Ind AS on Liabilities and Items Impacting Financial Statements — Practice

Question 1

A company is being sued for ₹50 lakh in damages arising from a product defect. Legal counsel advises that it is probable the company will be found liable, and estimates the likely damages at ₹35 lakh, though the exact figure remains uncertain pending trial. Apply Ind AS 37's three-part test to determine whether a provision should be recognised, and at what amount.

Accepted Answer

Applying the three-part test: first, a present obligation exists, since the product defect (the past event) has already occurred and given rise to the possibility of a legal obligation to pay damages; second, it is probable that an outflow of resources will be required, since legal counsel has specifically advised that it is probable the company will be found liable; third, a reliable estimate can be made, since legal counsel has estimated the likely damages at ₹35 lakh, and the mere fact that the exact figure remains uncertain pending trial does not by itself prevent a reliable estimate from being made — Ind AS 37 explicitly recognises that provisions, by their nature, involve estimation, and a reasonable best estimate, even if not precisely certain, satisfies this criterion. Since all three conditions are satisfied, a provision of ₹35 lakh, the best estimate of the expenditure required to settle the obligation, should be recognised.

Question 2

A company has no legal obligation to provide job retraining to employees affected by a plant closure, but it has a long-standing, well-publicised corporate policy of doing so, and has consistently followed this policy at every prior closure. It has now announced the closure of a specific plant. Explain whether a provision should be recognised, and why, even in the absence of any legal obligation.

Accepted Answer

A provision should be recognised, because Ind AS 37 recognises constructive obligations, not only strictly legal ones, as satisfying the 'present obligation' element of the recognition test; a constructive obligation arises where an entity's established pattern of past practice, published policies, or sufficiently specific current statements have created a valid expectation on the part of other parties that the entity will discharge certain responsibilities, even though no law or contract compels it to do so. Here, the company's long-standing, consistently applied and well-publicised policy of providing retraining at prior closures has created exactly this kind of valid expectation among the affected employees at the newly announced closure, who reasonably anticipate the same treatment based on the company's own established pattern of behaviour; since the closure has now been specifically announced, triggering the obligation in respect of this particular plant's employees, and an outflow is probable and reliably estimable given the company's own historical retraining costs, a provision should be recognised despite the complete absence of any legal obligation to do so.

Question 3

A company has filed a claim against a supplier for breach of contract and expects to recover damages. Legal counsel assesses the recovery as 'probable' but not virtually certain. Explain how this should be treated under Ind AS 37, contrasting it with how a probable obligation (rather than a probable recovery) would be treated.

Accepted Answer

A contingent asset, where the inflow of economic benefits is probable but not virtually certain, is disclosed in the notes to the financial statements but is not recognised in the balance sheet; only when realisation of the income is virtually certain does the underlying asset cease to be a contingent asset at all and become appropriate for recognition. This contrasts directly with the treatment of a probable obligation: where an outflow of resources is assessed as probable (not requiring the higher virtually-certain threshold), Ind AS 37 requires a provision to be recognised as a liability, not merely disclosed. This asymmetry between a probable gain (disclosed only) and a probable loss (recognised) is a deliberate feature of the standard, reflecting a cautious approach to genuinely uncertain future economic benefits, and prevents an entity from recognising income based on a possible favourable outcome that has not yet been confirmed with a high degree of certainty, even while requiring recognition of a probable, and therefore comparatively more likely to actually occur, obligation.

Question 4

A company's machine has a carrying amount of ₹60 lakh in its books and a written-down value of ₹40 lakh for tax purposes, due to accelerated tax depreciation claimed. The applicable tax rate is 25%. Compute the deferred tax balance arising from this difference, state whether it is a deferred tax asset or liability, and explain the underlying reasoning.

Accepted Answer

Temporary difference = Carrying amount ₹60 lakh − Tax base ₹40 lakh = ₹20 lakh, a taxable temporary difference since the carrying amount exceeds the tax base. Deferred tax liability = ₹20 lakh × 25% = ₹5 lakh. This is a deferred tax liability, not an asset, because the accelerated tax depreciation has allowed the company to claim a larger tax deduction than the accounting depreciation charged so far, meaning the company has effectively deferred paying tax on this amount into future periods; when the asset's economic benefits are eventually recovered, through use or sale, the lower remaining tax base relative to carrying amount will mean less depreciation is available for tax purposes in future, or a larger taxable gain arises on disposal, producing additional taxable income, and therefore additional tax payable, in those future periods — precisely what a deferred tax liability represents: tax that is currently being deferred but will become payable later as this taxable temporary difference reverses.

Question 5

A company has an unused tax loss of ₹80 lakh carried forward from prior years. Its tax rate is 25%. Explain the specific condition Ind AS 12 imposes before a deferred tax asset can be recognised for this unused tax loss, and what evidence would support satisfying that condition.

Accepted Answer

Ind AS 12 permits recognition of a deferred tax asset for an unused tax loss only to the extent it is probable that future taxable profit will be available against which the unused tax loss can be utilised, before the loss expires under applicable tax law if such expiry applies; this is a deliberately more demanding recognition threshold than the general 'probable' threshold applied to ordinary deductible temporary differences, because the existence of an unused tax loss is itself often evidence that the entity has recently experienced losses, which is precisely the situation where confidence in future taxable profit is hardest to establish reliably. Evidence supporting recognition would include the entity having sufficient taxable temporary differences of its own (deferred tax liabilities) that will reverse and generate taxable income in the same periods as the loss can be utilised, or convincing other evidence such as reliable forecasts of future profitability, provided those forecasts are not simply optimistic projections but are genuinely supportable given the entity's specific circumstances, since a history of recent losses is itself an indicator that future taxable profit may not be available, requiring more persuasive evidence before the ₹80 lakh × 25% = ₹20 lakh deferred tax asset can be recognised.

Question 6

A government has introduced a bill in parliament to reduce the corporate tax rate from 30% to 25%, and the bill has passed all substantive legislative stages required before formal presidential assent, with only a remaining procedural formality left before it becomes law. Explain which tax rate should be used to measure deferred tax at the reporting date, occurring before formal assent is given.

Accepted Answer

Ind AS 12 requires deferred tax to be measured at the tax rates expected to apply in the period the asset is realised or liability settled, based on tax rates and laws that have been enacted, or substantively enacted, by the reporting date; substantive enactment does not require the final formal step, such as presidential assent or gazette notification, to have occurred, provided the remaining steps are essentially a formality and future changes to the substance of the legislation are not expected. Since the bill here has passed all substantive legislative stages and only a remaining procedural formality is left, the reduced 25% rate should be regarded as substantively enacted, and deferred tax should therefore be measured using the 25% rate, not the still technically-current 30% rate, since the substantively enacted future rate is the rate genuinely expected to apply when the relevant temporary differences reverse.

Question 7

A company grants 10,000 share options to employees, with a 3-year service vesting condition, and a grant-date fair value of ₹40 per option. At the end of Year 1, the company estimates 90% of the options will vest; at the end of Year 2, this estimate is revised to 85%; the options fully vest at the end of Year 3 with 88% actually vesting. Compute the share-based payment expense for each of the three years.

Accepted Answer

Total fair value at grant date = 10,000 options × ₹40 = ₹4,00,000, and since this is equity-settled, this fair value is never remeasured for share price changes; only the estimate of the number of instruments expected to vest is revised for a non-market service condition. Year 1: cumulative expense = ₹4,00,000 × 90% × (1/3 of vesting period elapsed) = ₹1,20,000; expense for Year 1 = ₹1,20,000. Year 2: cumulative expense = ₹4,00,000 × 85% × (2/3 elapsed) = ₹2,26,667; expense for Year 2 = ₹2,26,667 − ₹1,20,000 = ₹1,06,667. Year 3: cumulative expense = ₹4,00,000 × 88% (actual vesting, full 3/3 elapsed) = ₹3,52,000; expense for Year 3 = ₹3,52,000 − ₹2,26,667 = ₹1,25,333. This year-by-year truing-up of the cumulative expense to the current best estimate of vesting, while never revising the ₹40 grant-date fair value itself, is the standard pattern for a non-market vesting condition under Ind AS 102.

Question 8

A company grants share options with a vesting condition that the company's share price must reach ₹500 within 2 years. The grant-date fair value, computed using an option-pricing model that already factors in the probability of achieving this share price target, is ₹18 per option. At the end of Year 2, the share price target is not achieved and the options lapse without vesting. Explain how this should be treated, and whether the previously recognised expense should be reversed.

Accepted Answer

A share price target is a market condition, and Ind AS 102 requires market conditions to be factored into the grant-date fair value estimate itself, using a valuation technique such as an appropriate option-pricing model that incorporates the probability of the market condition being achieved, rather than being treated as a vesting condition subject to subsequent reassessment the way a non-market condition (such as continued employment) would be. Because the market condition's probability of achievement is already built into the ₹18 grant-date fair value, an entity recognises the share-based payment expense over the vesting period as though the market condition will be achieved, regardless of whether it is actually achieved by the end of the period. Since the share price target is not achieved and the options lapse, no reversal of the previously recognised expense occurs; the expense already recognised remains standing, because Ind AS 102 treats the failure of a market condition as no different, for expense recognition purposes, from an employee who satisfies a market-condition-based award vesting but the entity's own share price simply did not perform as the market itself had, at grant date, assessed as reasonably probable — the accounting outcome does not get to be undone by the market condition's ultimate non-achievement.

Question 9

A company grants cash-settled share appreciation rights (SARs) to an employee. At grant date, the fair value of each SAR is ₹30; at the following reporting date, fair value has risen to ₹45; at settlement date, it is ₹38. Explain how the liability for these SARs should be measured at each of these three points, and why this differs from equity-settled treatment.

Accepted Answer

For a cash-settled share-based payment, Ind AS 102 requires the liability to be measured, initially and at the end of each reporting period until settlement, at the fair value of the SARs at that specific date, with any change in fair value recognised in profit or loss; the liability is therefore measured at ₹30 per SAR at grant date (as the starting point for the vesting-period expense build-up), remeasured to ₹45 per SAR at the following reporting date (with the increase from ₹30 to ₹45 driving an additional expense in that period, on top of any additional vesting-period service accrued), and finally measured at ₹38 per SAR at settlement date (the actual cash amount ultimately paid, again requiring a further remeasurement adjustment from the ₹45 previously recognised). This differs fundamentally from equity-settled treatment, where the ₹40-per-option grant-date fair value from the earlier example is fixed once and for all at grant date and never remeasured for subsequent share price movements, because the entity's actual obligation under a cash-settled arrangement is a cash amount that genuinely varies with the underlying share price until the moment of settlement, requiring ongoing remeasurement exactly as any other variable-value liability would, whereas an equity-settled arrangement's obligation is to deliver a fixed number of equity instruments, whose current market value fluctuation is irrelevant to what the entity has actually undertaken to deliver.

Question 10

At its reporting date, a company holds a foreign currency trade receivable, foreign currency inventory carried at historical cost, and a foreign currency investment property carried at fair value. Explain how each should be treated for foreign exchange retranslation purposes under Ind AS 21.

Accepted Answer

The foreign currency trade receivable is a monetary item, a fixed and determinable amount of foreign currency to be received, and is retranslated at the closing rate at each reporting date, with the resulting exchange difference recognised in profit or loss. The foreign currency inventory carried at historical cost is a non-monetary item measured at historical cost, and is not retranslated at all at subsequent reporting dates; it remains translated at the exchange rate ruling on the date of the original transaction that gave rise to its recognition, meaning its reported rupee carrying amount does not change merely because the exchange rate has since moved. The foreign currency investment property carried at fair value is a non-monetary item measured at fair value, and is translated using the exchange rate at the date its fair value was most recently determined; the resulting exchange component embedded within the overall fair value change follows the same profit-or-loss treatment that the fair value model for investment property itself requires under Ind AS 40, since the exchange effect here is inseparable from, and follows, the treatment of the fair value change as a whole rather than being extracted and treated on its own separate basis.

Question 11

A parent company translates the financial statements of its wholly owned foreign subsidiary for consolidation. The subsidiary's assets and liabilities are translated at the closing rate, and its income and expenses at the average rate for the year. Explain why a resulting exchange difference necessarily arises purely from this translation process, and where it is recognised.

Accepted Answer

An exchange difference necessarily arises because assets and liabilities are translated at the closing rate while income and expenses, which flow into and change the level of net assets over the year, are translated at a different rate, the average rate for the year (or transaction-date rates); since the subsidiary's net assets at the start of the year, plus its profit for the year (translated at the average rate) plus any other equity movements, will not, purely as an arithmetic consequence of using two different exchange rates for these different components, exactly equal the subsidiary's net assets at the end of the year when that closing net asset figure is instead translated directly at the closing rate, a difference between these two ways of arriving at the same net position necessarily emerges, purely as a mechanical translation artefact rather than reflecting any genuine economic gain or loss to the group. This resulting exchange difference is recognised in other comprehensive income and accumulated in a separate component of equity (the foreign currency translation reserve), not in profit or loss, because it is not considered a genuine, realised gain or loss from the group's perspective while the investment in the foreign operation continues to be held; it is reclassified to profit or loss only upon disposal, in full or in specified partial circumstances, of the foreign operation, at which point the cumulative translation effect the group has borne over the life of that investment is finally recognised as part of the gain or loss on disposal.

Question 12

A company has a non-cancellable supply contract requiring it to purchase raw material for the next 2 years at a fixed price of ₹100 per unit, but the market price has fallen and the raw material can now be obtained elsewhere for ₹70 per unit. The contract can be exited by paying a one-time penalty of ₹8 lakh; the ongoing loss of continuing to fulfil the contract at the above-market price is estimated at ₹15 lakh over its remaining life. Determine the provision to be recognised for this onerous contract.

Accepted Answer

Ind AS 37 requires a provision for an onerous contract to be measured at the lower of the cost of fulfilling the contract, ₹15 lakh (the ongoing loss from continuing to pay above-market prices for the contract's remaining life), and the cost of exiting the contract, ₹8 lakh (the one-time penalty for early termination), since a rational entity facing this choice would exit the contract rather than continue fulfilling it, given the exit cost is lower than the cost of continued fulfilment. A provision of ₹8 lakh should therefore be recognised, reflecting the lower of these two alternative costs, on the reasoning that Ind AS 37's onerous contract provision is meant to reflect the unavoidable net cost the entity genuinely cannot escape, which in this case is the smaller exit penalty rather than the larger cost of continuing to honour the above-market contract.

Question 13

A company revalues a building upward by ₹40 lakh, recognising the increase in OCI as revaluation surplus under Ind AS 16. This revaluation creates a taxable temporary difference of ₹40 lakh, and the applicable tax rate is 25%. Explain where the resulting deferred tax should be recognised, and why.

Accepted Answer

Ind AS 12 requires deferred tax relating to an item recognised in other comprehensive income to itself be recognised in other comprehensive income, following the same location as the underlying item that gave rise to the temporary difference, rather than being routed through profit or loss regardless of where the original item was recognised. Since the ₹40 lakh revaluation increase itself was recognised in OCI, the resulting deferred tax liability of ₹40 lakh × 25% = ₹10 lakh must also be recognised in OCI, reducing the net revaluation surplus recognised in OCI to ₹30 lakh (₹40 lakh gross increase less ₹10 lakh deferred tax), rather than recognising the full ₹40 lakh revaluation gain in OCI and separately charging the ₹10 lakh deferred tax to profit or loss, which would incorrectly show a tax charge in profit or loss unrelated to any item actually recognised there. This 'follow the item' principle for deferred tax location is a specific, frequently tested feature of Ind AS 12, ensuring that the tax consequence of a transaction is presented consistently with where the transaction's own gain or loss was itself recognised.

Question 14

A company's board approves, in principle, a plan to close two factories, but the plan has not yet been formally detailed, announced to employees, or begun implementation. Explain whether a restructuring provision should be recognised at this stage.

Accepted Answer

No provision should be recognised at this stage. Ind AS 37 requires a constructive obligation for restructuring to arise only once an entity has a detailed formal plan for the restructuring, identifying at minimum the business or part of a business concerned, the principal locations affected, the location, function and approximate number of employees who will be compensated for terminating their services, the expenditures involved, and when the plan will be implemented, and has either started to implement that plan or announced its main features to those affected by it, creating a valid expectation that the restructuring will actually be carried out. A mere board decision in principle, without a sufficiently detailed formal plan and without any communication to affected employees or commencement of implementation, does not create the valid expectation Ind AS 37 requires, and recognising a provision at this early stage would be recognising an obligation the entity is not yet genuinely, constructively committed to in a way third parties could reasonably rely upon.

Question 15

A company recognises a provision of ₹20 lakh for a warranty obligation, and separately holds an insurance policy that is virtually certain to reimburse ₹15 lakh of this amount if the warranty claim materialises. Explain how the reimbursement should be presented in the financial statements.

Accepted Answer

Ind AS 37 requires a reimbursement to be recognised as a separate asset, not netted against the provision itself, but only when it is virtually certain that the reimbursement will be received; here, since the insurance recovery is virtually certain, a separate asset of ₹15 lakh is recognised for the expected reimbursement, alongside the ₹20 lakh provision recognised in full as a liability. In the statement of profit and loss, however, the expense relating to the provision may be presented net of the amount recognised for the reimbursement, meaning the two items, while shown gross (not netted) on the balance sheet, may be shown net in the income statement; this distinction, gross presentation of the asset and liability on the balance sheet but permitted net presentation of the related expense in profit or loss, is a specific, examinable feature of how Ind AS 37 handles reimbursements.

Practice — Ind AS on Liabilities and Items Impacting Financial Statements

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