Accounting Standard – 7

Construction Contract

1.       Applicability and Nature : This AS is applicable from 01-04-2002 onwards and Mandatory for construction companies only.

2.       Objective:-The main objective of this AS is to prescribe rule for recognition of revenue and cost for a construction contract because a construction contract may take more than one accounting year to be completed.

3.       Meaning of Construction Contract:-As per the provision of AS-7 Construction Contract is a contractual agreement where contractor constructs Asset as per the requirement of customer. These construction contracts may be for construction of Building, roads and etc.

4.       Types of construction contracts:

(i)                  Fixed Price Contract:- A fixed price contract is that in which a fixed price is agreed to be paid to the contractor.

(ii)                Cost plus Contract:- The contract of construction for which contractor is paid following to payments:

(a)    Cost Incurred for construction,

(b)   A Fixed % of profit on Cost.

Note- There will be no loss under this type of contract to the contractor under this type of contracts.

5.       Meaning of cost escalation:- Cost Escalation is an agreement between contractor and contractee whereby contractee agreed to pay an extra amount on % basis to contractor for an increase in the cost of material and labour beyond a specified limit.

6.       Accounting for Fixed Price Contract:-

Revenue is recognized as per the provision of

Para-22, Para-23, Para-31

Para-22

Following steps are used for revenue recognition

Step-1   Calculate Completion Stage as follows:

                = Actual Cost/total estimated cost X100

Step-2   Contract Revenue

                = Contact Price X % of Completion

Example-1

Actual Cost till Date                                                                                        Rs.2,00,000

Total Estimated Cost                                                                                      Rs.5,00,000

Contract Price                                                                                                   Rs.6,00,000

                Sol.

                Step-1                   % of Completion= 20/50 X 100 = 40%

                Step-2                   Contract Revenue = Contract Price X % of completion

                                                                                = 60,00,000 X 40 % = 24,00,000

                Example-2

                                                                                                                                                                                (Rs. in Lacs)

	Year 1	Year 2	Year 3
Contract Price	60	60	60
Actual Cost	10	25	45
Total Estimated Cost	50	50

Contract Revenue and Profit for first year:

                                Completion Stage = 10/50 X 100 = 20%

               

                                Contract Revenue = 60 X 20% = 12 Lacs

                                Contract Profit = Revenue – Cost = 12-10 = 2 Lacs

Contract Revenue and Profit for Second year:

Completion Stage = 25/50 X 100 = 50%

               

                                Contract Revenue = 60 X (50%- 20%) = 18 Lacs

                                Contract Profit = Revenue – Cost = 18-(25-10) = 3 Lacs

Contract Revenue and Profit for Second year:

               

                                Contract Revenue = 60 – 18 - 12 = 30 Lacs

                                Contract Profit = Revenue – Cost = 30-(45-25) = 10 Lacs

Para-23

In case there is a difference in % of completion as per completion method and physical construction of asset then contract Revenue should be computed by survey method.

Under this specified method contract revenue should be recognized on the basis of certificate issued by surveyor.

Para-23

As per the provision of AS-7, application of para-31 can be made only if total estimate is not available. In this specified case, contract revenue will be equal to actual cost incurred by contractor an there will be no profit or loss.

7.       Variation in Contract Work:-A variation is an instruction by customer for a change in the scope of work to be performed under the contract revenue.

Additional Assets:- The Construction of additional Asset should be treated as a separate contract if:

(i)                  The asset differs significantly in design, technology

(ii)                If price of the asset is negotiated without regard to the original contract price.

8.       Claim :-The amount received by contractor in addition to the contract price is called as claim. This may be collected from contractee because of the following reason:

(i)                  Customer caused delay,

(ii)                Error in specification of designs

(iii)               Disputed variation in the contract work.

9.       Inventive:- The extra payment made by contractee to the contractor for achieving specified standards like- completion of construction before the time specified.

10.   Contract revenue includes the following:

(i)                  Initial contract price

(ii)                Variations in contract

(iii)               Claims

(iv)              Inventive payments.

Note- A variation is included in the contract revenue when it is probable that the customer will approve the variation and the amount of revenue can be measured reliably.

11.   Combining of contracts:

For the purpose of accounting, contracts are combined (i) if the negotiation of the contracts is made in a single package, (ii) the contracts are so closely interrelated that they are, in effect , part of single project with an overall profit margin and (iii) the contracts are performed concurrently or continuous sequence.

12.   Segmenting of contract.

For the purpose of accounting segmenting of contract is done if (i) Each Contract is supported by separate proposals, (ii) separate negotiation is made for each assets  and the contractor and the contractee are in position to accept or reject any contract. (iii) the cost and revenue of each assets can be identified.

13.   Contract Cost include the following:

(i)                  Direct Cost:- Site Labour Cost, Site supervision, cost of material, depreciation of FA, hire charge of FA, claims of third party etc.

(ii)                Allocable Cost: The cost which is attributable to contract activity in general and can be allocated to the contract. It includes the following:

Insurance, construction Overhead, Borrowing Costs etc.

(iii)               Special Cost:- The cost which is incurred on the basis of specification given by customer.

Accounting Standard – 14

Amalgamation of Companies

1.      Amalgamation means:

Combining of resources by two or more organization for making one single organization It includes the following:

Amalgamation

When two or more companies liquidate and new company is formed to takeover the business of liquidated companies, it is called amalgamation.

Absorption    

When an existing company is liquidated and its business is taken over by another existing company, it is called absorption.

External Reconstruction

When one existing company is liquidated and a new company is formed to take over the business of liquidated company, it is called external reconstruction.

2.      TYPES OF AMALGAMATION

As per the provision of AS- 14, Amalgamation may be:

1.       In the nature of Merger

2.       In the nature of Purchase

Amalgamation in the Nature of Merger:

As per the provision of AS- 14, amalgamation will be in the nature of merger if the following conditions are satisfied in totality.

(i)                 All the assets and all the liabilities of Transferor Company (Vendor Co.) become the Assets and liabilities of Transferee Company (Purchasing Co.) after amalgamation.

(ii)               Shareholders holding at least 90% of the face value of the equity shares of the transferor company (other than the equity shares which are already held by the transferee company or its subsidiary companies or their nominees, immediately before amalgamation) become equity shareholders of the transferee company by virtue of the amalgamation.

(iii)             The consideration is wholly discharged by issue of equity share of the transferee company to the shareholders of Transferor Company.

(iv)              The business of the transferor company must be carried on by the transferee company.

(v)                All the assets and all the liabilities of the transferor company must be recorded at the book value in the books of account of Transferee company. But adjustment can be done if the accounting policies are to be made uniform. E.g. SLM to WDV or vice a versa.

Amalgamation in the Nature of Purchase:

When anyone or more of  the conditions of amalgamation in the nature of merger does not satisfy then it is called amalgamation in the nature of purchase/

Method of Accounting

1.       Pooling of Interest Method

This method is used when amalgamation is in the nature of merger.

2.       Purchase method

This method is used when amalgamation is in the nature of purchase

Pooling of Interest Method

(i)                 Under this method all the assets and liabilities of the transferor company are recorded in the books of accounts of Transferee Company at their book value.

(ii)               Reserve is recorded at their existing carrying amount and in the same form (whether capital or revenue reserve)

(iii)             The balance of profit and loss account of Transferor Company should be aggregated with the corresponding balance of Transferee Company or transferred to the general reserve, if any.

(iv)              Difference between the purchase consideration and the amount of share capital of the transferor company should be adjusted in general reserve.

(v)                Accounting policies must be made uniform if any conflict exist.

Purchase Method

(i)                 Under amalgamation in the nature of purchase, the transferee company takes over the assets and liabilities of Transferor Company on selection basis.

(ii)               In addition to the power of selection, the assets and liabilities of vendor company are taken over by purchasing company at agreed value.

(iii)             Statutory reserve:   A reserve created under any law in known as statutory reserve.

Ex. Export Profit Reserve, Development Rebate Reserve, Investment Allowance Reserve, Profit Export Reserve, Tea Development Reserve and Foreign Project Reserve etc .

These reserves are created by the company to take tax benefit. Thus it is necessary to carry forward any such reserve in the books of the transferee company. It is done by making following entry:

                                Amalgamation Adjustment A/c          Dr.

                                                                To Particular Statutory Reserve A/c

Amalgamation adjustment account will be shown as fictitious asset in the balance sheet of the transferee company under the heading of miscellaneous expenditure.

The particular statutory reserve should be shown separately under the heading of Reserve and Surplus in the balance sheet of Transferee company.

When the statutory reserve is no longer required to be maintained, then both the statutory reserve and amalgamation adjustment account should be cancelled by means of a revere entry which is as follow:

                Particular Statutory Reserve A/c      Dr .

                                                                To Amalgamation Adjustment A/c

(iv)                The balance of the profit and loss account of the transferor company whether debit or credit loses its identity.

(v)                 The difference between purchase consideration and the net assets of the transferor company will be recognized as follows:

P.C,> Net Assets = Goodwill

P.C.< Net Assets = Capital Reserve.

If the difference is known as Goodwill then it should be amortized to income on a systematic basis over its useful life. The amortization period should not exceed 5 years unless a longer period is justified.

Purchase Consideration

As per AS- 14 purchase consideration is the amount which is paid by the purchasing company (transferee Co.) to the liquidator of the vendor Company (Transferor CO.) only for its equity and Preference shareholders. It does not include any payment payable to creditors and debenture holders etc.

Following methods are used to calculate P.C.

1.       Net Assets Method

2.       Net Payment Method

3.       Intrinsic Method

4.       Lump Sum Method

Net Assets Method

Under this method P.C. is calculated as follow

Agreed Value of Assets Taken Over                                        ****

Less:      Agreed Value of Liabilities Taken Over                   ****

                Purchase Consideration (Net Assets)                      ****

Points to be considered

(i)                 If nothing is specified in the question then book value of assets and liabilities given in the balance sheet will be taken as agreed value.

(ii)               Only real assets are taken over not the fictitious asset (like miscellaneous expenses, Profit and Loss Dr. etc.).

(iii)             Only outside liabilities are taken like debentures, creditors, bill payables etc. The agreed value for these liabilities is the value at which purchasing company has agreed to pay or settle with them.

(iv)              Purchase consideration will be discharged by issue of shares and payments in cash.

Net Payment Method

This method is also called “total payment method”. Under this method payment to shareholders will be purchase consideration which is calculated as follow:

                Cash paid                             ****

                Equity share                       ****

                Preference share             ****

                Other assets                      ****

                P.C.                                        ****

Intrinsic Value Method

Intrinsic value of share means the value of share on the basis of net assets of the company. This method is also called “share exchange method”. In this the purchasing company takes over the business of vendor company on the basis of ratio in which shares of purchasing company are to be exchanged for the share of Vendor Company. This ratio is called exchange ratio or swap ratio.

Intrinsic Value Per Share  = Net Assets/No. of shares

Lump-Sum Method

Under this method amount of purchase consideration is agreed between purchasing company and Vendor Company in a fixed amount. In the question it will be given.

Accounting Standard – 2

Inventories Valuation

1.       Applicability and Nature : This AS is applicable from 01-04-1999 onwards and Mandatory for SMC, NON-SMC and Level-I,II & III (It means mandatory for all)

2.       Objective:-The main objective of this AS is to prescribe rule for valuation of inventories

3.       Para-1  

AS -2 is not applicable on

(i)                  Service provider

(ii)                Shares, Debentures and other financial instruments

(iii)               WIP of construction contracts.

(iv)              Producers inventory of Livestock, agricultural and forest product.

4.       Para-3 & 4          

Inventory means assets:

(i)                  Held for sale in normal course of business (Finished Goods)

(ii)                Held in the process of production (WIP)

(iii)               Held for consumption for production of goods or rendering of services. (Raw Material)

NOTE- As per the provision of AS-2, any specific loose tools should be considered as a part of cost of assets and should be depreciated over the remaining useful life of assets but common loose tools should be valued as Raw Material is valued.(ASI-2)

Note:- Stand-by equipment is not of the nature of spare. It should be treated as separate Fixed Asset and should be depreciated like other Fixed Assets.

5.       Para-5  

Valuation of Inventory:

Inventory is valued at COST or NRV whichever is less

Note : Lower will be selected on item by item basis or category basis but should not be on global basis.

Note:- Producers inventories of Livestock, agriculture and forest products can be valued at NRV as per established practice if (a) Sale is assured by a forward contract or by government guarantee, (b) Market is homogeneous and there is negligible risk of sale failure.

6.       Para-6

COST: Cost means all cost of purchase, all cost of conversion all other costs incurred in bringing the inventories to their present condition and location.

Para-7

Purchase cost includes the following:

(i)                  Purchase Price

(ii)                Duties and Taxes

(iii)               Freight Inwards

(iv)              Other expenditure directly attributable

(Ex.- Cost of containers, transit insurance and buying commission etc.)

Following items are either not included or deducted from cost of purchase:

(i)                  Trade Discount

(ii)                Rebate

(iii)               Duties and taxes that are subsequently recovered by the enterprise from the taxing authorities and

(iv)              Other similar items.

Para-8 & 9

Conversion cost includes the following:

(i)                  Direct material, direct labour and direct expenses (all direct costs)

(ii)                Allocated variable production overheads i.e. indirect material and indirect labour etc. normally these are allocated on the basis of actual production.

(iii)               Allocated fixed overhead i.e. depreciation of machinery and factory building, insurance of factory building and machinery etc. Normally these are allocated on the basis of normal capacity of production.

Fixed production recovery rate is calculated as follow:

= (Fixed Production Overhead)/ Normal Production Unit or Actual Production unit (whichever is higher)

Para-10-Cost allocation for Joint Products:

Production of Joint Products only:

Calculate Joint Cost and apportion it on various products  on a rational and consistent basis. Like sale value at split off point , physical quantity method etc.

Production of Main Products and By Products:

i)                    Compute joint cost

ii)                  Calculate NRV of By Products

iii)                Calculate Net Joint cost  by reducing NRV out of Joint Cost

iv)                Apportion the Net Joint cost on main products on a rational and consistent basis.

NOTE- In case of joint products, when the cost of conversion of each product are not separately identifiable, they are to be allocated between the products on a rational and consistent basis. For example on the basis of sales value at split off point.                

               

                Para-11 & 12

                Other costs means:

Cost incurred in bringing the inventories to their present condition and location is included in other cost. For example cost of designing the product for certain customers.

                Note- Interest and cost of borrowing is not included in other cost.

               

                Para-13

                Following costs are not included in the cost of inventories:

(i)                  Abnormal amount of wasted material, labour, and production cost.

(ii)                Storage cost, unless these are necessary in the production process prior to a further production stage.

(iii)               Administrative overhead and selling and distribution overheads etc.

Formulas to be used to determine cost of inventories:

(i)                  Specific Identification Method:- this method is used when items of inventory are not ordinarily interchangeable  and goods and services produced and segregated for a specific project.

(ii)               FIFO and Weighted average method

(iii)             Standard cost method:-  This is the cost which is determined taking into account normal levels of consumption of Materials and supplies, Labour, efficiency and capacity utilization. It should be regularly reviewed. Standard cost may be used if the results approximates the actual cost and FIFO or WAM are not applicable.

(iv)              Retail Price Method:- Cost of Inventory = Sales value of Inventory LESS Gross Margin. This method may be used if FIFO or WAM are not applicable.

7.       Net Realizable Value (NRV)

Net Realizable Value means the estimated selling price in ordinary course of business, less estimated cost of completion and estimated cost necessary to make the sale.

               

                Para-20                 Conditions under which inventories are valued at NRV

(i)                 Damaged items of inventories.

(ii)               Partial or Complete Obsolescence.

(iii)             Decline in selling prices

(iv)              Increase in the estimated costs of completion or costs necessary to make the sale.

NOTE-  Material and other supplies held for the use in the production of inventories are not written down below the cost if the finished goods in which they will be used are expected to be sold at or above cost.

8.       In accordance with Guidance Note on “Accounting Treatment of Excise Duty” and AS-2, Excise Duty should be considered as Manufacturing expense and be considered as an element of cost for Inventory valuation. It is mandatory for an entity to provide for liability for excise duty on finished goods lying in stock as at the end of the year and add the same to the value of closing stock.

9.       Para-26                 Disclosure Requirements:

(i)                  The accounting policies adopted in measuring inventories including the cost formulas

(ii)                Carrying amount of inventories and its classification into Finished Goods, Traded Goods, WIP and RM etc.

(iii)               Any change in the accounting policies adopted and its impact on the items of Financial Statements.

Accounting standards for CA-IPC Nov-2014

Accounting Standard – 1

Disclosure of Accounting Policies

1.       Applicability and Nature : This AS is applicable from 01-04-1993 onwards and Mandatory for SMC, NON-SMC and Level-I,II & III (It means mandatory for all)

2.       Objective:- The main objective of this AS is to provide better understanding of the F/S by disclosing the significant accounting policies used in preparation of F/S. This also helps meaning full comparison between F/S s of different enterprises.