***
Shares issued at Par Shares issued at
Fully paid Shares
Premium
*** Forfeiture for non-payment of calls, premium, or the unpaid portion of the face
value of the shares is one of the many causes for which a share may be forfeited. But
fully paid-up shares may be forfeited for realization of debts of the shareholder if the
Articles specifically provide it.
JOURNAL ENTRIES – FORFEITURE OF SHARES

Important Amounts to consider:
(i) Amount called-up (i.e., amount credited to capital) in respect of forfeited

shares.
(ii) Amount already received in respect of those shares.
(iii) Amount due but has not been received in respect of those shares.
(Rs.) (Rs.)
Share Capital A/c Dr. xxxx No. of forfeited shares

(1a) Forfeiture of
x called-up value per
shares issued at
share
Par – No Calls-in-
Arrears To Forfeited Shares A/c xxx Amount already
received on forfeited
shares
To Share Allotment A/c xxx IF amount due but not

paid
To Share Call A/c xx IF amount due but not

paid
(1b) Forfeiture of Share Capital A/c Dr. xxxx No. of forfeited shares x
shares issued at called-up value per
Par – With Calls-in- share
Arrears
To Calls in Arrears A/c xx Total Amount due but
not paid
To Forfeited Shares A/c xxx Amount already

shares
(2a) Forfeiture of Share Capital A/c Dr. xxx Call amount received in
shares issued at advance
Premium – IF
Securities Premium A/c Dr. Amount of Security
premium not received

Premium NOT To Forfeited Shares A/c xxx Amount already
received received on forfeited
shares

paid

paid
(2a) Forfeiture of Share Capital A/c Dr. xxx Call amount received in
shares issued at advance
Premium – IF
Premium received To Forfeited Shares A/c xxx Amount already
shares

paid

paid
Note: If the premium has already received by the company, it cannot be cancelled even if the
shares are forfeited in the future:
RE-ISSUE OF FORFEITURE OF SHARES
✓ A forfeited share is merely a share available to the company for sale and remains
vested in the company as an obligation to dispose it off.
✓ Reissue of forfeited shares is not allotment of shares but only a sale. In practice,
forfeited shares are disposed off, by auction.
✓ These shares can be re-issued at any price so long as the total amount received
(from the original allottee and the second purchaser) for those shares is not less
than the amount in “Calls-in-arrears” on those shares.

Re-issue of Shares
Scenario I Scenario II
Loss on Re-issue Profit on Re-issue
❖ Important Points
➢ Loss on re-issue should not exceed the forfeited amount.
➢ When the shares are re-issued at a loss, such loss is to be debited to “Forfeited
Shares Account”.
➢ If the loss on re-issue is less than the total amount forfeited, the surplus should
be transferred to Capital Reserve.
➢ When only a portion of the forfeited shares are re-issued, then the profit made
on re-issue of such portion of shares only must be transferred to Capital
Reserve.
➢ If the shares are re-issued at a price which is more than the face value of the
shares, the excess amount will be credited to Securities Premium Account.
➢ The forfeited amount on shares (amount originally paid-up) not yet reissued
should be shown under the heading ‘share capital.’
➢ If the re-issued amount and forfeited amount (taken together) exceeds the face
value of the shares re-issued, it is not necessary to transfer such amount to
Securities Premium Account.
➢ The credit balance of forfeited shares account cannot be considered a surplus

until the shares forfeited have been re-issued, because the company may, on
re-issue, allow the discount to the new purchaser equivalent to the amount
held in credit in this regard in the forfeited shares Account
❖ Calculation of Profit on Re-issue of Forfeited Shares

Example
No.of shares forfeited 120
Nominal value of each share Rs.10
Paid up amount on each forfeited share Rs.5
First Re-Issue 50 shares (Rs.6 per share collected to make it fully paid up)

Amount received [50x 6] Rs.300
Amount transferred from No. of shares x (Nominal Value – Rs.200

Shares forfeited A/c to Amount received on re-issue) i.e. [50
Share Capital A/c (10 – 6)]
Surplus on Re-issue: Amount in Shares Forfeited A/c for Rs.50

Amount transferred to shares re-issued – Amount transferred
Capital Reserve to Share Capital A/c i.e.
[(50x5)-Rs.200]
Amount carried forward Total Value of Shares Forfeited – Rs.350
in Shares Forfeited A/c Amount transferred to Share Capital
on re-issue – Surplus transferred to
Capital Reserve
[(120x5) – Rs.200 – Rs.50]
JOURNAL ENTRIES – FORFEITURE OF SHARES
(Rs.) (Rs.)
Bank A/c Dr. xx Actual amount received

(1) Re-issue of
shares Forfeited Shares A/c Dr. xxx Profit on re-issue
To Share Capital A/c xxx
(Being the re-issue of…. shares @

Rs.…. each as per Board’s
Resolution No…. dated.)
(2) Surplus Forfeited Shares A/c Dr. xxxx

transferred to
To Capital Reserve A/c xx

Capital Reserve (Being the profit on re-issue,
A/c transferred to capital reserve).
ISSUE OF SHARES FOR CONSIDERATION OTHER THAN CASH
➢ A public limited company generally, issue their shares for cash but it may
issue shares
o in a direct exchange for land, buildings or other assets.
o in payment for services rendered by promoters, lawyers in the
formation of the company.
➢ These shares should be shown separately under ‘Share Capital’.
➢ Within specified time of allotment, the company must produce before
the Registrar a written contract of sale of service in respect of which
shares have been allotted.
When assets are purchased in exchange of shares
Assets Account Dr.

To Share Capital Account
Illustrations
Illustration – 1
Mr. Long who was the holder of 2,000 preference shares of Rs.100 each, on which Rs.
75 per share has been called up could not pay his dues on Allotment and First call
each at Rs.25 per share. The Directors forfeited the above shares and reissued 1500 of
such shares to Mr. Short at Rs. 65 per share paid-up as Rs.75 per share.
Give Journal Entries to record the above forfeiture and re-issue in the books of the
company.
Illustration – 2
Beautiful Co. Ltd issued 30,000 equity shares of Rs.10 each payable as
• Rs.3 per share on Application,
• Rs.5 per share (including Rs.2 as premium) on Allotment and

• Rs.4 per share on Call.
All the shares were subscribed. Money due on all shares was fully received except
from Ram, holding 500 shares, who failed to pay the Allotment and Call money
and Shyam, holding 1,000 shares, who failed to pay the Call Money. All those 1,500
shares were forfeited. Of the shares forfeited, 1,250 shares (including whole of Ram’s
shares) were subsequently re-issued to Jadu as fully paid up at a discount of Rs.2 per
share.
Pass the necessary entries in the Journal of the company to record the forfeiture and
re-issue of the share. Also prepare the Balance Sheet of the company.
Illustration – 3
Shreyas Ltd. did not receive the first call on 10,000 equity shares @ Rs. 3 per share
which was due on 1.7.2016. This amount was received on 1.4.2017.
Open Calls in arrears account and journalise the entries in the books of the company
on 1.7.2016 and 1.4.2017. Also show an extract of Balance Sheet on 31.3.2017.
Illustration – 4
Rashmi Limited issued at par 1,00,000 Equity shares of Rs.10 each payable:
• Rs.2.50 on application;
• Rs.3 on allotment;
• Rs. 2 on first call and balance on the final call.
All the shares were fully subscribed. Mr. Nair who held 10,000 shares paid full
remaining amount on first call itself. The final call which was made after 3 months
from first call was fully paid except a shareholder having 1000 shares who paid his
dues amount after 2 months along with interest on calls in arrears. Company also paid
interest on calls in advance to Mr. Nair.
Give journal entries to record these transactions
1.7 Buy Back of Shares
Objectives
I. Understanding buyback – meaning, objectives and conditions
II. Provisions of Companies Act 2013 relating to it
III. Accounting entries to record buyback + points to remember for exams
IV. Other Aspects from exam point of view

Meaning
Buyback = purchase, by a company, of its own shares/securities
Implication: Shares bought back are cancelled, hence there is reduction of capital
Primary Objectives
▪ To increase EPS
▪ To increase promoters’ holding
▪ To enhance share price on stock exchange (when the management thinks it is less
than its worth)
▪ To pay surplus cash to shareholders if not needed in business
Key Conditions
▪ Buyback can be made out of

(a) free reserves
(b) securities premium or
(c) proceeds of issue of other shares/securities (but not earlier issue of same kind of
shares/securities being bought back)
▪ Shares should be fully paid up. Partly paid up shares cannot be bought back
▪ It must meet Shares outstanding test, Resource test, Debt ratio test (explained below)
▪ End use restriction: company cannot buy for purpose of investment.
RELEVANT PROVISIONS OF COMPANIES ACT 2013:
A. Balance Sheet conditions
1. Buyback must meet Share Outstanding test i.e. buyback in a financial year must
be =< 25% of company’s total number of outstanding shares in that financial year
2. Buyback must meet Resource test i.e. must use amount =< 25% of company’s
total paid up capital + free reserves

3. Buyback must meet Debt equity ratio test i.e. after buyback, ratio of debt owed
by the company (secured & unsecured / long term & short term) to total of paid
up capital + free reserves should not be more than 2:1
Exception: Ratio may be higher in respect of certain class of shares, if so

prescribed by Central Government
4. Premium payable on buyback (buyback price less par value) to be adjusted from
free reserves and / or securities premium [revaluation reserve, which represents
unrealised profit, cannot be used]
5. Where shares are purchased out of free reserves / securities premium, transfer
amount = nominal value of shares to Capital Redemption Reserve (CRR) Account
(details of which to be disclosed in balance sheet)
To clarify: CRR is not required to be created when funds of fresh issue are being
utilized for paying shareholders on buyback
6. CRR A/c may be used to issue fully paid up bonus shares (hence, is not a free
reserve)
7. Company to ensure that at least 50% of the amount earmarked for buyback to be
utilized for the same
B. Procedural requirements
8. Buyback must be authorized by Articles of Association
9. Buyback must be authorized by special resolution passed in general meeting.

Notice for such meeting to be accompanied by an explanatory statement
specifying prescribed details viz. class of shares to be bought back & amount,
need for buyback, all material facts relating to buyback etc.
Exception to above two conditions: Where buyback is 10% or less of paid up capital
+ free reserves & is authorized by a board resolution passed at directors’ meeting
10. Buyback must be completed within 12 months from date of passing special
resolution/resolution passed by the board of directors
11. In case of listed shares, company to file a solvency declaration with ROC and SEBI
to the effect that company is capable of meeting its liabilities and will not
become insolvent within 1 year of date of declaration
12. Company to physically destroy shares post buyback
13. Maintain register of shares bought back. To record date of cancellation,

consideration paid, other particulars as prescribed
14. In case of listed shares, file prescribed return with ROC and SEBI
C. Other provisions
15. Buyback must meet SEBI regulations when listed shares are being bought back
16. Buyback may be:

− From existing security holder proportionately
− From open market (cannot exceed 15% of paid up capital + free reserves)
− By purchasing securities issued to employees (pursuant to stock option /
sweat equity)
17. Further shares of same kind cannot be issued for 6 months, unless by way of
bonus or towards discharge of subsisting obligations viz. warrants, ESOPs,
conversion of preference shares etc.
18. Non-compliance of above provisions / other SEBI regulations to be punishable

with specified fine (1-3 lakh rupees), imprisonment (upto 3 years) or both
19. Buyback must not be made directly or indirectly through subsidiaries or other
investment companies
20. Buyback cannot be made if there is a financial default like default in payment of
interest or dividend, repayment of deposit or loan installment, redemption of
debentures etc.
21. Buyback cannot be made within 1 year from date of closure of previous buyback
22. Meaning of free reserves – Reserves, which as per latest audited balance sheet,
are available for distribution as dividend
✓ Includes securities premium
 Does not include any unrealized gains / notional gains / revaluation of assets
(whether shown as reserve or otherwise)

 Does not include any change in carrying value of asset / liability recognized
in equity / P&L on measurement of asset / liability at fair value
ACCOUNTING ENTRIES:
1. To record amount due on buyback, including cancelling share capital
Equity share capital A/c Dry

Premium payable on buyback A/c Dr
To Equity shares buyback A/c
Remember:
(i) Ensure that exam question specifies shares being bought back are fully paid.
Otherwise, make suitable assumption.
(ii) Where question clearly specifies number of shares being bought back,
whether the three tests are being met need not be checked.
2. To adjust premium payable on buyback from free reserves
Securities Premium A/c

Revenue or General Reserve A/c
Profit and Loss A/c Dr
To Premium payable on buyback A/c
Remember:
(i) Follow the order as mentioned above while adjusting premium payable
(ii) Ensure there is sufficient balance as per the facts given in exam question.
Else, utilize the next in line free reserves.
3. To transfer appropriate amount to CRR A/c
Revenue or General Reserve Dr

To Capital Redemption Reserve A/c
Remember: Amount to be transferred = Amount debited in Equity share capital

A/c in #1 above
4. To record payment on buyback

Equity shares buyback A/c Dr
To Bank
Remember:
(i) Do a quick check if there are sufficient balances - existing or from having sold
investments etc. – as per exam question
(ii) Ensure that proceeds of a previous issue of same class of shares, if any, are
not required to be used.
OTHER ASPECTS:
Questions may specify other events like redemption of preference shares, issue of
shares against ESOPs granted etc. Pls take due note and pass necessary journal
entries.
1. Questions may require preparing balance sheet as well post journal entries.
Remember to update relevant closing balances like equity capital, bank balance,
securities premium and / or free reserves – all of which would have reduced
balances at year end.
2. Where exam question asks to determine maximum how many shares can be
bought back), compute using following tests, i.e.
(i) Shares Outstanding test: Maximum buyback can be upto 25% of shares
outstanding.
E.g. Company has 10,000 shares of Rs 10 each fully paid up. Buyback can be
made upto 2,500 shares only as per this test.
(ii) Resources test: Maximum buyback can be upto 25% of paid up capital + free
reserves
E.g. Company has 10,000 shares of Rs 10 each fully paid up. Buyback is to
be made at Rs 50 per share. Existing free reserves = Rs 150,000.
Thus, Paid up capital + free reserves = 100,000 + 150,000 = 250,000.
25% thereof = 62,500
Buyback price per share = 50
Buyback can be made upto 1,250 (62,500/50) shares as per this test.
(iii) Debt ratio test: After buyback, debt: capital+free reserves should be 2:1 or
less.
Remember, CRR is not a free reserve (has limited purposes).

Since this is a post buyback test, some backward calculations would need
to be made to calculate permissible buyback limits.
E.g. If Debt is 1200, capital + free reserves post buyback should be at least
600. Existing capital + free reserves = 750
Thus, 150 is available for buyback. However, the same has to be used:
- To cancel nominal value of equity that is being bought back. Say, Rs. X
- To adjust premium payable, if any, on buyback. Say Rs. 2X in this case
- To transfer to CRR as well. The amount to be transferred to CRR is same
as nominal value of shares. Thus, another Rs. X
Therefore, 150 = 4X
And X = 150/4 = Rs 37.5 which is the total face value of shares that can be
bought back. Divide it by face value of one share (Rs 10 or 100 or whatever
is specified in question) to arrive at number of shares that can be bought
back.

Illustrations
Illustration - 1
M Ltd. furnishes the following summarized balance sheet as at 31st March 2011.
Liabilities Rs. in Rs. in
(‘000) (‘000)
Equity and liabilities
Share capital:
Authorized capital: 5,000
Issued and subscribed capital
3,00,000 equity shares of Rs.10 each fully paid up 3,000
20,000 9% preference shares of Rs.100 each 2,000
(issued two months back for the purpose of buy back) 5,000
Reserves and surplus:
Capital reserves 10
Revenue reserves 4,000
Securities premium 500
Profit and loss account 1,800 6310
Non- current liabilities – 10% debentures 400
Current liabilities and provisions 40
Total 11,750
Assets Rs. in Rs. in
(‘000) (‘000)
Fixed Assets Cost 3,000
Less: Provision for depreciation 250 2,750
Non-current investments at cost 5,000
Current assets, loans and advances (including cash 4,000
and bank balances)
Total 11,750

The company passed a resolution to buy back 20% of its equity capital @Rs.15 per
shares. For this purpose, it sold its investments of Rs.30 lakhs for Rs.25 lakhs. You are
required to pass necessary journal entries.
Illustration - 2
Anu Ltd. (a non-listed company) furnishes you with the following summarized balance
sheet as on 31st March 2011.
Rs. Rs.
(in (in
crores) crores)
Sources of funds
Share capital:
Authorised 100
Issued:
12% redeemable shares of Rs. 100 each fully paid 75
Equity shares of Rs.10 each fully paid 25 100
Capital reserves 15
Securities premium 25
Revenue reserves 260 300
Total 400
Application of Funds
Fixed assets: cost 100
Less: Provision for depreciation (100) Nil
Non-current investments at cost (Market value Rs 400 100
Cr.)
Current assets 340
Less: Current liabilities (Trade Payables) (40) 300
Total 400

The company redeemed preference shares on 1st April 2011. It also brought back 50
lakhs equity shares of Rs. 10 each at Rs.50 per shares. The payment for the above
were made out of the huge bank balances, which appeared as a part of current
assets. The company redeemed preference shares on 1st April 2011. It also brought
back 50 lakhs equity shares of Rs. 10 each at Rs.50 per shares. The payment for the
above were made out of the huge bank balances, which appeared as a part of current
assets.
You are asked to:
(i) pass journal entries to record the above.

(ii) prepare balance sheet as at 1.04.2011
Illustration – 3
Dee Ltd. (a non-listed company) furnishes the following summarized balance sheet as
at 31st March 2011.
Liabilities Rs. (‘000) Rs. (‘000)

Share capital: 30,00
Authorised capital
Issued and subscribed capital: 25,00
2,50,000 equity shares of Rs.10 each fully paid up 2,00
2,000, 10% preference shares of Rs.100 each
(issued two months back for the purpose of buy back)
Reserves and surplus: 10,00
Capital reserves
Revenue reserves 30,00
Securities premium 22,00 97,00
Profit and loss account 35,00
Current liabilities and provision 14,00
Total 1,38,00
Assets
Fixed assets 93,00
Investments 30,00

Current assets, loans and advances (including cash and 15,00
bank balances)
Total 1,38,00
The company passed a resolution to buy back 20% of its equity capital @ Rs. 50 per
shares. For this purpose, it sold all of its investment for Rs.22, 00,000.
You are required to pass necessary journal entries and prepare the balance sheet.
Illustration - 4
Perrotte Ltd. (a non- listed company) has the following capital structure as on
31.03.2011.
Particulars Rs. Rs.
(in (in
crores) crores)
(1) Equity shares capital (shares of Rs.10 each fully paid) 330
(2) Reserves and surplus
General reserves 240 _
Securities premium account 90 _
Profit and loss account 90 _
Infrastructure development reserves 180 600
(3) Loan funds 1,800
Shareholders of Perrotte Ltd. on the recommendation of their Board of Directors,

have appeared on 12.09.2011 a proposal to buy back the maximum permissible
number of equity shares considering the large surplus funds available at the disposal
of the company.
The prevailing market value of the company’s shares is Rs.25 per shares and in order
to induce the existing shareholders to offer their shares for buy back, it was decided
to offer a price of 20% over market. You are also informed that the infrastructure
development reserves are created to satisfy income-tax Act requirements.
You are required to compute the maximum number of shares that can be brought
back in the light of the above information and also under a situation where the loan
funds of the company were Rs.1, 200 crores or Rs. 1,500 crores. Assuming that the

buyback is completed by 09.12.2011, show the accounting entries in the company’s
books in each situation.
1.8 Issue and Redemption of Preference Shares and

Debentures
INTRODUCTION
 Redemption is the process of repaying an obligation, at pre-arranged amounts and

timings.
 These shares are issued on the terms that shareholders will at a future date be
repaid the amount which they invested in the company (along with frequent
payment of a specified amount as return on investment during the tenure of the
preference shares).
 The redemption date is the maturity date, which specifies when repayment takes
place and is usually printed on the preference share certificate.
REASONS FOR ISSUING REDEEMABLE PREFERENCE SHARES
1. There is difficulty in issuing equity shares, if shares are not traded in stock market
and potential investors are skeptical in investing money.
2. Utilizing surplus funds in redeeming capital when they cannot use more beneficially.
SEC 55 OF COMPANIES ACT, 2013
1) Issue of Preference shares should be authorized by Articles.

2) Such shares should be redeemable within a period not exceeding 20 years from the
date of issue.
3) Only fully paid up shares can be redeemed.
Note –
If the question has partly paid shares, then due entry for final call and receipt entry is
passed before redemption entry.
If the question has both the fully paid and partly paid shares, then only fully paid is
considered for redemption.
4) If any premium is payable on redemption, the same shall be provided for out of the
profits of the company or out of the company’s securities premium account, before

such shares are redeemed.
5) However, in case of companies which are prescribed and who comply with sec 133 of
Companies act 2013, premium payable on redemption, shall be provided for out of
the profits of the company only. i.e... Securities premium cannot be used.
6) Shares can be redeemed out of profit of the company which would otherwise be
available for dividend or out of proceeds of fresh issue of shares made for the purpose
of redemption.
7) Where shares are proposed to be redeemed out of the free reserves, a sum equal to
the nominal amount of the shares redeemed should be transferred to a reserve
account called Capital Redemption Reserve Account (CRR A/c)
Methods of Redemption
Partly out of free reserves and

Out of free reserves Out of fresh issue
party out of fresh issue
CRR to be created for the

CRR to be created
portion of redemption out of
free reserves only
CREATION OF CRR (CAPITAL REDEMPTION RESERVE), AND FRESH ISSUE
1) CRR can be used only for issuing fully paid bonus shares only.
2) The objective of creating CRR is to provide assurance or security to creditors/
bankers, etc.
3) Some examples of Free reserves are – General reserve, Profit and loss a/c, Surplus
a/c, Residuary reserve, Dividend equalization reserve, Excess provision created etc.
There is no order in which free reserves are to be utilized to create CRR.
4) Fresh issue can be either of equity shares or preference shares.
5) The proceeds of a fresh issue of shares will not include the amount of securities
premium for the purpose of redemption of preference shares. (securities premium
can be utilized only as per Sec 52* of Companies Act, 2013)
6) Proceeds from the issue of Debentures cannot be utilized.
7) Companies may have sufficient investments, which can be sold, in the market to
arrange funds for redemption of preference shares.
8) When shares are redeemed by combination of Fresh Issue and capitalisation of
Undistributed Profits:

Amount to be Transferred to Capital Redemption Reserve
Face value of shares redeemed xxx
Less: Proceeds from new issue xxx
xxx
Proceeds to be collected from New issue
Face value of shares redeemed xxx
Less: Profits available for distribution as dividend xxx
xxx
* Sec 52 of Companies Act, 2013 - The securities premium account may be applied by
the company -
(a) Towards issue of un-issued shares of the company to be issued to members of the
company as fully paid bonus securities
(b) To write off preliminary expenses of the company
(c) To write off the expenses of, or commission paid, or discount allowed on any of
the securities or debentures of the company
(d) To provide for premium on the redemption of redeemable preference shares or
debentures of the company.
(e) For the purchase of its own shares or other securities.
Certain class of Companies whose financial statements comply with the Accounting Standards
as prescribed under Section 133 of the Companies Act, 2013, can’t apply the securities
premium account for the purposes (b) and (d) mentioned above.
REASONS FOR ISSUE OF EQUITY SHARES FOR THE PURPOSE OF

REDEMPTION
1) When the company realizes that the capital is needed permanently, and issue of Equity
Shares are better as they don’t carry any fixed rate of dividend.

2) When the balance of free reserves is insufficient.
3) When the liquidity position of the company is not good enough.
ADVANTAGES AND DISADVANTAGES OF REDEMPTION OF PREFERENCE

SHARES BY ISSUE OF FRESH EQUITY SHARES
Advantages Disadvantages
1. No cash outflow of money 1. There will be dilution of future earnings
2. New equity shares may be valued at a 2. Shareholding in the company is changed

premium
3. Shareholders retain their equity interest
Journal entries
When new shares are issued at par
Bank A/c Dr.
(Being the issue of ……. shares of Rs.……each for the purpose of redemption of
Preference shares, as per Board’s Resolution No…… dated…….)
When new shares are issued at premium
Bank A/c Dr.
(Being the issue of ……. shares of Rs.……each at a

premium of Rs.……each for the purpose of
redemption of preference shares as per Board’s
Resolution No…. dated……)

When preference shares are redeemed at par
Redeemable Preference Share Capital A/c Dr.
To Preference Shareholders A/c
(Being the amount payable on redemption of preference
shares transferred to Preference Shareholders Account)
When preference shares are redeemed at a premium
Redeemable Preference Share Capital A/c Dr.
Premium on Redemption of Preference Shares A/c Dr.
To Preference Shareholders A/c
(Being the amount payable on redemption of preference shares
(with premium on redemptions) transferred to Preference
Shareholders Account
When payment is made to preference shareholders
Preference Shareholders A/c Dr.
To Bank A/c
(Being the amount paid on redemption of preference shares)
For adjustment of premium on redemption
Profit and Loss A/c Dr.
To Premium on Redemption of Preference Shares A/c
(Being Premium on redemption transferred to P&L A/c)

ADVANTAGES AND DISADVANTAGES OF REDEMPTION OF PREFERENCE
SHARES BY CAPITALISATION OF UNDISTRIBUTED PROFITS
Advantages Disadvantages
1. No change in the percentage of equity 1. There may be a reduction in liquidity

shareholding of the company
2. Surplus funds can be used
Journal entries
Entry for redemption of Preference shares (at par or at premium), payment to preference
shareholders and adjustment of premium on redemption with the Profit and loss account
is same as given above.
For transferring nominal amount of shares redeemed to Capital Redemption Reserve

Account
To Capital Redemption Reserve A/c

(Being the amount transferred to Capital Redemption
Reserve Account as per the requirement of the Act).
COMPLIANCE OF SEC.55 UNDER VARIOUS SCENARIOS
Scenarios Compliance with Sec 55
1. When redemption is done with Create CRR equal to the value of nominal
Company’s own resources value of shares issued. (Even if they are
redeemed at premium)
2. When redemption is done by fresh New shares are issued such that
issue of new shares
nominal value of shares issued = nominal
value of shares redeemed.

When Equity shares are not fully called up,
only the called-up portion is considered for
computing the balance of P&L to be
utilized.
3. When minimum fresh issue of Step 1 - Ascertain maximum amount of

shares needs to be computed reserves and surplus available for
redemption from the balance sheet and
additional information given in the
question.
Step 2 - Adjust premium on redemption
payable out of profits in the reserves.
Step 3 - Minimum Proceeds of Fresh Issue of
shares =
Nominal value of preference shares to be
redeemed – Maximum amount of reserve
and surplus available for redemption
Step 4 - Minimum Number of Shares =
Minimum proceeds to comply with Section
55÷ Face value of one share (Fraction is
rounded off to next higher figure)
In step 4, face value is considered even if
shares are issued at premium. However, in
case of issue of share at a discount,
discounted value is considered.
4. When shares are issued at When Securities premium including

premium and redemptions is also premium on fresh issue is comparatively
at premium more than premium on redemption, profits
available for redemption are not required
for paying premium on redemption of
preference shares. Thus, in the above
equation, premium on redemption is not
adjusted in maximum amount of reserves
and surplus available for redemption.
5. When shares are issued at Follow the steps given in scenario 3

premium and redemptions is also
at premium. (The premium on
issue is higher than the premium
on redemption)

6. When the cash available for Step1 - Fresh issue (Rs.) = Amount payable
redemption is short to preference shareholders – amount
available
Step 2 - Fresh issue (no. of shares) = Fresh

issue (above) ÷ issue price per share
(including premium)
REDEMPTION OF FULLY CALLED BUT PARTLY PAID-UP PREFERENCE

SHARES
 When calls-in-arrears is received by the company
On receipt of amount of unpaid calls
Bank A/c Dr.
To Calls in arrears A/c
After receipt of calls in arrears, the shares become fully paid up and, then, company
can proceed with redemption in the normal course.
 In case of Forfeited Shares
When calls in arrears is not received and redemption is due, the board may decide to
forfeit the shares. The below forfeiture entry is passed before redemption entry.
On forfeiture of shares
Share Capital A/c Dr.
To Share forfeiture A/c
To Calls in arrears A/c

Illustrations
Illustration – 1
Hinduja Company Ltd. had 5,000, 8% Redeemable Preference Shares of Rs. 100 each,
fully paid up. The company decided to redeem these preference shares at par by the
issue of sufficient number of equity shares of Rs. 10 each fully paid up at par.
You are required to pass necessary Journal Entries including cash transactions in the
books of the company.
Illustration – 2
C Ltd. had 10,000, 10% Redeemable Preference Shares of Rs. 100 each, fully paid up.
The company decided to redeem these preference shares at par, by issue of sufficient
number of equity shares of Rs. 10 each at a premium of Rs. 2 per share as fully paid
up.
Illustration – 3
The Board of Directors of a Company decide to issue minimum number of equity

shares of Rs. 9 to redeem Rs. 5,00,000 preference shares. The maximum amount of
divisible profits available for redemption is Rs. 3,00,000. Calculate the number of
shares to be issued by the company to ensure that provisions of Section 55 are not
violated. Also determine the number of shares if the company decides to issue shares
in multiples of Rs. 50 only.
Illustration – 4
The Balance Sheet of X Ltd. as on 31st March, 20X3 is as follows:
Particulars Amount (Rs.)

EQUITY AND LIABILITIES
1. Shareholders’ funds
a Share capital 2,90,000
b Reserves and Surplus 48,000
2. Current liabilities
Trade Payables 56,500
Total 3,94,500
ASSETS
1. Fixed Assets

Tangible asset 3,45,000
Non-current investments 18,500
2. Current Assets
Cash and cash equivalents 31,000
(bank)
Total 3,94,500
The share capital of the company consists of Rs. 50 each equity shares of Rs. 2,25,000
and Rs. 100 each Preference shares of Rs. 65,000 (issued on 1.4.20X1). Reserves and
Surplus comprises Profit and Loss Account only.
In order to facilitate the redemption of preference shares at a premium of 10%, the

Company decided:
1. to sell all the investments for Rs.15,000.
2. to finance part of redemption from company funds, subject to, leaving a bank
balance of Rs. 12,000.
3. to issue minimum equity share of Rs. 50 each at a premium of Rs. 10 per share
to raise the balance of funds required.
You are required to pass:
The necessary Journal Entries to record the above transactions and prepare the
balance sheet as on completion of the above transactions.
Illustration – 5
The following are the extracts from the Balance Sheet of ABC Ltd. as on 31st
December, 20X1.
Share capital:
40,000 Equity shares of Rs. 10 each fully Rs. 4,00,000

paid
1,000,10% Redeemable preference share Rs. 1,00,00

s of Rs. 100 each fully paid
Reserve & Surplus:
Capital reserve Rs. 50,000
Securities premium Rs. 50,000

General reserve Rs. 75,000
Profit and Loss Account Rs. 35,000
On 1st January 20X2, the Board of Directors decided to redeem the preference shares
at par by utilization of reserve.
Illustration – 6
C Limited had:
3,000, 12% Redeemable Preference Shares of Rs. 100 each, fully paid up
The company had to redeem these shares at a premium of 10%
It was decided by the company to issue the following:
• 25,000 Equity Shares of Rs. 10 each at par

• 1,000 14% Debentures of Rs. 100 each
The issue was fully subscribed, and all amounts were received in full. The payment
was duly made. The company had sufficient profits.
Show Journal Entries in the books of the company.
Illustration – 7
The capital structure of a company consists of:
20,000 Equity Shares of Rs. 10 each fully paid up
1,000 8% Redeemable Preference Shares of Rs. 100 each fully paid up (issued on
1.4.20X1).
Undistributed reserve and surplus stood as:
General Reserve Rs. 80,000
Profit and Loss Account Rs. 20,000

Investment Allowance Reserve (out of Rs. 10,000
which Rs. 5,000, not free for distribution
as dividend)
Securities Premium Rs. 2,000
Cash at bank Rs. 98,000
Preference shares are to be redeemed at a Premium of 10% and for the purpose of
redemption, the directors are empowered to make fresh issue of Equity Shares at par
after utilizing the undistributed reserve and surplus, subjected to the conditions that
a sum of Rs. 20,000 shall be retained in general reserve and which should not be
utilized.
Pass Journal Entries to give effect to the above arrangements and show how the
relevant items will appear in the Balance Sheet of the company after the redemption
carried out.
Illustration - 8
The Balance Sheet of XYZ as at 31st December, 20X1 inter alia includes the following:
50,000, 8% Preference Shares of Rs. 100 35,00,000

each, Rs. 70 paid up
1,00,000 Equity Shares of Rs. 100 each 1,00,00,000

fully paid up
Securities Premium 5,00,000
Capital Redemption Reserve 20,00,000
Under the terms of their issue, the preference shares are redeemable on 31st March,
20X2 at 5% premium.
In order to finance the redemption, the company makes,

Rights issue of 50,000 equity shares of Rs. 100 each at Rs. 110 per share
Rs. 20 being payable on application
Rs. 35 (including premium) on allotment

Balance on 1st January, 20X3
1. The issue was fully subscribed, and allotment made on 1st March, 20X2. The
money due on allotment were received by 31st March, 20X2.
2. The preference shares were redeemed after fulfilling the necessary conditions
of Section 55 of the Companies Act, 2013.
You are asked to pass the necessary Journal Entries and show the relevant extracts
from the balance sheet as on 31st March, 20X2 with the corresponding figures as on
31st December, 20X1
Issue of Debentures
Debentures
(Types)
Convertibility Permanence Negotiability

Security basis Priority
basis basis basis
First
Secured Convertible Redeemable Registered
Mortgage
Second
Non- Mortgage
Unsecured Irredeemable Bearer
Convertible

Introduction
Sources of
Finance for
Companies
Borrowed
Own Funds Funds /
Debt
Loans from
Share
Profits Debentures Banks &
Capital
Institutions
Equity Preference
❖ Debenture
It is one of the most commonly used debt instrument issued by the company to
raise funds for the business. Reason for opting Debentures: Benefits of Debt
financing
✓ reduces the cost of the capital

✓ helps in designing appropriate capital structure of the company.
REVLAUATION
Debenture
A Bond
Company issues under its
seal
Acknowledges a Debt
Provides repayment of
principal and interest
Section 2 (30) of the Companies Act, 2013 - “Debenture” includes debenture stock,
bonds or any other instrument of a company evidencing a debt, whether constituting
a charge on the assets of the company or not.

Thus, debenture may be Secured Debenture or Unsecured Debenture. Those
debentures that have charge on the assets of the company are called “Secured
Debentures”
❖ Charge on Assets
➢ It is a right of a lender (debenture holder, in this case) to be paid from
a borrower's (Company’s) assets if the debt is not paid on time as
promised.
➢ The nature of the charge and the assets charged are described in the
Bond.
➢ The charge is not valid unless registered with the Registrar, and the
certificate registering the charge is printed on the bond.
➢ It is also customary to create a trusteeship in favour of one or more
persons in the case of mortgage debentures.
➢ The trustees of debenture holders have all powers of a mortgage of a
property and can act in whatever way they think necessary to
safeguard the interest of debenture holders.
Note: No company shall issue any debentures carrying any voting rights.
❖ Features of Debentures
➢ It is a fixed interest-bearing security where interest falls due on specific

dates.
➢ Interest is payable at a predetermined fixed rate, regardless of the level
of profit.
➢ The original sum is
o repaid at a specified future date or
o converted into
• shares or
• other debentures.
➢ It may or may not create a charge on the assets of a company as security.
➢ It is a document which evidences a loan made to a company.
➢ It can generally, be bought or sold through the stock exchange at a price
above or below its face value.

DISTINCTION BETWEEN DEBENTURES AND SHARES
Difference Debentures Shares
Holders - Creditors of the company. Owners of the company.

status
Voting No voting rights Holders have voting rights
Rights Thus, no threat to the existing control and thus issue will dilute
of the company. the existing control
Return on Interest is paid at a predetermined Dividend is paid at

Investment fixed rate. (i) a variable rate for
for the equity shares
holder (ii) fixed rate for
preference shares
Payment of Payable whether there is any profit or Payable only if profits are
Interest not. Interest on debentures has to be there.
paid
Deductible Interest is charge against profits and Dividends are

expense they are deductible as an expense in appropriation of profits
determining taxable profit of the and these are not
company. deductible.
Types Secured/Unsecured; Equity Shares;

Redeemable/ Irredeemable; Preference Shares.
Registered/Bearer;
Convertible / Non-convertible, etc.
Presentation “Long Term Borrowings” in the “Shareholder’s Fund” in

in financial Company’s Balance Sheet the Company’s Balance
statements Sheet.
Shares are shown under
detailed in ‘Share Capital’
of Notes to Accounts.
Convertibili Debentures can be converted into other Shares cannot be converted

ty debentures or shares as per the terms of into other shares in any
issue of debentures. circumstances.

Forfeiture Debentures cannot be forfeited for non- Shares can be forfeited
payment of call moneys. for non-payment of
allotment and call
moneys.
Redemption At maturity, debenture holders get back (i) Equity

their money as per the terms and shareholders:
conditions of redemption. cannot get back
their money
before the
liquidation of the
company
(ii) Preference
shareholders: can
get back their
money before
liquidation .
Winding up At the time of liquidation, debenture At the time of liquidation

holders are paid-out before the shareholders are paid at
shareholders. last, after paying
debenture holders, Trade
payable, etc.

TYPES OF DEBENTURES
Debentures
Security Convertibilit Permanence Negotiabilit

Priority
basis y basis basis y basis
First
Secured Convertible Redeemable Registered
Mortgage
Second
Non- Irredeemabl Mortgage
Unsecured Bearer
Convertible e
1. Based on Security
(a) Secured Debentures: These are secured by a charge upon some or all
assets of the company. There are two types of charges:
(i) Fixed charge: It is a mortgage on specific assets. These assets
cannot be sold without the consent of the debenture holders. The
sale proceeds of these assets are utilized first for repaying debenture
holders; and
(ii) Floating charge: It generally covers all the assets of the company
including future one.
(b) Unsecured or “Naked” Debentures: These are not secured by any
charge upon any assets. A company merely promises to pay interest
on due dates and to repay the amount due on maturity date.
2. Based on Convertibility
(a) Convertible Debentures: These will be converted into equity shares
(either at par or premium or discount) after a certain period of time
from the date of its issue. These debentures may be fully or partly
convertible.
(b) Non-Convertible Debentures: These cannot be converted into
shares in future. As per the terms of issue, these debentures are
repaid.
3. Based on Permanence

(a) Redeemable Debentures: These are repayable as per the terms of
issue.
(b) Irredeemable Debentures: These are not repayable during the
lifetime of the company i.e. they are repaid at the time of liquidation.
These are also called perpetual debentures.
4. Based on Negotiability
(a) Registered Debentures: These are payable to a registered holder
whose name, address and particulars of holding is recorded in the
Register of Debenture holders. They are not easily transferable.
Debenture interest is paid either to the order of registered holder as
expressed in the warrant issued by the company or the bearer of the
interest coupons.
(b) Bearer Debentures: These are transferable by delivery. These are
negotiable instruments payable to the bearer. No kind of record is
kept by the company in respect of the holders of such debentures.
Therefore, the interest on it is paid to the holder irrespective of any
identity. No transfer deed is required for transfer of such debentures.
5. Based on Priority
(a) First Mortgage Debentures: These are payable first, out of the property
charged.
(b) Second Mortgage Debentures: These are payable after
satisfying the first mortgage debentures.
ISSUE OF DEBENTURES
Debentures
Issued at Issued at Issued at

Par Discount Premium

ISSUE OF DEBENTURES – JOURNAL ENTRIES
Debentures issued at Par

The debentures which are issued at par are issued at the same price as their nominal
value
(Rs.) (Rs.)
Bank A/c Dr. xxxx

(1) Cash
received on
To Debentures Application A/c xxxx
application
(Being money received on __%
debentures @ Rs.___ each)
(2) Excess Debenture Application A/c Dr. xxx

money
refunded To Bank A/c xx Amount refunded
or adjusted
for future To Debenture Allotment A/c xxx Amount adjusted for
calls allotment
(Being excess money adjusted as per

Board’s resolution No…… dated……
(3) Debentures Debenture Application A/c Dr. xxxx

Allotted
To …… % Debenture A/c xxxx
(Being the allotment of ….%

Debentures of Rs….. each as per
Board’s resolution No….. dated……)
(4) Allotment Debenture Allotment A/c Dr. xxxx

money
To ….% Debentures A/c xxxx

being (Being allotment money being
called called)
(5) Allotment Bank A/c Dr. xxxx

money
being To Debenture Allotment A/c xxxx
received
(Being allotment money received)
(6) Debenture Debenture Calls A/c Dr. xxxx

Call money
being To ….. % Debentures A/c xxxx
called
(Being call money made due)
(7) Call money Bank A/c Dr. xxxx

received
To Debenture Calls A/c xxxx
(Being call money received)
Debentures issued at Premium

➢ The debentures, which are issued at a premium, are issued at a higher price
than their nominal value.
➢ Debentures are issued at a premium by a company when the market rate of
interest is lower than the debentures interest rate.
➢ The premium on debentures is credited to ‘Securities Premium Account’ as
‘Debentures’ are covered in the definition of ‘securities’ u/s 2(h) of the
Securities Contracts (Regulation) Act.
➢ Utilisation of such Debenture Premium is restricted as it is governed by
Section 52 of the Companies Act, 2013.
(Rs.) (Rs.)
Bank A/c Dr. xxxx

(1) Cash
received on
application
(Being money received on __%
debentures @ Rs.___ each)

money
refunded To Bank A/c xx Amount refunded
or adjusted
for future To Debenture Allotment A/c xxx Amount adjusted for
calls allotment


Allotted
To Securities Premium A/c xx Difference between

issue and nominal
value
(Being the allotment of ….%

Debentures of Rs….. each and
Premium amount transferred to
Securities Premium A/c as per
Board’s resolution No….. dated……)

money
being To ….% Debentures A/c xxxx
called
(Being allotment money being
called)

money
received

Call money
called
Bank A/c Dr. xxxx

(7) Call money
received (Being call money received)
Debentures issued at Discount
➢ The debentures which are issued at a discount are issued at a lower price than
nominal value
➢ The Companies Act does not impose any restriction on the price at which
debentures can be issued. Unlike shares, there is no limit for discount on issue
of debentures.
➢ The company issues debentures at a discount when the market rate of interest
is higher than the debenture interest rate.
➢ The difference between the nominal value of debentures and cash received is
transferred to “Discount on Issue of Debentures Account”.
➢ Such “Discount on Issue of Debentures” is written-off proportionately in
subsequent years by charging to the Statement of Profit and Loss. It is
considered a normal practice to amortize discount on issue of debentures
over the period of benefit, i.e., normally 3 to 5 years.
➢ The Discount on issue of debentures is considered as incremental interest
expense. The true expense (net borrowing cost) for a particular accounting
period is, therefore, the total interest payment plus the discount written
off.
(Rs.) (Rs.)
Bank A/c Dr. xxxx

(1) Cash
received on
application
(Being money received on __% debentures
@ Rs.___ each)

money
refunded To Bank A/c xx Amount
or refunded

adjusted To Debenture Allotment A/c xxx Amount adjusted
for future for allotment
calls

Allotted
Discount on Issue of Debentures A/c Dr. xx Difference
between issue
price and
nominal value
(Being the allotment of ….% Debentures

of Rs….. each and Discount amount
transferred to Discount on Issue of
Debentures A/c as per Board’s resolution
No….. dated……)

money
being To ….% Debentures A/c xxxx
called
(Being allotment money being called)

money
received

Call money
called
(7) Call money Bank A/c Dr. xxxx

received
(Being call money received)

ISSUE OF REDEEMABLE DEBENTURES – JOURNAL ENTRIES
Redeemable
Debentures
Scenario (1) Scenario (2) Scenario (3)

Issued at Par Issued at Discount Issued at Premium
(1.1) (2.1) (3.1)

Redeemable at Par Redeemable at Par Redeemable at Par
(1.2) (2.2) (3.2)

Redeemable at Redeemable at Redeemable at
Discount Discount Discount
(1.3) (2.3) (3.3)

Redeemable at Redeemable at Redeemable at
Premium Premium Premium
Scenario Entry Debit Credit Remarks
(Rs.) (Rs.)
Bank A/c Dr. xxxxx

(1.1)
Issued at Par To Debenture Application A/c xxxxx Application
Redeemed at money
Par
Debenture Application A/c Dr. xxxxx Application

money
To ____% Debenture A/c Xxxxx

(Being application money transferred to Debenture A/c)
(2.1 & 2.2) Bank A/c Dr. xxxxx The difference

between the
Issued @ To Debenture Application A/c xxxxx amount received
Discount
(Being application money received) and amount
Redeemed @ payable in
Par/ Discount Debenture Application A/c Dr. xxxxx future is
considered as
Discount on issue of debentures A/c Dr. xx
loss on issue on
To ____% Debenture A/c xxxxx debentures and
is to be written-
(Being application money transferred to Debenture A/c on off over the life
allotment) of debentures.
(3.1 & 3.2) Bank A/c Dr. xxxxx

The gain on
paying less
Issued @ To Debenture Application A/c xxxxx
than what is
Premium received in
this scenario
Redeemed @ will not be
Par/Discount Debenture Application A/c Dr. xxxxx
recognised in
To ____% Debenture A/c xxxxx the books at
the time of
To Securities Premium A/c xx issue of
debentures as
(Being application money transferred to Debenture A/c on per the
conservatism
allotment) concept.
(1.3) Bank A/c Dr. xxxxx The redemption

premium is
Issued @ Par To Debenture Application A/c xxxxx recorded as a
Redeemed @ (Being application money received) loss on issue of
premium debentures
Debenture Application A/c Dr. xxxxx allotment time.
Debenture
To ____% Debenture A/c xxxxx
Redemption
(Being application money transferred to Debenture A/c) Premium A/c is
a personal
Bank A/c Dr. xxxx account

Loss on issue of debenture A/c Dr. xxxx representing
company’s
(Amount equal to redemption premium) liability.
To __% Debenture A/c xxxxx
To __% Debenture Redemption Premium xxxxx

A/c
(Being call made subsequent to allotment)
(2.3) Bank A/c Dr. xxxxx The difference

between the
Issued @ To Debenture Application A/c xxxxx redemption
Discount
(Being application money received) price and par
Redeemed @ value plus
premium Debenture Application A/c Dr. xxxxx difference
between the
To ____% Debenture A/c xxxxx
issue price and
(Being application money transferred to Debenture A/c) par value is
treated as
Bank A/c Dr. xxxx discount/loss on
issue of
Discount/Loss on issue of debenture A/c Dr. xxxx
debentures
(Amount equal to discount on issue + premium
on redemption)
To __% Debenture A/c xxxxx
To _% Debenture Redemption Premium A/c xxxxx
(Amount equal to premium payable on

redemption)
(3.3) Bank A/c Dr. xxxxx The premium

received at the
Issued @ To Debenture Application A/c xxxxx time of issue of
premium
(Being application money received) debentures is
credited to
Debenture Application A/c Dr. xxxxx Securities

Redeemed @ To ____% Debenture A/c xxxxx premium
premium account and
(Being application money transferred to Debenture A/c) premium paid at
Bank A/c Dr. xxxx the time of
redemption is a
Discount/Loss on issue of debenture A/c Dr. xx loss to be
provided at the
(Amount equal to premium on redemption)
time of issue of
To __% Debenture A/c xxxxx debentures
To Securities Premium A/c xx
(Amount equal to premium on issue)
To _% Debenture Redemption Premium A/c xx
(Amount equal to premium payable on

redemption)
DEBENTURES AS COLLATERAL SOCIETY
Collateral security = Secondary or Supporting security for a loan

➢ Under this arrangement, the borrower agrees that a particular asset or a group
of assets of the company, will be realized and the proceeds there from will be
applied to repay the loan in the event that the amount due, cannot be paid.
➢ Sometimes companies issue their own debentures as collateral security for a
loan or a fluctuating overdraft.
o When the loan is repaid on the due date, these debentures are at once
released with the main security.
o In case, the company cannot repay its loan and the interest thereon on
the due date, the lender becomes the debenture holder who can
exercise all the rights of a debenture holder.
➢ The holder of such debentures is entitled to interest only on the
amount of loan, but not on the debentures.

Accounting Entries
There are two methods of showing these types of debentures in the accounts of a
company.
➢ Method 1
No entry is made in the books of account of the company at the time of making
issue of such debentures.
In the ‘Notes to Accounts’ of Balance Sheet, the fact of the debentures being
issued and outstanding is shown by a note under the liability secured.
➢ Method 2
Under this method, the following accounting entry is made to record the issue
of such debentures:
Debentures Suspense A/c Dr.

To …..% Debentures A/c
(Being the issue
of…debentures
collaterally as per
Board’s Resolution
No…..dated)
The Debentures Suspense Account will appear on the assets side of the
Balance Sheet under Other Non- Current Assets and Debentures on the
liabilities side of the Balance Sheet. When the loan is repaid, the entry is
reversed in order to cancel it.
Students should note that the Method 1 is much more logical from the accounting
point of view. Therefore, it is advised to follow Method 1.
DEBENTURES IN CONSIDERATION OTHER THAN FOR CASH
Debentures, just like shares, can also be issued for consideration other than for cash,
such as for purchase of land, machinery, etc.
In this case, the following entries are passed:

(a) Sundry Assets A/c Dr. [Assets taken over]
To Sundry Liabilities A/c [Liabilities assumed]
To Vendors Account [Purchase
consideration]
(Being the assets and liabilities taken over)
(b) Vendors A/c Dr.
To Debentures A/c
(Being the issue of….% debentures to satisfy purchase consideration)
Further it should be noted that these debentures can be issued at par,
premium and at discount. In each case the second entry for issue of
debentures would be done accordingly i.e. “Securities Premium A/c” will be
created in case of ‘issued at premium’ or “Discount on Issue of Debentures
A/c” will be created in case of ‘issued at discount’.
Number of debentures to be issued is calculated as follows:-
1. When debentures are issued at par
No. of Debentures = Purchase Consideration

Par Value
2. When debentures are issued at premium

Par Value + Premium
3. When debentures are issued at discount

Par Value - Discount
TREATMENT OF DISCOUNT / LOSS ON ISSUE OF DEBENTURES
The discount on issue of debentures is amortised over a period between the

issuance date and redemption date.
It should be written-off in the following manner depending upon the terms of

redemption:
(a) If the debentures are redeemable after a certain period of time, the total

amount of discount should be written-off equally throughout the life of the
debentures (applying the straight-line method). The main advantage of this
method is that it spreads the burden of discount equally over the years.
(b) If the debentures are redeemable at different dates, the total amount of
discount should be written-off in the ratio of benefit derived from
debenture loan in any particular year (applying the sum of the year’s digit
method). This method is suitable when debentures are redeemed by
unequal instalments.
The accounting entries would be as follows :

To Discount on Issue of Debentures A/c
(Being the amount of discount on issue of debentures written-off)
Loss on issue of debentures is also a capital loss and should be written off in
a similar manner as discount on debentures issued.
In the balance sheet both the items (Discount and Loss) are shown as Non-
current/ current assets depending upon the period for which it has to be written
off.
INTEREST ON DEBENTURES
➢ Interest payable on Debentures is treated as a charge against the profits

of the company.
➢ Interest on debenture is paid periodically and is calculated at coupon
rate on the nominal value of debentures.
➢ The company will pay interest net of tax to the debenture holders
because the company is under obligation to deduct tax at source at the
rates applicable under tax rules from time to time.
➢ The companies will deposit the tax so deducted with income tax
authorities.

Following accounting entries are to be recorded in this regard:
(Rs.) (Rs.)
(1) For Interest A/c Dr. xxx

making
interest To ….% Debentures holders’ A/c xxx
due
(Being interest due on debentures)
…% Debentures holders’ A/c Dr. xxx

(2) Payment
of To TDS Payable A/c xxx
interest
and To Bank A/c x
deduction
of tax at (Being interest paid to the
source debenture holders after deducting
(TDS)
tax at source)
(3) Payment of TDS Payable A/c Dr. x

TDS
To Bank A/c x
(Being TDS deducted from interest

on debentures paid)
(4) Interest Profit & Loss A/c Dr. xxx

charged to
P&L A/c To Interest A/c xxx
(Being interest charged as expense

to P&LA/c)
Illustrations
Illustration – 1
Agrotech Ltd. issued 150 lakh 9% debentures of Rs.100 each at a discount of 6%,
redeemable at a premium of 5% after 3 years payable as:
• Rs.50 on application and
• Rs. 44 on allotment.

Record necessary journal entries for issue of debentures.
Illustration – 2
Simmons Ltd. issued 1,00,000, 12% Debentures of Rs.100 each at par payable in full on
application by 1st April, Application were received for 1,10,000 Debentures.
Debentures were allotted on 7th April. Excess money refunded on the same date.
You are required to pass necessary Journal Entries (including cash transactions) in the
Illustration – 3
X Ltd. obtains a loan from IDBI of Rs.1,00,00,000, giving as collateral security of

Rs.1,50,00,000 (of Rs.10 each), 14%, First Mortgage Debentures.
Illustration – 4
HDC Ltd issues 1,00,000, 12% Debentures of Rs.100 each at Rs.94 on 1st January 2017.
Under the terms of issue, the debentures are redeemable at the end of 5 years from
the date of the issue.
Calculate the amount of discount to be written-off in each of the 5 years.
Redemption of Debentures
 A debenture is an instrument issued by a company under its seal, acknowledging a

debt and containing provisions as regards repayment of the principal and interest
 It’s a long-term debt for the company. They are commonly secured by charge. Thus,
they appear under “Secured Liabilities”.
 If a charge has been created on any or the entire asset of the company, the nature
of the charge and the asset charged therein are described in the bond. The certificate
registering the charge with the registrar is also printed on the bond.
 A trusteeship in favor of one or more persons in the case of mortgage debentures is
created. The trustees of debenture holders can take any action necessary to
safeguard the interest of debenture holders.
 It earns a fixed income in form of interest. Interest is payable by the company
whether it earns profit or not.
 The procedure for issue of debentures is similar to that of issue of shares. Thus, the
amount can be collected in lumpsum along with application or in instalments.

 In case of oversubscription, the excess applications must be rejected, and the
amount should be refunded. The excess money cannot be adjusted as in case of
shares.
 They can be issued for
➢ Cash
➢ Consideration other than cash.
➢ As collateral security.
 They can be issued at
➢ Par
➢ Premium
➢ At discount
 The terms of redemption should also be accounted at the time of issue.
Redemption of debentures at a premium is a known loss at the time of issue of
debentures as the terms of issue generally contain such provisions for redemption.
PROVISION OF COMPANIES ACT 2013
 Sec.71(1) - A company may issue debentures with an option to convert such

debentures into shares, either wholly or partly at the time of redemption. Provided
the issue of convertible debentures is approved by a special resolution passed at a
duly convened general meeting.
 Sec.71 (2) -No company can issue any debentures which carry any voting rights.
 Sec.71(4)-The company should create a debenture redemption reserve account
(DRR) out of free reserves and the amount credited to such account should not be
utilized by the company for any purpose other than the redemption of debentures.

TYPES OF DEBENTURES
Secured debentures
Security
Unsecured debentures
Convertible
Convertibility
Non-Convertible
Reedemable
Types of debentures Permanence
Irreedemable
Registered
Negotiability
Unregistered
First mortgage
Priority
second mortgage
Redeemable debentures - Debentures, which can be redeemed or for which payment

is made after a specified time are called Redeemable debentures.
These are redeemable-
(i) At the expiry of a specified period either at par or at a premium;
(ii) By purchasing in the open market at any time at the price prevailing in the
market; and
(iii) By annual drawings.
Irredeemable debentures - When the issuing company does not fix any date by which
debentures can be redeemed, and the holders of such debentures cannot demand
payment from the company so long as it is a going concern it is called irredeemable
debentures. Usually such debentures are repayable after a long period of time or when
the company decides to wind up.
First debentures: - Those debentures, which are repaid before other debentures are
paid out, are called First debentures.
Second debentures: - Those debentures, which are paid after the payment towards
the First debenture, are called Second debentures.
Convertible debentures: - Those debentures, which are given the option to convert

the debentures fully or partly into equity shares after a specified time, are called
Convertible Debentures. If the debentures are fully converted, then it is called as ‘Fully
Convertible debentures. those which are partly convertible are called ‘Partly
Convertible debentures.
Non-convertible Debentures: - The debentures that cannot be converted into equity

shares such are non-convertible debentures.
Mortgage Debentures: - Debentures, which are secured either on a particular asset

[called fixed charge], or on the general assets of the company [called floating charge],
are called Mortgage debentures.
Unsecured / Naked Debentures: - Those debentures which are not secured, are called
naked debentures. Companies with very good standing can issue such debentures.
Registered Debentures – Those which are registered with the Registrar
Unregistered Debentures – Those which are not registered with the registrar.
DEBENTURE REDEMPTION RESERVE – SEC 71 OF COMPANIES ACT 2013
(1) Where a company issues debenture under this section, it should create a Debenture
Redemption Reserve (DRR) account out of its profits which are available for
distribution of dividend every year until such debentures are redeemed.
(2) If Debentures are redeemed at a premium, DRR is created for an amount including
redemption amount.
(3) The amounts credited to the debenture redemption reserve should not be utilized
by the company except for the purpose aforesaid.
(4) The company should pay interest and redeem the debentures in accordance with
the terms and conditions of their issue.
(5) In case of failure by the company, the Tribunal may, on the application of any or
all the holders of debentures or debenture trustee and, after hearing the parties
concerned, direct, by order, the company to redeem the debentures forthwith by
the payment of principal and interest due thereon.
(6) The company can create an investment out of the amount set aside for the reserve.
It will be called Debenture Redemption Reserve Investment.
(7) Interest earned on DRR investments will be credited to profit and loss account.
(8) In last year, the Debenture Redemption Reserve Investments are encashed and the
amount so obtained is used for the redemption of debentures.
(9) Any profit or loss made on the encashment of Debenture Redemption investments
is also transferred to Profit & Loss account.

(10) The balance of Debenture Redemption Reserve is subsequently transferred to
General Reserve.
INVESTMENT OF DEBENTURE REDEMPTION RESERVE (DRR) AMOUNT
Rule 18(7) of Companies (Share Capital and Debentures) Rules, 2014 prescribes the
following conditions:
 Every company required to create DRR should before the 30th day of April of each
year, deposit or invest, as the case may be, a sum which should not be less than
15% of the amount of its debentures maturing during the year ending on the 31st
day of March next following in any one or more of the following methods, namely:
➢ in deposits with any scheduled bank, free from charge or lien;
➢ in unencumbered securities of the Central Government or of any State
Government;
➢ in unencumbered securities mentioned in clauses (a) to (d) and (ee) of
Section 20 of the Indian Trusts Act, 1882;
➢ in unencumbered bonds issued by any other company which is notified
under clause (f) of Section 20 of the Indian Trusts Act, 1882;
 The amount deposited or invested, as the case may be, above should not be utilized
for any purpose other than for the repayment of debentures maturing during the
year referred to above, provided that the amount remaining deposited or invested,
as the case may be, should not at any time fall below 15% of the amount of
debentures maturing during the 31st day of March of that year.

 Ministry of Corporate Affairs has made the following clarification on adequacy of
Debenture Redemption Reserve (DRR):
Pre August 16, 2019 Post August 16,

2019
1 For debentures issued No DRR is required No DRR is required

by All India Financial
Institutions (AIFIs)
regulated by Reserve
Bank of India and
Banking Companies for
both public as well as
privately placed
debentures
2 For other Financial 25% of the value of No DRR is required
Institutions (FIs) and outstanding debentures
NBFCs registered with issued through public
RBI and for housing issue. No DRR is
finance companies required in the case of
registered with National privately placed
Housing Bank debentures.
3 For debentures issued 25% of the value of No DRR is required
by listed companies outstanding debentures (irrespective of
including manufacturing issued through public public or Private
and infrastructure issue. Also 25% DRR is Issue)
companies. required in the case of
privately placed
debentures by listed
companies
4 For unlisted companies DRR will be 25% of the DRR will be 10% of
issuing debentures on value of outstanding the value of
private placement debentures. outstanding
basis, debentures

METHODS OF REDEMPTION
Method of redemption of
debentures
By payment in By payment in By purchase in open By conversion

lumsum installments market into shares
By payment in lumpsum
Under payment in lumpsum method, at maturity or at the expiry of a specified period
of debenture the payment of entire debenture is made in one lot or even before the
expiry of the specified period
By payment in Instalments
Under payment in installments method, the payment of specified portion of
debenture is made in installments at specified intervals
ACCOUNTING FOR DEBENTURE REDEMPTION FUND AND INVESTMENT
Journal entries
1. At the end of First Year
For setting aside the fixed amount of profit for redemption
To Debenture Redemption Reserve A/c

(Being transfer of profits to Debenture redemption reserve A/c)
For investing the amount set aside for redemption

Debenture Redemption Reserve Investment A/c Dr.
To Bank A/c
(Being amount invested in DRR investment A/c)
2. At the end of second year and subsequent years other than

last year
For receipt of interest on Debenture Redemption Reserve Investments
Bank A/c Dr.

To Interest on Debenture Redemption Reserve Investment
A/c
(Being interest on investment received)
For transfer of Interest on Debenture Redemption Reserve Investment

(DRRI) to profit and loss account.
Interest on Debenture Redemption Reserve Investment A/c Dr.
To Profit & Loss A/c

(Being interest on investment transferred to P&L A/c)

(Being transfer of profits to Debenture redemption reserve A/c)
For investments of the amount set aside for redemption and the interest
earned on DRRI
To Bank A/c
(Being amount invested in DRR investment A/c)
3. At the end of last year
For receipt of interest
Bank A/c Dr.

To Interest on Debenture Redemption Reserve Investment A/c
(Being interest on investment received)
For transfer of interest on Debenture Redemption Reserve Investment to
Profit and loss account.

Interest on Debenture Redemption Reserve Investment A/c
Dr.
To Profit and loss A/c

For encashment of Debenture Redemption Reserve Investments
Bank A/c Dr.

To Debenture Redemption Reserve Investment, A/c
For the transfer of profit/loss on realization of Debenture Redemption
Reserve Investments
(i) In case of Profit
To profit and loss A/c
Or
(ii) In case of Loss
Profit and loss A/c
Dr
To Debenture Redemption Reserve Investment, A/c
For amount due to debenture holders on redemption
Debenture A/c
Dr
To Debenture holder’s A/c

For payment to debenture holders
Debenture holder’s A/c
Dr
To Bank A/c
For transfer of balance in DRR to General Reserve
Debenture Redemption Reserve A/c Dr.
To General reserve A/c
ACCOUNTING FOR PURCHASE OF DEBENTURES IN THE OPEN MARKET
A company, if authorized by its Articles of Association, can buy its own debentures in
the open market.
This can be categorized as follows:
For immediate cancellation
When the company cancels the debentures so purchased, it amounts to redemption of
debentures. It means after cancellation; redemption is automatic, and these
debentures cannot be reissued.
For investment in the form of own debentures

If the company purchases its debentures from open market and holds them for some
time before cancellation, such debentures are known as own debentures. Own
debentures are held by company as investment and may be resold till cancellation.
After cancellation, the debentures are said to be redeemed and cannot be resold.

Accounting treatment for purchase of own debentures for immediate
cancellation.
Journal entries
On purchase and cancellation of debentures
Debentures A/c (with the amount paid) Dr.
To Bank A/c
(Being debentures purchased in the open market and cancelled
immediately)
If there is any difference between the nominal value of the debentures

cancelled and the price paid for them,
In case of profit
Debenture A/c Dr.
To Bank A/c
To Profit on redemption of debentures A/c
(Being debentures purchased in the open market for immediate
cancellation and profit made on the same)
Transferring the above profit to Capital reserve A/c
Profit on redemption of debentures A/c
Dr.
To Capital Reserve A/c
In case of loss
Debenture A/c Dr.

Loss on redemption A/c
Dr.
To Bank A/c
(Being debentures purchased in the open market for immediate
cancellation and Incurred loss on the same)
Transferring the above loss to Capital reserve A/c or P&L A/c or Securities
premium A/c
Profit and Loss A/c Or
Securities Premium A/c Or Dr.
Capital Reserve A/c
To Loss on redemption A/c Dr.
Dr.
ACCOUNTING FOR REDEMPTION BY CONVERSION
Journal entries
When shares are issued at Par
Debentures A/c Dr.

(Being debentures converted in ………… (no. of) Equity shares of Rs…. each)
When shares are issued at premium
Debenture A/c Dr.
To Share capital A/c

(Being debentures converted in ………… (no. of) Equity shares of Rs…. Each
issued at a premium of Rs……each)
Illustrations
Illustration – 1
X Ltd. issued 1,00,000; 9% Debentures of Rs.50 each at a premium of 10% on 30thJune,

2019 redeemable on 31st March 2021.The issue was fully subscribed. The Company
decided to create DRR on 31st March,2020 and invest in Fixed Deposit Earnings interest
@ 10% p.a. on 1st April 2020 to meet the legal requirement. Tax was deducted at
source (TDS) by bank @ 10%.
Pass journal entries for issue and redemption of debentures along with interest on
investment.

Illustration – 2
On January 1, Rama Ltd., had 500 Debentures of Rs.100 each outstanding in its books
carrying interest at 6% per annum. DRR balance is standing in books at
12,500/-. In accordance with the powers in the deed, the directors acquired
debentures from the open market for immediate cancellation as follows:
March 1 Rs.5,000 at 98.00/- (cum interest)
Aug. 1 Rs. 10,000 at 100.25/- (cum interest)
Dec. 15 Rs. 2,500 at 98.50/- (ex-interest)
Debenture interest is payable half-yearly, on 30th June and 31st Dec.
Show ledger accounts of Debenture and Debenture interest for the first year, ignoring
income-tax.
Illustration – 3
The following balances appeared in the books of Paradise Ltd as on 1-4-20X1:

1. 12 % Debentures Rs. 7,50,000
2. Balance of DRR Rs. 1,00,000
3. DRR Investment 1,12,500 represented by 10% 1,125 Secured Bonds of the
Government of India of Rs. 100 each.
Annual contribution to the DRR was made on 31st March every year. On 31-3-20X2,
balance at bank was Rs. 7,50,000 before receipt of interest. The
investment was realised at par for redemption of debentures at a premium of 10% on
the above date.
You are required to prepare the following accounts for the year ended 31st March,
20X2:
1. Debentures Account
2. DRR Account
3. DRR Investment Account
4. Bank Account
Debenture Holders Account.

Illustration – 4
Sencom Limited issued Rs.1,50,000 5% Debentures on 30th September Year 0 on which

interest is payable half yearly on 31st March and 30th September. The Company has
power to purchase debentures in open market for cancellation thereof.
The following purchases were made during the year ended 31st December Year 2 and
the cancellation were made on the same date. On 31st December Year 1, balance in
the DRR of the Company was Rs.25,000 and investments made for the purpose of
redemption were Rs.20,000.
The purchase details are:
➢ 1st March Year 2 – Rs.25,000 nominal value purchased for Rs.24,725 ex-interest.
➢ 1st September Year 2– Rs.20,000 nominal value purchased for Rs.20,125 cum-
interest.
You are required to draw up the following accounts up to the date of cancellation:
(i) Debentures Account and

(ii) Own Debenture (Investment) Account.
Ignore Taxation.
Illustration – 5
The following balances appeared in the books of Paradise Ltd as on 1-4-20X1:

1. 12 % Debentures Rs. 7,50,000
2. Balance of DRR Rs. 1,00,000
3. DRR Investment 1,12,500 represented by 10% 1,125 Secured Bonds of the
Government of India of Rs. 100 each.
Annual contribution to the DRR was made on 31st March every year. On 31-3-20X2,
balance at bank was Rs. 7,50,000 before receipt of interest. The
investment was realised at par for redemption of debentures at a premium of 10% on
the above date.
You are required to prepare the following accounts for the year ended 31st March,
20X2:
1. Debentures Account
2. DRR Account
3. DRR Investment Account
4. Bank Account
Debenture Holders Account.

Illustration – 6
The Summarized Balance Sheet of BEE Co. Ltd. as on 31st March, 20X1 is as under:
Liabilities Amount (Rs.) Assets Amount (Rs.)

Share Capital: Freehold property 1,15,000
Authorized:
30,000 Equity Shares 3,00,000
of Rs. 10 each
Stock 1,35,000
Trade receivables 75,000
Issued and Cash 30,000
Subscribed:
20,000 Equity Shares 2,00,000
of Rs. 10 each
fully paid
Balance at Bank 2,00,000
Profit and Loss 1,20,000

Account
12% Debentures 1,20,000
Trade payables 1,15,000 ________
5,55,000 5,55,000
At the Annual General Meeting, it was resolved:
1. To give existing shareholders the option to purchase one Rs. 10 shares at Rs. 15
for every four shares (held prior to the bonus distribution), this option being taken
up by all shareholders.
2. To issue one bonus share for every five shares held.
3. To repay the debentures at a premium of 3%.
Give the necessary journal entries and the company’s Balance Sheet after these
transactions are completed.
Illustration – 7
The summarised Balance Sheet of Convertible Limited, as on 30th June, 20X1, stood
as follows:
Liabilities:
Share Capital: 5,00,000 equity shares of 50,00,000
Rs. 10 each fully paid
Profit And loss A/c 10,00,000
Debenture Redemption Reserve 25,00,000

13.5% Convertible Debentures, 1,00,00,000
1,00,000 Debentures of Rs. 100 each
Other loans 65,00,000
Current Liabilities and Provisions 1,25,00,000
4,50,00,000
st
The Debentures are due for redemption on 1 July, 20X1. The terms of issue of
debentures provided that they were redeemable at a premium of 5% and conferred
option to the debenture holders to convert 20% of their holdings into equity shares at
a predetermined price of Rs.15.75 per share and the payment in cash.
Assuming that:
1. except for 100 debenture holders holding totally 25,000 debentures, the rest of
them exercised the option for maximum conversion.
2. the investments were realised at par on sale; and
3. all the transactions are put through, without any lag, on 1st July, 20X1.
Redraft the balance sheet of the company as on 1st July, 20X1 after giving effect to
the redemption. Show your calculations in respect of the number of equity shares to
be allotted and the necessary cash payment.

1.9 Underwriting of Shares and Debentures
Underwriting is a contract containing agreed terms Underwriting contract

wherein
one party undertakes to subscribe to shares / Underwriter

debentures
Company (making a public

being issued by the other party offer)
for a special consideration Underwriting commission
where shares / debentures are not subscribed to by Trigger point i.e. under
the public (whether fully or partially) subscription

D.

TYPES OF UNDERWRITING CONTRACTS
Normal Firm
Underwriting Underwriting
Whole / Part Firm Firm

Whole Issue is Part issue is issue is commitment is commitment is
underwritten underwritten underwritten over & above part of overall
by one person by one person by two or underwriting underwriting
more persons liability liability
Single Multiple
Credit of underwriter underwriters
marked
Credit of applications
marked
is given
applications is
(unmarked
not given are
(unmarked are distributed in
distributed in ratio of gross Credit of firm Credit of firm
ratio of gross liability less commitment is commitment is
liability) marked not given to given to
applications) underwriters underwriters

Illustrations
Illustration – 1
A company issued 1,50,000 shares of Rs.10 each at a premium of Rs.10.
The entire issue was underwritten as follows:
X - 90,000 shares (firm underwriting 12,000 shares)
Y - 37,500 shares (firm underwriting 4500 shares)
Z - 22,500 shares (firm underwriting 15,000 shares)
Total subscription received by the company (excluding firm underwriting and marked
applications) were 22,500 shares
The marked application (excluding firm underwriting ) were as follows :
X – 15,000 shares
Y – 30,000 shares
Z – 75000 shares
Commission payable to underwriters is at 5% of the issue price.
The underwriting contract provides that credit for unmarked applications be given to
the underwriters in proportion to the shares underwritten and benefit of the firm
underwriting is to be given to individual underwriters.
I. Determine the liability of each underwriter (number of shares);
II. Compute the amounts payable or due from underwriters; and
Pass journal entries in the books of the company relating to underwriting.
Illustration 2
A joint stock company resolved to issue 10 lakh equity shares of Rs.10 each at a premium
of Rs1 per share. One lakh of these shares were taken up by the directors of the
company, their relatives, associates and friends, the entire amount being received
forthwith. The remaining shares were offered to the public, the entire amount being
asked for with applications.
The issue was underwritten by X, Y and Z for a commission @2% of the issue price, 65%
of the issue was underwritten by X, while Y’s and Z’s shares were 25% and 10%
respectively.
Their firm underwriting was as follows :
X 30,000 shares,
Y 20,000 shares and
Z 10,000 shares.
The underwriters were to submit unmarked applications for shares underwritten firm
with full application money along with members of the general public.
Marked applications were as follows:
X 1,19,500 shares,
Y 57,500 shares and

Z 10,500 shares.
Unmarked applications totaled 7,00,000 shares. Accounts with the underwriters were
promptly settled.
You are required to:
i. Prepare a statement calculating underwriters’ liability for shares other than

shares underwritten firm
ii. Pass journal entries for all the transactions including cash transactions.
Illustration 3
Newton Limited incorporated on 1st January, 20X1 issued a prospectus inviting

applications for 20,000 equity shares of ₹ 10 each. The whole issue was fully
underwritten by A, B and C as follows:
A B C
10,000 shares 6,000 shares 4,000 shares
Applications were received for 16,000 shares, of which marked applications were
as follows:
A B C
8,000 shares 2,850 shares 4,150 shares
You are required to find out the liabilities of individual underwriters.

Illustration 4
Gemini Ltd. came up with public issue of 30,00,000 Equity shares of ₹10 each at ₹
15 per share. A, B and C took underwriting of the issue in 3 : 2 : 1 ratio.
Applications were received for 27,00,000 shares. The marked applications were
received as under:
A B C
8,00,000 shares 7,00,000 shares 6,00,000 shares
Commission payable to underwriters is at 5% on the face value of shares.
i. Compute the liability of each underwriter as regards the number of shares

to be taken up.
ii. Pass journal entries in the books of Gemini Ltd. to record the transactions
relating to underwriters.
Illustration 5
Rosy Ltd. made a public issue of 4,00,000 equity shares of ₹10 each, ₹ 2 payable on
application. The entire issue was underwritten by five underwriters as follows: A: 25%,
B: 25%, C: 25%, D: 10% and E: 15%. Under the underwriting terms, a commission of 2%
was payable on the amount underwritten. Further, the underwriter was at liberty to
apply, during the tenure of public issue, for any number of shares in which case he was
entitled to a brokerage equal to 0.5% of the par value of shares so applied for.
Applications received were to be analysed on the basis of rubber stamp of the

underwriter, who was to be given credit for the number of applications received
bearing his rubber stamp. Applications received which did not bear any rubber stamp
were considered as “direct applications” to be credited to all the underwriters in the
ratio of their respective underwriting commitment. If, any such credit being given a
“surplus” was to result in respect of any underwriter, as compared to his commitment,

such surplus was to be distributed amongst the remaining underwriters in the ratio of
their respective underwriting commitments.
As a result of the issue the following applications were received:
Bearing rubber stamp of A 1,02,000 shares
Bearing rubber stamp of B 95,000 shares
Bearing rubber stamp of C 60,000 shares
Bearing rubber stamp of D 32,000 shares
Bearing rubber stamp of E 51,000 shares
Not bearing any stamp 10,000 shares
Total 3,50,000 shares
Included in the number of applications mentioned against D in the above table was
an application made by D himself for 10,000 shares. The underwriters were
informed of the amounts due to or from them, the amounts were duly received or
paid.
Show, with the aid of necessary workings, the entries to record the amount so
received or paid.

Illustration 6
Libra Ltd. came up with an issue of 20,00,000 equity shares of ₹10 each at par.
5,00,000 shares were issued to the promoters and the balance offered to the public.
The issue was underwritten by three underwriters Anand, Vijay and Ashok - equally
with firm underwriting of 50,000 shares each. The total subscription received
were12,97,000 shares including the marked forms which were :
Anand Vijay Ashok
4,25,000 4,50,000 3,50,000
The underwriters had applied for the number of shares covered by firm
underwriting. The amounts payable on application and allotment were ₹2.50 and ₹
2.00 respectively. The agreed commission was 5%.
Pass summary journal entries for —
1. allotment of shares to the underwriters;

2. commission due to each of them; and
3. net cash paid and or received.
Note: Unmarked applications are to be credited to underwriters equally.

Benefit of firm underwriting is given to individual underwriter.

Study Note – 2 | Preparation of Financial Statements
(As per Schedule III)
2.1 Introduction
FINAL ACCOUNTS
 Section 129 of the Companies Act, 2013 - At the AGM(Annual General Meeting) of a
company, the Board of Directors of the company should lay financial statements before
the company
Financial Statements
As per Section 2(40) of the
Companies Act, 2013
Profit and loss Any

account, OR explanatory
A statement note annexed
Income and Cash flow of changes in
Balance statement to, or forming
sheet expenditure equity, if part of, any
account applicable document
(in the case of a referred
company carrying herein
on any activity not
for profit)
The financial statement, with respect to One Person Company, Small company and
Dormant company, does not include the cash flow statement.
 Objective of financial statements - It should give a true and fair view of the state of
affairs of the company as at the end of the financial year.
 Points to be kept in mind while preparing final accounts
➢ Requirements of Schedule III to the Companies Act
➢ Other statutory requirements;
➢ Accounting Standards notified by Ministry of Corporate Affairs (MCA)(AS 1 to AS
29);
➢ Statements and Guidance Notes issued by the Institute of Chartered Accountants
of India (ICAI); which are necessary for understanding the accounting treatment/
valuation/ disclosure suggested by the ICAI
 Section 133 of the Companies Act - It is mandatory to comply with accounting

standards notified by the Central Government from time to time.
Format of financial statements
Prescribed under the Act governing Balance Sheet as per Form set
such class of company out in Part I of Schedule III and
In case of Statement of Profit and Loss as
per Part II of Schedule III of
Companies Act 2013
Any any other

Insurance company class of
Banking
company engaged in company
company In case of all
generation for which
or supply of a Form is other
electricity prescribed companies
2.2 Balance Sheet
PART-I – FORM OF BALANCE SHEET

Name of the Company: .............................................................
Balance Sheet as at: .............................................................
Sr.No. Particulars Note Figure as Figures as

no. at the
at the
end of end of
Current

reporting the
Period Previous
Reporting
Period
I Equity and Liabilities
1 Shareholders’ Funds
(a) Share Capital

(b) Reserves & Surplus
(c) Money received against Share
Warrants
2 Share application money pending
allotment
3 Non-Current liabilities
(a) Long-term Borrowings
(b) DTL (Net)
(c) Other long-term liabilities
(d) Long-term Provisions

4 Current liabilities
(a) Short-term Borrowings
(b) Trade Payables
(c) Other Current liabilities
(d) Short-term Provisions
TOTAL
II Assets
1 Non-Current assets
(a) PPE (property, plant & Equipment)
(i) Tangible assets

(ii) Intangible assets
(iii) Capital WIP
(iv) Intangible assets under development
(b) Non-Current investments
(c) Deferred tax assets (DTA) (Net)
(d) Long-term loans & advances
(e) Other Non-Current assets
2 Current assets
(a) Current investments
(b) Inventories
(c) Trade receivables
(d) Cash & Cash equivalents
(e) Short-term loans & advances
(f) Other Current assets
TOTAL
DISCLOSURE REQUIREMENTS IN RESPECT OF BALANCE SHEET
The disclosure requirements and the points to be kept in mind with regard to each of the
above items is as follows:
1. SHARE CAPITAL
(a) Authorized Capital – to be shown separately

➢ It is the maximum number and face/par value, of each class of shares that a
corporate entity may issue in accordance with its instrument of incorporation.
➢ Face/Par Value, as per Capital Clause in Memorandum of association should be
disclosed.
➢ Separate disclosure for both Equity and Preference Shares.

(b) Number of Shares issued, Subscribed and Fully Paid, and Subscribed but not Fully
Paid
➢ Subscribed Share Capital” is “that portion of the issued Share Capital which has
actually been subscribed by the public and subsequently allotted to the
shareholders by the entity. This also includes any Bonus shares issued to the
Shareholders.
➢ “Paid-up Share Capital” is “that part of the Subscribed Share Capital for which
consideration is cash or otherwise has been received. This also includes Bonus
Shares allotted and Shares issued otherwise than for cash against purchase
consideration, by the corporate entity.”
➢ If Shares are not fully called, then disclose the called up value per share.
➢ Separate disclosure for both Equity and Preference Shares, which should again be
sub-classified and represented for each class of Shares.
(c )Rights, Preferences and restrictions attaching to shares including restrictions on

the distribution of dividends and the repayment of Capital
➢ All such Rights, Preferences and Restrictions attached to each class of Shares,
terms of redemption, etc., should be disclosed separately.
➢ Further, Preference Shares can be cumulative, non-cumulative, redeemable,
convertible, non-convertible, etc
(d) Disclose number of Shares held by the entire chain of Subsidiaries and associates
starting from the Holding Company and ending right up to the ultimate Holding
Company.
➢ All such disclosures should be made separately representing for each class of
Shares, (for both equity and Preference Shares).
(e) List of Shareholders holding more than 5% shares as on the Balance Sheet date
➢ If during the year, any Shareholder held more than 5% equity Shares but does not
hold as much at the Balance Sheet date, disclosure is not required.
➢ Companies should disclose the Shareholding for each class of Shares, both within
equity and Preference Shares. So, such% should be computed separately for each
class of Shares.
➢ This information should also be given for comparative previous period.

(g) Shares reserved for issue under Options and Contracts/ commitments for the sale
of Shares/ disinvestment, including the terms and amounts
➢ Shares under Options generally arise under Promoters or Collaboration

agreements, loan agreements or debenture deeds (including Convertible
debentures), agreement to convert Preference Shares into equity Shares, ESOPs
or Contracts for supply of Capital Goods, etc.
➢ Disclosure is required for the Number of Shares, amounts and Other terms for
Shares so reserved.
➢ Such options are in respect of unissued Portion of Share Capital
(h) For the period of 5 years immediately preceding the date as at which the
Balance Sheet is prepared-
• Aggregate Number & Class of Shares allotted as Fully Paid and up Pursuant to
Contract(s) without payment being received in Cash
• Aggregate No. and Class of Shares allotted as fully Paid up by way of Bonus Shares
• Aggregate Number & Class of Shares bought back
➢ Disclose only if such event has occurred during a period of 5 years immediately
preceding the Current year Balance Sheet date
➢ If the company is in operation for a period of less than 5 years, then disclosure
should cover all such earlier financial years
➢ The following allotments are considered as Shares allotted for payment being
received in cash, and hence should not be disclosed under this Clause –
(a) If the subscription amount is adjusted against a bonafide debt payable in
money at once by the Company,
(b)Conversion of loan into Shares in the event of default in repayment
(i) Terms of any Securities Convertible into Equity / Preference Shares issued along
with the earliest date of conversion in descending order starting from the farthest
such date.
➢ In case of Compulsorily Convertible Securities, where conversion is done in fixed

tranches, all the dates of conversion have to be considered.
➢ In case of Convertible Debentures/Bonds, etc., for the purpose of simplification,
reference may also be made to the terms disclosed under the note on long term
Borrowings where these are required to be classified in the Balance Sheet, rather
than disclosing the same against under this Clause.
(j) Calls Unpaid (showing aggregate value of Calls Unpaid by Directors and Officers)
➢ Unpaid amount towards Shares subscribed by the Subscribers of Memorandum of

association should be considered as ‘Subscribed and paid-up Capital’ in the
Balance Sheet and the debts due from the Subscribers should be appropriately
disclosed as an asset in the B/Sheet.
(l) Forfeited Shares (amount originally paid up)
2. RESERVES & SURPLUS
Reserves & Surplus shall be classified as –
(a) Capital reserves
(b) Capital redemption reserve
(c) Securities Premium
(d) Debenture redemption reserve
(e) Revaluation reserve
(f) Share Options Outstanding account
(g) Other reserves
(h) Surplus, i.e., balance in Statement of P&L disclosing allocations & appropriations,
such as, dividend, Bonus Shares and transfer to/from reserves, etc.
➢ Additions & deductions since last Balance Sheet to be shown under each of
specified heads.
➢ Appropriations to the Profit for the year (including carried forward balance) is to
be presented under the main head ‘Reserves and Surplus’.
➢ Under Sch III, the Statement of P&L will no longer reflect any appropriations, like
Dividends transferred to reserves, Bonus Shares, etc.
➢ A Reserve specifically represented by Earmarked Investments shall be termed as a
‘Fund’.
➢ Debit Balance Statement of P&L shall be shown as a Negative Figure under the
head ‘Surplus’. Similarly, the balance of ‘reserves & Surplus’, after adjusting
Negative balance of Surplus, if any, shall be shown under the head ‘Reserves &
Surplus’ even if the resulting figure is in the negative.
➢ Capital Reserve - It is a Reserve of a Corporate enterprise which is not available
for distribution as dividend.
Profit on Re-issue of Forfeited Shares is basically profit of a Capital Nature and,
hence, it should be credited to Capital reserve.
➢ Capital redemption reserve (CRR) is required to be created u/s 55 and 68 (for

redemption of Preference Share Capital and buyback of Equity Share Capital),
subject to conditions specified in the respective Sections.
➢ Debenture Redemption Reserve (DRR) is required to be created u/s 71, and
maintained until such debentures are redeemed. On redemption of the
debentures, the amounts no longer necessary to be retained in this account should
be transferred to the General reserve.
➢ Revaluation reserve is a reserve created on the revaluation of assets or Net assets
of an enterprise represented by the surplus of the estimated Replacement Cost
or estimated market values over the Book Values thereof.
➢ As per ICAI Guidance Note on ESOP, Share Options Outstanding should be shown
as separate line item. Under Schedule III, this line item should be shown separately
under reserves & Surplus.
➢ Other reserves - This includes any other Statutory reserves, e.g. tonnage tax
reserve to be created under the income tax act, 1961.
3. MONEY RECEIVED AGAINST SHARE WARRANTS
This is to be shown as a separate line item on the face of Balance Sheet. Since Shares are
yet to be allotted against the same, these are not reflected as a part of Share Capital,
but as a separate line-item.
4. SHARE APPLICATION MONEY PENDING ALLOTMENT
➢ Share application Money not exceeding the issued capital and to the extent not
refundable is to be disclosed as a separate line item after “Share Holders Funds”
and before “Non-Current Liabilities”.
➢ If the Company’s issued Capital is more than the authorized Capital, and
approval of increase in authorized Capital is pending, the amount of Share
application Money received over and above the authorized Capital should be
shown under the head “Other Current Liabilities”.
➢ The amount shown as ‘Share application Money Pending allotment’ will not
include Share application Money to the extent refundable, for example, the
amount in excess of issued Capital, or where Minimum Subscription requirement
is not met. Such amount will have to be shown separately under ‘Other Current
liabilities.
➢ Calls Paid in Advance are to be shown under “Other Current liabilities”. the
amount of interest which may accrue on such advance should also is to be
reflected as a liability.

5. NON-CURRENT LIABILITIES
(A) LONG-TERM BORROWINGS
Long-Term Borrowings shall be classified as –
a) Bonds/debentures,
b) Terms Loans – (i) from Banks, and (ii) from Other Parties,
c) Deferred Payment liabilities,
d) Deposits,
e) Loans & advances from related Parties,
f) Long-term Maturities of Finance lease Obligations,
g) Other loans & advances (specify nature)
1. Definitions and Meanings:
➢ Loans with repayment period beyond 36 months are usually known as “Term
Loans”. So, Cash Credit, Overdraft and Call Money accounts/ deposits are not
covered by the expression “Term Loans”.
➢ Deferred Payment liabilities would include any liability for which payment is to
be made on deferred credit terms, e.g., Deferred Sales tax liability, Deferred
Payment for Acquisition of fixed Assets, etc.
➢ Deposits classified under Borrowings would include deposits accepted from Public
and inter-Corporate deposits which are in the nature of Borrowings.
➢ Loans and advances from related parties are required to be disclosed. advances
under this head should include those advances which are in the nature of loans.
2. Security-wise Classification:
➢ Borrowings shall further be sub-classified as Secured and Unsecured. Nature of

Security shall be specified separately in each case.
➢ However, where one security is given for multiple loans, the same may be clubbed
together for disclosure purposes with adequate details of cross referencing.
➢ Disclosure about the nature of security should also cover the type of asset given
as security, e.g., Inventories, Plant and Machinery, land and Building, etc.
➢ When Promoters, other Shareholders or any third party have given any personal
security for any borrowing, e.g., Shares or Other assets held by them, disclosure
should be made thereof, though such security does not result in the classification

of such borrowing as secured.
3. Guarantees:
➢ Where loans have been guaranteed by directors or Others, the aggregate amount
of such
loans under each head shall be disclosed.
➢ Others” would mean any Person or entity other than a director, e.g., related
Parties, or any person associated with the Company in some manner.
4. Maturity Date wise:
➢ Bonds / debentures (along with rate of interest & particulars of redemption or

Conversion, as the case may be) shall be stated in descending order of maturity or
conversion, starting from farthest redemption or Conversion date, as the case may
be.
➢ Current Maturities of all Long-Term Borrowings will be disclosed under “Other
Current Liabilities” and not under long-term Borrowings and Short-term
Borrowings.
➢ So, it is possible that the same Bonds/Debentures/ Term Loans may be bifurcated
under both “Long-term Borrowings” as well as under “Other Current liabilities”.
5. Installment redemption:
➢ Where Bonds/ debentures are redeemable by installments, the date of Maturity

for the purpose must be reckoned as the date on which the First installment
becomes due.
6. Power to reissue:
➢ Particulars of any redeemed Bonds/debentures which the Company has power to

reissue shall be disclosed.
7. Terms of repayment:
➢ Repayment of term loans and Other loans shall be stated.

➢ Disclosure of terms of repayment should be made preferably for each loan unless
the repayment terms of individual loans within a category are similar, in which
case, they may be aggregated.
8. Continuing Default:
➢ Period and amount of continuing default as on the Balance Sheet date in

repayment of loans and interest, shall be specified separately in each case.
➢ The term “Continuing Default” is used w.r.t. Long Term Borrowings, whereas the
term “Default” is used w.r.t. Short-term borrowings.
➢ Under CARO, the Auditor shall report on the default made and the period of
default.
➢ Defaults other than in respect of repayment of loan and interest, e.g., non-
compliance with debt Covenants, etc., need not be disclosed.
➢ Any default that had occurred during the year and was subsequently made good
before the end of the year need not be disclosed.
(B) DEFERRED TAX LIABILITIES
➢ To be shown as a separate line item on the face of Balance Sheet.
(C) OTHER LONG-TERM LIABILITIES
It shall be classified as –
(a) Trade Payables

(b) Others
➢ Sundry Creditors for Goods or Services, and acceptances should be disclosed as

part of trade Payables.
➢ Disclosure requirements under Micro, Small & Medium enterprises development
(MSMED) act will also be required to be made in the annual Financial Statements.
➢ Amounts due under contractual obligations, e.g., payables in respect of statutory
obligations, like contribution to Provident Fund, Purchase of Fixed assets,
Contractually reimbursable expenses, interest accrued on trade Payables, etc.,
should be classified as “Others” and each such item should be disclosed nature
wise.
(D) LONG-TERM PROVISIONS
(a) Provision for Employee Benefits
(b) Others (Specifying nature)
➢ This should be classified into short-term and long-term portions, and the latter
amount should be included here.

➢ “Others” would include items like Provisions for Warranties.
(6) CURRENT LIABILITIES
(A) SHORT-TERM BORROWINGS
Short-Term Borrowings shall be classified as –
(a) Loans Repayable on demand– (i) from Banks, & (ii)Other Parties,
(b) Loans and Advances from Related Parties,
(c) Deposits,
(d) Other Loans and Advances (specify nature)
1. Definition & meaning:
➢ Short-Term Borrowings will include all Loans within a period of 12 months from
the date of the loan, loans payable on demand, etc., but they will not include
Current Maturity of long-term Borrowings (which should be treated only as “Other
Current Liabilities”).
➢ In case of Short-Term Borrowings, all defaults (not continuing defaults as in the
case of long-term Borrowings) existing as at the date of the Balance Sheet should
be disclosed (item wise)
➢ A 3-Year Loan taken for a business with a 4-year Operating Cycle will be
categorized only as Short term Borrowings, and not as long-term Borrowings.
2. Security wise Classification:
➢ Borrowings shall further be sub-classified as Secured and Unsecured.

➢ Nature of security shall be specified separately in each case.
3. Guarantees:
➢ Where loans have been guaranteed by directors or others, the aggregate amount
of such loans under each head shall be disclosed.
4. Default:
➢ Period & amount of default as on B/Sheet date in repayment of loans and

interest shall be separately in each case.
(B) TRADE PAYABLES
(a) Total outstanding dues of micro enterprises and small enterprises; and

(b) Total outstanding dues of creditors other than micro enterprises and small
enterprises.”
➢ Liability for Capital goods Purchases: Amount due towards purchase disclosed
under “Other Current liabilities” with a suitable description.
➢ Liability under Contractual Obligations: Liability towards employees, leases or
other Contractual liabilities should not be included under trade Payables.
➢ Only “Commercial Dues” can be included under trade Payables.
The following details relating to Micro, Small and Medium enterprises shall be disclosed
in the notes:
(a) the principal amount and the interest due thereon (to be shown separately)
remaining unpaid to any supplier at the end of each accounting year;
(b) the amount of interest paid by the buyer along with the amount of the payment
made to the supplier beyond the appointed day during each accounting year;
(c) The amount of interest due and payable for the period of delay in making payment
(which have been paid but beyond the appointed day during the year) but without
adding the interest specified under the Micro, Small and Medium enterprises
development act, 2006;
(d) the amount of interest accrued and remaining unpaid at the end of each accounting
year; and
(e) the amount of further interest remaining due and payable even in the succeeding
years, until such date when the interest dues above are actually paid to the small
enterprise, for the purpose of disallowance of a deductible expenditure under Section
23 of the Micro, Small and Medium enterprises development act, 2006.
(C) OTHER CURRENT LIABILITIES
(a) Current maturities of long-term debt,
(b) Current Maturities of Finance lease Obligations,
(c) interest accrued but not due on Borrowings,

(d) interest accrued and due on Borrowings,
(e) income received in advance,
(f) unpaid dividends,
(g) application Money received for allotment of Securities and due for refund and
interest accrued thereon
(h) unpaid Matured deposits and interest accrued thereon,
(i) unpaid Matured debentures and interest accrued thereon,
(j) Other Payables (specify nature).
➢ The portion of Long-Term Debts/ Lease Obligations, which is due for payments
within 12 months of the reporting date is required to be classified under “Other
Current Liabilities”, while the balance amount should be classified under long-
term Borrowings.
➢ Trade Deposits and Security Deposits which are not in the nature of Borrowings
should be
classified separately under Other Non-Current/ Current liabilities.
➢ ‘Other Payables’ under this head may be in the nature of statutory dues such as
withholding taxes, Service tax, VAT, Excise duty, etc.
➢ Current/Non-current Classification of Assets / Liabilities is determined on a
particular date, i.e., Balance Sheet date. So, if there is any change in the
position at the end of the current year resulting in a different classification of
Assets / Liabilities in the current year, it will not impact the classification made
in the previous year.
(D) SHORT TERM PROVISIONS
(a) Provision for Employee Benefits
(b) Others (Specifying nature)
➢ This should be classified into short-term and long-term portions, and the former
amount should be included here.

➢ “Others” includes Provision for dividend, Provision for taxation, Provision for
Warranties, etc.
(1) NON-CURRENT ASSETS
(A) (I) TANGIBLE ASSETS
1. Classification shall be given as –
(a) Land, (b) Buildings, (c) Plant and equipment, (d) Furniture & Fixtures, (e) Vehicles,
(f) Office Equipment, (g) Others (Specify Nature).
➢ AS-19 excludes land leases from its scope. Leasehold land should be presented as
a separate assets class under Tangible Assets. Also, Freehold land should be
presented as a separate asset class.
➢ Assets under Lease shall be separately specified under each class of asset. The
term “under lease” should mean –
• Assets given on Operating lease in the case of lessor, and
• Assets held under Finance lease in the case of lessee.
➢ Leasehold Improvements should continue to be shown as a separate asset class.
➢ AS-10 requires disclosure of details such as Gross Book Value of Revalued Assets,
Method adopted to compute revalued amounts, Nature of indices used, year of
appraisal, involvement of external valuer, etc. as long as the concerned assets are
held by the Enterprise. [But only 5 years period is specified in Sch III. AS-10
requirements will prevail.]
➢ AS-26 does not permit revaluation of intangible assets.
➢ Since reconciliation of Gross and Net Carrying amounts of Fixed assets is required,
the depreciation/ Amounts of fixed assets is required, the Depreciation/
amortization for each class of asset should be disclosed in terms of –
• Opening Accumulated Depreciation,
• Depreciation/Amortization for the year,
• Deductions/Other Adjustments, and
• Closing Accumulated Depreciation/ Amortization
➢ Similar disclosures should also be made for impairment, if any, as applicable.
➢ Business Combinations: Business Combination should be taken as an
amalgamation or acquisition or any other mode of restructuring of a set of assets
and/or a group of assets and liabilities constituting a business.
➢ Acquisitions through ‘Business Combinations’ should be disclosed separately for
each class of assets.

➢ Asset Disposals through Demergers, etc., if any also be disclosed separately for
each class of assets.
➢ Other Adjustments: This includes –
• Capitalization of FOREX Differences where such option has been exercised
by the Company as per AS-11.
• Adjustments on a/c of Exchange Fluctuations for Fixed assets in case of
Non-integral Operations (AS11).
• Borrowing Costs capitalized as per AS-16.
(A) (II) INTANGIBLE ASSETS
Classification shall be given as –
(a) Goodwill, (b) Brands / Trademarks, (c) Computer Software, (d) Mastheads and
Publishing titles, (e) Mining rights, (f) Copyrights, and Patents and Other intellectual
Property rights, Services and Operating rights, (g) recipes, Formula, Models, designs and
Prototypes, (h) licenses and Franchise, (i) Others (specify nature).
➢ Intangible assets under development should also be disclosed separately, if aS-

26 criteria are met.
(A) (III) CAPITAL WORK IN PROGRESS
➢ To be shown as a separate line item on the face of Balance Sheet .

➢ Capital advances should be included under long term loans and advances and
hence, cannot be included under Capital WIP.
(A) (IV) INTANGIBLE ASSETS UNDER DEVELOPMENT
➢ Intangible assets under development should be disclosed under this head

provided they can be recognized based on the criteria laid down in AS-26.
(B) NON CURRENT INVESTMENTS
Non-Current Investments shall be classified as Trade investments and Other

investments, and

further classified as Investments in –
(a) Property,
(b) Equity instruments,
(c) Preference Shares,
(d) Government / trust Securities,
(e) Debentures or Bonds,
(f) Mutual Funds,
(g) Partnership Firms, and
(h) Other Non-Current investments (specify nature).
➢ If a Debenture is to be redeemed partly within 12 months and balance again after

12 months, the amount to be redeemed within 12 months should be disclosed as
current, and balance as Non-Current.
➢ “Trade Investment” is normally understood as an investment made by a Company
in Shares or debentures of another Company, to promote the trade or business of
the first Company.
➢ Under each classification, details shall be given about
• The names of Bodies Corporate (indicating separately whether such bodies are
–
Subsidiaries, (ii) associates, (iii) Joint Ventures, or (iv) Controlled Special
Purpose entities) in whom investments have been made and
• The nature and
• Extent of the investment so made in each such Body Corporate (showing
separately investments which are partly-paid).
➢ “Nature and Extent” of Investment in each Body Corporate should be interpreted
to mean the number and face value of Share.
➢ Also, it is advisable to clearly disclose whether investments are fully paid or partly
paid. (itemwise)
➢ With regard to investments in the capital of Partnership Firms, the Names of the
Firms (with the names of all their Partners, total Capital and the Shares of each
Partner) shall be given.
➢ Investments in LLPs will be disclosed separately under “Other Investments”.
➢ In case of change in constitution of the Firm during the year, the names of the
other partners should be disclosed based on the position existing as on the date of
Company’s Balance sheet.

➢ Investments carried at other than at Cost should be separately stated specifying
the basis for valuation thereof.
➢ Basis could be (a) Cost, or (b) Cost less Provision for other than temporary
diminution, or
(c)Lower of Cost and Fair Value.
➢ The following shall also be disclosed- (a) aggregate amount of Quoted investments
and Market Value thereof, (b) Aggregate Amount of unquoted investments, (c)
aggregate Provision for diminution in value of investments.
(1) (C) DEFERRED TAX ASSET
To be shown as a separate line-item on the face of Balance Sheet.
(1) (D) LONG TERM LOANS AND ADVANCES
1. General Classification: Long-term loans and advances shall be classified as –
(a) Capital advances,
(b) Security deposits,
(c) Loans and advances to related Parties (giving details thereof),
(d) Other loans and advances (specify nature)
➢ Capital Advances are advances given for procurement of Fixed assets which are
Non-Current Assets. They are not realized back in cash, and over a period, get
converted into Fixed assets.
➢ Other loans and Advances should include all other items in the nature of
advances recoverable in cash or kind, e.g., Prepaid Expenses, Advance Tax,
CENVAT Credit receivable, VAT Credit receivable and Service tax Credit
receivable which are not expected to be realized within the next 12 months or
operating cycle whichever is longer, from the Balance Sheet date.
2. Security wise Classification: the above shall be separately sub-classified as –
(a) Secured, considered Good
(b) Unsecured, considered Good
(c) Doubtful.

3. Bad / Doubtful: allowance for Bad and doubtful loans and advances shall be disclosed
under the relevant heads separately.
4. Directors, etc.: loans and advances due by Directors or Other Officers of the
Company or any of
them either severally or jointly with any other persons or amounts due by Firms or
Private Companies respectively in which any director is a Partner in a director of a
Member should be separately stated.
(1) (E) OTHER NON-CURRENT ASSETS
1. General classification - Other Non-Current Assets shall be classified as
(a) long-term trade receivables (including trade receivables on deferred Credit terms)
(b) Others (specify nature)
➢ Dues in respect of Insurance Claims, Sale of Fixed assets, Contractually

reimbursable expenses, interest accrued on trade receivables, etc., should be
classified as “Others” and each such item should be disclosed according to their
nature.
2. Security wise Classification:
3. Bad / Doubtful:
4. Directors, etc.:
Same as above.
(2)CURRENT ASSETS
(2) (A) CURRENT INVESTMENTS
Current Investments shall be classified as –
(a) investments in equity instruments,
(b) investment in Preference Shares,
(c) investments in Government or trust Securities,
(d) investments in debentures or Bonds,

(e) investments in Mutual Funds,
(f) investments in Partnership Firms,
(g) Other investments (specify nature)
Principles given for Non-current investments will apply here also to the relevant.
However, trade vs Non-Trade Classification, is not required for Current investments.
(2) (B) INVENTORIES
Inventories shall be classified as –
(a) Raw materials,
(b) Work In Progress,
(c) Finished Goods,
(d) Stock-in-Trade (in respect of goods acquired for
trading),
(e) Stores and Spares,
(f) Loose tools,
(g) Others (specify nature)
➢ Goods in Transit should be included under relevant heads with suitable

disclosure.
➢ The heading “Finished Goods” should comprise all Finished Goods other than
those acquired for trading purposes.
➢ Those acquired for trading purposes are to be shown under “Stock in Trade”.
(2) (C) TRADE RECEIVABLES
1. Aggregate amount of trade receivables outstanding for a period exceeding 6 months

from the
date they are due for payment should be separately stated.

2. Security wise Details: trade receivables shall be separately sub classified as –
(a) Secured, considered Good
(b) Unsecured, considered Good
(c) Doubtful.
3. Bad /Doubtful: Allowance for Bad and doubtful loans and advances shall be disclosed
under the relevant heads separately.
4. Directors, etc: debts due by directors or Other Officers of the Company or any of
them either
severally or jointly with any other person or debts due by Firms or Private Companies,
respectively in which any director is a Partner, or a director, or a Member should be
separately stated.
➢ Where no due date is specifically agreed upon, normal credit period allowed by
the Company should be taken into consideration for computing the due date,
which may vary depending upon the Nature of Goods or Services sold and the
type of Customers, etc.
➢ Lean Period Activities: Receivables arising out of sale of materials / rendering of
services during a Company’s lean period, should be included under “Trade
Receivables”, if such activity is in the normal course of business. If they are not
part of “normal course of business”, they are to be classified under “Other
Assets”.
(2) (D) CASH AND CASH EQUIVALENTS
Cash and Cash Equivalents shall be classified as –
(a) Balances with Banks,
(b) Cheques, drafts on Hand,
(c) Cash on Hand,
(d) Other (Specify nature).
➢ Earmarked Balances with Banks (e.g. for Unpaid dividend) shall be separately
stated.
➢ Balances with Banks to the extent held as margin Money or Security against the
Borrowings, Guarantees, Other Commitments shall be disclosed separately.
➢ Repatriation restrictions, if any, in respect of Cash and Bank Balances shall be
separately stated.

➢ Bank Deposits with more than 12 months Maturity shall be disclosed separately.
(2) (E) SHORT TERM LOANS AND ADVANCES
1. General Classification: Short-Term Loans and Advances shall be classified as –
(a) loans and advances to related Parties (giving details thereof),
(b) Others (specify nature).
2. Securitywise Classification: The above shall also be subclassified as-
(a) Secured, considered Good,
(b) unsecured, considered Good,
(c) doubtful
3. Bad / doubtful: allowance for Bad and doubtful loans and advances shall be
disclosed under the relevant heads separately.
4. Directors, etc.: loans & advances due by directors or Other Officers of the Company
or any of them either severally or Jointly with any other person or amounts due by
Firms or Private Companies, respectively in which any director is a Partner or a director
or a Member shall be separately stated.
(2) (F) OTHER CURRENT ASSETS
➢ This is an all-inclusive heading, which incorporates Current Assets which do not

fit into any other Asset Categories.
➢ Nature of each item should be specified.
➢ In case any amount classified under this category is doubtful, it is advisable that
such doubtful amount as well as any provision made there against should be
separately disclosed. e.g., unbilled revenue, unamortized Premium on Forward
Contracts, etc.
Special note : Schedule III does not deal with any accounting treatment of special items (such as Share
issue expenses, ancillary borrowing Costs and discount or Premium relating to borrowings), and the
same continues to be governed by the respective AS / best practices. So, a Company can disclose the
Unamortized Portion of such expenses as “Unamortized Expenses”, under the head “Other Current/
Non Current assets”, depending on whether the amount will be amortized in the next 12 months or
thereafter.

2.3 Statement of Profit and Loss Account
PART II-FORM OF STATEMENT OF PROFIT AND LOSS
Name of the Company :…………………………………………………

Profit and loss Statement for the year ended:……………………………………….. (rs. in ……..)
Sr.No. Particulars Note Figures Figures

No. for the for the
Current Previous
reporting reporting
period
Period
I Revenue from Operations
II Other income
III Total revenue (I+II)
IV Expenses
Cost of Materials Consumed
Purchases of Stock-In-Trade
Changes in inventories of Finished Goods /
Work-in-progress and Stock-In-Trade
Employee Benefits Expense
Finance Costs
Depreciation and amortization expense
Other expenses
Total expenses
V Profit before Exceptional & Extraordinary
items and tax (III – IV)
VI Exceptional items

VII Profit before Extraordinary Items and Tax
(V-VI)
VIII Extraordinary items
IX Profit before Tax (VII-VIII)
X Tax expenses:
(1) Current tax
(2) deferred tax

XI Profit /(Loss) for the period from
Continuing
Operations (IX – X)
XII Profit /(Loss) from Discontinuing

Operations
XIII Tax expense of discontinuing Operations
XIV Profit /(Loss) from Discontinuing

Operations
(after tax) (XII-XIII)
XV Profit / (Loss) for the period (XI + XIV)
XVI earnings per equity Share:
(1) Basic
(2) Diluted
DISCLOSURE REQUIREMENTS IN RESPECT OF PROFIT AND LOSS

ACCOUNT
1. Section 25 Companies - The provisions of this part shall apply to the income
and expenditure account referred to in Sec. 129 of the act, in the same manner as
they apply to a Statement of Profit and Loss.

2. Revenue from Operations
For Company other than a Finance Company:
Revenue from Operations shall disclosed separately in the Notes, revenue from –
(a) Sale of Products
(b) Sale of Services
(c) Other Operating revenues
(d) less: excise duty
For Finance Company:
Revenue from Operations shall include revenue from:
(a) interest &
(b) Other Financial Services revenue under each of the above heads shall be
disclosed separately by way of Notes to accounts to the extent applicable.
3. Finance Costs
Finance Costs shall be classified as –
(a) Interest expenses,
(b) Other Borrowing Costs,
(c) Applicable Net Gain / loss on Foreign Currency transactions and translation.
4. Other Income
Other Income shall be classified as –
(a) Interest income (in case of a Company other than a Finance Company),
(b) Dividend income,
(c) Net Gain/loss on Sale of investments,

(d) Other Non-Operating income (Net of expenses directly attributable to such
income).
5. Additional Information:
(i) General breakup of income and expense
A Company shall disclose by way of Notes, additional information regarding

aggregate expenditure and income on the following items referred below.
a) Employee Benefits Expense [showed separately –

(i) Salaries & Wages, (ii) Contribution to PF and Other Funds, (iii)
Expense on ESOP and Employee Stock Purchase Plan (ESPP), (iv) Staff
Welfare expenses.
b) Depreciation and amortization expenses,
c) Any item of income of expenditure which exceeds 1% of revenue from
Operations or Rs. 1,00,000 whichever is higher,
d) Interest income,
e) Interest expense,
f) Dividend income,
g) Net Gain / loss on Sale of investments,
h) Adjustments to the Carrying amount of investments,
i) Net Gain / loss on Foreign Currency transaction & translation (other than
the cost considered as Finance Cost),
j) Payments to the auditor as – (a) auditor, (b) For taxation Matters, (c) For
Company law Matters, (d) For Management Services, (e) For other Services,
(f) For reimbursement of expenses,
k) Item of Exceptional and Extraordinary Nature,
l) Prior Period items.
(ii)Materials, goods, Services, etc.
a) In the case of Manufacturing Companies –

• Raw Materials under broad heads.
• Goods Purchased under broad heads.
b) In the case of trading Companies, Purchases in respect of goods traded in by

the Company under broad heads.
c) In the case of Companies rendering or supplying services, Gross income
derived from Services rendered or Supplied, are shown under broad heads.
d) In the case of Companies rendering or supplying services, Gross income
derived from Services rendered or Supplied, are shown under broad heads.
e) Broad heads shall be decided taking into account the concept of materiality
and presentation of true and fair view of Financial Statements.
(iii) Reserves – Creation & utilization:
(a) The aggregate, if material, of any amounts set aside or proposed to be set aside
to reserve, without including Provisions made to meet any Specific Liability,
Contingency or Commitment known to exist at the date as to which the Balance
Sheet is made up.
(b) The aggregate, if material, of any amounts withdrawn from such reserves.
(iv) Provision – Creation & utilization:
(a) The aggregate, if material, of the amounts set aside to Provisions made for
meeting Specific Liabilities, Contingencies or Commitments.
(b) the aggregate, if material, of the amounts withdrawn from such provisions, as
no longer required.
(v) expenses, etc: expenditure incurred on each of the following items,

separately for each item:
(a) Consumption of Stores and Spare Parts,
(b) Power and Fuel,
(c) Rent,
(d) Repairs of Buildings,
(e) Repairs of Machinery,
(f) Repairs of Machinery,

(g) Insurance,
(h) Rates and taxes, excluding taxes on income,
(i) Miscellaneous expenses.
(vi) Subsidiaries Information:
(a) Dividends from Subsidiary Companies.
(b) Provisions for losses of Subsidiary Companies.
(viii) FOREX Information:
The P&L a/c shall also contain by way of a Note the following information, namely
–
(a) Value of imports calculated on CIF basis by the Company during the Financial
year in respect of – (i) raw Materials, (ii) Components and Spare Parts, (iii) Capital
Goods,
(b) Expenditure in Foreign Currency during the Financial year on account of

royalty, Know-how, Professional and Consultation Fees, interest, and Other
Matters,
(c) Total Value if all imported raw Materials, Spare Parts and Components
consumed during the Financial year and the total Value of all indigenous raw
Materials, Spare Parts and Components similarly consumed and the Percentage of
each to the total Consumption,
(d) Amount remitted during the year in Foreign Currencies on account of

Dividends with a specific mention of the total number of Non-resident
Shareholders, the total Number of Shares held by them on which the dividends
were due and the year to which the dividends related.
(e) Earnings in Foreign Exchange classified under the following heads, namely-
Export of Goods calculated on FOB Basis, royalty, Know-How, Professional &

Consultation Fees, interest and dividend, Other income, indicating the nature
thereof

MANAGERIAL REMUNERATION
Managerial Remuneration
(calculated as a percentage of profit )
Governed by Sec 197 and Schedule V of the

Companies Act 2013
When profits are available In case of loss and inadequate profits
Limits mentioned in Sec 197 Limits specified under schedule V
SECTION 197
 Prescribes the overall maximum managerial remuneration payable and also

managerial remuneration in case of absence or inadequacy of profits.
 Total managerial remuneration payable

➢ by a public company,
➢ to its directors, including managing director and whole-time director, and its
manager
➢ in respect of any financial year
➢ should not exceed 11% of the net profits of that company,
➢ computed in the manner laid down in section 198
➢ except that the remuneration of the directors should not be deducted from the
gross profits.
 The company in general meeting may, authorise the payment of remuneration

exceeding 11% of the net profits of the company, subject to the provisions of Schedule
V.

MAXIMUM MANAGERIAL REMUNERATION –PAYABLE BY A PUBLIC
COMPANY IN CASE OF PROFITS
Overall for the year - 11% of Net profits
To Executive directors To Non-Executive

(ie. MD / WTD/ M)* Directors
In case of In case the In case

In case of 1 compnay Sitting fees
more than 1 there are no
already has a executive
MD/WTD/M Directors in
5% of Net 10% of Net the
profits company Max-1 lac
profits 1% of Net per board
(to all such meeting.
profits
directors Payable
togather) 3% of Net even in
profits case of loss
MD / WTD / M = Managing Director/ Whole time director/ Manager
Net profits is computed as specified in Sec 198
SEC 198 – COMPUTATION OF NET PROFIT FOR THE PURPOSE OF

COMPUTING MANAGERIAL REMUNERATION
1. THE FOLLOWING CREDIT SHOULD BE ADDED TO GROSS PROFIT
a) Subsidies or bounties received from any Government, or any public authority,

unless the Central Government otherwise directs
2. THE FOLLOWING CREDITS SHOULD NOT BE ADDED TO GROSS PROFIT
a) Profits, by way of premium on shares or debentures, which are issued or sold

by the company
b) Profits on sales by the company of forfeited shares
c) Profits of a capital nature including profits from the sale of the undertaking or
any of the undertakings of the company or of any part thereof
d) Profits from the sale of any immovable property or fixed assets of a capital
nature

Provided that where the amount for which any fixed asset is sold exceeds the
written-down value thereof, credit should be given for so much of the excess
as is not higher than the difference between the original cost of that fixed
asset and its written- down value.
Credit to P&L = [Sale price – WDV]-[Original cost – WDV]
e) Any change in carrying amount of an asset or of a liability recognised in equity
reserves including surplus in profit and loss account on measurement of the
asset or the liability at fair value.
3. THE FOLLOWING DEBITS SHOULD BE DEDUCTED FROM GROSS PROFIT
a) all the usual working charges

b) directors’ remuneration
c) bonus or commission paid or payable
d) any tax notified by the Central Government as being in the nature of a tax on
excess or abnormal profits
e) any tax on business profits imposed for special reasons or in special
circumstances and notified by the Central Government in this behalf
f) interest on debentures
g) interest on mortgages and loans and advances
h) interest on unsecured loans and advances
i) expenses on repairs, provided the repairs are not of a capital nature
j) outgoings inclusive of contributions made under section 181 of the Act
k) depreciation to the extent specified in section 123 of the Act
l) the excess of expenditure over income, which had arisen in computing the net
profits in accordance with this section in any year which begins at or after
the commencement of this Act, in so far as such excess has not been deducted
in any subsequent year preceding the year in respect of which the net profits
have to be ascertained
m) any compensation or damages to be paid in virtue of any legal liability
including a liability arising from a breach of contract
n) any sum paid by way of insurance against the risk of meeting any liability such
as is referred to in clause (m)
o) bad debts written off
4. THE FOLLOWING DEBITS SHOULD NOT BE DEDUCTED FROM GROSS PROFIT
a) Income-tax and super-tax payable under the Income-tax Act, 1961.

b) Any compensation, damages or payments made voluntarily, (other than those
mentioned above)

c) loss of a capital nature not including any excess of the written-down value of
any asset which is sold, discarded, demolished or destroyed over its sale
proceeds or its scrap value
d) any change in carrying amount of an asset or of a liability recognised in equity
reserves including surplus in profit and loss account on measurement of the
asset or the liability at fair value
SCHEDUE V - Part II
Remuneration payable to managerial person by companies having profits and also by
companies having no profits or inadequate profits
Section I
Remuneration Section II
payable by Remuneration payable by
companies having companies having no profit or
profits inadequate profit
Remuneration to a managerial
person or persons not
exceeding the limits specified Remuneration to the
in sec.197 managerial person is based
on effective capital (refer
the table below)

SECTION II - REMUNERATION PAYABLE BY COMPANIES HAVING NO
PROFIT OR INADEQUATE PROFIT
Maximum remuneration payable in case of loss

or inadequate profits
With ordinary With special

resolution in General resolution in General
meeting meeting
Normal limits (given

below) on the basis of No Limits
effective capital
NORMAL LIMIT BASED ON EFFECTIVE CAPITAL
Where the effective capital is Maximum payable per year per

director
Negative or less than 5 crores 60 lacs
5 crores and above but less than 100 Crores 84 lacs
100 crores and above but less than 250 Crores 120 lacs
250 crores and above 120 lakhs plus 0.01% of the

effective capital in excess of Rs.
250 crores.

EFFECTIVE CAPITAL
Aggregate of the paid-up share capital (excluding share application xxx

money or advances against shares)
(+) Securities premium account xxx
(+) Free reserves (excluding revaluation reserve) xxx
(+) Long- term loans, debentures and deposits repayable after one year xxx
(excluding working capital loans, over drafts, interest due on loans
unless funded, bank guarantee, etc., and other short- term
arrangements)
Total xxx
(-)aggregate of any investments (except in case of investment by an (xxx)

investment company whose principal business is acquisition of shares,
stock, debentures or other securities)
(-)preliminary expenses not written off (xxx)
(-) accumulated losses (xxx)
Effective capital xxx
Note –
1. Where the appointment is for a period less than 1 year then limits should be pro-
rated.
2. Where the appointment of the managerial person is made in the year in which
company has been incorporated, the effective capital should be calculated as on the
date of such appointment
3. In any other case the effective capital should be calculated as on the last date of the
financial year preceding the financial year in which the appointment of the
managerial person is made.
4. For the purposes of this Schedule, “negative effective capital” means the effective
capital which is calculated in accordance with the provisions contained above is less

than zero
CONDITIONS SUBJECT TO WHICH THE LIMITS APPLY
 Payment of remuneration is approved by a Board resolution passed and, in the

case of a company covered under Section 178(1) also by the Nomination and
Remuneration Committee.
 The company has not committed any default in repayment of any of its debts
(including public deposits) or debentures or interest payable thereon for a
continuous period of 30 days in the preceding financial year before the date of
appointment of such managerial person and
 In case of a default, the company obtains prior approval from secured creditors for
the proposed remuneration and the fact of such prior approval having been
obtained is mentioned in the explanatory statement to the notice convening the
general meeting
 An ordinary resolution or a special resolution, as the case may be, has been passed
at the general meeting of the company for a period not exceeding 3 years.
 A statement along with a notice calling the general meeting referred to in the
above clause is given to the shareholders containing the following information,
namely:-
I. General Information:
(1) Nature of industry
(2) Date or expected date of commencement of commercial production.
(3) In case of new companies, expected date of commencement of activities as
per project approved by financial institutions appearing in the prospectus
(4) Financial performance based on given indicators
(5) Foreign investments or collaborations, if any.
II. Information about the appointee:
(1) Background details
(2) Past remuneration
(3) Recognition or awards
(4) Job profile and his suitability
(5) Remuneration proposed
(6) Comparative remuneration profile with respect to industry, size of the
company, profile of the position and person (in case of expatriates the
relevant details would be with respect to the country of his origin)
(7) Pecuniary relationship directly or indirectly with the company, or
relationship

with the managerial personnel, if any.
III. Other information:
(1) Reasons of loss or inadequate profits
(2) Steps taken or proposed to be taken for improvement
(3) Expected increase in productivity and profits in measurable terms.
IV. Disclosures:
The following disclosures should be mentioned in the Board of Director’s report under
the heading “Corporate Governance”, if any, attached to the financial statement:-
(1) all elements of remuneration package such as salary, benefits, bonuses, stock
options, pension, etc., of all the directors;
(2) details of fixed component and performance linked incentives along with the
performance criteria;
(3) service contracts, notice period, severance fees;
(4) stock option details, if any, and whether the same has been issued at a
discount as well as the period over which accrued and over which exercisable.
PERQUISITES NOT INCLUDED IN MANAGERIAL REMUNERATION
1. A managerial person should be eligible for the following perquisites which should
not be included in the computation of the ceiling on remuneration specified in
Section II and Section III:-
(a) contribution to provident fund, superannuation fund or annuity fund to the
extent these either singly or put together are not taxable under the Income-
tax Act, 1961;
(b) gratuity payable at a rate not exceeding half a month’s salary for each
completed year of service; and
(c) encashment of leave at the end of the tenure.
2. In addition to the perquisites specified in paragraph 1 of this section, an
expatriate managerial person (including a non-resident Indian) should be eligible
to the following perquisites which should not be included in the computation of
the ceiling on remuneration specified in Section II or Section III-
(a) Children’s education allowance: In case of children studying in or outside
India, an allowance limited to a maximum of Rs. 12,000 per month per child
or actual expenses incurred, whichever is less. Such allowance is admissible
up to a maximum of two children.
(b) Holiday passage for children studying outside India or family* staying abroad:
Return holiday passage once in a year by economy class or once in two years
by first class to children and to the members ‘of the family* from the place
oftheir study or stay abroad to India if they are not residing in India, with

the managerial person.
(c) Leave travel concession: Return passage for self and family in accordance
with the rules specified by the company where it is proposed that the leave
be spent in home country instead of anywhere in India.
*For the purposes of this Schedule, “family” means the spouse, dependent children
and dependent parents of the managerial person
DIVISIBLE PROFIT
 A dividend is a distribution of divisible profit of a company among the members

according to the number of shares held by each of them in the capital of the
company and the rights attaching thereto.
 Such a distribution may or may not entail a release of assets; it would be where a
distribution involves payment of cash.d
 Bonus shares cannot be issued in lieu of dividends.
 Capital cannot be returned to the shareholders by way of dividend.
 A company who has committed any default in compliance with the provisions of
sec- 73 and 74 relating to the acceptance and repayment of deposits would be
barred to declare dividend.
 Dividend should be declared or paid only from free reserves.
 Dividend shall be payable by way of
(i) cash (ii) cheque (iii) warrant or (iv) in any electronic mode
 It shall be payable to the registered shareholder of such share or to his order or to
his banker
A company may, before the declaration of any dividend in any financial year,
transfer such percentage of its profits for that financial year, as it may consider
appropriate to the reserves of the company.
Appropriation of a part of profit can be done in the following cases
1. When required under a law - For example, under the Banking Regulation Act
2. When required under any contract – For example where the company has
undertaken, at the time of raising of loan, that before any part of its profit is
distributed, a specified percentage of the profit every year should be credited to
a reserve for the repayment of the loan and until the time for repayment arrives,
the amount should remain invested in a specified manner
 A company may if so authorised by its Article, pay a dividend in proportion to the
amount paid on each share in case of partly paid shares.
 Calls paid in advance do not rank for payment of dividend.
 Dividend on preference shares
➢Holders of preference shares are entitled to receive a dividend at a fixed rate
before any dividend is declared on equity shares.
➢But such a right can be exercised subject to there being profits and the Directors
recommending payment of the dividend.
 As per Section 2 (35) of the Companies Act, 2013, term “Dividend” includes interim
dividend also.
Final dividend Interim dividend
Declared at the AGM Declared between 2 AGMs
Paid after the finalization of accounts Paid before the finalization of accounts.
of the year
Dividend is recommended by BOD but This dividend is declared by BOD.

approved by shareholders in AGM.
(share holders can reduce the rate of

dividend but they cannot increase it)
Once it is declared it becomes the This can be revoked with the consent of
liability of the company and it must pay the shareholders
the amount.
 Sec 123 (3) - In case the company has incurred loss during the current financial year
up to the end of the quarter immediately preceding the date of declaration of
interim dividend, such interim dividend should not be declared at a rate higher than
the average dividends declared by the company during the immediately preceding
three financial years.

Dividends can be declared out of
[sec 123(1)]
Out of Out of both Out of the

Out of current moneys
year profits accumulated current
profits year and provided by the
accumulate Central
d profits Government or
any State
Government
Condition - provide for
Condition - current year as well as
provide for arrears of depreciation
depreciation of past years in Condition -
as per the accordance with the Provide for in pursuance
provisions of provisions of sec 123(2) depreciation of any
section guarantee
123(2) + given by that
Fulfilment of the government
conditions as per
Companies (Declaration
and Payment of
Dividend) Rules, 2014
 Sec 123(2) - Depreciation must be to the extent specified in Schedule II to the

Companies Act, 2013.
➢ When the assets are sold, discarded, demolished or destroyed in any financial
year, the excess of the written down value over its sale proceeds as scrap, if
any should be written off in the same financial year.
 Conditions as per Companies (Declaration and Payment of Dividend) Rules,
2014
(1) The rate of dividend declared should not exceed the average of the rates at
which dividend was declared by it in the three years immediately preceding that
year: However this condition shall not apply to a company, which has not
declared any dividend in each of the three preceding financial year.
(2) The total amount to be drawn from such accumulated profits should not exceed
one-tenth of the sum of its paid-up share capital and free reserves as appearing
in the latest audited financial statement.

(3) The amount so drawn should first be utilised to set off the losses incurred in
the financial year in which dividend is declared before any dividend in respect
of equity shares is declared.
(4) The balance of reserves after such withdrawal should not fall below 15% of its
paid up share capital as appearing in the latest audited financial statement.
(5) No company should declare dividend unless carried over previous losses and
depreciation not provided in previous year, are set off against profit of the
company of the current year. The loss or depreciation, whichever is less, in
previous years is set off against the profit of the company for the year for which
dividend is declared or paid.
 Sec 124 - Payment of dividend
(1) Deposit in separate bank - The amount of the dividend, including interim dividend,
should be deposited in a scheduled bank in a separate account within 5 days from
the date of declaration of such dividend.
(2) Mandatory payment - The dividend declared should be paid to the share holder
within 30 days from the date of declaration.
(3) Transfer to unpaid dividend account - Where any dividend has not been paid or
claimed within thirty days from the date of the declaration to any shareholder the
company should, within 7 days from the date of expiry of the said period of 30
days, transfer the total amount of dividend which remains unpaid or unclaimed to
a special account to be opened by the company in that behalf in any scheduled
bank to be called the Unpaid Dividend Account.
(4) Statement to be placed on website - The company should, within a period of 90
days of making any transfer to the Unpaid Dividend Account, prepare a statement
containing the names, their last known addresses and the unpaid dividend to be
paid to each person and place it on the website of the company, if any, and also
on any other website approved by the Central Government for this purpose, in such
form, manner and other particulars as may be prescribed.
(5) Interest of 12% in case of default - If any default is made in transferring any
amount to the Unpaid Dividend Account, the company should pay, from the date
of such default, interest on such amount, at the rate of 12% per annum.
(6) Claim to company - Any person claiming to be entitled to any money transferred
to the Unpaid Dividend Account of the company may apply to the company for
payment of the money claimed.
(7) Transfer to Investor education and protection fund - Any money transferred to
the Unpaid Dividend Account of a company which remains unpaid or unclaimed
for a period of 7 years from the date of such transfer should be transferred by the
company along with interest accrued, if any, thereon to the Fund “Investor

Education and Protection Fund” established section 125.
(8) Statement of such transfer - The company should send a statement in the
prescribed form of the details of such transfer to the authority which administers
the said Fund and that authority should issue a receipt to the company as evidence
of such transfer.
(9) Transfer of Share - All shares in respect of which unpaid or unclaimed dividend
has been transferred to “Investor Education and Protection Fund” should also be
transferred by the company in the name of Investor Education and Protection Fund
along with a statement containing such details as may be prescribed:
Provided that any claimant of shares transferred above should be entitled to claim
the transfer of shares from Investor Education and Protection Fund in accordance
with such procedure and on submission of such documents as may be prescribed.
(10) Punishment for failure to distribute dividend - If a company fails to comply with
any of the requirements of this section,
Liability for Fine

Company not be less than 5,00,000 but which may extend to
Rs.25,00,000
Every officer of the not be less than Rs.1,00,000 but which may extend to
company who is in default Rs.5,00,000.
ACCOUNTING FOR TAXES
 AS 22 Accounting for Taxes on Income prescribes the accounting treatment of taxes

on income and follows the concept of matching expenses against revenue for the
period.
 The concept of matching is more peculiar in cases of income taxes since in a number
of cases, the taxable income may be significantly different from the income
reported in the financial statements due to the difference in treatment of certain
items under taxation laws and the way it is reflected in accounts.
 Accounting for taxes on income should be in accordance with AS 22, irrespective of
whether such taxes are imposed by an Indian law or by the law of a foreign country.
 The amount to be included in respect of income-tax in the profit and loss account
should be the current tax plus or minus the deferred tax. Current tax is the tax
determined in accordance with the provisions of the Income- tax Act, 1961.
Deferred tax is the tax effect of timing differences.

Difference between accounting and income and
the taxable income
Permanent differences Timing differences
1.These differences which originate in one 1.These differences originate in one period
period and do not reverse subsequently. and are capable of reversal in one or more
subsequent periods. (Although, 100%
2.They arise due to recognition of certainty of reversal is not there)
revenues/gains/expenses/loses in the
profit and loss account but not for income- 2.They arise only in respect of
tax computation or vice versa. incomes/expenses which are considered
both in the profit and loss account as well
3.No accounting adjustments are necessary as for computation of taxable income,
for tax effects of permanent differences. although, in different periods.
3.It may result in a deferred tax asset or a
deferred tax liability.
The tax effect of timing difference i.e. deferred tax should be treated in the
following manner:
The deferred tax should form part of the tax expenses in the profit and loss account;
and
It should be accounted as a deferred tax asset (DTA)/deferred tax liability (DTL) in
the balance sheet.
DTA or DTL is created in the following cases

When book profit > taxable profit Deferred tax liability is created
When book profit < taxable profit Deferred tax asset is created
DTA is recognized in a case where there are unabsorbed losses/deprecation under the
tax laws.
DTA should be recognized only to the extent there is virtual certainty supported by
convincing evidence that adequate future taxable income will be available against

which DTAs can be realised. Mere forecasts of performance would not satisfy this
criterion. virtual certainty has to be backed up by convincing evidence i.e. evidence
available at the reporting date in concrete form.
Journal entries
In the year in which timing difference originates – In case of DTA
DTA A/c Dr.
To Profit & loss A/c
Note : The amount to be debited and credited arrived at by multiplying the

timing difference with the tax rate applicable for the year
In case of DTL
To Deferred tax Liability A/c
In the subsequent year - This is the entry to be passed to account for the
difference between the opening and closing balance in the DTA a/c which
represents reversal of timing difference during the year
Profit and loss A/c Dr.
To DTA A/c
Note:
1. The carrying amount of DTAs has to be reviewed at each balance sheet date.
2. The carrying amount of a DTA has to be written down to the extent that it is
no longer reasonably certain or virtually certain, as the case may be, that
adequate future taxable income would be available to realize the DTA.
3. Reversal of a previous write-down may be done to the extent it becomes
reasonably certain or virtually certain, as the case may be, that adequate
future taxable income would be available.
4. If the recognition criteria is not met, the entire balance should be written off.

Illustrations
Illustration – 1
The following is the Trial Balance of Omega Limited as on 31.3.20X2:
(Figures in Rs.‘000)
Particulars Debit Particulars Credit

Rs. Rs.
Land at cost 220 Equity Capital (Shares of Rs. 300
10 each)
Plant & Machinery at 770 10% Debentures 200
cost
Trade Receivables 96 General Reserve 130
Inventories (31.3.X2) 86 Profit & Loss A/c 72
Bank 20 Securities Premium 40
Adjusted Purchases 320 Sales 700
Factory Expenses 60 Trade Payables 52
Administration 30 Provision for Depreciation 172
Expenses
Selling Expenses 30 Suspense Account 4
Debenture Interest 20
Interim Dividend 18
Paid
1670 1670
Additional Information:
i. The authorised share capital of the company is 40,000 shares of Rs. 10

each.
ii. The company on the advice of independent valuer wish to revalue the
land at Rs. 3,60,000.
iii. Declared final dividend @ 10%.
iv. Suspense account of Rs. 4,000 represents cash received for the sale of
some of the machinery on 1.4.20X1. The cost of the machinery was Rs.
10,000 and the accumulated depreciation thereon being Rs. 8,000.
v. Depreciation is to be provided on plant and machinery at 10% on cost.
You are required to prepare Omega Limited’s Balance Sheet as on 31.3.20X2 and
Statement of Profit and Loss with notes to accounts for the year ended 31.3.20X2
as per Schedule III. Ignore previous years’ figures & taxation.

Illustration – 2
You are required to prepare a Profit and Loss Account and Balance Sheet from the
following Trial Balance extracted from the books of the international Hotels Ltd.,
on 31st March, 20X2.
Particulars Debit Credit
Authorized Capital - divided into 5,000 15,00,000

6% Preference Shares of Rs.100 each
and 10,000 equity shares of Rs.100
each
Subscribed Capital –
5,000 6% Preference Shares of Rs.100 5,00,000
each 8,05,000
Equity Capital
Purchases – Wines, Cigarettes, Cigars 45,800
etc
- Foodstuffs 36,200
Wages and Salaries 28,300
Rent, Rates and Taxes 8,900
Laundry 750
Sales – Wines, Cigarettes, Cigars, etc. 68,400
- Food 57,600
Coal and Firewood 3,290
Carriage and Cooliage 810
Sundry Expenses 5,840
Advertising 8,360
Repairs 4,250
Rent of Rooms 48,000
Billiard 5,700
Miscellaneous Receipts 2,800
Discount received 3,300
Transfer fees 700
Freehold Land and Building 8,50,000
Furniture and Fittings 86,300
Stock on hand, 1st April, 2011:
Wines, Cigarettes, Cigars etc. 12,800
Foodstuffs 5,260
Cash in hand 2,200
Cash with Bankers 76,380
Preliminary and formation expenses 8,000

2,000 Debentures of Rs.100 each (6%) 2,00,000
Profit and Loss Account 41,500
Sundry Creditors 42,000
Sundry Debtors 19,260
Investments 2,72,300
Goodwill at cost 5,00,000
19,75,000 19,75,000
Wages and Salaries Outstanding 1,280

Stock on 31st March, 2012:
Wines Cigarettes and Cigars, etc. 22,500
Foodstuffs 16,400
➢ Depreciation : Furniture and Fittings @ 5% p.a.: Land & Buildings @ 2% p.a.

➢ The equity capital on 1st April 2011 stood at Rs.7,20,000 that is 6,000
shares fully paid and 2,000 shares Rs.60 paid.
➢ The directors made a call of Rs.40 per share on 1st October 20X1. A
shareholder could not pay the call on 100 shares and his shares were then
forfeited and reissued @ Rs.90 per share as fully paid.
➢ The directors propose a dividend of 8% on equity shares, transferring any
amount that may be required from General Reserve.
➢ Ignore Taxation
Illustration – 3
From the following particulars furnished by Pioneer Ltd., prepare the Balance
Sheet as at 31st March, 20X1 as required by Schedule III of the Companies Act.
Give notes at the foot of the Balance Sheet as may be found necessary –
Equity Capital (Face value of 10,00,000

Rs.100) Calls in Arrears 1,000
Land 2,00,000
Building 3,50,000
Plant and Machinery 5,25,000
Furniture 50,000
Loan from State Financial 1,50,000
Corporation
Inventory:

Finished Goods 2,00,000
Raw Materials 50,000 2,50,000
Provision for Taxation 68,000
Trade receivables 2,00,000
Advances 42,700
Dividend Payable 60,000
Profit and Loss Account 86,700
Cash Balance 30,000
Cash at Bank 2,47,000
Loans (Unsecured) 1,21,000
Trade payables (For Goods and 2,00,000
Expenses)
18,95,700 18,95,700
The following additional information is also provided:
• 2,000 equity shares were issued for consideration other than cash.
• Trade receivables of Rs.52,000 are due for more than six months.
• The cost of assets:
Building Rs.4,00,000
Plant and Machinery Rs.7,00,000
Furniture Rs.62,500
• The balance of Rs.1,50,000 in the loan account with State Finance

Corporation is inclusive of Rs.7,500 for interest accrued but not due. The
loan is secured by hypothecation of the Plant and Machinery.
• Balance at Bank includes Rs.2,000 with Perfect Bank Ltd., which is not a
Scheduled Bank.
• The company had contract for the erection of machinery at Rs.1,50,000
which is still incomplete.
Illustration – 4
Due to inadequacy of profits during the year ended 31st March, 20X2, XYZ Ltd.
proposes to declare 10% dividend out of general reserves. From the following
particulars, ascertain the amount that can be utilised from general reserves,
according to the Companies (Declaration of dividend out of Reserves) Rules, 2014:
(Rs.)
17,500 9% Preference shares of Rs. 100 each, fully paid up 17,50,000
8,00,000 Equity shares of Rs. 10 each, fully paid up 80,00,000
General Reserves as on 1.4.20X1 25,00,000
Capital Reserves as on 1.4.20X1 3,00,000
Revaluation Reserves as on 1.4.20X1 3,50,000
Net profit for the year ended 31st March, 20X2 3,00,000

Average rate of dividend during the last five year has been 12%.
Illustration 5
The following extract of Balance Sheet of X Ltd. was obtained:
Balance Sheet (Extract) as on 31st March, 20X1
Liabilities Rs.
Authorised capital:
20,000, 14% preference shares of Rs.100 20,00,000
2,00,000 Equity shares of Rs.100 each 2,00,00,000
2,20,00,000
Issued and subscribed capital:
15,000, 14% preference shares of Rs.100 each fully paid 15,00,000
1,20,000 Equity shares of Rs.100 each, Rs.80 paid-up 96,00,000
Share suspense account 20,00,000
Capital reserves (Rs. 1,50,000 is revaluation reserve) 1,95,000
Securities premium 50,000
Secured loans:
15% Debentures 65,00,000
Unsecured loans:
Public deposits 3,70,000
Cash credit loan from SBI (short term ) 4,65,000
Current Liabilities:
Trade Payables 3,45,000
Assets: Rs.
Investment in shares, debentures, etc. 75,00,000
Profit and Loss account (Debit balance) 15,25,000
Share suspense account represents application money received on shares, the

allotment of which is not yet made.
You are required to compute effective capital as per the provisions of Schedule V.
Would your answer differ if X Ltd. is an investment company?
Illustration – 6
The following is the Draft Profit & Loss A/c of Mudra Ltd., the year ended 31st
March, 20X1:
Rs. Rs.

To Administrative, 8,22,542 By Balance b/d 5,72,350
Selling and distribution
expenses
To Directors fees 1,34,780 By Balance from 40,25,365
Trading A/c
To Interest on 31,240 By Subsidies 2,73,925
debentures received from
Govt.
To Managerial 2,85,350
Remuneration
To Depreciation on 522,543
fixed Assets
To Provision for Tax 12,42,500
To General Reserve 4,00,000
To Investment 12,500
Revaluation Reserve
To Balance c/d 14,20,185
48,71,64 48,71,64
0 0
Depreciation on fixed assets as per Schedule II of the Companies Act, 2013

was Rs.5,75,345. You are required to calculate the maximum limits of the
managerial remuneration as per the Companies Act, 2013.

Study Note – 3 | Cash Flow Statement
3.1 Introduction
INTRODUCTION
 Cash flow Statement (CFS) is an additional information provided to the users of

accounts in the form of an statement, which reflects the various sources from where
cash was generated (inflow of cash) by an enterprise during the relevant accounting
year and how these inflows were utilized (outflow of cash) by the enterprise.
Any transaction, which does not result in cash flow, should not be reported.
E.g.: Conversion of Debt into Equity, Depreciation charges, Acquisition of asset by
issuing shares. Etc.
Movements within cash or cash equivalents are not cash flows.
 A break-up of opening and closing cash shown as a note to cash flow statement.
 Fundamental technique of cash flow preparation – It is difficult to compile a summary
of cash transactions from cashbooks due to the large volume of transactions. Thus, it
is possible to compile such a summary by comparing financial statements at the
beginning and at the end of accounting period.
APPLICABILITY

Applicability
Mandatory Not mandatory Exempted
In case of Corporate - In case of Corporate -

Non - SMCs Small Company -A private company
SMCs with a maximum paid up capital of
In case of non- In case of non- Rs. 50 lakhs and a maximum
corporate - Level I corporate - Level II and turnover of Rs. 2 crores.
entities Level III entities One Person Company (OPC) - A
company which has only one single
person as its member.
Dormant Company is an inactive
company which is formed for some
future projects or only to hold an
asset and has no significant
transactions.
TRANSITION PROVISION
For all other enterprises though it is not compulsory, but it is encouraged to prepare such
statements.
Where an enterprise was not covered by this statement during the previous year but
qualifies in the current accounting year, they are not supposed to disclose the figures for
the corresponding previous years. Whereas, if an enterprise qualifies under this statement
to prepare the cash flow statements during the previous year but now disqualified, will
continue to prepare cash flow statements for another two consecutive years.

Transition Provision
Previous Year – Exempted Previous Year – Exempted

Current Year – Mandatory Current Year – Mandatory
Mandate – Not required to show Mandate – Continue to prepare
corresponding Previous Year figures Cash Flow Statement for next two
consecutive years
OBJECTIVE
➢ To identify the historical changes in the flow of cash & cash equivalents.
➢ To determine the future requirement of cash & cash equivalents.
➢ To study the insolvency and liquidity position of an enterprise.
➢ As an indicator of amount, timing and certainty of future cash flows.
➢ To check the accuracy of past assessments of future cash flows
➢ In examining the relationship between profitability and net cash flow and the
impact of changing prices.
BENEFITS
➢ Identifies cash generated from trading operations.

➢ The operating cash surplus which can be applied for investment in fixed assets.
➢ Portion of cash from operations is used to pay dividend and tax and the other
portion is ploughed back.
➢ Very useful tool of planning

3.2 Meaning of Cash and Cash Equivalent
Cash in Hand and at bank
Demand deposits with banks and Financial Institutions
Short term investments - highly liquid– Subject to insignificant

risk of change in value.
Eg: T-bills, Commercial papers, marketable securities
Securities with short maturity period – Maturity within 3 months
3.3 TYPES OF CASH FLOW
Classification of cash flow activities
Operating cash flows Investing cash flows Financing cash flows
Generated by Operating Generated by Investing

activities. ie. the Generated by financing
activities. ie. Acquisition activities. ie. activities that
principal revenue- and disposal of long-term
producing activities . result in changes in the size
assets and other and composition of the
Eg. cash purchase and investments not included owners’ capital and
sale of goods, in cash equivalents. borrowings of the
collections from Eg. Receipts from enterprise. Eg. Issue of
customers ,payment to disposals of fixed assets; shares / debentures,
suppliers, payment of loan given to / recovered redemption of debentures /
salaries, wages etc. from other entities etc. preference shares etc.

Cash flow type depends on the business of the enterprise and other factors.
For example, since principal business of financial enterprises consists of borrowing, lending and
investing, loans given, and interests earned are operating cash flows for financial enterprises and
investing cash flows for other enterprises.
METHOD OF ACCOUNTING
Method of computing
Direct method Indirect method
Gross receipts and gross cash The net cash from operating activities
payments are obtained from the is determined by adjusting net profit
accounting records to ascertain or loss instead of individual items
cash flows from operating appearing in the profit and loss
activities account
1. The direct method provides information which may be useful in estimating future cash
flows and which is not available under the indirect method and is, therefore, considered
more appropriate than the indirect method.
2. Direct method adjusts individual items of profit and loss account and indirect method
adjusts overall net profit (or loss) to determine cash from operation.
3. However, indirect method of determining the cash from operating activities is more
popular in actual practice.
4. Cash flow from Financing activities and Investing activities are computed in the same
manner under both the methods.

Format for Cash Flow from Operating activities under Direct method
Particulars Amount Amount

Operating Activities:
Cash received from sale of goods xxx
Cash received from Trade receivables xxx
Cash received from sale of services xxx
xxx
Less: Payment for Cash Purchases xxx
Payment to Trade payables xxx
Payment for Operating Expenses xxx
e.g. power, rent,
electricity Payment for xxx
wages & salaries Payment xxx
for Income Tax
(xxx)
Xxx
Adjustment for Extraordinary Items xxx
Net Cash Flow from Operating Activities Xxx
Format for Cash Flow from Operating activities under Indirect method

Net Profit for the year Xxx
Add: Non-Cash and Non-Operating Expenses: xxx
Depreciation xxx
xxx
Loss on Sale of Assets
xxx
Provision for taxation, etc.
Less: Non-Cash and Non-Operating Incomes:
Profit on Sale of Assets xxx
Net Profit after Adjustment for Non-Cash Items (xxx)
Cash from operation
Net Profit (after adjustment for Non-cash Items) xxx
(-) Increase in Current Assets xxx
(-) Decrease in Current Liability xxx
(+) Decrease in Current Asset xxx
(+) Increase in Current Liabilities xxx
Cash flow from Operating activities

Xxx

CLASSIFICATION OF BUSINESS ACTIVITIES
OPERATING INVESTING FINANCING

ACTIVITIES ACTIVITIES ACTIVITIES
Cash inflows: Cash inflows: Cash inflows:

1.Cash sales 1. Proceeds from 1. Proceeds from
sale of fixed assets issue of shares /
2.Cash from fees,
2. Proceeds from debentures
commission and sale of non-current
other income 2. Loan raised (both
assets long term and short
3.Cash received 3. Interest received term)
from debtors on debentures 3.Increase in bank
4. Dividend overdraft or cash
received on shares credit
Cash outflow:
1. Cash purchases
Cash outflow: Cash outflow:
2.Cash paid for
operating expenses 1. Purchase of fixed 1.Payment for buy
like salaries, rent etc assets back of equity shares
3. Cash paid to 2. Purchase of non- 2.Redemption of
creditors current assets Preference
shares/Debentures
4. Payment of
Income tax 3.Repayment of loans
4.Payment of dividend
5. Payment of Interest
on loans
6. Payment of
preliminary expenses
7. Decrease in bank
overdraft or cash
credit

Note: Profit or loss on sale of fixed asset is not operating cash flow. The entire proceeds
of such transactions should be taken as cash inflow from investing activity.
Format for Cash Flow statement under Indirect method

A. Cash flow from operating activities
Net Profit for the year xxx Xxx
Add: Non-Cash and Non-Operating Expenses: xxx
Less: Non-Cash and Non-Operating Incomes: xxx
Operating profit before working capital changes xxx
Add: Decrease in current assets &
Increase in current liabilities xxx
Less: Increase in current assets &
Decrease in current liabilities xxx
Cash generated from operations
Less: Income tax paid (net of tax refund received) xxx
(xx)
Net cash from operating activities xxx
B. Cash flows from Investing activities

Cash inflows from investing activities (write each of xxx
them separately)
Less: Cash outflows from investing activities (write (xx)
each of them separately)
Net cash from Investing activities xxx
C. Cash flow from Financing activities

Cash inflows from investing activities (write each of xxx
them separately)
Less: Cash outflows from investing activities (write (xxx)
each of them separately)
Net Cash flow from Financing activities xxx
Net increase (or decrease) in cash and cash xxx

equivalents (A +B+C)
Add: Cash and cash equivalents in the beginning of xxx
the year
Cash and cash equivalents at the end of the year xxx
TREATMENT OF SPECIFIC ITEMS
Loans/Advances given, and Interests earned
Operating
Operating Cash CF
Flow
➢ In case of financial enterprises – when it is earned in the ordinary course of business.
➢ In case of non-financial enterprises - when Interest is earned from customers for late
payments
➢ In case of all enterprises – when,
• Advances given to employees and interests earned on them
• Advance payments to suppliers and interests earned on them
Investing Cash Flow

➢ In case of all enterprises - when given to subsidiaries and interests earned on them
➢ In case of non-financial enterprises – any transaction other than mentioned under operating
cash flow
Loans/Advances taken, and Interests paid
Operating Cash Flow

➢ In case of financial enterprises – when it is paid in the ordinary course of business.
➢ In case of non-financial enterprises - when advance is taken from customers and interest paid
on them
➢ In case of all enterprises – when,
• Interest paid to suppliers for late payment
• Interest taken as part of inventory cost as per AS 16
Financing Cash Flow

➢ In case of all enterprises – when taken from subsidiaries and interests paid on them
➢ In case of non-financial enterprises – any transaction other than mentioned under operating
cash flow
Extraordinary cash flows
➢ Separate disclosure by classifying them as cash flows from operating, investing or financing
activities, as may be appropriate.
➢ Insurance claims received against loss of stock or loss of profits are extraordinary operating
cash inflows.
➢ Insurance claims received against loss of fixed assets are extraordinary investing cash inflows.
Investments made and dividends earned
Operating Cash Flow

➢ In case of financial enterprises - when it is earned in the ordinary course of business
Investing Cash Flow

➢ In case of non-financial enterprises – Generally.
➢ In case of all enterprises - Investments in subsidiaries and dividends earned on them
 Income Tax
Operating Cash Flow

➢ Tax paid on operating income
➢ Tax deducted at source on operating income and operating expense
Investing Cash Flow
➢ Tax deducted at source on Investing income e.g. Interest income
Financing cash flow
➢ Tax deducted at source on Financing expenditure e.g. Interest paid.
 Interest and Dividends
Operating Cash Flow

➢ In case of financial enterprises - interest paid and interest and dividends received
Investing Cash Flow
➢ In case of non-financial enterprises - interest and dividends received
Financing cash flow
➢ In case of all enterprises – Dividends paid

Exchange gains and losses
➢ The foreign currency monetary assets (e.g. balance with bank, debtors etc.) and liabilities (e.g.
creditors) are initially recognised by translating them into reporting currency by the rate of
exchange on transaction date.
➢ On the balance sheet date, these are restated using the rate of exchange on the balance sheet
date.
➢ The difference in values is exchange gain/loss. The exchange gains and losses are recognised
in the statement of profit and loss.
➢ The change in cash or cash equivalents due to exchange gains and losses are however not
cash flows. This being so, the net increases/decreases in cash or cash equivalents in the cash
flow statements are stated exclusive of exchange gains and losses.
➢ The resultant difference between cash and cash equivalents as per the cash flow statement
and that recognised in the balance sheet is reconciled in the note on cash flow statement.
 Business Purchase
➢ The aggregate cash flows arising from acquisitions and disposals of subsidiaries or other
business units should be presented separately and classified as cash flow from investing
activities.
➢ The cash flows from disposal and acquisition should not be netted off.
➢ While taking the differences between closing and opening current assets and liabilities for
computation of operating cash flows, the closing balances should be reduced by the values of
current assets and liabilities taken over
Reporting Cash Flows on Net Basis
➢ Netting of receipts and payments from investing and financing activities is forbidden by AS3.
i.e. cash paid on purchase of fixed assets should not be shown net of cash realised from sale
of fixed assets.

➢ Exceptions to the above rule - For Financial enterprises
▪ Cash flows on acceptance and repayment of fixed deposits with a fixed maturity date
▪ Cash flows on placement and withdrawal deposits from other financial enterprises
▪ Cash flows on advances/loans given to customers and repayments received there from.
➢ Exceptions to the above rule - For Investment companies
▪ Cash receipts and payments for items in which the turnover is quick, the amounts are
large, and the maturities are short, e.g. purchase and sale of investments
▪ Cash receipts and payments on behalf of customers.
DISCLOSURES
➢ AS 3 requires an enterprise to disclose the amount of significant cash and cash

equivalent balances held by it but NOT available for its use, together with a
commentary by management. This may happen for example, in case of bank balances
held in other countries subject to such exchange control or other regulations that the
fund is practically of no use.
➢ AS 3 encourages disclosure of additional information, relevant for understanding the
financial position and liquidity of the enterprise together with a commentary by
management. Such information may include:
▪ The amount of undrawn borrowing facilities that may be available for future
operating activities indicating any restrictions on the use of these facilities; and
▪ The aggregate amount of cash flows required for maintaining operating capacity,
e.g. additional machinery purchased to increase production.
➢ An enterprise should disclose, in aggregate, in respect of both acquisition and
disposal of subsidiaries or other business units during the period each of the
following:
▪ The total purchase or disposal consideration; and
▪ The portion of the purchase or disposal consideration discharged by means of
cash and cash equivalents.

Illustrations
Illustration 1
Following are the extracts of Balance Sheet of Ajay Ltd.:
Liabilities 31.3.20X1 31.3.20X2 Assets 31.3.20X1 31.3.20X2

(Rs.) (Rs.) (Rs.) (Rs.)
Share Capital 5,00,000 5,00,000 Goodwill 1,15,000 90,000
15% Debentures 5,00,000 7,50,000
Unpaid Interest -- 5,000 Discount on 90,000 1,15,000
issue of
Debentures
Profit & Loss A/c 50,000 90,000
You are required to present the cashflow from financing activity, if Discount on issue
of Debentures amounting to Rs. 10,000 has been written off during the year.
Illustration 2
The following summary cash account has been extracted from the company’s
accounting records:
Particulars Amount (Rs. Amount

‘000) (Rs. ‘000)
Balance at 1.3.20X1 35
Receipts from customers 2,783
Issue of shares 300
Sale of fixed assets 128
3,246
Payments to suppliers 2,047
Payments for fixed assets 230
Payments for overheads 115
Wages and salaries 69
Taxation 243
Dividends 80
Repayments of bank loan 250 (3,034)
Balance at 31.3.20X2 212
Prepare Cash Flow Statement of this company Hills Ltd. for the year ended 31st
March, 20X2 in accordance with AS-3 (Revised).

The company does not have any cash equivalents.
Illustration 3
Given below is the Statement of Profit and Loss of ABC Ltd. and the relevant Balance
Sheet information:
Statement of Profit and Loss of ABC Ltd. for the year ended 31st December 2013
Particulars Rs.in lakhs
Revenue
Sales 4150
Interest and dividend 100
Stock adjustment 20
Total Revenue(A) 4270
Expenditure
Purchases 2400
Wages and salaries 800
Other expenses 200
Interest 60
Depreciation 100
Total Expenditure (B) 3560
Profit before tax(A-B) 710
Tax Provision (200)
Profit after tax 510
Balance of Profit and Loss account brought 50
forward
Profit available for distribution 560
Appropriations:
Transfer to general reserve 200
Proposed dividend 300
Dividend Distribution Tax 30
Total Appropriations 530
Balance 30
Relevant Balance Sheet Information:

Particulars Closing Balance Opening Balance
Rs. in lakhs Rs. in lakhs
Trade receivables 400 250
Inventories 200 180
Trade payables 250 230
Outstanding Wages 50 40
Outstanding expenses 20 10
Advance Tax 195 180

Tax Provision-Assessed tax 200 180
liability
Compute cash flow from operating activities using

1. Direct method and
2. Indirect method
Illustration 4
Prepare Cash Flow Statement of M/s MNT Ltd. for the year ended 31st March, Year 1
with the help of the following information:
1. Company sold goods for cash only

2. Gross Profit Ratio was 30% for the year, gross profit amounts to Rs.3,82,500.
3. Opening inventory was less than closing inventory by Rs.35,000
4. Wages paid during the year Rs.4,92,500
5. Office & selling expenses paid during the year Rs.75,000
6. Dividend paid during the year Rs. 30,000 (including dividend distribution tax)
7. Bank loan repaid during the year Rs.2,15,000 (including interest Rs.15,000)
8. Trade payables on 31st March, Year 0 exceed the balance on 31st March Year 1
by Rs.25,000
9. Amount paid to trade payables during the year Rs.4,60,000
10. Tax paid during the year amounts to Rs.65,000 (Provision for taxation as on
31st March of Year 1 Rs.45,000)
11. Investments of Rs.7,00,000 sold during the year at a profit of Rs.20,000
12. Depreciation on fixed assets amounts to Rs.85,000
13. Plant and Machinery purchased on 15th November of Year 0 for Rs.2,50,000
14. Cash and Cash equivalents on 31st March of Year 0 - Rs.2,00,000
15. Cash and Cash equivalents on 31st March of Year 1 – Rs.6,07,500
Illustration 5
Prepare Cash flow for Gamma Ltd., for the year ending 31.3.2014 from the following
information:
(1) Sales for the year amounted to Rs.135 crores out of which 60% was cash sales.
(2) Purchases for the year amounted to Rs. 55 crores out of which credit purchase
was 80%.
(3) Administrative and selling expenses amounted to Rs.18 crores and salary paid
amounted to Rs. 22 crores.
(4) The Company redeemed debentures of Rs. 20 crores at a premium of 10%.
Debenture holders were issued equity shares of Rs. 15 crores towards redemption and
the balance was paid in cash. Debenture interest paid during the year was Rs1.5
crores.

(5) Dividend paid during the year amounted to Rs. 11.7 crores (including Dividend
distribution tax) was also paid.
(6) Investment costing Rs.12 crores were sold at a profit of Rs. 2.4 crores.
(7) Rs. 8 crores were paid towards income tax during the year.
(8) A new plant costing Rs. 21 crores were purchased in part exchange of an old
plant. The book value of the old plant was Rs.12 crores but the vendor took over the
old plant at a value of Rs.10 crores only. The balance was paid in cash to the vendor.
(9) The following balances are also provided:
Rs. in crores Rs. in crores
1.4.X0 31.3.X1
Debtors 45 50
Creditors 21 23
Bank 6 -
Illustration 6
From the following Balance Sheets of Mr. Zen, prepare a Cash flow statement as per
AS-3 for the year ended 31.3.20X1:
Balance Sheets of Mr. Zen
Liabilities 1.4.20X0 1.4.20X1
Zen’s Capital A/c 10,00,000 12,24,000
Trade payables 3,20,000 3,52,000
Mrs. Zen’s loan 2,00,000 --
Loan from Bank 3,20,000 4,00,000
18,40,000 19,76,000
Assets 1.4.20X0 1.4.20X1
Land 6,00,000 4,80,000
Plant and Machinery 6,40,000 8,80,000
Inventories 2,80,000 2,00,000
Trade receivables 2,40,000 4,00,000
Cash 80,000 56,000
18,40,000 19,76,000
Additional information:
A machine costing Rs.80,000/- (accumulated depreciation there on 24,000/-) was sold
for 40,000/-. The provision for depreciation on 1.4.20X0 was 2,00,000/- and
31.3.20X1 was 3,20,000/- The net profit for the year ended on 31.3.20X1 was
3,60,000/-.
Illustration 7
Ms. Jyoti of Star Oils Limited has collected the following information for the
preparation of cash flow statement for the year ended 31st March, 20X1:
(Rs. In lakhs)

Net Profit 25,000
Dividend (including dividend tax) paid 8,535
Provision for Income tax 5,000
Income tax paid during the year 4,248
Loss on sale of assets (net) 40
Book value of the assets sold 185
Depreciation charged to Profit & Loss Account 20,000
Profit on sale of Investments 100
Carrying amount of Investment sold 27,765
Interest income on investments 2,506
Interest expenses of the year 10,000
Interest paid during the year 10,520
Increase in Working Capital (excluding Cash & Bank Balance) 56,081
Purchase of fixed assets 14,560
Investment in joint venture 3,850
Expenditure on construction work in progress 34,740
Proceeds from calls in arrear 2
Receipt of grant for capital projects 12
Proceeds from long-term borrowings 25,980
Proceeds from short-term borrowings 20,575
Opening cash and Bank balance 5,003
Closing cash and Bank balance 6,988
Prepare the Cash Flow Statement for the year 20X1 in accordance with AS 3.
Illustration 8
The following data were provided by the accounting records of Ryan Ltd. at year-end,
March 31, 20X1:
Income Statement
(Rs.) (Rs.) `
Sales 6,98,000
Cost of Goods Sold (5,20,000)
Gross Margin 1,78,000
Operating Expenses
(including Depreciation Expense of Rs.37,000/-) (1,47,000)
31,000
Other Income / (Expenses)
Interest Expense paid (23,000)
Interest Income received 6,000
Gain on Sale of Investments 12,000
Loss on Sale of Plant (3,000)
(8,000)

23,000
Income tax (7,000)
16,000
Comparative Balance Sheets

31st March 20X1 31st March 20X0
Assets
Plant Assets 7,15,000 5,05,000
Less: Accumulated Depreciation (1,03,000) (68,000)
6,12,000 4,37,000
Investments (Long term) 1,15,000 1,27,000
Current Assets:
Inventory 1,44,000 1,10,000
Accounts receivable 47,000 55,000
Cash 46,000 15,000
Prepaid expenses 1,000 5,000
9,65,000 7,49,000
Liabilities
Share Capital 4,65,000 3,15,000
Reserves and surplus 1,40,000 1,32,000
Bonds 2,95,000 2,45,000
Current liabilities:
Accounts payable 50,000 43,000
Accrued liabilities 12,000 9,000
Income taxes payable 3,000 5,000
9,65,000 7,49,000
Analysis of selected accounts and transactions during 20X0-X1
1. Purchased investments for Rs.78,000/-.

2. Sold investments for Rs.1,02,000/-. These investments cost Rs.90,000/-.
3. Purchased plant assets for Rs.1,20,000/-.
4. Sold plant assets that cost Rs.10,000/- with accumulated depreciation of Rs.
2,000/- for Rs.5,000/-.
5. Issued Rs.1,00,000/- of bonds at face value in an exchange for plant assets on
31st March, 20X1.
6. Repaid Rs.50,000/- of bonds at face value at maturity.
7. Issued 15,000 shares of Rs. 10/- each.
8. Paid cash dividends Rs. 8,000/-.
Prepare Cash Flow Statement as per AS-3 (Revised), using indirect method.

Study Note – 4 | Accounting of Banking, Electricity and
Insurance Company
4.1 Accounts of Banking Company
Meaning
A Bank is a commercial institution which accepts, collects, transfers, lends and

exchange money both domestically and internationally and there by circulates and
manages money throughout the economy. In India banks and their activities are
governed by the Banking Regulation Act, 1949.
According to section 5 of the Banking Regulation Act, 1949 a banking company means
any company which transacts in
➢ Accepting deposits of money from public for the purpose of lending or investing
➢ These deposits are repayable on demand or otherwise, and can be withdrawn by
cheque, draft or otherwise.
Types of Bank
Following is the broad categories of banks in India
Sceduled
Commercial
Banks
Development
Nationalised Regional Rural Foreign Banks Private Sector
Banks Eg:
Banks Eg: SBI, Banks (Gramin Eg: Citi, HSBC, Banks Eg:
NABARD, EXIM
BOI etc. Bank) Yes etc. HDFC, AXIS etc.
etc.

Sceduled Co-
operative Banks
Scheduled State Scheduled Urban

Co-operative Co-operative
Banks Banks
Some of the
Functions of main functions
Commercial Bankof commercial banks are:
A) Accepting Deposits:- The most imp function of commercial bank is to accept

deposits for the public. Ex Fixed deposit, saving deposit, Current deposit.
B) Granting of Loans and Advances:- The public deposits are used by
commercial banks for the purpose of granting loans to individuals and
businesses. Commercial banks grant loans in the form of overdraft, cash
credit and discounting bills of exchange.
C) Agency Functions:- Bank functions in the form of agent and represents their
customers for the following:-
i) For collecting cheques, drafts, bills of exchange. Banks also collects
dividends, pension, interests on investments etc. on behalf of their
customers.
ii) Banks arrange to send money from one place to another by the way of
demand drafts, telegraphic transfers, travellers’ cheques, etc.
iii) Making payments of various obligations on behalf of their customers.
D) Other Functions:
i) Issuing Letter of Credit, Guarantees.
ii) Buying, Selling and dealing in Foreign Exchange.
iii) Safe custody of securities and valuables.
iv)
Statutory Provisions of Banking Regulation Act 1949

Capital and Reserve
Requirements as to minimum paid up capital and reserve (Section 11)
Cases Paid up capital and reserve

A) When Incorporated outside India :-
i) Having place of business in Mumbai i) Rs 20 lacs or more
or Kolkata or both.
ii) In other cities except Mumbai or ii) Rs 15 lacs or more
Kolkata.
All such companies are required to deposit

with Reserve bank either in cash or in the
form of unencumbered approved securities,
the minimum amount of paid up capital and
reserve
B) When Incorporated In India :-

i) Having place of business in more i) Rs 10 lacs or more.
than one state and it has a place or
places of business in Mumbai or
Kolkata or both. ii) Rs 5 lacs or more
ii) Having place of business in more
than one state but not in Mumbai or iii) Rs 1 lakh in respect of all its
Kolkata principal places of business plus Rs
iii) Having all its place of business in one 10,000 for its other places of
state and none of which is situated business situated in the same
in the Mumbai or Kolkata. district in which it has its principal
place of business plus Rs 25000 in
respect of each place of business
elsewhere in the state.
iv) Rs 5 lacs plus Rs 25,000 in respect
iv) Having all is places of business in one of place of business outside Mumbai
state and one or more of which is or Kolkata.
situated in city of Mumbai or
Kolkata.
Rs 50,000/-
C) When the banking company has only

one place of business and it is not Mumbai
or Kolkata.
Regulation relating to authorized capital subscribed capital and paid up capital.

(Section 12) - No banking company can carry on business in India unless it satisfies the
following conditions:-

1) Its subscribed capital shall not be less than half of its authorised capital and the
paid up capital shall not be less than half of its subscribed capital.
2) Its capital consists of ordinary shares only or ordinary or equity shares and such
preference shares as may have been issued prior to 1st April 1944
3) The voting right of any share holder cannot exceed 10% of the total voting rights.
Restriction on commission, brokerage, discount on sale of shares (Section 13)

No banking company shall pay out
- directly or indirectly,
- by way of Commission , brokerage, discount or remuneration,
- in respect of any shares issued by it,
- Any amount exceeding 2.5% of the paid up value of such shares.
-
Restriction as to payment of Dividend

No banking company shall pay any dividend on its shares until all its capitalised expenses
including the following have been completely written off
- Preliminary Expenses
- Organisation Expenses
- Share Selling Commission
- Brokerage
- Amount of losses Incurred by tangible assets
Reserve Funds
Every banking company incorporated in India shall create a Reserve Fund and transfer
to it at least 25% of its annual profit before declaration of any dividend
Cash Reserve Ratio (CRR)
All the commercial banks have to maintain a certain minimum amount of deposit with
Reserve Bank of India, at all the times for smoothly meeting cash payments
requirements. This is called Cash Reserve Ratio (CRR).
The current Cash Reserve Ratio Rate is 4%
Statutory Liquidity Ratio (SLR)
Every bank in India has to maintain at the close of business every day a minimum portion
of their net demand and time liabilities as liquid assets in the form of cash, gold and

un-encumbered approved securities. The ratio of such liquid assets to demand and time
liabilities is known as Statutory Liquidity Ratio (SLR).
Bank accounts from which you can withdraw your money at any time are called
“Demand Liabilities” for bank. For Example: Savings Account, Current Deposits etc.
Bank accounts from which you can withdraw your money only after certain period of
time are called “Time Liabilities” for bank. For Example: Fixed Deposits, Recurring
Deposits etc.
In simple words, Statutory Liquidity Ratio is percentage of total deposits that banks
have to invest in government bonds and other approved securities.
The assets that are maintained as SLR Assets are as below:
➢ Cash
➢ Gold
➢ SLR Securities:
o Dated Securities of Government of India
o Treasury Bills of Government of India
o State Development Loans of State Governments
➢ Deposits & Securities maintained with RBI (by a banking company incorporated
outside India) under the Banking Regulation Act 1949
➢ Surplus balance maintained with RBI under the RBI Act 1934
➢ Current Account net balances in other commercial banks
Current SLR rate is 19.5% p.a.
For example, when total deposit in a bank is Rs. 100 Cr, and the current SLR rate is
19.5% and CRR is 4%, the bank will have to invest Rs. 19.5 Cr in SLR assets as mentioned
above and maintain Rs. 4 Cr Cash Reserve with RBI
CRR
RBI
Rs 4.0 Cr
Government
Deposits SLR
Rs 100 Cr Rs 19.5 Cr Securities
Balance
Rs 76.5 Cr

In the above pictorial representation, the bank has Rs.76.5 Cr at its disposal for lending
and investment purpose.
Restrictions of Loans and Advances
No Banking Company shall:
➢ Grant any loans or advances on the security of its own shares

➢ Grant any loans or advances to or on behalf of:
o Any of its Directors
o Any firm in which any of its Directors is interested as partner employee,
manager or guarantor.
o Any individual in respect of whom any of its Directors is a partner or
guarantor.
Accounting System
A bank has a large number of customers whose accounts are to be maintained in such a
way so that these should be kept up to date and can be checked regularly. Therefore
it is very important that banks should have a proper system of book keeping.
The main characteristics of a bank’s system of book keeping are as follows:-
➢ Voucher posting -Entries in the personal ledgers are made directly from
vouchers
➢ Voucher summary sheets-From such entries in personal account each day
summary sheets in total are prepared
➢ Daily trial balance-The general ledger’s trial balance is extracted and agreed
everyday
➢ Control accounts- A trial balance of detailed personal ledger is prepared
periodically and gets agreed with general ledger.
➢ Double voucher system-Two vouchers are prepared for every transaction not
involving cash- debit and credit voucher. This helps to increase the quality of
internal check.
Slip (or Voucher) system of ledger posting
Under this system used in banking companies-

➢ Entries in the personal ledger are made directly from the vouchers instead of
being posted from the day book.
➢ Pay in slips (used by the customers at the time of making deposits) and the
cheques are used as slip, which form the basis of transactions are directly
recorded in the accounts of customers.
➢ The vouchers entered into different personal ledgers are summarized on
summary sheets every day.
➢ Total of which are posted to the different control accounts which are maintained
in general ledger.
This system helps in the division of labour and smooth flow of work.
Books of Accounts
In order to have proper track of voluminous transaction and internal check on the record
of these transactions, banks are required to maintain Principal books of accounts along
with its subsidiary books.
A) Principal Books of Accounts
i. General Ledger : It contains controls Accounts of all subsidiary ledgers and

different assets and liabilities account
ii. Profit and Loss Ledger : Apart from one account for profit and loss in the General
ledger some banks maintain separate books for detailed accounts. It provides
information regarding income and operating expenses.
B) Subsidiary books
i) Personal Ledgers : Banks keep separate ledgers for different types of account
Such as Current accounts, Savings accounts, Fixed Deposits accounts, Loans,
Overdrafts etc.
ii) Bills Registers: These record transactions pertaining to different types of bills
such as Bills purchased, Bills for Collection etc.
iii) Other Subsidiary Registers:
a. Resisters For Demand Drafts, Telegraphic Transfers
b. Letters Of Credit, Letter of Guarantee etc.

C) Memorandum Books
i. Departmental Journals : Each department of the bank maintains a journal to

record the entries passed by it. These are only memorandum entries and do not
affect the Main Books of Account.
ii. Cash Department : The cash department maintains the following books-
a) Receiving Cashiers Cash Book
b) Paying Cashiers Cash Book
c) Main Cash Book
d) Cash Balance Book
iii. Outward Clearing Department: The following books are maintained-

a) Clearing Cheques Received book
b) Bank wise list of above cheques sent to the Clearing House
iv. Loans and Overdrafts Department

a) Register of securities
b) Overdraft Sanction Register etc.
c) Storage Books, delivery order books
d) Drawing Power books
Financial Reporting by Banking Companies

Reserve Bank of India has issued certain guidelines for preparation of profit and loss
account and balance sheet by banking companies conducting affairs in India.
The financial statements are prepared in 18 schedules which are :-
➢ Schedules forming part of Form A- Balance sheet (Schedule 1 – Schedule 12)

➢ Schedules forming part of Form B- Profit and Loss Account (Schedule 13 –
Schedule 16)
➢ Schedules forming Part of Annual Report-
o Schedule-17 –Significant Accounting Policies.
o Schedule-18-Notes forming part of accounts.
Notes to Accounts (Schedule - 18)
In addition to the 16 schedules to their Balance Sheet, banks are required to furnish in
the ‘Notes to Account’ details such as:

• Capital Adequacy Ratio; Tier I ; Tier II capital;
• Percentage of shareholding of the Government of India in the nationalised banks;
• The gross value of investments in India and outside India and the net value of
investments in India and outside India;
• Provisions made towards depreciation in the value of investments and the movement
of such provisions;
• Provisions of net NPAs to net advances; Provisions made towards NPAs and the
movement of such provisions;
• Maturity pattern of investment securities, loans and advances, deposits, borrowings,
foreign currency assets and liabilities;
• Details of ‘Provisions and Contingencies’; provisions made during the year towards
income tax, standard asset, floating provisions;
• Disclosures of business ratios such as interest income as a percentage to working
funds; operating profit as a percentage to working funds; return in assets;
business(deposits plus advances ) per employee; and profit per employee
• Lending to sensitive sectors, which are sensitive to asset price fluctuation. These
should include advances to sectors such as capital market, real estate,etc.
• Disclosures relating to repo transactions; non –SLR investment; forward rate
agreement; and risk exposure in derivatives.
Disclosure of Accounting Policies
In order that the financial position of bank represents a true and fair view, the Reserve
Bank of India has directed the banks to disclose the accounting policies regarding the
key areas of operations along with the notes to account in their financial statements.
Such additional disclosures are regarding:-
• Concentration of Deposits, Advanced Exposures and NPAs

• Sector-wise NPAs;
• Movement of NPAs;
• Overseas assets ,NPAs and Revenue;
• Off –balance sheet SPVs sponsored by banks.

Capital Adequacy Ratio (CAR)
Banks in the modern world face an inherent risk of insolvency. Hence if the banking
system were to go bankrupt, the entire economy would collapse within no time.
Therefore banks must have enough cushions to absorb such risk.
According to recommendation of Basel Committee, a banking company is required to

maintain sufficient owner’s fund to absorb unexpected losses which the banking
company may suffer in future. To fulfill this requirement banks have to maintain Capital
Adequacy Ratio based on capital funds and risk assets. It is just like bank’s airbag.
Capital Adequacy Ratio mandates that a certain amount of deposits be kept aside
whenever loan is being made.
For example:- Suppose CAR rate is 8% and loan given by bank is say RS 1,00,000 then
the banks needs to maintain free capital for Rs 8,000 at that particular time.
Significance of Capital Adequacy Ratio
• It measures a bank’s financial strength by using its capital and assets.

• It is used to protect depositors and promote the stability and efficiency of
financial systems.
Currently the rate of CAR is 9%.
To calculate CAR we require two values:-
▪ Capital Fund
▪ Risk Weighted Assets
Capital fund of banking company is divided in 2 parts:-
▪ The primary Capital (TIER-I capital)

▪ Secondary Capital (TIER-II capital)
Primary Capital (Tier – I)
Tier – I capital is primary capital of banking company which is essentially the most
perfect form of a bank’s capital-the money the bank has stored to keep it functioning
through all the risky transactions it performs, such as trading/investing and lending. It
includes following elements:-

• Ordinary Share capital
XXX
• Non- Cumulative perpetual preference capital
XXX
• Reserve and Surplus (Free Reserve and Statutory Reserve
XXX
including share premium).
• Innovative perpetual Debt Instruments.
XXX
• Capital reserves which represent surplus arising out of
XXX
the sale proceeds of the assets.
Minus:
• Equity Investment in Subsidiaries XXX
• Intangible assets. XXX
• Losses ( current period + past carried forward) XXX
TIER –I CAPITAL XXX
TIER-II Capital can be said to be subordinate capitals. It is not readily available to absorb
unexpected losses. But on future it will be available for the same.
In calculation of CAR, Tier-II capital cannot be more than Tier-I capital.
(Tier I ≥ Tier II) i.e the quantum of tier II capital is limited to a maximum of 100% of
tier I capital.
It includes:-
• Cumulative Perpetual Preference Capital

XXX
• Undisclosed Reserve
XXX
• 45% of Revaluation Reserve
XXX
• General provisions and loss reserves, ‘Floating
XXX
Provisions’ held by bank, Investment Reserve (subject to
1.25% of risk weighted asset)
• Convertible Debentures/Hybrid Debts
XXX
• Sub –ordinate debts (subject to 50% of tier-I capital) XXX
Total Tier-II Capital (subject to 100% of Tier –I capital) XXX

Risk Weighted Assets
Banks have various kinds of Assets on its balance sheets-Corporate loans, Personal loans,
Sovereign loans etc. The riskiness also varies on the basis of type of loan. So these
assets are given different weightage based on their riskiness in order to calculate Risk
Weightage Assets. The riskier the asset, the higher the RWA and the greater the amount
of regulatory capital required. The important weights for the purpose of Ascertainment
of CAR are as follows:-
BALANCE SHEET ITEMS RISK WEIGHT %
1 Cash Balances with RBI 0

2 Balance with other Bank 20
3 Investment with Government Securities and 0
loans and advances guaranteed by government
4 Other Investments and loans and advances 100
5 Other Assets 100
6 OFF BALANCE SHEET ITEMS
7 Contingency Liability ( Bill Guarantee / Bill 100

Rediscounted/ Letter of Credit)
Non Funded exposure to Real estate 150
Capital Adequacy Ratio = Capital Fund/Risk weighted Assets x100
Income Recognition
Bank has major source of its income from interest on loans and advances given to its
customers. Income recognition form interest earned on such loans and advances is
based on whether such assets are Performing Assets or Non-Performing Assets.
Performing Assets:- Any such assets that generates income on regular basis are called
Performing Assets. Interest income generated from such assets is recognised on Accrual
Basis.
Non-Performing Assets (NPA):- An Asset (loans & Advances) including lease assets
becomes Non-Performing Assets when they cease to generate income for banks.

In most of the cases, debt is classified as non-performing when loan payments have not
been made for a period of 90 days. According to prudence norms interest income on
NPA’s cannot be recognised on accrual basis. It can be recognised only on Cash Basis.
Identification of Non Performing Asset

The Reserve Bank of India has issued guidelines to banks regarding identifying the NPA’s
which are:-
Type of Assets Conditions for identifying as NPA

Bills purchased and discounted When interest and principal remain overdue
for more than 90 days from due date of bill.
Term Loans When Interest and/or Installment of principal
remain overdue for a period of more than 90
days.
Cash Credit/ Overdraft The amount remains out of order** in respect
of overdraft and cash credit for a period of
more than 90 days.
Agricultural Advances In case of short term crops: - If the amount is
overdue for more than two crop season.
Long term crops:- If the amount is due for
more than one crop season.
Other Loans and Advances If the amount is overdue for more than 90
days from its due date.
Derivative Transaction Overdue receivables representing positive

mark to market value of a derivative contact
remaining unpaid for a period of 90 days from
specified due date.
Exception:-
➢ Advances against term deposits, NSCs, IVPs, KVPs and life Insurance policies need
not be treated as NPAs, till security cover is sufficient to cover outstanding
balance.
➢ Income to be recognised subject to availability of margin.
➢ Advances against gold ornaments/ Government securities not exempt.
➢ Central government guaranteed advance to be classified as NPA only if
Government repudiates the guarantee when invoked.

** Out of order
A credit facility is considered as out of order if:-
➢ Such credit facility is over limit (amount withdrawn above the sanction limit) for
a continuous period of more than 90 days.
Or
The amount deposited by borrower is not sufficient to bring the credit facility
within the limit.
➢ If the credit facility is within the limit but there was no deposit for a continuous
period of more than 90 days.
Or
Amount deposited is less than the interest accrues during the above period.
Example:-
Sanctioned Limit 50 lacs
Drawing power 45 lacs
Amt outstanding from 01.01.16 to 30 lacs

31.03.16
Total Interest due Rs 3,45,000
Total credits Rs 1,50,000
Since the credit in the account is not sufficient to cover the interest debited,
during the period, account will be said as NPA.
➢
Reversal of Income Credited for the Past Period
➢ Once any advance including bills purchased and discounted becomes NPA the
entire interest accrued and credited to income account in the past periods
should be reversed if the same is not realised.
➢ This will apply to government guarantee also.
➢
Interest Suspense
Banking companies are allowed to recognize interest on NPA only on cash basis. So in
final accounts we cannot record interest accrued on NPA in interest income account.

To mark the advance with interest accrued we should open a dummy account named
INTEREST SUSPENSE ACCOUNT.
Loans & Advances Dr

To Interest Suspense A/c
When the bank realises the amount from the borrower towards his outstanding
balance whether in full or in part, at that time we recognise income for actual cash
received in settlement
Interest Suspense A/c Dr

To Interest Income A/c (Actual Interest Received)
This income will be subsequently transferred to P/L Account

Interest Income A/c Dr
To P/L Account
Now reverse the irrecoverable portion of interest suspense with following entry:-
Interest Suspense A/c Dr
To Loans & Advances A/c
Entry for amount realised from loans and advances in final settlement
Cash A/c Dr
Balance due on loans & advances (Irrecoverable Principal amount) will be

transferred to Bad debt A/c
Bad Debt’s A/c Dr
Finally write off the Bad Debts against provision for NPA:-
Provision for NPA A/c Dr
To Bad Debt A/c

Classification of Bank Advances on basis of Performance
Banks advances can be classified as follows:-
Bank Advances
Performing Asset Non - Performing Asset

(Standard Asset)
Sub Standard Doubtful Assets Loss Assets

Asset
Standard Asset:- Standard assets are those which do not carry any risk other than
normal risk attached to the business.
Non – Performing Assets (NPA):
I. Sub Standard Assets- A Sub –standard asset is one which has been classified as
NPA for a period not exceeding 12 months.
In such cases the security available to the bank is inadequate and there is a
possibility that the bank may suffer some loss, if the deficiencies are not
corrected.
II. Doubtful Assets – if an asset is a sub –standard asset for a period exceeding 12
months, it should be classified as doubtful assets.
III. Loss Assets- An asset may remain doubtful asset for a period of 3 years. But as
soon as any of the following 3 authorities declare an advance as irrecoverable,
then it will become Loss Assets.
• Officer of bank
• Auditor of bank ( statutory or internal)
• Inspector of RBI during inspection.
In other words such an asset is considered uncollectible. However, only those advances
are classified as loss assets where no security is available. In accounts where some
security/ECGC/DICGC cover is available, these accounts are not reported under loss
asset.

Illustration:
Date of NPA Sub Standard Asset Doubtful Asset After 31.03.208

01.04.2014 Up to 1 Year From 01.04.2015 to Loss Assets
≤ 31.03.2015 31.03.2018
The classification of advances should be done taking into account:-
• Degree of well-defined credit weakness.

• Extent of dependence on collateral security for the recovery of dues.
Provisions: Rates of Provision on Loans & Advances
STANDARD ASSETS:
➢ Agricultural Loan and Small & Medium Enterprises 0.25%

➢ Non Funded Commercial Real Estate Advance 1.00%
➢ Other Loans and Advances 0.40%
SUB STANDARD ASSETS:
XXX (Amount Outstanding)
Secured Un Secured
(15%)
Loan given to Other Companies

Infrastructure companies And (25%)
bank had sufficient safety measure (20%)
DOUBTFUL ASSETS:
XXX (Amount Outstanding)
Secured Un Secured
Years Rate (100%)
≤1 : 25%
1 –3 : 40%
>3 : 100%
LOSS ASSETS:
Written Off 100%
Provision for Advances covered by ECGC/DICGC Guarantee
• If a loan is classified as doubtful and guaranteed by ECGC (Export Credit

Guarantee Corporation) or DICGC, then for such guaranteed part, bank is not
required to create any provision for bad debts.
• In case the bank also holds a security in respect of advance guaranteed, the
realisable value of security should be deducted from the outstanding balance
before the guarantee is off set.

For example - ABC had taken loan of Rs 50 lakh from BOI. The loan is guaranteed by
ECGC @ 40%. The loan has remained doubtful for more than 3 years. Bank also holds
security in respect of advance having realisable value of 20 lakhs.
Here the provision will be calculated as:- Rs 50 Lakh less Rs 20 lakh ( value of security).
From Balance of 30 lakhs ECGC cover will be deducted @40% = 18 lakh(30 lakh-30 lakh
x 40%). On 18 lakh 100% provision will be made. And on secured portion i.e 20 lakh also
100% provision will be made as it is doubtful for more than 3 years i.e, Total Provision
=(18+20= 38 lakh).
Classification of Advances:
The entire Investment Portfolio of the banks (including SLR securities and non-SLR
Securities are classified under three categories: -
• Held to Maturity
• Available for Sale
• Held for Trading
Held to Maturity (HTM) :-
➢ Held to Maturity investments are investments made by bank, which it intends to

hold till maturity.
➢ Only debt securities can be classified as held to maturity because they have a
definite maturity.
➢ Investments under this category should not exceed 25 per cent of the total
investment.
VALUATION: - They appear on the balance sheet at the Amortized Cost (Meaning the
Initial acquisition Cost plus any additional cost incurred to date.)
Held- For-Trading (HFT): - These are financial assets that are held with the sole intent
of generating short term profits. Such investments are held for a short period of time.
These securities are to be sold within 90 days.
VALUATION: - A held for trading investment is reported at its fair value on the balance
sheet and any change in the fair value during a period and any dividend or interest
income over the period is recognised in the profit or loss for the period.
Available –For –Sale (AFS):-

• Securities which do not fall within the above two categories should be classified
as ‘Available for Sale’.
• The banks can decide the extent of holding under HFT and AFS based on the
various aspects.
VALUATION: - Available for sales are also valued at the fair value. Any resulting gain
or loss is recorded to an unrealised gain and loss account.
Illustrations
Illustration 1
A commercial bank has the following capital funds and assets. Segregate the capital
funds into Tier I and Tier II capitals. Find out the risk-adjusted asset and risk weighted
assets ratio –
Capital Funds: Rs.

Lakh
Equity Share Capital 4,80,00
Statutory Reserve 2,80,00
Capital Reserve (of which ₹ 280 lakhs were due to revaluation of 12,10
assets and the balance due to sale)
Assets:
Cash Balance with RBI 4,80
Balances with other Bank 12,50
Claims on Banks 28,50
Other Investments 782,50
Loans and Advances:
i. Guaranteed by government 128,20
ii. Guaranteed by public sector undertakings of Government of 702,10

India
iii. Others 52,02,5

0
Premises, furniture and fixtures 182,00
Other Assets 201,20
Off-Balance Sheet Items:

Acceptances, endorsements and letters of credit 37,02,5
0
Following facts have been taken out from the records of Adarsha Bank in respect of
the year ending March 31, 2012:
a. On 1-4-2011 Bills for collection were Rs.7, 00,000. During 2011-2012 bills
received for collection amounted to Rs.64, 50,000, bills collected were Rs.47,
00,000 and bills dishonoured and returned were Rs.5, 50,500. Prepare Bills for
Collection (Assets) A/c and bills for Collection (Liability) A/C.
b. On 1-4-2011, Acceptance, Endorsement, etc. not yet satisfied amounted to

Rs.14, 50,000. During the year under question, Acceptances, Endorsements,
Guarantees etc., amounted to Rs.44, 00,000. Bank honoured acceptances to the
extent of Rs.25, 00,000 and client paid off Rs.10, 00,000 against the guaranteed
liability. Clients failed to pay Rs.1, 00,000 which the Bank had to pay. Prepare
the “Acceptances, Endorsements and other Obligations A/c” as it would appear
in the General ledger.
c. It is found from the books, that a loan of Rs. 6, 00,000 was advanced on 30-9-
2011 @ 10 per cent p.a. interest payable half yearly; but the loan was
outstanding as on 31-3-2012 without any payment recorded in the meantime,
either towards principal or towards interest. The security for the loan was 10,000
fully paid shares of Rs. 100 each (the market value was Rs. 98 as per the Stock
Exchange information as on 30th Sept., 2011). But due to fluctuations, the price
fell to Rs.40 per share in January, 2012. On 31-3-2012, the price as per Stock
Exchange rate was Rs.82 per share. State how you would classify the loan as
secured/unsecured in the Balance Sheet of the Company.
The outstanding amount (funded as well as unfunded) as on 31st March 2011 was
₹10,000. The realizable value of security of the same was ₹8,000. Period for which
the advance has remained in ‘doubtful’ category as on 31st March 2011 was: 2.5
years.
Compute the total provision required for year ended 31st March 2011 and 31st March
2012 as per relevant banking provisions.
Illustration 4
From the following information, find out the amount of provisions to be shown in the
Profit and Loss Account of AG bank.

Assets ₹In lakhs
Standard 5,000
Sub-standard 4,000
Doubtful : for one year 800
: for three years 600
: for more than three years 200
Loss Assets 1,000
Illustration 5
From the following information of AY Limited, compute the provisions to be made in

the Profit and Loss account:
₹ In lakhs
Assets
Standard 20,000
Substandard 16,000
Doubtful
For one year (secured) 6,000
For two years and three years (secured) 4,000
For more than three years (secured by mortgage of 2,000
plant and machinery ₹600 lakhs)
Loss Assets 1,500

Outstanding Balance ₹ 4 lakhs
ECGC Cover 50%
Period for which the advance has More than 3 years remained
remained doubtful doubtful (as on March 31, 2011)
Value of security held ₹1.50 lakhs
In KR Bank, the doubtful assets (more than 3 years) as on 31.3.2011 is ₹ 1,000 lakhs.
The value of security (including DICGC 100% cover of ₹100 lakhs) is ascertained at
₹500 lakhs. How much provision must be made in the books of the Bank towards
doubtful assets?
A loan outstanding of ₹50, 00, and 000 has DICGC cover. The loan guaranteed by DICGC
is assigned a risk weight of 50%. What is the value of Risk-adjusted asset?
The following is an extract from Trial Balance of overseas Bank as at 31st March, 2011
₹ ₹
Bills discounted 12,64,000
Rebate on bills discounted not due 22,160
on March 31st, 20X0
Discount received 1,05,708
An analysis of the bills discounted is as follows:
Amount Due Date 2011 Rate of Discount
₹ (%)
(i) 1, 40,000 June 5 14

(ii) 4, 36,000 June 12 14
(iii) 2, 82,000 June 25 14
(iv) 4, 06,000 July 6 16
Calculate Rebate on Bills Discounted as on 31-3-2011 and show necessary journal

entries.
On 31st March, 2011, Uncertain Bank had a balance of ₹ 9 crores in “rebate on bills
discounted” account. During the year ended 31st March, 2012, Uncertain Bank
discounted bills of exchange of ₹4,000 crores charging interest at 18% per annum
the average period of discount being for 73 days.
Of these, bills of exchange of ₹600 crores were due for realisation from the
acceptors/customers after 31st March, 2012, the average period outstanding after
31st March, 2012 being 36.5 days.
Uncertain Bank asks you to pass journal entries and show the ledger accounts
pertaining to:
(i) discounting of bills of exchange and

(ii) rebate on bills discounted.
Illustration 11
The following information is available in the books of X Bank Limited as on 31st

March, 2012:
₹
Bills discounted 1,37,05,000
Rebate on Bills discounted (as on 1.4.2011) 2,21,600
Discount received 10,56,650
Details of bills discounted are as follows:
Value of bill Due date Rate of

(₹) Discount

18,25,000 5.6.2012 12%
50,00,000 12.6.2012 12%
28,20,000 25.6.2012 14%
40,60,000 6.7.2012 16%
Calculate the rebate on bills discounted as on 31.3.2012 and give necessary journal
entries.
Illustration 12
From the following information, prepare a Balance Sheet of ADT International Bank as
on 31st March, 2011 giving the relevant schedules and also specify at least four
important Principal Accounting Polices:
Rs in Lakhs
Particulars Dr Cr
Share Capital 198.00
19,80,000 Shares of Rs. 10 each
Statutory Reserve 231.00
Net Profit before Appropriation 150.00
Profit and Loss Account 412.00
Fixed Deposit Account 517.00

Savings Deposit Account 450.00
Current Accounts 28.00 520.12
Bills Payable 0.10
Cash credits 812.10
Borrowings from other Banks 110.00
Cash in Hand 160.15
Cash with RBI 37.88
Cash with other Banks 155.87
Money at Call 210.12
Gold 55.23
Government Securities 110.17
Premises 155.70
Furniture 70.12
Term Loan 792.88
Total 2,588.22 2,588.2

2
Additional Information:
Bills for collection 18,10,000

Acceptances and endorsements 14,12,000
Claims against the Bank not acknowledged 55,000
as debt
Depreciation charges—Premises 1,10,000
Furniture 78,000
50% of the Term Loans are secured by Government guarantees. 10% of cash credit is
unsecured
Illustration 13
From the following information, prepare Profit and Loss A/c of Dimple Bank as on
31-3-2013:
Rs. in ’000
Item 2012-13
Interest and Discount 20,45
Income from investment 1,12
Interest on Balances with RBI 1,77
Commission, Exchange and 7,12
Brokerage
Profit on sale of investments 1,22
Interest on Deposits 8,22
Interest to RBI 1,47
Payment to and provision for 8,55
employees
Rent, taxes and lighting 1,79
Printing and stationery 2,12
Advertisement and publicity 98
Depreciation 98
Director’s fees 2,12
Auditor’s fees 1,10
Law charges 1,52
Postage, telegrams and tel. Ph 62

Insurance 52
Repair & maintenance 66
Also give necessary Schedules
Other Information:
(i) The following items are already adjusted with Interest and Discount (Cr.):
Particulars Rs. In
`000
Tax Provision 1,48
Provision for Doubtful Debts 92
Loss on sale of investments 12
Rebate on Bills discounted 55
(ii) Appropriations:
• 25% of profit is transferred to Statutory Reserves.
• 5% of profit is transferred to Revenue Reserve.
Illustration 14
From the following information, prepare Profit and Loss A/c of KC Bank for the year
ended 31st March, 2011
Items Rs in ‘000
Interest on cash credit 18,20
Interest on overdraft 7,50
Interest on term loans 15,40
Income on investments 8,40
Interest on balance with RBI 1,50
Commission on remittances and transfer 75
Commission on letters of credit 1,18
Commission on government business 82
Profit on sale of land and building 27
Loss on exchange transactions 52
Interest paid on deposit 27,20

Auditors’ fees and allowances 1,20
Directors’ fees and allowances 2,50
Advertisements 1,80
Salaries, allowances and bonus to 12,40

employees
Payment to Provident Fund 2,80
Printing and stationery 1,40
Repairs and maintenance 50
Postage, telegrams, telephones 80
Other Information
i. Interest on NPA’s is as follows

Rs. in ‘000s
Earned Collected
Cash Credit 8,20 4,00
Over Draft 4,50 1,00
Term Loans 7,50 2,50
ii. Classification of NPA’s

Rs. in ‘000s
Standard 30,00
Sub-Standard 11,20
Doubtful assets not covered 2,00

by security
Doubtful assets covered by 50

security for 1 year

Loss Assets 2,00
iii. Investments Rs 27, 50,000. Bank should not keep more than 25% of its
investment as ‘held-for-maturity’ investment. The market value of its rest
75% investment is Rs. 19,75,000 as on 31-3-2011
4.2 Accounts for Insurance Companies
Insurance is a contract containing agreed terms wherein Insurance policy
Insurer (Insurance
one party undertakes to indemnify
company)
specified losses Claim
suffered by the other party Insured
for a special consideration Premium

Insurable Interest •Insurance contracts cannot be entered into by anyone
•Every policy insists upon insurable interest
•E.g. A can insure life of B if B is his spouse, debtor, business
Having a vested interest manager etc., and NOT if B is a total stranger
in the contract •A contract without insurable interest = wagering contract
Principle of Indemnity
•Insurance contract is a contract of indemnity
•Insurer indemnifies the insured for loss incurred
To compensate for •One cannot make profit by insuring his risks
losses suffered
•Under ordinary law, there is no positive duty to tell whole

Principle of uberrimae truth. Only a negative obligation to tell nothing but the truth
fidei •Insurance contract is however a contract of uberrima fidei -
contract of utmost good faith
Uberrimae Fidei means •There must be full and frank disclosure of all material facts.
utmost good faith Assessment of risk and determination of premium depends
upon the same

TYPES OF INSURANCE
Life Insurance General

Insurance
Whole Life Term Annuity Fire Marine Miscellaneous

Insurance Insurance
1. Valued
2. Specific 1. Time 1. Motor Vehicle
3. Average 2. Voyage 2. Fidelity
4. Floating 3. Mixed 3. Credit
5. First loss & 4. Floating 4. Burglary
Excess 5. Blanket 5. Loss of Profit
6.Blanket 6. Fleet 6. Workmens'
7. Comprehensive Insurance Compensation
8. Consequential 7. Open 7. Professional
loss 8. Port Liability
9. Re-instatement 9. Composite 8. Exchange risk
10. Open 10. Valued 9. Cash in transit
declaration

Receipt / recording of Premium Claims
•Essentially confined to divisions/ •Essentially confined to divisions/

branches. Accounting also done there branches. Accounting also done there
•Branches communicate their transactions •Branches communicate their transactions

to divisions to divisions - every division prepares
separate claim statement
•Outstanding premium to be reported
separately in some cases. See Note 1 •Outstanding Liability / Claims provision is
determined at divisions/branches
•Separate bank accounts are maintained
for collecting premium and paying claims •Basis consolidated figure of all divisions,
HO may further provide for outs. claims
•Commissions to agents, earned towards
earning premium, are paid by following •Claims paid also disclosed separately.
law-prescribed basis and rates Divisions acertain genuineness, complete
formalities, obtain relevant sanctions,
and then pay claim. All evidence is
maintained in files
•Similar information to be submitted

regarding re-insurance and co-insurance.
See Note 2 and 3
BUSINESS ACTIVITIES
Loans & Investments

Others
•Housing and other loans to staff - •Unexpired risks reserve to be recorded at

recorded at Divisonal/regional level HO. See Note 8
•Other loans dealt with at HO •Management expenses - ledger and

Analysis Register maintained at divisions.
•Various types of loans & investments to Expenses to be apportioned to fire,
be reported in Balance Sheet. See Note 4 marine and miscellaneous revenue a/cs,
&5 basis of apportionment to be disclosed
•Guidelines for investing investible funds •Provision for outstaning expenses

to be adhered to. See Note 6.
•List of books / records normally
•Investment department of HO to maintained at adivisional office are listed
maintain certain books and records. See in Note 9.
Note 7.

Illustrations
Illustration – 1
Indian insurance company limited furnishes you with the following information:
(i) On 31.12.20X1 it had reserve for unexpired risk to the tune of Rs. 40 crores.
(ii) It comprised of Rs 15 crores in respect of marine insurance business: Rs 20
crores in respect of fire insurance business and Rs 5 crores in respect of
miscellaneous insurance business.
(iii) It is the practice of Indian Insurance Co. Ltd. to create reserves at 100% of
net premium income in respect of marine insurance policies and at 50% of
net premium income in respect of fire and miscellaneous income policies.
(iv) During 20X2, the following business was conducted:
(Rs. Crores)
Marine Fire Miscellaneous
Premia collected from:

(a) Insureds in respect of
policies issued 18 43 12
(b) Other insurance companies
in respect of risks undertaken 7 5 4
Premia paid/payable to
other insurance
companies on business ceded 6.7 4.3 7
Indian Insurance Co. Ltd. asks you to:
(a) Pass journal entries relating to “Unexpired risks reserve”.

(b) Show in columnar form “Unexpired risks reserve” a/c for 20X2.
Illustration 2
Janani Assurance Co. Ltd. received ₹5,90,000 as premium on new policies and ₹
1,20,000 as renewal premium. The company received ₹90,000 towards reinsurance
accepted and paid ₹70,000 towards reinsurance ceded. How much will be credited to
Revenue Account towards premium?
Illustration 3
From the following figures appearing in the books of Fire Insurance division of a
General Insurance Company, show the amount of claim as it would appear in the
Revenue Account for the year ended 31st March, 20X2:
Direct Re-
business insurance
Claim paid during the year 46,70,000 7,00,000
Claim Payable — 1st April, 2012 7,63,000 87,000

31st March 2012 8,12,000 53,000
Claims received 2,30,000
Claims Receivable — 1st April 2012 _ 65,000

31st March 2012 _ 1,13,000
Expenses of Management 2,30,000 _

(includes Rs.35,000 Surveyor’s fee and
Rs.45,000 Legal expenses for settlement of
claims)

Illustration 4
From the following information of Reliable Marine Insurance Ltd. for the year ending
31st March 2012 find out the
i. Net premium earned
ii. Net claims incurred

(Rs)
Direct business Re-insurance
Premium:
Received 88,00,000 7,52,000
Receivable -1.04.2011 4,39,000 36,000
Receivable -31.03.2012 3,77,000 32,000
Paid:
Payable- 1.04.2011 27,000
Payable – 31.03.2012 18,000
Claims:
Paid 69,00,000 5,54,000
Payable – 1.04.2011 89,000 15,000
Payable - 31.03.2012 95,000 12,000
Received 2,01,000
Receivable –1.04.2011
Receivable - 31.03.2012 40,000
38,000
Illustration 5
Prepare Revenue Account in proper form for the year ended 31st March 2011 from the
following particulars related to Goma General Insurance Co. for the year 2011-2012
Direct Business Re-Insurance
Premiums: 30,00,000 2,40,000

Amount received
Receivable at the beginning 1,80,000 24,000
Receivable at the end 2,40,000 36,000

Amount paid _ 3,60,000
Payable at the beginning 30,000
Payable at the end 42,000
Claims:
Amount paid 18,00,000 1,80,000
Payable at the beginning 60,000 12,000
Payable at the end 1,20,000 18,000
Amount recovered _ 1,20,000
Receivable at the beginning _ 18,000
Receivable at the end _ 12,000
Commission: 72,000 10,800

Amount paid _ 14,400
Amount received
Additional information:
i. Interest, dividend and rent received 30,000
Income-tax in respect of above 6,000
Management expenses including Rs.12,000 related to
Legal expenses regarding claims 132,000
(ii)Provision for income tax existing at the beginning of the year was Rs. 1,95,000 the
income – tax actually paid during the year Rs.1,68,000 and the provision necessary at
the yearend Rs. 2,07,000
The net premium income of the company during the year 2010-2011 was Rs. 24,00,000
on which reserves for unexpired risk @ 50% and additional reserve @7 ½ % was
created. This year the balance to be created forward to be carried forward is 50% of
net premium on reserves for unexpired risk and 5% on additional reserves.

Study Note – 5 | Accounting Standards
5.1 AS 11: Accounting for the Changes in Foreign Exchange

Rates
1.0 : The Scope of the Standard:
AS 11 (Revised 2003) is to be mandatorily applied by an enterprise:
i. In accounting for transactions in foreign currencies;
ii. In translating the financial statements of foreign operations;
iii. In accounting for foreign currency transactions in the nature of forward

exchange contracts (except the ones that are entered into hedge the foreign
currency risk of a ‘firm commitment’ or ‘highly probable forecast transaction’)
However, the standard is not applicable to:
i. The restatement of the enterprise’s financial statements from its reporting

currency into another currency for the users accustomed to that currency or for
similar purpose.
ii. The presentation in a cash flow statement of cash flows arising from
transactions in a foreign currency and the translation of cash flow of a foreign
operation.
iii. Exchange differences arising from foreign currency borrowings to the extent
that they are regarded as an adjustment to interest costs (covered by AS-16)
iv. Exchange differences arising on a forward exchange contract entered into to

hedge the foreign currency risk of a ‘firm commitment' or ‘a highly probable
forecast transaction' (A ‘firm commitment' as a binding agreement for the
exchange of a specified quantity of resources at a specified price on a specified
future date or dates whereas a ‘forecast transaction' is an uncommitted but
anticipated future transaction.)

2.0 : Terms that have been defined in the standard:
Exchange Rate: Exchange rate is the ratio for exchange of two currencies (e.g. if $ =
Rs. 50, it means that one US dollar can be exchanged for 50 Indian rupees) as
applicable to the realization of a specific asset or the payment of a specific liability
or the recording of a specific transaction or a group of inter-related transactions.
Average Rate: Average rate is the mean of exchange rates in force during a period,
Forward Rate: Forward rate is the specified exchange rate for exchange of two
currencies at a specified future date.
Closing Rate: Closing rate is the exchange rate at the balance sheet date.
Spot exchange rate is the exchange rate for immediate delivery
Monetary Items: Monetary items are money held and assets and liabilities to be
received or paid in fixed or determinable amounts of money, e.g., cash, receivables,
payables.
Long term monetary items are monetary items having a maturity of 12 months or
more from the date of initial recognition of asset or liability.
Non-monetary Items: Non-monetary items are assets and Liabilities other than
monetary items e. g., fixed assets, inventories, investments in equity shares.
Reporting Currency: Reporting currency is the currency used in presenting the

financial statements, e.g., Rupee will be the reporting currency to be used in
presenting the financial statements in India.
Foreign Currency: Foreign currency is a currency other than the reporting currency
of an enterprise, e.g., if a branch of an Indian Company is located in US then dollar
will be the foreign currency.
Exchange Difference: Exchange difference is the difference resulting from reporting

the same number of units of a foreign currency in the reporting currency at different
exchange rate.
Fair Value: Fair value is the amount for which an asset could be exchanged, or a
liability settled, between knowledgeable, willing parties in an arm's length
transaction.

Foreign Operation: Foreign operation is a subsidiary, associate, joint venture or
branch of the reporting enterprise, the activities of which are based or conducted in a
country other than the country of the reporting enterprise.
Forward Exchange Contract: Forward exchange contract means an agreement to

exchange different currencies at a forward rate.
Integral Foreign Operation: Integral foreign operation is a foreign operation, the

activities of which are an integral part of those of the reporting enterprise.
Non-integral foreign operations is a foreign operation that is not an integral foreign

operation
Net Investment in a Non-integral Operation: Net investment in a non-integral

foreign operation is the reporting enterprise's share in the net assets of that
operation.
Foreign Currency Transactions: Transactions denominated in a foreign currency or

those that require settlement in a foreign currency are called foreign currency
transactions.
3.0 : Foreign Currency Transactions:
a) Initial Recognition: Transactions involving foreign currencies can be brought under

four groups, namely,
(a) Buying or selling of goods and services,

(b) Borrowing or lending money,
(c) Acquiring or disposing of assets, or incurring and settling liabilities, or
(d) By being a party to a forward exchange contract.
For initial recognition, the Accounting Standard prescribes that a foreign

currency transaction should be recorded by applying the exchange rate at the
date of the transaction.
Note: For practical reasons, an average rate for day/ a week/ month may be
used, if the fluctuations are not high
b) Reporting at subsequent Balance sheet date: For the purpose of showing the
effect of change in foreign exchange rates, the transactions are classified into
monetary items and non-monetary items. At each balance sheet date:
Type Reporting Rate

Monetary Item Closing Rate
Non-Monetary Item carried at historical Exchange Rate on date of transaction

cost (e.g. Fixed Assets)
Non-Monetary items carried at fair Exchange Rates that existed when the
value fair values were determined.
C.Recognizing exchange difference: Exchange differences can arise on three

counts:
• A transaction – either a monetary item, or a non-monetary item – being settled

at a rate different from the rate at which it was initially recorded
(Settlement in the same accounting period).
• A transaction being reported at a rate different from the rate at which it

was either initially recorded (balance sheet reporting).
• A transaction being settled as a rate different from the one taken for
reporting in the last financial statement (settlement in different
accounting period).
Accounting for Exchange Differences
Option I: Exchange differences shall be recognized as income or expense in the

period in which they arise.
Option II - Long Term Foreign Currency Monetary Items
Exchange differences arising on reporting of long-term foreign currency

monetary items at rates different from those at which they were initially
recorded during the period, or reported in previous financial statements,
- If they relate to the acquisition of a depreciable capital asset,

o can be added to or deducted from the cost of the asset and shall be
depreciated over the balance life of the asset, and
- in other cases,
o can be accumulated in the Foreign Currency Monetary Item Translation
Difference (FCMITD) Account and should be written off over the useful
life of the assets (amortized over the balance period of such long term
assets or liability, by recognition as income or expense in each of such
periods)

The treatment availed at the option of the company shall be irrevocable and
shall be exercised till 31st March, 2020. In other words, if an entity chooses to
capitalize exchange differences, it should continue the same policy till 31st
March 2020.
An asset or liability shall be designated as a long-term foreign currency monetary

item, if the asset or liability is expressed in a foreign currency and has a term of 12
months or more at the date of origination of the asset or liability.
4.0 : Financial Statement of Foreign Operations:
1. Integral: A foreign operation is said to be integral operations as if were an

extended arm of the reporting entity. Any change in the foreign exchange rate will
have all immediate impact on the cash flows of the reporting entity. Such an
impact will arise from and will be relatable to all monetary items - except of
course, the net investment of reporting entity.
Example - A foreign operation might only sell goods imported from the reporting
entity and remits back the proceeds to the reporting entity. Certain other
situations that would be an integral operation are:
• Acts as a selling agency: receiving stocks of goods from and remitting proceeds
back to the investing company.
• Produces a raw material or component, and transfers the goods for inclusion in
the ultimate product being manufactured by investing company (end-products
of foreign operations are captivity consumed by reporting entity)
• Foreign operation has been set up to raise finance to help investing entity or
for tax reasons.
2. Non-integral: An operation which is not an integral operation is called Non-

Integral operation. A non-integral foreign operation accumulates cash and other
monetary items, incurs expenses, generates income and perhaps arranges
borrowings, all substantially in the local currency. It may also enter into
transactions in foreign currencies, including transactions in the reporting
currency".

A question to be asked is -
Will such operations have an impact on the cash flows from operations of
reporting entity?
If answer is negative it is non-integral operations.
An analysis will show that in cases of the nature cited above, a change in the
exchange rate between reporting currency, and the currency in which foreign
operations are conducted — will not have any direct effect on the cash flows for
reporting entity. The effect, if any, would be traceable to a change in the 'net
investment in foreign operations" of reporting entity.
The focus is on whether there are any regular movement of cash or cash equivalents,
or whether it is only occasional, i.e. remittance of dividends. Mere "control" is not a
determinant factor. Impact on cash flows from operations is relevant.

SUMMARY OF ACCOUNTING FOR INTEGRAL AND NON INTEGRAL FOREIGN
OPERATIONS
INTEGRAL FOREIGN NON INTEGRAL FOREIGN OPERATIONS –

OPERATIONS – (IFO) (NIFO)
Accounting treatment of integral Foreign ITEM CONVERSION RATE

Operations: The financial statements of All Balance At closing rate
an integral foreign operation should be Sheet items
translated using the principles and All Revenue Rate on date of
procedures in paragraphs 8 to16 as if the items transaction
transactions of the foreign operation had Any goodwill/ Closing rate
Cap reserve/
been those of the reporting enterprise
Contingent
itself. liability
The translation of the financial statements of a non-

integral foreign operation results in the recognition
of exchange differences arising from:
OUTSIDE INDIA
INDIA
a. translating income and expense items at the
exchange rates at the dates of transactions and
IFO X CO. assets and liabilities at the closing rate;
b. translating the opening net investment in the

TB OF TB OF non-integral foreign operation at an exchange rate
IFO X CO different from that at which it was previously
reported; and
c. other changes to equity in the non-integral

Convert the TB of IFO by using following rates: foreign operation.
ITEM CONVERSION RATE The exchange fluctuations on account of

Fixed assets (including rate on date of acquisition conversion should be transferred to Foreign
depreciation)
Currency Translation Reserve A/c (FCTR). FCTR
All monetary items at closing rate
cant be used for dividend distribution purpose. The
All incomes/ expenses Actual rate
(other than depreciation) Or same will be transferred to P&L when the NIFO is
Average rate if fluctuation is not disposed off or discontinued.
high
HO Account Actual amount as per books These exchange differences are not recognized as
income or expenses for the period because the
NOTE - After conversion of TB of IFO from Foreign Currency to changes in the exchange rates have little or no
domestic currency, it may/ may not tally, as different exchange direct effect on the present and future cash flows
rates are used. from operations of either the non-integral foreign
Such difference is foreign currency fluctuation on account of operation or the reporting enterprise. When a non-
integral foreign operations and is charged off to P&L integral foreign operation is consolidated but is not
wholly owned, accumulated exchange differences
arising from translation and attributable to minority
interests are allocated to, andreported as part of, the
minority interest in the consolidated balance sheet.

OTHER KEY ASPECTS IN ACCOUNTING FOR NIFO –
1. Consolidation as per AS 21, 23, 27:
The incorporation of the financial statements of a non-integral foreign

operation in those of the reporting enterprise follows normal consolidation
procedures, such as the elimination of intra-group balances and intra-group
transactions of a subsidiary (see AS 21, Consolidated Financial Statements, and
AS 27, Financial Reporting of interests in Joint Ventures). However, an
exchange difference arising on an intra-group monetary item, whether short-
term or long-term, cannot be eliminated against a corresponding amount
arising on other intra-group balances because the monetary item represents a
commitment to convert one currency into another and exposes the reporting
enterprise to a gain or loss through currency fluctuations. Accordingly, in the
consolidated financial statements of the reporting enterprise, such an
exchange difference continues to be recognized as income or an expense or, if
it arises from the circumstances described in paragraph 15, it is accumulated in
a foreign currency translation reserve until the disposal of the net investment.
2. DIFFERENT REPORTING DATES
When the financial statements of a non-integral foreign operation are drawn up

to a different reporting date from that of the reporting enterprise, the non-
integral foreign operation often prepares, for purposes of incorporation in the
financial statements of the reporting enterprise, statements as at the same
date as the reporting enterprise. When it is impracticable to do this, AS 21,
Consolidated Financial Statements, allows the use of financial statements
drawn up to a different reporting date provided that the difference is no
greater than six months and adjustments are made for the effects of any
significant transactions or other events that occur between the different
reporting dates. In such a case, the assets and liabilities of the non-integral
foreign operation are translated at the exchange rate at the balance sheet date
of the non-integral foreign operation and adjustments are made when
appropriate for significant movements in exchange rates up to the balance
sheet date of the reporting enterprises in accordance with AS 21. The same
approach is used in applying the equity method to associates and in applying
proportionate consolidation to joint ventures in accordance with AS 23,
Accounting for Investments in Associates in Consolidated Financial Statements
and AS 27, Financial Reporting of Interests in Joint Ventures.

3. CLASSIFICATION AND RECLASSIFICATION
The classification of a Foreign Operation as IFO / NIFO is the responsibility of

the management.
The accounting treatment to be followed on reclassification from IFO to NIFO

and NIFO to IFO is summarised below:
IFO to NIFO
➢ Till the date of reclassification, exchange differences are transferred to

P&L
➢ The exchange differences subsequent to date of reclassification are
accumulated in Foreign Currency Translation Reserve (FCTR)
NIFO to IFO
➢ The accumulated balance in FCTR will be carried in the Balance Sheet.

The balance will be transferred to P&L when the foreign operation is
disposed.
➢ The exchange differences subsequent to date of reclassification is
transferred to P&L.
➢ The translated amount of non-monetary items as on the date of change
is treated as historical cost.
4. DISPOSAL OF NIFO
On the disposal of a non-integral foreign operation, the cumulative amount of

the exchange differences which have been deferred and which relate to that
operation should be recognized as income or as expenses in the same period in
which the gain or loss on disposal is recognized.
5. FORWARD EXCHANGE CONTRACTS
Category I: An enterprise may enter into a forward exchange contract or

another financial instrument that is in substance a forward exchange contract,
which is not intended for trading or speculation purposes, to establish the
amount of the reporting currency required or available at the settlement date
or a transaction.

The premium or discount arising at the inception of such a forward exchange
contract should be amortized as expense or income over the life of the
contract. Exchange differences on such a contract should be recognized in the
statement of profit and loss in the reporting period in which the exchange rates
change. Any profit of loss arising on cancellation or renewal of such a forward
exchange contract should be recognized as income or as expense for the
period.
Category II: In respect of a forward contract entered into as a speculative

activity, Accounting Standard prescribes that the contract should he recognized
on the reporting date. A gain or loss on a such forward exchange contract
should be computed by multiplying the foreign currency amount of the forward
exchange contract by the difference between the forward rate available at the
reporting date for the remaining maturity of the contract and the contracted
forward rate (or the forward rate last used to measure a gain or loss on that
contract for an earlier period).
The gain or loss- so computed should be recognized in the statement of profit

and loss for the period. The premium or discount on the forward exchange
contract is not recognized separately.
Is forward contract
intended for trading
or speculative
purposes?
NO YES
Any premium or
discount arising at Exchange
the inception of a differences on such
forward exchange a contract are The premium or discount on the
contract is recognized in the contract is ignored and at each
amortised as statement of profit balance sheet date, the value of the
expense or and loss in the contract is marked to its current
income over the reporting period in market value and the gain or loss on
life of the which the exchange the contract is recognized.
contract. rates change.

5.0: Disclosure requirements: An enterprise should disclose:
a. the amount of exchange differences included in the net profit or loss for
the period; and
b. net exchange differences accumulated in foreign currency translation

reserve as a separate component of shareholders' funds, and a
reconciliation of the amount of such exchange differences at the
beginning and end of the period.
When the reporting currency is different from the currency of the country in
which the enterprise is domiciled, the reason for using a different currency
should be disclosed. The reason for any change in the reporting currency should
also be disclosed.
When there is a change in the classification of a significant foreign operation,

an enterprise should disclose:
a. the nature of the change in classification;
b. the reason for the change;
c. the impact of the change in classification on shareholders' funds; and
d. the impact on net profit or loss for each prior period presented had the
change in classification occurred at the beginning of the earliest period
presented.
Matters to be disclosed Place of

disclosure
Amount of exchange differences included in the net profit or Profit & Loss
loss for the period.
Net exchange differences accumulated in foreign currency Balance

translation reserve as a separate component of shareholders sheet notes
funds and a recognisation of such exchange differences at the
beginning and end of the period.
Reason for using a different currency, when the reporting Notes

currency is different from the currency of the country in which
the enterprises is domiciled.
Reason for any change, if any, in the reporting currency. Notes

When there is a change in the classification of a significant Notes
foreign operation,
(a) - the nature of the change in classification,
(b) - the reason for the change
(c) - the impact of the change in classification on presented

had the change in classification occurred at the beginning of
the earliest period presented.
Effect on foreign currency monetary items or on the financial Notes

statements of a foreign operation of a change in exchange
rates occurring after the balance sheet date, as per AS – 4.
Enterprise’s foreign currency risk management policy (optional Notes

disclosure).
PRESENTATION OF FOREIGN CURRENCY MONETARY ITEM TRANSLATION

DIFFERENCE ACCOUNT
In the format of Schedule III to the Companies Act, 2013, no line item has been specified for
the presentation of FCMITDA. Since the balance in FCMITDA represents the foreign
currency translation loss, it does not meet the above definition of asset, as it is neither a
resource nor any future economic benefit would flow to the entity there from. Therefore,
such balance cannot be reflected as an asset. Therefore, Dr/ Cr balance in FCMITDA should
11.6: ICAI Interpretations: N.A.
be shown on the EQUITY and LIABILITIES side of the balance sheet under the head
RESERVES AND SURPLUS as a separate line item
Question 1:
Explain Monetary Item as per AS 11. How are Foreign Currency Monetary
items to be recognized at each balance sheet date?
Classify the following as monetary or non-monetary items.
Share Capital, Trade Receivables, Investments, Fixed Assets
Solution1:

Monetary Items are money held and Assets & Liabilities to be received or paid
in fixed or determinable amounts of money. Eg: Debtors, Creditors, Loans etc.
Foreign Currency monetary items are recognized at closing rate at each

balance sheet date.
• Share Capital - Non Monetary Item
• Trade Receivables - Monetary Item
• Investments - Non Monetary Item
• Fixed Assets - Non Monetary Item
Question 2:
BK Limited purchased fixed asset costing Rs. 5,000 lacs on 1.4.2012 payable
in foreign currency (USD) on 5.4.2013. Exchange rate of 1 USD is Rs.50 and
Rs.54.98 as on 1.4.2012 and 31.3.2013 respectively. The Company also
obtained a soft loan of USD 100,000 on 1.4.12 payable in 3 equal annual
installments. First installment was due on 1.5.13. You are required to state
how these transactions are to be accounted for in the books of accounts for
the year ended 31.3.13
Solution2:
Part 1
Date of acquisition of Fixed Asset 1.4.2012
Cost of acquisition: Rs.5000 lacs = USD 100 lacs X Rs. 50/USD
Creditor Reinstatement Date: 31.03.2013; Exchange rate 1 USD = Rs.54.98
Rupee Depreciation over the year 2012-13: Rs.4.98 per USD
Increase in creditor payables consequent to reinstatement following rupee

depreciation:
Rs.4.98 /USD x USD 100 lacs = Rs.498 Lacs
Option 1: Rs.498 lacs of forex fluctuation can be debited to P&L in FY13
Option 2: The Company may also choose to capitalize this loss to the cost of the
fixed asset so acquired.
Part 2:
Assume USD 100,000 of loan was used to acquire a Fixed asset / a non-monetary
item
Loss on the reinstatement of the loan for FY2013 is
USD 100,000 x Rs.4.98 / USD = Rs. 4.98 lacs
Option 1: The loss may be entire charged off to P&L
Option 2:
a) If the asset so acquired from the loan is a fixed asset then the loss can be
transferred to the fixed asset account.
b) If the asset so acquired is not a depreciable fixed asset or is for working
capital purposes, the loss can be transferred to Foreign Currency Monetary
Item Translation Difference Account (FCMITD) and written off in 3 years
starting FY13. That will be well before 31.03.2020, the date before which
all FCMITDA balances are to be written off as mandated by AS11.
Question 3:
Sterling Ltd. purchased a plant for US $ 20,000 on 31st December, 2011

payable after 4 months. The company entered into a forward contract for 4
months @ Rs. 48.85 per dollar. On 31st December, 2011, the exchange rate
was Rs. 47.50 per dollar.
How will you recognize the profit or loss on forward contract in the books of
Sterling Limited for the year ended 31st March, 2012?
Solution3:
Forward premium Paid by the Company per USD = Rs.48.85 - 47.50 = Rs1.35
The forward premium of Rs.1.35 is for a period of 4 months
Total forward premium = Rs. 1.35 X 20,000 = Rs. 27,000
Amount to be amortised per month = Rs 27,000/4 = Rs. 6750
Amount to be amortised for year ending 31.03.2012 = Rs. 6,750 X 3 months = Rs.
20,250
Rs.20,250 will be recognized in the books of sterling limited as forward

premium expense for year ended 31st March 2012.

Question 4:
Goods purchased on 1.1.11 of USD 10,000 when USD 1 – Rs.45. Exchange rate
on 31.3.11 is Rs.44 and exchange rate on date of actual payment (07.07.11)
was Rs.43 . Ascertain the gain or loss for FY10-11 and FY11-12. Also give
treatment as per AS 11.
Solution 4:
Technical context:
As per AS 11, Monetary items have to be restated at the end of an accounting

period at the closing rate prevailing on such date
Analysis & Conclusion
Part 1
Liability towards Creditors for Cost of goods purchased on 1.1.11 – Rs.45 X 10,000
= Rs.4,50,000
On 31.3.11 such creditor balance (monetary item) needs to be reinstated at

closing rate. Closing rate on 31.3.11 is Rs.44 / USD
Rupee appreciated from Rs.45/ USD to Rs.44 USD – there is gain of Re 1.
For FY11 gain of Rs.10,000 ( USD 10,000 x Re.1/ USD of gain) will be recognized
in P&L
Part 2
Rupee appreciated by additional Re.1 between 31.3.11 and 7.7.11 and the
payment was made at Rs.43/ USD on 7.7.11
Additional gain of Rs.10,000 ( USD 10,000 x Re.1/ USD of gain) will be recognized
in P&L in FY12

Question 5:
Sunshine Company Limited imported raw materials worth US Dollars

9,000 on 25th February, 2011, when the exchange rate was Rs. 44 per US
Dollar. The transaction was recorded in the books at the above mentioned
rate. The payment for the transaction was made on 10th April, 2011, when
the exchange rate was Rs. 48 per US Dollar. At the year end 31st March,
2011, the rate of exchange was Rs. 49 per US Dollar.
The Chief Accountant of the company passed an entry on 31st March, 2011
adjusting the cost of raw material consumed for the difference between Rs.
48 and Rs. 44 per US Dollar. Discuss whether this treatment is justified as
per the provisions of AS-11.
Solution 5:
Technical context:
As per AS 11, Monetary items have to be restated at the end of an accounting

period at the closing rate prevailing on such date
Analysis:
In the current case, creditor in respect of raw materials is a monetary item and
has to be restated at the closing rate on 31.3.11 in the books of Sunshine Limited.
The creditor has to be reinstated on 31.3.11 at the exchange rate prevailing on
31.3.11 i.e. at Rs. 49 per USD
Exchange loss of Rs.45,000 i.e USD 9000 x ( Rs.49 –Rs.44 = Rs.5) is recognized in
FY11.

There is an exchange gain from the balance sheet date (31.03.2011) to the date
of actual payment. Exchange gain of Rs.9000 i.e USD 9000 x ( Rs.49/ USD –Rs.48/
USD = Rs.1/USD) is recognized in FY12.
Conclusion
The amount payable to creditor (which is a monetary item) must be reinstated.

Any loss or gain arising due to such reinstatement must be transferred to profit
and loss account as “Foreign Exchange Fluctuation Gain/(Loss). Treatment of
recognizing exchange gain of Rs.36000 by reducing the cost of raw material in
FY11 as proposed by the chief accountant is is not justified
Question 6:
Explain briefly the accounting treatment needed in the following cases as per
AS 11 as on 31.3.15:
1. Sundry debtors include amount receivable from Umesh Rs.5 lacs

recorded at the prevailing Exchange rate on the date of sale.
Transaction recorded at USD 1 = Rs. 58.50
2. Long term loan taken from a US company amounting to Rs.60 lacs
recorded at USD 1 = 55.6; exchange rate taken at rate prevailing on
date of transaction.
On 31st March 2015 USD 1 = Rs.61.20
Solution 6:
Sundry Debtors: Amount receivable from Umesh in USD = Rs. 5,00,000 / (Rs.58.5
per USD) = USD 8547
Accounting as on 31.3.15:
Rupee depreciation from date of transaction to 31.3.15 :
Rs. 61.20 / USD– Rs. 58.5/ USD = Rs. 2.70/ USD of gain
Total gain on monetary item i.e receivable from Umesh = USD 8547 x Rs.2.70 /
USD = Rs.23,077
This gain will be recognized in P&L with corresponding increase in the receivable
account.
Treatment of long term loan:
Loan in USD = Rs.60 lacs / Rs.55.60 per USD = USD 107913.67

For a monetary payable, rupee depreciation will result in a loss.
Loss is Rs.61.20/ USD – Rs.55.60 / USD = Rs.5.60/ USD
Total loss = Rs.5.60 / USD x USD 107913.67 = Rs.604317
This loss on long term loan can be
1) transferred to P&L or
2) If it is for a depreciable asset capitalised it along with the cost of the fixed
asset, If not it can be accumulated in FCMITD account and written off
5.2 AS 12: Accounting for Government Grants
WHY IS THIS STANDARD REQUIRED?
The receipt of Government assistance by an entity may be significant for the

preparation of financial statements for two reasons. Firstly, if resources have
been transferred, an appropriate method of accounting for transfer must be
found. Secondly, it is desirable to give an indication of the extent to which the
entity has benefitted from such assistance during the reporting period.
AS-12 Accounting for Government Grants

Scope: AS – 12 deals with this important topic of grants or assistance in the
from both capital and revenue, from various government agencies. These
grants are also referred to as subsidies, cash incentives, duty drawbacks etc.
These can also be non-monetary, e.g. land or other resources, the standard
provides accounting method that can be followed, to suit specific situations.
The standard does not deal with
1. Accounting for grants, in FS that reflect the effect of changing price
2. Other indirect forms of assistance, or
3. Government participation in the ownership of enterprises.
Definitions:
Government Grants – Defined: Government grants are assistance by

Government in cash or kind to an enterprise for past or future compliance with
certain conditions. They exclude those forms of government assistance which
cannot reasonably have a value placed upon them and transactions with

government which cannot be distinguished from the normal trading
transactions of the enterprise.
Illustration 1: Company A deals in a product which attracts 5% Sales Tax. However,

under some package scheme of incentive, the Company is exempt from Sales Tax upto
a certain limit. Is this a Govt. Grant?
Answer – NO. As, Government grant is “Assistance by government in cash or in kind”
Government refers to state and Central Government, Government agencies

and similar bodies, whether local, national or international.
Recognition of Government Grants
Government grants should be recognized only if there is a certainty that
(i) the enterprise will comply with the conditions attached to them; and
(ii) the grants will be received
Government grant may be awarded for the purpose of giving immediate

financial support to an enterprise rather than as incentive to undertake
specific expenditure. In this case, the grant may be taken to income in the
period in which the enterprise qualifies to receive it, as an extraordinary
item.
Method Of Accounting:
AS 12 lays down two possible methods for accounting treatments of

government grants, viz:
a)Capital Approach: In capital approach, grant is treated as part of

shareholders' funds.
b)Income Approach: In income approach, a grant is treated as income (of one

or more periods depending upon circumstances of each case).
In other words, government grants are recognised in the profit and loss
statement on a systematic and rational basis over the periods necessary to
match them with the related costs.
Government grants should not be recognised on a receipt basis. If these are

recognised on a receipt basis then that will not be in accordance with the
fundamental accounting assumption of 'Accrual' as envisaged in AS 1 on

'Disclosure of Accounting Policies.'
Which method should be adopted:
Accounting for government grants should be based on the nature of the grants.
Grants which have the characteristics similar to those of promoters' contribution
(i.e, which are given with reference to the total investment in an undertaking or
by way of contribution towards its total capital outlay and no repayment is
ordinarily expected) should be accounted for on the basis of 'Capital Approach',
whereas other grants (ie, grants related to revenue) should be accounted for on
the basis of 'Income Approach'.
Following paragraphs explain Accounting Treatment of Government Grants:
A. Accounting Treatment of Grants in the nature of capital receipts (Capital

Approach):
1. Grant received is not for acquiring specific fixed asset. (i.e. in the nature
of promoter‘s contribution):
Government grants can be in the nature of promoter‘s contribution, examples

include a capital subsidy for a project. Such grants should be credited to
capital reserve and treated as part of shareholders’ fund, in as much as no
repayment is ordinarily expected in respect of such grants.
Entry required:
Cash/ Bank Account…………………………….Dr.
To Capital Reserve A/c.
2. Grant received for acquiring specific fixed assets:
Grants related to specific fixed assets are government grants whose primary
condition is that an enterprise qualifying for them should purchase, construct or
otherwise acquire such assets. Other conditions may also be attached restricting
the type or location of the assets or the periods during which they are to be
acquired or held.

The grants relating to specific fixed assets could relate to depreciable as well as
non-depreciable fixed assets. We shall now discuss the treatment of grants in
each of these cases:
Option – 1 : Deduct the value of grant from the cost of Fixed Asset
• Deduct grant from gross value of asset.
• Depreciate the asset on net value (ie, gross value less the amount of
grant).
• If grant equals the whole or virtually the whole of the cost of the asset
then the asset should be recorded at a nominal value.
Entries required:
1. Cash/ Bank Account…………………….Dr.
To Government Grant A/c
2. Fixed Asset Account……………………Dr.
To Cash/Bank A/c.
3. Government Grant A/c …………………Dr.
To Fixed asset account
(Note: depreciation is charged on the adjusted balance of fixed

asset.)
➢ Example
Gross value of asset Rs.1 crore

Government grant
(i) Rs.20 lakhs

(ii) Rs. 1 crore
In situation (i), the asset will be recorded at Rs 80 lakhs in the balance sheet
and depreciation will also be charged on this amount of Rs 80 lakhs.
In situation (ii), the asset should be recorded at a nominal value, say, Rs 100,
in the balance sheet, so that the existence of the asset, is reflected. No

depreciation is to be charged in this case.
Option – 2:
Situation1: Fixed Asset is non-depreciable asset.
The grant is credited to capital reserve, However, if the grant requires the
fulfillment of certain obligations then the grant should be credited to income
over the same period over which the cost of meeting such obligations is charged
to income and the deferred income balance should be separately disclosed in the
financial statements.
Entry required:
Cash/Bank Account……………………… Dr.
To Capital reserve A/c
Situation 2: Fixed Asset is depreciable asset - Grant is treated as a deferred

income
• Treat the grant as deferred income and recognise it in the profit and loss
account in the proportions in which depreciation on such asset is charged.
• Depreciate the asset on the basis of its gross value.
Entries required:
1. Cash/Bank Account……………………...Dr.
To Government Grant A/c
2. Fixed Asset Account……………………..Dr.
To Cash/Bank A/c
3. Depreciation A/c…………………………Dr. Entry No 3 & 4 are passed each year
To fixed Asset A/c. during the useful life of the asset
4. Government Grant A/c…………………..Dr
To P& L Account

➢ Example
In the example that has been discussed, if it is desired that Option 2 is

followed, then in both the situations, the asset will be recorded at the
full value of Rs 1 crore in the balance sheet.
In the first situation, every year an amount of Rs 2 lakhs (assuming

useful life is 10 years and straight line method of depreciation is
followed) and in the next case, an amount of Rs 10 lakhs will be
credited to the profit and loss account for a period of 10 years.
B. Grant in the nature of revenue receipts (Revenue Approach)
Government grant related to revenue should be recognized on a systematic

basis in the profit and loss statement. Such recognition should be spread over
the periods necessary to match them with the related costs, which the grant is
intended to compensate.
Hence, two alternatives are possible:
Alternative I
Credit the grant to the profit and loss account, either separately or as a part of
‘other income’.
Alternative II
Deduct the grant so received from the related expenses (which they intend to
compensate).
Refund of Government Grants.
A government grant may have to be refunded if certain conditions attached to it

have not been fulfilled. In such a case, the following treatment should be
adopted:
Government grants that become refundable should be accounted for as an

extraordinary item.
Nature of Grant Treatment at the time Treatment required at

of receipt of Grant the time of refund
Revenue Credited to Profit & Loss Debit to Profit & Loss

Revenue/Capital Credited to Deferred Debit to Deferred
Income Income.
In case of insufficient
balance in Deferred
Income account, debit
Profit & Loss
Capital Reduced from value of Increase the value of

fixed asset fixed asset.
Depreciation to be
charged on revised asset
value prospectively over
the remaining useful life
of asset.
Capital Credited to Capital Debit to Capital Reserve

Reserve

Refund of Government Grants Treat
as Extra ordinary item AS 5
YES Adjust unamortized

Was the grant S portion of such deferred
initially credit. Adjust the
accounted for as remainder by debit to
deferred credit? P& L.
NO
Was the grant related Was the grant related

to specific fixed asset to specific fixed asset,
initially accounted for initially accounted by
by reduction in the credit to capital
value of asset ? reserve
Capital reserve should

Book value to be be adjusted.
increased by a sum
equal to refundable
amount
Depreciation on the
increased value of asset,
should be adjusted
prospectively, during the
remaining useful life of
asset
➢ Example
X Ltd. received a government grant for purchase of plant and machinery. The
grant amount was Rs 10 lakhs and the gross value of plant and machinery
was Rs 40 lakhs. The grant was received on 1-4-2005 and certain conditions
regarding production were attached to it. The plant and machinery, having
a useful life of 10 years, was acquired on the same date and put to use. In
the year 2008-09, an amount of Rs 4 lakh became refundable as the desired

level of production could not be achieved. Suggest how should this be
recorded in the accounts assuming that the company follows straight line
method of depreciation?
AS 12 provide several alternatives in which the refund of government grant

be treated in accounts. These are as under:
1. An amount of Rs 4 lakhs could be reduced set off against the deferred

income balance (in the present case which will be Rs 7 lakhs as the total
grant of Rs 10 lakhs will be recognised over a period of 10 years).
2. Alternatively, the book value of the plant and machinery can be increased
by Rs 4 lakhs and depreciation calculated accordingly. The relevant
calculations are shown below:
Rs.
Gross Book Value on 1-4-2005 40 lakhs
Net Book value on 1-4-2005 30 lakhs
Annual depreciation (assuming no scrap value) 3 lakhs
Book value on 1-4-2008 21 lakhs

(Rs. 30 lakhs – Rs, 9 lakhs)
Amount of grant refundable 4 lakhs
Revised book value 25 lakhs
Remaining useful life 7 years
Revised annual depreciation
= Revised book value

Remaining useful life
= Rs. 2500000 / 7
= Rs. 3,57,143 (approx)
12.1. Disclosure Requirements: The following are the disclosure requirements

of standard.

- The accounting policy adopted for government grants, including the
methods of presentation in the financial statements;
- The nature and extent of government grants recognized in the

financial statements, including grants of non-monetary assets given
at a concessional rate or free of cost.
12.2. Some Noteworthy points:
1) Grant may be Non-Monetary
Case 1: Grant may be in the form of Assets acquired at concessional rate. e.g.
Land allotted in industrial park at concessional rate. in such case it shall be
recorded at its. acquisition cost
Case 2: Grant may be in the form of Assets, received free of cost. In such case
it is recorded at a Nominal value (say Rs.100) for the purpose of identification
and control.
Grant may be receivable by an enterprise as compensation for expenses or

losses incurred in a previous accounting period. Such grant is recognized in
Income statement of the period in which it becomes receivable, as extra-
Ordinary items (if considered appropriate) as per AS-5
2) How should a contingency relating to government grants be treated
A contingency related to a government grant, arising after the grant has

been recognised, should be treated in accordance with AS 4 on "Contingencies
and Events Occurring after the Balance Sheet Date".
3) When can a government grant be treated as an extraordinary item
In the following circumstances a government grant may be treated as an

extraordinary item:
a) when the grant is awarded for the purpose of giving immediate financial
support to an enterprise rather than as an incentive to undertake specific
expenditure;
b) when the grant is awarded as compensation for expenses or losses

incurred in a previous accounting period.
In such a case, AS 5 on 'Net Profit or Loss for the period, prior period items and
changes in accounting policies' should be followed.

SAMPLE DISCLOURES IN BALANCE SHEET
Government grants The Group recognizes government grants only when there is reasonable assurance that the
conditions attached to them shall be complied with, and the grants will be received. Government grants related to
depreciable assets are treated as deferred income and are recognized in the consolidated statement of profit and
loss on a systematic and rational basis over the useful life of the asset. Government grants related to revenue are
recognized on a systematic basis in the consolidated statement of profit and loss over the periods necessary to
match them with the related costs which they are intended to compensate.
OTHER LONG TERM LIABILITIES
Particulars March 2015 March 2014
INR CRORES
Deferred income - government grant on land use rights* __ __
* During the year ended March 31, 2014, XYZ Co received a grant of approximately `___ crore from
Government towards construction of campus which is yet to be completed.
ILLUSTRATIONS
Question 1
Supriya Ltd. received a grant of Rs. 2,500 lakhs during the accounting year
2010-11 from
Government for welfare activities to be carried on by the company for its

employees. The grant prescribed conditions for its utilization. However, during
the year 2011-12, it was found that the conditions of grants were not complied
with and the grant had to be refunded to the government in full.
Elucidate the correct accounting treatment, with reference to the provisions of

AS-12.

Solution 1
The Government grant was received for carrying out welfare activities for its
employees. The Grant received was of revenue in nature and hence would have
been credited to profit and loss account at the time of receipt (or in proportion
of expenses over the years in which expenses for employee welfare was
incurred).
The amount refundable in respect of a government grant related to revenue is

applied first
Against any unamortised deferred credit remaining in respect of the grant. To
the extent that
the amount refundable exceeds any such deferred credit, or where no deferred
credit exists,
The amount is charged immediately to profit and loss statement. In the present
case, the amount of refund of government grant should be shown in the profit &
loss account of the company as an extraordinary item during the year 2011-12
A government grant that becomes refundable is treated as an extraordinary item

as per AS 5.
Question 2:
A Ltd. purchased a machinery for Rs. 40 lakhs. (Useful life 4 years and residual
value
Rs. 8 lakhs). Government grant received is Rs. 16 lakhs.
Show the Journal Entry to be passed at the time of refund of grant and the
value of the fixed assets, if:
i. the grant is credited to Fixed Assets A/c.
ii. The grant is credited to Deferred Grant A/c.
Solution 2:
i. If the grant is credited to Fixed Asset Account,

Fixed Asset A/c .... Dr. ... Rs. 16 lacs
To Cash/Bank Rs. 16 lacs
Original Cost Rs. 40 lacs

Less: Grant Received Rs. 16 lacs
Carrying Amount Rs. 24 lacs
Less: Residual Value Rs. 8 lacs
Depreciable Value Rs. 16 lacs
Useful Life 4 years
Depreciation Per Year Rs. 16 lacs/4 = Rs. 4 lacs
WDV at the end of Second Year = Rs. 24 lacs – Rs. 4 lacs X 2 = Rs. 16
lacs
Add: Amount of Refund Rs. 16 lacs
Value of Asset after Refund = Rs. 32 lacs
ii. If the grant was credited to Deferred Grant Account.

Depreciation per year = Rs. (40 lacs – Rs. 8 lacs) /4 = Rs. 8 lacs per annum.
The grant will be credited to Profit and Loss Account equally (because
depreciation is charged on SLM basis and hence ratio of depreciation is
1:1:1:1).
Amount credited to Profit & Loss Account for 2 years = Rs. 16 lacs/4 X 2 = Rs. 8
lacs.
Balance left in Deferred Grant Account after 2 years = Rs. 16 lacs – Rs. 8 lacs =
Rs. 8 lacs.
The refund of grant in this case should be debited to Deferred Grant Account to
the extent of balance available. Since the amount of refund is more than the
balance in Deferred Grant Account, the shortfall will be debited to profit and
loss account.
The journal entry will be:

Deferred Government Grant Dr ... Rs. 8 lacs

Profit & Loss Account Dr.... Rs. 8 lacs
The refund of grant will not impact the fixed asset account.
Balance in fixed asset account at the time of refund = Rs. 40 lacs – Rs. 8 lacs X
2 = Rs. 24 lacs.
Question 3:
Santosh Ltd. has received a grant of Rs. 8 crores from the Government for setting
up a factory in a backward area. Out of this grant, the company distributed Rs.
2 crores as dividend. Also, Santosh Ltd received land free of cost from State
Government but it has not recorded it at all in its books as no money has been
spent. In the light of AS 12 examine, whether the treatment of both the grants
is correct.
Solution 3:
Grant received for setting up a factory is in the nature of promoter’s
contribution and should be credited to Capital Reserve. Such amount is not
available for distribution as dividend. Hence, the company is not permitted to
distribute dividend out of such grant. The accounting treatment given by the
company is not in accordance with AS-12.
According to AS-12, if assets are received free of cost from Government as a

grant, such assets should be recorded at nominal value. Hence, in the given
case, the company must record the land received free of cost at a nominal
value (say Rs. 1 or Rs. 10). The accounting treatment given by the company is
not correct.
Question 4:
Viva Limited received a specific grant of Rs. 30 lacs for acquiring a plant of Rs.
150 lacs during 2007-08 having useful life of 10 years. The grant received was
credited to deferred income in the balance sheet.
During 2010-11, due to non-compliance of conditions laid down for the grant,
the company had to refund the whole grant to the government. Balance in the
deferred income account on that date was Rs. 21 lacs and written down value
of the plant was Rs. 105 lacs.

i. What should be the treatment of refund of grant and the effect on cost of
the fixed asset and amount of depreciation charged during the year 2010-11 in
profit and loss account?
ii. What should be the treatment of refund, if grant was deducted from the
cost of plant during 2007-08 assuming plant account showed a balance of Rs. 84
lacs as on 1.4.2010?
Solution 4:
i. If the amount was initially recorded to deferred income initially, the amount
of refund must be debited to the deferred account to the extent of balance
available. Any shortfall in deferred income account should be debited to profit
and loss account. The total amount of refund is Rs. 30 lacs and the balance
available in deferred income account is only Rs. 21 lacs. The shortfall of Rs. 9
lacs must be debited to profit and loss account.
Deferred Income A/c Dr.... Rs. 21 lacs
Profit & Loss A/c Dr. Rs. 9 lacs

ii. If the grant was deducted from cost of fixed asset account, the amount of
refund must be debited to fixed asset account. The value of fixed asset account
in this case would be increased by Rs. 21 lacs and the revised value of fixed asset
would be depreciated over the balance useful life.
Fixed Asset A/c Dr. ... Rs. 30 lacs

Balance in Fixed Asset account = Rs. 84 lacs + Rs. 30 lacs = Rs. 114 lacs.
Revised depreciation = Rs. 114/7 = Rs. 16.286 lacs per year.
5.3 AS 15: Accounting for Employee Benefits
REFERENCES:
INDIAN GAAP AS 15 – EMPLOYEE BENEFITS

IND AS IND AS 19 - EMPLOYEE BENEFITS
IND AS 19 - APPENDIX B - THE LIMIT ON A DEFINED BENEFIT ASSET,

MINIMUM FUNDING REQUIREMENTS AND THEIR INTERACTION.
Employee benefits, as the name suggests, comprises of benefits that are

payable to the employee as a result of an employer-employee relationship.
Employee benefits will also include benefits provided to the dependents of
employees. Employment may be part-time, full-time, permanent, temporary or
on casual basis. For this standard, employee includes directors and other
managerial personnel.
EMPLOYEE BENEFITS
This Statement should be applied by an employer in accounting for all
employee benefits, except employee share-based payments. (ESOP).
The standard prescribes accounting and recognition of employee benefits, the

two basic principles being:
i. Employer should recognize a liability when employees render services in

exchange for benefits be paid to them later.
ii. Employer should recognize an expense when the services provided by the
employees are consumed by him.
Employee benefits are all forms of consideration given by an enterprise in

exchange for service rendered by employees.
FORMS OF EMPLOYEE BENEFIT:

PAYABLE DURING SERVICE PAYABLE POST EMPLOYMENT
SHORT TERM EMPLOYEE POST-EMPLOYMENT

BENEFITS - paid BENEFITS
immediately. Gratuity, pension, Other
Any case<12m (salary, bonus retirement benefits payable on
etc) and after retirement
OTHER LONG TERM TERMINATION BENEFITS

EMPLOYEE BENEFITS
Gratuity, pension, Other
Payable later > 12 m retirement benefits payable on
( Sabbatical, Disability) and after retirement
Note: Dictionary meaning of sabbatical Leave: A Leave for a year or half to School
/ College / University teacher for study / rest
a. Short-term employee benefits
Short-term employee benefits are employee benefits (other than

termination benefits) which fall due wholly within 12 months after the
end of the period in which the employees render the related service.
b. Post-employment benefits
Post-employment benefits are employee benefits (other than termination

benefits) which are payable after the completion of employment.
c. Other long-term employee benefits
Other long-term employee benefits are employee benefits (other than

post-employment benefits and termination benefits) which do not fall due
wholly within twelve months after the end of the period in which the
employees render the related service.
d. Termination benefits
Termination benefits are employee benefits payable as a result of either:

• an enterprise's decision to terminate an employee's employment
before the normal retirement date (dismissal); or
• an employee's decision to accept voluntary redundancy in exchange for

those benefits (voluntary retirement).
DEFINITIONS
Post-employment benefit plans are formal or informal arrangements
under which an enterprise provides post-employment benefits for one or
more employees.
Defined contribution plans (DCP) are post-employment benefit plans

under which an enterprise pays fixed contributions into a separate entity
(a fund) and will have no obligation to pay further contributions if the
fund does not hold sufficient assets to pay all employee benefits relating
to employee service in the current and prior periods.
Defined benefit plans (DBP) are post-employment benefit plans other

than defined contribution plans.
Multi-employer plans are defined contribution plans (other than state

plans) or defined benefit plans (other than state plans) that:
• pool the assets contributed by various enterprises that are not under
common control; and
• use those assets to provide benefits to employees of more than one

enterprise, on the basis that contribution and benefit levels are
determined without regard to the identity of the enterprise that
employs the employees concerned.
Net defined benefit liability (asset)
It is the deficit or surplus adjusted for any effect of limiting a net defined
benefit asset to the asset ceiling.
Deficit or Surplus is
a. the present value of the defined benefit obligation LESS

b. the fair value of the plan assets if any

Asset Ceiling
It is the present value of any economic benefits available in the form of

refunds from the plan or reductions in future contributions to the plan.
Interest cost is the increase during a period in the present value of a

defined benefit obligation which arises because the benefits are one
period closer to settlement.
Plan assets comprise:
• assets held by a long-term employee benefit fund; and
• qualifying insurance policies.
Assets held by a long-term employee benefit fund are assets (other than
non-transferable financial instruments issued by the reporting enterprise)
that:
• are held by an entity (a fund) that is legally separate from the

reporting enterprise and exists solely to pay or fund employee
benefits; and
• are available to be used only to pay or fund employee benefits, are

not available to the reporting enterprise's own creditors (even in
bankruptcy), and cannot be returned to the reporting enterprise,
unless either:
– the remaining assets of the fund are sufficient to meet all the
related employee benefit obligations of the plan or the
reporting enterprise; or
– the assets are returned to the reporting enterprise to reimburse

it for employee benefits already paid.
A qualifying insurance policy is an insurance policy issued by an insurer

that is not a related party (as defined in AS 18 Related Party Disclosures)
of the reporting enterprise, if the proceeds of the policy:
– are not available to the reporting enterprise's own creditors (even

in bankruptcy) and cannot be paid to the reporting enterprise,
unless either:

• the proceeds represent surplus assets that are not needed
for the policy to meet all the related employee benefit
obligations; or
• the proceeds are returned to the reporting enterprise to

reimburse it for employee benefits already paid.
Fair Value
It is the price that would be received to sell an asset or paid to transfer a

liability in an orderly transaction between market participants at the
measurement date
Service Cost
It comprises of
a. Current service cost which is the increase in the present value of the
defined benefit obligation resulting from employee service in the
current period.
b. Past service cost which is the change in the present value of the
defined benefit obligation for employee service in prior periods,
resulting in the current period from the introduction of, or changes to,
post-employment benefits or other long-term employee benefits.
Past service cost may be either positive (where benefits are introduced or
improved) or negative (where existing benefits are reduced).
c. Any gains and losses on settlement
Net interest on the net defined benefit liability (asset)
It is the change during the period in the net defined benefit liability
(asset) that arises from the passage of time.
Re-measurements of the net defined benefit liability (asset)
It comprises of:
a. Actuarial gains and losses

b. Return on plan assets, excluding amounts included in net interest on
the net defined benefit liability (asset); and
c. any change in the effect of the asset ceiling, excluding amounts

included in net interest on the net defined benefit liability (asset).
Actuarial gains and losses
Actuarial gains and losses comprise:
• experience adjustments (the effects of differences between the

previous actuarial assumptions and what has actually occurred); and
• the effects of changes in actuarial assumptions.
Settlement
It is a transaction that eliminates all further legal or constructive

obligations for part or all of the benefits provided under a defined benefit
plan, other than a payment of benefits to or on behalf of, employees that
is set out in the terms of the plan and included in the actuarial
assumptions.
Vested employee benefits are employee benefits that are not

conditional on future employment.
The present value of a defined benefit obligation is the present value,

without deducting any plan assets, of expected future payments required
to settle the obligation resulting from employee service in the current and
prior periods.
BASIC PRINCIPLES
Though the standard prescribes 4 different methods, the recognition can
be narrowed down to 2 principles:
a. Accrual basis of accounting

b. Applying present value concept and recognizing a future liability at
present value as on the balance sheet date
Therefore, recognize the expenses of benefit to employees during their

service Period, which may be paid.
a. Currently;
b. On Retirement; or
c. Post Retirement

Employee benefits- Arise
due to employee-employer
relationship
Matching concept: Matching revenue generated from

assets called employees to their costs
Short term Post Other long

Termination
employee employment term employee
benefits
benefits benefits benefits
Falls due when

Falls due for employee-
Falls due for Falls due for
payment employer
payment < 12 payment at or
beyond 12 relation ends i.e
months after retirement
months “before normal
retirement”
Underlying concept of accounting treatment:

1) Accrual concept of accounting
2) Apply present value concept and recognize future liabilities
SCOPE
It Covers all employee Benefits as per
- Formal agreement;
- Legislative requirement; and
- Informal practice
It does not cover
- Employee benefit Plans e.g., ESOP
SHORT TERM EMPLOYEE BENEFITS

All short-term employee benefits are to be recognised on an undiscounted basis
(actual cost). The expenses in relation to the revenue derived from the
employees are to be accrued. If the amount paid already exceeds the amount
expected to be payable then the excess is to be recognised as an asset. In case
of capitalization of self-constructed fixed asset, a part of cost can be included

as cost of an asset. The following generally fall under short term employee
benefits-
1. Wages, Salaries
2. Leave Compensation
3. Bonus
4. Non-Monetary Benefits
Vested benefits
• They are not conditional on terms of future employment. The benefit

would be payable without any terms attached to the scheme of benefit
Non-vested benefits
• They are conditional on terms of future employment. The benefit would

be payable on satisfaction of the terms attached to the scheme of benefits
Short term employee

benefits
Vested benefits Non-vested benefits
Non-conditional on terms Conditional on terms of

of future payment future employment
Recognition and measurement

Accrual basis of accounting
Recognize on actual cost without any discounting
Liability Asset Includes cost of

Recognize amount Amount paid greater asset
expected to be paid than amount Labour cost in self
as “Accrued payable “Prepaid constructed fixed
Expense” expense” asset

The standard provides additional guidance on recognition and measurement of
short-term compensated absences and profit sharing bonus plans. These forms
of short term benefits require an element of estimation. The estimation of
short term benefits does not require actuarial valuation of these estimates as
these are not complex estimations and the entity can make a reliable estimate
on its own.
Special treatment
Short term compensated

Profit sharing bonus plan
absence ( Paid leave)
• Present obligation arises on

Earned leave
account of past service cost
Expected cost to be recognized
• Cost to be reliably estimated
as expense for unavailed
• Full cost be recognized on
portion of accumulated leave
actual basis
Casual leave
Recognize cost as and when
employee avails (No
accumulation- so no additional
cost)

LEAVES
Utilized during Un-utilized during

the year the year
Accumula
No Treatment Accumulation tion NOT
Allowed Allowed
Vesting Not
Vesting Allowed
Allowed (Leave Lapsed
(cash against leave)
against Leave)
Record Liability and NO

Recording liability and
Expenses on Proportion TREATM
Expenses on Full Basis
Basis (Based on Trends) ENT
POST EMPLOYMENT BENEFITS

- Gratuity
- Pension/Superannuation
- Provident Fund
- Medical Facilities
The recognition and measurement is based on the classification of the benefits.

They are classified as under:

Post employment benefits
DCP DBP
1. Enterprise pays fixed amount to 1. Benefits are determined by

fund length of service and other
2. No obligation to pay further variable factors
amounts in case of shortfall in the 2. Obligation to pay additional
fund funds as and when needed
Multi Employer plans

State Plans Insured benefits
Assets of many enterprises
•Established by legislation Arrangement made with an
are pooled, invested and
•Enterprise is to make fixed insurer and pay insurance
distributed by privately
periodical payment premia to the fund
managed third parties

Is actuarial risk shifted to
employer?
NO YES
Then its DCP Then its DBP
Obligation to pay arises as

Is the obligation to pay falling employee renders service
due within 12 months
Adopt present value concept
NO PV is determined using
•Then adopt present Projected Unit credit method,
value approach YES which presumes that each
•Discount rate Then adopt accrual period of service gives rise to an
should be market basis of accounting additional unit of obligation
yield on government and recognize this
bonds as on Balance
Sheet date Determine fair value assets held
by fund and qualifying insurance
policies (Plan assets)
All Costs attributable to be

recognized as expense like
Current service cost, interest
cost, actuarial gain or loss etc.,
The liability is to be adjusted with
the fair value of plan assets. Net
amount should be reflected in the
balance sheet

Summary of Accounting Principles for Defined Contribution Plan
Situation (1) Situation (2)
When obligation of an enterprise fall When obligations of an enterprise do

due for payment within 12 months not wholly fall due for payment within
12 months (i.e., > 12 months)
Recognise the liability (and expense) Recognise the liability (and expense)
on accrual basis of accounting at its Present Value.
Discount rate should be the market

yield on Government Bonds as on
balance Sheet date. Adopt the yield
for that tenor which equals the term
of obligations. E.g., if the term of
obligations of an employer entity is
estimated at 8 years, discount rate
should be the yield-to-maturity rate
for Government Bond with a remaining
maturity of 8 years.
Disclosures for Defined Contribution Plans: The Standard provided

disclosure in two area
i. In Profit & Loss: An enterprise should disclose the amount recognised as

an expense for defined contribution plans.
ii. As a part of Notes on Accounts: Where required by AS 18 ( Related Party

Disclosures), an enterprise disclose information about contributions to
defined contribution plans for key management personnel.
Accounting by an enterprise for defined benefit plans involves the following

steps:
Step 1: Reliable estimate of Employee Benefits: using actuarial techniques to

make a reliable estimate of the amount of benefit that employees have earned
in return for their service in the current and prior periods. This requires an
enterprise to determine how much benefit is attributable to the current and
prior periods and to make estimates (actuarial assumptions) about demographic
variables (such as employee turnover and mortality) and financial variables (such

as future increases in salaries and medical costs) that will influence the cost of
the benefit
Step 2: discounting that benefit using the Projected Unit Credit Method in
order to determine the present value of the defined benefit obligation and the
current service cost;
Step 3: determining the fair value of any plan assets;
Following Adjustments are often required:
(a) determining the total amount of actuarial gains and losses ;
(b) where a plan has been introduced or changed, determining the resulting past
service cost ; and
(c) where a plan has been curtailed or settled, determining the resulting gain or
loss.
In Profit and Loss Account following expenses are to be provided:
1. Current Service Cost
2. Interest Cost
3. Expected return on Plan Asset
4. Actuarial gain or losses
5. Past Service Cost
6. Effect of any curtailment or settlement
Noteworthy Points in relation to Defined Benefit Plan:
1. Where an enterprise has more than one defined benefit plan, the
enterprise applies these procedures for each material plan separately.
2. For measuring the amounts, in some cases, estimates, averages and

simplified computations may provide a reliable approximation of the
detailed computations. An enterprise should account not only for its legal

obligation under the formal terms of a defined benefit plan, but also for
any other obligation that arises from the enterprise's informal practices.
Informal practices give rise to an obligation where the enterprise has no

realistic alternative but to pay employee benefits. An example of such an
obligation is where a change in the enterprise's informal practices would
cause unacceptable damage to its relationship with employees. Simplified
computations may provide a reliable approximation of the detailed
computations.
3. Actuarial Valuation Method: An enterprise should use the Projected Unit

Credit Method to determine the present value of its defined benefit
obligations and the related current service cost and, where applicable,
past service cost.
The Projected Unit Credit Method (sometimes known as the accrued benefit
method pro-rated on service or as the benefit/years of service method) considers
each period of service as giving rise to an additional unit of benefit entitlement
and measures each unit separately to build up the final obligation. An enterprise
discounts the whole of a post-employment benefit obligation, even if part of the
obligation falls due within twelve months of the balance sheet date.
4) Attributing Benefit: In determining the present value of its defined benefit

obligations and the related current service cost and, where applicable, past
service cost, an enterprise should attribute benefit to periods of service under
the plan's benefit formula. However, if an employee's service in later years will
lead to a materially higher level of benefit than in earlier years, an enterprise
should attribute benefit on a straight-line basis from:
(a) the date when service by the employee first leads to benefits under the plan
(whether or not the benefits are conditional on further service); until
(b) the date when further service by the employee will lead to no material
amount of further benefits under the plan, other than from further salary
increases.
5) Actuarial Assumptions: Actuarial assumptions are needed to estimate the

size of the future ( post-employment) benefits that will be payable under a
defined benefits scheme. The main categories of actuarial assumptions are as
follows:
Demographic assumptions Financial assumptions

• Mortality rates before • Discount rates to apply
and after retirement
• Rate of employee • Expected return on Plan assets

turnover
• Early retirement • Future salary levels (allowing for

seniority and promotion as well as
inflation )
• Claim rates under • Future rate of increase in medical

medical plans for former costs ( not just inflationary cost
employees rises, but also cost rises specific to
medical treatments and to
medical treatments required
given the expectations of longer
average life expectancy)
The standard requires actuarial assumptions to be neither too cautious nor too
imprudent : they should be 'unbiased'. They should also be based on market
expectations' at the reporting date, over the period during which the obligations
will be settled.
Assumption about Discount Rate: The rate used to discount post-employment

benefit obligations (both funded and unfunded) should be determined by
reference to market yields at the balance sheet date on government bonds. The
currency and term of the government bonds should be consistent with the
currency and estimated term of the post-employment benefit obligations.
Actuarial Gains and Losses: Actuarial gains and losses should be recognised
immediately in the statement of profit and loss as income or expense.
6) Past Service Costs: In measuring its defined benefit liability, an enterprise

should recognise past service cost as an expense on a straight-line basis over the
average period until the benefits become vested. To the extent that the benefits
are already vested immediately following the introduction of, or changes to, a
defined benefit plan, an enterprise should recognise past service cost
immediately.
Past service cost arises when an enterprise introduces a defined benefit plan or
changes the benefits payable under an existing defined benefit plan. Such
changes are in return for employee service over the

period until the benefits concerned are vested. Therefore, past service cost is
recognised over that period, regardless of the fact that the cost refers to
employee service in previous periods. Past service cost is measured as the change
in the liability resulting from the amendment.
7) Curtailments & Settlements: A curtailment occurs when an enterprise

either:
(a) has a present obligation, arising from the requirement of a statute/regulator

or otherwise, to make a material reduction in the number of employees covered
by a plan; or
(b) amends the terms of a defined benefit plan such that a material element of
future service by current employees will no longer qualify for benefits, or will
qualify only for reduced benefits.
A curtailment may arise from an isolated event, such as the closing of a plant,
discontinuance of an operation or termination or suspension of a plan. An event
is material enough to qualify as a curtailment if the recognition of a curtailment
gain or loss would have a material effect on the financial statements.
Curtailments are often linked with a restructuring. Therefore, an enterprise
accounts for a curtailment at the same time as for a related restructuring.
A settlement occurs when an enterprise enters into a transaction that eliminates

all further obligations for part or all of the benefits provided under a defined
benefit plan, for example, when a lump-sum cash payment is made to, or on
behalf of, plan participants in exchange for their rights to receive specified post-
employment benefits.
An enterprise should recognise gain or losses on the curtailment or settlement of

a defined benefit plan when the curtailment or settlement occurs. The gain or
loss on a curtailment or settlement should comprise:
a) any resulting change in the present value of the defined benefit

obligation;
b) any resulting change in the fair value of the plan assets;
c) any related past service cost that, had not previously been
recognised.
Before determining the effect of a curtailment or settlement, an enterprise

should remeasure the obligation (and the related plan assets, if any) using
current actuarial assumptions (including current market interest rates and other

current market prices).
8) Defined Benefit Plan Assets:
a) Meaning: Defined Benefit Plan assets mean those assets created for sole
purpose of meeting the cash flows relating to payment of benefits to
employees and not for any other purpose. These are not held by employer
entity. Third party entity holds these assets. Fair value of these assets
represents the amount that is available to settle the benefit payments.
b) Recognition of Defined Benefit Asset: Plan asset shall be recognised at

it's fair value. When no market price is available, the fair value of plan
assets is estimated. e.g. by discounting expected future cash flows using
a discount rate that reflects both risk associated with plan assets and the
maturity or expected disposal rate of these assets ( if they have no
maturity, the expected period until the settlement of the related
obligation ).
Where plan assets include qualifying insurance policies that exactly match
the amount and timing of some or all of the benefits payable under the
plan, the fair value of those insurance policies is deemed to be the present
value of the related obligations, as described in paragraph 55 (subject to
any reduction required if the amounts receivable under the insurance
policies are not recoverable in full)
Plan assets exclude unpaid contributions due front the reporting

enterprise to the fund, as well as any non-transferable financial
instruments issued by the enterprise and held by the fund. Plan assets are
reduced by any liabilities of the fund that do not relate to employee
benefits, for example, trade and other payables and liabilities resulting
from derivative financial instruments.
c) Return on Plan Assets: Difference between the expected return on plan

assets and the actual return on plan assets is an actuarial gain or Loss.
The expected return on plan assets is based on market expectations, at

the beginning of the period, for returns over the entire life of the related
obligation. The expected return on plan assets reflects changes in the fair
value of plan assets held during the period as a result of actual
contributions paid into the fund and actual benefits paid out of the fund.
In determining the expected and actual return on plan assets, an enterprise

deducts expected administration costs, other than those included in the
actuarial assumptions used to measure the obligation.

d) Reimbursements: When, and only when, it is virtually certain that
another party will reimburse some or all of the expenditure required to
settle a defined benefit obligation, an enterprise should recognise its right
to reimbursement as a separate asset. The enterprise should measure the
asset at fair value. In all other respects, an enterprise should treat that
asset in the same way as plan assets. In the statement of profit and loss,
the expense relating to a defined benefit plan may be presented net of
the amount recognised for a reimbursement.
Sometimes, an enterprise is able to look to another party, such as an insurer, to

pay part or all of the expenditure required to settle a defined benefit obligation.
Qualifying insurance policies are plan assets. An enterprise accounts for
qualifying insurance policies in the same way as for all other plan assets. When
an insurance policy is not a qualifying insurance policy, the enterprise recognises
its right to reimbursement under the insurance policy as a separate asset, rather
than as a deduction in determining the defined benefit liability.
e) Offset: An enterprise should offset an asset relating to one plan against a

liability relating to another plan when, and only when, the enterprise:
i. has a legally enforceable right to use a surplus in one plan to settle

obligations under the other plan; and
ii. intends either to settle the obligations on a net basis, or to realise

the surplus in one plan and settle its obligation under the other
plan simultaneously.

OTHER LONG-TERM EMPLOYEE BENEFITS
Other long term employee

benefits
Recognition and measurement
Treatment similar to “Post

Employment benefits” On introduction of a
Examples: scheme, benefit or charge
Sabbatical leave, Jubilee shall be recognized
benefits, Long term immediately
disability benefits etc.,

TERMINATION BENEFITS
Termination benefits
When does obligation arise?

Employer’s decision
Employee’s decision like VRS
1. Occurrence of obligation is uncertain
2. If obligation is not met, it becomes a liability
1. Enterprise has present obligation as a result of past events

2. Provision created as per AS 29
1. If benefit falls due for payment more than 12 months after balance
sheet date, benefit to be discounted using Present value concept
Actuarial Assumptions
a. Demographic
- Mortality
- Employee Turnover
b. Financial
- Future Salary increase
- Discount rate
- Return on plan asset
- Medical Treatment Cost
- Change in cost of Medical Services

Discount rate to be as per return on Government Bonds
Special Features of Revised AS-15
• Disclosure of Different Components of cost to be charged to P& L Account.
• Disclosure and break up of actuarial assumptions.
• Discounting Rates as per yield on Government Bonds.
• Actuarial Assumptions may be reviewed by Management/ Auditors.
• Benefit Obligations and plan asset to be separately disclosed.
• Management of plan assets is separately reflected.
Disclosures
• Nature of Defined Benefit plans and effect of changes if any.
• Break up and reconciliation of different components of defined benefit

obligation.
• Break up and reconciliation of different components or plan assets and

return on assets.
• Expenses recognized in P& L Account in different components.
• Main Actuarial assumptions used.

AS 15 VIS-À-VIS IND AS 19
Employee AS 15 (Revised 2005) - Ind AS 19 - Employee Benefits

Benefits - Employee Benefits
Primary Ind AS 19 - Appendix B - The
literature Limit on a Defined Benefit
Asset, Minimum Funding
Requirements and their
Interaction.
Short - term and The distinction between The distinction between short-
other long-term short-term and other long- term and other long-term
employee benefits term employee benefits employee benefits depends on
depends on whether they fall whether those benefits are
wholly due within 12 months expected to be settled wholly
after the end of the period in before twelve months after
which the employees render the end of the annual
the related service. reporting period. Short-term
employee benefits are
There is an inconsistency in recognised as an expense in
the definition of short-term the period in which the
employee benefits and the Employee renders the related
current / non-current service. Unpaid short-term
classification in Schedule III. benefit liability is measured at
While the definition of short- an undiscounted amount.
term employee benefits as
per AS 15 refers to benefits
"which fall due wholly within
12 months after the end of
the period in which the
employees render the
related service", as per
Schedule III requirements,
for classification as current
liabilities, the benefits
should be "due to be settled
within 12 months after the
reporting date".

However, the Guidance Note
to the Revised Schedule VI to
the Companies Act, 1956
(Schedule VI has been
superseded by Schedule III
under the companies Act,
2013), issued by ICAI, has
clarified that while AS 15
governs the measurement
requirements, Schedule VI
(now Schedule III) governs
the presentation
requirements. Therefore,
each company will need to
apply these criteria to its
facts and circumstances and
decide an appropriate
classification of its employee
benefit obligations.
Short-term Short-term employee Short-term employee benefits
compensated benefits include short-term include paid annual leave and
absences compensated absences where paid sick leave if it is expected
the absences are expected to to be settled wholly before
occur within 12 months after twelve months after the end of
the end of the period in the annual reporting period in
which the employees render which the employees render
the related service. the related services.
There is an inconsistency in
the description of short-term
compensated absences and
the current / non-current
classification in Schedule III.
While the description of
short-term employees
compensated absence as per
AS 15 refers to absences that
"are expected to occur within
12 months after the end of
the period in which the

employees render the
related service", as per
Schedule III requirements,
for classification as current
liabilities, the absences
should be "due to be settled
within 12 months after the
reporting date".
However, the Guidance Note

to the Revised Schedule VI to
the Companies Act, 1956
(Schedule VI has been
superseded by Schedule-III
under the Companies Act,
2013), issued by ICAI, has
clarified that while AS 15
governs the measurement
requirements, Schedule VI
(now Schedule III) governs
the presentation
requirements. Therefore, to
the extent the employees has
an unconditional right to
avail the leave, the same
needs to be classified as
current even though a
portion of the same may
have to be measured as other
long term employee benefits
as per AS 15
Actuarial Similar to Ind AS, except that Detailed actuarial valuation to
valuation detailed actuarial valuation determine the present value of
to determine present value the net defined benefit
of the benefit obligation is liability (asset) is performed
carried out at least once with sufficient regularly so
every three years and fair that the amounts recognised in
value of plan assets are the financial statements do
determined at each balance not differ materially from the
other date. amounts that would have been

determined at the end of the
reporting period IAS 19 does
not specify sufficient
regularity.
Actuarial gains All actuarial gains and losses Actuarial gains and losses
and losses should be recognised representing changes in the
immediately in the present value of the defined
statement of profit and loss benefit obligation resulting
from experience adjustment
and effects of changes in
actuarial assumptions are
recognised in other
comprehensive income and not
reclassified to profit or loss in
a subsequent period.
Discount rate Market yields at the balance Post-employment benefit
sheet date on government obligations (both funded and
bonds are used as discount unfunded) should be
rates. The currency and discounted using a discount
term of the government rate determined by reference
bonds should be consistent to market yields at the end of
with the currency and the reporting period on
estimated term of the post- government bonds. However,
employment benefit subsidiaries, associates, joint
obligations. ventures and branches
domiciled outside India should
use a rate determined by
reference to market yields on
high quality corporate bonds at
the end of the reporting
period. In case, such
subsidiaries, associates, joint
ventures and branches are
domiciled in countries where
there is no deep market in
such bonds, the market yields
(at the end of the reporting
period) on government bonds
of that country should be
used. The currency and term

of the government bonds or
corporate bonds should be
consistent with the currency
and estimated term of the
post-employment benefit
obligations.
Defined benefit The changes in defined The change in the defined
plans benefit liability (surplus) has benefit liability (asset) has the
the following components : following components:
a) Service cost - recognised a) Service cost - recognised in

in profit or loss; profit or loss;
b) Interest cost - recognised b) Net interest cost (i.e. time

in profit or loss; value) on the net defined
benefit deficit / (asset) -
c) The expected return on recognised in profit or loss;
any plan assets - recognised
in profit or loss; c) Remeasurement including
d) Net actuarial gains and i) changes in fair value of plan

losses - recognised in profit assets that arise from factors
or loss. other than time value and
ii) Actuarial gains and losses on

obligations - recognised in
other comprehensive income.
Termination Termination benefits are A termination benefit liability
benefits recognised as a liability and is recognised as the earlier of
an expense when, and only the following date :
when:
* When the entity can no
* the enterprise has a longer withdraw the offer of
present obligation as a result those benefits - additional
of a past event; guidance is provided on when
this occurs in relation to an
* it is probable that an employee's decision to accept
outflow of resources an offer of benefits on
embodying economic termination and as a result of
benefits will be required to an entity's decision to

settle the obligation; and terminate an employee's
employment.
* a reliable estimate can be
made of the amount of the * When the entity recognizes
obligation. costs for a restructuring under
IND AS 37 provisions,
Contingent Liabilities and
Contingent Assets which
involves the payment of
termination benefits.
Past service cost Past service cost is Past service cost (includes
and curtailments recognised as under: curtailments) is recognised as
an expense at the earlier of
* As an expense on a straight- the following dates:
line basis over the average
period until the benefits * When the plan amendment or
become vested. curtailment occurs; and
* If benefits already vested, * When the entity recognizes

recognised as an expense related restructuring costs or
immediately. termination benefits.
Entitles recognize a
curtailment when it occurs.
However when a curtailment
is linked with a restructuring,
it is accounted for at the
same time as the related
restructuring.
Actuarial The expected and actual In determining the return on
assumptions - return on plan assets is plan assets, an entity deducts
administration arrived at after deducting the costs of managing the plan
costs expected administrative assets and any tax payable by
costs, other than those the plan itself, other than tax
included in the actuarial included in the actuarial
assumptions used to measure assumptions used to measure
the defined benefit the defined benefit obligation.
obligation. But AS 15 does Other administration costs are
not specify which costs not deducted from the return
on plan assets

should be included in those
actuarial assumptions.
Contributions No specific guidance Provides guidance on
from employees or accounting for contributions
third parties to from employees or third
defined benefit parties to defined benefit
plans plans, which are linked to
service - both dependent and
independent of the number of
years of service.
The Limit on a No specific guidance Addresses when refunds or
Defined Benefit reductions in future
Asset, Minimum contributions are regarded as
Funding available for recognition of an
Requirements and asset; how minimum funding
their interaction requirements may affect the
availability of reductions in
future contributions and when
minimum funding requirement
may give rise to a liability. It
also deals with prepayments of
a minimum funding
requirement.

OTHER KEY ASPECTS OF IND AS 19
1. DISCLOSURES
SHORT TERM; OTHER LONG TERM AND TERMINATION BENEFITS

• NO SPECIFIC DISCLOSURE REQUIREMENTS
DEFINED CONTRIBUTION PLANS

• Amound recognized as expense for DCP in P&L
• DCP for Key Managerial Personnel as per Ind AS 24
DEFINED BENEFIT PLAN
• General description of the type of plan
• Net defined benefit liability/ (asset) - showing separate reconciliation between opening
and closing balances of PV of obligation and FV of plan assets. Reconcicliation should
comprise
• Current service cost
• Interest income or expense
• Return on plan assets
• Actuarial gains and losses arising from demographic assumptions
• Actuarial gains and losses arising from changes in financial assumptions
• Past service costs
• Gains and losses from settlements
• effects of changes in forex rates
• contribution to the plan
• payments from the plan
• effects of business combinations and disposals
• Principal actuarial assumptions
• A sensitivity analysis for each significant actuarial assumptions, showing how defined
benefit obligation would have been affected
• methods and assumptions used in sensitivity analysis and changes from previous period

2. APPENDIX A TO IND AS 19 - THE LIMIT ON A DEFINED BENEFIT ASSET, MINIMUM
FUNDING REQUIREMENTS AND THEIR INTERACTION.
IS THERE MINIMUM
FUNDING
REQUIREMENT?
NO YES
FUTURE The minimum funding

RIGHT TO REFUND - EXISTENCE
CONTRIBUTION requirement for future accrual of
AND MEASUREMENT
REDUCTION benefit shall be reduced from the
future service costs determined
as above. The entity measures
the future reduction in
-Entity has right to refund only when it is contribution as future service
unconditional Such economic cost less minimum funding
- It may be entitled to refund either during benefit shall be requirement for future accrual of
life of the plan measured at lower benefits.
- The right to refund shall be measured as of surplus in the
excess of the fair value of the plan assets plan and present
The entity shall consider whether
over the PV of Defined benefit obligation value of future
minimum funding requirement
(i.e, surplus) service cost.
for past services will be available
as a refund or future reductions
in contribution. If no, the entity
shall create a liability for the
same
3. COMPARISION WITH IFRS
For determining discount rates, corporate bond rates can be taken in case of IFRS, whereas
only government bond rates are allowed in IND AS.
Illustrations
Illustration -1
A Company has a scheme for settlement allowance to retiring employees. Under the
scheme retiring employees are allowed to reimbursement of certain travel expenses
for a class they are entitled to as per company rules and to a lumpsum payment to
cover expenses of food and stay during the travel. Alternatively, employees can

claim a lumpsum amount equal to one month pay last drawn.
The company’s contention in this matter are
(i) Settlement allowance does not depend upon length of service of employee,
it is restricted to employees eligibility under travel rules of the company or
where option for lumpsum payment is exercised, equal to last pay drawn.
(ii) Since it is not related to length of service of employee it is accounted on

claim basis.
State whether contentions of the company are correct as per relevant accounting
standards. Give reasons in support of your answer
Solution
Settlement allowance payable by the company is a defined retirement benefit,

covered by AS 15 (Revised). A provision should be made every year in the accounts
for the accruing liability on account of settlement allowance. The amount of
provision should be calculated according to actuarial valuation. Where, however,
the amount of provision so determined is not material, the company can follow
some other method of accounting for settlement allowances.
The contention of the Company that the settlement allowance will be accounted
for on claim basis is not correct even if company’s obligation under the scheme is
uncertain and requires estimation.
Illustration - 2
As on 1st April 2008, the fair value of Plan assets is Rs 1 lac in respect of pension
plan of Zealius Ltd. On 30th September 2008 the plan laid out benefits of
Rs.19,000 and received inward contributions of Rs.49,000.
Plan Assets on 1/4/08 Rs. 1 lac

As on 30/9/08
Paid out benefits ( A) Rs.19,000
Contribution from company(B) Rs.49,000
Net difference(B-A) Rs 30,000
On 31st March 2009 the fair value of plan assets was Rs.1,50,000 and present value
of defined benefits obligation was Rs.1,47,920. Actuarial losses on obligations for
the year 2008-09 was Rs.600.
On 1st April 2008 the company made the following estimates based on its market
studies understanding prevailing prices.
• Interest and dividend incomes after tax payable by the fund 9.25%

• Realised & Unrealised gain on plan assets after tax 2%
• Fund administrative costs 1%
• Expected rate of return 10.25%
Find the expected and actual return on plan assets.
Solution
Amount Interest Period Workings Amount

Rate (Rs)
Opening 1,00,000 10.25% 12m 1,00,000 X 12/12 X 10.25% 10,250
balance
Net Amount 30,000 10.25% 6m 30,000 X 6/12 X 10.25 = 1,500
30,000 X 5%
Total Expected return on plan assets 11,750
Plan Assets A/c (Rs)

To Bal b/d 1,00,000 By Benefits Paid 19,000
To Contributions 49,000
To Return on Plan Assets 20,000
(Bal figure)
By Bal c/d 1,50,000
1,69,000 1,69,000
Illustration 3
The following data applies to X Ltd. Define benefit pension plan for the year ended
31 March 2009. Calculate the actual return on plan assets
Benefits paid Rs. 2.00 lacs
Employer contribution Rs. 2.80 lacs
Fair market value of plan assets on 31 March 2009 Rs.11.40 lacs
Fair market value of plan assets on 31 March 2008 Rs. 8.00 lacs
Solution
Plan Assets A/c (Rs)

To Bal b/d 8,00,000 By Benefits Paid 2,00,000
To Contributions 2,80,000

To Return on Plan Assets 2,60,000
(Bal Figure)
By Bal c/d 11,40,000
13,40,000 13,40,000
Illustration - 4
Kumar Ltd. is in engineering industry. The company received an
actuarial valuation for the first time for its pension scheme which
revealed a surplus of Rs. 6 lakhs. It wants to spread the same over the
next 2 years by reducing the annual contribution to Rs. 2 lakhs instead
of Rs. 5 lakhs. The average remaining life of the employee is
estimated to be 6 years.
You are required to advise the company.
Solution
According to AS 15 (Revised) “Employee Benefits”, actuarial gains and

losses should be recognized immediately in the statement of profit
and loss as income or expense. Therefore, surplus of Rs. 6 lakhs in
the pension scheme on its actuarial valuation is required to be
credited to the profit and loss statement of the current year.
Hence, Kumar Ltd. cannot spread the actuarial gain of Rs. 6 lakhs
over the next 2 years by reducing the annual contributions to Rs. 2
lakhs instead of Rs. 5 lakhs. It has to contribute Rs. 5 lakhs annually
for its pension schemes and provide for the same as an expense.
Illustration 5
Z Ltd changed its employee remuneration policy from 1 April 2012 to

provide for 12% contribution to Provident fund on leave encashment
also. As per the leave encashment policy the employees can either
utilise or encash it. As at 31 March 2013 the company opted an
actuarial valuation for leave encashment liability. However, it did not
provide for 12% provident fund contribution on it.
The auditor of the company wants it to be provided but the

management replied that as and when employees availed leave
encashment provident fund contribution was made. The company

further contends that this is correct treatment as it is not sure
whether the employees will avail leave encashment or utilise it.
Comment
Solution
As per AS-15 Employee Benefits, compensated absences are part of

employee benefits. An enterprise must recognise the cost of
compensated absences when the employees render services which
increase the entitlement to future compensated absences. An
enterprise should measure the expected cost of compensated absences
using actuarial valuation techniques.
In the given case, the company must provide for compensated absences
including the 12% provident fund contribution. The contention of Auditor
is valid.
Illustration 6
P Ltd has 3 business segments which are FMCG, batteries and sports
equipment. The batteries segment has been consistently under
performing and P Ltd after several discussions with labour unions have
finally decided on closure of this segment.
Under the agreement with the labour union, the employees of the
battery segment will earn no further benefit as the arrangement is a
curtailment without settlement where in the employees of the
discontinued segment will continue to receive benefits of services
rendered when the segment was functioning.
As a result of curtailment the company’s obligation that were arrived

on the basis of actuarial valuation before the curtailment have come
down.
The following information is also furnished :
Value of gross obligation before curtailment calculated on Rs 4,000 lacs

actuarial basis
Value of unamortised past service costs Rs 100 lacs

Curtailment will bring down gross obligations by Rs 500 lacs
Fair Value of Plan assets on date is estimated Rs 3,250 lacs
And, P Ltd anticipates a proportional decline in the value of

unamortized past service costs also.
You are required to calculate the gain from curtailment and also show
the liability to be recognized in the P&L a/c and Balance Sheet of P
Ltd after curtailment.
Solution
Before After Curtailment Impact

curtailment fro
m Curtailment
Gross obligation 4,000 lacs 3,500 lacs 500 lacs
Fair Value of Plan 3,250 lacs 3,250 lacs
Unamortized Past 100 lacs 87.5 lacs 12.5 lacs
Service Costs
Illustration - 7
An employee Darshan joined a company PQR Ltd in the year 2014. The
annual emoluments of Darshan as decided is Rs 15,52,303. The
company also has a policy of giving a lumpsum payment of 25% of the
last drawn salary of the employee for the each of the completed years
of service, if the employee retires after completing minimum 5yrs of
service. Salary of Darshan is expected to grow at 10% per annum. The
company has inducted Darshan at the beginning of the year and it is
expected that he will complete minimum 5yr term before retiring.
What is the amount the company should charge in its Profit & Loss a/c
every year as cost for defined benefit obligation? Also calculate service
cost and the interest costs to be charged per year assuming a discount
rate of 8%.
Solution

(a) Calculation of Defined Benefit Obligation
If Darshan will complete minimum 5 year term, then it is assumed that

he will retire in the 6th year.
Accordingly, Expected last drawn salary in the 6th year

= Rs. 15,52,303 x 110% x 110% x 110% x 110% x 110% = Rs. 25,00,000 Defined
Benefit
Obligation (DBO) = Rs. 25,00,000 x 25% x 5 = Rs. 31,25,000
Amount of Rs. 6,25,000 will be charged to Profit and Loss Account

of the company every year as cost for Defined Benefit Obligation.
Calculation of Current Service Cost & Interest Cost to be charged per year
Year Openin Current Service Cost Interest = Op Bal * 8% Closing

g Balanc
Balanc e
e
2014 - 6,25,000*0.735= 4,59,375 Nil 4,59,375
2015 4,59,375 6,25,000*0.794= 4,96,250 4,59,375*8%=36750 9,92,375
2016 9,92,375 6,25,000*0.857= 5,35,625 9,92,375*8%=79,390 16,07,390
2017 16,07,390 6,25,000*0.926= 5,78,750 16,07,390*8%=1,28,591 23,14,731
2018 23,14,731 6,25,000*1.000= 6,25,000 23,14,731*8%=1,85,269 31,25,000
5.4 AS 16: Borrowing Costs
Objective and Scope

The interest and other costs incurred before the asset is effectively used,
is known as borrowing cost. AS-16 aims to provide accounting for
borrowing costs. However, it does not deal with the actual or imputed
cost of capital, both equity and preference.
Coverage Under AS-16 Excluded
The Standard does not apply to the following:

• Actual cost of owners' equity- including preference share capital, or
• Imputed cost of such equity,
• And such other items forming part of equity and not classified as a
liability.
The substance of AS-16 is that, by applying the matching and accrual concepts,
borrowing costs can be capitalized as a part of the cost of a qualifying asset,
within certain limits.
KEY TERMS USED

Borrowing costs
Borrowing costs are interest and other costs incurred by an enterprise in

connection with the borrowing of funds, e.g.
a) Interest and commitment charges on bank borrowings and other short

term and long-term borrowings;
b) amortization of discounts or premiums relating to borrowings;
c) amortization of ancillary costs incurred in connection with the

arrangement of borrowings;
d) finance charges in respect of assets acquired under finance leases or

under other similar arrangements; and
e) Exchange differences arising from foreign currency borrowings to the

extent that they are regarded as an adjustment to interest costs.
Qualifying asset
It is an asset that necessarily takes a substantial period of time to get ready for
its intended use or sale, Examples of qualifying assets are:
• Manufacturing plants,
• Power generation facilities,
• Inventories that require a substantial period of time to bring them to a

saleable condition, and

• Investment properties.
However, if an asset is ready for its intended use or sale at the time of its
acquisition then it is not treated as a qualifying asset for the purposes of AS 16,
eg, if a ready building is acquired and put to use immediately, it is not a
qualifying asset.
What is substantial period of time
Ordinarily, a period of twelve months is considered as substantial period of time

unless a shorter or longer period can be justified on the basis of facts and
circumstances of the case. In estimating the period, time which an asset takes,
technologically and commercially, to get ready for its intended use or sale should
be considered.
The following assets ordinarily take twelve months or more to get ready for
intended use or sale unless the contrary can be proved by the enterprise:
i. assets that are constructed or otherwise produced for an enterprise’s own

use, eg, assets constructed under major capital expansions;
ii. assets intended for sale or lease that are constructed or otherwise
produced as discrete projects, eg, ships or real estate developments.
Further, in case of inventories, substantial period of time is considered to be

involved where time is the major factor in bringing about a change in the
condition of inventories, eg, liquor is often kept in store for more than twelve
months for maturing.
1. When should the borrowing costs be capitalized?
Borrowing costs should be capitalized as part of the cost of qualifying asset

when:
a) it is probable that they will result in future economic benefits;
b) they can be measured reliably.
If these conditions are not satisfied, then the borrowing costs should be
treated as an expense in the period in which they are incurred.
2. How to determine the amount to be capitalized when the funds

have been borrowed specifically
When the funds have been borrowed specifically then the amount of
borrowing costs to be capitalized is to be calculated as under:
• Ascertain actual borrowing costs [say (a)]
• Ascertain any income on the temporary investment of these borrowings
[say (b)]
• Ascertain the borrowing costs to be capitalized by deducting (b) from
(a), -
➢ Example
Rs.
Amount borrowed 10 crores
Borrowing costs incurred (a) 1.5 crores
Income from temporary investment of funds
During the period they were in surplus (b) 0.2 crores
Amount to be capitalized (a) – (b) 1.3 crores
3. How to determine the amount to be capitalized when the funds

have been borrowed generally
• When the funds have been borrowed generally then the amount of
borrowing costs to be capitalized is to be calculated by applying a
capitalization rate to the expenditure on that asset.
• The capitalization rate, here, means the weighted average of the
borrowing costs applicable to the borrowings of the enterprise that are
outstanding during the period, other than borrowings made specifically
for obtaining a qualifying asset.
• However, the amount of borrowing costs capitalized during a period
should not exceed the amount of borrowing costs incurred during that
period.
4. How to treat the excess of carrying amount of the qualifying asset

over its recoverable amount
The carrying amount or the expected ultimate cost of a qualifying asset

should not exceed its recoverable amount or net realizable value. In case

it so exceeds, the carrying amount should be written down or written off
as per AS 2 or AS 10, as the case may be. In certain circumstances, the
amount so written down or written off can also be written back as per AS
2 or AS 10, as the case may be.
➢ Example
2007-08
Rs.
Carrying Amount 1,00,000
Recoverable amount 84,000

Written down to 84,000
Amount written off 16,000
If in the year 2008-09, the recoverable amount becomes Rs. 96,000 then
the carrying amount can be written back to Rs. 96,000. However, if the
recoverable amount exceeds Rs. 1,00,000 (say Rs. 1,10,000) then the
carrying amount cannot be increased beyond Rs. 1,00,000.
5. When should capitalization commence
There are certain conditions that need to be satisfied for capitalization to

commence. These conditions are:
a) Expenditure for the acquisition, construction or production of a
qualifying asset is being incurred.
(For this purpose, only such expenditure as has resulted in payments of
cash, transfers of other assets or the assumption of interest bearing
liabilities will be included. Further, it will be reduced by progress
payments, if any, received as well as grants received in connection with
the asset in question.)
b) borrowing costs is being incurred; and
c) Activities which are necessary to prepare the asset for its intended use
or sale are in progress.
Following 'Acid Test' shall be applied to capitalize bon-owing costs:

1) There is borrowing.
2) Borrowing is directly attributable to Acquisition / production /

construction of Asset.
3) That asset is qualifying Asset i.e., Asset requires substantial period of

Time to get ready for its intended use or sale. Thus Qualifying Asset may
be Fixed Asset or Stock for sale. Generally a period of 12 months is
considered as a substantial period of time
✓ If all above 3 conditions are fulfilled capitalize Borrowing cost i.e., add to
acquisition cost of asset.
✓ Otherwise Borrowing Cost shall be treated as expense of the period and

charged to Profit & Loss A/c.
Borrowing costs incurred while land is under development are capitalized during
the period in which activities related to the development are being undertaken.
However, borrowing costs incurred while Land acquired for building purposes is
held without any associated development activity do not qualify for
capitalization.
6. Suspension of Capitalization: Capitalization of borrowing costs should

be suspended during extended periods in which active development is
interrupted. Borrowing costs may be incurred during an extended period
in which the activities necessary to prepare an asset for its intended use
or sale are interrupted. Such costs are costs of holding partially completed
assets and do not qualify for capitalization.
Exceptions:
1) Capitalization of borrowing costs is not normally suspended 'during a

period when substantial technical and administrative work is being
carried out.
2) Capitalization of borrowing costs is also not suspended when a

temporary delay is a necessary part of the process of getting an asset
ready for its intended use or sale. For example, capitalization
continues during the extended period needed for inventories to mature
or the extended period during which high water levels delay
construction of a bridge, if such high water levels are common during
the construction period in the geographic region involved.

7. Cessation of Capitalization: Capitalization of borrowing costs should
cease when substantially all the activities necessary to prepare the
qualifying asset for its intended use or sale are complete. An asset is
normally ready for its intended use or sale when its physical construction
or production is complete even though routine administrative work might
still continue. If minor modifications, such as Ike decoration of a property
to the user's specification, are all that are outstanding, this indicates that
substantially all the activities are complete.
8. When the construction of a qualifying asset is completed in parts and a

completed part is capable of being used while construction continues
for the other parts, capitalization of borrowing costs in relation to a
part should cease when substantially all the activities necessary to
prepare that part its intended use or sale are complete.
A business park comprising several buildings, each of which can be used

individually, is an example of a qualifying asset for which each part is
capable of being used while construction continues for the other parts. An
example of a qualifying asset that needs to be complete before any part
can be used is an industrial plant involving several processes which are
carried out in sequence at different parts of the plant with in the same
site, such as a steel mill.
9. Which exchange difference can be included in borrowing costs (Para

4(e) of AS 16)
• Exchange differences arising from foreign currency borrowings and

considered as borrowing costs are those exchange differences which
arise on the amount of principal of the foreign currency borrowings to
the extent of the difference between interest on local currency
borrowings and interest on foreign currency borrowings.
• Thus, the amount of exchange difference not exceeding the difference

between interest on local currency borrowings and interest on foreign
currency borrowings is considered as borrowings costs to be accounted
for under this Standard and the remaining exchange difference, if any,
is accounted for under AS 11 – The Effects of Changes in Foreign
Exchange Rates.
• For this purpose, the interest rate for the local currency borrowings is
considered as that rate at which the enterprise would have raised the
borrowings locally had the enterprise not decided to raise the foreign
currency borrowings.
➢ Example

RGS Ltd. has raised a loan of $ 1,00,000 on 1-4-2008 for a specific
project @ 6% p.a. payable annually. On 1-4-2008, the exchange rate is
Rs. 48 per $. On 31-3-2009, the exchange rate is Rs. 50 per $. The
corresponding amount could have been borrowed by RGS Ltd. in local
currency @ 10% p.a. as on 1-4-2008.
In this case, the amount that can be included in the borrowing costs
will be computed as under:
1) Interest for the period
= $ 1,00,000 x 6% x 50 = Rs. 3,00,000
2) Increase in liability towards the principal amount
= $ 1,00,000 x 2 = Rs. 2,00,000
3) Interest that would have resulted if the loan was taken in local
currency
= $ 1,00,000 x 48 x 10% = Rs. 4,80,000
4) Difference between interest on local currency and foreign currency

borrowing
= Rs. 1,80,000 (Rs. 4,80,000 – Rs. 3,00,000)
Thus, out of Rs. 2,00,000 increase in the liability towards principal

amount, only Rs. 1,80,000 will be considered as the borrowing cost.
Thus, the total borrowing costs would be Rs. 4,80,000 (Rs. 3,00,000 +
Rs. 1,80,000). The remaining amount of Rs. 20,000 would be
considered as the exchange difference to be accounted for as per AS
11 (Revised 2003).
Ministry of Corporate Affairs has clarified vide circular no. 25/ 2012
dated 09th August, 2012 that Para 49e) of AS 16 should not apply to a
company which is applying Para 46A of AS 11 (refer chapter 11: AS on
‘Effects of Changes in Foreign Exchange Rates’, i.e., the entire foreign
exchange arising on subsequent reporting of a long-term foreign
currency monetary item will be either capitalized or transferred to
FCMITDA, as the case may be.
➢ Example

XYZ Ltd. has taken a long-term loan of USD 10,000 on April 1, 2011 at
an interest rate of 5% p.a., payable annually. On April 1, 2011, the
exchange rate between the currencies was Rs. 45 per USD. The
exchange rate, as at march 31, 2012, is Rs. 48 per USD. The
corresponding amount could have been borrowed by XYZ Ltd. in local
currency at an interest rate of 11 percent per annum as on April 1,
2011.
The following computation would be made to determine the amount

of borrowing costs for the purposes of paragraph 4(e) of AS 16-
a) Interest for the period = USD 10,000 x 5% X Rs. 48 / USD = Rs. 24,000
b) Increase in the liability towards the principal amount = USD 10,000

x (48-45) = Rs. 30,000
c) Interest that would have resulted if the loan was taken in Indian
currency = USD 10000 x 45 x 11% = Rs. 49,500
d) Difference between interest on local currency borrowing and

foreign currency borrowing = Rs. 49,500 – Rs. 24,000 = Rs. 25,500
Therefore, out of Rs. 30,000 increase in the liability towards principal

amount, only Rs. 25,500 will be considered as the borrowing cost.
Thus, total borrowing cost would be Rs. 49,500 being the aggregate of
interest of Rs. 24,000 on foreign currency borrowings (covered by
paragraph 4(a) of AS 16) plus the exchange difference to the extent of
difference between interest on local currency borrowing and interest
on foreign currency borrowing of Rs. 25,500. Thus, Rs. 49,500 would
be considered as the borrowing cost would be considered as the
borrowing cost to be accounted for as per AS 16 and the remaining Rs.
4,500 would be considered as the exchange difference to be accounted
for as per AS 11. It may be noted here that this accounting
treatment is valid if the company does not opt for Para 46A of AS
11.
Borrowing costs of Rs. 49,500
Capitalize if in relation to a qualifying Otherwise, charge to profit and loss

asset account as on ‘interest expense’ under
the head ‘finance costs’
Foreign exchange loss of Rs. 4,500:

Recognize as an expense in profit and loss account:
In case the company opts for Para 46A of AS 11:
Entire exchange difference of Rs. 30,000 will be accounted for under Para
46A of AS 11.
Foreign exchange loss of Rs. 30,000:
If in relation to acquisition of a In any other case:

depreciable capital asset:
Add to the cost of the asset and depreciate Accumulate in FCMITDA and amortize over
over the balance life of the asset the balance period of such borrowings
For Insightful Learning...!
Exchange Difference treated as borrowing cost: As per paragraph 4(e) of AS

16, exchange differences to the extent of adjustments to interest costs, are
treated as borrowing costs. Since interests on foreign currency borrowing are
recognized and paid on the same day and hence translated at same rate, no
exchange difference can arise on account of interest payments, unless the
payments are delayed. It therefore appears that the term 'exchange difference'
for the purpose of paragraph 4(e) does not mean the exchange difference on
interest payments.
It has now been interpreted that a part of exchange difference arising on the
principal amount of foreign currency borrowed should be regarded as
borrowing cost. The part of exchange difference treated as borrowing cost
should be dealt in accordance with AS 16. The remaining exchange difference
if any, can be treated as per AS 11.
As explanation to paragraph 4(e) of notified AS 16, the exchange difference to

be treated as borrowing cost is the difference between interest on local
currency borrowings and interest on foreign currency borrowings. If this
difference is equal to or more than the exchange difference on the principal,
the entire exchange difference is treated as borrowing cost.

10. Disclosure: AS —16 requires that the Financial statement should disclose:
a) The accounting policy adopted by the firm for borrowing costs; and
b) The amount of borrowing costs capitalized during the period.
11. ICAI Interpretations: ASI 1, 10
ASI 1: Substantial period of time: Ordinarily, a period of twelve months is

considered as substantial period of time, unless a shorter or longer period can
be justified on the basis of facts and circumstances of the case. Thus, a
rebuttable presumption of a period of twelve months, is considered a
"substantial” period of time. Para 4 (e) of AS-16 i.e. "Borrowing costs may include
exchange differences arising from foreign currency borrowings to the extent that
they are regarded as an adjustment to interest costs."
Land not Qualifying Asset: Interest on loan taken for the purpose Nov 2005
of constructing building / cannot be capitalized as borrowing cost CA
since land is not a Qualifying Asset, The fact that acquisition of Journal
land is an integral part of development of a property, would not
make it a Qualifying Asset since each of the asset necessary for
the project should be considered separately for the purpose of
deciding whether it constitutes a 'Qualifying Asset' for AS-16
purposes. 'Land and Building' in a case are considered separate
asset.

Eligible items or Borrowing Cost
BC that are directly attributable to BC that would have been avoided

acquisition, construction or production if the expenditure on QA had
of Qualifying Asset (QA) not been made
Capitalization conditions
YES • QA will give future economic benefits? NO
• Costs to be capitalized can be measured reliably?
Capitalize the BC Charge of as Expense
Specific Borrowings General Borrowings
• These could have been avoided but for • Borrowing is wholly or partly for
expenditure on QA expenditure incurred on QA
• Capitalization rate = “Weighted
• Capitalization rate = “Actual BC” average” of BC
• BC capitalized should not exceed actual
• Amount of BC = Actual BC (less) income cost incurred during the period.
on temporary investment
COMMENCEMENT
SUSPENSION CESSATION
• Expense on QA being • Substantial completion

• Active development is
incurred of all activities
interrupted (avoidable)
• Bc are incurred • Completed part of an
• Other unavoidable asset if the same is
• Activity in progress reasons (earthquake) capable of use

Question and Answers
Question 1:
GHI Limited obtained a loan for Rs.70 lacs on 15.4.2010 from JKL Bank to be
utilized as under:
Construction of factory shed Rs.25 lacs
Purchase of machinery Rs.20 lacs

Working capital Rs.15 lacs
Advance for purchase of truck Rs.10 lacs
Total Rs.70 lacs
On March 31st construction of factory shed was completed and machinery which
was ready for its intended use was installed. Delivery of Truck was received in
the next financial year.
Total interest of Rs.9.1 lacs was charged by the bank for FY11. Show the
treatment of interest under AS 16 and explain the nature of asset
Solution:
Treatment of Interest (Borrowing cost) as per AS 16 ‘Borrowing Costs’
Construction of Factory Shed:
If the period April 2010 to March 2011 is substantial period as per the Company’s
policy, then interest incurred on borrowings taken for such construction can be
capitalized, if not such interest cost should be charged off to the P&L Interest

attributable to Factory shed:
Rs.9.1lacs x Rs.25 lacs /Rs. 70 lacs = Rs.3.25 lacs
Purchase of Machinery:
It is not a qualifying asset as it is ready for intended use on its purchase itself.
The interest cost on same should be charged off to P&L: Rs. 9.1 lacs X 20/70 =
Rs. 2.6 lacs
Working Capital:
Interest cost on inventory can be capitalised if it takes substantial period of

time. Working capital is generally a non-qualifying asset and interest cost on
such working capital should be charged off: Rs. 9.1 lacs X 15/70 = Rs. 1.95 lacs
Advance for purchase of truck:
Even after delivery is made, if an asset takes substantial period of time to be

ready for intended use only then will it be considered as a qualifying asset.

Hence, truck is a non-qualifying asset and the interest pertaining to the loan
will be debited to profit and loss account: Rs. 9.1 X 10/70 = Rs. 1.3 lacs.
Question 2:
Axe Ltd began construction of a new plant on 1.4.2011 and obtained a special
loan of Rs.4 lacs to finance construction of the plant. Interest rate is 10%.
Expenditure that was made on the project of plant was as follows:
1.4.2011 Rs. 5 lacs
1.8.2011 Rs. 12 lacs

1.1.2012 Rs. 2 lacs
The Company’s other outstanding non-specific loan was Rs.23 lacs at interest
rate of 12%. Construction of the plant completed on 31.3.2012. You are required
to:
(a) Calculate the amount of interest to be capitalized as per the provisions of AS

16 “Borrowing Cost”.
(b) Pass a journal entry for capitalizing the cost and the borrowing cost in respect
of the plant.
Solution:
Total expenses to be capitalized for borrowings as per AS 16 “Borrowing Costs”:

Rs.
Cost of Plant (5,00,000 + 12,00,000 + 2,00,000) 19,00,000

Add: Amount of interest to be capitalised (W.N.1) 1,54,000
20,54,000
Journal Entry
Rs. Rs.

31st March, Plant A/c Dr. 20,54,0
2012 To Bank A/c 00 20,54,0
00
[Being amount of cost of plant
and borrowing cost thereon
capitalised]
Working Notes:
1. Computation of Interest
Date Amount Month Rate Interest

s
01.04.2011 4,00,000 12 10% 4,00,000 X 10%
X12/12
=40,000
01.04.2011 1,00,000 12 12% 1,00,000 X 12% X

12/12
=12,000
01.08.2011 12,00,000 8 12% 12,00,000 X 12% X
8/12
=96,000
01.01.2012 2,00,000 3 12% 2,00,000 X 12% X 3/12
=6,000
Total Rs. 1,54,000
Question 3:
On 18th April, 2011, Amazing Construction Ltd. obtained a loan of Rs. 32 crores
to be utilized as under:
(i) Construction of sea link across two cities (work was held up Rs. 25 crores
totally for a month during the year due to high water levels)
(ii) Purchase of equipment and machineries Rs. 3 crores

(iii) Working capital Rs. 2 crores
(iv) Purchase of vehicles Rs.50,00,000
(v) Advance for tools/cranes etc Rs.50,00,000
(vi) Purchase of technical know-how Rs.1 crores

(vii) Total interest charged by the bank for the year ending 31st Rs. 80,00,000
March 2012
Show the treatment of interest by Amazing Construction Ltd.
Solution:
According AS 16 ‘Borrowing costs’, a qualifying asset is an asset that necessarily

takes substantial period of time to get ready for its intended use or sale.
Borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset should be capitalised as part of the cost of that
asset. Other borrowing costs should be recognised as an expense in the period in
which they are incurred.
In the given case, construction of sea-link is a qualifying asset. The capitalisation

is continued for periods in which active development is stopped due to high water
levels (which is common in construction of bridges).
Purchase of equipment and vehicles are not qualifying asset as they are generally
ready for use at the time of purchase. Similarly, technical know-how are not
qualifying assets.
Working capital for day to day operations of business is not qualifying asset
The treatment of interest by Amazing Construction Ltd. can be shown as:
Qualifyi Interest Interest to

ng to be be charged
Asset Capitalize to Profit &
d Rs. Loss A/c
Rs.

Construction of sea-link Yes 62,50,00 [80,00,000*(25/32)
Purchase of equipment No 0 7,50,000 ]
and machinery [80,00,000*(3/32)]
Working capital No 5,00,000
Purchase of vehicles No 1,25,000 [80,00,000*(2/32)]
Advance for tools, cranes No 1,25,000 [80,00,000*(.5/32)
etc. No 2,50,000 ]
Purchase of technical [80,00,000*(.5/32)
knowhow 62,50,00 ]
Total 0 17,50,000 [80,00,000*(1/32)]
Question 4:
Suhana limited issued 12% secured debentures of Rs.100 lacs on 1.5.2013 to be

utilised as under:
• Construction of factory building – Rs.40 lacs

• Purchase of Machinery – Rs.35 lacs
• Working Capital Rs.25 lacs
In March 2014 construction of factory building was completed and Machinery was
installed and is ready for its intended use.
Total interest on debentures for FY14 was 11 lacs. During the year 13-14, the
company had invested idle funds out the money raised from debentures in Bank
FDs and earned interest of Rs.2 lacs. Show the treatment of interest under AS 16
and explain the nature of asset.
Solution:
According to AS 16 “Borrowing Costs”, borrowing costs that are directly

attributable to the acquisition, construction or production of a qualifying asset
should be capitalised as part of the cost of that asset.Other borrowing costs
should be recognised as an expense in the period in which they are incurred.
Also para 10 of AS 16 “Borrowing Costs” states that to the extent that funds are
borrowed specifically for the purpose of obtaining a qualifying asset, the amount
of borrowing costs eligible for capitalisation on that asset should be determined
as the actual borrowing costs incurred on that borrowing during the period less
any income on the temporary investment of those borrowings.
Thus, eligible borrowing cost = Rs. 11,00,000 - Rs. 2,00,000 = Rs. 9,00,000
Interest to be
Interest to be charged to
Capitalized Profit & Loss
S.No. Particulars Nature of assets (Rs.) Account (Rs.)
Construction of factory Qualifying 9,00,000x40/10

1 building Asset* 0 = Rs. 3,60,000 NIL
9,00,000x
Not a Qualifying 35/100
2 Purchase of Machinery Asset NIL = Rs.3,15,000
9,00,000x
Not a Qualifying 25/100 = Rs.
3 Working Capital Asset NIL 2,25,000
Total Rs. 3,60,000 Rs. 5,40,000
* A qualifying asset is an asset that necessarily takes a substantial period of

time to get ready for its intended use or sale.
Question.5
Shan Builders Limited has borrowed a sum of US $ 10,00,000 at the beginning of

Financial Year 2014-15 for its residential project at LIBOR + 3 %. The interest is
payable at the end of the Financial Year. At the time of availing the
loan, exchange rate was Rs. 56 per US $ and the rate as on 31st March,2015
was Rs. 62 per US $. If Shan Builders Limited had borrowed the loan in India in
Indian Rupee equivalent, the pricing of loan would have been 10.50%. Compute
Borrowing Cost and exchange difference for the year ending 31st March, 2015 as
per applicable Accounting Standards. (Applicable LIBOR is 1%).
Solution:
(i) Applicable interest rate : 1% +3% = 4%

Interest for the period 2014-15 = US $10,00,000 x 4% × Rs. 62 per US $ =
Rs. 24.80 lakhs
(ii) Increase in the liability towards the principal amount = US $ 10,00,000 ×

Rs. (62 - 56) = Rs. 60,00,000
(iii) Interest that would have resulted if the loan was taken in Indian
currency = US $ 10,00,000 × Rs. 56 x 10.5% = Rs. 58,80,000
(iv) Difference between interest on local currency borrowing and foreign

currency borrowing = Rs. 58,80,000– Rs. 24,80,000 = Rs.34,00,000.
Borrowing Costs include exchange differences arising from foreign currency

borrowings
To the extent that they are regarded as an adjustment to interest costs.
Therefore, out of exchange fluctuation loss of Rs.60 lakhs towards principal
amount, only Rs. 34 lakhs will be considered as the borrowing cost.
Total Borrowing Cost = Rs. 24,80,000 + Rs. 34,00,000 = Rs. 58,80,000
Hence, Rs. 58.80 lakhs would be considered as the borrowing cost to be

accounted for as per AS 16 “Borrowing Costs” and the remaining Rs. 26 lakhs (60
- 34) would be considered as the exchange difference to be accounted for as per
AS 11 “The Effects of Changes in Foreign Exchange Rates”.
5.5 AS 17 Segment Reporting
INDIAN GAAP AS 17 – SEGMENT REPORTING
IND AS IND AS 108 – OPERATING SEGMENTS
AS17 SEGMENT REPORTING
Applicability
Mandatory for
1. Enterprises whose equity or debt securities are listed whether in India or

outside India.

OR
2. Enterprises which are in the process of listing their equity or debt

securities as evidenced by the Board's resolution in this regard.
Scope
a) Applied in presenting general purpose financial statements.
b) The requirements of this Statement are also applicable in case of

consolidated financial statements.
c) If a single financial report contains both consolidated statements and the

separate financial statements of the parent, segment information need
be presented only on the basis of the consolidated financial statements,
the references in this Statement to any financial statement items should
constructed to be the relevant item as appearing in the consolidated
Definitions of the terms used in this standard:

A business segment is a distinguishable component of an enterprise that is
engaged in providing an individual product or service or a group of related
products or services and that is subject to risks and returns that are different
from those of other business segments.
Aggregation Criteria: Two or more business segments may be aggregated in to a

single business Segment if the segments have similar economic characteristics
on following aspects
a) The nature of the products and services;
b) The nature of the production processes;
c) The type or class of customer for their products and services;
d) The methods used to distribute their products or provide their

services; and
e) If applicable, the nature of the regulatory environment, for example,

banking, insurance or public utilities.

A geographical segment is a distinguishable component of an enterprise that is
engaged in providing products or services within a particular economic
environment and that is subject to risks and returns that are different from those
of components operating in other economic environments. Factors that should
be considered in identifying geographical segments include:
a) similarity of economic and political conditions;
b) relationships between operations in different geographical areas;
c) proximity of operations;
d) special risks associated with operations in a particular area;
e) exchange control regulations; and
f) the underlying currency risks.
A reportable segment is a business segment or a geographical segment identified

on the basis of foregoing definitions for which segment information is required
to be disclosed by this Statement.
Ind AS 108 uses the term “OPERATING SEGMENT” which is defined later in
this chapter

How do you identify Business Segments?
a) Nature of Products and Services (risk and returns associated): Dabur has identified
following segments based on risk and returns.
Dabur India Ltd.
Personal Care Health Care Foods Home Care

➢ Hair Care ➢ Health ➢ Juices, ➢ Mosquito
➢ Body Care Supplements Nectars & Repellants
➢ Skin Care ➢ Oral Care Drinks ➢ Air
➢ Baby Care ➢ Honey fresheners
➢ Digestives ➢ Culinary ➢ Hard
➢ Ayurvedic Products surface
Portfolio cleaners
b) Production Processes
Example: Shroff Furniture Manufactures and sells furniture. The main products are chairs,
tables and sofas. The production process is similar for chairs and tables. Hence the
aggregation criteria can be applied and the product chairs and tables can be reported as on
operating segment.
c) Customer
Example: IDBI Bank provides the following services: corporate banking, retail banking,
personal banking, commercial banking and cash management services. Its major customers
for corporate banking and cash management services are corporate bodies. Therefore the
entity can merge corporate banking services and commercial banking services and treat them
as one reporting segment using the aggregation criteria.
d) Distribution Methods
Example: Sultanchand Publications carry out the following two major activities: Publishing
of books, both academic and educational and story / novel. The distribution methods for the
academic & educational books action are quite similar. Therefore, applying the aggregation
criteria, the publishing activities of the both types of books can be merged and reported as
a single reporting segment.
e) Regulatory environments
Example: Reliance Capital is involved in various business activities which include insurance
underwriting and share Broking. Under insurance, it provides insurance of life and property.
Its insurance activities are -regulated by the Insurance Act. So all the services under the

insurance business may be aggregated and the merged segment may be reported as a single
segment.
REPORTABLE SEGMENT
BUSINESS SEGMENT GEOGRAPHICAL SEGMENT
BASED ON LOCATION BASED ON LOCATION

OF ASSETS OF CUSTOMERS
Segment revenue is the aggregate of
a) the portion of enterprise revenue that is directly attributable to a

segment,
b) the relevant portion of enterprise revenue that can be allocated on a

reasonable basis to a segment, and
c) revenue from transactions with other segments of the enterprise.
Segment revenue does not include:
a) extraordinary items as defined in AS 5, Net Profit or Loss for the Period,

Prior Period Items and Changes in Accounting Policies;
b) interest or dividend income, including interest earned on advances or

loans to other segments, unless the operations of the segment are
primarily of a financial nature; and

c) gains on sales of investments or on extinguishment of debt unless the
operations of the segment are primarily of a financial nature.
Meaning of revenue is explained by following chart:
SEGMENT REVENUE
DIRECT SALES ALLOCATED REVENUE INTERNAL SALES
NOTE - Do not include extra-ordinary items, Interest or dividend

income, gain on sale of investment
Segment expense is the aggregate of:
a) the expense resulting from the operating activities of a segment that is

directly attributable to the segment, and
b) the relevant portion of enterprise expense that can be allocated on a

reasonable basis to the segment, including expense relating to
transactions with other segments of the enterprise.
Segment expense does not include:
a) extraordinary items are defined in AS 5, Net Profit or Loss for the Period,
Prior Period Items and Changes in Accounting Policies.
b) interest expense, including interest incurred on advances or loans from

other segments, unless the operations of the segment are primarily of a
financial nature;

c) losses on sales of investments or losses on extinguishment of debt unless
the operations of the segment are primarily of a financial nature;
d) income tax expense; and
e) general administrative expenses, head-office expenses, and other

expenses that arise at the enterprise level and relate to the enterprise as
a whole. However, costs are sometimes incurred at the enterprise level
on behalf of a segment. Such costs are part of segment expense if they
relate to the operating activities of the segment and if they can be
directly attributed or allocated to the segment on a reasonable basis
Segment expense can be summarized as under:
SEGMENT EXPENSE
EXPENSE RELATING
DIRECTLY TO TRANSACTIONS
ALLOCATED EXPENSE
ATTRIBUTABLE WITH OTHER
SEGMENTS
NOTE - Do not include extra-ordinary items, Interest Expenses, loss on sale

of investment, Income tax expenses and Head Office Expenses.
Segment result is segment revenue less segment expense.
Segment assets are those operating assets that are employed by a segment in
its operating activities and that either are directly attributable to the segment
or can be allocated to the segment on a reasonable basis. If the segment result
of a segment includes interest or dividend income, its segment assets include
the related receivables, loans, investments, or other interest or dividend
generating assets. orient assets do not include income tax assets.
Segment assets are determined after deducting related allowances/provisions

that are reported as direct offsets in the balance sheet of the enterprise.
Meaning of Segment asset can be summarized as under:
SEGMENT ASSETS
DIRECTLY ATTRIBUTABLE
ALLOCATED ASSETS
ASSETS
NOTE - Include
• Receivable loans, investments etc., if segment results includes

Interest, dividend income.
• Do not include income tax assets.
Segment liabilities are those operating liabilities that result from the
operating activities of a segment and that either are directly attributable to
the segment or can be allocated to the segment on a reasonable basis. If the
segment result of a segment includes interest expense, its segment liabilities
include the related interest-bearing liabilities.
NOTE - Segment liabilities do not include income tax liabilities.

SEGMENT LIABILITIES
(OPERATING)
DIRECTLY ATTRIBUTABLE ALLOCATED
Segment accounting policies are the accounting policies adopted for preparing
and presenting the financial statements of the enterprise as well as those
accounting policies that relate specifically to segment reporting
Deciding Primary and Secondary Segments format
Deciding Primary and Secondary Segments format:
1. Some businesses have business as well as geographical segment e.g. a

multiproduct company like HUL having operations in several countries,
segmentation by either the line of activity (business segments) or by
geographical areas of operation (geographical segments) is taken as
primary.
a. If the risks and returns are affected predominantly by difference in

products and services it process it's primary format for reporting
segment information should be business segments with secondary
information reported geographically.
b. Similarly if the risks and returns of the enterprise are affected

predominantly by the fact it operates in different countries or other
geographical areas, it's primary format for reporting segment
information should be geographical segments with secondary
information reported for group of related products or services.
2. Normally organizational and management structure of an enterprise and

it's internal financial reporting system provides best evidence of
predominant source of risks and returns of the enterprise for the purpose

of segment reporting.
a. Except in rare circumstances, an enterprise will report segment

information in its financial statements on the same basis as it
reports internally to top management.
b. Its predominant source of risks and returns becomes its primary

segment-reporting format.
c. Its' secondary source of risks and returns becomes its secondary

segment reporting format.
3. ‘Matrix presentation' –
a. for some businesses, both business segments and geographical

segments as primary segment reporting formats with full segment
disclosures on each basis
b. will often provide useful information if risks and returns of an

enterprise are strongly affected both by differences in the products
and services it produces and by differences in the geographical
areas in which it operates.
c. This Statement does not require, but does not prohibit, a 'matrix
presentation'.
The objective is to achieve a reasonable degree of comparability with other

enterprises, enhance understandability of the resulting information, and meet
the needs of investors, creditors, and others for information about
product/service-related and geographically related risks and returns.
Deciding Reportable Segments:

1. Apply Quantitative threshold Test: A business segment or geographical
segment should be identified as a reportable segment if:
a) its revenue from sales to external customers and from transactions

with other segments is 10 per cent or more (>=10%) of the total
revenue, external and internal, of all segments;
OR

b) its segment result, whether profit or loss, is 10 per cent or more
(>=10%) of –
i. the combined result of all segments in profit, 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 (>=10%) of the total assets
of all segments.
For Insightful Learning…..
The10 per cent thresholds in this Statement are not intended to be a

guide for determining materiality for any aspect of financial reporting
other than identifying reportable business and geographical segments.
2. Management discretion: A business segment or a geographical segment

which is not a reportable segment may be designated as a reportable
segment despite its size 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.
3. 75% Revenue coverage: If total external revenue attributable to

reportable segments constitutes less than 75 per cent of the total
enterprise revenue, additional segments should be identified as
reportable segments, even if they do not meet the 10 per cent thresholds,
until at least 75 per cent of total enterprise revenue is included in
reportable segments.
1. A segment identified as a reportable segment in the immediately

preceding period because it satisfied the relevant 10 per cent thresholds
should continue to be a reportable segment for the current period
notwithstanding that its revenue, result, and assets all no longer meet

the 10 per cent thresholds.
2. If a segment is identified as a reportable segment in the current period

because it satisfies the relevant 10 per cent thresholds, preceding-period
segment data that is presented for comparative purposes should, unless
it is impracticable to do so. be restated to reflect the newly reportable
segment as a separate segment, even if that segment did not satisfy the
10 per cent thresholds in the preceding period.
Accounting Policies followed in Segment Reporting

Uniform Accounting Policies:
a) Segment information should be prepared in conformity with the

accounting policies adopted for preparing and presenting the
financial statements of the enterprise as a whole.
b) It is not indicated whether the accounting policies are to be

applied to reportable segments as if these segments were
separate reporting entities.
c) A detailed calculation done in applying a particular accounting

policy at the enterprise wide level may be allocated to segments
if there is a reasonable basis for doing so. Eg. Pension calculations
are done for an enterprise as a whole, but the enterprise wide
figures may be allocated to segments based on salary and
demographic data.
1. Different Accounting Policies: Additional Segment Information on the

basis of policies other than the enterprise's Accounting Policies may be
disclosed provided that-
a) The information is reported internally to the Board of Directors

and the CEO for making decisions about allocating resources to
the segment and assessing its performance, and
b) The basis of measurement for this additional information is clearly

described

AS-17 Summary:
Step 1: Identify segments: Segments may be Business segments or geographical

segments
Segments may be
Business Segment Geographical
Product or Services Economic and Political

Conditions
Geographical Area
Production Process
Type or class of Proximity of operations

customers
Methods used to Special risk associated with

distribution operations in different areas
Regulatory Norms Exchange Control
Currency Risk
Step2: Decide basis for Primary Segments Report and Secondary Segment Report
Based on predominant Risk and Returns
If primary Reporting is business segment. If primary reporting is geographical

Secondary information is geographical segment, Secondary information is
segments Business Segment

Step3: Identifying reportable segments.
Segments so identified above are they reportable segment?
Does it satisfy 10% No

Threshold PY?
Yes Does management want to treat

Yes it as a reportable segment?
No
Does it satisfy 10% threshold last
Yes year?
No
Unallocated reconciling item
Reportable Segment
Do the identified reportable segments comprise 75%of total enterprise revenue

(external) or more?
No
Include segments even if they do not satisfy 10% criteria till included segments
constitute 75% or more of enterprise revenue.
NOTE – IND AS 108 PROVIDES ADDITIONAL GUIDANCE ON THE

FOLLOWING, WHICH ARE EXPLAINED IN DETAIL IN THE LATER PART OF
THE CHAPTER
- Residual category: All other segments

- Continuity
- Newly identified reportable operating segments
- Flexibility in the area or detailed disclosures

Disclosure Requirements
A. Disclosure requirements for primary reporting Format
1. Applicability: The disclosure requirements of AS 17 should be applied to each

Reportable Segment based on primary Reporting Format of an enterprise.
2. Disclosure: An enterprise should disclose the following, for each reportable

segment-
• Revenue from external customers
• Inter-Segment Revenue
• Segment Result
• Carrying amount of Segment Assets
• Segment Liability
• Capital Expenditure
• Depreciation & amortization Expense
• Non-Cash Expense
• Share of Profit / Loss in associate / Joint Venture
• Investment in associate / Joint Venture (equity method)
• Reconciliation of revenue, result, assets & liabilities by business segment
3. Extra Ordinary items warranting disclosure:
a) As required by AS-5 disclosure is required in respect of the nature and

mount of any items of Segment revenue and Segment Expense that are
of such size, nature or incidence that their disclosure is relevant to
explain the performance of the segment for the period.
b) Examples:
1. Write downs of inventories

2. Provisions for restructuring
3. Disposals for fixed assets and long term investments,
4. Legislative changes having retrospective application
5. Litigation settlements
6. reversal of provisions etc.
Effect of Disclosure of extra

ordinary items
Changes the level at which the Non intended to change the

significance of such items is classification of any such items of
evaluated for disclosure purposes revenue or expense from ordinary to
from the enterprise level to the extra ordinary or to change the
Segment level measurement of such items
NOTE – AS PER IND AS 1 - PRESENTATION OF ANY ITEM OF INCOME OR

EXPENSE AS EXTRAORDINARY IS PROHIBITED
4. Cash flow Statements: When an enterprise presents a Cash flow statement and
reports Cash flows from operating, investing and Financing Activities of each
reportable segment, depreciation and amortization expense and non cash
expenses of such segment as required above need not be disclosed.
5. Reconciliation: A Reconciliation between the information disclosed for

reportable segments and the aggregated information in the enterprise financial
statements should be presented. The reconciliation should be for the following-
a. Segment revenue reconciled with enterprise revenue,

b. Segment result reconciled with enterprise net profit or loss,
c. Segment assets reconciled with enterprise assets, and
d. Segment liabilities to enterprise liabilities,
Total of all Total

Segment enterprise
Add / Less:
items i.e. items i.e.
reconciling
Revenue, Revenue,
items
Result assets result, assets
and liabilities and liabilities
NOTE – IND AS 108 ALSO PRESCRIBES ‘RESIDUAL SEGMENT’ CATEGORY.

HENCE IT HAS TO BE CONSIDERED IN RECONCILIATION ALSO.
Disclosure requirement for Secondary Segments

Applicability: The disclosure requirements of AS-17 should be applied to each
Reportable Segment based a Secondary Reporting Format of an enterprise
Primary Format Secondary Disclosure requirements
• The Secondary Format report the following

information-
Segment revenue from external customers by
geographical area based on the geographical
location of its customers, for each
geographical segment whose revenue from
sales to external customers is 10% or more of
enterprise revenue
• Total Carrying amount of Segment assets by

Business Segments geographical location of assets, for each
geographical segment whose segment assets
are 10% or more of the total assets of all
geographical segments, and
• Total cost incurred during the period to
acquire segment assets that are expected to
be used during more than one period (tangible
and intangible fixed assets) by geographical
location of assets, for each geographical
segment whose segment assets are 10% or
more of the total assets of all geographical
segments
For each business Where the location of

its customers is
segment whose revenue different from the
from
location of its assets,
sales to external then the enterprise
customers is should also report
Revenue from sales to
10% or more of enterprise external customers for
each customer based
revenue, or whose
geographical segment
segment
whose revenue from
assets are 10% or more of sales to external
the customers in 10% or
more of enterprise
total assets of all business revenue.
segments the following
Geographical segments
based on the location of information: -
assets
a. Segment revenue
from
external customers,
b. Total Carrying
amount
of segment assets,
and
c. Total cost incurred

during the period
acquires segment

assets
that are expected

to be
used during more

than
one period (tangible

and
Intangible fixed
assets).
For each business Where the assets of the

enterprise are located
segment whose revenue in different
from
geographical areas from
sales to external its customers, then, for
customers is each asset based
geographical segment
10% or more of enterprise whose revenue from
sales to external
revenue or whose segment
customers or segment
assets
assets are 10% or more
of all business segments, of total enterprise
the amounts, the following
Geographical segments based information-
on the location of its following information-
customers a. Total carrying
a. Segment revenue amount
from of segment assets
external by geographical
customers, location of the
assets and
b. Total carrying
amount b. Total cost
of segment assets, incurred during
and the period to
c. Total cost incurred acquire segment
during the period assets that are
to expected to be
used during more
acquire segment than one period
assets (tangible and
intangible fixed
that are expected assets) by location
to be used during of the assets.
more than one
period (Tangible
and intangible
fixed assets)
Disclosure requirements
C. Other disclosure requirements of AS-17
Particulars Matter to be disclosed
• Basis of pricing inter segment transfers, and

• Any changes therein
Inter Segment
Note: Inter segment transfer should be measured on the basis that
transfers
enterprise actually used to price those transfers.
• Changes in accounting policies adopted for segment reporting

(e.g. changes in identification of segments basis of allocating
revenues and expenses) having a material effect on segment
information indicating (a) nature of the change and (b)
financial impact over financial statements of the period of
such change.
• Where the effect of such change is not ascertainable, wholly or
in parts an indication of the fact of change.
• Even if a change in accounting policies has no material effect
on the financial statements for the current period but is
reasonably expected to have a material effect in later periods,
Change in the fact of such change in the period in which the change is
adopted.
Accounting Policies • Nature of the change and the financial effect of the change in
accounting policies which are specifically related to Segments.

• Business segments: The types of products and services
included in each reported business segment so as to assess the
impact of shifts in demand. changes in prices of inputs or other
factors of production, development of alternative products and
processes on a business segment.
Types of products/ • Geographical segments: the composition of each reported

services geographical segment, both primary and secondary to assess
(Composition) the impact of changes in economic and political environment
on risks and returns of a geographical segment.
ASI-20 Disclose in the Note of Accounts, the fact that there is only one
business segment and/ or geographical segment and therefore the
requirements of AS-17 is not complied with.
NOTE – IND AS 108 PROVIDES ADDITIONAL GUIDANCE ON DISCLOSURE

REQUIREMENTS. THE SAME ARE ELABORATED IN THE LATER PART OF THE
CHAPTER
ICAI Interpretations: ASI 20, 22

ASI 20: Single Segment: - No reporting
In cases where on applying the definitions in the Standard, it is conducted that there
if there is neither more than one Business Segment, nor more than one Geographical
NOTE – IND AS 108 MENTIONS THAT CERTAIN DISCLOSURES SHOULD BE

MADE EVEN FOR SINGLE REPORTING SEGMENT
Segment, segment information as per AS 17 is not acquired to be disclosed.

ASI 22: Interest on Bank Overdraft: Interest expenses relating to overdrafts and
other operating liabilities identified to a particular segment, should not be included
as a part of the segment expenses unless the operations of the segment are primarily
of a financial nature, or unless the interest is included as part of the cost of
inventories in compliance with AS 16. In all situations where, interest forming a part
of cost of inventories is included as segment expense, a separate disclosure should be
made to that effect.
NOTE – IND AS 108 REQUIRES SPECIFIC DISCLOSURES ABOUT INTEREST
REVENUE AND INTEREST EXPENSE OF EACH REPORTABLE SEGMENT.
HENCE NOT SPECIFICALLY DEALT WITH.
Segment Reporting for a Finance Company: Despite the fact that Source: ICAI
separate disclosures have to be made for different products of the Website
Finance Company as required by prudential norms, the Risk and
Returns of the different products of a Financial Company have to be
evaluated for the purpose of identification of different Business
Segments under AS -17. A test of this would be the evaluation of the
internal reporting and the organizational structure of the Finance
Company.
Segment Reporting for Sale of Power to State Grid: For applying Aug 2006 -
10% threshold limit test With reference to Revenue, both Revenues CA Journal
from Sales to External Customers and from transactions with other Page 228
Segments is to be taken into account. Other tests like Segment
Result and Assets should also be considered.

AS 17 VIS-À-VIS IND AS 108
IND AS 108 is different from existing provision of AS 17 for identifying segments, but
threshold for reportable segments remain the same.
Segments – AS 17 – Segment Reporting Ind AS 108 – Operating Segments

Primary
Literature
Scope Applicability of the standard Ind AS 108 is applicable to

is not linked to the listing companies to which Ind AS
status of an entity. notified under the Companies Act
apply.
Operating Not defined Ind AS 108 defines the term

segment “OPERATING SEGMENT” which is
defined as a component of an
entity:
- That engages in business
activities from which it may
earn revenues and incur
expenses (including
revenues and expenses
relating to transactions
with other components of
the same entity);
- Whose operating results are
regularly reviewed by the
entity’s chief operating
decision maker (CODM) to
make decisions about
resources to be allocated to
the segment and assess its
performance; and
- for which discrete financial
information is available
Determination AS 17 requires an enterprise Identification of segments is based

of segments to identify two sets of on management approach.
segments (business and Operating segments are identified
geographical), using a risks based on the financial information
and rewards approach, with that is regularly reviewed by the

the enterprise’s system of chief operating decision maker in
internal financial reporting deciding how to allocate resources
to key management and in assessing performance.
personnel serving only as the
starting point for the
identification of such
segments.
Measurement Segment information is Segment profit or loss is reported

prepared in conformity with on the same measurement basis as
the accounting policies that used by the chief operating
adopted for preparing and decision maker.
presenting the financial There is no definition of segment
statements of the enterprise revenue, segment expense,
as a whole. segment result, and segment asset
Segment revenue, segment or segment liability nor does it
expense, segment result, require segment information to be
segment asset and segment prepared in conformity with the
liability have been defined. accounting policies adopted for
A reconciliation is presented the entity’s financial statement.
between the information Requires reconciliation of segment
disclosed for reportable performance measures with the
segments and the corresponding amounts reported
aggregated information in in the financial statements. A
the enterprise’s financial reconciliation of the total of the
statements segments’ assets and total of the
segments’ liabilities to the
entity’s assets and the entity’s
liabilities respectively should only
be provided if the segment assets
and segment liabilities are
regularly provided to the chief
operating decision-maker.
Aggregation No specific guidance in AS 17 Two or more operating segments

criteria may be aggregated into a single
operating segment if the
aggregation is consistent with the
principles laid down in the
standard. Management need to
disclose the judgments made in

applying the aggregation criteria
for operating segments
Single When there is not more than Certain disclosures should be

reporting one geographic segment or made even for single reporting
segment business segment, segment segment
information need not be
disclosed. It should be
mentioned in a footnote.
Interest Interest expense identified Requires specific disclosures about

Revenue and with overdrafts or other interest revenue and interest
Interest operating liabilities expense of each reportable
expense identified to a particular segment. Hence not specifically
segment should not be dealt with.
included as segment expense
Entity wide Disclosures are required Requires disclosure of

disclosures based on the classification of a) external revenues from each
segments as primary or product or service;
secondary. Disclosure
b) Revenues from customers in the
requirements for secondary
country of domicile and from
reporting format are less
foreign countries;
detailed than those required
for primary reporting c) Geographical information on
formats. non-current assets located in the
country of domicile and foreign
countries.
Information on major customers
including total revenues from each
major customer is disclosed if
revenue from each customer is
10% or more of total segment
revenues. The entity need not
disclose the identity of such
customers.

SUMMARY OF IND AS 108
Operating Segment
Segment or component of the organization, which
➢ Incurs expense & earns revenue

➢ Is reviewed by CODM
➢ Has discrete financial information
Individual Operating Segment Aggregated operating segments

(on satisfying all criteria)
Passes the quantitative threshold (1) Management decides to disclose (2)
Additional Operating if total revenue of Unqualified segments aggregated on satisfying

(1+2+3) < 75% entity’s revenue majority of aggregation
criteria (3)
“All other segment category” Qualifies as Reportable segments
DISCLOSURES
• Basic of Selection
• Required line items for all reportable segments
• Reconciliation between
➢ Segment revenue, result, assets, liabilities & others &
➢ Entity’s revenue, result, assets, liabilities & others
• Entity Revenue based on
➢ Products & Services
➢ Geographical Areas
• Customer accounting for > 10% revenue

OTHER KEY POINTS IN IND AS 108
IND AS 108 sets out requirements for disclosure of information about an entity’s
operating segments and also about the entity’s products and services, the
geographical areas in which it operates, and its major customers. The standard
requires the whole entity’s financial information to be segmented and reported
on the basis of principles laid down for identification of Operation segments,
and for measurement of items to be reported.
1. ORGANIZATION HIERARCHY
Vested with the

responsibility of
reviewing the operating
results of segments, and CHIEF OPERATING
the authority for DECISION MAKET
allocating resources and (CODM)
assessing the performance
of one or more segments.
Individual (irrespective of
designation) exercising
the function of reporting
the operating activities,
performances, forecasts of SEGMENT MANAGER
the segments etc in
respect of one or more
segmetns to CODM
2. OPERATING SEGMENTS
Operating segments are components involved in the business activities capable

of generating income (including internal sales) for which discrete financial
information is available and whose performance is reviewed regularly by CODM.

Operating segments include:
segments
engaged in
in-house
trade
Startup
segments
activities OPERATING
having both
provided they SEGMENTS
internal and
meet the BASED ON
external
definition ACTIVITIES
sales; and
criteria
segments
having only
external
sales
HOW DOES A SET OF

ACTIVITIES QUALIFY AS
OPERATING SEGMENT?
Bears all the

Permitted by situations where the
characteristics set
organisation structure designed by
out in the
MIS
definition criteria
Based on products Based on Or both -

or services geography overlapping

3. AGGREGATION OF OPERATING SEGMENTS
Two or more operating segments may be aggregated into a single segment if

they have similar characteristics and are similar in each of the following
parameters:
the type or class of

customer for their
products and
services
the methods used to
the nature of distribute their
production processes products or provide
their services
if applicable, the
PARAMETERS nature of the
the nature of
FOR regulatory
products and
AGGREGATION environment
services
OF SEGMENTS (banking/insuranc/
public utilities)
4. REPORTABLE SEGMENTS
IND AS prescribes a step by step process for the identification of an operating

segment.
The operating segments so identified (either single or two or more segments

aggregated) are subjected to the test of quantitative thresholds to determine
the reportable segments. The thresholds are same as mentioned above in AS
17.
Residual category: All other segments
Information about other business activities and operating segments that are not
reportable shall be combined and disclosed in ‘all other segments’ category

separately from other reconciling items.
Continuity
If management concludes that an operating segment identified as a reportable

segment in the immediately preceding period is of continuing significance,
information about that segment shall continue to be reported separately in the
current period even if no longer meets the criteria for reportability
Newly identified reportable operating segments
If the business activities which did not qualify either as an operating segment
or a reporting segment in the prior periods qualify as a reportable segment
through the quantitative threshold tests in the current period, the comparative
figures for the prior periods of such reportable segment shall be disclosed.
Flexibility in the area or detailed disclosures
Considering the cost-benefit aspect of gathering and reporting segment data,

the standard requires the entities to review whether a practical limit is
reached, if the number of reportable segments exceeds ten in number
(rebuttable).
DISCLOSURE
In addition to the disclosure requirements in AS 17, the following additional
disclosure requirements are needed by IND AS 108.
a. THE ENTITY SHALL DISCLOSE

the basis of factors considered for identifying the reportable segment
types of products and services from which each reportable segment derives its revenues
information of the following lines about each reportable segment if these are regularly
reviewed by CODM
•(all the disclosure items mentioned above in AS 17)

•interest revenue
•interest expense
•material items of income and expense disclosed in accordance with Ind AS 1
•income tax expense or income
b. MEASUREMENT FOR THE PURPOSES FOR DISCLOSURES:
- all the items of reportable segments shall be stated at the measure

reported to the CODM irrespective of the measure used in entity’s
- the accounting policies used to measure the line items of reportable
segments maybe different from that of entity’s accounting policies
- this standard requires that an entity shall provide an explanation of the
measurements of segment profit or loss, segment assets and liabilities
for each reportable segment.
c. MINIMUM DISCLOSURES
• DESCRIPTIVE DISCLOSURES
• The basis of accounting for transactions between reportable segments
• The nature of any difference between the measure adopted for

reporting the profit or loss, assets, liabilities, etc and the measure
adopted for reporting them in the entity's financial statements
• The nature of any changes relative to prior periods in the measurement

methods including its effect on determining profit or loss
• The nature and effect of any asymmetrical allocations to reportable

segments

d. QUANTITATIVE RECONCILIATION
• SAME AS AS 17
e. RESTATEMENT OF PREVIOUSLY REPORTED INFORMATION
• When there is a change in the entity's internal organization resulting in

the change of composition of reportable segments, the entity shall
restate the earlier period amounts or disclose the fact whether
restatement has been done or not if information is not available or cost
to develop that information is excessive
• If restatement is not done due to the above said reasons, the entity shall
disclose amounts for the current period on both old basis and new basis
unless if information is not available or cost to develop that information
is excessive.
f. ENTITY WIDE DISCLOSURES
The standard requires disclosure of revenues attributable to external

customers. The disclosure of amounts in this area shall be based on
financial information used to produce the entity’s financial statements.

ON THE
BASIS OF ON THE BASIS OF GEOGRAPHICAL AREA
PRODUCT (if the below information is not available or the cost to INFORMATION ABOUT MAJOR
OR develop the same is excessive, then disclose that fact and CUSTOMERS
SERVICE explain the reason)
S
Revenue
if 10% Or
from
more of
external Non current assets (other
external
customers than financial instrumetns,
revenue
for each Revenue from external deferred tax assets, post The following are treated
generated
product or customers attributable to: employment benefit assets as SINGLE CUSTOMER:
from single
services or and rights under insurance
customer,
group of contracts) located in:
disclose
product or
detais
services
2. all
2. all other
foreign
foreign
1. the countires 1. the entities Governmen
countries
entity's with entity's under t and its
with
country of separate country of common controlled
material
domicile disclosures domicile control entities
non current
(significant/
assets
material)
Illustration 1
Tirumala Limited has the following business or geographical segments. Examine

which of these are reportable segments under AS 17.
Rs.’ Lacs
Segments Revenue Profit (+)/Loss(-) Assets

A 9,600 1,750 4,100
B 300 180 450
C 100 70 450
Solution:
Test 1 : Revenue Test

Segments Revenue (Rs.)
A 9,600
B 300
C 100
Total 10,000
10% of Revenue 1,000
Since only Segment A has revenue >= 1,000, Segment A is reportable.
Test 2 : Segment Result Test
Segments Profit (+)/Loss(-)

A 1,750
B 180
C 70
Total 2,000
10% of Segment Results 200
Since only Segment A has results >= 200 Segment A is reportable.
Test 3 : Segment Assets Test
Segments Assets
A 4,100
B 450
C 450
Total 5,000
10% of Segment Assets 500
Since only Segment A has assets >= 500, Segment A is reportable
External revenue is not given in question and hence, 75% test is not recognised.
As per the three tests, only Segment A is reportable.
Illustration 2
Chief Accountant of Sports Limited gives the following data on its six segments

Segments Assets Results Revenue
M 40 50 300
N 80 -190 620
O 30 10 80
P 20 10 60
Q 20 -10 80
R 10 30 60
Total 200 -100 1200
Chief Accountant is of the opinion that M & N alone should be reported. Is he

justified in his view? Discuss.
Solution:
Segments Assets Absolute Absolute Revenue
Profits Loss
M 40 50 300
N 80 190 620
O 30 10 80
P 20 10 60
Q 20 10 80

R 10 30 60
Total 200 100 200 1200
10% 20 20 (higher) 120
As per Revenue Test, Segment A&B are reportable
As per Asset Test, Segments M, N, O, P & Q are reportable
As per Segment Result test, M, N & R are reportable
Hence all segments are reportable, and the contention of the Chief Accountant
is not correct.
Illustration 3
M/s XYZ Ltd has three segments namely X,Y and Z.
The total of the assets of the company are Rs.10 crores. The details of segment
wise assets are given below.
X: Rs. 2 Crores
Y: Rs. 3 Crores
Z: Rs. 5 Crores.
Deferred tax assets included in the assets of each segment are
Segment X – 0.5 cr
Segment Y – 0.4 cr
Segment Z – 0.3 cr
The accountant contends that all three segments are reportable segments.
Comment
Solution:
As per AS-17, Deferred Tax Assets do not form a part of Segment Assets.

Segment Total Assets Deferred Assets Segment Assets
X 2 0.5 1.5
Y 3 0.4 2.6
Z 5 0.3 4.7
Total 8.8
10% of Assets 0.88
Since all segments have assets more than 10% of total segment assets, all
segments are reportable. The contentions of Accountant is correct.
5.6 AS 18 Related Party Disclosures
Scope
AS- 18 is mandatory in nature and primarily a disclosure based standard. It is
concerned to improve the quality of information provided by Financial
Statements. It focuses on need of "users" to receive information for financial
decisions rather than merely information on the stewardship of management.
Applicability
The standard is applicable to both:
i. Independent Financial Statements of reporting enterprise.
ii. Consolidated Financial Statements (except for intra group

transactions)
Objective:
The objective of this standard is to establish requirements for disclosure of
a. Related Party relationships and
b. Transactions between a reporting enterprise and its related party.
1. Related Party Relationships (RPR):

At any time during the reporting period, one party has the ability to control the other party or
exercise significant influence over other party, in making financial or/ and operating decisions.

Related Party Relationships (RPR), can be grouped into relationships that
lead to either
(a) Control, or
(b) Significant Influence.
A variety of situations can be envisaged, which lead to either Control or
significant influence. However, Only the following related party relationships
are covered by this Standard: -
i. enterprises that directly, or indirectly through one or more
intermediaries, control, or are controlled by, or are under the common
control with, the reporting enterprises. This includes a company, its
subsdiaries and fellow subsidiaries.
ii. associates and joint ventures of the reporting enterprise and the investing
party or venturer in respect of which the reporting enterprise is an
associate or a joint venture;
iii. individuals owning, directly or indirectly, an interest in the voting power
of the reporting enterprise that gives them control or significant influence
over the enterprise and relatives of any such individual;
iv. key management personnel and relatives of such personnel; and
v. enterprises over which any person described in (iii) or (iv) is able to
exercise significant influence. This includes enterprises owned by
directors or major shareholders of the reporting enterprise and
enterprises that have a member of key management in common with the
reporting enterprise.
The related party relationships covered by AS 18 are illustrated in the diagram
below:

Individuals
Owning directly or indirectly, voting power giving control
or significant influence >= 20%
RELATIVES
(note 4)
Enterprises in which any
of these persons is able
to exercise significant
Holding Company influence
KMP (note
5)
Fellow subsidiary Reporting

Enterprise
Subsidiary >= 20%

Company
NOTE:
1. Indirect holding refers to holding shares only

through a subsidiary and not through any other
Subsidiary Co.
person
(Indirect Holding)
(Note 1) 2. Fellow venturers (co-venturer) are not related
parties
3. Fellow associates are not related parties. However,
partner of the investor is a related party
Fellow investor 4. Relative refers to Spouse, Siblings, One step lineal
ascendants/ descendants
5. KMP = authority and responsibility for planning,
deciding and controlling reporting entity’s
Joint venture
activities (designation is not material)
Associate Co. (Note (note 2)
3)
Parties Not Deemed to be Related Party:
i. Common Directors: Two Companies, simply because they have a Director in
common, unless the Director is able to affect the policies of both Companies in
their mutual dealings.
ii. Economic Dependence: A single Customer, Supplier, Franchiser, Distributor, or

General Agent with whom an enterprise transacts a significant volume of business
merely by virtue of the resulting economic dependence.
iii. Participation in decision-making: The parties listed below, in the course of
their normal dealings with an enterprise by virtue only those dealings (although
they may circumscribe the freedom of action of the enterprise or participate in
its decision-making process)-
- Providers of finance,
- Trade Unions
- Public Utilities
- Government Departments and Government Agencies including Government
Sponsored Bodies.
iv. Co-Ventures who share joint control over a joint venture.
RELATED PARTY TRANSACTIONS

A transfer of resources or obligations between related parties regardless of
whether or not a price is charged, DURING THE PERIOD OF EXISTENCE OF SUCH
RELATION
Definitions:
➢ Related Party: Parties are considered to be related if at any time during the
reporting period, one party has ability to control the other party or exercise
significant influence over other party, in making financial or/ and operating
decisions.
➢ An Associate: an enterprise in which an investing reporting party has

significant influence, and which is neither a subsidiary nor a joint venture of
that party.
➢ A Joint venture: a contractual arrangement whereby two or more parties

undertake an economic activity which is subject to joint control.
➢ Holding company: a company having one or more subsidiaries
➢ Subsidiary: a company:

a. in which another company (the holding company) holds, either by itself and/or
through one or more subsidiaries, more than one-half in nominal value of its equity
share capital; or
b. of which another company (the holding company) controls, either by itself and/or
through one or more subsidiaries, the composition of its board of directors.
➢ Fellow subsidiary: a company is considered to be a fellow subsidiary of

another company if both are subsidiaries of the same holding company.
➢ State-controlled enterprise: an enterprise which is under the control of the

Central Government and/or any State Government(s).
➢ Control means
i. Ownership, directly or indirectly of more than one-half of the voting power of

an enterprise.
ii. Control of the composition of the Board of Directors in the case of a company
or Governing Body in the case of any other enterprise.
iii. A substantial interest in voting power AND the power to direct, by statute or
agreement, the financial and / or operating policies of the enterprise
➢ Significant influence means participation in the financial and/ or operating

policy decisions of an enterprise, but not in the control of those policies.
➢ Joint control means the contractually agreed sharing of power to govern the
financial and operating policies of an economic activity so as to obtain benefits
from it.
➢ Relatives in relation to an individual, means the spouse, son, daughter,

brother, sister, father and mother who may be expected to influence or be
influenced by that individual in his or her dealings with the reporting
enterprise.
➢ Key Management Personnel: are those persons who have the authority and
responsibility for planning, directing and controlling the activities or reporting
enterprise. E.g. Managing Director, Whole-time director and Manager under
Companies Act.

The control of composition of Board of Directors of a Company or Governing Body of

other enterprises arises out of power that can be exercised without consent or
concurrence of any other person to appoint or remove all or a majority of directors
and, such a power is said to be vested in an enterprise (say, X) when.
• A person cannot be appointed as director without X casting a favorable vote for
the purpose
• A person's appointment as director necessarily follows his appointment to a
position in X.
• Nomination by X, or by Subsidiary of X.
Is the term Control bearing same meaning as in AS 21?
It has different meaning. The Term Control has broader meaning in AS 18 as compared
to AS 21. It includes same scenario as in AS 21, but additionally it includes Control
through Substantial Interest.
An enterprise is considered to have a substantial interest in another enterprise if that

enterprise owns, directly or indirectly, 20 per cent or more interest in the voting
power of the other enterprise. Similarly, an individual is considered to have a
substantial interest in an enterprise, if that individual owns, directly or indirectly, 20
per cent or more interest in the voting power of the enterprise. In addition to two
parameters as that of AS 21, the term control in AS 18 stands for substantial interest +
power to direct financial and / or operating policies of the enterprise. Such power
may be obtained by virtue of statute or agreement.
Significant influence (as per AS 23) implies right to participate in policy making
process and includes ability to influence intercompany transactions that are material
or an ability to change managerial personnel. The ability to exercise significant
influence may flow from:
• Ownership (e.g. Azim Premji in Wipro — holding 20% or more of voting power)
• Statue (e.g. SBI in its associate bank like SBT), or
• Agreement (e.g. Managing Director of a company)
Significant influence has a direct linkage with shareholding or voting power in an

enterprise. The standard clarifies this aspect further.
i. When there is ownership of shares with direct or indirect control of 20% or greater
than 20% of voting power, (referred as substantial interest) it is presumed that
significant influence exists unless proved otherwise.
ii. Conversely, when there is ownership of shares with direct or indirect control of less
than 20% of voting power, it is presumed that no significant influence exists unless
proved otherwise.
iii. Consider the situation of two parties A and B. A holds 63% voting power, while B
holds 27%. A's position is majority ownership. The standard clarifies that this position
of substantial or majority ownership by A. does not preclude B from having significant
influence on the reporting

Disclosure Requirements:
AS 18 - RELATIONSHIPS
CONTROL PARTIES SIGNIFICANT

INFLUENCE PARTIES
x.co Reporting
Entity
Substantial
Interest (>= 20%)
WITHOUT
powers
OR
Voting Power BOD By Statute

Substantial
Composition Interest (>= OR
20%)
By Agreement
PLUS
Power to
control,
operating a&
financial
aspects
1. Irrespective of transactions, always disclose Disclosure of names of related parties,

names of parties and nature of relationships, relationships and transaction details required,
even if such relationship existed at any point only if there are any transactions during the year
of time during the year.
2. If there are any transactions with above

parties “DURING THE EXISTENCE OF
RELATED PARTY RELATIPNSHIP”,
disclose such transaction details

1. Related Party Relationships: Name of the Related Party and nature of the Related
Party Relationship where control exists should be disclosed irrespective of whether or
not there have been transactions between the related parties.
2. Related Party Transactions: If there have been transactions between related

parties, during the existence of a related party relationship, the reporting enterprise
should disclose the following
a. the name of the transacting related party.
b. a description of the relationship between the parties,
c. a description of the nature of transactions,
d. volume of the transactions either as an amount or as an appropriate proportion,
e. any other elements of the related party transactions necessary for an

understanding of the Financial Statements, e.g. disclosure making and indication that
the transfer of a major asset had taken place at an amount materially different from
that obtainable on normal commercial terms.
f. the amounts or appropriate proportions of outstanding items pertaining to related

parties at the Balance Sheet date and provisions for doubtful debts due from such
parties at that date, and
g. amounts written off or written back in the period in respect of debts due from or
to related parties.
3. Grouping: Items of a similar nature may be disclosed in aggregate according to

type of related party. However, when separate disclosure is necessary for an
understanding of the effects of related party transactions on the Financial Statements
of the reporting enterprise, it should be separately disclosed and not grouped.
Therefore,
a. Items of a similar nature may be disclosed in aggregate by type of related party,

since voluminous information does not mean effective disclosure. However, the
following points are to be considered in this regard:
• Separate disclosure is necessary for an understanding of the effects of related

party transactions on the financial statements of the reporting enterprise. In
other words, though items of a similar nature may be disclosed in aggregate
by type of related party, this is not done in such a way as to obscure the
importance of significant transactions. For example, purchases or sales of

goods are not aggregated with purchases or sales of fixed assets nor a
material related party transaction with an individual party is clubbed in an
aggregated disclosure.
• Materiality primarily depends on the facts and circumstances of each case. In
deciding whether an item or an aggregate of items is material, the nature
and the size of the item(s) are evaluated together.
• As regards size, for the purpose of applying the test of materiality, ordinarily
a related party transaction, the amount of which is in excess of 10% of the
total related party transactions of the same type (such as purchase of goods),
is considered material, unless on the basis of facts and circumstances of the
case it can be concluded that even a transaction of less than 10% is material.
• As regards nature, ordinarily the related party transactions which are not
entered into in the normal course of the business of the reporting enterprise
are considered material.
• Importance of significant transactions should not be diminished/ obscured by
aggregation. Material Related Party Transaction should not be clubbed in the
course of aggregation.

1. Should the relationship persist on the date of balance sheet to be a related party for this
accounting standard? No. Relationship at any time during the reporting period is sufficient to
place a party as related party.
2. What are the important factors to decide as whether a party is related or not? Ability of one
party to control the other party or exercising significant influence over the other party in making
financial or operating decisions.
3. Should the relationship and transactions co-exist to be covered under AS 18? Yes,
Relationship and transactions should co-exist to be disclosed.
4. Is it necessary to make disclosure where there is no transaction between related parties? Yes.
When the relationship is on account of control. No. When the relationship is on account of
significant influence.
5. Is the term 'Control' bearing the same meaning as in AS 21 or is it different in this AS? It has a
different meaning. The term Control is broader in AS 18. It includes the same scenarios as in AS
21, but additionally includes control through 'Substantial Interest'.
6. Arms Length transaction — Need not be disclosed
Ans : Wrong, All transactions between Related parties shall be disclosed.

7. In separate financial statements of a parent company, presented on a "stand-alone" basis as
permitted under AS 18, transactions with its subsidiaries would be disclosed as related-party
transactions. However, in "consolidated financial statements" of the parent company, there will
be no related-party transactions or balances reported between members of the consolidated group,
as all such items will have been eliminated upon consolidation by applying the procedures
outlined in AS 21, Consolidated and Separate Financial Statements.
8. The pricing of related-party transactions is often a sensitive subject, particularly if pricing is

not at arm's length. This area can be a difficult one that is open to judgment. For example, an
entity may sell 60% of its production to a related party at unit prices substantially lower than
what it charges to other third parties for the balance 40% production. None of the third parties
accounted for more than 5% of the sales. It may be very difficult to determine whether the
volume discount was at a market rate. It can be even more difficult to determine arm's length if
there are no sales to third parties. In such cases, the Standard states that a transaction can be
described as at arm's length only if it can be substantiated. Thus it is the responsibility of the
management to prove the market value of transactions if it wishes to describe transactions as "at
market value."

2. Disclosure specifically exempt under AS-18: No disclosure is required
in the following cases:
a. Intra group transactions need not be disclosed in Consolidated Financial

Statements.
b. Related party relationships (RPR) and transactions between two or more

state controlled entities.
c. Where disclosure of RPR and transactions with such enterprises would come
in conflict with the duties of confidentiality, of the reporting enterprises e.g.
Banks.
ICAI Interpretations: ASI 13,19,21,23 ASI 13: Reporting

Format
ICAI have provided a specimen format in which aggregated information on
transactions with related parties be presented. This is reproduced below:

DISCLOSURE FORMAT – AS 18
Name of the Company

Notes forming part of the financial statements
GN 6.13 Note 30 Disclosures under Accounting Standards (contd.)
Ref. No. Particulars
AS 18 Related party transactions

GN 6.15
Details of related parties:
AS 18.21 Description of relationship Names of related parties
AS 18.23 Ultimate Holding Company AA Ltd.

Holding Company A Ltd.
Ultimate Holding Company AA Ltd.
Subsidiaries B Ltd. and C (P) Ltd.
Fellow Subsidiaries (to be given only if there are transactions) D Ltd. and Q Ltd.
Associates X Ltd. and Y Ltd.
Key Management Personnel (KMP) Mr. Y and Mr. Z
Relatives of KMP Mrs. Y (wife of Mr. Y), Mr. F (father of Mr. Z)
Company in which KMP / Relatives of KMP can exercise D Ltd in which MD(KMP) and his wife hold 50%
significant influence
Note: Related parties have been identified by the Management.
Details of related party transactions during the year ended 31 March, 20X2 and balances outstanding as at 31 March, `
AS 18.23 Ultimate Holding Holding Subsidiarie Fellow Associates KMP Relati Entities in Total
Company Company s Subsidiaries ves of which KMP /
KMP relatives of
KMP have
significant
influence
AS 18.24
AS 18.26
? Party-wise details - aggregation to be done only if the related party is < 10 % of the total
amount of that particular type of transaction - e.g. purchases. Also note that in some cases even less than
10% will be required to be disclosed and such importance depends on circumstances of the respective companies.
Purchase of goods
Sale of goods
Purchase of fixed assets
Sale of fixed assets
Rendering of services
Receiving of services
Agency arrangements
Leasing or hire purchase arrangements
Transfer of research and development
License agreements
Finance (including loans and equity contributions in cash or in

kind)
Guarantees and collaterals
Management contracts including for deputation of employees
Provision for doubtful receivables, loans and advances
Write off / write back made during the year
Balances outstanding at the end of the year
Trade receivables
Loans and advances
Trade payables
Borrowings
Provision for doubtful receivables, loans and advances
Note: Figures in bracket relates to the previous year

ASI 19: Intermediary: The term "intermediary" used in Paragraphs 3 and 13 of
AS-18, means enterprises which are "subsidiaries" as defined in AS 21.
ASI 21: Non Executive Director – KMP? A non-executive Director, merely by

virtue of his being a Director will not be covered within the meaning of related
party and hence AS 18 is not
applicable to such a non executive director. However a non —executive

director would be covered by a related party relationship in case, any other
requirement of AS 18 is met.
ASI 23: Remuneration to KMP: Key Management Personnel being related

parties under AS 18, remuneration paid to KMP will be a related party
transaction requiring disclosure under AS 18, except that remuneration paid to
a non-executive Director merely by virtue of being a Director, need not be
reported in less any other provisions of AS 18 are attracted.

Question 1
As a statutory auditor, how would you deal with the following?
A husband and wife are controlling 34% of voting power in XY Co. Ltd. They
are having a separate partnership firm which supplies mainly the raw
material to the company. The management says that the above transaction
need not be disclosed.
Solution
The husband and wife hold more than 20% of voting power and hence exercise
significant influence over XY Co. Ltd. Hence, they are related parties as per AS-
18. If the persons having significant influence over the reporting entity control
or have significant influence over another entity, the other entity is also
considered as a related party.
Hence, the partnership firm which is controlled by them is also a related party
under AS-18.
If there is any transaction with related party,
• Name and nature of relationship needs to be disclosed.
• Transactions which occur during the existence of relationship party

relationship needs to be disclosed.
Conclusion : The contention of management is not correct.
The treatment given by the company is not in accordance with AS-18 on

Related Parties. The auditor (I) would issue a suitable modified report.
Question 2
Narmada Ltd. sold goods for Rs. 90 lakhs to Ganga Ltd. during financial year
ended 31st March 2006. The managing director of Narmada Ltd owns 100%
Ganga Ltd. The sales were made to Ganga Ltd. at normal selling prices
followed by Narmada Ltd.
The Chief Accountant of Narmada Ltd contends that these sales need not
require a different treatment form the other sales made by the company and
hence no disclosure is necessary as per Accounting Standard. Is the Chief
Accountant correct?
Solution:
As per AS-18, Key Management Personnel [KMP], Managing Director in this case,
are considered to be related party. The enterprises controlled by KMP are also
considered to be related parties. Since Ganga Ltd. is controlled by Managing
Director, Narmada Ltd and Ganga Ltd are considered to be related parties.
Disclosure of related parties transaction is required irrespective of the fact
that the transactions are at market/normal prices.
Transactions of 90 lakhs happened between Narmada Ltd. and Ganga Ltd. The
transaction is a related party transaction which requires disclosure.
Conclusion: The view of the chief accountant is not in line with AS-18. The
transactions must be disclosed even if the transactions are at normal market
prices.
Question 3
P Ltd. has 60% voting right in Q Ltd. Q Ltd. has 20% voting right in R Ltd.
[22325] Also, P Ltd. directly enjoys voting right of 14% in R Ltd. R Ltd. is a
listed company and regularly supplies goods to P Ltd. The management of R
Ltd. has not disclosed its relationship with P Ltd.
How would you assess the situation from the viewpoint of AS 18 on Related
Party Disclosures?

Solution
A company has significant influence over another company if it enjoys at least

20% of voting rights. Since P Ltd enjoys voting right of 34% [14% directly and
20% thorough Q Ltd] in R Ltd, it exercises significant influence over R Ltd. As
per AS-18 two parties are considered to be related if one exercises significant
influence over the other. Hence a related party relationship exists between P &
R
According to the disclosure requirements of AS-18, R Ltd. should disclose the

relationship with P Ltd in its financial statements. The transactions with P Ltd.
should also be disclosed.
5.7 AS 19 Accounting for Leases
Status and Applicability

AS — 19 is mandatory in nature and is applicable to all enterprises in respect of
assets leased during the period commencing on or after 1.4.2001. Consequently,
the Guidance Note e d by the Institute of Chartered Accountants of India on
'Accounting for lease' is not applicable.
Objective and Scope

Lease arrangement is a specific type of a transaction in which one party, ailed
lessor, allows the use of an asset to another party, called lessee, in return for a
rental. It is not a sale or base transaction. Lease allows the user to use the asset
for a limited period or for almost the full economic life without owning the asset.
The objective of AS — 19 is to provide for accounting treatment of lease
transaction in the books of both the parties. It covers lease arrangements for
asset except the following:
1. Lease agreements to explore for or use of natural resources, such as oil,

gas, timber, metals and other mineral rights; and
2. Licensing agreements for items such as motion picture films, video

recordings, plays, manuscripts, patents and copyrights; and
3. Lease agreements to use lands.
4. It does not apply to services which do not transfer the right to use the

asset.
Definitions
The following terms have been used in the Standard:
A lease is an agreement whereby the lessor conveys to the lessee in return for a
payment or series of payments the right to use an asset for an agreed period of
time. A lease agreement also includes a Hire Purchase agreement.
A financial lease is a lease that transfers substantially all the risks and rewards
incident to ownership of an asset.
An operating lease is a lease other than a finance lease.
A NON-CANCELLABLE LEASE is a lease that is cancellable only:
a. upon the occurrence of some remote contingency; or

b. with the permission of the lessor; or
c. if the lessee enters into a new lease for the same or an equivalent asset
with the same lessor; or
d. upon payment by the lessee of an additional amount such that at
inception, continuation of the lease is reasonably certain.
The inception of the lease is the earlier of the date of the lease agreement and
the date of a commitment by the parties to the principal provisions of the lease.
Lease term is the non-cancellable period for which the lessee has agreed to take
on lease the asset together with any further periods for which the lessee has the
option to continue the lease of the asset, with or without further payment, which
option at the inception of the lease it is reasonably certain that the lessee with
exercise.
Minimum lease payments are the payments over the lease term that the lessee
is, or can be required, to make excluding contingent rent, costs for services and
taxes to be reimbursed to the lessor, together with:
a) in the case of the lessee, any residual value guaranteed by or on behalf

of the lessee; or
b) in the case of the lessor, any residual value guaranteed to the lessor:
i. by or on behalf of Lessee or

ii. by an independent third party financially capable of meeting this
guarantee.
However, if the lessee has an option to purchase the asset at a price which is
expected to be sufficiently lower than the fair value at the date the option
becomes exercisable that, at the inception of the lease, is reasonably certain to
be exercised, the minimum lease payments comprise minimum payments
payable over the lease term and the payment required to exercise this purchase
option
Fair value is the amount for which an asset could be exchanged between willing
parties in an arm's length transaction.
Economic life is either (a) the period over which an asset is expected to be
economically usable by one or more users; or,(b) the number of units expected
to be produced from the asset by one or more users.
Useful life of a leased asset is the period over which the leased asset is expected
to be used by the lessee: or the number of units expected to produced from the
use of the asset by the lessee.
Residual value of a leased asset is estimated fair value of the asset at the end
of the lease term.
Guaranteed residual value in the case of the lessee, is that part of the residual
value which is guaranteed by the lessee or by a party on behalf of the lessee;
and in case of lessor, is that part of the residual value which is guaranteed by or
on behalf of the lessee to the lessor.
Unguaranteed residual value of a leased asset is the difference between the

expected residual value of the asset and its guaranteed residual value.
Gross investment in the lease is the aggregate of the minimum lease payments
under a finance lease from the standpoint of the lessor plus any unguaranteed
residual value accruing to the lessor.
Net investment in the lease is the gross investment in the lease less unearned
finance income.
The interest rate implicit in the lease is the discount rate at which the
aggregate present value of
a) the minimum lease payments under a finance lease from the standpoint
of the lessor plus.

b) the present value of any unguaranteed residual value is equal to the fair
value of the leased asset.
The lessee’s incremental borrowing rate of interest is the rate of interest the
lessee would have to pay on a similar lease or if that is not determinable, the
rate that, at the inception f the lease, the lessee would incur to borrow over a
similar term, and with a similar security, the funds necessary to purchase the
asset.
Contingent rent is that portion of the lease payments that is not fixed in amount
but is based on a factor other than just the passage of time (e.g, percentage of
sales, amount of usage, price indices, market rates of interest).
Classification of Leases
At the inception of Lease itself, a lease is required to be "classified" either as
finance or an operating lease. The term "at the inception of lease" means, date
of the lease agreement or the date of commitment by the parties to the principal
provisions of the lease. whichever is earlier. Such a classification is linked to the
"substance" of the agreement rather than its "form". Determination is based on
the extent to which the risks and rewards attributable to ownership of the asset
lie with lessor or lessee. If the arrangement transfers to lessee "substantially all
the risks and rewards incidental to ownership", the transaction is classified as a
Finance Lease. Else, it is an operating lease. It should, however, be noted that
at the inception of lease, the final transfer of title in favour of lessee may or
may not take place.
A lease is classified as finance lease in any of the following situations:
1. Transfer of ownership of the asset to the Lessee by the end of the lease
term.
2. Option to purchase the asset, to the lessee, at a price which is sufficiently

lower than the fair value at the date the option becomes exercisable such that,
at the inception of the lease, it is reasonably certain that the option will be
exercised.
3. Lease Term is for the major part of the economic life of the asset even if title
is not transferred,
4. Present Value of the minimum lease payments at the inception of the lease
amounts to at least substantially all of the Fair Value of the leased asset, (i.e.
PV of MLP = Fair Value approximately) and

5. The leased Asset is of a specialized nature such that only the lessee can use
it without major modifications being made.
Note: Classification of lease are to be made at the inception of the lease. The
inception of a lease is the earlier of the agreement date and the date of the
commitment by the parties to the principle provisions of the lease.
Indicative Factors: In following cases a lease may be classified as a Finance

Lease:
a. If the lessee can cancel the lease, the lessor's losses associated with the
cancellation are borne by the lessee.
b. Gains or losses from the fluctuation in the Fair Value of the residual fall
to the lessee, (e.g. in the form of a rent rebate equaling most of the sales
proceeds at the end of the lease), and
c. The lessee can continue the lease for a secondary period at a rent, which
is substantially lower than Market Rent.
Classification of Leases

Start

Is ownership transferred
Start Yes
by the end of the lease
term ?
No
Yes
Does the lease contain a
bargain purchase option?
No
Is the lease term for a Yes
major part of the asset's
useful life ?
No
Is the Present Value of
minimum lease payments
greater than or Yes
substantially equal to the
asset's fair value?

 No
Operating Lease Finance Lease
It may be noted that first five criteria, 1 to 5 are determination, and if any of
these is met, the lease would ie classified as a finance lease. In these five
situations, economic reality (substance) is that risk and •maw& associated with
ownership are transferred to lessee. However. the other three criteria, a to b,
are suggestive only and may indicate that the lease may be classified as finance
lease. A lease which is not financing lease is classified as an operating lease.
Accounting Treatment for Leases in the Books of Lessee.

A: Finance Leases:
1. Initial Recognition: This is to be done at the inception of finance lease. The

lessee should recognize the lease as an asset and a liability. Accordingly, (I)
the value of asset and (11) amount of liability has to be quantified. The
amount will be LOWER of
a. Fair value of leased asset
b. Present value of minimum lease payments (for lessee). This PV is

computed at the interest rate implicit in the lease. Where this is found
impracticable, PV is computed at lessee's incremental borrowing, rate.
In considering PV of MLP, contingent rent is excluded. Contingent rent

means that portion of the lease payments that is not fixed in amount but
is based on a factor other than .just the passage of time (e.g. % of sales,
amount of usage, price indices, market rates of interest).
Incremental borrowing rate- on the other hand- has a linkage with lessee's
position. If lessee does not know lessor's IRR, lessee will adopt his
incremental borrowing rate for accounting for "finance charges". This
connotes lessee's borrowing cost from an alternative source, and not his
‘veif.-1,1ited average cost of capital i.e. the rate that the lessee would
incur at the inception of the lease to borrow a similar term, and with a
similar security, for the funds necessary to purchase the asset should be
used.
2. Lease Payments- Lease payments should be apportioned between the

finance charge and the reduction of the outstanding liability. The finance

charge should be allocated to periods during the lease term so as to produce
a constant periodic rate of interest on the remaining balance of the liability
for each period. (The Standard permits some approximations being made, for
convenience).
3. Depreciation Charge:- The finance lease give rise to (i) finance expense and
(ii) depreciation, in each accounting period. The depreciation policy for a
leased asset should be consistent with that for other, owned, depreciable
assets. Consistent Amount of depreciation recognized should be calculated
on the basis set out in AS-6 Depreciation Accounting.
Three elements in computation of depreciation
Amount of asset Lower of Present value of MIT or fair

value, adjusted for finance charge.
Rate of depreciation Consistent with depreciation policy in

compliance with statute and with AS-
6.
Tenor or period during which the asset (i) Economic life of asset if lessee
will be depreciated were to obtain ownership at the end
of lease term.
(ii) lease term or economic life

whichever is shorter — if lessee were
not to obtain such ownership.
B: Operating Leases: Lease payments: In an operating lease the risks and

rewards incidental to ownership rest with the lessor- and not with the lessee.
The critical aspect relevant for accounting treatment for operating leases, is
"lease payments". Lease payments should be recognized as an expense in the
statement of profit and loss on a straight- line basis over the lease term unless
another systematic basis is more representative of the time pattern of the user's
benefit.

Accounting by a Finance lease by a lessee
Determination of Start
discount rate
Interest Present
rate value of
implicit in MLP less
known to than fair
lessee i.e, value of
No IRR) asset
At the Fair value of asset

Inception recorded as asset
of the and liability
lease Present value of MLP
Discount rate is Discount rate is recorded as asset and
lessee’s interest rate liability
incremental implicit in lease
borrowing rate (i.e.IRR)
Finance charge
allocated so as to
produce a constant
Obligation reduced by periodic interest
rentals payable after
allowing for finance charge
Ownership
expected to
be
transferred
During
the end of
the
lease term
Lease
Term
Yes
Depreciate
Depreciate
asset over
asset over its
shorter of the
useful life
lease term or
its useful life
MLP = Minimum lease Payments

Accounting Treatment for Leases in the Books of Lessor
—
A. Finance Leases — The finance Lease transaction stands recognized as an
"asset and liability" in the books of lessee. It follows; therefore, the lessor
cannot account for the same items as an asset. What is a liability (dues to)
for lessee, will get reflected in the books of lessor as "receivables" (due from).
Accounting treatment is explained as under
1. Asset Recognition: The Lessor should recognise Assets given under a

Finance Lease in its Balance Sheet as a receivable at an amount equal
to the Net Investment in the Lease. Since risks and rewards incidental
to the legal ownership are transferred by the Lessor, the Lease
Payments Receivable is treated by the Lessor as repayment of principal
i.e. Net Investment in the Lease.
2. Income Recognition: The recognition of Finance Income should he

based on a pattern reflecting a constant periodic rate of return on the
Net Investment of the Lessor outstanding in the respect of the Finance
Lease. The Finance Income constitutes the reward to the Lessor for its
investment and services. The Lessor aims to allocate finance income
over the lease tern on a systematic and rational basis.
3. Lease Payments received: Lease Payments relating to the accounting

period, excluding costs for services, are reduced from both the
Principle (i.e. Not Investment in the Lease) and the Unearned Finance
Income.
4. Review of Unguaranteed Residual Value (URV): The Estimated URV

used in computing the Lessor's Gross Investment in the lease are review
regularly. When there is a reduction in the estimated URV, the income
allocation over the remaining lease term is revised and a reduction in
respect of amounts already accrued is recognised immediately.
However, an upward adjustment of the Estimated URV is not made.
5. Initial Direct Costs: Initial Direct Costs, (e.g. commission and legal
fees), incurred by Lessors in negotiating and arranging a lease to
produce Finance Income and are either —
a) recognised immediately in the Profit & Loss Statement, or
b) allocated against the Finance Income over the lease term.
Example:

Kasyapa Ltd has taken an asset on lease from Varuna Ltd for a period of 3 years.
Annual Lease Rentals are Rs.6 Lakhs payable at the end of every year. The
Residual Value guaranteed by Kasyapa is Rs.2 Lakhs where as Varuna expects the
estimated salvage value to be Rs.5 Lakhs at the end of the lease term. If the Fair
Value of the asset at the lease inception is Rs.15 Lakhs and the interest rate
implicit in the lease is 12%, compute the Net Investment in the Lease from the
viewpoint of Vanilla Ltd and the annual Finance Income.
(F( A/c)-
RTPI)
Answer: Analysis from Lessor's point of view –
(A) Gross Investment : Rs.
Minimum Lease Payments receivable 18,00,000

(6,00,000 x 3)
2,00.000
Guaranteed Residual Value (GRV)
3.00,000
Unguaranteed Residual Value (UGRV)
23,00,000
(B) Net Investment (PV of above 23,00,000 (&

12%)
Present Value of minimum Lease Payment 14.41.140

(6,00,000 x Annuity)
Present Value of GR + UGRV 5,00,000 x
0.7118 3,55,900
17,97,040
(C) Unearned Finance Income (A-B) 5,02,960
B. Operating Leases in the Financial Statement of Lessor:
1. Asset Recognition: The Lessor should present an asset given under

Operating Lease in its Balance Sheet under Fixed Assets.
2. Income Recognition : Lease Income (excluding receipts for services

provided e.g. insurance and maintenance), should be recognised in the
Statement of Profit & Loss on a Straight Line Basis over the Lease term,
even if it is not received on that basis, unless another systematic basis is
more representative of the time pattern in which benefit derived from
the use of the leased asset is diminished.

3. Cost Recognition: Costs, including depreciation, incurred in earning the
Lease Income are recognised as an Expense.
4. Initial Direct Costs : initial Direct Costs incurred specifically to earn

revenues are either — (a) deferred and allocated to income over the
lease term in proportion to the recognition of rent income, or (b) are
recognised as an expense in the statement of profit and loss in the
period in which they are incurred.
5. Depreciation: Depreciation of Leased Assets should be on a basis

consistent with the normal depreciation policy of the Lessor for similar
assets. the Depreciation charge should be calculated on the basis set out
in AS-6.
6. Impairment Losses: To determine Whether a Leased Asset has become

impaired, the Lessor should apply AS-28 that sets out the requirements
for review of the carrying amount of an asset, determination of
recoverable amount of an asset and principles for recognition or
reversal, of an impairment loss.
7. Selling Profit: A Manufacturer or Dealer Lessor does not recognise any

Selling Profit on entering into an Operating Lease because it is not the
equivalent of a sale.
C. Finance Leases in the Financial Statements of Manufacturer / Dealer

Lessor:
1. Option to Customers: Manufacturers or dealer offer customers the

choice of either buying or leasing an asset. A Finance Lease by a
Manufacturer or Dealer Lessor gives rise to two types of income-
a) Profit or Loss equivalent to the Profit or Loss resulting from an

outright sale of the asset being leased, at normal selling prices,
reflecting any applicable volume or trade discounts, and
b) Finance Income over the lease term.
2. Sale Recognition: The Manufacturer or Dealer Lessor should

recognise the transaction of sale in the Profit & Loss Statement for
the period, in accordance with the policy followed by the enterprise
for outright sale.
3. Sales Revenue: The Sales Revenue recorded at the commencement of

a Finance Lease term by a Manufacturer or Dealer Lesser is the Fair

Value of the asset. When Present Value of Minimum Lease Payments
accruing to the Lessor computed at a commercial rate of interest <
Fair Value, the amount recorded as Sales Revenue = Present Value so
computed.
4. Cost Recognition: Cost of Sale (in respect of Leased Asset) = Cost or

Carrying amount of the Leased Asset less Present Value of the
Unguaranteed Residual Value (URV).
5. Selling Profit: Selling Profit Selling Profit = Sales Revenue less Cost of
Sale. It is recognised in accordance with the policy followed by the
enterprise for sales.
6. Low Rates of Interest: To attract Customers, Manufacturer or Dealer

Lessors quote artificially low rates of interest, which would result in
an excessive portion of the total income from the transaction being
recognised at the time of sale. If artificially low rates of interest are
quoted, Profit on sale should be restricted to that which would apply
if a commercial rate of interest were charged.
7. Initial Direct Costs: Initial Direct Costs are recognised as an Expense

at the commencement of the lease term, because they are mainly
related to earning the Manufacturer's or Dealer's selling profit.
Example: Following information is in respect of a Manufacturer Lessor. Explain

how you will treat this under AS-19. (a) Fair Value of the asset at the inception
of lease = Rs.5,60,000, (b) Present Value of MLP accruing to the Lessor,
discounted at commercial rate of interest = Rs.5,00,000, (c) Cost of Leased Asset
at the commencement of lease = Rs.4,16,000, (d) Present Value of URV =
Rs.12,000, (e) Initial Direct Costs (sales Commission) = Rs.18,000, (1) Gross
Investment in the Lease = Rs.5,96,000, (g) Lease Term = 36 months.
Answer: Analysis from Lessors' (Manufactures' / Traders') Point of View:
(A) Gross Investments (Receipts ) given 5,96,000
(B) Net Investments (Selling Price)
Present Value of Minimum Lease Payments 5,12,000

5,00,000
Present Value of Unguaranteed Residual Value

12,000
(C) Acq. Cost (Cost of Manufacturing) 4,16,000

(D) Sales Commission 18,000
Remark:
1) Gross Profit (B-C) 5,12,000 — 4,16,000 96,000
Less: Sales Commission (18,000)
Operating Profit 78,000
2) Gross Investment 5,96,000
Net Investment (5,12,000)
Un earned Finance Income 84,000
Treatment of Initial Direct Costs

Lease transactions often require lessors and lessees to incur certain costs directly
attributable to conclude a lease arrangement. These would include commission,
legal charges and consultant's fees for negotiating and finalizing a lease plan.
These charges are to be capitalized only in case of finance lease in the books of
lessee.
Sale and Leaseback Transactions

A sale and leaseback transaction involve the sale of an asset by the owner and
the leasing of the same asset back by the buyer (lessor) to the vendor (lessee).
Sale and leaseback transaction have been shown in following figure:
Leaseback transaction has been shown in following figure:
Owner (Seller)/
Lessee
Sale of asset Funds

Leaseback Lease Rentals
Buyer/Lessor
The accounting treatment of a sale and leaseback transaction depends upon

the type of lease involved:
(A) Sale and Leaseback Transaction results in a Finance Lease:

1. Effect of Transactions: When an asset is sold and leased back, it
effectively results in the same asset being capitalized at a different
amount and is similar to revaluation of that asset.
2. Deferral: Any Excess or deficiency of Sales proceeds over the carrying

amount should not be immediately recognised as Income or Loss in the
Profit & Loss Account of the Seller-Lessee.
3. Amortisation: Such Gain / Loss arising as above, should be deferred

and amortised over the lease term in proportion to the depreciation,
of the Leased Asset.
4. Impairment Losses: No adjustment is necessary in respect of Fair

Value, unless there has been an impairment in value, in which case the
carrying amount is reduced to recoverable amount as per AS-28.
(B) Sale and Leaseback transaction results in an Operating Lease:
1. When the transaction established at Fair Value, there has been effect
a normal sale transaction and any Profit or Loss should be recognised
in the Profit & Loss Account immediately.
2. If Sale Price < Fair Value, any Profit or Loss should be recognised
immediately. However. if the loss is compensated by Future Lease
payments at below Market Price, it should be deferred and amortised
in proportion to the Lease Payments over the period for which the
asset is expected to be used.
3. If Sale Price > Fair Value, the excess of Sale Proceeds over Fair Value
should be deferred and amortised over the period for which the asset
is expected to be used.
4. If the Fair Value at the time of a Sale and Leaseback Transaction is

less than the carrying amount of the asset, a loss equal to the amount
of the difference between the carrying amount and Fair Value should
be recognised immediately.
Example illustrating the application of Para 50 and Para 52:
Particulars Situation 1 Situation 2 Situation 3 Situation 4
Fair Value at the Rs.1,00,000 Rs.1,00,000 Rs.1,00,000 Rs.1,00,000

time of Sale &

Leaseback
Sale Proceeds Rs.1,00,000 Rs. 88,000 Rs.1,15,000 Rs.1,15,000
Carrying amount of Rs.96,000 Rs.96,000 Rs.1. I 2,000 Rs.96,000

Asset
Application of Para Not Not Impairment Not Applicable

52 F Impairment Applicable Applicable Loss = Rs.
Loss] 12,000
Application of Para Profit = Rs. Loss = *Profit = Applicable = Rs.4,000

50 [ Profit & loss is 4,000 Rs.8,000 Rs.15.000 profit is to be
the difference recognised recognised deferred and recognised
between sale immediately immediately amortised immediately & Rs.
proceeds and (see note) over period 15,000 shall be
carrying amount of of use. deferred
asset]
Note: If the loss is compensated by Future Lease Payments at below Market

Price, it should be deferred and amortised in proportion to the Lease Payments
over the period for which the asset is expected to be used.
*Since Impairment Loss of 12,000 is recognised, the Revised Carrying Amount of

the Asset will be Rs.1,00.000 ( by reducing the Carrying Amount to the Fair
Value). Hence Profit will be Rs.1,15,000 — Rs.1,00,000 = Rs.15,000.
Disclosure
AS-19 requires that the finance lease and the operating lease should be disclosed
in the financial assets by both the lessor and the lessee. The disclosure
requirements are:
Disclosure by Lessee:
Finance Lease: In case of finance lease, the lessee should disclose:
(a) Assets acquired under finance lease as segregated from the assets owned:
(b) The net carrying amount of the leased assets
(c) A reconciliation between the total of minimum lease payments at the

balance sheet date and their present value. The total of minimum lease
payments at the balance sheet date, and their present value, for each of the
following periods:

i. Not later than 1 year;
ii. Later than 1 year and not later than 5 years;
iii. Later than 5 years.
Operating Lease: Lease payments under an operating lease should be

recognized as an expense in the statement of profit and loss on a straight line
basis over the lease term even if the payments are not equal. The lessee should
also disclose.
(a) The total of future minimum lease payments for each of the following
periods:
(i) Not later than 1 year;
(ii) Later than 1 year and not later than 5 years:
(iii) Later than 5 years.
(b)The total of future minimum sublease payments expected to be

received;
(c) Lease payments recognized in the statement of profit and loss for the
period.
Disclosure by Lessor:
Finance Lease: In case of finance lease, the lessor should disclose:
(a) A Reconciliation between the total gross investment in the lease, and the
present value of minimum lease payments receivable at the balance sheet date.
In addition, an enterprise should disclose the total gross investment in the lease
and the present value of minimum lease payments receivable at the balance
sheet date, for each of the following periods:
(b) Not later than 1 year:
(c) Later than 1 year and not later than 5 years;
(d) Later than 5 years.
(e) Unearned finance income.

Operating Lease: Assets leased on operating lease should be shown in the
balance sheet as Fixed Assets. as per AS-10. Depreciation on these assets and
impairment losses on these assets should be shown in the financial statements.
Lease rentals received in respect in respect of operating lease should be shown

as revenue in the Profit & Loss A/c on a straight-line basis or some other
systematic basis, over the lease period. Costs including depreciation incurred in
earning the lease income are recognized as expense of the period.

SUMMARY
LEASE
• Convey right to use an asset

• In return for payment or series of payments
• For an agreed period of time
Classify “at the inception” and not from the

commencement of the lease term-
Finance Lease Operating Lease
• Consider “Substance over form” • Other than finance lease

• Substantially transfer all risks and rewards • Negative definition
incident to ownership
Minimum Lease payment (MLP)
• Total lease rent + Guaranteed residual value, (or)

• Total lease rent + Payment on purchase option
In the books of lessee In the books of lessee
• Recognise as asset and liability • Recognise lease payment in P&L

• Initial recognition of asset – at lower of • Pattern – Straight line basis over the
FV and PV of MLP leaseInterm
the books of Lessor
if increase is not to
• Charge Lease payment to P&L compensate for inflation.
• Recognise as asset.
• Depreciation as per accounting policy
• Recognise lease income in P&L using
straight line method if increase is not
to compensate for inflation.
In the books of Lessor
• Depreciation as per accounting policy.
• Recognise as “Receivables” at an amount
equal to net investment in the lease.
• Recognise lease income in P&L Disclosure
• Details of leasing agreement / Accounting policy for initial direct cost.

• Age wise beak up of Gross investment, PV of MLP / Upto 1 year / > 1 year < 5 years / > 5 years.

SECTION B: AUDITING (50 MARKS)
Study Note – 6 | Auditing Concepts
6.1 Nature, Scope and Significance of Auditing
OVERVIEW
Meaning
and types
of audit
Quality Objective
control & scope
Audit
Ethical Advantages
requirements &
in audit Limitations
Relationship
with Other
disciplines
1. What is audit?
Definition - An audit is independent examination of financial information of any

entity, whether profit oriented or not, and irrespective of its size or legal form,
when such an examination is conducted with a view of expressing an opinion
thereon.
 Independent examination – Unbiased examination.
1FIN by IndigoLearn | CMA Inter | Paper 12 – Company Accounts and Audit 405
 Financial information – The financial statements and accounts of the entity
 Any entity - whether profit oriented or not and irrespective of its size or legal
form.
 Objective – To give opinion there on – Auditing gives an assurance that the

financial statements are prepared properly and they are not misleading.
2. How is it important for a company form of entity?
Auditing is required for any entity as the auditor will ensure the compliance with
accounting standards and relevant statutes.
It is all the more important for a company form of entity because:
 In a company form of organization, the ownership and management is different.

Members invest money into the company and it is managed by a set of people
called the board or the management.
 Management of the company prepares financial statements and presents to the

members as proof, that money invested has been properly used.
 The members are not allowed to interfere in the day to day business of the
company. It is also not practically possible for the members to scrutinize and get
into the details of the financial statements. And thus, members of the company
appoint an auditor to check the management of the company.
 The auditor reports to the members through an audit report. Thus everyone gets
to know about the functioning of the company through the auditor.
3. Define the following terms that are often used in this subject.
a. Appropriate audit opinion
b. Reasonable assurance
c. Material misstatement
d. Fraud and error
e. Financial reporting framework
f. Audit evidence
g. Audit risk
Appropriate audit opinion –The opinion on financial statements which is a good
indicator of the correct position of the company is called appropriate audit opinion.
The auditor is required to give an appropriate audit opinion after conducting the audit.
To give an appropriate audit opinion, the auditor has to be

1. Independent 2. knowledgeable
Independent - The auditor’s opinion should be unbiased.
Unbiased – It is not influenced by any prior perception of the auditor.
Knowledgeable – He should gain knowledge of the relevant business to be able to form
a correct opinion.
Reasonable assurance – it is the best assurance that the auditor can give. He cannot
give a 100% guarantee as the audit is subject to certain inherent limitations. Thus
reasonable assurance is the assurance given to the best of his ability and with the
information made available.
Material misstatement – A significant mistake in the financial statements. An item is

called material if it has the ability to change the decision of the user.
Fraud and error – Error is an unintentional mistake. Something which has happened
inadvertently. But fraud is deliberate and intentional mistake.
Financial reporting framework – It is the format in which the financial statements

should be prepared and presented. The laws governing different types of entities will
provide such format. For companies – The Companies Act 2013 prescribes the format,
for Banks – RBI provides the format etc.
Thus, the management must prepare its financial statements as per the prescribed
format only. The auditor has to report on the compliance of the same.
Audit evidence – Proof collected during the audit, in order to issue an appropriate
audit opinion is called audit evidence.
Audit risk – Audit risk means auditor’s objective not being met. That is the risk that
the auditor might give an inappropriate opinion. There are 3 kinds of audit risk:
a. Inherent risk
b. Control risk
c. Detection risk
4. What are the overall objectives of audit?
As per SA-200 “Overall Objectives of the Independent Auditor”, in conducting an

audit of financial statements, the overall objectives of the auditor are:
 To obtain reasonable assurance
 To ensure whether the financial statements as a whole are free from material
misstatement
 To report on the financial statements, and
 To communicate as required by the SAs
5. What is the scope of audit?
Scope of audit –
 To form an opinion the auditor should be satisfied that the accounting

information is reliable and sufficient as the basis for the preparation of the
 All aspects of the enterprise are covered in audit.
 In forming his opinion, the auditor should decide whether the relevant
information is properly disclosed in the financial statements.
 The auditor is not expected to perform duties which are outside the scope of his
competence. For example, the professional skill required of an auditor does not
include that of a technical expert for determining physical condition of certain
assets.
 Constraints on the scope of the audit that impair the auditor’s ability to express
an unqualified opinion should be set out in his report.
6. What are the major aspects covered in SA 200? OR What are the key qualities
that the auditor should possess to complete the audit and issue an appropriate
audit report?
There are 5 major aspects covered in SA 200
 Ethical requirements in relation to financial statements
➢ Code of Ethics for Professional Accountants (IESBA Code) establishes the

following as the fundamental principles of professional ethics relevant to
the auditor when conducting an audit of financial statements :
▪ Integrity - Auditor should have integrity/honesty while conducting an
audit.
▪ Objectivity - He should be independent from the client’s operation.
Independence implies that the judgement of a person is not subordinate
to the wishes or direction of another person who might have engaged him.
▪ Professional competence and due care - He should be knowledgeable

and should exercise due professional care while performing the audit
▪ Confidentiality - he should follow confidentiality by not sharing the
client’s information with any person except when client permits or when
the law governing the entity requires.
▪ Professional behavior – His behavior should be professional ie. He should
be uncompromising and disciplined. He should ensure that the team
members also possess the same qualities.
 Carrying out an audit with professional skepticism
➢ Professional skepticism refers to an attitude that includes a questioning

mind, being alert to conditions which may indicate possible misstatement
due to error or fraud, and a critical assessment of audit evidence.
➢ The auditor shall not start the audit with a view that everything is fine or
with a view that everything is not fine. He has to approach the audit with
alertness.
➢ The auditor may accept records and documents as genuine unless the auditor
has reason to believe the contrary. Nevertheless, the auditor is required to
consider the reliability of information to be used as audit evidence.
➢ Some examples where alertness is required is

▪ Audit evidence that contradicts other audit evidence obtained.
▪ Overlooking unusual circumstances.
▪ Over generalizing when drawing conclusions from audit observations.
▪ Information that brings into question the reliability of documents and
responses to inquiries to be used as audit evidence.
 Exercising professional judgement wherever required.
➢ Professional judgement refers to judgment taken by the auditors based on his

or her professional experience.
➢ In cases involving estimation the auditor has to make professional judgement.
 Obtaining sufficient and appropriate audit evidence
➢ Sufficiency refers to quantity of evidence and appropriateness refers to
quality of evidence.
➢ Reasons for failing to obtain sufficient, appropriate audit evidence have to

be documented as per the requirement of SA 230 on audit documentation.
 Complying with standards on auditing
➢ Standards on auditing provide the framework for conduct of an audit. It is

mandatory for the auditor to comply with all the relevant SAs.
➢ However, the auditor can make deviations in the procedure mentioned in the
standards as long as the purpose mentioned in the standard is met.
7. How can the auditor ensure that the financial statements as a whole are free
from material misstatements?
The auditor can ensure this by honestly satisfying himself that:
 The accounts have been drawn up with reference to entries in the books
of account;
 The entries in the books of account are adequately supported by sufficient

and appropriate evidence;
 None of the entries in the books of account has been omitted in the process
of compilation and nothing which is not in the books of account has found
place in the statements;
 The information conveyed by the statements is clear and unambiguous;
 The financial statement amounts are properly classified, described and

disclosed in conformity with accounting standards; and
 The statement of accounts presents a true and fair picture of the

operational results and of the assets and liabilities.
8. Enumerate the management’s responsibilities towards members and towards

auditors.
Following are the management’s responsibilities towards members:
➢ Maintenance of proper books of accounts

➢ Choosing appropriate accounting policies.
➢ Designing internal controls in line with size and nature of entity.
➢ Prevention and early detection of fraud and error.
➢ Follow fundamental accounting assumptions
➢ Ensure that financial statements are in line with proper financial reporting
framework.
➢ Safeguard the assets of the entity.
Following are the management’s responsibilities towards auditors:
➢ Access to books and records of the entity.

➢ Provide information and explanation whenever asked for.
9. What is an audit flow chart?
It describes the process from the beginning to end in an audit engagement.

AUDIT FLOW CHART
Form an
Issue an audit
Acceptance of audit appropriate audit
report
opinion
Obtain audit Form conclusion on

evidence - using areas of financial
audit techniques statements
Perform audit Ensure the

procedures - evidence is
Examination of sufficient and
audit evidence appropriate.
10. What is the framework of audit of financial statements? OR what are the
principal aspects to be covered in audit?
Audit comfort •Existence / Occurrence

bucket •Accuracy
•Completeness
•Opening balances •Test of details •Valuation
•Transactions •Substantive analytical •Rights & Obligations
(Additions & procedures
Deletions) •Cut off
•Test of control
•Presentation & Disclosure
•Test of complaince with
Ledger a/c laws and regulations Assertions
 Ledger A/c
➢ Checking opening balances with the previous year’s closing balances.
➢ Verification of the authenticity and validity of transaction entered into by making

an examination of the entries in the books of accounts with the relevant
supporting documents.
 Test of control
➢ Examination of the system of accounting and internal control to ascertain

whether it is appropriate for the business and helps in properly recording all
transactions.
➢ Reviewing the system and procedures of internal control to ensure they are
adequate.
 Test of compliance with laws and regulations
➢ Confirm whether the applicable laws and regulations governing the entity have
been complied with.
 Test of details
➢ Ascertaining that a proper distinction has been made between items of capital
and of revenue nature and that the amounts of various items of income and
expenditure adjusted in the accounts correspond to the accounting period.
➢ Checking the result shown by the profit and loss and to see whether the results
shown are true and fair.
 Substantive procedures
➢ Verification of the authenticity and validity of transaction entered into by making

an examination of the entries in the books of accounts with the relevant
supporting documents.
➢ Comparison of the balance sheet and profit and loss account or other statements
with the underlying record in order to see that they are in accordance therewith.
➢ Obtaining external confirmations
 Assertions
➢ In representing the financial statements are in accordance with the applicable

financial reporting framework, management implicitly or explicitly makes
assertions regarding the recognition, measurement, presentation and disclosure
of the various elements of financial statements.
➢ Auditor has to verify each of the assertions.
▪ Existence / Occurrence – Transactions that occurred pertain to the entity.

Assets, liabilities and equity interest exists.
▪ Accuracy – Verify the arithmetical accuracy
▪ Completeness – all transactions have been recorded
▪ Valuation - Assets, Liabilities, and Equity interests are included in the
financial statements at appropriate amounts and any resulting valuation or
allocation adjustments are appropriately recorded.
▪ Rights & Obligations - the entity holds or controls the rights to assets, and
liabilities are the obligations of the entity.
▪ Cut off – Transactions are recorded for correct accounting period.
▪ Presentation & Disclosure – Appropriate disclosures have been made and the
presentation as in accordance with the governing law.
11. How can the audit firm ensure a high quality of audit? OR what are the
elements of a system of quality control at the firm level?
The firm’s system of quality control should include policies and procedures
addressing each of the following elements:
 Leadership responsibilities for quality within the firm
➢ The engagement partner shall take responsibility for the overall quality on
each audit engagement to which that partner is assigned.
➢ Engagement partner is the person who is responsible for the audit and also
for the audit report to be issued on behalf of the firm
➢ He is responsible for communicating the quality control policies to the entire

team engaged in the audit.
 Ethical requirements
➢ Personnel in the firm should follow the principals of independence, integrity,

objectivity, confidentiality and professional behavior.
➢ Personnel should have independence of mind as well as independence of

appearance.
➢ Independence of mind – the state of mind that permits the provision of an
opinion without being affected by influences allowing an individual to act
with integrity, and exercise objectivity and professional skepticism; and
➢ Independence in appearance – the avoidance of facts and circumstances that
are so significant that a third party would reasonably conclude an auditor’s
integrity, objectivity or professional skepticism had been compromised. (E.g.
The judge and the criminal going in the same car)
➢ Independence of the auditor has not only to exist in fact, but also appear to
so exist to all reasonable persons.
 Acceptance and continuance of client relationships and specific

engagements.
➢ The firm must evaluate the client and the risk associated with such audit
before accepting the engagement.
➢ The engagement partner shall be satisfied that appropriate procedures

regarding the acceptance and continuance of client relationships and audit
engagements have been followed.
➢ The engagement partner should collect information on significant matters

that have arisen during the current or previous audit engagement, and their
implications for continuing the relationship.
 Human resources
➢ Number of resources - The firm should ensure that it has sufficient number
to resources to carry on the audit.
➢ Skill and competence – Personnel should have sufficient degree of skill and
competence.
➢ Assignment – The audit work should be assigned to every person depending

on his competence.
➢ Delegation – There should be sufficient direction, supervision, and review of

works at all levels
 Engagement performance
➢ The firm should establish policies and procedures designed to provide it

with reasonable assurance that engagements are performed in accordance
with professional standards and regulatory and legal requirements
➢ Through its policies and procedures, the firm seeks to establish consistency
in the quality of engagement performance.
➢ This is often accomplished through written or electronic manuals, software
tools or other forms of standardized documentation,
➢ The audit partner and personnel should consult experts wherever required.
 Monitoring
➢ The firms should have policies and procedures which include an ongoing
consideration and evaluation of the firm’s system of quality control, including
a periodic inspection of a selection of completed engagements.
➢ The purpose of monitoring compliance with quality control policies and

procedures is to provide an evaluation of whether the quality control system
has been appropriately designed and effectively implemented.
➢ Follow-up by appropriate firm personnel so that necessary modifications are

promptly made to the quality control policies and procedures.
12. what are the elements of a system of quality control at the individual audit
level?
The audit partner should confirm on the relevant policies and procedures which are
applicable to that particular audit.
It has to be ensured that the work is carried on as per the firm’s quality standards,
by every person involved in the audit. This can be done by –
Direction – Involves informing assistants about their responsibilities, objectives, and

other important matters affecting the nature, timing and extent of their audit
procedures.
Supervision by senior audit assistants – monitor progress, obtain information about

significant accounting and auditing questions raised, and resolve differences of
professional judgement
Review of work performed – to ensure completion of audit work, achievement of

objective, consistency of audit conclusions, consideration of significant matters
etc.
13. What are the pre-conditions for audit? OR What are the key criteria that the
audit firm should consider before accepting the engagement?
 Pre-conditions to audit – It is an agreement between the management and the
auditor on the premise on which audit is conducted.
 Before acceptance of audit, auditor has to prepare an audit engagement letter
stating the pre-conditions of audit which will be signed by both, the management
and the auditor.
 Auditor has to confirm if the management understands and accepts its
responsibilities towards members and auditors in the pre-condition of audit.
 As part of pre-conditions, the management agrees for the following:
➢ The use of acceptable financial reporting framework in the preparation of
➢ Existence of necessary the internal controls.
➢ To provide the auditor with access to all information such as records,
documentation and other additional information that the auditor may request
➢ To provide the auditor with unrestricted access to persons within the entity
from whom the auditor determines it necessary to obtain audit evidence.
 The auditor will not accept the audit or if already accepted, will withdraw from
the audit IF
➢ There is no specified financial reporting framework or the management does
not agree with the framework provided by the auditors
➢ The management or TCWG (Those Charged With Governance) disagree with
any of the points of pre-conditions to audit.
14. Who signs the engagement letter?
The two parties that must sign the engagement letter are:
1. Partner / Proprietor who is a chartered accountant and
2. Those charged with governance (Like, CEO, Managing director etc)
15. Is audit mandatory for all entities?
Types of audit
Audit required under law Voluntary Audits
Companies audit, Proprietary entities

LLP audit, Partnership firms
Audit for corporations, Hindu undivided families
Banking companies, Some may be required to get their
accounts audited on the directives of
Statutory bodies required by their Government for various purposes like
regulators or by specific Act sanction of grants, loans, etc.
➢ But the important motive for getting accounts audited lies in the advantages that
follow from an independent professional audit.
➢ That’s why large numbers of proprietary and partnership business get their
accounts audited.
➢ The auditor should get the scope of his duties and responsibilities defined by
obtaining instructions in writing. It is always a wise precaution to state in the
report, accompanying the balance sheets of proprietary or partnership firms or
other similar organisations, the nature of the work carried out and explain the
important features of the financial statements on which a report has been made.
➢ A special reference is necessary for non-profit making institutions like schools,

clubs, educational institutions, hospitals, associations, etc., irrespective of any
internal rules, to get their accounts audited because most of them enjoy
government or municipal grants and, generally, for this purpose audited accounts
are insisted upon.
➢ Both public and private trusts have their own reasons to always get their accounts
audited.
16. Is it mandatory to mention the scope of work in the audit engagement letter?
How is scope agreed upon?
 SA 210 “Agreeing the Terms of Audit Engagements” states that it is, important,
both for the auditor and client, that each party should be clear about the nature
of the engagement.
 It must be reduced to writing and should exactly specify the scope of the work.
 The audit engagement letter is sent by the auditor to his client
1. Where the audit terms are already given in the laws governing the
enterprise - for eg, companies, registered societies, LLPs etc
• The auditor shall refer such mention of audit terms in the engagement
letter
2. In case of voluntary audits where audit terms are not prescribed by any
law like, partnership, sole proprietorship
• The auditor shall agree the terms of the audit engagement with
management or those charged with governance, as appropriate and
should mention in the engagement letter.
17. What should be the auditor’s response in the following situations?
Situation 1
If there is a conflict between Accounting standards (issued by ICAI) and any
provision of the law, governing the enterprise (eg. Companies Act 2013 for
companies)
Situation 2
If the auditor is of the opinion that financial reporting framework prescribed by
the law governing the enterprise is unacceptable.
Situation 3
If the audit report is prescribed by the governing law and the language used by
the law is confusing or misleading and users may misunderstand the information
in the financial statement.
Situation 1 and 2
 The auditor shall ask the management to make additional disclosure in notes to
accounts
➢ explaining how they have reconciled the difference between accounting
standards and the provision of governing law
➢ the limitation of or the confusion caused by, the financial reporting
framework prescribed by the governing law and the actual scenario
 The auditor may also give an ‘Emphasis of matter’ paragraph in the audit report
 He may also issue a modified opinion if there is disagreement with the
management.
Situation 3
 The auditor should communicate to the management on the confusion that will
be caused because of the language and the additional para that he will add to
avoid the confusion.
 If the management disagrees on the additional para then the auditor may even
withdraw from the engagement.
18. Do the terms of an engagement letter singed in one year be relevant for
future years as well?
Generally, terms of engagement letter signed for one period will be continued
for future years also. However, it is changed in the following cases.
Terms of engagement
Is there any change in the management ? or

Significant change in ownership or
Significant change in nature or size of the entity’s
business or
Yes No
New letter of Has the terms changed in future? Or

engagement to be change in legal or regulatory
issued requirements ?
Yes No
New letter of New letter not

engagement to be required
issued
19. Can the management ask the auditor to change terms before completion of the
engagement? Does the auditor have a right to reject the engagement in such
circumstance?
Yes. The management may request the auditor to change the engagement before
its completion. Such request may result from
1. A change in circumstances affecting the need for the service,
2. A misunderstanding as to the nature of an audit or related service originally
requested.
3. A restriction on the scope of the engagement, whether imposed by
management or caused by circumstances.
Before taking any decision, the auditor would consider carefully the reason given
for the request, particularly the implications of a restriction on the scope of the
engagement, especially any legal or contractual implications.
The auditor’s course of action can be explained through the following table:
Situation Auditor’s response

No reasonable justification for change in Need not agree to such change. He
audit terms is given by the management. may even choose to withdraw from
the engagement.
During the course of assignment, the Determine if it is reasonable. If it is
management requests the auditor to limit not so then withdraw from the
his scope. engagement.
In spite of reasons given by management, Withdraw from the audit engagement,
the auditor is unable to agree to the where possible and determine
change in terms and believes it provides a whether there is any obligation to
lower level of assurance report the matter to other parties like
management, regulators etc.
If the auditor finds the reasons for change He will accept the new terms of
in engagement valid engagement.
If auditor proposes any change in the terms Send a new engagement letter to the
of engagement client to communicate the revision of
terms and take the client’s
acceptance for the same.
20. What are the advantages of audit?

➢ Obvious utility is, reliable financial statements on the basis of which the state of
affairs may be easy to understand.
➢ It safeguards the financial interest of persons who are not associated with the
management of the entity, whether they are partners or shareholders, bankers,
Financial Institutions, public at large etc.
➢ It acts as a moral check on the employees from committing defalcations or
embezzlement.
➢ Tax computation is made easy
➢ Loan negotiations and purchase consideration for business becomes easy
➢ Useful for settling trade disputes for higher wages or bonus
➢ Useful for determining claims in respect of damage suffered by property, by fire

or some other calamity.
➢ Helps in the settlement of accounts at the time of admission or death of partner.
➢ Disputes among partners can be easily resolved.
➢ Helps in the detection of wastages and losses to show the different ways by which
these might be checked, especially those that occur due to the absence or
inadequacy of internal checks or internal control measures
➢ Audit ascertains whether the necessary books of account and allied records have
been properly kept and helps the client in making good, deficiencies or
inadequacies in this respect.
➢ Government may require audited and certified statement before it gives

assistance or issues a license for a particular trade.
➢ Helps in identifying weaknesses in internal control system and internal reporting

system.
21. What are the inherent limitations of audit ?
The auditor cannot reduce audit risk to zero as there are some inherent limitations.
These have been enumerated in SA 200.
Audit risk means risk that the auditor may issue an inappropriate opinion. It is of 3
kinds – Inherent risks, control risks and detection risk.
 Audit is a process of persuasion and not a process of proof
➢ The preparation of financial statements involves judgment by management in

applying the requirements of the entity’s applicable financial reporting
framework to the facts and circumstances of the entity. Sometimes auditor
has to satisfy himself with alternative proofs.
 Auditor obtains reasonable assurance and not absolute assurance
➢ Many financial statement items involve subjective decisions or assessments
or a degree of uncertainty, and there may be a range of acceptable
interpretations or judgments that may be made.
➢ There is the possibility that management or others may not provide,

intentionally or unintentionally, the complete information that is relevant
➢ The existence and completeness of related party relationships and

transactions may be difficult to identify.
 Timelines of financial reporting and balance between benefit and cost may affect
the quality of audit.
➢ There is a balance to be struck between the reliability of information and its
cost.
➢ Appropriate planning assists in making sufficient time and resources available
for the conduct of the audit. However, the complexities in transactions may
elongate the time.
 Audit is never absolutely fraud proof.
➢ Some frauds in which top management is involved cannot be found even if

audit is complete.
➢ Frauds involve sophisticated and carefully organized schemes designed to

conceal it.
➢ An audit is not an official investigation into alleged wrong doing.
➢ Accordingly, the auditor is not given specific legal powers, such as the power
of search, which may be necessary for such an investigation.
 Estimation cannot be accurate and reliable
➢ Preparation of financial statement calls for estimations in many scenarios

like, provision for doubtful debts, estimation of useful life of the asset etc.
22. How is auditing related to other disciplines?
The field of auditing as a discipline involves review of various assertions; both in

financial as well as in non-financial terms and expressing an opinion thereon.
Thus, it is quite logical and natural that the function of audit can be performed if
and only if the person also possesses a good knowledge about the fields in respect
of which he is conducting such a review.
Accounting
Financial
management Law
& costing
Auditing
Data
Economics
processing
Behavioural Maths &

science Statistics
 Auditing and Accounting

➢ Both accounting and auditing are closely related with each other as auditing
reviews the financial statements which are nothing but a result of the overall
accounting process.
➢ It naturally calls on the part of the auditor to have a thorough and sound
knowledge of generally accepted principles of accounting before he can
review the financial statements.
➢ It is said that auditing starts where accounting ends.
 Auditing and Law
➢ The relationship between auditing and law is very close one. Auditing involves
examination of various transactions from the view point of whether or not
the
various provisions of the governing law has been complied with. For eg:
Companies are governed by Companies Act 2013, Banks are governed by RBI
regulations, Partnerships and LLPs are governed by Partnership Act 1932 and
LLP Act 2008 etc.
➢ It necessitates that an auditor should have a good knowledge of business laws

affecting the entity. He should be familiar with the law of contracts,
negotiable instruments, etc.
➢ The knowledge of taxation laws is also inevitable as ever entity is required to

prepare their financial statements taking into account various provisions
affected by both direct and indirect tax laws.
 Auditing and Economics

➢ Accounting is concerned with the accumulation and presentation of data
relating to economic activity.
➢ From the auditing viewpoint, the auditors are more concerned with Micro
economics rather than with the Macro economics.
➢ The knowledge of Macroeconomics should include the nature of economic

force that affect the firm, relationship of price, productivity and the role of
Government and Government regulations.
➢ Auditor is expected to be familiar with the overall economic environment in

which his client is operating.
 Auditing and Behavioural Science

➢ The discipline of behavioral science is closely linked with the subject of auditing.
While it may be said that an auditor, deals basically with the figures contained
in the financial statements but he shall be required to interact with a lot of
people in the organization.
➢ One of the basic elements in designing the internal control system is personnel.
Howsoever, if a sound internal control structure is designed, it cannot work until
and unless the people who are working in the organisation are competent and
honest.
➢ The knowledge of human behaviour is indeed very essential for an auditor so as

to effectively discharge his duties.
 Auditing and Statistics & Mathematics

➢ With the passage of time, test check procedures in auditing have become part
of generally accepted auditing procedures.
➢ The auditor is also expected to have the knowledge of statistical sampling so

as to arrive at meaningful conclusions.
➢ The knowledge of mathematics is also required on the part of auditor

particularly at the time of verification of inventories.
➢ The use of data analytics is advancing rapidly in auditing where many

organizations are using continuous auditing and continuous monitoring of data
to identify risks as part of their system of internal control.
 Auditing and Data Processing

➢ Today, organizations are witnessing revolution in the field of data processing
of accounts. Many organizations are carrying out their financial accounting
activities with the help of computers which can document, record, collate,
allocate and value accounting data and information in very large quantity at
very high speed.
➢ The dependence on the accuracy of the programmed instructions given today,

the computer is able to carry out each of these activities with complete
accuracy.
➢ With such a phenomenal growth in the field of computer sciences, the auditor
should have good knowledge of the components, general capability of the
system and the related terms.
➢ In fact, Computerised Information System auditing in itself is developing as a

discipline in itself.
 Auditing and Financial Management & Costing

➢ The auditor is expected to have knowledge about various financial techniques
such as working capital management, funds flow, ratio analysis, capital
budgeting etc.
➢ The auditor is also expected to have a fair knowledge of the institutions that
comprise the marketplace.
➢ The knowledge of various institutions and Government activities that

influence the operations of the financial market are also required to be
understood by an auditor.
➢ While carrying out the audit activity, the auditor is required to evaluate
transactions from the accounting aspect in relation to the process through
which it has passed through as accounting for by-products; joint- products
may also require to be done.
➢ The knowledge of production process shall become more essential in case of

an internal auditor. The auditor shall also require understanding the cost
system in operation in the factory and assessing whether the same is
adequate for the particular company.
➢ The understanding of the terminology of the production shall enable an

auditor to communicate with production employees in connection with his
work.
 Conclusion
➢ Auditing as a discipline is also closely related with various other disciplines

as there is lot of linkages in the work which is done by an auditor in his day-
to-day activities.
➢ Auditing itself is a logical construct and everything done in auditing must be

bound by the rules of logic. Ethical precepts are the foundations on which the
foundation of the entire accounting profession rests.
➢ The knowledge of language is also considered essential in the field of auditing

as the auditor shall be required to communicate, both in writing as well as
orally, in day-to-day work.
➢ Auditing is also closely related with other functional fields of business such as
finance, production, marketing, personnel and other general areas of business
management.
23. Define the role of IAASB and AASB?
 In 1977, the International Federation of Accountants (IFAC) was set up with a

view to bringing harmony in the profession of accountancy on an international
scale.
 In pursuing this mission, the IFAC Board has established the International Auditing
and Assurance Standards Board (IAASB) to develop and issue, in the public
interest and under its own authority, high quality auditing standards for use
around the world.
 The IAASB functions as an independent standard-setting body under the auspices

of IFAC.
 The objective of the IAASB is
▪ to serve the public interest by setting high quality auditing standards
▪ to facilitate the convergence of international and national standards,
▪ enhancing the quality and uniformity of practice throughout the world
▪ and strengthening public confidence in the global auditing and assurance
profession.
 The IAASB achieves this objective by establishing high quality auditing standards
and guidance for
▪ Financial statement audits that are generally accepted and recognized
by investors, auditors, governments, banking regulators, securities
regulators and Other key stakeholders across the world;
▪ Other types of assurance services on both financial and non-financial
matters;
▪ Other related services;
▪ Quality control covering the scope of services addressed by the IAASB;
and
▪ Publishing other pronouncements on auditing and assurance matters,
 ICAI is a member of the IFAC and is committed to work towards the

implementation of the guidelines issued by the IFAC.
 ICAI constituted the AASB (erstwhile Auditing Practices Committee) to review

the existing auditing practices in India and to develop Engagement and Quality
Control Standards (erstwhile Statements on Standard Auditing Practices) so that
these may be issued by the Council of the Institute.
 The main function of the AASB is to review the existing auditing practices in India
and to develop Statements on Standard Auditing Practices (SAPs) so that these
may be issued by the Council of the Institute.
 While formulating the SAPs in India, the AASB gives due consideration to the
international auditing guidelines issued by the IAASB and then tries to integrate
them to the extent possible in the light of the conditions and practices prevailing
in India.
 These standards apply to all entities whether profit oriented or not, and
irrespective of its size, or legal form (unless specified otherwise)
AASB
pronouncements
Standard for Standards on Standards on Standards on

Standards on
quality Reveiw Assurance related
Auditing (SAs)
control(SQC) engagements engagements services (SRS)
(SREs) (SAEs)
 While discharging their attest function, it will be the duty of members of the
Institute to ensure that the Standards are followed in the audit of financial
information covered by their audit reports.
 If for any reason a member has not been able to perform an audit in accordance
with the Standards, his report should draw attention to the material departures
there from.
 Auditors will be expected to follow Standards in the audits commencing on or

after the date specified in the statement. It is obligatory upon members of
Institute to adhere to these standards whenever an audit is carried out.
 The Institute has, from time to time, issued ‘Guidance Notes’ and ‘Statements’
on a number of matters.
 ‘Guidance Notes’ : are primarily designed to provide guidance to members on
matters which may arise in the course of their professional work and on which
they may rely in the course of their professional work and on which they may
desire assistance in resolving issues which may pose difficulty.
 Guidance Notes are recommendatory in nature. There are however a few
guidance notes in case of which the Council has specifically stated that they
should be considered as mandatory on members while discharging their attest
function.
24. What are the threats to an auditor’s independence?
The Code of Ethics for Professional Accountants prepared by the International
Federation of Accountants (IFAC) identifies five types of threats. These are:
 Self-interest threats - which occurs when an auditing firm, its partner or
associate could benefit from a financial interest in an audit client.
Examples include
(i) direct financial interest or materially significant indirect financial interest in
a client,
(ii) loan or guarantee to or from the concerned client
(iii) undue dependence on a client’s fees and, hence, concerns about losing the
engagement,
(iv) close business relationship with an audit client,
(v) potential employment with the client, and
(vi) contingent fees for the audit engagement.
 Self-review threats - which occurs when an auditor also appointed for non-audit
engagement.
Non audit services include any professional services provided to an entity by an
auditor, other than audit or review of the financial statements. These include
management services, internal audit, investment advisory service, design and
implementation of information technology systems etc.
This also occurs when a member of the audit team was previously a director or
senior employee of the client.
 Advocacy threats - which occurs when the auditor promotes, or is perceived to

promote, a client’s opinion to a point where people may believe that objectivity
is getting compromised, e.g. when an auditor deals with shares or securities of
the audited company or becomes the client’s advocate in litigation and third
party disputes.
 Familiarity threats - which occurs when auditors form relationships with the
client where they end up being too sympathetic to the client’s interests. For
example:
(i) close relative of the audit team working in a senior position in the client
company,
(ii) former partner of the audit firm being a director or senior employee of the
client
(iii) long association between specific auditors and their specific client
counterparts,
(iv) acceptance of significant gifts or hospitality from the client company, its
directors or employees.
 Intimidation threats - which occurs when auditors are deterred from acting
objectively with an adequate degree of professional skepticism. Basically, these
could happen because of threat of replacement over disagreements with the
application of accounting principles, or pressure to disproportionately reduce
work in response to reduced audit fees.
➢ Before taking on any work, an auditor must conscientiously consider whether it
involves threats to his independence.
➢ When such threats exist, the auditor should either desist from the task or put in
place safeguards that eliminate them.
➢ If safeguards are inadequate, he should reject the work.
6.2 Audit Engagement, Audit Programme, Audit Wroking
Papers, Audit Notebook, Audit Evidence and Audit Report
Overview
Audit
Strategy
Audit
Materiality
planning
Documentation Advantages &

of audit plan Disadvantages
Audit
programme
Acceptance of engagement
Knowing objective of audit
Defining scope of audit
Preparing an audit plan
Conduct of audit
Preparing audit report
1. What is audit planning?
 It is said, ‘Well begun is half done’. Thus audit planning is the preparatory work
done by the auditor before he starts the audit. It is an essential step in
conducting the audit. Audit flow chart is given below
 SA-300, “Planning an Audit of Financial Statements” further emphasizes that
planning is not a discrete phase of an audit, but rather a continual and
iterative process. Plans should be further developed and revised as necessary
during the course of the audit.
 Per SA- 300 the process begins shortly after (or in connection with) the
completion of the previous audit and continues until the completion of the
current audit engagement.
 The auditor shall establish an overall audit strategy that sets the scope, timing
and direction of the audit, and that guides the development of the audit plan.
 Plans must cover the following:

➢ Understanding business environment - Acquiring knowledge of the client’s
accounting systems, policies and internal control procedures.
➢ Understanding the environment in which the client operates helps in making
the planning more effective.
➢ Study of Internal control – This helps in establishing the expected degree of
reliance to be placed on internal control. ie. the extent to which internal
controls are strong.
➢ This highlights the areas that need focus. A detailed plan is required for such
areas.
➢ Determining and programming the nature, timing, and extent of the audit
procedures to be performed –
➢ Nature helps to decide on the audit procedure to be applied e.g. Whether we
should apply compliance testing or substantive testing.
➢ Timing involves decisions like whether audit should be commenced at the end
of the year or if surprise checks during the year is required etc.
➢ Coordinating the work to be performed - This includes decisions regarding
the audit team size, the delegation of work etc.
2. What are the benefits of audit planning?
There are plenty of benefits of planning. Some are mentioned below:

 Critical risk areas can be identified and verified – It helps the auditor to devote
appropriate attention to important areas of the audit.
 Audit issues are identified and resolved in time – Any issue that arises during
the course of audit is addressed immediately. Such a mechanism should be inbuilt
as part of audit procedure.
 Conduct of audit in efficient and effective manner – It helps the auditor to

properly organize and manage the audit engagement so that it is performed in
an effective and efficient manner.
 Selection of engagement team members – Based on the risk analysis and

complexity of transactions, appropriate engagement team members are selected
with appropriate levels of capabilities and competence to respond to anticipated
risks, and the work is assigned accordingly.
 Audit work coordination becomes easy - It facilitates the direction and

supervision of engagement team members and the review of their work.
 Using work of others (internal auditors, branch auditors, experts etc) is made
easy – It assists, where applicable, in coordination of work done by auditors of
components and experts.
3. Is audit strategy and audit plan one and the same?
 In very simple terms, strategy refers to Where one wants to reach and planning
refers to how to reach there.
Audit Audit
strategy Sets the scope, planning I It is the
timing and procedure to
direction of the execute/achieve
audit. the strategy
 Thus, the audit planning is based on the strategic goals of the audit firm.
 Once the overall audit strategy has been established, an audit plan can be
developed to address the various matters identified in the audit strategy.
 The audit strategy and the detailed audit plan are closely inter-related since
changes in one may result in consequential changes to the other.
4. How is the audit strategy helpful to the auditor?
The process of establishing the overall audit strategy assists the auditor to
determine :
 The resources to deploy for specific audit areas - such as

➢ The use of appropriately experienced team members for high risk areas,
➢ The involvement of experts on complex matters etc.
 The number of resources to allocate to specific audit areas - such as
➢ The number of team members assigned to observe the inventory count
➢ The extent of review of other auditors’ work in the case of group audits,
 Time of resources deployment -Example
➢ whether at an interim audit stage or at key cut-offdates
➢ how many days for internal control testing etc.
 How such resources are managed, directed and supervised - Example
➢ when team briefing and debriefing meetings are expected to be held
➢ how engagement partner and manager reviews are expected to take place
(for example, on-site or off-site).
What are the parameters (or steps) involved in Establishment of Overall Audit
Strategy? Give suitable examples.
In establishing the overall audit strategy, the auditor shall

 Identify the characteristics of the engagement that define its scope -
➢ Number and locations or branches to be audited
➢ Nature of business (eg: Manufacturing, service oriented etc) and number of
business segments
➢ Previous experience gained about the client etc.
 Ascertain the reporting objectives of the engagement to plan the timing and
the nature of the communications required -
➢ When should the audit be completed and by when the audit report should be
submitted?
➢ Who from the management team should be reached in case of clarifications?
➢ Whom should be updated on the status of audit work throughout the

engagement?
 Consider the factors that, in the auditor’s professional judgment, are significant
in directing the engagement team’s efforts -
➢ Suppose the client has started a new factory then transactions relating to the
factory should be checked more thoroughly
 Consider the results of preliminary engagement activities-
➢ Whether the auditor has collected any preliminary information through
questionnaires etc. before starting the audit
➢ whether knowledge gained on other engagements performed for the same
entity
 Ascertain the nature, timing and extent of resources necessary to perform the
engagement
5. What is included in an audit plan?
Audit plan inlcudes a
description of
Nature, timing and extent of
Planned risk Other planned audit

Audit procedures at
assessment procedures to ensure
the assertion level
procedures compliance with SAs
 Planning for these audit procedures takes place over the course of the audit as
the audit plan for the engagement develops.
 Planning of the auditor’s risk assessment procedures occurs early in the audit
process.
 However, planning the nature, timing and extent of specific further audit
procedures depends on the outcome of those risk assessment procedures
6. Elaborate the meaning Nature, timing and extent of audit procedures.
 Nature–Refers to kind of work that needs to be done.
Nature - Kind of work that needs
to be done
Compliance Substantive
procedures procedures
Substantive analytical Test of

Test of compliance Test of details
with laws and procedures
controls
regulations
-
 Timing of audit procedures – Refers to time when the audit procedures have to
be performed. For eg: If the auditor wants to verify the cash balance as on 31 st
March, then physical verification has to happen on that day itself.
Timing
Beginning of the year During the year End of the year
 Extent – Refers to the scope of work to be included.
Extent
What all areas needs to be How many transactions are to be

verified in detail ? verified in selected areas?
One of the important principles in developing an overall audit plan is Knowledge of
the Client’s Business. In fact, without adequate knowledge of client’s business, a
proper audit is not possible. What should the auditor know as part of knowledge of
client’s business ? Explain with examples.
Yes. Knowledge of client’s business is the primary requirement for audit planning. As
each business has its own risk. Only a complete knowledge of client’s business will
help him in performing risk assessment procedures.
In order to get the knowledge of client’s business the auditor will have to obtain the
understanding of the following factors which affect the client’s business:
1. Global factors
2. National and policy level factors
3. Industry specific factors and
4. Company specific factors.
The information is gathered in the above order only. Thus the auditor will first get
the understanding of macroeconomic factors (or external factors) and then come to
company specific factors.
Global factors
National and policy factors
Industry specific
Company
specific
 Global factors
➢ Competitive environment like demand, cost of raw material in the global
market.
➢ An entity with components in multiple tax jurisdictions, has additional risk
 National and policy factors–
➢ Income tax rates, Government schemes etc.
 Industry specific factors

➢ Technological developments, such as those related to the entity’s products,
Shortage of skilled labour etc.
➢ Supplier and customer relationships, such as types of suppliers and
customers.
 Company specific factors –
➢ Non-financial factors like production capacity, headcount, input-output ratio
➢ Financial factors like Past performances, turnovers, employee cost etc.
7. Specify the key information about the company that helps the auditor in his risk
assessment.
About the company, the auditor should have knowledge of the following
information:
➢ Ownership and governance structures
➢ The types of investments that the entity is making and plans to make
➢ Capital decisions like joint ventures, mergers etc.
➢ Transactions outside the entity’s normal course of business-like leasing of
premises, equity transactions etc.
➢ The entity’s selection and application of accounting policies, including the
reasons for changes thereto.
➢ The entity’s objectives and strategies, and those related business risks.
The above information helps the auditor

➢ To perform risk assessment procedures
➢ To identify areas of special audit consideration,
➢ To evaluate the reasonableness, both of accounting estimates and
management representations and
➢ To make judgements regarding the appropriateness of accounting policies
and disclosures
8. Is Audit planning a continuous process or a discrete one?
➢ Planning is definitely not a discrete process, but rather a continual and iterative
process.
➢ It begins shortly after (or in connection with) the completion of the previous
audit and continues until the completion of the current audit engagement.
➢ A good audit plan is never rigid. It has the inbuilt flexibility to make changes
based on the circumstances.
➢ The auditor shall update and change the overall audit strategy and the audit
plan as necessary during the course of the audit.
➢ The change in planned nature, timing and extent of further audit procedures
may happen -
▪ When information comes to the auditor’s attention that differs significantly
from the information available when the auditor planned the audit
procedures
▪ When unexpected events or changes in conditions occur,
▪ When audit evidence obtained from the results of audit procedures
necessitate a change.
➢ Thus, the iterative process is inevitable.
Planning
Implementing
Review
Issues
and
crop up
Monitor
Make
necessary
changes
9. By discussing the nature and timing of detailed audit procedures with

management, is the responsibility of audit strategy and audit plan shared with
the management? Does such a action result in compromising the effectiveness
of audit?
➢ The overall audit strategy and the audit plan remains the auditor’s
responsibility. By no means it can, be shared with the management.
➢ However, to coordinate some of the planned audit procedures with the work
of the entity’s personnel such discussions are necessary.
➢ When discussing matters included in the overall audit strategy or audit plan, care
is required in order not to compromise the effectiveness of the audit.
➢ The involvement of the engagement partner and other key members of the
engagement team in planning the audit enhances the effectiveness and
efficiency of the planning process. It is because of their experience, expertise
and insights.
10. What do you understand by Direction, Supervision and review in the context of
audit planning? What factors influence them?
➢ Direction refers to giving guidance to the audit team by the engagement

partner. The guidance is given both while framing the audit plan and also while
executing it.
➢ Supervision and review refers to the constant overview of the plans by the
superiors and engagement partner.
➢ It provides a constant feedback and support mechanism to ensure the

achievement of audit goals.
➢ Thus, the auditor shall plan the nature, timing and extent of direction and
supervision of engagement team members and the review of their work.
➢ The factors that influence the nature, timing and extent of direction,
supervision and review are:
a. The size of the audit entity.

b. The complexity of the audit entity.
c. The area of the audit
d. The assessed risks of material misstatement
e. The capabilities and competence of the individual team members
performing the audit work.
11. What should be documented as part of audit plan ?

The following should be documented:
 The overall audit strategy – It is a record of
➢ Key decisions considered necessary to properly plan the audit and
➢ Communicate significant matters to the engagement team.
 The audit plan–It is a record of

➢ The planned nature, timing and extent of risk assessment procedures &
➢ Further audit procedures at the assertion level in response to the
assessed risks
 Any significant changes made during the audit engagement to the overall audit
strategy or the audit plan, and the reasons for such changes– It is a record which
explains
➢ Why the significant changes were made,
➢ The overall strategy and audit plan finally adopted for the audit and
➢ The appropriate response to the significant changes occurring during the
audit.
12. What is an audit programme? How is it related to audit plan and audit strategy?
An audit programme is a detailed plan of applying the audit procedures in the given
circumstances with instructions for the appropriate techniques to be adopted for
accomplishing the audit objectives.
It is a list of examination and verification steps to be applied and set out in such
a way that the inter-relationship of one step to another is clearly shown.
Detailed plan of With instructions for the

for accomplishing the
applying the audit appropriate techniques to
audit objectives.
procedures be adopted
Audit programme is nothing but an elaborate description of steps to execute audit

plan. Thus it ensures the accomplishment of audit plan. And Audit plan ensures the
accomplishment of audit strategy.
The relationship between audit plan, strategy and programme can be shown as
below.
Audit strategy - Specifies what needs to be done
Audit plan - Specifies how it needs to be done
Audit programme - Specifies step by step procedures

for executing audit plan.
13. What are the features of an audit programme?
The following are the features of an audit programme:
 One Audit Programme for every audit.

The following factors vary from assignment to assignment.
➢ Nature of business, their size and composition
➢ Work which is suitable to one business may not be suitable to others,
➢ Efficiency and operation of internal controls and
➢ The exact nature of the service to be rendered by the auditor
Thus, one audit programme applicable to all business under all circumstances is
not practicable. We need to draw a separate audit programme for every
engagement.
The Assistant engaged - Be encouraged to keep an open mind
The engagement team should be instructed to

➢ Trust the audit programme
The trust can be built by involving them in the planning phase itself.
➢ Keep an open mind and focused view
Open mind refers to being vigilant and make necessary changes to the
programme wherever required and
Focused view refers to ensuring that the procedure followed helps to
meet the objective.
➢ Note and report significant matters coming to his notice, to his seniors
or to the engagement partners.
So long as the suggested change is not approved by the principal, every team
member should stick to the initial programme. This is only to ensure that only
genuine changes are made.
 Periodic Review of The Audit Programme
The auditor prepares a standard audit programme keeping in mind the

➢ nature, size and composition of the business
➢ the dependability of the internal control
➢ His past experience with such engagement
➢ and the given scope of work
However periodic review of the audit programme should be done to assess

➢ If there are any inadequacies in collecting the proper evidence
➢ If there is any procedure which is redundant and need not be carried on
➢ If it is relevant to the audit, based on the changed facts and circumstances
The client’s operations and internal control should also be reviewed periodically
If periodic review is not done

➢ any change in the business policy of the client may not be adequately
known
➢ the auditor may have to face legal consequences for negligence of duty.
14. What are key factors to be kept in mind while drawing an audit programme?
The following are the key factors to be kept in mind while drawing an audit
programme:
(1) Stay within the scope and limitation of the assignment.

Example of scope – The various laws that the entity has to comply with.
Example of limitation – The strength of internal control
(2) Determine the evidence reasonably available and identify the best evidence
for deriving the necessary satisfaction.
For every assertion, there will be multiple evidences. The auditor should
understand what the possible evidences are available with the entity and
which one provides most corroborative evidence.
(3) Apply only those steps and procedures which are useful in accomplishing the
verification purpose in the specific situation.
Every procedure should be drawn keeping the objective in mind. For eg. The
best way to verify cash balance is physical counting.
(4) Consider all possibilities of error.

This does not mean that the procedures should be drawn with a doubtful mind
but instead they should be drawn with a vigilant mind.
(5) Co-ordinate the procedures to be applied to related items.

This refers to the order in which the procedures have to be carried on.
Because evidence regarding one area may also provide suggestions regarding
another area.
15. Audit Programme is designed to provide Audit Evidence. Elaborate this point.
Audit Evidence is defined as the information collected, examined and used by the
auditor in arriving at the conclusions on which the auditor’s opinion is based.
Information Used for drawing
Examined and
collected conclusions
It can be either from an internal source or from an external source.
As per the audit flowchart (discussed in chapter 1), audit techniques are applied to
obtain audit evidence.
And audit procedures are performed to examine the audit evidence. In other
words, audit procedures are aimed at ensuring the sufficiency and appropriateness
of the audit evidence. So that appropriate opinion can be formed.
Aim of Audit procedures
To ensure audit evidence

is
Sufficient and Appropriate
Refers to Quantity Refers to Quality of

or adequacy mesured by
Relevance - means whether Reliablility - means whether

it answers the specific it is a corroborative or
assertion in question complimentary in nature
What is best evidence is a matter of expert knowledge and experience. This is
the primary task before the auditor when he draws up the audit programme.
In all cases one procedure may not bring the highest satisfaction and thus he has
to collect many evidences for the same assertion.
Each evidence is weighed to ascertain its weight to prove or disprove the

assertion.
16. Name few avenues which provide audit evidence.
Following are few types of audit evidences:
i. Documentary examination,
ii. Physical examination,
iii. Statements and explanation of management, officials and employees,
iv. Statements and explanations of third parties,
v. Arithmetical calculations by the auditor,
vi. State of internal controls and internal checks,
vii. Inter-relationship of the various accounting data,
viii. Subsidiary and memorandum records,
ix. Minutes,
x. Subsequent action by the client and by others.
17. How is an audit programme drawn? OR Mention the steps in developing the audit
programme.
 Written Audit Programme :Once the detailed programme is written, it is easy
to communicate it to the engagement team.
 Audit Objective and Instruction to Assistants: The programme should contain

➢ Audit objectives for each area and
➢ A set of instructions to the assistants with sufficient details
This gives great clarity to the team as to what is expected out of them or what
is course of action in every scenario.
Thus, it becomes a means to control the proper execution of the work.
 Reliance on Internal Controls :The auditor, should have an understanding of the

accounting system and related internal controls for determining the nature,
timing and extent of required auditing procedures.
As part of compliance procedure, the auditor has to check

▪ If controls exists
▪ If they are adequate and
▪ If they are operating effectively.
This will help him decide the nature, timing and extent of substantive
procedures.
However, the auditor may decide not to rely on internal controls when there are
other more efficient ways of obtaining sufficient appropriate audit evidence.
The auditor should also consider the coordination from the client, the availability
of assistants, and the involvement of other auditors or experts.
 Timings of Performance of Audit Procedures: The auditor normally has

flexibility in deciding when to perform audit procedures.
However, in some cases, the auditor may have no discretion as to timing, for
example, when observing the taking of inventories by client personnel or
verifying the securities and cash balances at the year-end.
 Audit Planning : The audit procedures should be aligned to the audit plan, which
in turn should aligned to audit strategy.
Planning ideally commences at the conclusion of the previous year’s audit.
Planning and procedures are subject to change as the audit progresses.
18. What are advantages and disadvantages of audit programme?
The advantages of an audit programme are:
➢ It provides clear set of instructions to audit assistants. They know what is

exactly expected out of them.
➢ It provides a total perspective of the work to be performed. Audit

programme is aligned to the audit plan which is in turn aligned to the audit
strategy. This is more important for large audits.
➢ It helps in Selection of audit team on the basis of capabilities.
➢ A written document always ensures that all areas and issues relevant to
audit are considered. Without a written and pre-determined programme,
work is carried out on the basis of some ‘mental’ plan which may result in
ignoring or overlooking certain books and records.
➢ It ensures accountability of audit assistants. The assistants, by putting their

signature on programme, accept the responsibility for the work carried out
by them individually and, if necessary, the work done may be traced back to
the assistant.
➢ The principal can control the progress of the various audits in hand by
examination of audit programmes initiated by the assistants deputed to the
jobs for completed work.
➢ It serves as a guide for audits to be carried out in the succeeding year.
➢ It serves as evidence in the event of any charge of negligence being brought

against the auditor. It may be of considerable value in establishing that he
exercised reasonable skill and care that was expected of professional auditor.
The disadvantages are:
➢ The work may become mechanical and particular parts of the programme
may be carried out without any understanding of the object of such parts
in the whole audit scheme.
➢ The programme may become rigid and inflexible if changes are not made
based on new developments. For eg. Changes in staff or internal control may
render precaution necessary at points different from those originally decided
upon.
➢ Incomplete audit programmes may increase the risk of material

misstatement.
➢ Inefficient assistants may take shelter behind the programme i.e. defend
deficiencies in their work on the ground that no instruction in the matter is
contained therein.
➢ A hard and fast audit programme may kill the initiative of efficient and
enterprising assistants.
All these disadvantages may be eliminated by
➢ Extensive supervision of the work carried on by the assistants
➢ The auditor must have a receptive attitude as regards the assistants and
➢ The assistants should be encouraged to observe matters objectively and

bring significant matters to the notice of supervisor/principal
19. What is materiality and how it is related to audit planning?
 Definition and Usage - Materiality refers to a limit to decide what is important

and what is not important.
Materiality is an important consideration for an auditor to evaluate whether

the financial statements reflect a true or fair view or not.
It has the following benefits:
➢ It helps the auditor to focus on important areas in the audit.

➢ It enables the auditor to select audit procedures
➢ It enables to support the audit opinion at an acceptably low degree of
audit risk
 SA 320 - SA 320 on “Materiality in Planning and Performing an Audit” requires

that an auditor should consider materiality and its relationship with audit risk
while conducting an audit.
There is an inverse relationship between Audit risk and materiality levels. Ie

when the level of risk is low the materiality levels are high and vice versa.
As per SA 320
➢ It is the auditor’s responsibility to apply the concept of materiality in planning
and performing the audit of financial statements.
➢ The auditor’s determination of materiality is a matter of professional
judgement.
➢ Any error or misstatement is considered to be material if it is likely to affect

the decision making of users of financial statements.
➢ The auditor’s preliminary assessment of materiality related to specific

account balances and classes of transactions helps the auditor decide such
questions as what items to examine and whether to use sampling and
analytical procedures.
➢ Concept of materiality is used in audit

▪ At the planning stage
▪ At the execution stage
▪ In evaluating the effect of identified misstatements on the audit
▪ In evaluating the effect of uncorrected misstatements on the audit
▪ In forming an opinion on financial statements.
20. What should the auditor know to decide on the ‘materiality’ level? What are the
types of materiality levels?
The auditor should have the understanding of the following for deciding the
materiality level.
1. Understand the business.
2. Understand how financial statements are prepared.
3. Understand that many estimates are used for the financial statements and
these estimates may be different from actual.
4. Understand what users may consider as material or important.
Types of Materiality
Specific or Statutory Amount driven

materiality materiality
Nature of account is more The amount is important but is

important than the amount subject to circumstances and
(Substance over form) size of the company
21. Name few areas of statutory materiality.
The following have to be verified completely irrespective of the amounts involved

1. Share capital
2. Reserves and surplus
3. Statutory items
4. Taxation and
5. Legal expenses
22. What are the key aspect of setting up materiality levels?
 Phases of Materiality computation
1. Overall materiality - computed on the basis of size of the company, which

is set based on a benchmark which could be profit, turnover or net assets.
2. Planning materiality – Computed on the basis of audit risk
3. Summary of difference. (Dealt in SA 450)
 Determining materiality and performance materiality
When establishing the overall audit strategy, the auditor shall determine
materiality for the financial statements as a whole.
If, in the specific circumstances of the entity, there is one or more particular
classes of transactions, account balances or disclosures for which
misstatements of lesser amounts in aggregate exceeds theoverall materiality
(in such a way that it influences the economic decisions of users), then he
should determine levels for such classes of transactions, account balances or
disclosures.
Planning materiality = Adjusted overall materiality after considering the

company specific risk.
Once planning materiality is determined, the overall materiality becomes

redundant.
 Use of Benchmarks in Determining Materiality for the Financial Statements as

a Whole
Determining materiality involves the exercise of professional judgment.
A percentage is often applied to a chosen benchmark as a starting point in

determining materiality for the financial statements as a whole.
Factors that may affect the identification of an appropriate benchmark include

the following:
➢ The elements of the financial statements (eg. Assets, liabilities, equity

etc.)
➢ Items on which the attention of the users of the particular entity’s
financial statements tends to be focused (eg. Profit, revenue or net
assets)
➢ The nature of the entity, where the entity is at in its life cycle,
➢ the industry and economic environment in which the entity operates;
➢ The entity’s ownership structure and the way it is financed.
➢ The relative volatility of the benchmark
In relation to the chosen benchmark, relevant financial data ordinarily include
➢ Prior periods’ financial results and financial positions

➢ The period to-date financial results and financial position
➢ Budgets or forecasts for the current period
➢ Significant changes in the circumstances of the entity
➢ Relevant changes of conditions in the industry or economic
environment
 Revision in Materiality levels
Materiality levels for financial statements as a whole or materiality level or
levels for particular classes of transactions, account balances or disclosures
may be subject to change due to
➢ Change in circumstances that occurred during the audit,
➢ Availability of new information, or
➢ Change in the auditor’s understanding of the entity and its operations
If the materiality level is lowered, he has to determine if whether the nature,
timing and extent of the further audit procedures remain appropriate.
23. What are the factors to be documented with regard to the materiality?
The audit documentation shall include the following amounts and the factors
considered in their determination:
➢ Materiality for the financial statements as a whole;
➢ The materiality level or levels for particular classes of transactions, account
balances or disclosures ;
➢ Performance materiality ; and
➢ Any revision as the audit progresses
6.3 Internal Check, Internal Control, Internal Audit - Industry
Specific
Overview
Audit risk
Entity and its Risk of material

environment misstatement
Internal Risk assessment

control procedures
1. What is audit Risk and what is risk of material misstatement? What are the types
of audit risk ?
 Risk means deviation from expectation. It denotes the possibility that the
objective might not be met.
Risk that the auditor gives an

Audit risk
inappropriate audit opinion.
Risk that the financial

Risk of material
statements are materially
misstatement
misstated prior to audit
 Misstatement refers to a difference between the amount, classification,
presentation, or disclosure of a reported financial statement item and the
amount, classification, presentation, or disclosure that is required for the item
to be in accordance with the applicable financial reporting framework.
 Misstatements can arise from error or fraud.
Amount, classification, Applicable

presentation, or financial
Misstatement
disclosure of a reported reporting
financial statement item framework
Types of Audit risk
Inherent Risk Control Risk Detection Risk
 Inherent Risk – It is risk of misstatement in financial statements arising due to

an error or omission as a result of factors other than a failure of control.
 Inherent risk is likely to be higher where a high degree of judgement or

estimation is involved or where transactions of the entity are highly complex.
Because in such cases, those accounts are generally vulnerable to higher risk.
 Inherent risk factors are considered while designing tests of controls and
substantive procedures.
 Management will decide on the level of controls based on the inherent risks
identified.
 Inherent risks are based on size and nature of business. Thus management is
responsible for planning and implementing controls based on the size and
nature of business.
 External circumstances giving rise to business risks may also influence inherent
risk. For example, technological developments might make a particular product
obsolete.
 Control risk – It is risk of controls designed by management being weak or non-

existent and thereby not arresting inherent risk.
 Inherent risk and control risk are the entity’s risks; they exist independently of
the audit of the financial statements.
 Internal control can only reduce but not eliminate risks of material misstatement
in the financial statements. This is because of the inherent limitations of internal
control.
 The possibility of human errors or mistakes, or of controls being circumvented

by collusion. Accordingly, some control risk will always exist.
 Detection risk – Risk that procedures performed by auditor to reduce audit risk
to an acceptably low level will not detect a misstatement that exists and which
could be material either individually or when aggregated with other
misstatements.
2. How is risk of material misstatement assessed?

The risks of material misstatement may exist at two levels:
The overall financial statement level- It refers to risks of material misstatement
that relate pervasively to the financial statements as a whole and potentially
affect many assertions.
The assertion level for classes of transactions, account balances, and
disclosures- Risks of material misstatement at the assertion level are assessed in
order to determine the nature, timing, and extent of further audit procedures
necessary to obtain sufficient appropriate audit evidence. This evidence enables
the auditor to express an opinion on the financial statements at an acceptably low
level of audit risk.
3. If every business has unique risk, how can the auditor identify the risk?
The auditor can identify the risk by understanding the business environment.
In order to get the knowledge of client’s business the auditor will have to obtain the
understanding of the following factors which affect the client’s business:
5. Global factors
6. National and policy level factors
3. Industry specific factors and
4. Company specific factors
Global factors
External factors National and policy

(Macro economic related factors
factors)
Factors relevant for Industry specific

understanding business factors
Internal factors
Company specific
(Micro economic
factors
factors)
The information is gathered in the above order only. Thus the auditor will first get
the understanding of macroeconomic factors (or external factors) and then come to
company specific factors.
 Global factors
➢ Competitive environment like demand, cost of raw material in the global
market.
➢ An entity with components in multiple tax jurisdictions, has additional risk
 National and policy factors–

➢ Income tax rates, Government schemes etc.
 Industry specific factors

➢ Technological developments, such as those related to the entity’s
products,Shortage of skilled labour etc.
➢ Supplier and customer relationships, such as types of suppliers and
customers.
 Company specific factors –
➢ Non-financial factors like production capacity, headcount, input-output ratio
➢ Financial factors like Past performances, turnovers, employee cost etc.
➢ The nature of the entity, including:
(i) its operations;
(ii) its ownership and governance structures;
(iii) the types of investments that the entity is making and plans to make,
including investments in special-purpose entities; and
(iv) the way that the entity is structured and how it is financed;
This enables the auditor to understand the classes of transactions, account
balances, and disclosures to be expected in the financial statements.
Apart from this the auditor should get an understanding of joint ventures,
partnerships etc. which pose new risks.
4. What is included as part of risk assessment procedure?
 Risk assessment procedure - A basis for the identification and assessment of risks
of material misstatement at the financial statement and assertion levels
 Enquiries of management and others within the entity - helps to understand what
they perceive as the risk factors. The auditor should enquire not only the
management and those charged with governance but also internal auditors, legal
counsels and employees of all departments like marketing and sales personnel,
information system personnel etc.
 Use of analytical procedures – Implies using ratios, trends etc to see what the new
risk factors are. Analytical procedures performed as risk assessment procedures may
include both financial and non-financial information. It helps to identify the
existence of unusual transactions or events, and amounts
 Observation and inspection – This supports inquiries of management and others.

This includes observation or inspection of:
➢ The entity’s operations
➢ The entity’s premises and plant facilities.
➢ Reports prepared by management (such as quarterly management reports and
interim financial statements) and those charged with governance (such as
minutes of board of directors’ meetings).
 Information obtained in prior periods – The auditor should check his working papers
for all the previous years. This will give him an information of critical areas and
about the strength of the internal control. For example, if any fraud was noticed in
the last year, then the auditor has to be more cautious in that area for the current
year also.
 Discussion among engagement teams - understanding of the entity, its environment

and the risk assessment is a continuous process. So, the auditor should ensure free
flow of communication and regular discussion with the engagement team. This will
help him focus on all areas involving risk.
5. What are the aspects of identifying and assessing the risk of material
misstatement?
There are 5 aspects to identify and assess the risk of material misstatement
1. Assessment of risks of material misstatement at the financial statement level
This risk affects the financial statements as a whole. The following are some
indicators of such risks:
▪ Management’s lack of competence
▪ Management’s lack of integrity
▪ Weak internal controls etc.
2. Assessment of risks of material misstatement at the assertion level.

The auditor should identify such risks in order to determine the nature, timing
and extent of other audit procedures.
3. The entity’s selection and application of accounting policies.

The entity cannot apply or change any accounting policy with an intention of
manipulating profits. Thus The auditor shall evaluate whether the entity’s
accounting policies are appropriate for its business and consistent with the
applicable financial reporting framework and accounting policies used in the
relevant industry.
4. Objectives, strategies and related business risks.

The objectives and strategies also have their own risks. For example,
Industry development, expansion by way of new products and services,
geographical expansion, new accounting requirements etc.
5. Measurement and review of Entity’s financial performance.

Auditor should understand if there are pressures to achieve performance targets
which may increase the risk of material misstatement. These measures include,
Budgets, incentives and compensation to employees linked to their performance,
credit rating agency reports etc.
6. What are the steps that the auditor should take as part of risk assessment
procedure?
1. The auditor shall identify and assess the risks of material misstatement at:
i. The financial statement level
ii. The assertion level for classes of transactions, account
balances, and disclosures
2. Identify risks throughout the process of obtaining an understanding of the entity
and its environment.
3. Identify relevant controls that can prevent or detect material misstatements.
4. Assess the identified risks, and evaluate whether they relate more pervasively
to the financial statements as a whole and potentially affect many assertions;
5. Consider the likelihood of misstatement and assess its materiality. Consider if

there is a possibility of multiple misstatements, and whether the potential
misstatement is of a magnitude that could result in a material misstatement.
7. Throw some light on the framework provided by SA 315 on how internal controls
can be analysed by the auditor.
SA315 provides an interesting framework for auditors to consider how internal

controls can be analysed in a business. It helps to understand how different aspects
of an entity’s internal control may affect the audit.
It divides the internal control in 5 components.
Control Risk Infomration and Contol Monitoring of
environment assessment communication activities controls
•Type of •Kind of •Policies and •Ongoing
organisation people who •Accounting procedures monitoring on
wrok in the controls for like daily
•Ethics and recording the
principles of organisation • Variance activities
transactions
the entity • Technology analysis • Information
•People used between processing ie.
governing the • Growth budgets and audit trail
entity plans actuals from
•Policies of •Business •physical beginning to
the entity models security of end
• Locations of assets •cross
the business •segregation verification
of duties
8. What is not included as part of audit risk?

1. Audit risk does not include the risk that the auditor might express an opinion that
the financial statements are materially misstated when they are not. This risk is
ordinarily insignificant.
2. Further, audit risk is a technical term related to the process of auditing; it does
not refer to the auditor’s business risks such as loss from litigation, adverse
publicity, or other events arising in connection with the audit of financial
statements.
9. What is internal control, what are the types of internal control that any
organization should implement and what will the auditor ensure while checking
the internal control?
➢ Internal controls refers to the processes and procedures laid by management to

ensure that there is no material misstatement in the financial statements.
➢ For example if an organization wants to order raw material, then the process
starting from selecting a suitable vendor to accounting the receipt of the raw
material, including the ensuring of quality and quantity of it is called as internal
control.
➢ According to the nature, there are 3 type of internal control and according to
process they can be divided into 2 types.
According to nature According to process
Preventive Controls- Automated - Controls

Eg.Amount column in the through computers where
system does not allow human intervention is
negative figures minimal
Detective Controls - Eg.

Unauthorised access Manual controls - where
without a correct controls are through
password personnel. eg. segregation
of duties
Corrective controls - Eg.
spell check or
autocorrect feauture of
the system
➢ The auditor has to ensure that the internal controls prevent, detect and
correct material misstatements, regarding financial statements.
➢ As per management’s discretion, internal controls can be Manual, automated or
semi-automated. In case of automated process, the auditor needs to perform CIS
audit (Computer Information Systems audit)
➢ For all the areas, where risk is identified, the auditor has to ensure
▪ If controls exists
▪ If controls are adequate
▪ Does controls operate effectively
➢ The auditor needs to form an overall understanding of the strength of controls.
This will enable him to decide on the extent of substantive procedures to be
carried on.
10. Define internal control as per SA315? What are its objectives? How does
understanding the internal controls help the auditor?
 Definition
As per SA-315,“Identifying and assessing the risk of material misstatement through

understanding the entity and its environment”, the internal control may be defined
as
➢ The process designed, implemented and maintained
➢ By those charged with governance, management and other personnel
➢ to provide reasonable assurance about the achievement of an entity’s
objectives
➢ with regard to reliability of financial reporting, effectiveness and efficiency
of operations, safeguarding of assets, and compliance with applicable laws
and regulations.
 Objectives of Internal Control
➢ Transactions are executed in accordance with
managements general or specific authorization;
➢ All transactions are promptly recorded in the correct amount in the
appropriate accounts and in the accounting period in which executed so as
to permit preparation of financial information within a framework of
recognized accounting policies and practices and relevant statutory
requirements, if any, and to maintain accountability for assets;
➢ Assets are safeguarded from unauthorized access, use or disposition; and
➢ Verification of existence of physical assets regularly – The recorded assets

are compared with the existing assets at reasonable intervals and
appropriate action is taken with regard to any differences.
 Benefits of Understanding of Internal Control
An understanding of internal control assists the auditor in :
➢ Identifying types of potential misstatements
➢ Identifying factors that affect the risks of material misstatement, and
➢ Designing the nature, timing, and extent of further audit procedures.
11. How does the auditor assesses control risk? OR how does the auditor report
when control deficiencies are identified ?
➢ When making control risk assessments, the auditor consider:
▪ The control environment’s influence over internal control. A control

environment that supports the prevention, and detection and correction,
of material misstatements allows greater confidence in the reliability of
internal control and audit evidence generated within the entity.
▪ Evaluations of the related IT processes that support application and IT-
dependent manual controls.
▪ The expectation of the operating effectiveness of controls based on the
understanding of entity’s processes.
➢ When auditor identifies deficiencies and reports on internal controls, he
determines the significant financial statement assertions that are affected by
the ineffective controls.
➢ The auditor concludes that they support a ‘rely on controls’ risk assessment,
if he thinks it is appropriate. Otherwise he will change control risk assessment
to ‘not rely on controls.’
➢ When control deficiencies are identified and auditor identifies and tests more
than one control for each relevant assertion, he evaluates control risk
considering all of the controls he has tested.
12. Controls would include both financial as well as non-financial aspects of an

entity. Should the auditor get an understanding of every aspect of internal
control?
➢ The auditor shall obtain an understanding of internal control relevant to the

audit. Although most controls relevant to the audit are likely to relate to financial
reporting, not all controls that relate to financial reporting are relevant to the
audit.
➢ It is a matter of the auditor’s professional judgment whether a control,

individually or in combination with others, is relevant to the audit.
➢ The auditor puts more focus on areas that have greater impact on financial
statements.
➢ The auditor can understand the internal controls by the understanding the
following four aspects of it:
General Nature
Controls
and
Relevant to
Characteristics of
the Audit
Internal Control
Nature and
Extent of the
Components of
Understanding of
Internal Control
Relevant
Controls
13. How can the auditor understand the general nature and characteristics of
Internal control?
The auditor can understand the general nature and characteristics of Internal
control by understanding the purpose and limitations of Internal control.
 Purpose of Internal Control:

Internal control is designed, implemented and maintained to address identified
business risks that threaten the achievement of any of the entity’s objectives that
concern:
➢ The reliability of the entity’s financial reporting;
➢ The effectiveness and efficiency of its operations;
➢ Its compliance with applicable laws and regulations; and
➢ Safeguarding of assets.
 Limitations of Internal Control:
➢ Internal control can provide only reasonable assurance.

Internal control, no matter how effective, can provide an entity with only
reasonable assurance about achieving the entity’s financial reporting
objectives. They don’t provide absolute assurance.
Inbuilt control for unforseen event is not possible.
➢ Human judgment in decision-making:
Human judgment in decision-making can be faulty. Human error may result in
breakdowns in internal control. The possibility of biased decision cannot be
ruled out.
➢ Lack of understanding the purpose:
The operation of a control may not be effective, such as where information
produced for the purposes of internal control (for example, an exception
report) is not effectively used because the individual responsible for reviewing
the information does not understand its purpose or fails to take appropriate
action.
➢ Collusion among People:
Controls can be circumvented by the collusion of two or more people.
Inappropriate management may also override of internal control. For example,
management may enter into side agreements with customers that alter the
terms and conditions of the entity’s standard sales contracts, which may result
in improper revenue recognition.
➢ Judgements by Management:
In designing and implementing controls, management may make judgments on
the nature and extent of the controls it chooses to implement, and the nature
and extent of the risks it chooses to assume.
Management choices can be sub-optimal.
➢ Limitations in case of Small Entities:
Smaller entities often have fewer employees due to which segregation of duties
is not practicable. In a small owner-managed entity, the owner-manager may be
able to exercise more effective oversight than in a larger entity. However, the
owner-manager may be more able to override controls because the system of
internal control is less structured.
14. What are the factors which make any particular control relevant to audit? Or
what are the aspects that influence the auditor’s professional judgement
regarding test of controls ?
There is a direct relationship between an entity’s objectives and the controls it

implements to provide reasonable assurance about their achievement.
The entity’s objectives, and therefore controls, relate to financial reporting,
operations and compliance.
However, not all of these objectives and controls are relevant to the auditor’s risk
assessment. Factors relevant to the auditor’s judgment about whether a control,
individually or in combination with others, is relevant to the audit includes the
following:
➢ Principles of Materiality.
➢ The significance of the related risk.
➢ The size of the entity and the nature of the entity’s business, including its
organization and ownership characteristics.
➢ The diversity and complexity of the entity’s operations.
➢ Applicable legal and regulatory requirements.
➢ The circumstances and the applicable component of internal control.
➢ The nature and complexity of the systems that are part of the
entity’s internal control, including the use of service
organizations.
➢ Whether, and how, a specific control, individually or in combination with
others, prevents, or detects and corrects, material misstatement.
The auditor will delve deep into the following types of control:
Controls over the completeness and accuracy of

information
Controls over the completeness and accuracy of information produced by the
entity is relevant to the audit. For example, in auditing revenue by applying
standard prices to records of sales volume, the auditor considers the accuracy
of the price information and the completeness and accuracy of the sales volume
data. Controls relating to operations and compliance objectives may also be
relevant to an audit.
Internal control over safeguarding of assets

Internal control over safeguarding of assets against unauthorized acquisition,
use, or disposition may include controls relating to both financial reporting and
operations objectives. The auditor’s consideration of such controls is generally
limited to those relevant to the reliability of financial reporting. For example,
use of access controls, such as passwords, that limit access to the data and
programs that process cash disbursements may be relevant to a financial
statement audit. Conversely, safeguarding controls relating to operations
objectives, such as controls to prevent the excessive use of materials in
production, generally are not relevant to a financial statement audit.
Controls relating to objectives that are not relevant to an audit

An entity generally has controls relating to objectives that are not relevant to
an audit and therefore will not be considered by the auditor. For example, an
entity may rely on a sophisticated system of automated controls to provide
efficient and effective operations such as an airline’s system of automated
controls to maintain flight schedules, but these controls ordinarily would not be
relevant to the audit.
The statute may require the auditor to report on compliance with certain
internal controls
In certain circumstances, the statute or the regulation governing the entity
may require the auditor to report on compliance with certain specific aspects
of internal controls as a result, the auditor’s review of internal control may be
broader and more detailed.
15. How will the auditor find out about the controls which will individually or in
combination of few other controls ensure that misstatement, frauds and errors
don’t happen in financial statements.
➢ The auditor has to understand the nature and extent of the relevant Controls.
➢ Evaluating the design of a control involves considering whether the control,
individually or in combination with other controls, is capable of effectively
preventing, or detecting and correcting, material misstatements.
➢ Implementation of a control means that the control exists and that the entity is
using it.
➢ Risk assessment procedures to obtain audit evidence about the design and
implementation of relevant controls may include-
▪ Inquiring of entity personnel.
▪ Observing the application of specific controls.
▪ Inspecting documents and reports.
▪ Tracing transactions through the information system relevant to
financial reporting.
➢ Inquiry alone, however, is not sufficient for such purposes. He has to personally
check if the controls are effectively operating.
➢ Obtaining an understanding of an entity’s controls is not sufficient to test their
operating effectiveness, unless there is some automation that provides for the
consistent operation of the controls.
16. What are the Components of internal control?
Control
environment
Monitoring Risk
of assessment
controls process
Components
of Internal
control
Control Information
activities system
17. Elaborate the elements of control environment.
Elements of the control environment that may be relevant when obtaining an
understanding of the control environment include the following:
 Communication and enforcement of integrity and ethical values

These are essential elements that influence the effectiveness of the design,
administration and monitoring of controls.
 Commitment to competence
Management’s consideration of the competence levels for particular jobs and
whether right persons with requisite skill and knowledge are appointed.
 Participation by those charged with governance
Attributes of those charged with governance such as:
➢ Their independence from management.
➢ Their experience and stature.
➢ The extent of their involvement and the information they receive, and the
scrutiny of activities.
➢ The appropriateness of their actions, including the degree to which
difficult questions are raised and pursued with management, and their
interaction with internal and external auditors.
 Management’s philosophy and operating style
Characteristics such as management’s:
➢ Approach to taking and managing business risks.
➢ Attitudes and actions toward financial reporting.
➢ Attitudes toward information processing and accounting functions and
personnel.
 Organizational structure
The framework within which an entity’s activities for achieving its objectives are
planned, executed, controlled, and reviewed.
 Assignment of authority and responsibility
Matters such as how authority and responsibility for operating activities are
assigned and how reporting relationships and authorization hierarchies are
established.
 Human resource policies and practices
Policies and practices that relate to, for example, recruitment, orientation,
training, evaluation, counselling, promotion, compensation, and remedial
actions.
18. Explain the Entity’s Risk Assessment Process as a component of Control
Environment.
➢ The entity’s risk assessment process forms the basis for the risks to be managed.
➢ If that process is appropriate, it would assist the auditor in identifying risks of
material misstatement. Whether the entity’s risk assessment process is
appropriate to the circumstances is a matter of judgment.
➢ The auditor shall obtain an understanding of whether the entity has a process
for:
(a) Identifying business risks relevant to financial reporting
objectives;
(b) Estimating the significance of the risks;
(c) Assessing the likelihood of their occurrence; and
(d) Deciding about actions to address those risks.
19. How can the auditor gain be understanding of the information system,
including?
the related business processes, relevant to financial reporting?
The auditor shall obtain an understanding of the following:

(a) The classes of transactions in the entity’s operations that are significant to
the financial statements;
Transactions can be divided into categories or classes and then accordingly
traced their reporting in financial statements. For example – Based on
geographic locations (domestic/ international) based on nature (sales/
purchases), based on means of recording (digital/maual) etc.
(b) The procedures by which those transactions are initiated, recorded,

processed, corrected as necessary, transferred to the general ledger and
reported in the financial statements;
This refers to the trail of transactions from beginning to end ie from its
originating source to ultimately appearing in financial statements.
Grouping in Financial
Journal entry Ledger posting
trial balance statements
Understand the controls at each of the above level.
(c) The related accounting records, supporting information and specific

accounts in the financial statements that are used to initiate, record, process
and report transactions;
This refers to the various supporting documents that gets generated at each
level of recording the transaction. For example – For an inventory, the various
supporting documents are Purchase order, Invoice, Goods receipt note, Gate
pass etc. The auditor has to understand that there is not only a supporting
document at each level but also that such document is approved by an
authorized person. This can either be under a manual system or an electronic
system.
(d) How the information system captures events and conditions that are
significant to the financial statements;
This refers to capturing of all those information which needs to be disclosed
as part of financial statement as a result of compliance to any applicable law.
Every information which is required to be disclosed as a matter of statutory
compliance should be captured properly.
(e) The financial reporting process used to prepare the entity’s financial
statements;
This refers to the process of preparing the financial statements from the
books of accounts is strong and effective to ensure that there is no
possibility of errors. This is a control at the last step ie the step at which
financial statements are prepared. For example, how information from
branches is incorporated in the financial statements.
(f) Controls surrounding journal entries

The primary mode of recording a transaction is journal entry. Thus, from
journal entry, any transaction will reach the financial statements. Thus, the
auditor has to understand all the controls at the point of recording journal
entries to ensure they are
▪ Recorded by authorized persons
▪ Recorded in proper manner
▪ Verified by a senior
▪ Approved by a senior.
20. The financial roles and responsibilities are Communicated to the concerned
personnel by the management. What are the key considerations that the auditor
should keep in mind while understanding the same?
The auditor shall obtain an understanding of how the entity communicates financial
reporting roles and responsibilities. This includes
1. Communications between management and those charged with governance;
and
2. External communications, such as those with regulatory authorities.
The key considerations that the auditor should keep in mind while understanding
the same are :
(i) Communication by the entity of the financial reporting roles and responsibilities
would involves providing an understanding of individual roles and
responsibilities pertaining to internal control over financial reporting.
(ii) It includes understanding by employees as to how their activities relate to the
work of others and the means of reporting exceptions to higher level within the
entity.
(iii) Communication may take such forms as policy manuals and financial reporting
manuals.
(iv) Open communication channels help ensure that exceptions are reported and
acted on.
(v) Communication may be less structured and easier to achieve in a small entity
than in a larger entity due to fewer levels of responsibility and management’s
greater visibility and availability.
21. What are the control activities which are relevant to the audit and which the
auditor considers necessary to assess the risks of material misstatement?
➢ An auditor requires an understanding of only those control activities related to

significant class of transactions, account balance, and disclosure in the
financial statements and the assertions which he finds relevant in his risk
assessment process.
➢ Control activities are those policies and procedures laid by the
management to ensure that significant transactions are accounted properly.
➢ Control activities, whether within IT or manual systems, have various
objectives and are applied at various organizational and functional levels.
➢ Thus, control activities relevant to audit are:
▪ Control activities that relate to significant risks and those that relate to
risks for which substantive procedures alone do not provide sufficient
appropriate audit evidence; or
▪ Those that are considered to be relevant in the judgment of the
auditor;
➢ Specific control activities for any significant transaction include the following:
Physical Segregation of Performance Information

Authorisation
controls duties review processing
•The •The Record •One will •If the •How the

safeguarding keeping initiate the processes and information is
of physical function and transaction, procedures are flowing across
documents the custodial one will verify operating the
and files. function it and a effectively organisation
should not be concerned through these
with the same authority will control
person. approve it. activities
22. In exercising judgment as to which risks are significant risks, What shall the
auditor consider?
In exercising judgment as to which risks are significant risks, the auditor shall
consider at least the following:
(a) Whether the risk is a risk of fraud;
(b) Whether the risk is related to recent significant economic, accounting, or other
developments like changes in regulatory environment, etc., and, therefore,
requires specific attention;
(c) The complexity of transactions;
(d) Whether the risk involves significant transactions with related parties;
(e) The degree of subjectivity in the measurement of financial information related
to the risk, especially those measurements involving a wide range of
measurement uncertainty; and
(f) Whether the risk involves significant transactions that are outside the normal
course of business for the entity, or that otherwise appear to be unusual.
23. What is significant risks and how is it identified?
➢ Significant risks are inherent risks with both a higher likelihood of occurrence
and a higher magnitude of potential misstatement.
➢ Significant risks often relate to significant non- routine transactions or
judgmental matters.
➢ Non-routine transactions are transactions that are unusual, due to either size or
nature, and that therefore occur infrequently.
➢ Judgmental matters may include the development of accounting estimates for
which there is significant measurement uncertainty.
➢ Risks of material misstatement may be greater for significant non-routine
transactions arising from matters such as the following:
▪ Greater management intervention to specify the accounting treatment.
▪ Greater manual intervention for data collection and processing.
▪ Complex calculations or accounting principles.
▪ The nature of non-routine transactions, which may make it difficult for
the entity to implement effective controls over the risks.
➢ Risks of material misstatement may be greater for significant judgmental matters
that require the development of accounting estimates, arising from matters such
as the following:
▪ Accounting principles for accounting estimates or revenue recognition
may be subject to differing interpretation.
▪ Required judgment may be subjective or complex, or require assumptions
about the effects of future events, for example, judgment about fair
value.
24. What do you mean by monitoring of controls and how does it help the auditor?
The last Component of Internal Control is monitoring of controls. This function can
be divided into 2 parts – 1. Monitoring 2. Evaluation.
Monitoring of controls
Monitoring Evaluation
Monitoring of controls is a process to assess the effectiveness of internal control

performance over time and includes taking necessary remedial actions.
Monitoring refers to ensuring that proper control exits and that they are
adequate. Evaluation refers to ensuring that they are operating effectively.
Ongoing monitoring activities are often built into the normal recurring activities of
an entity and include regular management and supervisory activities.
Management’s monitoring activities may include using information from
communications from external parties such as customer complaints and regulator
comments that may indicate problems or highlight areas in need of improvement.
In case of small entities, it is often accomplished by management’s or the owner-

manager’s close involvement in operations. This involvement often will identify
significant variances from expectations and inaccuracies in financial data leading
to remedial action to the control.
25. Why internal control should be evaluated?
The auditor needs reasonable assurance that the accounting system is adequate
and that all the accounting information which should be recorded has in fact been
recorded. Internal control normally contributes to such assurance.
Thus, the examination and evaluation of the internal control system is an
indispensable part of the overall audit programme.
Benefits of Evaluation of Internal Control to the Auditor are as follows:
(i) whether errors and frauds are likely to be located in the ordinary course of
operations of the business;
(ii) whether an internal control system is in use, is it adequate, and operating
as planned by the management;
(iii) whether an effective internal auditing department is operating;
Internal control = Internal check + Internal audit.

(iv) whether the controls adequately safeguard the assets;
(v) how far and how adequately the management is discharging its function in
so far as correct recording of transactions is concerned;
(vi) how reliable the reports, records and the certificates to the management
can be;
(vii) the extent and the depth of the examination that he needs to carry out in
the different areas of accounting;
(viii) what would be appropriate audit technique and the audit procedure in the
given circumstances;
(ix) what are the areas where control is weak and where it is excessive; and
(x) whether some worthwhile suggestions can be given to improve the control
system
26. What are the tools available with an auditor to evaluate the internal controls?
➢ A review of the internal control can be done by a process of study,

examination and evaluation of the control system installed by the
management.
➢ The first step involves determination of the control and procedures laid down by
the management.
➢ By reading company manuals, studying organisation charts and flow charts and
by making suitable enquiries from the officers and employees, the auditor may
ascertain the character, scope and efficacy of the control system.
➢ In many cases, very little information is available in writing; the auditor must
ask the right people the right questions if he is to get the information he wants.
➢ It would be better if he makes written notes of the relevant information and

procedures contained in the manual or ascertained on enquiry.
➢ To facilitate the accumulation of the information necessary for the proper review
and evaluation of internal controls, the auditor can use one of the following tools
Narrative records Checklist

Tools
Questionnaire Flow charts
 The Narrative Record

➢ This is a complete and exhaustive description of the system as found in
operation by the auditor.
➢ Actual testing and observation are necessary before such a record can be
developed.
➢ It may be recommended in cases where no formal control system is in operation
and would be more suited to small business.
➢ The basic disadvantages of narrative records are:
(i) The system in operation is quite difficult to comprehend.
(ii) To identify weaknesses or gaps in the system.
(iii) To incorporate changes arising on account of reshuffling of manpower, etc.
A Check List
➢ This is a series of instructions and/or questions which a member of the

auditing staff must follow and/or answer.
➢ When he completes instruction, he initials the space against the instruction.
➢ Answers to the check list instructions are usually Yes, No or Not Applicable.
➢ This is again an on the job requirement and instructions are framed having
regard to the desirable elements of control.
➢ The complete check list is studied by the Principal/Manager/Senior to ascertain

existence of internal control and evaluate its implementation and efficiency.
Internal Control Questionnaire
➢ This is a comprehensive series of questions concerning internal control.

➢ This is the most widely used form for collecting information about the
existence, operation and efficiency of internal control in an organization.
➢ An important advantage of the questionnaire approach is that oversight or
omission of significant internal control review procedures is less likely to occur
with this method.
➢ With a proper questionnaire, all internal control evaluation can be completed at
one time or in sections.
➢ The review can more easily be made on an interim basis.
➢ In the questionnaire, generally questions are so framed that a ‘Yes’ answer
denotes satisfactory position and a ‘No’ answer suggests weakness. Provision
is made for an explanation or further details of ‘No’ answers. In respect of
questions not relevant to the business, ‘Not Applicable’ reply is given.
➢ The questionnaire is usually issued to the client and the client is requested to
get it filled by the concerned executives and employees.
A Flow Chart
➢ It is a graphic presentation of each part of the company’s system of internal
control.
➢ A flow chart is considered to be the most concise way of recording the auditor’s
review of the system.
➢ It minimizes the amount of narrative explanation and thereby achieves a

consideration or presentation not possible in any other form.
➢ It gives bird’s eye view of the system and the flow of transactions and integration
and in documentation, can be easily spotted and improvements can be
suggested.
 Best tool – Each tool has its share of advantages and disadvantages so the auditor
has to use his profession judgement to decide which tool can be used based on the
requirement of information.
27. Discuss the significance of testing the controls.
➢ After assimilating the internal control system, the auditor needs to examine
whether and how far the same is actually in operation.
➢ For this, he resorts to actual testing of the system in operation. This is done on
a selective basis.
➢ He can plan this testing in such a manner that all the important areas are
covered in a period of, say, three years. Selective testing is done by application
of procedural tests and auditing in depth.
➢ Test of controls are performed to obtain audit evidence about the effectiveness
of the
▪ Design of the accounting and internal control system ie. Whether they are
designed to prevent, detect and correct material misstatements. And
▪ Operation of internal controls throughout the period.
➢ Some of the procedures performed to obtain the understanding of the accounting
and internal control systems may not have been specifically planned as tests of
control but may provide audit evidence about the effectiveness of the design and
operation of internal controls relevant to certain assertions.
➢ Test of controls may include:

▪ Inspection of documents supporting transactions and other events.
▪ Inquiries about, and observation of, internal controls which leave no
audit trail, for example, determining who actually performs each function
and not merely who is supposed to perform it.
▪ Re-performance involves the auditor’s independent execution of
procedures or controls for example, reconciliation of bank accounts, to
ensure they were correctly performed by the entity.
▪ Testing of internal control operating on specific computerized
applications or over the overall information technology function, for
example, access or program change
28. How is audit risk and materiality related? what are the steps to apply materiality
in audit?
➢ In conducting an audit of financial statements, the overall objectives of the

auditor are
▪ to obtain reasonable assurance
▪ about whether the financial statements as a whole
▪ are free from material misstatement,
▪ whether due to fraud or error,
▪ thereby enabling the auditor to express an opinion on whether the
financial statements are prepared, in all material respects, in accordance
with an applicable financial reporting framework;
▪ and to report on the financial statements, and communicate as required
by the SAs, in accordance with the auditor’s findings.
➢ The auditor obtains reasonable assurance by obtaining sufficient appropriate

audit evidence to reduce audit risk to an acceptably low level.
➢ Audit risk is the risk that the auditor expresses an inappropriate audit opinion
when the financial statements are materially misstated.
➢ Audit risk is a function of the risks of material misstatement and detection risk.
➢ Materiality and audit risk are considered throughout the audit, in particular,
when:
(a) Identifying and assessing the risks of material misstatement;
(b) Determining the nature, timing and extent of further audit procedures;
and
(c) Evaluating the effect of uncorrected misstatements, if any, on the
financial statements and in forming the opinion in the auditor’s report.
 Phases of Materiality computation
1. Overall materiality - computed on the basis of size of the company, which

is set based on a benchmark which could be profit, turnover or net assets.
2. Planning materiality – Computed on the basis of audit risk
3. Summary of difference. (Dealt in SA 450)
 The steps to apply materiality in audit is as follows:
1. List out all the account balances
2. Segregate accounts of statutory materiality
3. Identity high risk areas
4. Sort the remaining accounts in descending order of amounts
5. Group small accounts cumulating to the level of planning materiality and
ignore them.
6. Conduct audit of remaining areas.
29. What all needs to be documented at the time of identifying, assessing and
assessing risk?
The auditor shall document:
(a) The discussion among the engagement team and the significant
decisions reached;
(b) Key elements of the understanding obtained regarding each of the
aspects of the entity and its environment
(c) Understanding obtained of each of the internal control components,
(d) the sources of information from which the understanding was obtained;
(e) the risk assessment procedures performed;
(f) The identified and assessed risks of material misstatement at the
financial statement level and at the assertion level ; and
(g) The risks identified, and related controls.
30. If the entity has an internal audit function, then how will the auditor monitor
the controls?
If the entity has an internal audit function, the auditor shall obtain an
understanding of the following :
➢ The internal audit function’s responsibilities and how the internal audit function
fits in the entity’s organizational structure -
▪ The objectives of an internal audit function vary widely depending on the
size and structure of the entity and the requirements of management.
➢ The activities performed, or to be performed, by the internal audit function.
▪ The entity’s internal audit function is likely to be relevant to the audit if
its activities are related to the entity’s financial reporting.
▪ If it relates to entity’s financial reporting, then the auditor will use the
work of the internal auditors to modify the audit procedures to be
performed.
31. What is internal audit? Enumerate the provisions contained in Companies Act
2013 regarding the applicability of internal audit.
 Internal Audit means –
➢ An independent management function, which involves
➢ A continuous and critical appraisal of the functioning of an entity
➢ With a view to suggest improvements thereto and
➢ Add value to and strengthen the overall governance mechanism of the entity,
➢ Including the entity’s strategic risk management and internal control system.
 Applicability - As per section 138 of the Companies Act, 2013 internal audit is
applicable to the following companies:
Applicability of internal
audit
Public limited Private limited

company company
Listed Unlisted Applicable if

Turnover >=200 Crs during the
preceeding financial year
If during the preceeding financial Outstanding loan > Rs.100 Cr
Always year - at anytime during the
applicable preceeding financial year
Paid up share capital >= 50 cr. OR
Turnover >= 200 Crs OR
At Anytime during the previous
financial year
Outstanding loans >= 100 Crs OR
Outstanding deposits >=25 crs
It is provided that an existing company covered under any of the above criteria
shall comply with the requirements within six months of commencement of such
section.
 Who can be appointed as Internal Auditor?
➢ A Chartered accountant or a Cost accountant (whether engaged in practice or
not),
➢ Such other professional as may be decided by the Board
➢ The internal auditor may or may not be an employee of the company.
 Who appoints an internal auditor?
Audit committee of the company or the board
 What is scope of work
➢ The central government may by rules prescribe the manner and intervals in
which internal audit shall be conducted and reported to the board.
➢ But the act has neither specified the scope nor the time frame for conducting an
internal audit. Thus, the audit committee or the board shall formulate the scope,
functioning, periodicity, methodology and reporting requirements for conducting
the internal audit.
32. What is the objectives and scope of internal audit functions as enumerated
under SA-610?
Activities relating to Ethics, Values and performance

governance of management
Identify significant risks

Activities relating to
risk management
Design suitable controls
SA 610 - Using the work of
internal auditor
Evaluation of
internal control
Examination of financial
and operating
information
Activities relating to
Internal control
Reveiw of operating
activities
Review of compliance
with laws & Regulations
As per SA-610, “Using the Work of an Internal Auditor”, the objectives of internal
audit functions vary widely and depend on the size and structure of the entity
and the requirements of management and, where applicable, those charged with
governance. It includes the following:
 Activities Relating to Governance:
The internal audit function assesses
➢ The governance process
➢ Ethics and values of the management and those charged with governance
➢ Performance management and accountability
➢ Communicating risk and control information to appropriate areas of the
organization
 Activities Relating to Risk Management:
The internal audit function may assist the entity by

➢ Identifying and evaluating significant exposures to risk
➢ Contributing to the improvement of risk management and internal control
(including effectiveness of the financial reporting process).
➢ The detection of fraud.
 Activities Relating to Internal Control:

The internal audit function is assigned
➢ Evaluation of internal control: Specific responsibility for reviewing controls,
evaluating their operation and recommending improvements thereto.
➢ In doing so, it provides assurance on the control.
➢ Examination of financial and operating information: To review the means
used to identify, recognize, measure, classify and report financial and
operating information, and to make specific inquiry into individual items,
including detailed testing of transactions, balances and procedures.
➢ Review of operating activities: To review the economy, efficiency and
effectiveness of operating activities, including non-financial activities of an
entity.
➢ Review of compliance with laws and regulations: To review compliance with
laws, regulations and other external requirements, and with management
policies and directives and other internal requirements.
33. Give a brief note on Committee on Internal Audit (CIA).
➢ Considering the increasing importance of internal auditing, the Institute of

Chartered Accountants of India has constituted a Committee on Internal Audit
(CIA) as a non- standing committee on February 5, 2004.
➢ The CIA was constituted with the object of formulating Standards and
Guidance Notes on Internal Audit.
➢ Now it is known as Internal Audit Standard Board.
➢ The Board has, till date, issued eighteen Standards on Internal Audit (SIAs)
(which are recommendatory in nature).
➢ The SIAs aim to codify the best practices in the area of internal audit and also
serve to provide a benchmark of the performance of the internal audit
services.
➢ While formulating SIAs, the Board takes into consideration the applicable
laws, customs, usages and business environment and generally accepted
auditing practices in India.
34. What do you mean by internal financial control? Enumerate the provisions of
Companies Act 2013 which emphasis on internal financial control.
➢ Section 134(5) explains the meaning of internal financial controls as,

▪ “the policies and procedures adopted by the company for ensuring the
orderly and efficient conduct of its business, including adherence to
▪ company’s policies,
▪ safeguarding of its assets,
▪ prevention and detection of frauds and errors,
▪ Accuracy and completeness of the accounting records, and
▪ The timely preparation of reliable financial information.”
➢ From the above definition, it is clear that internal financial controls are the
policies and procedures adopted by the company for :
▪ Ensuring the orderly and efficient conduct of its business,
including adherence to company’s policies,
▪ The safeguarding of its assets,
▪ The prevention and detection of frauds and errors,
▪ The accuracy and completeness of the accounting records, and
▪ The timely preparation of reliable financial information.”
➢ Clause (i) of Sub-section 3 of Section 143 of the Act requires the auditors’ report
to state whether the company has adequate internal financial controls system in
place and the operating effectiveness of such controls.
➢ Accordingly, reporting on internal financial controls will not be applicable with
respect to interim financial statements, such as quarterly or half-yearly
financial statements, unless such reporting is required under any other law or
regulation.
➢ The auditor’s objective in an audit of internal financial controls over financial
reporting is, “to express an opinion on the effectiveness of the company’s
internal financial controls over financial reporting.”
➢ It is carried out along with an audit of the financial statements.
➢ Reporting under Section 143(3)(i) is dependent on the underlying criteria for
internal financial controls over financial reporting adopted by the management.
That is management is ultimately responsible.
➢ However, any system of internal controls provides only a reasonable assurance
on achievement of the objectives for which it has been established.
➢ The auditor shall use the concept of materiality in determining the extent of
testing such controls.
➢ Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014 requires the board report
of all companies to state the details in respect of adequacy of internal financial
controls with reference to the financial statements.
➢ The inclusion of the matters relating to internal financial controls in the directors
responsibility statement is in addition to the requirement of the directors
stating that they have taken proper and sufficient care for the maintenance of
adequate accounting records in accordance with the provisions of the 2013 Act
for safeguarding the assets of the company and for preventing and detecting
fraud and other irregularities.
35. What is the difference between internal financial control and internal control
over financial reporting?
Internal Financial Control as per Section 134(5)(e), “the policies and procedures
adopted by the company for ensuring the orderly and effcient conduct of its
business, including adherence to company’s policies, the safeguarding of its
assets, the prevention and detection of frauds and errors, the accuracy and
completeness of the accounting records, and the timely preparation of reliable
financial information.”
On the other hand, Internal controls over financial reporting-is concerned with
safeguards that the organization has regarding preparation and presentation of
Thus Internal controls over financial reporting is addition to whatever the auditor
does as per sec 134(5)(e).
Study Note – 7 | Provision relating to Audit under
Companies Act
7.1 Auditor’s qualifications, disqualifications, appointment,

remuneration removal, powers and duties
Qualifications of auditor
The provisions relating to eligibility, qualifications and disqualifications of an auditor

are governed by section 141 of the Companies Act, 2013. The main provisions are stated
below:
1. Individuals – A person shall be eligible for appointment as auditor, only if he is a
Chartered Accountant, holding Certificate of Practice.
2. Firm (Including LLP) – Majority of its partners should be Chartered Accountants,

holding Certificate of Practice. Where a firm is appointed as the auditor, only the
partners who are Chartered Accountants shall be authorized to act and sign on behalf
of the firm.
NOTE – LLPs can operate with non-CA partners in line with international standards.
Case Study - 1
Preksha, a member of the ICAI, does not hold a Certificate of practice. Is her
appointment as an auditor valid?
Answer
Qualifications of an Auditor: A person shall be qualified for appointment as an
auditor of a company, only if one is a Chartered Accountant within the meaning of the
Chartered Accountants Act, 1949. Under the Chartered Accountants Act, 1949, only a
Chartered Accountant holding the certificate of practice can engage in public practice.
Preksha does not hold a certificate of practice and hence cannot be appointed as an
auditor of a company.
Disqualifications
Under sub-section (3) of section 141 along with Rule 10 of the Companies (Audit and
Auditors) Rule, 2014 (hereinafter referred as CAAR), the following persons shall not be
eligible for appointment as an auditor of a company, namely:-
1. Body Corporate (Except LLP)
2. An officer or employee of the Company.
3. A partner or employee of the officer or employee of the Company.
4. A person who, or his relative, or partner
a. Holding any security of/ interest in the company/ its subsidiary/ its
holding/associate or any fellow subsidiary.
i. The relative may hold security or interest in the company of
face value not exceeding Rs.100000.
ii. If the relative acquires security or interest of face value
exceeding Rs.100000,
iii. Further, in the event of acquiring security or interest by a
relative above the threshold limit of Rs.100000, it should come
back to the prescribed limits within 60 days of such acquisition
of interest, failing which the auditor will be deemed to have
vacated the office.
b. Indebted to the Company/ its subsidiary/ holding/ associate/ fellow
subsidiary in excess of Rs. 500000. (i.e. the limit is applicable to the
person, or his relative or partner)
c. Has given guarantee or provided any security in connection with
indebtedness if third party to the Company/ its subsidiary/ its holding/
associate/ fellow subsidiary for more than Rs. 100000.
5. a person or a firm who, whether directly or indirectly has business
relationship with the Company, or its Subsidiary, or its Holding or
Associate Company or Subsidiary of such holding company or associate
company, of such nature as may be prescribed
a. The term “directly or indirectly” above includes a relative.
b. Business relationship doesn’t include –
i. Professional services of a CA firm.
ii. Transactions in ordinary course of business as a customer. E.g.
Telecom, Hospitals, Hotels, Airlines etc.
6. A person whose relative is –
a. A Director; or
b. Is in the employment of the Company as a Director or a key
managerial personnel.
7. A person who
a. Has been convicted by court of an offense involving fraud; and
b. A period of ten years has not elapsed since the date of conviction.
8. A person who is in full time employment elsewhere; or a person who is
holding appointmnet as auditor for more than twenty companies.
9. Any person whose subsidiary or associate company or any other form of
entity, is engaged as on the date of appointment in consulting and
specialised services as provided in section 144.
NOTE – If any of these disqualifications are attracted after appointment, then the
auditor shall be deemed to have vacated the office.
Case Study - 2
Comment on the following:
Mr. Amar, a Chartered Accountant, bought a car financed at Rs. 7,00,000 by Chaudhary
Finance Ltd., which is a holding company of Charan Ltd. and Das Ltd. He has been the
statutory auditor of Das Ltd. and continues to be to even after taking the loan.
Answer
According to section 141 (3)(d) (ii) of the Companies Act, 2013, a person is not eligible
for appointment as auditor of any company, if he is indebted to the company, or its
subsidiary, or its holding or associate company or a subsidiary of such holding
company, in excess of rupees five lakh.
In the given case Mr. Amar is disqualified to act as an auditor under section141 (3)(d)
(ii)) as he is indebted to M/s Chaudhary Finance Ltd. for more than 5,00,000 Rs.
Also, according to Section141 (3)(d) (ii) he cannot act as an auditor of any subsidiary
of Chaudhary Finance Ltd. i.e. he is also disqualified to work in Charan Ltd. & Das Ltd.
Therefore, he has to vacate his office in Das Ltd. Even though it is a subsidiary of
Chaudhary Finance Ltd.
Hence audit work performed by Mr. Amar as an auditor is invalid, he should vacate his
office immediately and Das Ltd must have to appoint any other CA as an auditor of the
company.
Case study – 3
An auditor purchased goods worth Rs. 501,500 on credit from a company being audited
by him. The company allowed him one month’s credit, which it normally allowed to
all known customers.
Answer
Purchase of goods on credit by the auditor: Section 141(3)(d)(ii) of the Companies
Act, 2013 specifies that a person shall be disqualified to act as an auditor if he is
indebted to the company for an amount exceeding five lakh rupees.
Where an auditor purchases goods or services from a company audited by him on credit,
he is definitely indebted to the company and if the amount outstanding exceeds rupees
five lakh, he is disqualified for appointment as an auditor of the company.
It will not make any difference if the company allows him the same period of credit as
it allows to other customers on the normal terms and conditions of the business. The
auditor cannot argue that he is enjoying only the normal credit period allowed to other
customers. In fact, in such a case he has become indebted to the company and
consequently he has deemed to have vacated his office.
Case Study – 4
Ram and Hanuman Associates, Chartered Accountants in practice have been appointed
as Statutory Auditor of Krishna Ltd. for the accounting year 2013-2014. Mr. Hanuman
holds 100 equity shares of Shiva Ltd., a subsidiary company of Krishna Ltd.
Answer
Auditor holding securities of a company : As per sub-section (3)(d)(i) of Section 141 of
the Companies Act, 2013 along with Rule 10 of the Companies (Audit and Auditors)
Rule, 2014, a person shall not be eligible for appointment as an auditor of a company,
who, or his relative or partner is holding any security of or interest
• in the company or
• its subsidiary, or
• of its holding or
• associate company or
• a subsidiary of such holding company.
Provided that the relative may hold security or interest in the company of face value
not exceeding rupees one lakh.
Also, as per sub-section 4 of Section 141 of the Companies Act, 2013, where a person
appointed as an auditor of a company incurs any of the disqualifications mentioned in
sub-section (3) after his appointment, he shall vacate his office as such auditor and
such vacation shall be deemed to be a casual vacancy in the office of the auditor.
In the present case, Mr. Hanuman, Chartered Accountant, a partner of M/s Ram and
Hanuman Associates, holds 100 equity shares of Shiva Ltd. which is a subsidiary of
Krishna Ltd. Therefore, the firm, M/s Ram and Hanuman Associates would be
disqualified to be appointed as statutory auditor of Krishna Ltd., which is the holding
company of Shiva Ltd., because one of the partner Mr. Hanuman is holding equity
shares of its subsidiary.
Case Study – 5
‘B’ owes Rs. 5,01,000 to ‘C’ Ltd., of which he is an auditor. Is his appointment valid?
Will it make any difference, if the advance is taken for meeting-out travelling
expenses?
Answer
Indebtedness to the Company: As per Section 141(3)(d)(ii) of the Companies Act, 2013,
a person who, or his relative or partner is indebted to the company, or its subsidiary,
or its holding or associate company, or a subsidiary of its holding company, for an
amount exceeding Rs. 5,00,000/- then he is not qualified for appointment as an
auditor of a company. Accordingly, B’s appointment is not valid, and he is disqualified
as the amount of debt exceeds Rs. 5,00,000. Even if the advance was taken for meeting
out travelling expenses particularly before commencement of audit work, his
appointment is not valid because in such a case also the auditor shall be indebted to
the company. The auditor is entitled to recover fees on a progressive basis only.
Case Study – 6
Mr. Fat, auditor of Thin Ltd., has his office and residence in the building owned by
Thin Ltd. Mr. Fat has been given 10% concession in rent by the company as compared
to other tenants.
Answer
As per SA 200, “Overall Objectives of the Independent Auditor and the conduct of an
audit in accordance with standards on auditing”, In the case of an audit engagement
it is in the public interest and, therefore, required by the Code of Ethics, that the
auditor be independent of the entity subject to the audit. The Code describes
independence as comprising both independence of mind and independence in
appearance. The auditor’s independence from the entity safeguards the auditor’s
ability to form an audit opinion without being affected by influences that might
compromise that opinion. Independence enhances the auditor’s ability to act with
integrity, to be objective and to maintain an attitude of professional skepticism.
In the instant case, Mr. Fat has his office and residence in the building owned by Thin
Ltd. who are subject to audit by Mr. Fat. Giving 10% concession in rent may be due to
some other reasons other than holding auditor ship of Thin Ltd. It may be due to being
very old tenant or due to office and residence in the same building or Mr. Fat might
have carried out major renovation and so on. Thus, in the instant case unless and until
there is direct proof, giving 10% concession in rent does not affect independence of
the auditor in expressing his opinion on the audit of Thin Ltd.
Appoinment of auditors ( Under Section139(1) of the Companies Act, 2013)
1. Every company shall, at the first annual general meeting appoint an

individual or a firm as an auditor who shall hold office from the conclusion
of that meeting till the conclusion of its sixth annual general meeting and
thereafter till the conclusion of every sixth meeting.
2. Competent authority for appointment are –
a. If constitution of Audit Committee is needed for company, then Audit
Committee;
b. Else, Board of Directors.
3. The Competent Authority, if Audit Committee, shall recommend auditor to
the Board for consideration.
a. If the Board doesn’t agree with the recommendation--- it shall refer back
to Audit Committee for reconsideration, with reasons.
b. If the Board agrees with the recommendation--- it shall recommend
appointment of such auditors to members in AGM.
4. In case of disagreement between the Audit Committee and the Board of
Directors
a. If the Audit Committee agrees with the Board’s reasons for
reconsideration, then it shall place the Board’s recommendation before
members in AGM.
b. If the Audit Committee disagrees with the Board’s reason for
reconsideration, the Board shall record reasons for disagreement and send
this fact to the members for their consideration in AGM.
5. Prior to the appointment, a certificate shall be obtained from the Auditor
stating that the
a. Auditor is qualified for appointment;
b. Auditor is not disqualified for appointment;
c. Proposed appointment is as per the Act, and within the limits prescribed.
d. Disclosure of any cases of professional misconduct pending against the
proposed auditor or his firm, or his partner.
6. Form ADT-1 shall be filed with the ROC by the company, within 15 days of
meeting in which the auditor is appointed or re-appointed. Also, the
concerned auditor shall be informed.
7. Ratification of appointment: the appointment shall be subject to
ratification in every AGM till the 6th meeting by way of passing of an
ordinary resolution.
If not ratified, the Board of Directors shall appoint another individual or firm as its
auditor or auditors after following the procedure laid down in this behalf under the Act.
Term of Auditor
Applicability of section 139(2): “Rotation of Auditors” is applicable to the following

“class of companies”
Category Rotation Applicable u/s 139 (2)
Listed Companies Yes
Unlisted Public Companies PUC >= Rs. 10 Crores
Private Companies PUC >= Rs. 50 Crores
Unlisted/Private Companies Public Deposits + Borrowings >= Rs. 50 Crores
Term of Auditors:
Individual Auditor Term: One term of 5 years Cooling period: 5 years
Audit firm Term: Two terms of 5 years Cooling period: 5 years
Firms with common partners – If firm that has just completed its term and proposed
firm has common partners, then such proposed firm would be ineligible to be appointed
as auditors.
Example –
• M/s Krishna & Associates is an audit firm having 2 partners namely Mr. Krishna
and Mr. Shyam. Mr. Shyam is also a partner of another audit firm named M/s
Kukreja & Associates.
• M/s Krishna & Associates was appointed as the auditors in the company Golden
Smith Ltd. for two consecutive periods i.e. from year 2014 to year 2024.
• Now, if Golden Smith Ltd. wants to appoint Ms Kukreja & Associates as its audit
firm, it can not do so because Mr. Shyam was the common partner between both
the Audit firms.
• This prohibition is only for 5 years i.e. upto year 2029. After 5 years Golden
Smith Ltd. may appoint M/s Kukreja & Associates as its auditors.
Transitional Provisions –
1. Transition period for Companies existing on or before commencement of the Act

is 3 years from the date of commencement of this Act.
2. Period for which office as auditor is held prior to commencement of this act
should also be considered for rotation and cooling period.
3. The incoming auditor or audit firm should not be in same network of audit firms
as the outgoing auditor; i.e, firms operating or functioning under the same brand
name, trade name or common control.
If a signing partner resigns from the firm which is appointed as auditor of a company
and joins another firm, then such other firm is ineligible for appointment as auditor for
5 yrs i.e cooling period rule applies.
Illustration explaining rotation of an individual auditor
Number of consecutive years Maximum number of Aggregate period which
for which an individual auditor consecutive years for which the auditor would
has been functioning as he may be appointed in the complete in the same
auditor in the same company same company (including company in view of
[in the first AGM held after transitional period) column I and II
the commencement of
provisions of section 139(2)]
I II III
5 Years (or more than 5 3 years 8 years or more
years)
4 years 3 years 7 years
1 year 4 years 5 years
Illustration explaining rotation of an audit firm
Number of consecutive Maximum number of Aggregate period
years for which an audit consecutive years for which the firm would
firm has been functioning as which the firm may be complete in the same
auditor in the same appointed in the same company in view of
company [in the first AGM company (including column I and II
held after the transitional period)
commencement of
provisions of section 139(2)]
I II III
10 Years (or more than 3 years 13 years or more
1 0 years)
Case Study – 7
No Annual General Meeting (AGM) was held for the year ended 31st March, 2014, in
XYZ Ltd., Ninu is the auditor for the previous 3 years, whether she is continuing to
hold office for current year or not.
Answer
Tenure of Appointment: Section139(1) of the Companies Act, 2013 provides that every
company shall, at the first annual general meeting appoint an individual or a firm as
an auditor who shall hold office from the conclusion of that meeting till the conclusion
of its sixth annual general meeting and thereafter till the conclusion of every sixth
meeting. But in this regard, it is to be noted that the company shall place the matter
relating to such appointment of ratification by member at every Annual General
Meeting.
In case the annual general meeting is not held within the period prescribed, the auditor
will continue in office till the annual general meeting is actually held and concluded.
Therefore, Ninu shall continue to hold office till the conclusion of the annual general
meeting.
Resolution by members
▪ Members may resolve to rotate partners of appointed audit firm at intervals
OR
▪ The audit shall be conducted by more than one auditor.
This resolution is optional.

Joint Auditors’ reappointment
2 or more firms / individuals are to be appointed in such a way that both or all the joint
auditors do not complete their term in the same year.
Appointment of First Auditor for other than a Government
Company
The first auditor of a company, other than a Government Company, shall be appointed by:
➢ Board of Directors SHALL within 30 days of registration of company

OR
➢ Members MAY within 90 days, at Extraordinary General Meeting

TERM: Till the conclusion of the first annual general meeting
Appointment of First Auditor in case of a Government

Company
➢ By Comptroller& Auditor General within 60 days of registration of company

• OR
➢ By Board of Directors within the NEXT 30 days
• OR
➢ Members shall appoint within next 60 days at EGM
TERM: Till the conclusion of the first annual general meeting.
Case Study – 8
As an auditor, comment on the following situations/statements:
The first auditors of Health and Wealth Ltd., a Government company, was appointed
by the Board of Directors.
Answer
Appointment of the First Auditor by the Board of Directors: Section 139(6) of the
Companies Act, 2013 (the Act) lays down that “the first auditor or auditors of a
company shall be appointed by the Board of directors within 30 days from the date of
registration of the company”.
Thus, the first auditor of a company can be appointed by the Board of Directors within
30 days from the date of registration of the company.
However, in the case of a Government Company, the appointment of first auditor is
governed by the provisions of Section 139(7) of the Companies Act, 2013. Hence in the
case of M/s Health and Wealth Ltd., being a government company, the first auditors
shall be appointed by the Comptroller and Auditor General of India.
Thus, the appointment of first auditors made by the Board of Directors of M/s Health
and Wealth Ltd., is null and void.
Case Study – 9
Managing Director of PQR Ltd. himself wants to appoint Shri Ganpati, a practicing
Chartered Accountant, as first auditor of the company. Comment on the proposed
action of the Managing Director.
Answer
Appointment of First Auditor of Company: Section 139(6) of the Companies Act, 2013
(the Act) lays down that “the first auditor or auditors of a company shall be appointed
by the Board of directors within 30 days from the date of registration of the company”.
In the instant case, the appointment of Shri Ganapati, a practicing Chartered

Accountant as first auditors by the Managing Director of PQR Ltd by himself is in
violation of Section 139(6) of the Companies Act, 2013, which authorizes the Board of
Directors to appoint the first auditor first auditor of the company within one month
of registration of the company.
In view of the above, the Managing Director of PQR Ltd should be advised not to appoint
the first auditor of the company.
Appointment of Auditor (other than first auditor) in case of a Government
Company (U/S 139(5))
C &AG SHALL appoint within 180 days from COMMENCEMENT of financial year in
the case of:
▪ a Government company; or
▪ any other company owned or controlled, directly or indirectly, by the
Central Government, or by any State Government or Governments, or
partly by the Central Government and partly by one or more State
Governments,
TERM: Till the conclusion of the annual general meeting.
Case Study – 10
Nickson Ltd. is a subsidiary of Ajanta Ltd., whose 20% shares have been held by Central
Government, 25% by Uttar Pradesh Government and 10% by Madhya Pradesh
Government. Nickson Ltd. appointed Mr. P as statutory auditor for the year.
Answer
According to Section 139 (7) of the Companies Act, 2013, a Government company is
defined “as any company in which not less than 51% of the paid-up share capital is held
by the Central Government or by any State Government or Governments or partly by
the Central Government and partly by one or more State Governments and includes a
company which is a subsidiary of a Government Company as thus defined”. The auditors
of a government company shall be appointed or re- appointed by the Comptroller and
Auditor General of India.
In the given case Ajanta Ltd is a government company as its 20% shares have been held
by Central Govt, 25% by U.P. State Government and 10% by M.P. State Govt. Total 55%
shares have been held by Central and State governments. Therefore, it is a Government
company.
Nickson Ltd. is a subsidiary company of Ajanta Ltd. Hence Nickson Ltd. Is covered in
the definition of a government company. Hence the Auditor of Nicksons Ltd. can be
appointed only by C & AG.
Therefore, appointment of ‘P’ is invalid, and ‘P’ should not give acceptance to the
Directors of Nicksons Ltd.
Filling of a casual vacancy (Under section 139(8))
➢ BOD MAY fill casual vacancy in office of Auditor within 30 days of

vacancy (reasons OTHER than resignation)
➢ Vacancy as a result of RESIGNATION Appointment shall also be approved
in General Meeting convened within 3 months of Board’s recommendation
➢ Casual Vacancy for C&AG appointed auditors within 30 days BY C&AG
• OR
o Within next 30 days BY BOD
Scenario Who? When?
Casual Vacancy Board of Directors Within 30 days
(Except
Resignation)
Resignation Recommended by Board & Approved Within 3 months of Board

by shareholders in General Meeting Recommendation
Casual Vacancy for C&AG or Within 30 days

C&AG appointed
Board of Directors
Auditors
TERM OF CASUAL VACANCY AUDITOR: Until the conclusion of the next annual
general meeting.
Resignation by Auditor
• If the Auditor has resigned from the company, he shall file within a period of 30
days from the date of resignation, a statement in Form ADT 3.
o In case of government companies, the auditor shall file such statement
• with the Comptroller and Auditor-General of India
• Company and
• ROC.
o In other cases,
• with the company and
• ROC
• The auditor shall indicate the reasons and other facts as may be relevant with
regard to his resignation, in the statement.
Penalty on non-compliance shall not be less than Rs 50,000 but which may extend to Rs
5 Lacs.
Case Study – 11
‘At the AGM of ICI Ltd., Mr. X was appointed as the statutory auditor. He, however,
resigned after 3 months since he wanted to give up practice and join industry. State,
how the new auditor will be appointed by ICI Ltd and the conditions to be complied
for.
Answer
Appointment of New Auditor in case of Resignation: Section 139(8) of the Companies
Act, 2013 deal with provisions relating to appointment of auditor caused due to casual
vacancy. A casual vacancy normally arises when an auditor ceases to act as such after
he has been validly appointed, e.g., death, disqualification, resignation, etc. In the
instance case, Mr. X has been validly appointed and thereafter he had resigned.
The law provides that in case a casual vacancy has been created by the resignation of
the auditor (as in this case), the Board cannot fill in that vacancy itself, such
appointment shall also be approved by the company at general meeting convened
within three months of the recommendation of the board and then he shall hold office
till the conclusion of the next annual general meeting.
In this case the casual vacancy has been created on account of resignation. Therefore,
Board of Directors will have to fill the vacancy within thirty days and such appointment
shall be approved by the company at the general meeting within three months of the
recommendations of the board.
The new auditor so appointed shall hold office only till the conclusion of the next
annual general meeting.
The provisions of the Companies Act, 2013 applicable for the appointment of an
auditor in place of a retiring auditor would equally applicable in the instant case are
given below:
i. Section 140(4)(i): Special notice shall be required for a resolution at an annual
general meeting appointing as auditor a person other than a retiring auditor.
ii. Section 115: Special notice is to be given by such number of members holding
not less than one percent of total voting power or holding shares on which such
an aggregate sum of not exceeding five lakh rupees has been paid upto the date
of the notice. The notice shall be sent by the members to the company at least
seven days before the date of the meeting
iii. Section 140(4)(ii): On receipt of notice of such a resolution, the company shall
forthwith send a copy thereof to the retiring auditor.
iv. Section 140(4)(iii): Representation if any, received from the retiring auditor
should be sent to the members of the company.
v. Section 139: Before any appointment or reappointment of auditors is made at
an annual general meeting, a written certificate is to be obtained from the
auditor proposed to be appointed that his appointment will be in accordance
with the limits specified in Section 141(3)(g).
vi. The incoming auditor should also satisfy himself that the notice provided for
under Sections 139 and 140 has been effectively served on the outgoing auditor.
Case Study – 12
M/s Young & Co., a Chartered Accountant firm, and Statutory Auditors of Old Ltd., is
dissolved on 1.4.2014 due to differences of opinion among the partners. The Board of
Directors of Old Ltd. in its meeting on 6.4.2014 appointed another firm M/s Sharp & Co.
as their new auditors for one year.
Answer
a) Section 139(8) of the Companies Act, 2013 lays down that the Board of Directors
may fill any casual vacancy in the office of an auditor provided that where such
vacancy is caused by the resignation of an auditor, the vacancy shall be filled in
general meeting.
The expression “casual vacancy” has not been defined in that Act. Talking its
natural meaning it may arise due to a variety of reasons which include death,
resignation, disqualification, dissolution of the firm etc. Furthermore Section
139(8) stipulates that any auditor appointed in a casual vacancy shall hold office
until the conclusion of the next AGM.
In the instant case the action of the board of directors in appointing M/s Sharp &
Co. to fill up the casual vacancy due to dissolution of M/s Young & Co., is correct.
However, the board of directors are not correct in giving them appointment for one
year. M/s Sharp & Co. can hold office until the conclusion of next AGM only.
Reappointment of retiring Auditor
1. At any annual general meeting, a retiring auditor may be re-appointed at an AGM, if—
- he is not disqualified for re-appointment;
- he has not given the company a notice in writing of his unwillingness to be re-appointed;
and
- a special resolution has not been passed at that meeting appointing some other auditor or
providing expressly that he shall not be re-appointed.
2. Where at any annual general meeting, no auditor is appointed or re-appointed, the existing
auditor shall continue to be the auditor of the company.
3. Where a company is required to constitute an Audit Committee under section 177, all
appointments, including the filling of a casual vacancy of an auditor under this section
shall be made after taking into account the recommendations of such committee.
Constitution of Audit Committee (Sec 177)In addition to listed companies, following

classes of companies shall constitute an Audit Committee -
a. Public companies with a paid-up capital >= Rs.10 Cr
b. Public companies having turnover >= Rs.100 Cr
c. Public companies, having in aggregate, outstanding loans or borrowings or debentures
or deposits > Rs. 50 Cr
Case Study – 13
Under what circumstances the retiring Auditor cannot be reappointed?
Answer
In the following circumstances, the retiring auditor cannot be reappointed:
1. A specific resolution has not been passed to reappoint the retiring auditor.
2. The auditor proposed to be reappointed does not possess the qualification
prescribed under section 141 of the Companies Act, 2013.
3. The proposed auditor suffers from the disqualifications under section 141(3),
141(4) and 144 of the Companies Act, 2013.
4. He has given to the company notice in writing of his unwillingness to be
reappointed.
5. A resolution has been passed in AGM appointing somebody else or providing
expressly that the retiring auditor shall not be reappointed.
6. A written certificate has not been obtained from the proposed auditor to the
effect that the appointment or reappointment, if made, will be in accordance
within the limits specified under section 141(3)(g) of the Companies Act, 2013.
Removal of Auditor before expiry of term

• The auditor may be removed from his office before the expiry of his term by
▪ a special resolution of the company, and
▪ After obtaining the previous approval of the Central Government (fee paid
application form ADT 2)
• The application shall be made to the Central Government within 30 days of the
resolution passed by the Board.
• The Company shall hold the general meeting within 60 days of receipt of approval
of the Central Government for passing the special resolution.
• The auditor shall have an opportunity of being heard.
Case Study – 14
Why is Central Government permission required, when the auditors are to be removed
before expiry of their term, but the same is not needed when the auditors are changed
after expiry of their term?
Answer
Permission of Central Government for removal of auditor under section 140(1) of the
Companies Act, 2013: Removal of auditor before expiry of his term i.e. before he has
submitted his report is a serious matter and may adversely affect his independence.
Further, in case of conflict of interest the shareholders may remove the auditors in
their own interest. Therefore, law has provided this safeguard so that central
government may know the reasons for such an action and if not satisfied, may not
accord approval.
On the other hand, if auditor has completed his term i.e. has submitted his report and
thereafter, he is not re-appointed then the matter is not serious enough for central
government to call for its intervention. In view of the above, the permission of the
Central Government is required when auditors are removed before expiry of their term
and the same is not needed when they are not re-appointed after expiry of their term.
Appointment of Auditor other than the retiring Auditor

• If the retiring auditor has not completed a consecutive tenure of 5 years or 10
years, as the case may be, special notice shall be required for
▪ a resolution at an annual general meeting appointing as auditor a person
other than a retiring auditor, or
▪ Providing expressly that a retiring auditor shall not be re-appointed.
• On receipt of notice of such a resolution, the company shall send a copy thereof
to the retiring auditor.
• Outgoing auditor has the right to give representation, —
o in the notice of resolution given to members, stating fact that
representation has been made
o send a copy of the representation to every member of the company to
whom notice of the meeting is sent
If a copy of the representation is not sent as aforesaid, it shall be read out at the
meeting, and a copy shall be filed with Registrar
Auditor’s remuneration
• The remuneration of the auditors of a company shall be fixed by the company in
general meeting or in such manner as the company in general meeting may
determine.
• In the case of first auditor, remuneration may be fixed by the Board.
• The remuneration shall include the fee payable, expenses incurred in connection
with the audit and any facility extended to him, but not remuneration paid to him
for any other service rendered at the request of the company.
Ceiling on number of Audits
• The number of audits held at any point of time shouldn’t exceed 20.
• In the case of a firm of auditors, the ceiling limit of 20 shall be applicable for every
partner of the firm who is not in full time employment elsewhere. This limit of 20
company audits is per person. In the case of an audit firm having 3 partners, the
overall ceiling will be 3 × 20 = 60 company audits.
• Where a chartered accountant is a partner in a number of auditing firms, all the
firms in which he is partner or proprietor will be together entitled to 20 company
audits on his account.
Powers of Auditors
1. Right of access to books of accounts and vouchers.
2. Right to obtain information and explanation from officers.
3. Right to receive notices and to attend general meeting.
4. Right to report to the members of the company on the accounts examined by him.
5. Auditor can exercise lien on books and documents placed at his possession by the
client for non-payment of fees, for work done on the books and documents.
6. The auditor shall have right to be heard at such meeting on any part of the business
which concerns him as the auditor.
Case Study – 15
Give your comments and observations on the following:
a) KBC & Co. a firm of Chartered Accountants has three partners, K, B & C; K is also
in whole time employment elsewhere. The firm is offered the audit of ABC Ltd.
and is already holding audit of 40 companies.
b) At an Annual General Meeting of a listed company, Mr. R a retiring auditor after
completing the tenure of five consecutive years of his service claims that he has
been reappointed automatically, as the intended resolution of which a notice had
been given to appoint Mr. P, could not be proceeded with, due to Mr. P's death.
Answer
a) Ceiling on Number of Company Audits: As per section 141(3)(g) of the Companies
Act, 2013, a person shall not be eligible for appointment as an auditor if
- he is in full time employment elsewhere.
- if such person or partner is at the date of such appointment or reappointment
holding appointment as auditor of more than twenty companies.
In the firm of KBC & Co., K is in whole-time employment elsewhere, therefore, he
will be excluded in determining the number of company audits that the firm can
hold. If B and C do not hold any audits in their personal capacity or as partners of
other firms, the total number of company audits that can be accepted by KBC &
Co., is forty, and in the given case company is already holding forty audits,
therefore, KBC & Co. can’t accept the offer for audit of ABC Ltd.
b) Term of Auditor: Section 139(2) of the Companies Act, 2013 deals with the term of
an Auditor which provides that listed companies and other prescribed class or
classes of companies (except one person companies and small companies) shall not
appoint or reappoint an individual as auditor for more than one term of five
consecutive years.
In the given case, notice has been given of an intended resolution to appoint some
person or persons in the place of a retiring auditor, and by reason of the death,
incapacity or disqualification of that person or of all those persons, as the case may
be, the resolution cannot be proceeded with and consequently casual vacancy in
the office has been created."
Therefore, as per Section 139(8) of the Companies Act, 2013, casual vacancy to be
filled by the Board of Directors within thirty days. Thus, the claim of Mr. R would
not hold good.
Case Study – 16
PBS & Associates, a firm of Chartered Accountants, has three partners P, B and S. The
firm is already having audit of 45 companies. The firm is offered 20 company audits.
Decide and advise whether PBS & Associates will exceed the ceiling prescribed under
Section 141(3)(g) of the Companies Act, 2013 by accepting the above audit
assignments?
Answer
Ceiling on number of audits: Before appointment is given to any auditor, the company
must obtain a certificate from him to the effect that the appointment, if made, will
not result in an excess holding of company audit by the auditor concerned over the
limit laid down in section 141(3)(g) of the Act which prescribes that a person who is in
full time employment elsewhere or a person or a partner of a firm holding appointment
as its auditor, if such person or partner is at the date of such appointment or
reappointment holding appointment as auditor of more than twenty companies.
In the case of a firm of auditors, it has been further provided that ‘specified number
of companies’ shall be construed as the number of companies specified for every
partner of the firm who is not in full time employment elsewhere.
If Mr. P, B and S do not hold any audits in their personal capacity or as partners of
other firms, the total number of company audits that can be accepted by M/s PBS &
Associates is 60. But the firm is already having audit of 45 companies. So the firm an
accept the audit of 15 companies only, which is well within the limit, specified by
Section 141(3)(g) of the Companies Act, 2013.
Case Study – 17
What will be position of the Auditor in the following cases:
A, a chartered accountant has been appointed as auditor of Laxman Ltd. In the Annual
General Meeting of the company held in September 2013, which assignment he
accepted. Subsequently in January 2014 he joined B, another chartered accountant,
who is the Manager Finance of Laxman Ltd., as partner.
Answer:
Disqualifications of an Auditor: Section 141(3)(c) of the Companies Act, 2013 prescribes
that any person who is a partner or in employment of an officer or employee of the
company will be disqualified to act as an auditor of a company.
Sub-section (4) of Section 141 provides that an auditor who incurs any of the
disqualifications mentioned in sub-section (3) after his appointment, he shall vacate
his office as such auditor.
In the present case, A, an auditor of M/s Laxman Ltd., joined as partner with B, who
is Manager Finance of M/s Laxman Limited, has attracted clause (3) (c) of Section 141
and, therefore, he shall be deemed to have vacated office of the auditor of M/s
Laxman Limited.
Case Study – 18
Y, is the auditor of X Pvt. Ltd. In which there are four shareholders only, who are also
the Directors of the company. On account of bad trade and for reducing the expenses
in all directions, the directors asked Y to accept a reduced fee and for that he has
been offered not to carry out such full audit as he has done in the past. Y accepted
the suggestions of the directors.
Answer
Restricting Scope of Audit: Y may agree to temporary reduction in audit fees, if he so
wishes, in view of the suggestions made by the directors (perhaps in accordance with
the decision of the company taken in general meeting). But his duties as a company
auditor are laid down by law and no restriction of any kind can restrict the scope of
his work either by the director or even by the entire body shareholders.
There is no concept of full or part audit under Section 143 of the Companies Act, 2013.
Further, remuneration is a matter of arrangement between the auditor and the
shareholders.
Section 142 specifies the remuneration of an auditor, shall be fixed by the company in
general meeting or in such manner as the company in general meeting may determine.
His duties may not necessarily commensurate with his remuneration. Y,therefore,
should not accept the suggestions of the directors regarding the scope of the work to
be done.
Even if Y accepts the suggestions of the directors regarding the scope of work to be
done, it would not reduce his responsibility as an auditor under the law. Under the
circumstances, Y is violating the provisions of the Companies Act, 2013.
Case Study – 19
While conducting the audit of a limited company for the year ended 31st March, 2014,
the auditor wanted to refer to the Minute Books. The Board of Directors refused to
show the Minute Books to the auditor.
Answer
Right of Access to Minute Books: Section 143 of the Companies Act, 2013 grants powers
to the auditor that every auditor has a right of access, at all times, to the books and
account including all statutory records such as minute books, fixed assets register, etc.
of the company for conducting the audit.
In order to verify actions of the company and to vouch and verify some of the
transactions of the company, it is necessary for the auditor to refer to the decisions
of the shareholders and/or the directors of the company.
It is, therefore, essential for the auditor to refer to the Minute Books. In the absence
of the Minute Books, the auditor may not be able to vouch/verify certain transactions
of the company.
In case the directors have refused to produce the Minute Books, the auditor may
consider extending the audit procedure as also consider qualifying his report in any
appropriate manner.
Case Study – 20
Mr. Budha, Statutory Auditors of Secret Ltd. was not permitted by the Board of
Directors to attend general meeting of the company on the ground that his right to
attend general meetings is restricted only to those meetings at which the accounts
audited by him are to be presented and discussed.
Answer
According to Section 146 of the Companies Act, 2013 the auditors of a company are
under an obligation to attend any general meeting of the company and not only those
meetings at which the accounts audited by them are to be presented and discussed.
In the instant case, the board of directors of Secret Ltd., have no right to restrict Mr.
Buddha from attending the general meeting and Mr. Buddha has every right to attend
such meeting as conferred by Section 146.
Thus, the action of the board of directors is contrary to the provisions of law and
curtails the right of the auditor.
Case Study – 21
At the Annual General Meeting of the Company, a resolution was passed by the entire
body of shareholders restricting some of the powers of the Statutory Auditors.
Whether powers of the Statutory Auditors can be restricted?
Answer
Restrictions on Powers of Statutory Auditors: Section 143 of the Companies Act, 2013
provides that an auditor of a company shall have right of access at all times to the
books and accounts and vouchers of the company whether kept at the Head Office or
other places and shall be entitled to require from the offices of the company such
information and explanations as the auditor may think necessary for the purpose of
his audit.
These specific rights have been conferred by the statute on the auditor to enable him
to carry out his duties and responsibilities prescribed under the Act, which cannot be
restricted or abridged in any manner. Hence, any such resolution even if passed by
entire body of shareholders is ultra vires and therefore void.
Duties of auditor
Duty to Report: As per sub section 3 of section 143 of the Companies Act, 2013, the auditor’s
report shall also state –
a) whether he has sought and obtained all the information and explanations which to the best of
his knowledge and belief were necessary for the purpose of his audit and if not, the details thereof
and the effect of such information on the financial statements;
b) whether, in his opinion, proper books of account as required by law have been kept by the
company
c) returns adequate for the purposes of his audit have been received from branches not visited by
him, for branches audited by persons other than him;
d) whether the company’s balance sheet and profit and loss account dealt with in the report are in
agreement with the books of account and returns;
e) whether, in his opinion, the financial statements comply with the accounting standards;
f) the observations or comments of the auditors on financial transactions or matters which have any
adverse effect on the functioning of the company;
g) whether any director is disqualified from being appointed as a director u/s 164(2);
h) any qualification, reservation or adverse remark relating to the maintenance of accounts and
other related matters;
i) whether the company has adequate internal financial controls system in place and the operating
effectiveness of such controls;
j) such other matters as may be prescribed.
Section 146 requires auditor to attend AGM either in person or through representative unless
exempted by the Company.
LATEST ADDITION: Further, Rule 11 of the Companies (Audit and Auditors) Rules, 2014
prescribes that the auditor’s report shall also include views and comments on the following
matters, namely: -
- whether the company has disclosed the impact, if any, of pending litigations on
its financial position in its financial statement;
- whether the company has made provision, as required under any law or
accounting standards, for material foreseeable losses, if any, on long term
contracts including derivative contracts;
- whether there has been any delay in transferring amounts, required to be
transferred, to the Investor Education and Protection Fund by the company.
LATEST ADDITION: Duty to report fraud – Report to Central Government in sealed cover
with RPAD in form ADT 4 within 60 days of his knowledge of fraud after following this
procedure
a. Send a report in this regard to BOD / AC and seek reply <=45 days
b. Upon receipt of such reply, send report of auditor along with replies to CG <=15 days of
receipt of reply
c. If no reply is received in 45 days’ time, send a report to CG indicating this fact.
d. Penalty for failure to follow this procedure is >=1L, <=25L
2. Duty to report on any other matter specified by Central Government.
3. Duty to state the reason for qualification or negative report.
4. Duties and powers in relation to Brach audit and the Branch Auditor.
5. The auditor shall attend the AGM either by himself or through his authorized
representative. Thus, it is compulsory for him to attend the meeting unless otherwise
exempted by the company.
Case Study – 22
Give your comments on the following:
Mr. X, a Director of M/s KP Private Ltd., is also a Director of another company viz.,
M/s GP Private Ltd., which has not filed the financial statements and annual return
for last three years 2010-11 to 2012-13. Mr. X is of the opinion that he is not
disqualified u/s 164(2) of the Companies Act, 2013, and auditor should not mention
disqualification remark in his audit report.
Answer
a) Disqualification of a Director under section 164(2) of the Companies Act, 2013:
Section 143(3)(g) of the Companies Act, 2013 imposes a specific duty on the auditor
to report whether any director is disqualified from being appointed as director
under section 164(2) of the Companies Act, 2013.
As per provisions of Section 164(2), if a director is already holding a directorship of

a company which has not filed the financial statements or annual returns for any
continuous period of three financial years shall not be eligible to be reappointed
as a director of that company or appointed in other company for a period of five
years from the date on which the said company fails to do so.
In this case, Mr X is a director of M/s KP Private Ltd. as well as of M/s GP Private

Ltd., And, M/s GP Private Ltd., has not filed the financial statements and annual
return for last three years. Hence the provisions of section 164(2) are applicable to
him and as such he is disqualified from directorship of both the companies.
Therefore, the auditor shall report about the disqualification under section
143(3)(g) of the Companies Act, 2013.
Case Study – 23
An auditor became aware of a matter regarding a company, only after he had issued
his audit opinion. Had he become aware of the same prior to his issuing the audit
report, he would have issued a different opinion.
Answer
Section 146 of the Companies Act, 2013 empowers the auditors of a company to attend
any general meeting of the company; to receive all the notices and other
communications relating to the general meeting, unless otherwise exempted by the
company, and to be heard at any general meeting in any part of the business of the
meeting which concerns them as auditors.
Where the auditor has reason to believe that the directors concealed deliberately a
serious fact from the shareholders which came to his note after issuance of the audit
report, he should exercise this right. Normally speaking, an auditor considers
subsequent events only up to the date of issuance of the audit report.
The discovery of a fact after issuance of the financial statements that existed at the
date of the audit report which would have caused the revision of the audit report,
requires the auditor to bring this to the notice of shareholders.
Likewise, it may be advisable for the auditor to attend the meeting with a view to
bringing to the notice of the shareholders any matter which came to his knowledge
subsequent to his signing the report and if it had been known to him at the time of
writing his audit report, he would have drawn up the report differently; or where the
accounts have been altered after the report was attached to the accounts.
Case Study – 24
a) The auditor of Trilok Ltd. did not report on the matters specified in sub-section (1)
of Section 143 of the Companies Act, 2013, as he was satisfied that no comment is
required.
b) The members of C. Ltd. preferred a complaint against the auditor stating that he
has failed to send the auditor’s report to them.
Answer
a) Comment on Matters Contained under Section 143(1) of the Companies Act, 2013:
Section 143(1) of the Act deals with duties of an auditors requiring auditor to make
an enquiry in respect of specified matters.
The matters in respect of which the enquiry has to be made by the auditor include
relating to loans and advances, transactions represented merely by book entries,
investments sold at less than cost price, loans and advances shown as deposits, etc.
Since the law requires the auditor to make an enquiry, the Institute opined that
the auditor is not required to report on the matters specified in sub-section (1)
unless he has any special comments to make on any of the items referred to therein.
If the auditor is satisfied as a result of the enquiries, he has no further duty to

report that he is so satisfied. Therefore, the auditor of Trilok Ltd. is correct in non-
reporting on the matters specified in Section 143(1).
b) Dispatch of Auditor’s Report to Shareholders: Section 143 of the Companies Act,
2013 lays down the powers and duties of auditor. As per provisions of the law, it is
no part of the auditor’s duty to send a copy of his report to members of the
company.
The auditor’s duty concludes once he forwards his report to the company. It is the
responsibility of company to send the report to every member of the company. In
Re Allen Graig and Company (London) Ltd., 1934 it was held that duty of the auditor
after having signed the report to be annexed to a balance sheet is confirmed only
to forwarding his report to the secretary of the company. It will be for the secretary
or the director to convene a general meeting and send the balance sheet and report
to the members (or other person) entitled to receive it. Hence in the given case,
the auditor cannot be held liable for the failure to send the report to the
shareholders.
Case Study – 25
a) A Ltd. has its Registered Office at New Delhi. During the current accounting year,
it has shifted its Corporate Head Office to Indore though it has retained the
Registered Office at New Delhi. The Managing Director of the Company wants to
shift its books of account to Indore from New Delhi, as he feels that there is no
legal bar in doing so.
b) The Board of Directors of a company have filed a complaint with the Institute of
Chartered Accountants of India against their statutory auditors for their failure to
attend the Annual General Meeting of the Shareholders in which audited accounts
were considered.
Answer
a) Shifting of Books of Account: As per section 128(1) of The Companies Act 2013,
every company shall keep at its registered office proper books of accounts. It is
permissible, however, for all or any of the books of accounts to be kept at such
place in India as the Board of Directors may decide but, when a decision in this
regard is taken, the company must file within seven days of such decision with the
Registrar of Companies a notice in writing giving full address of the other place.
Conclusion: In view of the above provisions, A Ltd should maintain its books of
account at its registered office at New Delhi. The Managing Director is not allowed
to shift its books of account to Indore unless decision in this behalf is taken by the
Board of Directors and a notice is also given to the Registrar of Companies within
the specified time. The auditor may, accordingly, inform the Managing Director
that his contention is not in accordance with the legal provisions.
b) Auditor’s Attendance at Annual General Meeting: Section 146 of the Companies Act,
2013 confers right on the auditor to attend the general meeting.
The said section provides that all notices and other communications relating to any
general meeting of a company also to be forwarded to the auditor. Further, it has
been provided that the auditor shall, unless otherwise exempted, entitled attend
any general meeting and has the right to be heard at such general meeting which
he attends on any part of the business which concerns him as an auditor.
Therefore, the section casts a duty on the auditor to attend the annual general
meeting. Therefore, the complaint filed by the Board of Directors is valid.
Case Study – 26
M/s XYZ & Co., auditors of Goodwill Education Foundation, a recognized nonprofit
organisation feels that the standards on auditing need not to be applied as Goodwill
Education Foundation is a non-profit making concern.
Answer
a) Compliance with Standards on Auditing: As per sub section 9 of section 143 of the
Companies Act, 2013, every auditor shall comply with the auditing standards.
Further as per sub section 10 of section 143 of the Act, the Central Government
may prescribe the standards of auditing or any addendum thereto, as recommended
by the Institute of Chartered Accountants of India, constituted under section 3 of
the Chartered Accountants Act, 1949, in consultation with and after examination
of the recommendations made by the National Financial Reporting Authority:
b) Provided that until any auditing standards are notified, any standard, or standards
of auditing specified by the Institute of Chartered Accountants of India shall be
deemed to be the auditing standards.
c) Further, the Preface to Standards on Auditing gives the scope of the Standards on
Auditing. As per the Preface, the SAs will apply whenever an independent audit is
carried out; that is, in the independent examination of financial
statements/information of any entity; whether profit oriented or not and
irrespective of its size, or legal form (unless specified otherwise) when such an
examination is conducted with a view to expressing an opinion thereon.
d) Also, while discharging their attest function; it is the duty of the Chartered
Accountant to ensure that SAs are followed in the audit of financial information
covered by their audit reports.
e) In the given case, even though the client is a non-profit oriented entity the SAs
shall apply and the auditor shall be guilty of professional misconduct for failing to
discharge his duty in case of non-compliance with SAs.
Prohibited Services for auditors
An auditor appointed under this Act shall provide to the company only such other services as are
approved by the Board of Directors or the audit committee, as the case may be. But such services
shall not include any of the following services (whether such services are rendered directly or
indirectly to the company or its holding company or subsidiary company), namely
a. Accounting and bookkeeping services;

b. Internal audit;
c. Design and implementation of any financial information system;
d. Actuarial services;
e. Investment advisory services;
f. Investment banking services;
g. Rendering of outsourced financial services;
h. Management services [ this excludes services permitted by ICAI as per professional ethics]; and
i. Any other kind of services as may be prescribed [E.g. Prohibited services by CA in practice as per
ICAI like Portfolio management, Underwriting and Stock broking are under this category]
Note – If an auditor or audit firm who or which has been performing any non-audit
services on or before the commencement of the Companies Act, 2013, shall comply
with the provisions of this section (i.e. section 144) before the closure of the first
financial year after the date of such commencement
Case Study – 27
Give your comments on the following:
a) Mr. Aditya, a practicing-chartered accountant is appointed as a “Tax
Consultant” of ABC Ltd., in which his father Mr. Singhvi is the Managing
Director.
b) You, the Auditor of A Ltd., have been considered for ratification by the
members in the 4th general meeting as the sole auditor, where you were one of
the joint auditors for the immediately preceding three years and the said joint
auditors are not re-appointed.
Answer
a) Appointment of a Practicing CA as ‘Tax Consultant’: A chartered accountant
appointed as an auditor of a company, should ensure the independence in
respect of his appointment as an auditor, else it would amount to "misconduct"
under the Chartered Accountants Act, 1949 read with Guidance Note on
Independence of Auditors.
In this case, Mr. Aditya is a "Tax Consultant" and not a "Statutory Auditor" or
"Tax Auditor" of ABC Ltd., hence he is not subject to the above requirements.
b) Appointment of Sole Auditor: When one of the joint auditors of the previous
years is considered for ratification by the members as the sole auditor for the
next year, it is similar to non-re-appointment of one of the retiring joint
auditors.
As per sub- section 4 of section 140 of the Companies Act, 2013, special notice
shall be required for a resolution at an annual general meeting appointing as
auditor a person other than a retiring auditor, or providing expressly that a
retiring auditor shall not be re-appointed, except where the retiring auditor has
completed a consecutive tenure of five years or, as the case may be, ten years,
as provided under sub-section (2) of section 139 of the said Act. Accordingly,
provisions of the Companies Act, 2013 to be complied with are as under:
1. Ascertain that special notice u/s 140(2) of the Companies Act, 2013 was
received by the company from such number of members holding not less than
one percent of total voting power or holding shares on which an aggregate
sum of not less than five lakh rupees has been paid up on the date of the
notice not earlier than three months but at least 14 days before the AGM
date as per Section 115 of the Companies Act, 2013 read with rule 23(1) and
23(2)of the Companies (Management and Administration) Rules, 2014
2. Check whether the said notice has been sent to all the members at least 7
days before the date of the AGM as per Section 115 of the Companies Act,
2013 read with rule 23(3) of the Companies (Management and
Administration) Rules, 2014.
3. Verify the notice contains an express intention of a member for proposing
the resolution for appointing a sole auditor in place of both the joint
auditors who retire at the meeting but are eligible for re-appointment.
4. The notice is also sent to the retiring auditor as per Section 140(4)(ii) of the
Companies Act, 2013.
5. Verify whether any representation, received from the retiring auditor was
sent to the members of the company.
6. Verify from the minutes book whether the representation received from the
retiring joint auditor was considered at the AGM
COMPANIES (AUDITOR’S REPORT) ORDER, 2016
✓ Applicability of the CARO – 2016
Every report made by the auditor under section 143 of the 2013 Act for financial year
commencing on or after 1 April 2014 should include CARO – 2015.
✓ Companies covered under the CARO – 2015
Applies to every company (except companies that are excluded, see below),
including a foreign company as defined under section 2(42) of the 2013 Act i.e. any
company or body corporate incorporated outside India which:
▪ has a place of business in India whether by itself or through an agent,
physically or through an electronic mode, and
▪ conducts any business activity in India in any other manner.
✓ COMPANIES EXCLUDED FROM CARO APPLICATION:
• Banking company as defined under section 5(c) of the Banking Regulation Act,
1949
• Insurance company as defined under the Insurance Act,1938.
• Companies incorporated with charitable objects, etc. i.e. companies licensed
to operate under section 8 of 2013 Act
• Private company (other than holding or subsidiary of a public company):
o with a paid-up capital and reserves not more than Rs. 1 crore
o does not have outstanding loan exceeding Rs. 1 crore from any bank or
financial institution, and
o does not have a turnover exceeding Rs. 10 crores at any point of time
during the financial year
• One-person company as defined under section 2(62) of the 2013 Act i.e. a
company which has only one person as a member
• Small company as defined under section 2(85) of the 2013 Act i.e. a company
other than a public company:
Following companies will not qualify as a small company:

o a holding or a subsidiary company,
o a company registered under section 8 of 2013 Act, or
o a company or body corporate governed by any special Act
MATTERS TO BE REPORTED IN THE CARO – 2016 (12 CLAUSES)
• When Auditor’s response to any of the reporting matters is

UNFAVOURABLE/QUALIFIED, the auditor should state the reason for such
response
• When Auditor is unable to express any opinion in response to a particular question,
the audit report should indicate such fact together with the reasons why it was not
possible to provide a response to such a question.
Fixed assets • Whether the company is maintaining proper records
(Para 3(i)) showing full particulars, including quantitative details and
situation of fixed assets?
• Whether these fixed assets have been physically verified

by the management at reasonable intervals?
• Whether any material discrepancies were noticed on such

verification and if so, whether the same have been
properly dealt with in the books of account?
• whether the title deeds of immovable properties are held

in the name of the company?
Inventories • Whether physical verification of inventory has been

(Para 3(ii)) conducted at reasonable intervals by the management?
• whether any material discrepancies were noticed on
physical verification, and if so, whether the same have
been properly dealt with in the books of account?
Granting of loans to ▪ Whether the company has granted any loans, secured or
certain parties unsecured to companies, firms or other parties covered in the
(Para 3(iii)) register maintained under section 189 of the 2013 Act. If so:
• whether the terms and conditions of the grant of such
loans are not prejudicial to the company’s interest;
• whether the schedule of repayment of principal and
payment of interest has been stipulated and whether the
repayments or receipts are regular;
• if the amount is overdue, state the total amount overdue
for more than 90 days and whether reasonable steps have
been taken by the company for recovery of principal and
interest
Loans, investments, in respect of loans, investments, guarantees, and security
guarantees Para 3(iv) whether provisions of section 185 and 186 of the Companies
Act, 2013 have been complied with. If not, provide the details
thereof.
Acceptance of in case the company has accepted deposits,
deposits (Para 3(v)) - whether the directives issued by the Reserve Bank of India
and the provisions of sections 73 to 76 or any other
relevant provisions of the Companies Act, 2013 and the
rules framed there under, where applicable, have been
complied with?
- If not, the nature of such contraventions be stated;
- If an order has been passed by Company Law Board or
National Company Law Tribunal or Reserve Bank of India
or any court or any other tribunal, whether the same has
been complied with or not?
Maintenance of cost Where maintenance of cost records has been specified by the
records (Para 3(vi)) Central Government under section 148(1) of the 2013 Act,
whether such accounts and records have been made and
maintained?
Deposit of statutory a) Is the company regular in depositing undisputed statutory

dues (Para 3(vii)) dues including:
– provident fund– income-tax, wealth tax, duty of customs,
value added tax, employees’ state insurance, sales-tax, service
tax, duty of excise, cess
and any other statutory due with the appropriate authorities
and
- if not, the extent of the arrears of outstanding statutory dues
as at the last day of the financial year concerned for a period of
more than six months from the date, they became payable,
shall be indicated by the auditor.
b) In case dues have not been deposited on account of any
dispute, then the amounts involved and the forum where
dispute is pending shall be mentioned.
(A mere representation to the concerned department shall not
constitute a dispute.)
Accumulated losses Whether in case of a company which has been registered for a
and incurrence of period not less than five years, its accumulated losses at the end
cash losses of the financial year are not less than 50 per cent of its net worth
(Para 3(viii)) and whether it has incurred cash losses in such financial year and
in the immediately preceding financial year?
Whether the company has defaulted in repayment of dues to a
Default in financial institution or bank or debenture holders?
repayment of dues
If yes, the period and amount of default to be reported.
(Para 3(viii))
Application of - whether moneys raised by way of initial public offer or
money raised further public offer (including debt instruments) and
through public issue term loans were applied for the purposes for which those
(Para 3(ix)) are raised.
- If not, the details together with delays or default and
subsequent rectification, if any, as may be applicable, be
reported;
Fraud reporting Whether any fraud on or by the company has been noticed or
(Para 3(x)) reported during the year? If yes, the nature and the amount
involved is to be indicated.
Managerial - whether managerial remuneration has been paid or

Reporting provided in accordance with the requisite approvals
(Para 3(xi)) mandated by the provisions of section 197 read with
Schedule V to the Companies Act, 2013?
- If not, state the amount involved and steps taken by the
company for securing refund of the same;
Nidhi Company - whether the Nidhi Company has complied with the Net
(Para 3(xii)) Owned Funds to Deposits in the ratio of 1:20 to meet out
the liability and
- whether the Nidhi Company is maintaining ten per cent
unencumbered term deposits as specified in the Nidhi
Rules, 2014 to meet out the liability;
Related parties - whether all transactions with the related parties are in
transactions compliance with sections 177 and 188 of Companies Act,
(Para 3(xiii) 2013
- whether the details have been disclosed in the Financial
Statements etc., as required by the applicable
accounting standards;
Preferential - whether the company has made any preferential

allotment allotment or private placement of shares or fully or
(Para 3(xiv)) partly convertible debentures during the year under
review and
- if yes, as to whether the requirement of section 42 of
the
Companies Act, 2013 have been complied with and the
amount raised have been used for the purposes for which
the
funds were raised.
- In case of non-compliance, provide the details in respect
of the amount involved and nature of non-compliance;
Non-Cash - whether the company has entered into any non-cash

Transactions transactions with directors or persons connected with
(Para 3(xv)) him
- and if so, whether the provisions of section 192 of
Companies Act, 2013 have been complied with;
RBI Registration - whether the company is required to be registered under

(Para 3(xvi)) section 45-IA of the Reserve Bank of India Act, 1934
- and if so, whether the registration has been obtained.
7.4 Miscellaneous Audit
Introduction: - A financial statement audit is the examination of an entity’s financial

statements which consists of Balance Sheet, Profit & Loss Account, Cash Flow
Statement, Notes to account and accompanying disclosures. The purpose of a financial
statement audit is to add credibility to the reported financial position and performance
of a business.
Audit Framework
While performing the audit of financial items, an auditor has to go through certain
sort of framework which is as under:-
A) Ledger Account: - While doing the audit of the ledger account there should
be clarity as what items should come under particular ledger account.
➢ In case of Balance Sheet Items:-
• Check the opening balances with the last year audited closing
balances.
• Check whether there are any additions and deletions during the year.
➢ In case of profit and loss items:-
• Check the transactions occurring during the period
B) Test of Details: - Under test of details certain Audit assertions needs to be

verified which are as follows.
1. Existence /occurrence:
a. Existence is to confirm that the assets were in existence on the

date of balance sheet by physical inspection, comparison of assets
registers with general ledger balances.
b. Occurrence is the assertion for all P&L items and additions &
deletions to ascertain whether the transactions during the period
have actually taken place {Risk addressed: Fictitious entries}.
c. Auditor shall ascertain that all the assets and liabilities are actually
in existence as on Balance Sheet date.
d. All the transactions for the period so recorded have actually
occurred.
2. Accuracy: The basis for invoice preparation is accurate and also the
amount of invoice is accurately recorded in the books. {Risk addressed:
Error of Commission}
3. Completeness: In transactions, all related costs/items have been

considered. Similarly, all the transactions have been correctly and
completely recorded { Risk addressed : Error of omission}
4. Valuation/ Measurement: The values at which assets/liabilities are
carried in the books on balance sheet date are appropriate i.e. neither
overvalued not undervalued. {Risk addressed: Risk of over/under
valuation of balance sheet items.}
5. Rights and obligation:
a. To ascertain that all the assets as on balance sheet are the rights
of the entity. Similarly, all liabilities are the obligations of the
entity.
b. Further, there might be certain obligations attached to rights of
the company, which requires suitable disclosure in the financial
statements. Ex: Fixed assets offered on charge in connection with
secured loan raised. {Risk addressed : Not being the original
owner, claiming to be the owner of any asset/ liability}
6. Cut off:
a. This assertion is relevant for all P&L items and additions & deletions
to assets and liabilities.
b. All the transactions in which risk and reward in the property got
transferred to or from the entity during the period, for which
financial statements are prepared, shall be accounted in the
relevant account period. {Risk Addressed : Violation of periodicity
concept of accountancy}
7. Presentation and disclosure:
a. Transactions should be recorded in appropriate accounts.

b. Correct accounts should be debited and credited.
c. Applicable accounting standard and regulatory requirements shall

be borne in mind while recording transactions.
d. Suitable disclosures shall be made if required.
{Risk addressed: Presentation and disclosure not in accordance

with applicable financial reporting framework.}
C) Test of controls: - These are the process designed, implemented and
maintained to provide reasonable assurance about the achievement of the
entity’s objectives with regard to:-
o The reliability of the entity’s financial reporting;
o The effectiveness and efficiency of its operations;
o Its compliance with applicable laws and regulations; and

o Safeguarding of assets, and compliance with applicable laws and
regulations.
D) Analytical procedures: -
• Analytical procedures” means evaluations of financial information

through analysis of plausible relationships among both financial and
non-financial data.
• These can help auditor to identify inconsistencies in financial
statements.
BALANCE SHEET ITEMS

Audit of Share Capital
Every company’s lifecycle starts with raising of capital. The receipt of applications for
shares and allotment of shares are two important aspects of every issue of capital as
these constitute the legal basis of the transactions related to purchase of shares.
Therefore, an auditor should be careful while doing the verification process.
Audit procedures while auditing share capital are as follows: -

A) Ledger A/c:-
➢ Tally the opening balance of share capitals to the previous year audited
➢ Check the additions and deletions to share capital through fresh issue or
bonus issue and reduction in the share capital.
B) Test of Compliance with laws & regulations

➢ Check the provisions of companies Act regarding: -
• Whether the authorized Capital of the company is as per capital

clause of Memorandum of association
• Verify the terms related to fresh issue mentioned in the prospectus

has been complied by the company.
• Check the compliance of

o Section 52- in case of shares issued at premium,
o Section 53 - when the shares are issued at discount,
o Section 54- in case of Sweat equity shares of the Companies Act.
• Examine whether the provisions for forfeiture of shares are followed

by the company.
• In case of Reduction of capital verify whether board resolution has

been passed along with a special resolution passed in the member
meeting. Also verify that the memorandum of association of the
company has been suitably altered.
➢ Check the Registrar of companies (RoC) provisions regarding:-
• Whether form PS 3 & PS 4 is filed with RoC
• Whether FCGPR form is filed with RBI (in case of foreign

shareholders).
➢ Check whether fee for the increase in authorized capital is paid to Registrar
of company.
C) Test of Controls: -
➢ Check whether the compliance officer has followed appropriate procedures
for issuing shares.
➢ Ascertain that there exists an internal check on receipt of amounts along with
the application and that the same throughout has continued to function
satisfactorily.
D) Analytical Procedure: -
➢ Check whether the Stamp duty paid is in accordance to the increase in

authorized capital.
➢ Apply analytical procedures for share premium provisions.
E) Test of Details: - Verify the Following assertions:-
Assertions Audit Procedures
Existence • Check the forms filed with Roc, Memorandum of company

and bank statements in order to verify the existence of
share capital.
Occurrence • Check the register of members for allotment of shares.
• Check the prospectus, bank statements, various forms etc.
Accuracy • Extract balances of shareholder’s account contained in the

share register and tally their total with the balance in the
share capital.
Completeness • Check whether all the aspects related to shares issues have
been properly accounted.
Valuation • Obtain a written confirmation from company secretary that

there were no changes to entity’s capital structure during
the year.
• In case there is change, obtain the certified copies of

relevant resolution passed at the board meeting.
• Verify whether the paid-up capital as at the period- end is

within the limits of authorized capital.
Rights & • Verify the board resolution for allotment.

Obligation
• Verify the share certificates and resisters of members.
Presentation & • Ensure where the following disclosure as per schedule III of
Disclosure the companies Act, 2013 are made:-
➢ Whether Authorized capital, Issued and subscribed
capital and unpaid capital are separately shown.
➢ Whether the unpaid capital it should be shown as Calls

in arrears.
➢ Whether Shares issued in consideration other than cash
are separately disclosed.
➢ Disclosure for shares held in company by the following
entities:
• Holding company
• Ultimate holding company
• Subsidiaries of the holding company
• Associates of the holding company
• Subsidiaries of the ultimate holding company
• Associates of the ultimate holding company

➢ Details of each shareholder (name, no of Shares & %)
with more than 5% stake.
Above disclosure should have been made for a period of five

years immediately preceding the balance sheet date.
Audit of Reserves and Surplus

Reserves are the amount appropriated out of the profits that are not intended to meet
any liability, contingency, commitment or diminution in the value of asset known to
exist as at the date of the balance sheet.
Provision is an amount that you put in aside in your accounts to cover a future liability.
It is created as a charge against the profit which means it is created irrespective of
the sufficiency of the profit. Ex: - Provision for tax, Provision for doubtful debts etc.
Revenue reserve represents profits that are available for distribution to shareholders
as dividends.
Capital Reserve represents a reserve which does not include any amount regarded as
free for distribution through the statement of profit and loss.
Share premium: - When a company has issued its shares at amount in excess of the
nominal value of shares it is called shares issued at premium. The company has to
transfer the amount received through premium to security premium account. The
company can use this amount only for the purpose specified in section 52 of the
Companies Act 2013.
Capital Redemption Reserve (CRR)
The audit procedures generally accepted to be undertaken while auditing reserve and
surplus are as follows: -
A) Ledger A/c:-
➢ Tally the opening balance of reserves and surplus to the previous year audited
➢ Check for addition/utilization from the current year profit /loss Account and
appropriation account if any.
B) Compliance with laws and regulation:-
➢ Check the minutes of the board of directors and ensure that the profits
are appropriated as per the decision taken by directors.
➢ Verify whether the requirements of articles of association regarding the
appropriation of profit to general or special reserves are duly followed by
the company.
➢ Check whether the management has complied with the required

provisions of Companies Act while utilizing any part of the general reserve
for payment of dividend.
C) Test of Controls:-
➢ Check whether the required entries are duly passed and approved by competent
authority.
➢ Check whether the board approval is taken wherever required.
D) Substantive analytical procedures: - Substantive analytical procedures are

applicable in case of only Capital redemption reserve. (CRR).
➢ Check whether CRR is created only under following situations:-
a) In case of redemption of preference shares the nominal value of

the shares to be redeemed is put to capital redemption fund.
b) When a company buys its own shares.
c) In case of fresh issue of equity or preference share in order to

redeem the old preference share, the difference between the face
value of preference shares and fresh shares issued will be
transferred to CRR.
➢ Verify that this fund is utilized only for issuing fully paid bonus shares.
No dividend is distributed out of this fund.
➢ Check the calculation for the amount of CRR.
E) Test of Details: The following assertions needs to be verified
Assertions Audit procedures
Occurrence • Check whether any additions/ utilization to /from

the reserve and surplus have actually occurred.
Completeness • Verify that the reserve and surplus balances that

were supposed to be recorded have been recognized
in the financial statements.
Valuation • Check whether the provisions regarding dividend

declaration and share premium have been complied.
Presentation and • Ensure the disclosure requirements under part I of

Disclosure Schedule III to the companies act has been made
regarding:-
➢ Opening balances, additions, Deduction & closing
balances of the reserves and surplus.
➢ Reserve and Surplus shall be classified as:

a) Capital Reserves;
b) Capital Redemption Reserve;
c) Securities Premium Reserve;

d) Debenture Redemption Reserve;
e) Revaluation Reserve;
f) Share Options Outstanding Account;
g) Other Reserves – (specify the nature, amount and

purpose of each reserve)
h) Surplus i.e. balance in Statement of Profit and
Loss disclosing allocations and appropriations
such as dividend, bonus shares and transfer
to/from reserves etc. (Additions and deductions
since last balance sheet to be shown under each
of the specified heads)
Audit for Loans and Long-term Borrowings

Liabilities are the financial obligations of an enterprise other than owner’s fund.
Liabilities include loans/ borrowings, trade payables and other current liabilities.
Verification of the loans and borrowings will be done as follows: -

A) Ledger A/c:-
➢ Check the opening balance with the previous year’s audited closing
balances.
➢ Check any addition or deletion to Loan (i.e. any loan taken or repaid)
B) Test of Compliance: - Under test of compliance verify the following:-

➢ Whether the company is authorized to raise the loans as per its
Memorandum.
➢ Whether the board approval is there by passing the board resolution

for loan. (check the minutes of board meeting)
➢ Wherever necessary the member’s approval is taken in the general
meeting.
➢ There is compliance of section 180, section 185 and 186 of the

Companies Act on the borrowings of company.
➢ In case of foreign currency loan whether compliance with RBI
requirement is there.
➢ Check whether the loan documents are signed by competent
authority.
➢ Check whether there is proper utilization of loan. Short term
borrowings can’t be used for long term borrowings.
D) Substantive analytical procedures: -

➢ Check the computation of interest on loan by using substantive
procedures.
➢ Examine relevant records and documentation supporting the validity

and accuracy of loans.
E) Test of Details: -Verify the following Assertions: -
Verify existence o Confirm loans and borrowings outstanding and interest payable
occurrence and on them by obtaining direct confirmation from the lender.
Accuracy
o Examine the loan agreement for rate of interest and other
terms of loan. Verify that borrowing limits imposed by
agreements are not exceeded.
o Examine reconciliation of the books balances with statement

of lenders.
o Agree details of lease and hire purchase creditors recorded to
underlying agreement.
o Check the arithmetic correctness of the loan amount.
Completeness o Verify that the total amount of loan amount has been reflected
in the financial statements.
o Obtain a schedule of short term and long-term borrowing

showing beginning and ending balances and repayments during
the year.
Valuation o Agree loan balance and loan payables to loan agreement.

o Check computation of the amortization of premium or
discount.
o For foreign currency loans, agree the closing exchange rates

used and test the translation calculations.
Rights and o Examine documents evidencing any charge created in respect

Obligation of loans and advances. Specially examine the requirements of
the applicable statue regarding creation and registration of
charges.
o Verify that the secured loans are shown separately. Where
the market value of an asset offered as a security against loan
has fallen below the amount of loan outstanding ensure that
the loan is classified as secured only to the extent of market
value of security. (Details of the securities should be
mentioned).
o Check balances are confirmed by external sources. (SA-505)
Cut off o Check whether the interest payable as on balance sheet is
accounted appropriately.
o Ensure whether the closing balance of the loan is same as

balance confirmation received.
Presentation and o Examine whether the installments of long-term loans falling

Disclosure due within next twelve months have been disclosed in the
balance sheet as a footnote.
o Ensure whether the following disclosures required under

Companies Act under the heading of long-term borrowings have
been complied with: -
▪ Sub –classification as, Non-Current and Current Loan, secured
and unsecured, Rupee loan and Forex loan.
▪ For secured borrowings, nature of security separately

disclosed.
▪ Where loans are guaranteed by directors or others are
separately disclosed.
▪ For default in repayment of borrowing or interest on the

balance sheet date following disclosure should be made: -
- Period of default
-Amount of default
Audit of Trade Receivables/Sundry Debtors

Trade receivables are an essential part of any organization’s balance sheet. These are
monies which are owned to an organization by a customer. Ex: - sales made on credit.
In order to check the authenticity for receivables following procedures should be
performed by Auditor: -
A) Ledger A/c: -
o Check the opening balance with the previous period’s audited closing
balances.
o Check additions & deletions – Credit sales, Amount recovered & Bad
Debts.
B) Test of Controls: -
o Check whether there are controls in place to ensure that invoices cannot
be recorded more than once.
o Ensure that all the invoices are accounted and approved by the
authorized person.
C) Substantive Analytical Procedures: -
Auditor should make comparison of:

o Current year ageing schedule with that of the previous year.
o Significant ratio and trends pertaining to debtors.
o Budgeted figures with actual figures.

o Closing balances of current year with those of previous year.
o Other ratios and analytical procedures relevant and applicable to the
enterprise.
D) Test of Details: Verify the following Assertions: -
Existence • Check Invoices, Bank Statements & obtain Balance

Confirmation to ensure that the trade receivable
exists.
• Follow up all the balance disagreements and non –

replies to the receivables’ confirmation.
Occurrence • Obtain a schedule of debtors duly signed by

responsible officer and examine it with reference to
individual debtors account.
• Inspect underlying documents (such as invoice, credit

memos etc.).
Accuracy • Ensure whether the balances shown in the ledger

accounts are consistent with balances as per control
accounts.
Completeness • Ensure all sales, cash receipts and sales adjustment
transactions occurred during the period have been
recorded.
• Ensure accounts receivables includes all claims on

customers at the balance sheet date.
Valuation • Assess the allowance for doubtful accounts. Review

the process followed by the company to derive an
allowance for doubtful debts.
• Scrutinize and identity those debts which appear

doubtful, discuss with management their reasons if any
of these debts are not included in the provision for bad
debts.
• Assess bad debt write-offs.
• Prepare schedule of movements on bad debts,

provision accounts and debts written off and compare
the proportion of bad debt expense to sales for the
current year in comparison to prior years.
Rights and • Check through balance confirmation whether the

Obligation amount is receivable to the company.
• Debtor as a charge for working capital loan should be

disclosed.
Cut Off • Verify the year-end transactions and balances to

ensure whether the cut –off procedures are
appropriately followed.
Presentation and • Check that the restatement of foreign currency trade

Disclosure receivables has been done properly.
• Verify that the split between more than 6 months and

less than 6 months has been done from the due date
instead of sales invoice date.
• Check that the classification of the amount due is

properly disclosed as: -
o Secured
o Unsecured
o Doubtful
• Verify that proper disclosure has made for the amounts
due from
o Directors
o Other officers of the company

o By firms
o By private companies in which any director is a

partner or director or member.
• Ensure all the transactions with related parties are

properly reported in CARO.
Audit of Cash & Cash Equivalents

Cash and Cash equivalent in the form of cash in hand, balances held with bank in current
accounts/margin money accounts, fixed deposits, cheques in hand etc. represent the
most liquid asset of an enterprise. Utmost professional skepticism needs to be exercised
while auditing such balances.
Audit procedures for verification of cash & cash equivalents are as follows: -
A) Ledger A/c: -
➢ Check the opening balance with the previous period’s audited closing
balances.
➢ Check the inflows and outflows of cash during the year.
B) Test of Compliance: - Check whether cash payments are under the limit
of income tax act.
➢ Check whether Cash is handled by responsible officer.

➢ Ensure that cashier should not make entries in the books of accounts.
➢ Carry out surprise verification of cash during the year particularly

when the entity is consistently maintaining unduly large cash balance.
D) Test of Details: -
Existence • Carry out a physical verification of cash in hand at the

end of the year
• Carry out surprise checks anytime during the year.
• Examine all items of Cash Balance like Main cash balance,

petty cash balance, imprest cash with employees etc.,
simultaneously.
Occurrence • Examine the Cash Vouchers and Cash Book.
• Examine all the other supporting documents such as cash

receipts.
Accuracy Verify mathematical accuracy of recorded cash balance:-
• Trace total to the general ledger and to year end bank

reconciliations prepared by the client.
• Test cash on hand as necessary.
Completeness • Obtain and review or prepare year-end bank

reconciliation.
• Obtain a bank cut-off statement directly from the bank

to ascertain whether the items on the year –end
reconciliation have cleared from the bank and therefore
were valid.
Valuation • The auditor should ensure that all bank account holding
foreign currency have been restated at the closing
exchange rates.
Rights and • Verify ownership of cash by carrying out simultaneous

Obligation physical verification of cash at multiple locations to
prevent fraudulent entry for cash.
Cut off • Check whether the inflows and outflows are accounted in
the relevant accounting period.
Presentation • Ensure disclosure of cash in the financial statements as

& Disclosure per recognized practices and relevant statutory
requirements.
• Ensure that temporary advances given are not classified

under Cash balances.
• If postage and revenue stamps exists in a substantial

manner towards the year end, they should be shown
separately and not included in the Cash in Hand.
A cash certificate should be prepared on the verification date, which should be
signed both by the auditor and cashier, each retain a copy of the same.
Audit of Bank Balances

Following Audit Procedures are required to verify the bank balances: -
• Check the opening balance with the previous year audited financial statements
and the deposits and withdrawals during the year
• Check whether the provisions of Negotiable Instruments Act regulation and RBI
regulations wherever required are duly complied.
Verify ➢ Compare the entries in the ledger of the client with entries
Existence, in cash book/bank statement.
Occurrence,
Completeness, ➢ Examine fixed deposit receipts and bank advises for
accuracy and verification of fixed deposits made.
valuation.
➢ Cash in transit should be verified with reference to their
subsequent credit in bank account.
➢ In case of stale cheques, the auditor should ensure suitable
adjustments have been made in books of account.
➢ Examine the bank reconciliation statement to ascertain the

differences.
➢ Verify the total number of bank accounts maintained by the
entity. New account opening requires Board resolutions.
Hence verify the same.
➢ Obtain balance confirmation from the banker.
➢ In case of foreign currency account conversions rates should

be checked.
Presentation and Disclosures for Cash and Cash Equivalents: -
Ensure whether the following disclosures as required under Ind AS compliant Schedule
III to Companies Act, 2013 have been made: -
i) Cash and Cash equivalents shall be classified as:
a. Balance with banks;

b. Cheques, drafts on hand;
c. Cash on hand;
d. Others (specify nature)
ii) Earmarked balances with banks (for example, for unpaid dividend) shall be
separately stated.
iii) Balances with banks to the extent held as margin money or security against
the borrowings, guarantees, other commitments shall be disclosed
separately.
iv) Repatriation restrictions, if any, in respect of cash and bank balances shall
be separately stated.
v) Bank deposits with more than 12 months maturity shall be disclosed

separately.
Audit of Inventories
Inventories are the tangible property held for -
➢ Sale in the ordinary course of business or

➢ in the process of production for such sale or
➢ For consumption in the production of goods or services for sale.
Verification for inventories will be done as follows: -

A) Ledger Account: -
• Check the opening balance of inventory with the previous year’s audited
closing balance.
• Check for the purchases and issue of inventory during the year through
stock registers.
B) Test of Compliance: -
Check for the compliance of AS-2 (valuation of inventories) for the following: -
• Recording inventory movement
• Valuation of inventory issued
• Valuation of closing balance. (Cost or Net realizable value whichever is

less).
C) Test of controls: -
• Ensure inventory custody & issues are done by authorized person.
• Verify stores and other material ledgers including purchase, issue and
closing balance.
• Review the instructions for stock take and physically attend the stock
take.
• Ensure whether the stock records are updated by the management on

continuous basis.
D) Analytical procedures: - Conduct analytical procedures for: -
• Quantitative reconciliation of input-output
• Previous year Vs. Current year comparison
• Ratio Analysis
• Comparison with industry standards and budgets.

E) Test o f Details: - Verify the following assertions
Existence • Conduct the physical verification of inventories to

check: -1) Existence of inventory 2) Condition of
inventory.
• Management is responsible for the physical

verification of inventory; auditor has to verify whether
management has conducted the same.
• Ensure the method of physical verification is fool

proof.
• Ensure the physical verification sheets are signed by

both management and auditor.
• Pick samples randomly to ensure all items and aspects

for verification are covered.
• Ensure outside party stocks are not included in the

company’s inventory list.
• Physical verification should be done at the end of the

financial year.
Occurrence • Check Delivery challans and gate passes, and goods
received notes, bin card details etc. to check whether
transaction has actually been occurred.
Accuracy • Verify the clerical and arithmetical accuracy of

inventory listings.
• Reconcile physical counts with general ledger control

total.
Completeness • Examine non- financial information related to

inventory, such as weights and measures.
• With respect to tagged inventory, perform tests for

omitted transactions and test for invalid transactions.
Valuation • Examine the method adopted by the management for

inventory valuation(FIFO, LIFO or weighted average
system)
• Ensure that the valuation of inventory is as per AS-2 and

the condition of inventory is recognized in their
valuation.
Rights & • Vouch recorded purchases to underlying

obligation documentation. (purchase requisition, purchase order,
vendor invoice
• Evaluate the consigned goods. Examine client

correspondence, sales and receivables records,
purchase documents.
• Review consignment agreements.
• Examine invoices for evidence of ownership
• Obtain a declaration from the third party duly signed

by the authorized personnel in case inventory is held by
third party confirming that the inventory belongs to the
entity and is held by the third party on behalf of the
entity.
Cut Off • Check invoices, gate passes, delivery challahs,

GRN’s etc.
• Perform purchase and sale cut- off tests. Trace

shipping documents (bill of lading and receiving
reports, inventory records) to inventory records
immediately before and after year-end.
Presentation and • Ensure whether the following disclosures as required

Disclosure under In AS compliant Schedule III to companies Act,
2013 have been made: -
• Whether mode of valuation has been stated

separately for each class of inventory.
• Whether inventory has been classified as-
• Raw materials
• Work-in –progress
• Finished goods
• Stock in trade
• Stores and spares
• Loose tools
• Others (specify nature)
• Whether goods in transit have been disclosed

separately under each sub-head of inventory
Audit of Fixed Assets

Fixed assets may be defined as an asset
➢ which is held with the intention that it will be used for the production or
provisions of goods and services and
➢ not for sale in the normal course of business and

➢ Such use shall have the potential to give future economic benefits to the
enterprise.
Fixed asset can be further classified as Tangible Fixed Assets and Intangible
Fixed Assets.
Fixed Assets Tangible includes Land, Building, Plant & Equipment, Furniture &
Fixture, Vehicles, Office Equipment, and Computers etc.
For the audit of Tangible Fixed Asset, we need to understand the difference
between Revenue Expenditure and Capital Expenditure.
Revenue Expenditure: -
An expenditure, the benefits of which shall be exhausted in the process of
earning revenue within a short span of time , maximum period being one year
are classified under Revenue Expenditure. Revenue expenditure are charged
to P/L Account Example: - Cost of raw material and stores consumed in the
process of manufacture/ production, Rent, rates and taxes, Power and Fuel,
Repairs, maintenance and renewals of fixed Assets, Legal and professional
charges etc.
Capital Expenditure: - An expenditure incurred for the following purpose will be

classified under capital expenditure: -
➢ Acquiring fixed assets, which are held not for resale but for the use within the
business, whose benefits will last for multiple of accounting period.
➢ Making additions / enhancements to the existing fixed assets with the intent to
increase earning capacity of the business.
➢ Minimizing the cost of production.
All such expenditures are added to the cost of assets.
Expenses which are essentially of revenue nature, if incurred for creating an

asset or adding to its value for increasing productivity are also regarded as of
Capital Nature.
Audit Procedures required to be undertaken while auditing tangible fixed assets
are as follows: -
➢ Check the opening balances of fixed assets with the previous year’s
audited closing balances.
➢ Check any addition & deletion in the fixed assets account through the
fixed asset register.
➢ Check whether all the accounting standard related to fixed assets have
been complied.
➢ Verify whether the board approvals have been obtained for purchase
of assets.
➢ Check Board & Members resolution for major sale as per companies
Act.
C) Test of Control: -
➢ Check whether the purchase of fixed asset is made by the authorized
person on behalf of the entity.
➢ Physical verification is done regularly
D) Substantive Analytical Procedures: -
Apply Substantive analytical procedures for depreciation (SA520)

E) Test of Details
Existence • Conduct physical verification of fixed assets.

Management is responsible for the physical verification
of fixed assets; auditor has to verify whether
management has conducted the same.
• Review client’s plan for performing physical

verification, whether done by own staff or third party
and the interval for verification.
• Verify the discrepancies noted based on physical

verification and manner in which such discrepancies are
dealt.
Occurrence • In order to ensure that the fixed asset exists vouch all the
supporting documents related to fixed assets such as,
vendor invoices, purchase agreements, Sale deeds, RCs
etc.
Accuracy • Verify the movement in the fixed assets schedule

complied by the management i.e. Opening+ Additions-
Deletions= closing and tally the closing balance to the
entity’s book of account.
Completeness • Ensure that all the incidental costs to acquisition of the

assets are capitalized along with the asset.
Valuation • Ensure that the valuation of the fixed assets is done in line
with the applicable accounting standards.
• In order to arrive at the closing balance of assets, the
provision for depreciation has followed (whether SLM or
WDV).
• Verify whether any asset damaged is written off.
Rights and • Verify that all purchase invoices are in the name of the
obligation entity that entitles legal title to the ownership to the
respective entity.
• Obtain copies of conveyance deed/ sale deed for all the

additions to land and building to ensure that the entity is
the legal and valid owner.
• Ensure that the title deed is in the custody of owners.
• In case of mortgage obtain a certificate from mortgagee

or his lawyer confirming the possession of the title deed.
• Also verify the register of charges, available with the

entity to assess the fixed assets that has been given as
security to any third parties.
Cut off • Check whether the transaction occurred during the period
has been recorded in the current accounting period.
Presentation • Ensure whether the following disclosures as required

and disclosure under Ind AS compliant Schedule III to companies Act,2013
have been made:
• Whether all items of property, plant and equipment

have been classified as
- Land
- Buildings
- Plant and Equipment

- Furniture and fixtures
- Vehicles
- Office equipment
- Other (Specify nature)
• Whether the entity has disclosed asset “under lease”
both whether operating and finance lease separately
under each class of asset.
• For each class of property whether the entity has

disclosed a reconciliation of the gross and net carrying
amounts at the beginning and end of the reporting
period showing separately: -
- Opening balance of gross carrying amount

- Additions
- Acquisitions through business combinations

- Disposals
- Disposals through demergers

- Other adjustments (Borrowing cost capitalized)
- Closing balance of gross carrying amount.
• For each class of property, plant and equipment,

whether the entity has disclosed:
- Opening accumulated depreciation
- Charge for the year

- Deduction/other adjustments for depreciation
- Closing accumulated depreciation
• For each class of property, plant and equipment,

whether the entity has disclosed:
- Opening accumulated impairment losses
- Impairment losses
- Impairment reversals
- Closing accumulated impairment losses.
Fixed Assets- Intangible Assets Comprising Goodwill Licenses, patents Brand/

Trademark, Computer Software etc.
Meaning: - Intangible assets are those assets: -
➢ Which do not have a physical identity but are used by the enterprise for
production or supply of goods or for retails to other or for the purpose of
administration.
➢ Such assets do not have physical existence but their presence in the business is
pointed out with a value placed there on.
➢ These assets include the rights and benefits to the owners subject to their utility.
For Ex: patent, copyright, trademark etc.
Goodwill internally generated is not recognized as an asset and not covered under
AS 26.
Audit Procedures for the verification of Intangible Fixed asset are as follows: -
➢ Check the opening balances of intangible fixed assets with the previous year’s
audited closing balance.
➢ Additions to intangible through internally generated or through amalgamations

should be checked.
➢ Check whether principles of AS 26 are complied with which says that purchase
of intangible asset should include stamp duty, legal charges etc. to arrive at the
cost of intangible.
➢ Check whether the internally generated intangible asset meets the criteria of
recognition. In case of: -
o Research phase: - No intangible asset arising from research shall be
recognized. Expenditure on research shall be recognized as an expense and
charge off.
o Development phase- Expenditure incurred during this phase should be
capitalized if product is successful commercially otherwise it should be
charge off if conditions of AS -26 are not fulfilled.
➢ See whether board approval has been taken for the purchase of intangible
assets.
C) Test of control: -
➢ Check whether authorized personnel has approved and executed purchase and
sale of intangibles.
➢ Verify if proper internal processes and procedures like inviting competitive
quotations were followed prior to finalizing the vendor.
D) Substantive Analytical procedures: -

➢ Check whether the entity has charged the amortization on all intangibles.
➢ Verify that the amortization method used reflects the pattern in which the asset’s
future economic benefits are expected to be consumed by the entity.
➢ Also verify that the management has undertaken an impairment assessment to
determine whether an intangible asset is impaired.
E) Test of details: - Verify the following assertions in relation to intangibles: -
Existence • Verify documents related to asset.
• Obtain confirmation letters from client’s legal adviser as

to the validity and existence of intangibles asset. (SA 620
work of an expert)
• Check the documents related to purchase of asset, bank

statements, and board approvals.
Occurrence
• If the assets have been transferred ensure whether the
rights have been transferred related to assets.
• Ensure that all the components related to the cost of

assets are taken into consideration for arithmetic
Accuracy accuracy
• Obtain list for all additions during the period under audit.
And for all material additions verify if such expenditure
meets recognition criteria.
• Verify the movement in the intangible assets schedule

complied by the management i.e. Opening+ Additions-
Deletions= closing and tally the closing balance to the
entity’s book of account.
Completeness • Assess whether for an internally generated intangible

asset meets the criteria for recognition, an entity
classifies the generation of assets into: -
➢ Research phase.
➢ Development Phase
• Verify that Amortization principle as per AS 26 has been

complied
Valuation
• Check that Impairment provisions has been followed as
per AS 28
• Ensure whether the following disclosure as required under

Ind AS compliant Schedule III to Companies Act, 2013 have
Rights and been made: -
obligation
➢ For Goodwill whether the entity has disclosed a
reconciliation of the gross and net carrying amounts at
the beginning and end of the reporting period showing
separately: -
• Opening balance of gross carrying amount
• Additions
• Disposals
• Impairments
• Other adjustments
➢ Whether all items of intangible assets have been
classified as:
• Brands/ Trademarks
• Computer Software
• Mining rights
• Copy rights and patents and other intellectual

property rights,
• Licenses and franchise
• Of Other (specify nature)

➢ For each class of intangibles, whether the entity has
disclosed a reconciliation of the gross and net carrying
amounts at the beginning and end of the reporting
period showing separately:-
• Opening balance of gross carrying amount
• Additions
• Acquisitions through business combinations
• Disposals
• Disposals through demergers
• Other adjustments
• Borrowing cost capitalized
• Closing balance of gross carrying amount.

disclosed: -
• Opening accumulated amortization
• Charge for the year
• Deduction/ other adjustments for amortization
• Closing accumulated amortization

disclosed: -
• Opening accumulated impairment losses
• Impairment losses
• Impairment reversals
• Closing accumulated impairment losses
The auditor must verify requirements required by CARO in respect of Fixed Assets.
Audit of Trade Payables and Other Current Liabilities
Liabilities in addition to borrowing include trade payables and other current liabilities.
Trade payables are the liabilities owned to suppliers for purchases or services rendered.
Verification of liabilities is important to ensure whether any liability is not understated
or overstated.
Audit Procedures for the verification of trade payables are as follows: -
➢ Check the opening balances of Trade payables with the previous year’s audited
closing balances.
➢ Check the expenses incurred and payment made during the year.
➢ Check whether all the requirements under Micro, Small and Medium Enterprises
Development Act, 2006 (MSME) has been complied regarding the payments
made to such parties having MSME registration.
C) Test of Control: -
➢ Check whether the management has adequate internal control regarding
recording of purchases, invoices are not recorded twice, purchases are for
business purpose only.
➢ Ensure whether the payments are approved by the authorized person.

➢ Test checks few bills for payments made during the period.
➢ Related party transactions to be verified carefully as risk of fraud are more.

D) Substantive Analytical Procedures: - Apply substantive procedures to calculate:
-
➢ Creditor Turnover Ratio

➢ Creditor to credit purchases
➢ Average payment period
Also obtain the list of vendors with whom company has disputes and any claims
from customers, under litigation and compare with previous year.
E) Test of details.
Assertion Audit Procedures
• Obtain Balance confirmation from Creditor.

Existence • Vouch Subsequent payments to the creditors.
• Inspect documents underlying purchases such as invoices receiving

reports purchase order etc. and verify individual creditor’s
Occurrence accounts balance against these documents.
• Check the invoices raised by the vendors to the company.
• Ensure there is no duplicate invoice.
Accuracy • Verify that the total of the creditor’s balance in the schedule
agrees with the balances of the total account relating to the
bought ledger in the general ledger.
Completeness • Verify whether all the transactions related to purchase & services
received are accounted and there is no unrecorded liability.
• Verify whether all the statutory dues are properly recorded in

books of accounts.
Valuation • Assess the old outstanding liability balances-Review the process

followed by the company to identity any creditors/ liability needs
to be written back.
• Match ledger balances with direct balance confirmations from the

creditor and ensure that both are reconciled.
• Perform subsequent period bank statement verification if there

are no replies from the creditors for balance confirmation.
• Check that the restatement of foreign currency trade payables

has been done properly.
Rights and • Check the direct confirmation obtained by the creditors.

obligation
Cut off • Verify the balance confirmations obtained, BRS, Reconciliation for
difference in balances to confirm that transaction occurred during
the periods are recorded in the current period.
Presentation & • Ensure whether the following disclosures as required under Ind AS
Disclosure compliant Schedule III to Companies Act, 2013 have been made:
• Whether the Company has classified a payable as a trade

payable if it is in respect of the amount due on account of
goods sold or services rendered in the normal course of
business.
• Whether the Company has disclosed the following details
relating to micro enterprises and small enterprises in the
notes:
o The principal amount and the interest due thereon (to
be shown separately) remaining unpaid to any supplier
at the end of each accounting year.
o The amount of interest paid by the buyer in terms of
section 16 of the Micro, Small and Medium Enterprises
Development Act, 2006, along with the amount of the
payment made to the supplier beyond the appointed day
during each accounting year.
o The amount of interest due and payable for the
period of delay in making payment (which have been
paid but beyond the appointed day during the year) but
without adding the interest specified under the Micro,
Small and Medium Enterprises Development Act, 2006.
o The amount of interest accrued and remaining unpaid
at the end of each accounting year.
o The amount of further interest remaining due and

payable even in the succeeding years, until such date
when the interest dues above are actually paid to the
small enterprise, for the purpose of disallowance of a
deductible expenditure under section 23 of the Micro,
Small and Medium Enterprises Development Act, 2006.
• Whether the amount disclosed under other current liabilities

are classified as below:
o Revenue received in advance

o Other advances (specify nature)
o Other current liabilities (specify nature)
Audit of Loans and Advances, Other Current Assets.
Loans means money advanced to related or other parties with or without interest while
advances include amounts recoverable either in cash or in kind or for value to be
received accrued interest, e.g., rates, taxes and insurance paid in advance/ prepaid.
Other current assets primarily include accrued interest on loans/ fixed deposits held,
balances with statutory/ governments etc.
A) Ledger A/c: -
➢ Check the opening balances of Loans & advances, with the previous year’s
audited closing balance.
➢ Check the additions and deletions in the loans & advances and current assets.
➢ Check whether any loans or advances granted is as per the Memorandum and
Articles of Association.
➢ Inspect the minutes of meeting of board of directors to confirm if all material

loans and advances were approved by board of directors.
➢ In case of related party loans and advances check the whether they are
properly authorized, and the value of such transactions were reasonable. And
whether provisions of companies act, and disclosure requirements of
accounting standard are complied.
➢ Check whether loans given are approved by the authorized person.
➢ Ensure that the securities against loans are periodically reviewed.

➢ All the documents related to loans and advances are in safe custody.
D) Substantive Analytical Procedures: -

➢ If there are interest on loans carry out substantive audit procedures.
➢ Obtain the list of loans and advances under litigation and compare with
previous period.
➢ Scrutinize and analyze those loans and advances that appear doubtful and
discuss the reasons with management for the same.
E) Test of Details: -
Assertion Audit Procedures
Existence • For establishing existence of loans and advances,

account receivables obtain direct confirmation from the
parties who receive that loan.
Occurrence • Verify the bank statements, loan agreement, and letter

from statutory authority from deposits made.
Accuracy • Obtain list of all advances and other current assets and
compare them with balances in the ledger
Completeness • Check whether all the advances given have actually

been recorded
• Inspect loan agreements and acknowledgements of

parties in respect of outstanding loans.
Valuation • Assess the allowance for doubtful accounts. Review the

process followed by the company to identity doubtful
accounts needs to be written off.
• Obtain ageing report of loans and advances, split

between current, less than 30 days old, 30-60 days
old, 60 -180 days old, 180 -365 days old and more
than 365 days old
• Check that the restatement of foreign currency loans

and advances has been done properly
Rights and obligation • Check that in the loan deed the name of the company
exists.
• In case of deposits with statutory authorities, name of

the company should be existing.
Cut off • Verify the balance confirmations obtained, BRS,

Reconciliation for difference in balances to confirm that
transaction occurred during the periods are recorded in
the current period.

Disclosure under Ind AS compliant Schedule III to companies
Act,2013 have been made:
▪ Whether loans have been classified as: -
- Security deposits
- Loans to related parties (give details)

- Other loans (specify nature)
▪ Whether all the above loans have been further sub –

classified as: -
- Secured
- Unsecured
- Doubtful
▪ Whether allowance for bad and doubtful loans has
been disclosed separately for each category of loans.
▪ Check whether separate disclosure is made in case
of loans due from: -
- Director(s) of the company

- Director(s) of the company jointly with other
persons.
- Other Officer(s) of the company.

- Other Officer(s) of the company jointly with
other persons.
- Firm(s) in which director is a partner.

- Private company (ies) in which director is a
director or member.
• Other Current Assets.

▪ Whether other current assets are classified as: -
- Advances other than capital advances which are
further sub –classified as: -
➢ Security Deposits
➢ Advances to related parties (give
details)
➢ Other advances (specify nature)

- Other current assets (specify nature)
▪ For advances, whether separate disclosure has been
made for amounts due by: -
- Director(s) of the company

- Director(s) of the company jointly with other
persons
- Other officer(s) of the company

- Other Officer(s) of the company jointly with
other persons.
- Firm(s) in which director is a partner

- Private company (ies) in which director is a
director or a member.
Audit of Provisions and contingent liabilities

Provision: -
• is a present obligation of the entity arising from the past events,
• the settlement of which is expected to result in an outflow from the entity of

resources embodying economic benefits.
• a reliable estimate can be made of the amount of obligation.
Example: - Provision for litigation, provision for warranties, provision for employee
benefit expenses etc.
Audit Procedures for provisions: -
• Make the best estimate of the provision required using the given information.
For this check: - records, agreements, legal cases etc.
• Use the work of the expert to ensure that provisions are reasonably made. (SA
620). Example Actuary, Lawyer
• Check reversals or additions to provisions and the same are accounted for.
• Ensure the compliance of the applicable accounting standards. Ex AS 29, AS 15.
• Check the legal register to know the legal cases & disputes pending against the
company. And also check & verify BOD minutes to know the updates for the same.
• Check expert opinions and computations.
• Ensure that the presentation & Disclosure as per Schedule III of the companies
Act,2013 have been made: -
- Whether Current/ Non-current provision is split
- Disclosure is made for each class of provision. (Opening balance & Closing
balance)
- Additional provision increased/ decreased this year.
- Brief disclosure to be made for each class of asset, specifying

(Nature of obligation, expected timing of outflow of resources)
- Indication of uncertainties of amount and time of provisions.

- Amount of any expected disbursement.
Contingent Liability
Contingent liabilities refer to: -
• Obligations relating to past transactions or other events or conditions that

may or may not arise in future.
• The possibility of a contingent liability crystal ling into an actual liability thus
depends upon happening/ non happening of an event.
Example: - Pending litigation against the entity, discounted bills receivable, Guarantees
of third-party obligations etc.
Audit Procedures to verify Contingent liabilities are as follows:-
• Obtain a certificate from the client that all known contingent liabilities have
been included and properly disclosed in the financial statements.
• Review the minutes of meeting of board of directors to discover contingency

commitments if any.
• Obtain list of pending legal cases and check the legal status of pending cases
with help of experts.
• Assess the provision made or contingent liability disclosed, is in line with AS

29.
• Whether as per Schedule III of the companies Act,2013 disclosure in the notes
to accounts in the following manner:-
• Whether Contingent Liability have been classified as:-

➢ Claims against the company not acknowledged as debt
➢ Guarantees
➢ Other money for which the company is contingently liable
• Whether the amount of any guarantees given by the entity on behalf of

the directors or other officers of the company has been stated.
PROFIT AND LOSS ACCOUNT ITEMS
Sales
A sales audit is an examination of the entire sales process.
The sales and collection cycle refer to the set of processes that begin when a customer
purchases goods or services and ends when the entity receives complete payment for
purchase.
An auditor needs to obtain a clear understanding about the organization and its revenue
centers to ensure the sales are appropriate. Example: - type of services or products,
major selling product, introduction of new product, sales term, major customers etc.
A) Test of compliance rules & regulation: Check the following:-

➢ Check that the applicable laws & regulations are compiled regarding sale like
GST requirements.
➢ Check whether accounting treatment is as per Accounting Standard-9.
B) Test of controls:-Following steps should be taken by auditor to ensure internal

control:-
➢ Examine the internal control system and ascertain whether it operates
satisfactorily.
➢ Examine whether the sales has been authorized by a responsible officer.

➢ Ensure proper co-ordination between billing and dispatch sections.
➢ Identify possible loopholes in the system whereby cash collected from sales
could be misappropriated.
➢ Authority for granting special discounts should be examined.
➢ Review the related party transactions for their collectability as well as see
whether they are properly authorized.
C) Substantive Analytical Procedures: - Performing substantive audit procedures
is must for verification of sales. This includes:-
➢ Sales trend analysis

➢ Calculate the ratio of sales return to sales and compare it with previous
accounting period.
D) Test of Details: Verify the following assertions: -
Occurrence • Examine copies of sales invoices.
• Check the sales return with sales invoice, challan, credit

note, stock register etc.
• Check transactions recorded are supported with proper

evidence& there is no error of duplication to avoid risk
of fictitious error.
Accuracy • Examine the entry in sales account as well as in

customer’s account to ensure their correct posting.
Completeness • Check whether quantity is appearing in sales register or

not and check reconciliation of total sales as per stock
records and financial records and excise records.
Valuation • In case of sale in foreign currency check whether

conversion is at appropriate rate and also any “exchange
gain/ loss” arising from sales.
• Recalculate prices and extensions on sales invoice.
Rights & obligation • Check whether the sales recorded are actually by the
entity.
• Ensure no fake transactions are recorded.
• Check whether invoices are generated in the letter head

of company.
Cut off • Check the pre -cut off and post cut off transactions to
ensure that revenues are recognized in the current
accounting period and sales were not tampered towards
the period end.
Presentation & • Ensure the following disclosures as per schedule III to

Disclosure companies Act 2013, have been made:-
o Whether disclosure of sales in respect of each class of
goods has been made.
o Whether revenue from operations is disclosed

separately in the notes as revenue arising from:-
• Sale of product( include excise duty)
• Sale of Services
• Other operating revenues

o Whether brokerage and discount on sales, other than
usual trade discount has been disclosed.
o Whether the transactions with related parties are

appropriately disclosed in notes to accounts.
Audit of other Income Comprising interest Income, Dividend Income, and Gain/Loss
on Sale of Investments etc.
Any form of income earned by an entity which is not linked to the entity’s core business
operations is generally classified as other income. Example: - interest on fixed deposits,
interest on loans given to third party etc.
Interest income on fixed deposits is recognized on a time proportion basis taking

into account the amount outstanding and the applicable interest rate.
Interest income from debt instruments is recognized using effective interest rate.
Dividends are recognized only if:-

➢ The entity’s right to receive payment of the dividend is established,
➢ It is probable that the economic benefits associated with the dividend will flow
to the entity and
➢ The amount of the dividend can be measured reliably.
Gain / (loss) on sale of investment in mutual fund is recorded as other income on

transfer of title from the entity.
Audit procedures for verifying other income are as follows:-
A) Test of compliance with loss and regulations:-
➢ Ensure compliance with AS 9 on revenue recognition.

➢ Check the compliance of SEBI Act wherever required.
➢ Verify that any tax deducted at source from income is as per the provisions of
income tax act.
B) Test of controls:-
➢ Whether receipts are collected by appropriate authority

➢ Whether investment documents are held by proper authority
➢ See whether TDS certificates are promptly received and kept in safe custody
C) Substantive Analytical procedure:-
➢ Check computation of accrued interest on cumulative deposits.

➢ Obtain a statement showing interest and dividend income including details such
as:-
• Amount of Investment
• Date of investment
• Rate of interest/dividend
• TDS if any
• Net receipt
D) Test of Details:
Occurrence • Obtain register of investments. See the list of fixed
deposits opened during the year along with the
applicable interest rate.
• Check counterfoils of interest and dividend warrants

along with relevant investments and the dates when
normally due and the period to which they relate.
• Trace net receipts of dividends and interest to the bank

statement.
Accuracy • Verify the arithmetical accuracy of the interest

calculation by multiplying the deposit amount with the
applicable rate and number of days during the period
under audit.
• Obtain a confirmation of interest and dividend income

from the bank and verify that income as per bank
reconciles to the calculation shared by the entity.
• Also obtain a copy of form 26AS and reconcile the

interest reflected therein to the calculation shared by
client.
Completeness and cut • Obtain a direct confirmation from the bank /financial
off institution for deposits still outstanding as at the period
end.
Rights & obligation • Verify that the investments are in the name of the entity.
Presentation & • Ensure the following disclosures as per schedule III to

Disclosure companies Act 2013, have been made:-
o Whether ‘other income’ has been classified as
• Interest income
• Dividend Income
• Other non- operating income (net of expenses

directly attributable to such income)
Audit of Purchase
Purchase is another significant process of entity. Auditor should be very careful while
doing audit for purchase transaction and internal control to ensure that the entity is
not materially misstating its purchases or accounts payable.
Auditor needs to obtain a clear understanding about the organization and its production
centers. Ex type of services or products they procure that are used in production,
sources of procurement, major vendors, credit period, purchase terms etc.
Audit procedures for verifying purchases are as follows:-

A) Test of compliance rules & regulation:-
➢ Check whether entity is complying with the applicable laws relating to

purchases.
➢ Ensure that in case of purchases made from related party board approvals are
taken.
B) Test of controls: -
➢ Examine the internal control system to see that the purchases have been
recorded starting from the purchase order to disbursement stage.
➢ Check that the goods receipt note and purchase invoice is prepared and signed
by authorized personnel.
➢ Check whether quality inspection of goods was done.
➢ Check entries recorded in purchase return book with reference to debit notes
issued and ensure that particulars relating to accounts, suppliers name,
quantities etc. are correct.
C) Substantive analytical Procedures: -
➢ Check any increase in the cost of purchase and locate the reasons there off.
Verify the price charged. It may be agreed price or in line with market price.
➢ Carry out analytical procedures to acquire audit evidence for the reasonableness
of purchase quantity and price. Such as Consumption analysis, Stock composition
analysis, quantitative reconciliation of closing stocks with opening stock,
purchase and consumption.
➢ Compare purchase on quarterly/monthly basis to note unusual fluctuations,
actual purchases with budgeted purchases.
➢ In case of related party purchases perform analytical procedures in relation to
price of goods to confirm that price charged is at arm’s length.
Occurrence • Examine purchases recorded with reference to purchase
invoices and underlying documents such as purchases
requisition notes, inspection reports, goods received
notes, delivery challans etc.
• The invoice should be marked ‘original’
• If the invoices received in duplicate and /or triplicate it

should be verified whether original has been lost or
mislaid and has not been entered elsewhere in the
accounts.
• The invoice should not be already verified ones.
Accuracy • Verify that the supplier’s account has been credited with
the full amount of the invoice and the deductions in the
amount if any
• The amount of the invoice should agree with entry in the

purchase register.
Completeness • Verify and confirm that all the purchase transactions are
actually recorded by taking direct confirmations from the
suppliers.
• All the taxes and cess related to the quantity purchased

should form part of purchase value unless they are
refundable.
Valuation • Check whether the values at which at foreign purchases

are converted is appropriate.
Rights and obligation • Check whether the purchases are made in the name of
the entity.
• The invoice should be addressed to the appropriate

branch/factory in case different branches are operated
by the client.
Cut off procedure • Ensure that purchases pertaining to a specific accounting

period are not mixed up with purchases of the next
accounting period.
• Auditor should examine material inward records for few

days prior to closing date to check that all corresponding
invoices have been duly entered in the purchase book
and none have been omitted.
Presentation and • Ensure the following disclosures as per schedule III to
disclosure companies Act 2013, have been made:-
o Whether purchases of stock –in –trade has been
specifically disclosed
o Whether changes in inventories of finished goods,

stock in trade and work-in-progress has been
specifically disclosed.
o Whether the transactions with related parties are

appropriately disclosed in notes to accounts.
Audit of employee benefits expense

All the expenses incurred by the employer for the benefit of employees are employee
benefit expense. Example salary, bonus, commission, post-employment benefits such
as gratuity, superannuation, leave encashment, provident fund contribution etc.
Auditor should have a clear understanding about the organization and its hiring,
appraisal and retirement process to ensure that such expenditure is appropriate and as
per applicable accounting standards and generally accepted accounting principles.
Audit procedures for verifying employee benefit expense are as follows:-
A) Test of compliance of rules and regulations:-

➢ Check Compliance with AS 15 and other employee benefits laws like:-
• Payment of gratuity Act, 1972
• Employees provident fund Act, 1952
• Payment of bonus Act 1965
B) Test Of controls.
➢ Verify employee benefit computations and payments are made by authorized

persons.
➢ Check whether transactions entered and amounts paid matches with actuary’s
report.
➢ Obtain monthly deposit challans to verify if the month on month liability was
subsequently deposited with the authorities within defined timelines.
➢ Check the monthly expense reasonability, comparison with previous accounting
period.
D) Test of Details
Occurrence • Check the employee records on a sample and verify all

the transactions related to chosen employees:-
o Appointment letter, increment letter, leave

records
o Bank statements
• On a random basis, correlate from payroll to employee

records and vice versa
• Verify whether leave policy and attendance records are

considered before making payments.
• Verify that no expense is recorded in the name of

fictitious employees
Accuracy • Check whether amount recorded as employee benefit

expense matches with actual payments made.
• The auditor should check the quantification of the

gratuity liability. He should ascertain whether the same
had been actuarially determined.
Completeness • Verify that all the details of employees are included in

the payroll.
• To ensure this an auditor may choose sample of

employees and ask the pay roll department to share
their bank details/ identity proofs etc.
Valuation • Verify whether the salary for the first month and
subsequent months was processed as per the agreed
terms.
• For a sample of resigned employees obtain their full and

final computation and verify whether all their dues
including post –retirement benefits like gratuity, leave
encashment have been paid and employee’s
acknowledgement has been obtained.
Rights and obligation • Verify that the appointment letters are issued by the
company.
Cut off procedure • Confirm that liability for last month has been accounted
if salaries are paid in arrears, and as asset is created if
salaries are paid in advance.
• Confirm that the bonus paid or declared, gratuity to be

provided is accounted for the current accounting period.
Presentation and • Ensure whether the following disclosure as required

disclosure under In AS compliant Schedule III to Companies Act,
2013 have been made:
o Whether employee benefit expense has been
classified as:
▪ Salaries and wages

▪ Contributions to provident and other funds
▪ Staff Welfare expenses.
Audit for depreciation and Amortization.

Depreciation represents systematic allocation of the depreciable assets over its
useful life related to tangible fixed assets and amortization is related to intangible
fixed assets.
Depreciation and amortization constitute a significant part of over all expenses and
have direct impact on the profit/loss of entity. Hence auditor needs to verify that such
expenditure is appropriate and accurately calculated.
Auditor needs to consider the following attributes while verifying for depreciation
and amortization expenses: -
• Obtain the understanding of entity’s accounting policy related to depreciation and

amortization and ensure that they are in accordance to applicable accounting
standards (AS10) & GAAP
• Whether depreciation has been calculated after making adjustment of residual

value from cost of assets.
• Obtain a list of all additions and deletions along with their approval from the
authorized person for the same.
• Ensure the parts of each item of property, plant and equipment that are to be
depreciated separately has been properly identified.
• Perform substantive analytical procedures to arrive at the estimated depreciation,

compare with actuals and investigate significant variances
Verify the following assertions: -
Occurrence • Check whether the asset exists through physical

verification.
• Obtain the fixed assets register maintained by the

entity.
Accuracy • Check the arithmetical accuracy of the records, re-

compute or compute and ensure depreciation is correctly
computed and accounted.
Completeness • Check whether depreciation is calculated for all assets

owned.
• Ensure intangibles assets like patents and goodwill have

been properly amortized over the period.
• Ensure all the capital costs have been included to arrive

at the Cost of assets.
Valuation • Ensure depreciation on revalued amount has been

properly accounted from revaluation reserve.
• Ensure the amount of depreciation is correctly calculated

by the entity using SLM or WDV or any other method.
Rights and obligation • Ensure that the assets are in the ownership of company
Cut off procedure • Ensure depreciation is charged on the assets from date
when it is ready to use.

disclosure under Ind – AS compliant Schedule III to Companies Act,
2013 have been made:
• Accounting Policy for depreciation and

amortization
• Useful lives of assets as per Schedule III
• Residual value of assets
• Depreciation method
Audit of other Expenses like power and fuel, Rent, Repair to Building, Plant and
Machinery, Insurance, Travelling, Legal and Professional, Miscellaneous Expenses.
In addition to purchases and employee benefit expenses there are other expenditure
which are essential and incidental to running of business operations. Example rent,
power and fuel, repairs and maintenance, insurance, travelling, miscellaneous
expenses etc. All such other expenses must be properly verified by the auditor.
Audit procedures for verifying other expenses are as follows: -
A) Test of Compliance with laws and regulation: -

➢ Ensure all the expenses are as per the agreements.
➢ Check minutes or letter of authorities wherever required.
B) Test of controls
➢ Ensure that payments are authorized by competent authority.
➢ Whether the expenditure had valid supporting documents like travel tickets,
insurance policy, third party invoice etc.
➢ Whether the expenditure is qualified as revenue and not capital expenditure.

➢ Wherever possible, the auditor should prepare a summary of expenditure on
monthly basis and then analytically compare the trends.
➢ Auditor should review of unusual entries.

Occurrence • In order to check rent expense, obtain a month wise
expense schedule along with the rent agreements
• To verify power and fuel expense obtains a month wise

expense schedule along with the power bills.
• To verify insurance expense, obtain a summary of

insurance policies taken along with their validity
period.
Accuracy • Check whether the expenditure has been classified

under the correct expense head.
Completeness and cut • Verify whether the expenses are recorded for all 12
off months.
• Check whether the expenditure pertained to current

period under audit.
Rights & obligation • Ensure whether the expenditure was in relation to the
entity’s business and not a personal expenditure.
Presentation & • Ensure other expenses have been classified under: -

Disclosure
o Rent
o Insurance
o Power and fuel
o Repairs and maintenance-Building, Plant and

machinery, others
o Legal and professional
o Printing and stationery
o Travel expenses
o Miscellaneous expenses
FOCUS POINTS FOR SPECIAL AUDIT WITH REGARD TO EXAMINATIONS:

1. Constitution / Legal form.
2. Charter Documents and laws governing enterprise.
3. Incomes:
a. Internal Controls.
b. Analytical review procedure.
c. Test of details.
4. Expenditures:
a. Internal Controls.
b. Analytical review procedure.
c. Test of details.
5. Assets:
a. Fixed assets – Initial recognition, Valuation and Physical
verification.
b. Current assets – Valuation and Physical verification.
6. Liabilities (if any) – Outstanding payables, incomes received in
advance, Secured / unsecured loans, Refundable deposits.
7. Accounting treatment as per Accounting Standards and GAAPs
and applicable taxes.
8. Internal controls.
9. Others – Special points.
Audit of Sole Trader:

a. Salient features
1. Non- Mandatory Audit: A sole trader is under no legal obligation to get his
accounts audited except under Income Tax Act 1961, but it is only subject to the
satisfaction of certain conditions such as tax audit u/s 44AB. Some sole trader gets their
financial statement audited due to regulatory requirements, such as on a specific
instruction of the bank for approval of loans etc. otherwise it is not compulsory.
2. Scope determination by Engagement letter: The scope of audit and the
conditions under which it is carried out can be determined by the sole trader himself.
In order to prevent mis-understanding a written letter of appointment should be
obtained by the sole-trader. The letter must define clearly the scope of audit work
3. Partial Audit: A sole trader may decide for a partial audit i.e. the audit would
be carried out in respect of only a part of the books of accounts.
b. Advantages of Audit to Sole Trader

1. Moral Check: It act as a moral check on the employees from committing
defalcations.
2. Tax Liability: Audited statements of accounts are helpful in setting liability for
taxes.
3. Credit Negotiation: Financers and Bankers use audited financial statement in
evaluating the credit worthiness of individuals in negotiating loan. It is also useful for
determining the purchase consideration for a business.
4. Trade Dispute Settlement: Audited statements are also useful for setting trade
disputes for higher wages or bonus as well as claims in respect of damages suffered by
property due to some other calamity.
5. Control over Inefficiency: It also helps in the detection of wastages and losses
and shows the different ways by which these might be checked especially those that
occur due to the absence or inadequacy of internal checks or internal control
measures.
6. Arbitration: Audited financial statements are useful in settling disputes by
arbitration.
7. Appraisal: Audit reviews the existence and operations of various controls in the
organization and reports inadequacies, weakness etc. in them. The trader can take
suitable action based on the reports.
8. Assistance to Government: Government may require audited and certified
statements before it gives assistance or issues a license for a particular trade
Audit of Partnership firm:

a. Aspects to be verified in a partnership deed
1. Name: Name and style under which the business shall be conducted.
2. Duration: Duration of the partnership, if any, that has been agreed upon.
3. Capital: Amount of capital that shall be contributed by each partner -whether it
will be fixed or could be varied from year to year.
4. Accounts Closure: The period at the end of which the account of the partnership
will be closed periodically.
5. Profit sharing: Proportions in which the profit/losses shall be divided among the
partners.
6. Contribution to losses: Pattern of contribution to losses by the partners whether
the losses shall be borne by the partners or whether any of the partners will not be
required to do so.
7. Provisions: Provisions regarding maintenance of books of account.
8. Borrowing powers: Borrowing capacity of the partnership (when it is not implied
in the case of non-trading firms)
9. Interest on capitals: Rate of interest allowed on partner's capital and loans
provided by partners and the rate at which it will be charged on their drawings and
current accounts.
10. Remuneration of partners: Amount of remuneration payable to the partners or
withdrawals permitted against shares of profit.
11. Duties: Duties of the partners as regards the management of firm's business.
12. Bank Accounts: Nature of bank accounts which is in operation, single or joint;
names of partners who operate the bank account, etc.
13. Accounting Policies (if any): The matters which must be taken into account for
determining the profits; profits division among the partners
14. Investments: Modes of investment of the available surplus funds of the
partnership.
15. Limitations: Limitations and restrictions that have been agreed upon; rights and
powers of partners; and their implied authority to pledge the firm's credit or to render
it liable.
b. Aspects of Partnership deed specifically concerning the auditor

1. Capital contribution by each partner
2. Ratio of profit sharing and loss sharing
3. Whether the partners are entitled to any interest on capital. Payable out of
profits
4. Management rights of the partners
5. Salary to partner, if any
6. Rights and duties of partners
7. The property of the firm must be held and used by the partners exclusively for
its business.
8. If a partner derives any profit for himself from any transaction of the firm or
from the property or business connections of the firm or the firm name, he must
account for and pay to the firm; also the profit from any competing business carried on
by other partners' consent must also be accounted for and paid to the firm.
9. The firm is liable to third parties:
a. If a partner acting within the scope of his apparent authority, receiver misapplies
it, or
b. If the firm in the ordinary course of the business receives money, which is
partner
10. No person can be introduced as a partner without the consent of the other
partner.
11. Any differences arising as to ordinary matters connected with the business are
to the majority of the partners, but no change can be made in the nature of the consent
of all the partners.
12. Method of settlement in the event of death or retirement of partners
c. Advantages of audit of a partnership firm

1. To settle financial dispute amongst partners
2. Where there are sleeping or dormant partners, such partners can be satisfied
that there are no frauds if the accounts of the firm are fully audited
3. Valuation of Goodwill in the event of Admission, retirement, death and
dissolution of partners
4. Moral Check: It act as a moral check on the employees from committing
defalcations.
5. Tax Liability: Audited statements of accounts are helpful in setting liability for
taxes.
6. Credit Negotiation: Financers and Bankers use audited financial statement in
evaluating the credit worthiness of individuals in negotiating loan. It is also useful for
determining the purchase consideration for a business.
7. Trade Dispute Settlement: Audited statements are also useful for setting trade
disputes for higher wages or bonus as well as claims in respect of damages suffered by
property due to some other calamity.
8. Control over Inefficiency: It also helps in the detection of wastages and losses
and shows the different ways by which these might be checked especially those that
occur due to the absence or inadequacy of internal checks or internal control
measures.
9. Arbitration: Audited financial statements are useful in settling disputes by
arbitration.
10. Appraisal: Audit reviews the existence and operations of various controls in the
organization and reports inadequacies, weakness etc. in them. The trader can take
suitable action based on the reports.
11. Assistance to Government: Government may require audited and certified
statements before it gives assistance or issues a license for a particular trade
d. Aspects that would be considered in auditing the Books of a Partnership Firm
Aspects to be Auditors’ Approach
addressed
Agreement Ensure that the appointment letter, signed by a partner, duly
Letter authorized, clearly specifies the nature and scope of audit
considered by the partners particularly the limitation, if any, under
which the auditor functions
Partnership Inspect the partnership deed duly signed by all the partners and its
Deed registration with the register of firm. Also determine from the
partnership deed, the capital contribution, profit sharing ratio,
interest on capital, powers and responsibilities of the partners etc.
Minutes Book Peruse the minutes book, if any, maintained to record the policy
decision undertaken by the partners especially the minutes
pertaining to authorization of extraordinary and capital expenditure,
raising of loans, purchase of assets, extraordinary contracts entered
into and other matter which are not routine in nature.
Agreement Verify that the business in which the partnership is involved is
authorized by the partnership agreement, or by any extension or
modification of that agreed to subsequently.
Books ofInvestigate whether the books account is reasonable and considered
Accounts adequate pertaining to the nature of partnership business.
Interest on Verify that the interest on capital calculations is in line with the
capital provisions in partnership deed.
Provision for Tax Ensure that a provision for tax of the firm payable by the partnership
has been made in the accounts prior to arrival at the amount of profit
divisible among the partners. Also check various requirements of
the legislation applicable to the partnership firm such as Section 44
(AB) of the Income tax Act, 1961 have been complied with
Profit Sharing Verify that the profits or losses are distributed among or losses are
distributed among the partners in the profit-sharing ratio as agreed.
e. Reports on the accounts of Sole traders and Partnerships:

1. The auditor should clearly define the scope of work and nature of records
examined.
2. The auditor should clearly mention in this report the extent of responsibilities
accepted by him. He should express an opinion on the truth and fairness of accounts
only in case of such accounts which have been audited by him.
3. Where accountants have been instructed to prepare but not to audit, the report
should be titled “Accountant’s Report” and not “Auditors Report.”
4. Where the auditors are instructed to carry out specific checks, then carry out
the same.
Example of an Accountant’s Report on Unaudited Financial Statements
To.......
On the basis of information provided by management we have compiled the balance
sheet of .......... (name of the entity) as of March 31, XXXX and the statement of
profit and loss for the period then ended. The balance sheet and the statement of
profit and loss are in agreement with the books of account. We have not audited or
reviewed these financial statements and accordingly express no opinion thereon.
Date:
For A & Co.
Firm registration number
Signature (Name of the partner and membership number)
Partner
Chartered Accountants
Limited Liability Partnership

Meaning: - Limited liability partnership (LLP) is a form of partnership organizations
where some or all partners have limited liabilities. In an LLP, each partner is not
responsible or liable for another partner’s misconduct or negligence.
An LLP shall be under obligation to maintain annual accounts reflecting true and fair
view of its state of affairs. A “Statement of Accounts and Solvency” in prescribed form
shall be filed by every LLP with the Registrar every year.
The accounts of every LLP shall be audited in accordance with Rule 24 of LLP, Rules
2009.
LLPs Liable for Audit
• Only the LLP whose turnover exceed 40 Lakh rupees or
whose contribution exceed 25 Lakh rupees are required to annually get their
accounts audited by any Chartered Accountant in practice.
• LLPs that are exempted from mandatory audit may also get their accounts
audited if the partners decide to get the accounts of such LLP audited.
Filing Annual Return: -
• Every LLP would be required to file annual return in Form 11 with ROC within
60 days from the closure of financial year.
• The annual return will be available for public inspection on payment of
prescribed fees to Registrar.
Filing Annual Accounts: -
All LLPs are required to submit statement of Account and Solvency in Form 8 within 30
days from the end of six months the financial year to which the statement of Account
and Solvency relates.
Powers of Registrar: -
• To obtain such information which he may consider necessary, for the purpose of
carrying out the provisions from any designated partner or employee.
• To summon any designated partner or employee to appear before him, in case
any information has not been furnished or he is not satisfied with the information
furnished to him.
Appointment of Auditor by Designated Partners
LLPs have to appoint Auditor for each financial year unless it is exempt from audit. The
Designated Partners may appoint an Auditor: -
• At any time for the first financial year but before the end of first financial year.
• Within 30 days before the end of Financial year (other than the first financial
year)
• To fill the casual vacancy in the office of Auditor.
• To fill the casual vacancy caused by removal of Auditor
The partners may appoint the auditors if the designated partners have failed to
appoint them.
Books of Accounts: -
Limited Liability Partnership are required to maintain books of account in respect of
their income and expenditure
The books of account shall contain: -
• Particulars of all sums of money received and expended by the limited liability
partnership and the matters in respect of which the receipt and expenditure takes
place;
• A record of the assets and liabilities of the limited liability partnership;
• Statements of cost of goods purchased, inventories, work-in-progress, finished
good and cost of goods sold; and
• Any other particulars which the partners may decide.
Advantages /Purpose/Need of Audit: -
• Deducting frauds and errors: - Audited Accounts helps in deducting errors
&frauds and verification of financial statements.
• Settlement of Disputes: - Disputes, if any between any partners in matter of
accounts can be settled with the help of audited accounts.
• Lending Money: -Banks & Financial institutions lend money on the basis of
audited accounts.
• Improving Management: -Periodical visits and suggestions by auditor help in
improving the management of LLP.
• Settlement of Accounts: -For settling accounts between partners at the time of
admission, death, retirement, insolvency etc. audited accounts are required.
Auditor’s Duty Regarding Audit of LLP
1. Definite Instructions: - The auditor should get definite instructions in writing
for the work to be performed by him.
2. The auditor should mention: -

• Whether the records appear to be correct & reliable
• Whether he has obtained all information & explanation necessary for his
work.
• Whether any restriction was imposed on him.
3. Regarding LLP Agreement the auditor should mention: -

• Nature of business of LLP
• Amount of Capital contributed by each partner
• Duration of partnership
• Drawings allowed
• Salaries, commission etc. payable to partner.
• Borrowing power of LLP
• Rights and duties of partners
• Method of settlement of accounts between partners at the time of
admission, retirement etc.
• Any loans advanced to partners
• Profit sharing ratio
4. Check minutes books tor any resolution passed regarding the accounts.
Audit of Incomplete records

1. The examination of records and documents is one of the most important
techniques through which an auditor collects evidence. Therefore, in case the records
and documents maintained by an enterprise are incomplete, it would prove to be a
great handicap to the auditor.
2. An auditor may face the situation of incomplete records under the following
circumstances:
a. Where records are kept on single entry basis; or
b. Where records are kept on double entry basis, but some of the records are
destroyed accidentally, or are seized by authorities, or are otherwise not
available for the auditors examination due to similar reasons.
3. Under the second circumstance, an ideal approach for carrying out audit would
be that the auditor may direct the management of the enterprise to complete or
reconstruct the accounting records, e.g., if vouchers are available but the cash book,
journal and the ledger are not maintained, then the cash book, journal and ledger
should be written up.
4. However, if vouchers are also not available, then cash book/journal/ledger will
have to be prepared by correlating the evidence available, e.g., memoranda records,
bank statements, statements from outside parties, etc. Even though such books which
are prepared may not be complete but may still contain useful information for the
auditor.
5. On the other hand, when books are maintained on single entry basis, then the
management of the enterprise would be asked to write up the books, to the extent
possible, as they would have been written up under double entry system.
6. In any case, the following steps would be required to conduct an audit:
a. Ascertain that the balance sheet or statement of affairs as at the beginning of
the year should be prepared and all the relevant accounts should be opened in the
ledger. Normally, under the single-entry system, cash, bank, and personal accounts
are maintained.
b. Confirming that all entries on receipt side of the cash book are posted in the
ledger, even by opening new account(s) wherever necessary.
c. Check that all entries on the payment side of cash book are posted in the ledger.
d. Confirming that all entries appearing in bank account are posted in the ledger.
e. Analyze personal accounts of debtors. This will provide vital information
regarding credit sales, sales returns, discounts allowed, bills received, bills
dishonored, etc. It would be necessary to post such items to relevant accounts, to
complete the double entry from the debtors’ accounts.
7. Similarly, it would be necessary to analyze the creditors' accounts and post
entries relating to credit purchase made, discounts earned, purchases return, bills
payable issued to suppliers, bills payable dishonored, etc., to relevant accounts.
8. From an auditor's viewpoint, the supervisory controls exercised by the owners
are generally less reliable and hence while auditing incomplete records, auditor will
largely depend on extensive substantive procedures and obtain external evidence,
physical examination/ observation, management representation and perform analytical
procedures.
9. Based on sufficiency and appropriateness of audit evidence, auditor shall issue
an appropriate opinion. If there is any limitation on scope of work owing to lack of
information, he may issue qualified or disclaimer of opinion, as appropriate.
Audit of an Educational Institution:
Aspects Auditors’ Approach

Constitution Examine the Trust Deed or Regulations and determine the constitution of the
organization. Also note down the provisions affecting accounts,
contained in the Regulations.
Minutes BookCarefully examine the minutes of the Managing Committee's or Governing
and Charter Body's meetings, noting down the resolutions affecting the accounts. Confirm
Documents that the decisions undertaken are duly complied with,
for operation of Bank accounts, approval of expenditure.
Fees • Verify the names entered into the Student's
obtained Fees Register for each term or month, along with the class,
from Registers showing the students name on roll and testing the amount of
Students fees charged
• Check that the system of internal check ensures proper issuance of
demand against students for fees outstanding.
• Verify the fees received by the comparison of counterfoils of receipts
provided with the entries in the Cash Book.
• Mark out the collections in the Fees Register to ensure that the
revenue earned from such source has been duly accounted for.
• Determine whether the fees paid in advance is duly considered under
the approval of proper authority.
• Check the admission fees with admission slips duly signed by the
College Principal and ensure that the amount is credited to a Capital Fund
or Separate Account decided by the Managing Committee.
• Verify whether the fines for late payment, absence, etc. have been
either collected or foregone under proper authority.
• Determine whether hostel dues were recovered before the closure of
the student’s accounts and refund of their deposited caution money.
• Report to the Managing committee, old huge arrears on account of
fees, dormitory rents, etc. if any.
Other • Check the rental income earned from landed property with Rent
Incomes Receipts and Agreements.
• Affirm the income from endowments and legacies and also the
dividend and interest from investment and verify the securities with
respect to investment held.
• Verify any local authority or government grant with the grant memo.
If any expenses have been disallowed for the grant purpose,
determine the reasons for it.
Expenditure • Determine the operation of internal control system over the various
heads of expenditures.
• Affirm the various items of expenditure, noting down the abnormal or
heavy items, if any. Get the appropriate explanations for noteworthy
items of expenditure.
Taxation • Verify that tax exemptions under the Income Tax Act are enjoyed by
the institutions
• In case of TDS from rents, interest, etc. check whether the refund
claim has been made
• Investigate that the conditions subject to which
exemption has been granted, have been followed or complied with.
Accounting • Verify the fixed assets and ensure that sufficient depreciation
Adjustments has been provided
• Verify the capital fund and other liabilities
• Ensure that caution money and other deposits paid by students during
admission are shown as liability in B/S and not transferred to revenue,
unless and until they are not refundable
• Note that the investments which represent endowment fund for prizes
have been kept separate and any income in excess of such prizes is
accumulated and invested along with the corpus.
• Confirm that separate accounts statement has been prepared with
regards to Scholarship Fund, Games Fund, Staff Provident Fund, Hostel
Fund, etc.
Financial Verify whether the form and manner of presenting financial information
Information comply with the Accounting Standards and applicable legal requirements.
Certificates Get the appropriate representation of management and certificates
with respect to various aspects covered during the audit course.
Case Study – Exam Question

Mention any six points to be considered for good internal control for collection of
tuition fees from students of college
Internal control points for collection of tuition fees:
a. There must be a clear-cut tuition fee structure approved by the college council.
b. The challan or paying in slip should contain necessary fields for identifying the
roll number of the student, class, and period for which fees is paid etc. The slips
should have such number of counterfoils to cross check the remittance.
c. The paying in slip when filled by the students, should be checked for its
correctness as to applicable amount etc. by one clerk and the amount should be
entered in a scroll. He must initial the slip which authorizes the cashier to accept
the fees as per slip.
d. The cashier scroll and the authorizing officer/s scroll should be checked by an
officer daily.
e. All remittance should be banked each day. No amount should be allowed to be
spared for meeting any type of expense.
f. Alternatively, the fees may be directly remitted into bank and banker’s daily
remittance slip should be scrutinized by college officers.
g. Arrears list should be periodically prepared from the students rolls. Any
concession, remission of tuition fees should have approval of competent authority.
h. Delayed remittance should carry fines or compensating charges for delay.
i. When students are readmitted after removal for non-payment of fees, the
admission should carry the permission of competent authority.
Audit of a Charitable Institution

addressed
Formation/ • Determine the formation of charitable institution and note
Constitution/ down the financial powers of the executives and managing
Legal Form committee.
• Investigate the relevant byelaws or trust deed for
determining the powers and duties of the Managing Committee
or Board of trustees
Functions • Investigate the functions being carried on by the institution
and verify whether they are within the permitted objects of
the institution.
• Scrutinize the minutes book of the Managing Committee
regarding various financial decisions constituting the decision
on sale or purchase of investment, acquisition or disposal of
fixed assets, donation receipts, endowment, etc.
Funds • Note the specific conditions attached to the funds operated
by the trust.
• Confirm whether the objectives in operating each fund are
fulfilled.
Subscriptions and • Determine the changes if any, with regards to annual or life
Donations membership subscription for during the year.
• Determine that there is sufficient internal control over the
issue of official receipts, custody of receipt books not used,
printing of receipt books, etc.
• Investigate the internal check system regarding the money
received from box collection, flag days, etc.
• Ensure proper control system over collections and also
ensure that they have been properly accounted.
• Verify the total subscription and donation received with the
figures published in the issued reports of Charitable
Institutions.
Legacies • Verify the amount received with the agreement in this
regard and other available information.
Grants • Verify the amount received with the relevant
correspondence receipts and minute books and gain a
certificate from the responsible official indicating the amount
of grant received.
Income from • Affirm strongly the amount received with the interest and
Investment dividend, counterfoils and computation of interest on
securities for sale or purchase of investment.
• Ensure that appropriate dividend is received; also compare
the dividend received with the investment list to confirm that
dividend has been received with respect to all investment.
Rents • Inspect the rent roll and tenancy agreements with respect
to rent amount and due date. Also, affirm strongly the rent
receipts with rent roll, cash book and counterfoils of receipt
book.
Specific Functions • Affirm strongly the gross receipts and payments in respect
to any specific function and confirm that the proceeds of all
tickets issued are accounted for after making allowance for
return.
Income Tax • Verify the refund of TDS on dividend or interest from the
Refunds Income Tax Authorities as Charitable Institutions are provided
exemption from income tax.
Expenditure • Affirm strongly the payment of grants and it should be paid
only for charitable purpose.
• Verify the schedules of securities held and inventories of
properties held.
• Confirm that the trustees or any officials are
not benefited out of the charitable institution.
• Carry physical verification of securities, title deeds and
movable properties.
• Verify the cash and bank balances.
• Confirm that any fund contributed for a specific purpose is
used for that particular purpose only.
Audit of NGOs
NGOs are non-profit making organization which raise funds from members, donors or
contributors and spend them for the provisions of various services to the society. They
also receive donation of time, energy and skills for achieving their social objectives
like imparting education, providing medical facilities, economic assistance to poor,
managing disasters and emergent situation.
Constitution: NGO's can be incorporated in the following ways:
1. As a society under Society Registration Act, 1860 or
2. As a trust under the Indian Trust Act 1882.
3. As a company u/s 25 of the Companies Act, 1956.
Examples of NGO's are religious organization, voluntary health and welfare
agencies, charitable organizations, hospitals, old age homes, CRY etc.
1) Main sources of funds for an NGO:
1. Revolving fund contribution: The aim of this fund is to revolve the amount by
giving temporary loans. The interest income earned there from is added to the fund.
2. Corpus contribution: A contribution made towards the capital corpus of an NGO
is known as corpus contribution.
3. Specific donations: These are acquired for specific purposes like acquiring
fixed assets.
4. Contributions in kind includes assets such as land, building, vehicles etc.
5. Other income: Advertisement fees from members:
i.Subscriptions
ii.Income from fund raising concerts.
2) Application of funds:
1. Establishment costs.
2. Maintenance expenses.
3. Office and administration expenses.
4. Program / Project expenses.
5. Charity.
6. Donation and contributions given.
3)Planning of audit
1. The auditor must obtain knowledge about the client’s activities, recent
amendments, etc.
2. The constitutional form and organizational structure of the NGO should be
carefully studied and reviewed.
3. Decisions taken by the board, committee, managing body etc. can be evaluated
by an analysis of the respective minute books.
4. Study and verify the applicability of the accounting system, procedure, internal
control and internal check.
5. Materiality levels should be determined.
6. Nature and timing of the various audit report and other communications must
be set.
7. The expert’s opinion and his report can be involved.
8. The previous year audit report should be thoroughly studied.
4)Audit Programme: The sequential order of assets, liabilities, incomes and

expenditure must be maintained to see that no material items get omitted.
1. Corpus fund:
(i) Vouch it with reference to Agreement/Letter from donors
(ii) Tally the interest income with the investment register and physical
investment in hand.
2. Reserves Vouching:
(i) Transfer of amt. from projects/programmers with donor letters and board
resolutions.
(ii) Transfer of gross value of asset from capital reserve to general reserve and
adjustment during the years.
3. Ear-marked funds:
Check: - requirements of donor institutions, board resolutions of NGO, rules
and regulations of the schemes of ear-marked funds.
4. Project/Agency balances:
Vouch - the disbursement and expenditure as per agreement with donor for
each of the balances.
5. Loans:
Vouch - With loan agreement.
- Receipt - counter foil issued.
6. Fixed assets:
o Vouch - acquisition/sale/disposal/ depreciation.
o Verify - its approval by appropriate authority.
o Check - donor's letter or agreement for grant, and the title for
immovable property.
7. Investments:
o Check - the investment register, and - the investments physically; to
ensure that the name of the NGO is included in it.
o Verify - approval of appropriate authority.
o Refer bank account - for the principal and interest amount of the
investment.
8. Cash in hand:
o Verify, at the year end, physically, the cash in hand and the imprest
balance.
o Check that it tallies with the books of account.
9. Bank balance:
o Check the bank reconciliation statement (BRS).
o Ascertain details for:
▪ Old outstanding balances.
▪ Unadjusted amounts.
10. Stock in hand:
Verify and obtain certificate from management for its quantities and valuation.
11. Programme/Project expense:
• Verify the agreement with the donor or contributor for the particulars
project or programme in order to find out the condition.
• If it involves contracts-then:
o check its conditions and
o Ensure that income tax is deducted, deposited and return filed.
12. Establishment expenses:
• Verify that the PF, Life insurance premium, ESI and their administrative
charges are deducted, contributed and deposited in the prescribed time.
• Verify the office and other administrative expenses like postage,
stationery, traveling etc.
5) Audit of NGO's income:
(i) Contributions and grants for projects and programmers:
Check:
(a) agreement with donor and grant letter- to ensure that money received has
been accounted for.
(b) that all foreign contribution receipts-are deposited in FCRA (Foreign
Contribution (regulation) Act, 1976) Accounts.
(ii) Receipt from fund raising programme:

Verify:
(a) the internal control system.
(b) who is the person responsible for the collection of funds.
(c) mode of payment.
(d) collections are counted and deposited in the bank daily.
(iii) Membership fees:

(a) Check:
• the fees received with the membership register.
• that proper classification is made between.
• entrance fees.
• annual fees.
• life membership fees.
(b) Reconcile the fees received and fees to be received during the year.
(iv) Subscriptions:
(i) Check or compare:
(a) subscription register with receipt issued.
(b) receipt issued with subscription rate schedule.
(ii) Reconcile - subscription received with printing and dispatch of
corresponding magazines, circulars and periodicals.
(v) Interests and Dividends:
Check interest received and receivable with investments held during the year.
CASE STUDY
1Q) State any six important points to be examined by you, as an auditor, in
verifying the correctness of bank balance of an Educational Institution which
deposits all its collection/receipt in separate collection account of a bank
Ans) For verifying the balances lying with bank in collection account, the auditor
should adopt following procedure:
a. Examine and compare the pay-in-slips with the entries in the ledger account of
the educational institute.
b. Check the casting, carry forwards and balancing of ledger account.
c. Compare the entries in the ledger account with the bank statement.
d. Review the bank reconciliation statement for its correctness.
e. Scrutiny the subsequent period bank statement to ensure that items of
reconciliation are subsequently cleared.
f. Verify the balance confirmation certificate.
2Q) The Vidhwat college, an institution managed by Dayal Trust, has received a
grant of Rs.1.35 Crores from Government Nodal agency for funding a project on
rural health system in India. Draft an audit programme for auditing this fund in
the accounts of the college
Ans) a) Examine Grant sanction letter:

i.Check the purpose and conditions relating to the use of monies.
ii.Any express restrictions / prohibitions on the use of the moneies for certain
purpose.
iii.Manner of investment of grant amounts.
iv.Reporting requirements to nodal agency.
b. Minutes book shall be perused to verify:
i.Resolution passed relating to use of grant.
ii.Decisions taken have been duly complied with.
c. Expenses audit:
i.Examine the receipt and payment account of the fund.
ii.Test check few expenditure entries along with supporting documents, to ensure
genuineness of the claims and payments.
iii.Ensure that the fund is not misappropriated.
d. If the grant had been used for creation of fixed asset, verify such asset so
created.
e. Verify investments of the funds as on the balance sheet date.
f. Obtain certificate from bank towards confirmation of Bank balance as on the
Balance sheet date.
Audit of a Hospital

addressed
Internal Check • Investigate the internal check with regards to issues and
receipts of stores, lines, apparatus, clothing, instruments,
etc.
• Confirm that the purchase is made appropriately
and is recorded in the Stock Register and the issue is made only
against an appropriate authorization.
Income from • Investigate the Bill Register of patients and also the copies
Services of bills issued to them.
• Test check some of the bills with the attendance
records of the patients to see that the bills are correctly
prepared
• Verify that the bills are issued to all the patients who have
paid any amount according to the rules of the hospital
• Get satisfactory explanations of the unbilled and
concessional billing cases.
Collection of • Verify collection of cash from Cash Book along
Cash with receipt counterfoils and other evidences such as
copies of patient's bills, dividend warrants, rent bills, etc.
• Carry unexpected cash verification at all cash handling
locations on the same day.
• Verify whether there is an existence of procedure for
deposit of all cash collections on the same day and also that
the procedures have been followed.
Grants and • Verify whether the receipts of grants, if any, are duly
Donations accounted for.
• Determine that the legacies and donations received for
specific purpose are so applied.
• Confirm that appropriate classification between
Revenue and Capital with respect to various grants has been
made.
Income from • Analyze the Property and Investment Registers to check
Investment that collections of income have been made through rent from
properties, dividend and interest on securities, etc.
• Verify whether the dues collectible are properly
followed up with the concerned parties.
Purchases and • Affirm strongly the purchases and expenses
Expenses and get satisfactory explanations for non-recurring and
abnormal items, prevailing if any.
• Verify whether appointment of staff and their salary
increments have been appropriated and authorized by the
Trustees/Managing Committee.
• Verify whether the Capital Expenditure is incurred only if
the Trustees/Managing Committee has sanctioned.
• Make comparison of the total value of various items of
income and expenditure with the
budgeted amount for them. Peruse the variance reports
submitted to the management.
Stock-in-Trade • Get the closing inventories of assets, stocks and stores
physically examined.
• Make comparison of their total value with the particular
ledger balances.
• Verify whether income tax liability is properly ascertained
and provided for.
• If the institution is eligible for exempting the income tax,
verify whether refund to TDS is properly claimed.
Registers • Examine the bonds shares, Scripts and Title Deeds of
Properties and make comparison of their particulars with that
of Property and Investment Registers.
Balance Sheet • Verify the fixed assets and confirm that sufficient
Items depreciation has been provided for.
• Examine in detail the accounts of sundry creditors for
goods, auditors for services and also analyze if there are any
abnormal movements verify Share Capital, Reserves and
surplus, Secured Loans and Unsecured Loans.
Compliance with • Verify whether the form and way of presenting
Accounting financial information comply with the Accounting
Standards Standards and applicable statutory requirements.
Management • Get proper management representation and certificates
Representation with respect to various aspects covered during the audit
and Certificate course.
Audit of a Club

addressed
Formation • Investigate the formation of club and powers of the
governing body. Study the relevant rules or byelaws
pertaining to preparation and finalization of accounts.
• Inspect the minutes book of the Governing Body and
ensure whether the powers have been appropriately
exercised.
Members Entrance • Affirm strongly the receipts on account of entrance fees
Fees with the application of members, counterfoils issued and
minutes of the Managing Committee.
Subscription of • Affirm strongly the subscription of members with
Members the counterfoils of receipts issued to members.
{May 2005, May • Mark out the receipts of selected periods to the Members
2010} Register
• Reconcile the total amount of subscription
due with the amount collected and outstanding.
• Check the total of various columns of Members Register
and tally them across.
• Check the Members Register to determine the dues areas
and examine whether necessary steps have been taken for
their recovery. The amount considered irrecoverable, if
any, must be written off.
• Check bank statements in case of direct bank
remittances for remittances in foreign currency and
remittance by way of e-payment gateways.
• Confirm that arrears of subscription for the previous year
are brought over correctly and arrears for the year under
audit and advance subscription received is correctly
adjusted.
Services Charges • Verify the internal check system with regards to

from Members members being charged for (a) Foodstuffs and drinks
provided, (b) Fees chargeable for specific services
rendered e.g. billiards, tennis, etc.
• Mark out the debits for a selected period from subsidiary
register maintained with
respect to supplies and services to members to ensure
that the account of members have been debited by the
amounts recoverable from them.
Purchases • Affirm strongly the purchase of sports items, furniture,
crockery, etc. and mark out their entries into particular
stock registers.
• Also affirm strongly the purchase of foodstuff and drinks,
etc. and test their sale price in order to ensure that normal
rates of profit have been earned on their sale.
• Carry physical verification of closing stock on unsold
provision and stores and check the valuation.
• Check the stock of furniture, sports material and other
assets physically with particular, stock registers or
inventories prepared at the year-end.
Investment and • Investigate the share scraps and bonds with respect to
income tax investments. Check their current value for
disclosure in final
accounts and also determine the arrangement for
their safe custody are satisfactory.
• Check the accrual of income there from and provision of
income tax thereon.
General • Verify the fixed assets and confirm that
sufficient depreciation is provided. Examine in detail
the accounts of Sundry Creditors for goods, Creditors for
services and analyze if there are any abnormal movements.
• Verify whether the form and way of
presenting the financial information comply with
Accounting Standards and applicable statutory
requirements.
• Get proper management representation and certificates
with respect to various aspects covered during audit course.
Audit of Cinema Hall

addressed
Internal Control Verify that adequate and proper
System internal control system and procedures have been
designed and fulfilled i.e. with regards to tickets for entrance
in hall to be pre-printed for each show and class and serially
numbered and bound into books having separate series for
advance booking issued and are under the charge of a
responsible official.
Cash Collection Reconcile the statement of tickets sold with the collection of
cash at the end of the show referring to the counterfoils
collected at the entrance to the hall.
Free Pass Verify that appropriate authority prevails for Free Passes.
Entertainment Tax Verify the entertainment tax collected with the total
tickets issued for each class.
Advertisement • Vouch other income from advertisement slides referring
Slides the relevant registers and agreements.
• Cross verify the advertisement
income based on the Slides Register and shots exhibited
kept at cinema.
Expenditure • To verify that the expenditure
Verification incurred on advertisement and repairs and maintenance
are not capitalized accounted as revenue expenditure.
• Check that appropriate depreciation on fixed assets has
been charged with regards to the useful life of the assets
having respective reference to the asset.
• Affirm strongly the expenditure incurred on film hired
with relevant bills of distributors with reference to
agreements.
Advance to • Inspect the unadjusted balance out of
Distributors the advances paid to the distributor against the film
hire contracts to check that they are good and recoverable.
• Check whether adequate provision
is made with respect to irrecoverable advances.
• Verify whether all advances in respect to film already
running are fully adjusted.
Restaurant • If the restaurants are run by the
cinema, its accounts must be investigated covering the
purchase and sale of drinks, etc. and confirm that the
closing stock of these items have been duly
considered.
• If the restaurant is let out, enquire into the arrangement
for collection of share in the restaurant income which may
either be a fixed sum or fixed percentage of the takings.
Audit of a Hotel {Nov 1989, May 1991, May 1994, May 2005,
Nov 2009}

addressed
Internal Control Room Verify the Room Sales, Collection from the guest
•
Sales register.
• Sometimes, daily occupancy reports and exit reports
are prepared. In such case test check a few reports with
the guest register and with the individual guest's bill to
ensure proper billing.
• See whether standard room rates have been charged
in different guests bills. In case there is variation, get
the satisfactory explanation and sanction for the same.
Internal Control • All Sales points in a hotel make both cash and credit
Restaurant, Billing and sales. The auditor must see the internal control system
Sales. as regards:
(i) Procedure for billing customers for room services
and sundry services, (ii) Procedure for issue of
provisions and commodities.
(ii) Safe custody of edibles wines, linen etc.
He should :
• Perform the compliance test to ensure the internal
control system operates effectively.
• Reconcile the total sales reported with the total of
the bills issued by the sale point.
• Check the numerical control system to ensure that
all bills are included in the total.
• Verify a few restaurant bills by reference to KOT's
(Kitchen Order Tickets) or basic records.
Trace the cash elements of sales in the cash book
•
and the credit sales in total and detail to the guest’s
bills.
Internal Control on • Examine the documentation procedure in respect of
Stocks. stock since hotel stock are readily (a) portable & (b)
saleable.
• Perform compliance tests to ensure that all such
documentation is accurately processed.
• Ensure that movements of provision and goods in or
out of the stores take place only after proper
authorization and recording.
• Supervise the physical stock taking and test checking
pricing calculations.
• Verify the basis of valuation adopted for stocks.
Casual Labor Generally the hotels employ casual labor to a very large
extent. Hence the auditor should:
• Examine the wage payment registers and attendance
records to see whether any manipulation has been
made.
• Verify whether adequate records, as needed by law,
wherever applicable, have been maintained.
Commission Payments • Verify that the amounts due are recovered from
agents as per the term of credit allowed.
• Check the commission, if any, paid to agents by
reference to the agreement.
Fixed Assets • Obtain a schedule of fixed assets and verify whether
adequate depreciation has been provided at the
prescribed rates.
• Verify whether the capitalization and depreciation
policies have been followed properly or not. Conduct
physical inspection of fixed assets and get
management certificates for periodic inspections.
Examine the method of recording the assets.
Statutory Compliance • Note the provisions, rules and regulations of various
laws governing the operation of hotels.
• Verify whether the condition of license for running
the hotel have been complied with.
• Check whether all the foreign exchange transactions
have been properly entered into appropriately and
reported.
Analytical Review • Compare the expenses and receipts with the figures
of the previous year. Work out the occupancy rate and
compare it with similar other hotels.
General • Examine the customer's ledger on a sample basis in
depth to see that all charges that should be made to the
customers are actually made.
• Check whether income receivable but not yet billed
has been accounted.
• See whether provision for replacement of current
assets is made.
• Verify the share capitals, reserves, secured and
unsecured loan.
• Obtain the appropriate management representation
and certification respect of various aspects covered
during the course of audit.
Audit of the leasing transaction of a Leasing Company

addressed
Relevant Note down the relevant provisions of the Companies
•
Introductory Act, 1956 or any other governing legislation applicable to
Arrangements the company, and study the impact of the directions, if
any issued by the relevant authority such as RBI.
• Note down the relevant provisions of
Memorandum of Association and Articles of Association.
• Obtain list of books of accounts, registers, memoranda
records and accounting policies adopted by the company.
• Examine the Minutes of Board Meeting and note the
delegation of powers to execute lease agreements,
sanction for various agreements, authorization for
purchasing certain assets, etc.
Internal Control Examine the existence and operation of internal control
procedures on the following aspect:
• Determination of credit analysis of the lease such as
lessee’s ability to meet the commitment
under lease, past credit records, capital strength,
availability of collateral security, etc.
• Executions of documents for lease transactions.
• Receipts and accounting of lease transactions, in
accordance with AS 19 on Leases.
• Sanction for incurring expenditure and purchase
of assets under lease agreements.
Lease Agreements Examine the clauses of the lease agreement with reference
to the following points :
• Description of the lesser, lease, equipment and
location of installing the equipment (the
stipulation that equipment would not be displaced
from the location described except for repairs. For
identification, the lesser may also need plates or
markings to be connected with the equipment.)
• Note the amount of lease tenure, payment date, late
charges, deposits or advances, etc.
• Stipulation to terminate agreement i.e. whether the
equipment should be returned to the lesser and the cost
should be borne by the lessee.
• Stipulation regarding subletting right i.e. whether the
agreement prohibits the lessee from assigning or
subletting equipment and authorizes the lesser to do so.
• Nature of lease agreement as to whether it is an
operating lease or finance lease and accounting
treatment in either case in line with AS 19.
Substantive Test check some of the lease agreements with reference to
Procedure following aspects:
• Terms and conditions of the form of lease proposal
submitted.
• Contents of invoice and its custody aspects as lease is
a long term contract.
• Acceptance letter obtained from the lessee showing
that the equipment is received in order and is also
accepted by the leases.
• Resolution of the board authorizing a respective
director for the execution of lease agreement.
• Copies of insurance policies on various assets obtained
by the lesser for his records.
• List of clients from whom the lease rents are overdue,
reconciliation statement and balance confirmation.
• Sufficient amount of provision for bad and doubtful
debts referring to the recovery of payments, litigation's,
subsequent realizations etc.
• Proper accounting treatments of the assets have been
given on lease or repossessed.
GOVERNMENT AUDIT AND AUDIT OF LOCAL BODIES
1) Government Audit:
The U.N. handbook on 'Government Auditing and Developing Countries' defines
Government Auditing as:
'The systematic, professional and independent examination of financial administrative
and other operations of a public entity, for the purpose of evaluating and verifying them
and presenting a report containing comments, conclusion and recommendations and
expressing the appropriate professional opinion in respect of financial statements'.
In India, the government audit is discharged by the independent statutory authority
known as Comptroller and Auditor General of India, the head of the agency Indian
Audit and Accounts Department.
2) Comptroller & Auditor General:

Appointment: The C & AG shall be appointed by the President of India and shall not
be removed from the office except on the ground of proven misbehavior or
incapacity.
Remuneration: The C& AG should be paid remuneration equivalent to that of a
Supreme Court Judge.
Removal: C & AG will be removed only when the parliament house decides to do so.
Powers and duties (articles 149): They are to be followed as per the C &AG Act, 1971.
Maintenance of Accounts (articles 150): Accounts will be maintained as per the
description given by the President to C & AG.
Submission of accounts (articles 151): The report of the C & AG shall be submitted to
the President/Governor who shall cause them to be laid before the parliament house.
3) Duties of the C & AG:

What is to be done
Compilation and The C & AG should compile the accounts pertaining to annual
submission of receipts and disbursements of the Union or State or Union Territory
Accounts and submit these to the President or Governor or Administrator.
Rendering The C & AG should provide such information to the Union or State
Assistance in or Union, as they may require from time to time and render such
Accounts assistance for preparing annual financial statements as they
Maintenance reasonably ask for.
Auditing and a. The C & AG should audit and report on:
Reporting i.All the expenditures from Consolidate Fund of India/State/Union
Territory having a Legislative Assembly and to determine whether
the monies disbursed were legally available for and applicable to
the purpose and service for which they are applied and whether the
expenditures comply with the authority governing it.
ii.All the transactions of Union or State pertaining to Contingency
Funds and Public Accounts.
All the trading, manufacturing, Profit & Loss Accounts and Balance
Sheets and other subsidiary accounts kept in any department of a
Union or State.
Auditing i.The C & AG should audit and report on all the receipts and
Receipts and expenditure of anybody or authority substantially financed by
Expenditure Consolidated Fund of India or State or Union Territory. For such
purpose, a body or authority shall be treated as substantially
financed if the amount of grant or loan in year is:
1. More than Rs. 25 lakhs
2. More than 75% of the total expenditure of that body
or authority.
Auditing Grants i.This applies to the grant or loan of any specific purpose, provided
or Loans from the Consolidate Fund of India or State or Union Territory, to
anybody or authority other than a Foreign State or International
Organization.
ii.The C & AG should examine in detail the procedures by which the
approving authority satisfies itself the fulfillment of the conditions
of providing such grants or loans.
Auditing Receipti.The C & AG should audit all the receipts payable into the
of Union orConsolidated Funds of India or State or Union Territory.
State ii.He may satisfy himself that the rules and procedures have been
designed to make an effective check on the assessment, collection
and proper allocation of revenue and are duly being observed.
Auditing Stores The C & AG should be authorized to audit and report on the stores
and Stock and stock accounts kept in any office or department of the Union or
Accounts State.
Auditing The C & AG should exercise such powers and duties according to the
Government provisions of Companies Act, 1956, pertaining to Government
Companies and Companies and Corporations.
Corporation
Accounts
Powers of C &AG
He can inspect any office of accounts under the control of the union or state
government.
1. He may require that any accounts, books, papers and other documents, which
are relevant to the transactions under audit, be sent to specified places.
2. He can put such questions, as he may consider necessary, to the person in
charge.
3. He can call for such information as he may require for the preparation of any
account or report.
4. Supplementary audit:
a. He is empowered to conduct a supplementary or test audit of the accounts
of a company and for the purpose of such an audit in any form as he may by
general or special order, direct to require information or additional information
to be furnished to authorized person on the required matter.
b. Accordingly, the C &AG has issued directions to the auditors in detail and
further is empowered to conduct supplementary audit in any such manner as he
thinks correct.
5) Audit of Government Expenditure
The auditor examines the fulfillment of conditions for incurring government
expenditure. It involves:
a. Audit of rules and orders
b. Audit of sanctions
c. Audit against provision of funds
d. Propriety audit
e. Performance audit
Audit of expenditure of government organization or department is conducted by the C

& AG of India. It is a major constituent of the government audit. The basic standards
established for expenditure audit are to confirm that there is provision for funds
authorized by the competent authority setting the limits within which expenditure can
be incurred. These standards are as follows:
1. The expenditure incurred comply with the relevant provisions of the law and
according to the Financial Rules and Regulation constructed by the competent
authority. Such audit is known as “Audit against Rules and Orders.”
2. There is either special or general sanction allowed by the competent authority
authorizing the expenditure. Such an audit is known as “Audit of Sanctions.”
3. There is provision for funds out of which expenditure is incurred and also it is
authorized by the competent authority. Such audit is known as “Audit against Provision
for Funds.”
4. The expenditure has been incurred with due regards to the broad and general
principles of the financial propriety. Such audit is known as “Propriety Audit.”
5. Various programmers’ scheme and project in which huge financial expenditures
have been incurred or being run economically and are yielding results expected from
them. Such audit is known as “Performance Audit.”
6. The propriety audit and performance audit suggest completely, a different
approach, adopted by the C & AG as against the regulatory audit. In propriety, audit
the C & AG brings out the cases of avoidable, improper or unfruitful expenditure even
though the expenditure has been incurred in compliance with the existing rules and
regulations. Performance audit goes even a step ahead and has a quite comprehensive
approach as it includes 3 Es i.e. Efficiency, Economy and Effectiveness.
(a)Audit against Rules and Orders
The auditors have to ensure that the expenditure incurred complies with the relevant
provisions of the legal enactment and is according to the financial rules and
regulations framed by the competent authority.
Rules and orders: The rules, regulations and orders against which regularity audit is
conducted mainly fall under the following categories:
• Expenditure from consolidated fund and the contingency fund of India or
State.
• Presentation of claims against Government, withdrawing monies from the
consolidated fund, Contingency fund and Public Accounts of India/State, and in
general the financial rules prescribing the detailed procedure to be followed by
Government servants in dealing with Government transactions; and
• Rules and Orders regulating the conditions of Service, Pay and allowances and
pensions of Government servants.
The function of Audit is to carry out examination of various rules, regulations and orders
issued by the executive Authorities to see that:
i.They are not inconsistent with any provisions of the Constitution or any laws made
there under.
ii.They are consistent with the essential requirements of audit & accounts as
determined by the C & AG.
iii.They do not come in conflict with the orders of, or rules made by any higher
authority and
iv.In case they have not been separately approved by competent authority, the issuing
authority possesses the necessary rule making power.
(b)Audit of Sanctions
The auditor has to ensure that each item of expenditure is covered by:
1. A Sanction, either
i.General or
ii.Special
2. The authority sanctioning:

i.is it competent for the purpose?
ii.by virtue of the powers vested in it by the provisions of the constitution and of
the laws, rules or orders made hereunder; or
iii.By the rules of delegation of financial powers made by an authority competent
to do so.
(c)Audit against Provision of Funds

There are two aspects, which have to be considered while carrying out an audit
against provision of funds:
(i) To determine that the expenditure has been incurred on the purpose for which
the grant and appropriation has been provided, and
(ii) To ensure that the amount of such expenditure does not exceed the
appropriation made.
(d)Propriety Audit
In propriety audit, the auditor tries to bring out the cases of avoidable, improper and
unfruitful expenditure even though the expenditure has been incurred in compliance
with the existing rules and regulations.
1. Audit against propriety endeavor to ensure that the expenditure comply to the
principle as stated below:
a. The expenditure must not be prima facie more than except in the occasions
demanded. Each and every public officer is expected to maintain the same alertness
with respect to the expenditure incurred from public amounts as a person of
ordinary prudence would do with respect to the expenditure of his own amount.
b. No authority should use its powers of approving expenditure to pass an order
which will be directly or indirectly to its own advantage.
c. Public amounts should not be used in the favor of a particular person or section
of the community until and unless:
• The expenditure amount involved is insignificant or
• A claim for the amount could be enforced in the court of law and
• The expenditure is in pursuance of a recognized policy or custom
d. The allowances amount such as traveling allowances, provided to meet
expenditure of a particular type, should be regulated that the allowances are not
wholly the sources of profit to the recipients.
e. It may be expressed that the executive departments are responsible for enforcing
economy in public expenditure. The function of auditor is to bring into the notice
of the proper authorities, the wastage in public administration and the case of
avoidable, improper and unfruitful expenditure.
f. Identify cases of improper, avoidable or anfractuous expenditure even though
the expenditure has been incurred in conformity with the existing rules and
regulations.
g. This will ensure a reasonably high standard of public financial morality when
auditors look into the wisdom, faithfulness and economy, of transactions.
(e)Performance Audit / Full scope audit:
The scope of audit has been extended to cover 3 E's i.e. Efficiency, Economy and
Effectiveness audit which is also known as Performance audit or Full Scope audit.
(i)Efficiency Audit examines the execution of various schemes or projects and their
economical operation and also whether they are yielding the results expected from
them i.e. the relationship between the goods and services produced and resources used
to produce them and examination with the purpose of finding out the extent to which
operations are performed in an economical and efficient manner.
(ii)Economy Audit examines the acquisition of financial resources, human resources and
physical resources economically by an entity and whether the approving and spending
authorities have observed economy.
(iii)Effectiveness Audit is performance appraisal of the programmers, schemes,
projects with reference to the overall targeted goals as well as the efficiency of means
adopted for achieving these goals.
(iv)Efficiency-cum-performance audit, anywhere used is an objective examination of
the financial and operational performance of an organization, programme, function or
authority and is oriented towards identification of opportunities for greater economy
and effectiveness.
The procedure of performance audit covers:

1. Identification of topic
2. Preliminary study
3. Planning and execution of audit
4. Reporting
Generally, the performance audit is conducted by the government with respect to

various expenditures incurred. While the trends towards comprehensive approach for
conducting the performance of full scope audit are visible, the coverage and depth of
evaluation may vary on the basis of statutory limits
6) Audit of receipts:
The audit of receipts is concerned with the following:
1. Assessment: Whether all revenues or other debts due to government have been
correctly assessed, realized & credited to Government account by the designated
authorities.
2. Procedure of collection: Whether adequate regulations & procedures have been
framed by the department or agency concerned to secure an effective check on
assessment, collection & Proper allocation of cases.
3. Implementation: Whether such regulations and procedures are actually
operated.
4. Monitor over irregularities and frauds: Whether adequate checks are imposed
to ensure the prompt detection & investigation of irregularities, double refunds,
fraudulent or forged refund vouchers, or other loss of revenue through fraud or willful
omission or negligence to levy or collect Taxes or to issue refunds, and
5. Review and suggestion: Review of systems and procedures to see that the
internal procedures adequately secure correct and regular accounting of demands
collection & refunds & pursuant of dues up to final settlement & to suggest
improvements. The extent of audit under each of the above category is determined by
the C&AG. These are neither negotiable nor questioned. This audit is conducted both:
a. Centrally - Where accounts and Original vouchers are kept, and
b. Locally - Where the drawing and disbursing functions are performed.
7) Audit of stores and stocks in respect of Government Audit

Documents to be Aspects to be vouched
vouched
1. Compliance with Rules Determine whether the Regulations which govern purchase,
& Procedures receipt and issue, custody, sale and stock taking of stores
are well-devised one & properly carried out.
Confirm that-
2. Purchase of stores The price paid are reasonable and agree with those shown in
the contract for the supply of stores, and
The quality and quantity certificates are provided by the
inspecting and receiving units.
Verify the accuracy, correctness and reasonableness of the

3. Accounts of Receipts, balances in stocks referring to the specified patterns
Issues & Balances consumption level and stock holding level.
2. Conduct periodic stock verification for ensuring their
existence.
3. Revise the reasonableness of charging the costs to consumption
in case of priced stores ledgers.
4. Examine in detail the approval obtained for write- off, if
any.
8) Audit of Commercial Accounts
The Governments also involves itself in commercial activities and to fulfill this purpose
it may incorporate the following types of enterprises such as:
1.Departmental enterprises involved or engaged in commercial and trading operations
which are subject to the same laws, financial and other regulations as other
government department and agencies.
2. Statutory bodies, Corporations created by specific statues, mostly financed by
governments in the form of loans, grants etc.
3. Government Companies set up under the Companies Act, 2013
All the enterprises or entities stated about are required to maintain accounts on
commercial basis.
9) Audit Mechanism:
The audit of departmental enterprises is undertaken by the C&A G in the same manner
as any other government department. Audit of statutory bodies depends upon the
nature and type of governing statues.
In respect of Government Companies audit is conducted by Statutory Auditor appointed
by the C& AG. In addition to this C& A G conducts a supplementary test audit. Further
the powers of C & AG are:
1. Direction: To direct the way in which the company's accounts will be audited by
the auditor and to give such an auditor instruction in regard to any matter relating to
the performance of his function as such.
2. Supplementary Audit: To conduct a supplementary or test audit of the company's
accounts and for the purpose of such audit, to require information or additional
information to be furnished to authorized person or persons, on the required matters,
in such form, as the C& AG may by general or special order direct.
3. Report: The Statutory auditor will submit a copy of his audit report to C & AG
who shall have the right to comment upon or supplement the audit report in such a
way as he may think fit.
The comments or supplement made on the audit report must be placed before the
company, at the same time and in the same manner as the audit report. Thus, two
layers of audit are conducted by a Government Company, one by the statutory auditor,
and other by C&AG. Audit done by C&AG is a mixture of government and commercial
audit. The nature and the scope of audit is influenced by the concept of autonomy and
accountability.
10) Audit of Municipal Authorities / Local Bodies:
Local self- Government refers to administration of a locality i.e. Village, Town, City
etc., by a body representing the local inhabitants possessing fairly large autonomy,
raising at least a part of its revenue through local taxation property taxes, fees &
licenses, professional tax, non, tax incomes e.g. rent, government grants etc. and
spending its income on services which are regarded as local services district from state
and central services.
(a)Types: Municipal Government in India covers five different types of urban local
authorities:
i.Municipal Corporations
ii.Municipal Councils
iii.Notified Area Committees
iv.Town Area Committees
v.Cantonments Committees
(b)Functions: The functions of Municipal Authorities are endowed with specific local
functions covering:
i.Regulatory
ii.Maintenance and
iii.Development activities.
(c)Sources of funds: The auditor verifies the following income with the available
evidence:
i.Properly taxes & Octroi
ii.Profession tax
iii.Non - mechanized vehicles tax
iv.Taxes on advertisements
v.Taxes on animals & boats
vi.Tolls
vii.Show tax
viii.Different types of grants from the state
ix.Administration.
(d) Application of fund: The Auditor vouches following expenditures for the accuracy
& propriety:
(i)General administration & revenue collection
(ii)Public health
(iii)Public safety
iv.Education, Public works etc.
(e) Objectives of Audit

Reporting on:
i.Reporting on the fairness of the content and presentation of financial statements
ii.Reporting upon the strengths and weaknesses of systems of financial controls
iii.Reporting on the adherence to legal and / or administrative requirements
iv.Reporting upon whether value is being fully received on money spent, and
v.Detection and Prevention of error, fraud and misuse of resources.
(f) Grants: Local bodies receive three types of grants from the state administration:
• General Purpose Grants: These are to substantially bridge the gap between
the needs and resources of the local bodies.
• Specific Purpose Grants: To provide certain services or to perform certain
tasks in the local area.
• Statutory and Compensatory Grants: These grants are given to local bodies to
compensate on account of loss of any revenue on taking over of a tax by the state
Government from the Local Government.
(g) Salient features of Financial Administration of Local Bodies
The salient features of Financial Administration of Local Bodies may be grouped

under three heads:
1. Budgetary Procedures:
The objective of local bodies budgetary procedures are:
i.financial accountability
ii.control of expenditure and
iii.ensuring that funds are raised and spent by the executive department according
to the rules and regulation and within the approval limits and authorization by
the Legislature or Council.
The various aspects covered in budgeting are:
(i) Determination of taxation levels, fees, rates, and
(ii) Laying down the ceilings on expenditure, under revenue and capital heads.
2. Expenditure Control:
The Central and State level, there is a clear-cut demarcation between the
legislature and executive. In case of the local body, the legislative powers are
vested in the council while executive powers are delegated to the officers.
Generally, all the matters of regular revenue and expenditures are delegated to
the executive wing. In case of special situation such as reduction in property taxes,
refund of security deposits, etc. approval from the legislative wing i.e. Municipal
Council should be obtained.
3. Accounting System:
Municipal Accounting System has traditionally been prepared under the cash
system. However, in recent years, it is being changed into the accrual system in
some states such as Tamil Nadu. This accrual system of accounting is
characterized by:
i.Subsidiary and Statistical Registers for assets, cheques, taxes, etc.
ii.Separate Vouchers for every type of transaction.
iii.Compulsory monthly Bank Reconciliation.
iv.Submitting summary reports on periodical basis to different authorities at
regional level.
Audit of Co-operative Societies
Introduction: -
A Co-operative society is an autonomous body of people united voluntarily to meet their
common economic, social and cultural needs through a jointly –owned controlled
enterprise.
The Co-operative Societies Act 1912 contains the fundamental law regarding the
formation and working of the Co-operative Societies in India and is applicable in many
states.
Important Provisions of Co-operative Societies Law
Qualification of Auditors: - Following persons can act as an auditor for audit
of co-operative society:-
• A chartered accountant within the meaning of the Chartered Accountant Act -
1949 or
• A person who holds a government diploma in Co-operative Accounts or in
Cooperation and Accountancy or
• A person who has served as an Auditor in the co-operative society department
of a government.
Appointment of Auditor:-
• An auditor of a co-operative society is appointed by the Registrar of Co-
operative Societies.
• The auditor so appointed conducts the audit on behalf of the Registrar and
submits his report to him and also to the society.
• The audit fees are paid by co-operative society according to the statutory scale
of fees prescribed by the Registrar.
Books Accounts and other records of Co-operative Societies:-
Under section 43 (h) of the Co-operative Societies Act, a state government can frame
rules prescribing the books and accounts to be kept by co-operative society.
For example, in Maharashtra the co-operative societies are required to maintain books
and accounts in respect of following:-
i.All sums of money received and expended by the society.
ii.All sales and purchases of goods by the society.
iii.Assets and liabilities of the society.
The society is at liberty to maintain such additional records according to its convenience
and which it thinks fit more useful for clarity and detailed explanation. For example:-
a. Property and Investment Register
b. Fixed Deposit Register
c. Surety Register
d. Daily Cash Sales Summary Register
e. Register of collection from Debtors if credit sales allowed by Bye laws.
f. Loan Disbursement and Recovery Register in case of credit society.
Restrictions on share holdings:-
According to section 5 of the Act, where liabilities of the members of a society is
limited, no member of a society other than a registered society can hold more
than 20% of the shares capital or shares of the society worth more than Rupees one
thousand.
The auditor of a co-operative society will be concerned with this provision so as to
watch any breach relating to holding of shares.
Restrictions on loans :-( section 29)
• A registered society shall not make a loan to any person other than a member.
• With the special sanction of the Registrar, a registered society may make a loan
to another registered society.
• The State Government has the power and can prohibit or can put restrictions on
the loaning power of the society to its members or to other societies in the interest
of society and its members.
Restrictions on borrowings :-( Section 30)
A registered society may accept loans and deposits from its members and others subject
to the restrictions and limits of the bye-laws of the society.
Investment of funds: - According to section 32 of the Central Act, a society may invest
its fund in any one or more of the following:-
a. In the Central or State Co-operative Bank
b. In any of the securities specified in section 20 of the Indian Trusts Act, 1882.
c. In the shares, securities, bonds or debentures of any other society with limited
liability.
d. In any co-operative bank other than a Central or State co-operative bank as
approved by the Registrar on specified terms and conditions.
e. In any other money permitted by the Central or State Government.
Appropriation of profits-(section 33)
A prescribed percentage of the profits should be transferred to Reserve Fund, before
distribution as dividends or bonus to members.
Contribution to Charitable purposes: - (section 34)

A registered society may, with the sanction of the Registrar, contribute an amount not
exceeding 10% of the net profits remaining after the compulsory transfer to the
reserve fund for any charitable purpose.
Investment of Reserve Fund outside the business or utilization as working capital
Some of the State Acts Provide that a society may use the Reserve Fund:
• In the business of a society , as working capital
• Invest as per provisions of the Act
• For some public purposes likely to promote the object of the society.
Contribution to Education Fund:-
Some of the State Acts provide that:-
• Every society shall contribute annually towards the Education Fund of the State
Federal Society, at the appropriate rate prescribed.
• Contribution to the Education Fund is a Charge on the Profits and not an
Appropriation of Profits.
Special Features of Co-operative Societies Audit
The general process of auditing includes the areas such as
• Posting Checking,
• Vouching, Ledger Scrutiny,
• Verification of Assets& Liabilities,
• Review of Balance Sheet
However, the special features of Co-operative audit while conducting the audit are as
follows:-
1. Examination of overdue debts:-
• Overdue Debts have to be classified and reported by the auditor into 2
categories, i.e. between 6 months to 5 years and more than 5 years.
• A further analysis of these overdue debts from the viewpoint of chances of
recovery will have to be made and will be classified as good or bad.
• The auditor will have to ascertain whether proper provisions for doubtful debts
are made and whether the same is satisfactory.
2. Overdue Interest:-
• Overdue Interest should be excluded from Interest outstanding and
accrued due while calculating profit.
3. Certification of Bad Debts:-

• Writing off of bad debts must be authorized by the managing committee or
certified by the auditor (wherever the law so requires) as irrecoverable losses.
4. Valuation of Assets and Liabilities:-

• The auditor will have to ascertain existence, ownership and valuation of assets.
• Fixed assets should be valued at cost less adequate provision for
depreciation. All incidental expenses incurred in the acquisition and
installation expenses of assets should be properly capitalized.
• Current assets are valued at cost or market price, whichever is
lower.
• Regarding the liabilities the auditor should see that all known liabilities are
brought into the account, and contingent liabilities are stated by way of note.
5. Adherence to Co-operative Principles:-

• The Auditor needs to assess the extent of achievement of the objects of the co-
operative society, not in terms of profits, but in terms of social benefits to its
members.
• While auditing the expenses, the auditor should see that they are economically
incurred and there is no wastage of funds.
• The principles of propriety audit should be followed for the purpose.
6. Observations of the Provisions of the Act and Rules:-

• The auditor has to ensure that all the rules &regulations and bye laws of the Co-
operative Societies Act have been followed.
• If any deviations exist, their financial implications have to be reported by the
auditor.
• Some of the State Acts contain restriction on payments of dividend , which should
be noted by the auditor.
7. Verification of Members’ Register and examination of their pass books:-

• The Auditor has to examine the passbooks of the members in order to verify the
loans given, repayment made, and confirmation of loan balances.
• Test –checks to be carried out based on the Auditor’s discretion, in order to
safeguard the interests of the members and to mitigate frauds.
8. Special report to the Registrar: - During the course of audit, if the auditor
notices that there are some serious irregularities in the working of the society, he
may report these special matters to Registrar.
Circumstances in which special report is required:
i.Personal profiteering by members of managing committee in transaction of the
society, which are detrimental to the interest of the society.
ii.Detection of fraud relating to expenses, purchase, property and stores of the
society.
iii.Mismanagement (decisions of management against co-operative principles).
iv.In the case of urban co-operative banks
• Disproportionate advances to vested interest groups, such as
relatives of management, and deliberate negligence about the recovery
thereof.
• Cases of reckless advancing, where the management is
negligent about taking adequate security and proper safeguards for
judging the credit worthiness of the party.
(9) Audit classification of society

• After a judgment of an overall performance of the society, the auditor has to
award a class to the society. This judgment is to be based on the criteria specified
by the Registrar.
• It may be noted here that if the management of the society is not satisfied about
the award of audit class, it can make an appeal to the Registrar, and the Registrar
may direct to review the audit classification.
• The auditor should be very careful, while making decision about the class of
society.
(10) Discussion of Draft Report with Managing Committee

• On conclusion of the audit the auditor should ask the Secretary of the society to
convene a meeting of the managing committee to discuss the draft audit report.
• The audit report should never be finalized without discussion with the managing
committee.
Rights and Duties of Auditor of Co-operative Societies

• The Registrar or any other person authorized by him by general or special order
in writing shall audit the accounts of registered society once at least in every
year.
• The audit includes an examination of overdue debts, if any, and valuation of the
assets and liabilities of the society.
• The auditor has right to access to all the books, accounts, papers and securities
of the society, and every officer of the society has to furnish the required details.
On completion of audit, the auditor has to submit his audit report to the society and
to respective authorities.
Matters requiring reporting:-
The audit report has to be submitted in the prescribed form specified by the Registrar.
The auditor has to state:-
• Whether he has obtained all the necessary information and explanations which
to the best of his knowledge and belief were necessary for the purpose of audit.
• Whether in his opinion and to the best of his information and according to the
explanations given, the said accounts give all the information required by the Act.
• Whether the Profit and Loss Account of the society gives a true and fair view of
the Profit and Loss made by the society.
• Whether the Balance Sheet drawn up as at the end of the year gives a true and
fair view of the state of affairs of the society as on the given date.
• Whether in his opinion, proper books of account as required by the Act, the Rules
and the byelaws of the society have been properly maintained.
• Whether the Balance Sheet and the Profit and Loss Account examined by him are
in agreement with the books of account and returns of the society.
The auditor will have to give qualifying observations, if any of the answers to the
above-mentioned matters are negative.
Schedules forming part of Audit Report:

The form of the audit report to be submitted by the auditor contains a number of
matters which the auditor has to state or comment upon. In addition to that, the auditor
will have to attach schedules to the report regarding the following information:
• All transactions which appear to be contrary to the provisions of the Act, the
rules and byelaws of the society.
• All sums, which ought to have been, but have not been brought into account by
the society
• Any material, or property belonging to society which appears to the auditors to
be bad or doubtful of recovery.
• Any material irregularity or impropriety in expenditure or in the realisation or
monies due to society.
• Any other matters specified by the Registrar in this behalf.
In the case of nil report in any of the above matters, the auditor will have to give a nil
report.
Audit, Inquiry and Inspection of Multi-State Co-Operative Societies

Multi-State Cooperative Societies Act, 2002 is applicable to the societies whose objects
are not confined to one state.
Books of Account: As per the Multi State Co-operative Society Rules, 2002, every multi
state co-operative society shall keep books of account with respect to:
• All sum of money received & expended
• All sales and purchase of goods.
• The assets and liabilities of the society.
• In the case of Multi State Co-operative Society engaged in production, processing
and manufacturing, particulars relating to utilization of materials or labor or other
term of cost as may be specified in the bye laws.
Qualifications of Auditors- section 72
A person who is CA can only be appointed as auditor of a multi-state co-operative
society. Following persons cannot be appointed as auditor:-
• Body Corporate
• Officer/Employee of Multi State Cooperative Society
• Partner/Employee of Officer/ Employee of Multi State Cooperative Society.
• A person who is indebted to multi state co-operative society or who has given
guarantee in connection with a loan of third party to multi state cooperative society
for an amount exceeding one thousand rupees
Appointment of Auditors- (section 70)
First Auditor ▪ First Auditor shall be appointed by BOD

within one month of registration.
▪ If BOD fails, company may appoint first
auditor at general meeting.
▪ Auditor so appointed hold office till
conclusion of first AGM.
Subsequent ▪ Subsequent auditors are appointed at each

Auditor AGM.
▪ Auditor so appointed hold office till
conclusion of next AGM.
Power and duties of Auditors. (Section 73)

Powers – Sec .73(1):-
• Right of access at all times to the books, accounts and vouchers whether kept at
the head office or elsewhere.
• Entitled to require from the officers or other employees such information and
explanation as required by auditor to conduct his duties.
Duties – Sec .73 (2):-
Conduct Inquiry • Whether loans and advances made on the basis of
security have been properly secured and whether
the terms on which they are made are not
prejudicial to the interests of the society or its
members.
• Whether transactions which are represented
merely by book entries are not prejudicial to the
interest of the society.
• Whether personal expenses have been charged
to revenue account and
• Where any shares that are allotted for cash,
whether cash has been actually received and if not
whether the position as stated in the account books
and balance sheet as correct not misleading.
Making Report to the • On the accounts examined by him

members • Balance Sheet and Profit &Loss Account and on
• Every other document required to be part or
annexed to the balance sheet or profit &loss
account.
Which are laid before the society in
general meeting.
The report shall state whether , in his opinion and to
the best of his information and explanations given to
him, the accounts give a true and fair view-
• In the case of the balance –sheet, of the state of
the multi-state co-operative society’s affairs at the
end of its financial year and
• In the case of the profit and loss account, of the
profit or loss for its financial year.
Power of Central Government to direct special audit in certain cases:- (Section 77)
Central Government may pass an order for the special audit if they are of opinion:-
• That the affairs of any Multi –State co-operative society are not in accordance
with co-operative principles or prudent commercial practices or with sound business
principles; or
• That any Multi –state co-operative society is being managed in a manner likely
to cause serious inquiry or damage to the interests of the industry or business to
which it pertains; or
• That the financial position of any Multi –State Co-operative society is such as to
endanger its solvency.
Such audit shall be conducted either by a Chartered Accountant or Auditor of Multi
State Co-operative society
Powers and Duties:- Same as covered in section 73 except that the audit report will
be submitted to Central Government instead of society.
Inquiry by Central Registrar- Sec 78

Circumstances when inquiry may be hold or ordered
The Central Registrar may, on a request from:-
• a federal cooperative to which a multi –state co-operative society is affiliated
• a creditor
• not less than 1/3rd of the members of the board
• not less than 1/5th of the total number of members of a multi-state cooperative
society
hold an inquiry or direct some person by order in writing in this behalf to hold an
inquiry into the constitution, working and financial condition of a multi-state
cooperative society.
Power of person conducting inquiry:-
• Access to books, accounts, documents, securities, cash and other properties
belonging to society.
• Require the officer to call the general meeting and where the officer fails to do
so, he shall have the power to call himself.
• May summon any person who is reasonably believed by him to have any
knowledge of the affairs of the society, to appear before him at any place and can
examine such person on oath.
Inspection of multi state cooperative societies –sec 79

Circumstances when inquiry may be hold or ordered
(Same as above)
Powers of person conducting inspection
• Access to all books, accounts, papers, securities, stock and other property of
that society. And can take them into custody if any irregularities are discovered.
• Verify the cash balance of society
• Call board or general meeting if necessary.

@cmalogics Paper 12 CAA

Uploaded by

Copyright:

Available Formats

@cmalogics Paper 12 CAA

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

@cmalogics Paper 12 CAA

Uploaded by

Copyright:

Available Formats

INDIGOLEARN

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 1

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 3

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 4

Study Note | Accounting of Shares and Debentures

A Company is a separate legal entity registered

Company consists of individuals, called

Shareholders are authorised by law to elect a

Through Board of Directors , the Companyt

▪ Incorporated Association – Invisible/ Intangible / Existing only in the eyes

▪ Separate Legal Entity

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 5

▪ Distinction between ownership and management

Why ‘Company’ form of organisation?

Large amount of money, modern technology, large human contribution etc. is

1. Government Company - Section 2(45) of the Companies Act, 2013

3. Private Company - Section 2(68) of the Companies Act, 2013

4. Public Company - Section 2(71) of the Companies Act, 2013

Note:The minimum paid-up share capital requirement of INR 1,00,000

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 7

6. Small Company - Section 2(85) of the Companies Act, 2013

7. Listed Company - Section 2 (52) of the Companies Act, 2013

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 8

12. Holding Company - Section 2 (46) of the Companies Act, 2103

13. Subsidiary Company - Section 2(87) of the Companies Act, 2013

MAINTENANCE OF BOOKS OF ACCOUNTS – Section 128

➢ Who should maintan : Every company

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 9

Procedure for raising funds through equity

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 10

Directors make Pro-rata

Note: Section 53 of Companies Act,

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 11

Funds provided by the owners.

Business Organization Ownership Type of Capital Liability of Owners

Partnership Partners Partners' Capital Unlimited

❖ Face / Nominal Value of Share

(–) Discount, if any]

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 12

Authorised Share Issued Share Capital Subscribed Share

•It is disclosed on the face •The remaining portion of

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 13

Called-up Paid-up Share Subscribed Reserve Share

•In balance sheet,

1. Authorised Capital = Issued Capital + Unissued Capital.

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 15

Based on "Right to • Cumulative

Based on "Right to • Participating

Based on Conversion • Convertible

(a) Cumulative Preference Shares

(b) Non-cumulative Preference Shares:

(c) Participating Preference Shares

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 16

(e) Redeemable Preference Shares

(f) Non-redeemable Preference Shares

(g) Convertible Preference Shares

(h) Non-convertible Preference Shares

1FIN by IndigoLearn|CMA Inter|Paper 12 – Company Accounts & Audit 17

Special Points for Equity Shares