Presentation and Disclosure Standards — Practice

Question 1

A company has followed going concern and accrual but has changed its method of inventory valuation, so consistency has not been followed. Its accountant proposes a note stating that going concern and accrual have been followed and consistency has not. Comment on this proposal by reference to AS 1.

Accepted Answer

The proposal discloses more than AS 1 requires and, in doing so, misunderstands the rule. AS 1 identifies three fundamental accounting assumptions — going concern, consistency and accrual — and provides that where they are followed, no specific disclosure is required, because their observance is assumed. Disclosure is required only where a fundamental assumption is not followed, and then the fact must be disclosed. So the statement that going concern and accrual have been followed is unnecessary, adds nothing a reader did not already assume, and clutters the note. The statement that consistency has not been followed is required and must be made. Beyond that bare disclosure, the change in inventory valuation is itself a change in accounting policy, and AS 1 requires that any change having a material effect be disclosed, together with the amount by which any item in the financial statements is affected, to the extent ascertainable; where the amount is not ascertainable, wholly or in part, that fact must be stated. The correct note therefore records the departure from consistency, describes the change from the old method to the new, and quantifies its effect.

Question 2

Classify each of the following for a manufacturing company preparing a cash flow statement, and state how the answer would change for a bank: interest paid on debentures, interest received on a fixed deposit, dividends received from an investment, dividends paid to shareholders, income tax paid on trading profits.

Accepted Answer

For a manufacturing company, interest paid on debentures is a financing activity, because it is the cost of the borrowing that changes the composition of the entity's capital. Interest received on a fixed deposit and dividends received from an investment are both investing activities, being returns on assets held. Dividends paid to shareholders are financing, being a return to the providers of capital. Income tax paid on trading profits is an operating activity, taxes being classified as operating unless they can be specifically identified with an investing or financing activity. For a financial enterprise the first three answers change: interest paid, interest received and dividends received are all classified as operating activities, because lending, borrowing and investing are that enterprise's principal revenue-producing activities rather than incidental to them. Dividends paid remain financing even for a financial enterprise, since a distribution to owners is a financing transaction whatever the business, and tax paid remains operating on the same basis as before.

Question 3

A company reports net profit before tax of ₹40 lakh. Depreciation charged was ₹12 lakh, profit on sale of a machine was ₹3 lakh, interest paid was ₹5 lakh and interest income was ₹2 lakh. Trade receivables rose by ₹9 lakh, inventories fell by ₹4 lakh, and trade payables rose by ₹6 lakh. Tax of ₹11 lakh was paid. Compute net cash from operating activities and explain the three families of adjustment.

Accepted Answer

The three families are non-cash items charged or credited to profit, items belonging to another activity, and changes in working capital. Applying them in order: start with net profit before tax and extraordinary items of 40. Add back depreciation of 12, a non-cash charge. Deduct profit on sale of machine of 3, which is non-cash in this statement because the whole sale proceeds appear under investing. Add back interest paid of 5, which belongs in financing. Deduct interest income of 2, which belongs in investing. That gives operating profit before working capital changes of 52. Now working capital: an increase in a current asset consumes cash, so deduct the 9 increase in receivables; a decrease in a current asset releases cash, so add the 4 fall in inventories; an increase in a current liability provides cash, so add the 6 rise in payables. That gives cash generated from operations of 53. Finally deduct taxes paid of 11, giving net cash from operating activities of 42 lakh. The value of learning the three families rather than a list is that any unfamiliar item can be placed by asking which family it belongs to.

Question 4

During the year a company issued equity shares worth ₹80 lakh to acquire a running business, and converted ₹50 lakh of debentures into equity. The accountant has shown both in the financing section. Advise.

Accepted Answer

Both entries are wrong and both should be removed from the statement entirely. AS 3 requires that investing and financing transactions not requiring the use of cash or cash equivalents be excluded from the cash flow statement, because the statement reports movements of cash and neither of these transactions moved any. The acquisition of a business by issuing shares transfers ownership without any payment; the conversion of debentures into equity changes the composition of the capital structure by an accounting entry alone. Including them would overstate both the financing inflows and, on the other side, whatever the accountant has shown as the corresponding outflow, misrepresenting the scale of the entity's cash activity. AS 3 does not, however, treat these transactions as unimportant: it requires them to be disclosed elsewhere in the financial statements in a way that provides all relevant information about the investing and financing activity concerned. So the correct treatment is exclusion from the statement itself, coupled with a note describing both transactions and their amounts.

Question 5

An enterprise has four business segments with results of ₹90 lakh profit, ₹40 lakh profit, ₹15 lakh loss and ₹120 lakh loss. Apply the segment result test in AS 17 and identify which segments qualify on this test alone.

Accepted Answer

The test is that a segment is reportable if its segment result, whether profit or loss, is ten per cent or more in absolute amount of the greater in absolute amount of the combined result of all segments in profit and the combined result of all segments in loss. The two combined figures must be computed separately and must not be netted off, which is the error the question is set to catch. Combined result of segments in profit is 90 plus 40, which is 130. Combined result of segments in loss is 15 plus 120, which is 135 in absolute amount. The greater in absolute amount is 135, so the threshold is ten per cent of 135, that is 13.5 lakh. Testing each segment on the absolute amount of its result: 90 exceeds 13.5, so it qualifies; 40 exceeds 13.5, so it qualifies; 15 exceeds 13.5, so it qualifies; 120 exceeds 13.5, so it qualifies. All four segments are reportable on this test. Note that had the two combined figures been netted, the base would have been 5 lakh and the threshold 0.5 lakh, which would still have brought all four in but by wrong reasoning; in many fact patterns netting changes the answer, so the method matters even when the result does not.

Question 6

After applying the ten per cent tests, an enterprise's reportable segments account for external revenue of ₹620 crore out of total enterprise revenue of ₹1,000 crore. State what AS 17 requires and explain the purpose of the requirement.

Accepted Answer

AS 17 requires that if the total external revenue attributable to reportable segments constitutes less than seventy-five per cent of total enterprise revenue, additional segments should be identified as reportable segments, even if they do not meet any of the ten per cent tests, until at least seventy-five per cent of total enterprise revenue is included in reportable segments. Here reportable segments account for 620 out of 1,000, which is 62 per cent, below the threshold. The enterprise must therefore designate further segments as reportable, working down in size, until the cumulative external revenue of reportable segments reaches at least 750 crore. The purpose of the rule is completeness of the picture rather than significance of individual segments. The ten per cent tests identify segments large enough to matter individually, but an enterprise composed of many mid-sized activities could satisfy those tests with segments covering only a minority of its business, leaving the reader with disaggregated information about a fraction of the enterprise and an undifferentiated remainder. The seventy-five per cent rule guarantees that segment disclosures describe most of what the enterprise actually does.

Question 7

State, with reasons, whether each of the following is a related party of Alpha Ltd under AS 18: (a) Beta Ltd, which shares one non-executive director with Alpha but whose policies that director cannot affect in their mutual dealings; (b) a single customer accounting for 70% of Alpha's turnover; (c) a bank that has lent Alpha ₹200 crore; (d) the managing director's wife.

Accepted Answer

None of (a), (b) or (c) is a related party; (d) is. AS 18 defines related parties as parties where one has the ability to control the other or exercise significant influence over the other in making financial or operating decisions, and it then expressly excludes several relationships that might otherwise be assumed to qualify. Beta Ltd is excluded: two companies are not related merely because they have a director in common, unless that director is able to affect the policies of both companies in their mutual dealings, which the facts state is not the case. The dominant customer is excluded: a single customer, supplier, franchiser, distributor or general agent with whom the enterprise transacts a significant volume of business is not a related party merely by virtue of the resulting economic dependence, however commercially real that dependence is. The bank is excluded: providers of finance, together with trade unions, public utilities and government departments, are not related parties in the course of their normal dealings with the enterprise. The managing director's wife is a related party, being a relative of key management personnel — relative meaning the spouse, son, daughter, brother, sister, father and mother who may be expected to influence, or be influenced by, that individual in dealings with the enterprise.

Question 8

A company had 10,00,000 equity shares outstanding throughout the year ended 31 March 2026 and earned ₹60,00,000 attributable to equity. On 1 September 2026 it made a bonus issue of one share for every two held. The prior year EPS was reported as ₹6. Explain the treatment for the year ended 31 March 2027 and for the comparative, and state the principle.

Accepted Answer

The principle is that a bonus issue increases the number of shares without any corresponding increase in resources: no new money enters the company and therefore no new earning capacity is created. If the additional shares were weighted from 1 September, the resulting EPS would fall for a reason that has nothing to do with performance, and the year-on-year comparison would be meaningless. AS 20 therefore requires bonus shares to be treated as if they had been outstanding from the beginning of the earliest period reported, and requires the EPS of all prior periods presented to be restated accordingly. So for the year ended 31 March 2027 the denominator is 15,00,000 shares for the whole year, not a time-weighted figure. For the comparative year ended 31 March 2026, the reported EPS of 6 must be restated: the earlier denominator of 10,00,000 becomes 15,00,000, and earnings of 60,00,000 divided by 15,00,000 gives a restated EPS of 4. Failing to restate the comparative is the single most common error in AS 20 questions, and it is easily spotted by an examiner because the restated comparative is arithmetically forced once the bonus ratio is known.

Question 9

A company has 20,00,000 shares outstanding. On 1 January it makes a rights issue of one share for every four held at ₹15, when the fair value immediately before exercise is ₹25. Compute the theoretical ex-rights fair value and the adjustment factor, and explain why a rights issue is treated differently from both a bonus issue and an ordinary cash issue.

Accepted Answer

Rights shares issued are one for every four on 20,00,000 shares, that is 5,00,000 shares at 15, raising 75,00,000. Fair value of shares before exercise is 20,00,000 at 25, that is 5,00,00,000. Total value after exercise is 5,00,00,000 plus 75,00,000, that is 5,75,00,000, spread over 25,00,000 shares, giving a theoretical ex-rights fair value of 23 per share. The adjustment factor is fair value immediately before exercise divided by theoretical ex-rights fair value, that is 25 divided by 23, or 1.0870. Shares outstanding before the rights issue are multiplied by this factor for the period before the issue, and prior period EPS is restated by the same factor. The reason for this treatment is that a rights issue at below market price is a hybrid. An ordinary cash issue at fair value brings in resources proportionate to the shares issued, so simple time-weighting is correct and no restatement is needed. A bonus issue brings in nothing, so full retrospective treatment is correct. A rights issue at a discount does both: part of it is a genuine issue for cash at fair value, and part of it is a transfer of value to existing shareholders that has the character of a bonus. The adjustment factor is the device that separates the two, applying bonus-style retrospective treatment to the bonus element alone.

Question 10

A company has basic EPS of ₹8. It has outstanding convertible debentures whose conversion would add 2,00,000 shares and save after-tax interest of ₹20,00,000, and convertible preference shares whose conversion would add 5,00,000 shares and save a preference dividend of ₹15,00,000. Explain how AS 20 requires these to be tested and why order matters.

Accepted Answer

AS 20 requires that potential equity shares be included in the computation of diluted EPS only when they are dilutive, that is only where their inclusion decreases earnings per share from continuing ordinary operations or increases loss per share. Anti-dilutive potential shares are ignored entirely, because including them would report a diluted EPS higher than basic, which would be misleading — dilution is meant to show the worst case for existing holders, not an improvement. Each class must be tested separately, and the classes are considered in sequence from the most dilutive to the least. The measure of dilutive effect for each class is the incremental earnings per incremental share: for the debentures, 20,00,000 saved over 2,00,000 shares, which is 10 per share; for the preference shares, 15,00,000 over 5,00,000 shares, which is 3 per share. The preference shares are the more dilutive because 3 is below the basic EPS of 8, whereas the debentures at 10 are above it and are therefore anti-dilutive in isolation. Order matters because dilution is cumulative: adding a class changes the running EPS against which the next class must be tested, so a class that appears anti-dilutive against basic EPS may become dilutive after a more dilutive class has been included. Testing from most to least dilutive is what guarantees the sequence produces the lowest possible diluted figure.

Question 11

State which of the following qualify as discontinuing operations under AS 24, with reasons: (a) a company closes one of three factories making the same product to consolidate production; (b) a company sells its entire pharmaceutical division, a separate major line of business, under a binding agreement; (c) a company gradually phases out one model in its product range over three years.

Accepted Answer

Only (b) qualifies. AS 24 defines a discontinuing operation as a component of an enterprise that, pursuant to a single plan, is being disposed of substantially in its entirety, disposed of piecemeal, or terminated through abandonment; that represents a separate major line of business or geographical area of operations; and that can be distinguished operationally and for financial reporting purposes. Item (b) meets all three limbs: there is a single plan, a binding sale agreement for the whole division, the division is a separate major line of business, and a division of that kind is ordinarily distinguishable both operationally and for reporting. Item (a) does not qualify. AS 24 expressly excludes closing a facility to achieve productivity improvements or other cost savings, and shifting production or marketing activities from one location to another; the enterprise continues to make the same product and only its production footprint has changed, so nothing has been discontinued in the standard's sense. Item (c) does not qualify either, since the standard expressly excludes the gradual or evolutionary phasing out of a product line or class of service, as well as discontinuing several products within an ongoing line of business. The distinction the standard is drawing throughout is between ceasing to be in a line of business and merely reorganising how a continuing business is run.

Question 12

On 20 February the board of a company approves a detailed formal plan to dispose of a major division and announces it publicly. A binding sale agreement is signed on 14 May. The financial year ends on 31 March. From which period must AS 24 disclosures begin, and why is the trigger defined as it is?

Accepted Answer

Disclosures begin from the year ended 31 March, because the initial disclosure event occurred on 20 February, within that year. AS 24 defines the initial disclosure event as the earlier of two occurrences: the enterprise entering into a binding sale agreement for substantially all of the assets attributable to the discontinuing operation, and the board of directors or similar governing body both approving a detailed formal plan for the discontinuance and making an announcement of the plan. Here the second occurred first, and both of its limbs are satisfied — the plan was detailed and formal, and it was announced. The binding agreement of 14 May falls in the following year and is therefore irrelevant to when disclosure starts. The trigger is defined as the earlier of the two because the purpose of the standard is to let readers assess which results will not recur, and that assessment becomes necessary as soon as discontinuance has become sufficiently definite to be relied upon. Requiring both approval and announcement, rather than approval alone, is what prevents an internal decision that might still be reversed quietly from triggering disclosure, since a public announcement commits the enterprise in a way an unannounced board minute does not.

Question 13

A company with a 31 March year end incurs ₹40 lakh of advertising in the quarter to 30 June for a campaign expected to generate sales over the whole year. It proposes to charge ₹10 lakh in each quarter. It also expects annual profit of ₹200 lakh taxed at an average rate of 25%, but earns ₹80 lakh in the first quarter, which alone would fall in a 20% band. Advise on both matters.

Accepted Answer

The advertising cannot be spread. AS 25 requires that a cost which does not meet the definition of an asset at the end of an interim period must not be deferred merely on the ground that it is expected to benefit later interim periods. Advertising already broadcast confers no controlled resource from which future benefits will flow — the company cannot recover it, sell it or prevent competitors from advertising too — so it fails the definition of an asset and the whole 40 lakh is charged in the quarter to 30 June. The reasoning underlying this is the discrete approach the standard adopts: measurements are made on a year-to-date basis so that the frequency of reporting does not alter the annual result, and permitting deferral would let a company choose its interim profits. The tax charge, by contrast, is deliberately not measured discretely. AS 25 requires income tax expense to be recognised in each interim period on the basis of the best estimate of the weighted average annual income tax rate expected for the full financial year. So the first quarter is charged at 25 per cent, giving 20 lakh, and not at the 20 per cent band the quarter's own profit would attract in isolation. The two rules look inconsistent and are not: tax is an annual liability computed on annual income, so an interim estimate must anticipate the annual rate, whereas an expense incurred is simply incurred.

Question 14

A company selling woollen garments earns 70% of its annual revenue in the quarter to 31 December. Its finance director proposes to recognise one quarter of expected annual revenue in each interim period, arguing that this presents a truer picture of the business's underlying performance. Advise.

Accepted Answer

The proposal must be rejected. AS 25 provides that revenues received seasonally, cyclically or occasionally within a financial year should not be anticipated or deferred as of an interim date if anticipation or deferral would not be appropriate at the end of the financial year. Revenue is recognised when it is earned, and a woollen garment sold in December is earned in December; smoothing it across four quarters would report revenue in the June quarter that has not been earned and defer revenue in the December quarter that has. The finance director's argument confuses two different things: seasonality is a real feature of this business, and the interim statements should show it rather than conceal it, since a reader who sees three weak quarters and one strong one has learnt something true about the entity. What the standard offers instead is disclosure — the interim report should include commentary on the seasonality or cyclicality of operations, and users of interim reports of seasonal businesses are directed to information for the twelve months ending on the interim reporting date, together with comparatives, precisely so that they can judge underlying performance without the figures being manipulated to produce it.

Question 15

Which of the following are cash equivalents for AS 3 purposes: a 90-day treasury bill acquired 15 days before maturity; a 5-year bond acquired 2 months before its redemption date; equity shares in a listed company that are highly liquid; preference shares acquired one month before their specified redemption date?

Accepted Answer

AS 3 defines cash equivalents as short-term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value, held for the purpose of meeting short-term cash commitments rather than for investment. An investment normally qualifies only if it has a short maturity of, say, three months or less from the date of acquisition, and the words from the date of acquisition are decisive in this question. The 90-day treasury bill acquired 15 days before maturity qualifies, since what matters is the remaining period from acquisition, not the instrument's original tenor. The 5-year bond acquired two months before redemption also qualifies for the same reason, its original five-year term being irrelevant once acquired with two months to run. The listed equity shares do not qualify: equity investments are excluded from cash equivalents because their value can change materially, and liquidity is not the same as insignificant risk of change in value. The preference shares do qualify, falling within the express exception for preference shares acquired within a short period of their maturity and with a specified redemption date.

Practice — Presentation and Disclosure Standards

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