Application of Accounting Standards: Notes (Part - 2) | Advanced Accounting for CA Intermediate

Percentage Completion Method

• Construction contracts are mostly long term, i.e. they take more than one accounting year to complete. This means, the final outcome (profit/ loss) of a construction contract can be determined only after a number of years from the year of commencement of construction are over. It is nevertheless possible to recognise revenue annually in proportion of progress of work to be matched with corresponding construction costs incurred in that year. This method of accounting, called the stage of completion method (percentage completion method), provides useful information on the extent of contract activity and performance during an accounting period. 
• AS 7 prescribes that the percentage completion method should not be used unless it is possible to make a reasonable estimate of the final outcome of the contract.  Also, AS 7 provides that whenever total contract cost is expected to exceed the total contract revenue, the loss should be recognised as an expense immediately. 
• As per AS 7, the outcome of fixed price contracts can be estimated reliably when all the following conditions are satisfied:
  (i) total contract revenue can be measured reliably;
  (ii) it is probable that the economic benefits associated with the contract will flow to the enterprise;
  (iii) both the contract costs to complete the contract and the stage of contract completion at the reporting date can be measured reliably.
  (iv) the contract costs attributable to the contract can be clearly identified and measured reliably so that actual contract costs incurred can be compared with prior estimates.
• The outcome of a cost plus contract can be estimated reliably when all the following conditions are satisfied:
  (i) it is probable that the economic benefits associated with the contract will flow to the enterprise.
  (ii) the contract costs attributable to the contract, whether or not specifically reimbursable, can be clearly identified and measured reliably.

Example 1: (The percentage completion method)

X Ltd. commenced a construction contract on 01/04/X1. The fixed contract price agreed was Rs.  2,00,000. The company incurred Rs.  81,000 in 20X1-X2 for 45% work and received Rs.  79,000 as progress payment from the customer. The cost incurred in  20X2-X3 was Rs.  89,000 to complete the rest of work.

AS 7 provides that the percentage completion method should not be applied if the outcome of a construction contract cannot be estimated reliably. In such cases:
(a) revenue should be recognised only to the extent of contract costs incurred of which recovery is probable.
(b) contract costs should be recognised as an expense in the period in which they are incurred.

• When it is probable that total contract costs will exceed total contract revenue, the expected loss on the construction contract should however be recognised as an expense immediately.
• When the uncertainties that prevented the outcome of the contract being estimated reliably cease to exist, revenue and expenses associated with the construction contract should be recognised by the percentage completion method.

Example 2: X Ltd. commenced a construction contract on 01/04/X1. The contract price agreed was reimbursable cost plus 10%. The company incurred Rs.  1,00,000 in 20X1-X2, of which cost of Rs.  90,000 is reimbursable. The further non-reimbursable costs to be incurred to complete the contract are estimated at Rs.  5,000. The other costs to complete the contract could not be estimated reliably.

The Profit & Loss A/c extract of X Ltd. for 20X1-X2 is shown below:

Treatment of Costs Relating to Future Activity

Under the percentage of completion method, contract revenue is recognised as revenue in the statement of profit and loss in the accounting periods in which the work is performed. Contract costs are usually recognised as an expense in the statement of profit and loss in the accounting periods in which the work to which they relate is performed. The contract costs that relate to future activity on the contract are however recognised as an asset provided it is probable that they will be recovered. Such costs represent an amount due from the customer and are often classified as contract work in progress.

Uncollectable Contract Revenue

When an uncertainty arises about the collectability of an amount already included in contract revenue, and already recognised in the statement of profit and loss, the uncollectable amount or the amount in respect of which recovery has ceased to be probable is recognised as an expense rather than as an adjustment of the amount of contract revenue. 

Stage of Completion

The stage of completion of a contract may be determined in a variety of ways. The enterprise uses the method that measures reliably the work performed. Depending on the nature of the contract, the methods may include:

• the proportion that contract costs incurred for work performed upto the reporting date bear to the estimated total contract costs; or
• surveys of work performed; or
• completion of a physical proportion of the contract work.

Progress payments and advances received from customers may not necessarily reflect the work performed. 

Example 3: Show Profit & Loss A/c (Extract) in books of a contractor in respect of the following data.

Combining and Segmenting Construction Contracts

A contractor may undertake a number of contracts.
The standard identifies certain cases where for the purposes of accounting, it is necessary to apply the Standard to the separately identifiable components of a single contract or to a group of contracts together in order to reflect the substance of a contract or a group of contracts.
(a) When a contract covers a number of assets, the construction of each asset should be treated as a separate construction contract when:

• separate proposals have been submitted for each asset;
• each asset has been subject to separate negotiation and the contractor and customer have been able to accept or reject that part of the contract relating to each asset; and
• the costs and revenues of each asset can be identified.

(b) A group of contracts, whether with a single customer or with several customers, should be treated as a single construction contract when:

• the group of contracts is negotiated as a single package;
• the contracts are so closely interrelated that they are, in effect, part of a single project with an overall profit margin; and
• the contracts are performed concurrently or in a continuous sequence.

(c) A contract may provide for the construction of an additional asset at the option of the customer or may be amended to include the construction of an additional asset. The construction of the additional asset should be treated as a separate construction contract when:

• the asset differs significantly in design, technology or function from the asset or assets covered by the original contract; or
• the price of the asset is negotiated without regard to the original contract price.

Example 4: XYZ construction Ltd, a construction company undertakes the construction of an industrial complex. It has separate proposals raised for each unit to be constructed in the industrial complex. Since each unit is subject to separate negotiation, he is able to identify the costs and revenues attributable to each unit. Should XYZ Ltd, treat construction of each unit as a separate construction contract according to AS 7?

As per AS 7 ‘Construction Contracts’, when a contract covers a number of assets, the construction of each asset should be treated as a separate construction contract when:
(a) separate proposals have been submitted for each asset;
(b) each asset has been subject to separate negotiation and the contractor and customer have been able to accept or reject that part of the contract relating to each asset; and
(c)  the costs and revenues of each asset can be identified.

Therefore, XYZ Ltd. is required to treat construction of each unit as a separate construction contract.

Contract Revenue and Costs

(a) Contract revenue should comprise:

• the initial amount of revenue agreed in the contract; and
• variations in contract work, claims and incentive payments to the extent that it is probable that they will result in revenue and they are capable of being reliably measured.

(b) Contract costs should comprise:

• costs that relate directly to the specific contract;
• costs that are attributable to contract activity in general and can be allocated to the contract; and
• such other costs as are specifically chargeable to the customer under the terms of the contract.

NOTE: 

(1) Examples of costs that relate directly to a specific contract include:

• site labour costs, including site supervision
• costs of materials used in construction
• depreciation of plant and equipment used on the contract
• costs of moving plant, equipment and materials to and from the contract site
• costs of hiring plant and equipment
• costs of design and technical assistance that is directly related to the contract 
• the estimated costs of rectification and guarantee work, including expected warranty costs
• claims from third parties
  Direct costs can be reduced by incidental income that is not included in contract revenue, e.g. sale of surplus material and disposal of plant and equipment.

(2) Example of costs that may be attributable to contract activity in general and can be allocated to specific contracts include:

• insurance
• costs of design and technical assistance that is not directly related to a specific contract
• construction overheads
  The allocation of indirect costs should be based on normal levels of construction activity. The allocable costs may include borrowing costs as per AS 16.

(3) Examples of costs that cannot be attributed to contract activity or cannot be allocated to a contract are excluded from the costs of a construction contract. Such costs include:

• general administration costs for which reimbursement is not specified in the contract
• selling costs
• research and development costs for which reimbursement is not specified in the contract
• depreciation of idle plant and equipment that is not used on a particular contract

Changes in Estimates

The percentage of completion method is applied on a cumulative basis in each accounting period to the current estimates of contract revenue and contract costs. Therefore, the effect of a change in the estimate of contract revenue or contract costs, or the effect of a change in the estimate of the outcome of a contract, is accounted for as a change in accounting estimate in accordance with AS 5. The changed estimates are used in determination of the amount of revenue and expenses recognised in the statement of profit and loss in the period in which the change is made and in subsequent periods. 

Disclosure

(a) An enterprise should disclose:
(i) the amount of contract revenue recognised as revenue in the period;
(ii) the methods used to determine the contract revenue recognised in the period; and 

(iii) the methods used to determine the stage of completion of contracts in progress.  

(b) An enterprise should disclose following in respect of contracts in progress at the reporting date:
(i) the aggregate amount of costs incurred and recognised profits (less recognised losses) upto the reporting date;
(ii) the amount of advances received; and
(iii) the amount of retentions.

• Retentions are amounts of progress billings which are not paid until the satisfaction of conditions specified in the contract for the payment of such amounts or until defects have been rectified.
• Progress billings are amounts billed for work performed on a contract whether or not they have been paid by the customer.
• Advances are amounts received by the contractor before the related work is performed.

(c) An enterprise should present:
(i) the gross amount due from customers for contract work as an asset; and
(ii) the gross amount due to customers for contract work as a liability.

Example 1: A firm of contractors obtained a contract for construction of bridges across river Revathi.  The following details are available in the records kept for the year ended 31st March, 20X1.

The firm seeks your advice and assistance in the presentation of accounts keeping in view the requirements of AS 7 issued by your institute.

According AS 7, when it is probable that total contract costs will   exceed total contract revenue, the expected loss should be recognized as an expense immediately. 

(c) Proportion of total contract value recognised as revenue:
55% of Rs.  1,000 lakhs = Rs.  550 lakhs
(d) Amount due from/to customers  = (Contract costs + Recognised profits – Recognised Losses) – (Progress payments received + Progress payments to be received)
= (605 + Nil – 100) – (400 + 140) Rs. in lakhs
= [505 – 540] Rs.  in lakhs
Amount due to customers   = Rs.  35 lakhs
The amount of Rs.  35 lakhs will be shown in the balance sheet as liability.
(e) The relevant disclosures under AS 7 are given below:

Example 2: On 1st December, 20X1, Vishwakarma Construction Co. Ltd. undertook a contract to construct a building for Rs.  85 lakhs.  On 31st March, 20X2, the company found that it had already spent Rs.  64,99,000 on the construction.  Prudent estimate of additional cost for completion was Rs.  32,01,000.  What amount should be recognized in the statement of profit and loss for the year ended 31st March, 20X2 as per provisions of Accounting Standard 7 (Revised)?

According to AS 7, the amount of Rs.  12,00,000 is required to be recognised as an expense.
Contract work in progress = = 67%
Proportion of total contract value recognised as turnover:
= 67% of Rs.  85,00,000 = Rs.  56,95,000.

Revenue Recognition (AS 9)

AS 9 is mandatory for all enterprises. AS 9 deals with the bases for recognition of revenue in the statement of profit and loss of an enterprise. The Standard is concerned with the recognition of revenue arising in the course of the ordinary activities of the enterprise from

• the sale of goods
• the rendering of services
• the use by others of enterprise resources yielding interest, royalties and dividends\

AS 9 does not deal with the following aspects of revenue recognition to which special considerations apply:

• Revenue arising from construction contracts;
• Revenue arising from hire-purchase, lease agreements;
• Revenue arising from government grants and other similar subsidies;
• Revenue of insurance companies arising from insurance contracts.

Examples of items not included within the definition of “revenue” for the purpose of AS 9 are:

• Realized gains resulting from the disposal of, and unrealized gains resulting from the holding of, non-current assets e.g. appreciation in the value of fixed assets;
• Unrealized holding gains resulting from the change in value of current assets, and the natural increases in herds and agricultural and forest products;
• Realized or unrealized gains resulting from changes in foreign exchange rates and adjustments arising on the translation of foreign currency financial statements;
• Realized gains resulting from the discharge of an obligation at less than its carrying amount;
• Unrealized gains resulting from the restatement of the carrying amount of an obligation.

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

In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration.

Sale of Goods 

Revenue from sales transactions should be recognised when the requirements as to performance set out in below paragraph are satisfied, provided that at the time of performance it is not unreasonable to expect ultimate collection. If at the time of raising of any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed. 

In a transaction involving the sale of goods, performance should be regarded as being achieved when the following conditions have been fulfilled: 

• the seller of goods has transferred to the buyer the property in the goods for a price
• all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to a degree usually associated with ownership; and
• no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods.

Rendering of Services

Revenue from service transactions is usually recognised as the service is performed. There are two methods of recognition of revenue from service transaction, viz, 

 Proportionate Completion Method is a method of accounting which recognises revenue in the statement of profit and loss proportionately with the degree of completion of services under a contract. Here performance consists of the execution of more than one act. Revenue is recognised proportionately by reference to the performance of each act.

Completed Service Contract Method is a method of accounting which recognises revenue in the statement of profit and loss only when the rendering of services under a contract is completed or substantially completed. In this method performance consists of the execution of a single act e.g. installation of a machine, or repair service. 

The completed service contract method is relevant to these patterns of performance and accordingly revenue is recognised when the sole or final act takes place and the service becomes chargeable. Revenue from sales or service transactions should be recognised when the service is performed provided that at the time of performance it is not unreasonable to expect ultimate collection. If at the time of raising of any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed.

Income from other sources - Interest, Royalties and Dividends

Use by others of such enterprise resources gives rise to:

• Interest: charges for the use of cash resources or amounts due to the enterprise. Revenue is recognised on a time proportion basis taking into account the amount outstanding and the rate applicable.
• Royalties: charges for the use of such assets as know-how, patents, trade marks and copyrights. Revenue is recognized on an accrual basis in accordance with the terms of the relevant agreement.
• Dividends: rewards from the holding of investments in shares. Revenue is recognized when the owner’s right to receive payment is established.

Revenue arising from the use by others of enterprise resources yielding interest, royalties and dividends should only be recognized when no significant uncertainty as to measurability or collectability exists.

* Sale of goods “for consideration” should be considered as situation when no significant uncertainty exists regarding amount of consideration. 

Effect of Uncertainties on Revenue Recognition

Where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, revenue recognition is postponed to the extent of uncertainty involved. 

When the uncertainty relating to collectability arises subsequent to the time of sale or the rendering of the service, it is more appropriate to make a separate provision to reflect the uncertainty rather than to adjust the amount of revenue originally recorded. 

An essential criterion for the recognition of revenue is that the consideration receivable for the sale of goods, the rendering of services or from the use by others of enterprise resources is reasonably determinable. When such consideration is not determinable within reasonable limits, the recognition of revenue is postponed.

Disclosure 

An enterprise should disclose the circumstances in which revenue recognition has been postponed pending the resolution of significant uncertainties. 

Example 1: The Board of Directors decided on 31.3.20X2 to increase the sale price of certain items retrospectively from 1st January, 20X2.  In view of this price revision with effect from 1st January 20X2, the company has to receive Rs.  15 lakhs from its customers in respect of sald whether to include Rs.  15 lakhs in the sales for 20X1-20X2.Advise.es made from 1st January, 20X2 to 31st March, 20X2.  Accountant cannot make up his min

Price revision was effected during the current accounting period 20X1-20X2.  As a result, the company stands to receive Rs.  15 lakhs from its customers in respect of sales made from 1st January, 20X2 to 31st March, 20X2. If the company is able to assess the ultimate collection with reasonable certainty, then additional revenue arising out of the said price revision may be recognized in 20X1-20X2.

Example 2: Y Ltd., used certain resources of X Ltd. In return X Ltd. received Rs.  10 lakhs and Rs.  15 lakhs as interest and royalties respective from Y Ltd. during the year 20X1-X2.  You are required to state whether and on what basis these revenues can be recognized by X Ltd.

As per AS 9 on Revenue Recognition, revenue arising from the use by others of enterprise resources yielding interest and royalties should only be recognized when no significant uncertainty as to measurability or collectability exists. These revenues are recognized on the following bases:

• Interest: on a time proportion basis taking into account the amount outstanding and the rate applicable. Therefore X Ltd. should recognize interest revenue of Rs. 10 Lakhs
• Royalties: on an accrual basis in accordance with the terms of the relevant agreement. X Ltd. therefore should recognize royalty revenue of Rs. 15 Lakhs.

Example 3:  A claim lodged with the Railways in March, 20X1 for loss of goods of Rs.  2,00,000 had been passed for payment in March, 20X3 for Rs.  1,50,000.  No entry was passed in the books of the Company, when the claim was lodged.  Advise P Co. Ltd. about the treatment of the following in the Final Statement of Accounts for the year ended 31st March, 20X3.

AS 9 on ‘Revenue Recognition’ states that where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, revenue recognition is postponed to the extent of uncertainty involved. When recognition of revenue is postponed due to the effect of uncertainties, it is considered as revenue of the period in which it is properly recognised.  In this case it may be assumed that collectability of claim was not certain in the earlier periods.  This is supposed from the fact that only Rs.  1,50,000 were collected against a claim of Rs.  2,00,000. So this transaction can not be taken as a Prior Period Item. In the light of AS 5, it will not be treated as extraordinary item.  However, AS 5 states that when items of income and expense within profit or loss from ordinary activities are of such size, nature, or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately. Accordingly, the nature and amount of this item should be disclosed separately.

Example 4: In the year 20X1-X2, XYZ supplied goods on Consignment basis to ABC – a retail outlet worth Rs. 10,00,000. As per the terms, ABC will only pay XYZ for the goods which are sold by them to the third party. Rest of the goods can be returned back to XYZ and ABC will not have any further liability for these goods.  During the year 20X1-X2, ABC has sold goods worth Rs. 5,50,000 only and rest of the goods are still lying in its store which may get sold by next year. Advise XYZ, how much revenue it can recognize in its books for period 20X1-X2. 

As per AS 9, For consignment risk and rewards are not transferred to the customer on just delivery of the goods and no revenue should be recognized until the goods are sold to a third party.  Therefore, XYZ can recognize revenue of Rs. 5,50,000 only.

Accounting for Amalgamations (AS 14 (Revised)

AS 14 (Revised) deals with the accounting to be made in the books of Transferee company in the case of amalgamation and the treatment of any resultant goodwill or reserve. 

• An amalgamation may be either in the nature of merger or purchase.  The standard specifies the conditions to be satisfied by an amalgamation to be considered as amalgamation in nature of merger or purchase.
• An amalgamation in nature of merger is accounted for as per pooling of interests method and in nature of purchase is dealt under purchase method.
• The standard describes the disclosure requirements for both types of amalgamations in the first financial statements. We will discuss the other amalgamation aspects in detail in subsequent paragraphs of this unit.
• AS 14 (Revised) does not deal with cases of acquisitions.  The distinguishing feature of an acquisition is that the acquired company is not dissolved and its separate entity continues to exist. 

Definition of the Terms used in the Standard

• Amalgamation means an amalgamation pursuant to the provisions of the Companies Act, 2013 or any other statute which may be applicable to companies and includes ‘merger’.
• Transferor company means the company which is amalgamated into another company.
• Transferee company means the company into which a transferor company is amalgamated.

Types of Amalgamations

Amalgamations fall into two broad categories.

• Merger - In amalgamations where there is a genuine pooling not merely of the assets and liabilities of the amalgamating companies but also of the shareholders’ interests and of the businesses of these companies.
• Purchase - In amalgamations which are in effect a mode by which one company acquires another company and as a consequence:
• the shareholders of the company which is acquired normally do not continue to have a proportionate share in the equity of the combined company, or 
• the business of the company which is a cquired is not intended to be continued. Such amalgamations are amalgamations in the nature of 'purchase'.

Amalgamation in the Nature of Merger

Amalgamation in the nature of merger is an amalgamation which satisfies all the following conditions.
(i) All the assets and liabilities of the transferor company become, after amalgamation, the assets and liabilities of the transferee company.
(ii) Shareholders holding not less than 90% of the face value of the equity shares of the transferor company (other than the equity shares already held therein, immediately before the amalgamation, by the transferee company or its subsidiaries or their nominees) become equity shareholders of the transferee company by virtue of the amalgamation.
(iii) The consideration for the amalgamation receivable by those equity shareholders of the transferor company who agree to become equity shareholders of the transferee company is discharged by the transferee company wholly by the issue of equity shares in the transferee company, except that cash may be paid in respect of any fractional shares.
(iv) The business of the transferor company is intended to be carried on, after the amalgamation, by the transferee company.
(v) No adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated in the financial statements of the transferee company except to ensure uniformity of accounting policies.

Example: X Ltd and Y Ltd, are both in telecom business. As per the arrangeme nt X Ltd will get merged with Y Ltd and their shareholders will get shares in Y Ltd.  X Ltd operations will going to be continued under Y ltd.

Amalgamation in the Nature of Purchase 

Amalgamation in the nature of purchase is an amalgamation which does not satisfy any one or more of the conditions specified above for “Amalgamation in the nature of merger”.

Methods of Accounting for Amalgamations

There are two main methods of accounting for amalgamations.

• For an amalgamation in the nature of merger - pooling of interests method and
• For an amalgamation in the nature of purchase - purchase method.

Pooling of Interests Method

• Pooling of interests is a method of accounting for amalgamations the object of which is to account for the amalgamation as if the separate businesses of the amalgamating companies were intended to be continued by the transferee company. Accordingly, only minimal changes are made in aggregating the individual financial statements of the amalgamating companies.
• Under this method, the assets, liabilities and reserves of the transferor company are recorded by the transferee company at their existing carrying amounts 
• If, at the time of the amalgamation, the transferor and the transferee companies have conflicting accounting policies, a uniform set of accounting policies is adopted following the amalgamation.  The effects on the financial statements of any changes in accounting policies are reported in accordance with AS 5.

Purchase Method 

Under the purchase method, the transferee company accounts for the amalgamation either

• By incorporating the assets and liabilities at their existing carrying amounts or
• By allocating the consideration to individual identifiable assets and liabilities of the transferor company on the basis of their fair values at the date of amalgamation. The identifiable assets and liabilities may include assets and liabilities not recorded in the financial statements of the transferor company.

Consideration

• Consideration for the amalgamation means the aggregate of the shares and other securities issued and the payment made in the form of cash or other assets by the transferee company to the shareholders of the transferor company. In determining the value of the consideration, an assessment is made of the fair value of its elements.
• Many amalgamations recognise that adjustments may have to be made to the consideration in the light of one or more future events. When the additional payment is probable and can reasonably be estimated at the date of amalgamation, it is included in the calculation of the consideration. In all other cases, the adjustment is recognised as soon as the amount is determinable.

Treatment of Reserves of the Transferor Company on Amalgamation

• If the amalgamation is an ‘amalgamation in the nature of merger’, the identity of the reserves is preserved and they appear in the financial statements of the transferee company in the same form in which they appeared in the financial statements of the transferor company.
• Thus, for example, the General Reserve of the transferor company becomes the General Reserve of the transferee company, the Capital Reserve of the transferor company becomes the Capital Reserve of the transferee company and the Revaluation Reserve of the transferor company becomes the Revaluation Reserve of the transferee company. As a result of preserving the identity, reserves which are available for distribution as dividend before the amalgamation would also be available for distribution as dividend after the amalgamation.

Adjustments to reserves - Amalgamation in the Nature of Merger

When an amalgamation is accounted for using the pooling of interests method, the reserves of the transferee company are adjusted to give effect to the following:

• A uniform set of accounting policies should be adopted following the amalgamation and, hence, the policies of the transferor and the transferee are aligned.
• Difference between the amount recorded as share capit al issued (plus any additional consideration in the form of cash or other assets) and the amount of share capital of the transferor company.

Adjustments to reserves - Amalgamation in the Nature of Purchase

• If the amalgamation is an ‘amalgamation in the nature of purchase’, the identity of the reserves, other than the statutory reserves is not preserved. The amount of the consideration is deducted from the value of the net assets of the transferor company acquired by the transferee company. If the result of the computation is negative, the difference is debited to goodwill arising on amalgamation and if the result of the computation is positive, the difference is credited to Capital Reserve.
• Certain reserves may have been created by the transferor company pursuant to the requirements of, or to avail of the benefits under, the Income-tax Act, 1961; for example, Development Allowance Reserve, or Investment Allowance Reserve or any other statutory reserve. The Act requires that the identity of the reserves should be preserved for a specified period. Likewise, certain other reserves may have been created in the financial statements of the transferor company in terms of the requirements of other statutes. Though normally, in an amalgamation in the nature of purchase, the identity of reserves is not preserved, an exception is made in respect of reserves of the aforesaid nature (referred to hereinafter as ‘statutory reserves’) and such reserves retain their identity in the financial statements of the transferee company in the same form in which they appeared in the financial statements of the transferor company, so long as their identity is required to be maintained to comply with the relevant statute. This exception is made only in those amalgamations where the requirements of the relevant statute for recording the statutory reserves in the books of the transferee company are complied with.
• In such cases the statutory reserves are recorded in the financial statements of the transferee company by a corresponding debit to a suitable account head (e.g., ‘Amalgamation Adjustment Reserve’) which is presented as a separate line item. When the identity of the statutory reserves is no longer required to be maintained, both the reserves and the aforesaid account are reversed.

The Standard gives a title, which reads as "Reserve". This gives rise to following requirements.
(1) The corresponding debit is "also" to a Reserve Account
(2) That Reserve account will show a negative balance
(3) But it has to be shown as a separate line item - Which implies, that this debit "cannot be set off against Statutory reserve taken over".

So the presentation will be as follows:
Notes to Accounts for “Reserves and Surplus”

Treatment of Goodwill Arising on Amalgamation

Goodwill arising on amalgamation represents a payment made in anticipation of future income and it is appropriate to treat it as an asset to be amortised to income on a systematic basis over its useful life.  Due to the nature of goodwill, it is frequently difficult to estimate its useful life with reasonable certainty.  Such estimation is, therefore, made on a prudent basis. Accordingly, it is considered appropriate to amortise goodwill over a period not exceeding five years unless a somewhat longer period can be justified. 

Factors which may be considered in estimating the useful life of goodwill arising on amalgamation include:
(a)  the foreseeable life of the business or industry
(b)  the effects of product obsolescence, changes in demand and other economic factors 

(c) the service life expectancies of key individuals or groups of employees
(d)  expected actions by competitors or potential competitors
(e)  legal, regulatory or contractual provisions affecting the useful life

Balance of Profit and Loss Account

In the case of an ‘amalgamation in the nature of merger’, the balance of the Profit and Loss Account appearing in the financial statements of the transferor company is aggregated with the corresponding balance appearing in the financial statements of the transferee company. Alternatively, it is transferred to the General Reserve, if any.

In the case of an ‘amalgamation in the nature of purchase’, the balance of the Profit and Loss Account appearing in the financial statements of the transferor company, whether debit or credit, loses its identity.

Disclosures

For all amalgamations, the following disclosures are considered appropriate in the first financial statements following the amalgamation:

• Names and general nature of business of the amalgamating companies;
• Effective date of amalgamation for accounting purposes; 
• The method of accounting used to reflect the amalgamation; and
• Particulars of the scheme sanctioned under a statute.

For amalgamations accounted for under the pooling of interests method, the following additional disclosures are considered appropriate in the first financial statements following the amalgamation:

• Description and number of shares issued, together with the percentage of each company’s equity shares exchanged to effect the amalgamation;
• The amount of any difference between the consideration and the value of net identifiable assets acquired, and the treatment thereof.

For amalgamations accounted for under the purchase method, the following additional disclosures are considered appropriate in the first financial statements following the amalgamation:

• Consideration for the amalgamation and a description of the consideration paid or contingently payable; and
• The amount of any difference between the consideration and the value of net identifiable assets acquired, and the treatment thereof including the period of amortisation of any goodwill arising on amalgamation.

Amalgamation after the Balance Sheet Date

When an amalgamation is effected after the balance sheet date but before the issuance of the financial statements of either party to the amalgamation, disclosure is made in accordance with AS 4, ‘Contingencies and Events Occurring After the Balance Sheet Date’, but the amalgamation is not incorporated in the financial statements. In certain circumstances, the amalgamation may also provide additional information affecting the financial statements themselves, for instance, by allowing the going concern assumption to be maintained.

Example 1:  A Ltd. take over B Ltd. on April 01, 20X1 and discharges consideration for the business as follows: 

(i) Issued 42,000 fully paid equity shares of Rs.  10 each at par to the equity shareholders of B Ltd.
(ii) Issued fully paid up 15% preference shares of Rs.  100 each to discharge the preference shareholders (Rs. 1,70,000) of B Ltd. at a premium of 10%.
(iii) It is agreed that the debentures of B Ltd. (Rs.  50,000) will be converted into equal number and amount of 13% debentures of A Ltd.
Determine the amount of purchase consideration as per AS 14.

Note: As per AS 14, consideration for the amalgamation means the aggregate of the shares and other securities issued and the payment made in the form of cash or other assets by the transferee company to the shareholders of the transferor company. Thus, payment to debenture holders are not covered by the term ‘consideration’.

Example 2: A Ltd. and B Ltd. were amalgamated on and from 1st April, 20X1.  A new company C Ltd. was formed to take over the business of the existing companies.  A Ltd. and B Ltd. have  the following ledger balances as on 31st March, 20X1:

Additional Information:
(1) 10% Debenture holders of A Ltd. and B Ltd. are discharged by C Ltd. issuing such number of its 15% Debentures of Rs.  100 each so as to maintain the same amount of interest.
(2) Preference shareholders of the two companies are issued equivalent number of 15% preference shares of C Ltd. at a price of Rs.  150 per share (face value of Rs.  100).
(3) C Ltd. will issue 5 equity shares for each equity share of A Ltd. and 4 equity shares for each equity share of B Ltd.  The shares are to be issued @ Rs.  30 each, having a face value of Rs.  10 per share.
(4) Investment allowance reserve is to be maintained for 4 more years.
Prepare the Balance Sheet of C Ltd. as on 1st April, 20X1 after the amalgamation has been carried out on the basis of Amalgamation in the nature of purchase.

Notes to Accounts

Working Notes:

Note: For problems based on practical application of AS 14 (Revised), students are advised to refer Chapter 5 ‘Accounting for Amalgamation of Companies’ of the study material.

AS 17: Segment Reporting

• AS 17 is mandatory in respect of non-SMCs (and level I entities in case of noncorporates). Other entities are encouraged to comply with AS 17.
• This standard establishes principles for reporting financial information about different types of products and services an enterprise produces and different geographical areas in which it operates. The standard is more relevant for assessing risks and returns of a diversified or multi-locational enterprise which may not be determinable from the aggregated data.

Objective

Many enterprises provide groups of products and services or operate in geographical areas that are subject to differing rates of profitability, opportunities for growth, future prospects, and risks. The objective of this Standard is to establish principles for reporting financial information, about the different types of products and services an enterprise produces and the different geographical areas in which it operates. Such information helps users of financial statements:

• Better understand the performance of the enterprise;
• Better assess the risks and returns of the enterprise; and 
• Make more informed judgements about the enterprise as a whole.

Scope

• AS 17 should be applied in presenting general purpose financial statements.
• An enterprise should comply with the requirements of this Standard fully and not selectively. If a single financial report contains both consolidated financial statements and the separate financial statements of the parent, segment information need be presented only on the basis of the consolidated financial statements.