|1 Crore+ students have signed up on EduRev. Have you? Download the App|
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:
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.
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.
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:
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.
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:
(b) A group of contracts, whether with a single customer or with several customers, should be treated as a single construction contract when:
(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:
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.
(a) Contract revenue should comprise:
(b) Contract costs should comprise:
(1) Examples of costs that relate directly to a specific contract include:
(2) Example of costs that may be attributable to contract activity in general and can be allocated to specific contracts include:
(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:
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.
(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.
(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.
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
AS 9 does not deal with the following aspects of revenue recognition to which special considerations apply:
Examples of items not included within the definition of “revenue” for the purpose of AS 9 are:
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.
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:
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.
Use by others of such enterprise resources gives rise to:
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.
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.
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.
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.
Amalgamations fall into two broad categories.
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 is an amalgamation which does not satisfy any one or more of the conditions specified above for “Amalgamation in the nature of merger”.
There are two main methods of accounting for amalgamations.
Under the purchase method, the transferee company accounts for the amalgamation either
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:
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”
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
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.
For all amalgamations, the following disclosures are considered appropriate in the first financial statements following the amalgamation:
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:
For amalgamations accounted for under the purchase method, the following additional disclosures are considered appropriate in the first financial statements following the amalgamation:
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:
(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
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.
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: