Tag: Cash Flow

(1) Where one or more tax invoices have been issued for supply of any goods or services or both and the taxable value or tax charged in that tax invoice is found to exceed the taxable value or tax payable in respect of such supply, or where the goods supplied are returned by the recipient, or where goods or services or both supplied are found to be deficient, the registered person, who has supplied such goods or services or both, may issue to the recipient one or more credit notes for supplies made in a financial year containing such particulars as may be prescribed.

(2) Any registered person who issues a credit note in relation to a supply of goods or services or both shall declare the details of such credit note in the return for the month during which such credit note has been issued but not later than September following the end of the financial year in which such supply was made, or the date of furnishing of the relevant annual return, whichever is earlier, and the tax liability shall be adjusted in such manner as may be prescribed:

Provided that no reduction in output tax liability of the supplier shall be permitted, if the incidence of tax and interest on such supply has been passed on to any other person.

Conditions on issue of credit note:

1. The supplier may issue one or more credit notes for supplies made in a financial year through one or more tax invoices which have been issued by him earlier.
2. The credit note cannot be issued at any time after either of the following 2 events.

• Annual return has been filed for the FY in which the original tax invoice was issued.
• September of the FY immediately succeeding the FY in which the original tax invoice was issued.

(3) Where one or more tax invoices have been issued for supply of any goods or services or both and the taxable value or tax charged in that tax invoice is found to be less than the taxable value or tax payable in respect of such supply, the registered person, who has supplied such goods or services or both, shall issue to the recipient one or more debit notes for supplies made in a financial year containing such particulars as may be prescribed

(4) Any registered person who issues a debit note in relation to a supply of goods or services or both shall declare the details of such debit note in the return for the month during which such debit note has been issued and the tax liability shall be adjusted such manner as may be prescribed.

The GST Law mandates that a registered supplier may issue one or more debit notes for supplies made in a financial year through one or more tax invoices which has been issued by him earlier under the following circumstances:

1. Actual value of supply is higher than that stated in the original tax invoice.
2. Tax charged in the original tax invoice is lower than that applicable on the supply.
3. The debit note needs to be linked to the original tax invoice(s).
4. The debit note contains all the applicable particulars as specified in Rule 53(1A) of the CGST Rules, 2017.
5. A debit note issued under Section 74, 129 or 130 would not entitle the recipient to avail credit in respect thereof, and the supplier shall specify prominently, on such debit note the words “INPUT TAX CREDIT NOT ADMISSIBLE”; as provided in Rule 53(3).
6. It may also be noted that no time limit has been prescribed for issuing debit notes. Meaning, a debit note may be raised and uploaded subsequently, with no restriction as to the time period for doing so.

IAS 28 Investments in Associates and Joint Ventures (as amended in 2011) outlines how to apply, with certain limited exceptions, the equity method to investments in associates and joint ventures. The standard also defines an associate by reference to the concept of “Significant Influence“, which requires power to participate in financial and operating policy decisions of an investee (but not joint control or control of those polices).

Objective of IAS 28

The objective of IAS 28 (as amended in 2011) is to prescribe the accounting for investments in associates and to set out the requirements for the application of the equity method when accounting for investments in associates and joint ventures. [IAS 28(2011).1]

Scope of IAS 28

IAS 28 applies to all entities that are investors with joint control of, or significant influence over, an investee (associate or joint venture). [IAS 28(2011).2]

Important Definition:

Significant influence: The power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies.

Associate: An entity over which the investor has significant influence.

Joint arrangement: An arrangement of which two or more parties have joint control.

Joint venture: A joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.

Joint ventures: A party to a joint venture that has joint control of that joint venture.

Equity method: A method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s net assets. The investor’s profit or loss includes its share of the investee’s profit or loss and the investor’s other comprehensive income includes its share of the investee’s other comprehensive income.

Joint control: The contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control.

Significant influence

Where an entity holds 20% or more of the voting power (directly or through subsidiaries) on an investee, it will be presumed the investor has significant influence unless it can be clearly demonstrated that this is not the case. If the holding is less than 20%, the entity will be presumed not to have significant influence unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an entity from having significant influence. [IAS 28(2011).5]

The existence of significant influence by an entity is usually evidenced in one or more of the following ways: [IAS 28(2011).6]

• Participation in the policy-making process, including participation in decisions about dividends or other distributions.
• Representation on the board of directors or equivalent governing body of the investee.
• Material transactions between the entity and the investee.
• Provision of essential technical information.
• Interchange of managerial personnel.

The equity method of accounting

Distributions and other adjustments to carrying amount. The investor’s share of the investee’s profit or loss is recognised in the investor’s profit or loss. Distributions received from an investee reduce the carrying amount of the investment. Adjustments to the carrying amount may also be necessary for changes in the investor’s proportionate interest in the investee arising from changes in the investee’s other comprehensive income (e.g. to account for changes arising from revaluations of property, plant and equipment and foreign currency translations.) [IAS 28(2011).10]

Basic principle. Under the equity method, on initial recognition the investment in an associate or a joint venture is recognised at cost, and the carrying amount is increased or decreased to recognise the investor’s share of the profit or loss of the investee after the date of acquisition. [IAS 28(2011).10]

Potential voting rights. An entity’s interest in an associate or a joint venture is determined solely on the basis of existing ownership interests and, generally, does not reflect the possible exercise or conversion of potential voting rights and other derivative instruments. [IAS 28(2011).12]

Classification as non-current asset. An investment in an associate or a joint venture is generally classified as non-current asset, unless it is classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. [IAS 28(2011).15]

Interaction with IFRS 9. IFRS 9 Financial Instruments does not apply to interests in associates and joint ventures that are accounted for using the equity method. An entity applies IFRS 9, including its impairment requirements, to long-term interests in an associate or joint venture that form part of the net investment in the associate or joint venture but to which the equity method is not applied. Instruments containing potential voting rights in an associate or a joint venture are accounted for in accordance with IFRS 9, unless they currently give access to the returns associated with an ownership interest in an associate or a joint venture. [IAS 28(2011).14-14A]

Application of the equity method of accounting

Basic principle. In its consolidated financial statements, an investor uses the equity method of accounting for investments in associates and joint ventures. [IAS 28(2011).16] Many of the procedures that are appropriate for the application of the equity method are similar to the consolidation procedures described in IFRS 10. Furthermore, the concepts underlying the procedures used in accounting for the acquisition of a subsidiary are also adopted in accounting for the acquisition of an investment in an associate or a joint venture. [IAS 28. (2011).26]

Exemptions from applying the equity method. An entity is exempt from applying the equity method if the investment meets one of the following conditions:

The entity is a parent that is exempt from preparing consolidated financial statements under IFRS 10 Consolidated Financial Statements or if all of the following four conditions are met (in which case the entity need not apply the equity method): [IAS 28(2011).17]

• The entity is a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the investor not applying the equity method
• The investor or joint venturer’s debt or equity instruments are not traded in a public market
• The entity did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market
• The ultimate or any intermediate parent of the parent produces financial statements available for public use that comply with ifrss, in which subsidiaries are consolidated or are measured at fair value through profit or loss in accordance with ifrs 10.

Classification as held for sale. When the investment, or portion of an investment, meets the criteria to be classified as held for sale, the portion so classified is accounted for in accordance with IFRS 5. Any remaining portion is accounted for using the equity method until the time of disposal, at which time the retained investment is accounted under IFRS 9, unless the retained interest continues to be an associate or joint venture. [IAS 28(2011).20]

Ind AS 16 Property Plant Equipment is applicable to all Property and P&E (Plant & Equipment) unless and until any other accounting standard asks for a different treatment. Ind AS 16 Property Plant Equipment is not applicable in the following cases:

• Biological assets which are related to agricultural activities except bearer plants.
• Property and P&E (Plant & Equipment) which are classified as held for sale as per Ind AS 105.
• Mineral rights and reserves like oil, natural gas and other such non-regenerative resources.
• The measurement and recognition of exploration and evaluation assets.

Constituents of cost

The cost of the item of PPE includes:

(a) Costs which are directly attributable to bringing assets to the condition and location essential for it to operate in a manner as intended by the management.

(b) The purchase price, which includes the import duties and any non-refundable taxes on such purchase, after deducting rebates and trade discounts.

(c) Initial estimate of costs of removing and dismantling an item and restoring a site where it is located.

Recognition

Recognition simply means incorporation of item in the business’s accounts, in this case as a non-current asset. The recognition of property, plant & equipment depends on two criteria:

a) It is probable that future economic benefits associated with these assets will flow to the entity.

b) Cost can be measured reliable.

Initial Measurement

The cost of items of Property, plant & equipment compromises:

• Purchase price, including import duties, non-refundable purchase taxes, less trade discount & rebate.
• Initial estimates of cost of dismantling/decommissioning removing, & site restoration at present value if the entity has an obligation that it incurs on acquisition of the asset or as a result of using the asset other than to produce inventories.
• Cost directly attributable to bringing the asset to the location & condition necessary for it to be used in a manner intended by management.

Measurement subsequent to initial recognition

The standard offers two possible treatments here, essentially a choice between keeping an asset recorded at cost model or revaluation model. However, the same policy must be applied to each entire class of property, plant and equipment.

Cost Model carry the asset at its cost less depreciation and any accumulated impairment losses.

Revaluation Model carry the assets at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses.  The revised IAS 16 makes clear that the revaluation model is available only if the fair value of the item can be measured reliably.

Revaluation Model

The market value of Land & Buildings usually represents the fair value, assuming existing use and line of business. Such valuations are usually undertaken by professionally qualified valuers.

In case of plant & equipment, fair value is usually market value. If the market value is not available, fair value is estimated using depreciated replacement cost.

The frequency of valuation depends on the volatility of the fair values of the individual items of property, plant and equipment. The more volatile the fair value, the more frequently revaluations should be carried out. Where the current fair value is very different from the carrying amount then a revaluation should be carried out. Most importantly, when an item of property, plant & equipment is revalued, the whole class of assets to which it belongs should be revalued.

All the items within a class should be revalued at the same time, to prevent selective revaluation of the certain assets and to avoid disclosing a mixture of costs and values from different dates in the financial statements. Items within a class may be revalued on a rolling basis within short period of time provided revaluation are kept upto date.

Accounting for a revaluation

How should any increase in value to be treated when a revaluation takes place? The debit will be the increase in value in the statement of financial position, but what about the credit? IAS 16 required the increase to be credited to other comprehensive income and accumulated in a revaluation surplus (part of owner’s equity).

Debit: Assets Value (Statement of financial position)

Credit: Other comprehensive income (revaluation surplus)

Retirement & Disposals

When the assets are permanently withdrawn from the use, or sold or scrapped, and no future economic benefits are expected from its use or disposal, it should be withdrawn from the financial position. Gains or losses are the difference between the net disposal proceeds and the carrying amount of the asset. They should be recognized as income or expense in profit or loss.

Derecognition

Any entity is required to derecognize the carrying amount of an item of property, plant or equipment that it disposes of on the date the criteria for the sale in IFRS 15 would be met. This also applies to part of assets. An entity cannot classify as revenue a gain which it realizes on the disposal of an item of property, plant & equipment.

Depreciation

IAS 16 requires the depreciable amount of a depreciable asset to be allocated on a systematic basis to each accounting period during the useful life of the asset. Every part of an item of property, plant & equipment with a cost that is significant in relation to the total cost of the item must be depreciated separately.

There are situations where, over a period, an asset has increased in value, i.e. its current value is greater than the carrying amount in the financial statements. You might think that in such situation it would not be necessary to depreciate the asset. The standard states, however, that this is irrelevant, and that depreciation should still be charged to each accounting period, based on the depreciable amount, irrespective of a rise in value.

An entity is required to begin depreciating an item of property, plant and equipment when it is available for use and to continue depreciating it until it is derecognized even if it is idle during the period.

The following factors should be considered when estimating the useful life of a depreciable asset:

• Expected physical wear and tear.
• Legal or other limits on the use of the assets.

Disclosure Requirement

• Depreciation method used.
• Measurement bases used for determining gross carrying amount.
• Useful lives or the depreciation rate used.
• Reconciliation of carrying amount at the beginning and end of period.
• Property, plant and equipment pledged as security for liabilities.
• Amount of compensation from third parties for items of property, plant and equipment.
• Amount of expenditure recognized in the course of construction
• Contractual commitments for the acquisition of property, plant and equipment.
• Gross carrying amount and accumulated depreciation at beginning and end of the period. Accumulated impairment losses are aggregated with accumulated depreciation.

Disclosure for revalued assets:

• Whether an independent valuer was involved.
• Effective date of revaluation.
• Revaluation surplus, including movement and any restrictions on distribution of balance to shareholders.
• Carrying amount of each class of revalued property, plant and equipment if the cost model had been applied.

Ind AS-17: Leases Lessee Accounting:

Initial recognition:

• A Lessee is required to recognise a right of use asset representing its right to use the underlying leased asset and a lease liability representing its obligations to make lease payments.
• A Lessee will recognise assets and liabilities for all leases for a term of more than 12 months, unless the underlying asset is of low value.
• A lessee will measure right-of-use assets similarly to other non-financial assets (such as property, plant and equipment) and lease liabilities similarly to other financial liabilities.
• Lease liability = Present value of lease rentals + present value of expected payments at the end of lease. The lease liability will be amortised using the effective interest rate method.
• Lease term = non-cancellable period + renewable period if lessee reasonably certain to exercise.
• Right to use asset = Lease liability + lease payments (advance)-lease incentives to be received if any initial + initial direct costs + cost of dismantling/ restoring etc. The asset will be depreciated as per IND AS 16 Property plant and equipment.
• A lessee recognises depreciation of the right-of-use asset and interest on the lease liability (as per IND AS 17 the same was classified as rent in case of operating lease on a straight-line basis)

Presentation:

A lessee shall either present in the balance sheet, or disclose in the notes:

• Lease liabilities separately from other liabilities.
• Right-of-use assets separately from other assets.

Lessor Accounting:

• A lessor shall classify each of its leases as either an operating lease or a finance lease.
• A lease is classified as a finance lease if it transfers substantially all the risks and rewards, incidental to ownership of an underlying asset. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.
• For operating leases, lessors continue to recognize the underlying asset.
• For finance leases, lessors derecognize the underlying asset and recognize a net investment in the lease.
• Any selling profit or loss is recognized at lease commencement.

Classification of leases

A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. All other leases are classified as operating leases. Classification is made at the inception of the lease. [IAS 17.4]

Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form. Situations that would normally lead to a lease being classified as a finance lease include the following: [IAS 17.10]

• The lease transfers ownership of the asset to the lessee by the end of the lease term.
• The lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain that the option will be exercised.
• The lease term is for the major part of the economic life of the asset, even if title is not transferred at the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset.
• The lease assets are of a specialised nature such that only the lessee can use them without major modifications being made.

Other situations that might also lead to classification as a finance lease are: [IAS 17.11]

• If the lessee is entitled to cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee
• Gains or losses from fluctuations in the fair value of the residual fall to the lessee (for example, by means of a rebate of lease payments).
• The lessee has the ability to continue to lease for a secondary period at a rent that is substantially lower than market rent.

Accounting by lessees

The following principles should be applied in the financial statements of lessees:

• Finance lease payments should be apportioned between the finance charge and the reduction of the outstanding liability (the finance charge to be allocated so as to produce a constant periodic rate of interest on the remaining balance of the liability) [IAS 17.25]
• At commencement of the lease term, finance leases should be recorded as an asset and a liability at the lower of the fair value of the asset and the present value of the minimum lease payments (discounted at the interest rate implicit in the lease, if practicable, or else at the entity’s incremental borrowing rate) [IAS 17.20]
• For operating leases, the lease payments should be recognised as an expense in the income statement over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user’s benefit [IAS 17.33]
• The depreciation policy for assets held under finance leases should be consistent with that for owned assets. If there is no reasonable certainty that the lessee will obtain ownership at the end of the lease the asset should be depreciated over the shorter of the lease term or the life of the asset [IAS 17.27]

Accounting by lessors

The following principles should be applied in the financial statements of lessors:

• At commencement of the lease term, the lessor should record a finance lease in the balance sheet as a receivable, at an amount equal to the net investment in the lease [IAS 17.36] the lessor should recognise finance income based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment outstanding in respect of the finance lease [IAS 17.39]
• Assets held for operating leases should be presented in the balance sheet of the lessor according to the nature of the asset. [IAS 17.49] Lease income should be recognised over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern in which use benefit is derived from the leased asset is diminished [IAS 17.50]

Sale and leaseback transactions

For a sale and leaseback transaction that results in a finance lease, any excess of proceeds over the carrying amount is deferred and amortised over the lease term. [IAS 17.59]

For a transaction that results in an operating lease: [IAS 17.61]

• If the sale price is below fair value: Profit or loss should be recognised immediately, except if a loss is compensated for by future rentals at below market price, the loss should be amortised over the period of use.
• If the transaction is clearly carried out at fair value: The profit or loss should be recognised immediately.
• If the fair value at the time of the transaction is less than the carrying amount a loss equal to the difference should be recognised immediately [IAS 17.63]
• If the sale price is above fair value: The excess over fair value should be deferred and amortised over the period of use.

Derivatives Accounting

A derivative is a financial instrument whose value changes in relation to changes in a variable, such as an interest rate, commodity price, credit rating, or foreign exchange rate. There are two key concepts in the accounting for derivatives. The first is that ongoing changes in the fair value of derivatives not used in hedging arrangements are generally recognized in earnings at once. The second is that ongoing changes in the fair value of derivatives and the hedged items with which they are paired may be parked in other comprehensive income for a period of time, thereby removing them from the basic earnings reported by a business.

The essential accounting for a derivative instrument is outlined in the following bullet points:

• Initial recognition. When it is first acquired, recognize a derivative instrument in the balance sheet as an asset or liability at its fair value.
• Subsequent recognition (hedging relationship). Recognize all subsequent changes in the fair value of the derivative (known as marked to market). If the instrument has been paired with a hedged item, then recognize these fair value changes in other comprehensive income.
• Subsequent recognition (ineffective portion). Recognize all subsequent changes in the fair value of the derivative. If the instrument has been paired with a hedged item but the hedge is not effective, then recognize these fair value changes in earnings.
• Subsequent recognition (speculation). Recognize in earnings all subsequent changes in the fair value of the derivative. Speculative activities imply that a derivative has not been paired with a hedged item.

The following additional rules apply to the accounting for derivative instruments when specific types of investments are being hedged:

• Trading securities. This can be either a debt or equity security, for which there is an intent to sell in the short term for a profit. When this investment is being hedged, recognize any changes in the fair value of the paired forward contract or purchased option in earnings.
• Held-to-maturity investments. This is a debt instrument for which there is a commitment to hold the investment until its maturity date. When such an investment is being hedged, there may be a change in the fair value of the paired forward contract or purchased option. If so, only recognize a loss in earnings when there is an other-than-temporary decline in the hedging instrument’s fair value.
• Available-for-sale securities. This can be either a debt or equity security that does not fall into the held-to-maturity or trading classifications. When such an investment is being hedged, there may be a change in the fair value of the paired forward contract or purchased option. If so, only recognize a loss in earnings when there is an other-than-temporary decline in the hedging instrument’s fair value. If the change is temporary, record it in other comprehensive income.

Rules for Accounting Derivatives

Accounting of derivatives is based upon the purpose for which it is used as it can be used for speculation, i.e. to earn profit from derivatives transactions and hedging, i.e. to control the risk of future contracts. Suppose there is speculation loss that is to be recognized immediately in the accounts.

Some of the rules for Accounting of derivatives are as under:

• Initially, derivatives are to be recorded at fair value.
• Re-measurement of fair value is to be done at the end of the financial year or at the end of the contract period, whichever falls earlier.
• The purpose of the derivative is to be determined at the time of entering so as to decide whether it is speculation or hedging.
• Any transaction cost for entering into derivatives is to be charged to the profit and loss account immediately.
• If the derivative is of speculation in nature, the loss or profit is to be immediately recognized in the profit and loss account.
• If the derivative is non-speculative, the loss or gain is to be transferred to a comprehensive income account.
• Journal entries of accounting for derivatives are:

Date	Particulars	Debit ($)	Credit ($)
	On entering into a transaction for an underlying derivative asset:
	Forward Asset A/c                 Dr.	XXX
	To Bank/ Creditor A/c		XXX
	(Being underlying asset purchased by entering into a derivative contract)
	Increase in fair value of forward asset resulting in a gain
	Forward Asset A/c                      Dr.	XXX
	To Forward value gain A/c		XXX
	(Being increase in the value of forward asset results in gain)
	Decrease in fair value of asset resulting in loss
	Fair Value Loss A/c                         Dr.	XXX
	To Forward Asset A/c		XXX
	(Being Decrease in value of asset resulted loss in forward contract)
	Settlement of Forward contract
	Creditor/ Bank A/c                             Dr.	XXX
	To Forward Asset A/c		XX
	To Profit and Loss A/c		XX
	(Being Forward contract settled and net gain or loss is transferred to profit and loss A/c)

Hedge Accounting

Hedge accounting is an accountancy practice, the aim of which is to provide an offset to the mark-to-market movement of the derivative in the profit and loss account. There are two types of hedge recognized. For a fair value hedge, the offset is achieved either by marking-to-market an asset or a liability which offsets the P&L movement of the derivative. For a cash flow hedge, some of the derivative volatility is placed into a separate component of the entity’s equity called the cash flow hedge reserve. Where a hedge relationship is effective (meets the 80%–125% rule), most of the mark-to-market derivative volatility will be offset in the profit and loss account. Hedge accounting entails much compliance involving documenting the hedge relationship and both prospectively and retrospectively proving that the hedge relationship is effective.

Under IAS 39, derivatives must be recorded on a mark-to-market basis. Thus, if a profit is taken on a derivative one day, the profit must be recorded when the profit is taken. The same holds if there is a loss on the derivative.

If that derivative is used as a hedging tool, the same treatment is required under IAS 39. However, this could bring plenty of volatility in profits and losses on, at times, a daily basis. Yet, hedge accounting under IAS 39 can help decrease the hedging tool’s volatility. However, the treatment of hedge accounting for hedging tools under IAS 39 is exclusive to derivative instruments.

A specific type of hedging transaction that entities can engage in aims to manage foreign currency exposure. These hedges are undertaken for the economic aim of reducing potential loss from fluctuations in foreign exchange rates. However, not all hedges are designated for special accounting treatment. Accounting standards enable hedge accounting for three different designated forex hedges:

• A cash flow hedge may be designated for a highly probable forecasted transaction, a firm commitment (not recorded on the balance sheet), foreign currency cash flows of a recognized asset or liability, or a forecasted intercompany transaction.
• A fair value hedge may be designated for a firm commitment (not recorded) or foreign currency cash flows of a recognized asset or liability.
• A net investment hedge may be designated for the net investment in a foreign operation.

There are three main asset categories that companies use hedge accounting for:

Foreign currency exposures: For transaction exposures, such as forecasted purchases, revenues and expenses in foreign currencies, as well as foreign-currency-denominated assets and liabilities.

Interest rate exposures: Such as forecasted fixed-rate borrowing, variable-rate assets and liabilities, as well as fixed-rate assets and debt.

Commodity exposures: These include forecasted purchases, sales and inventory.

Accounting standards enable hedge accounting for three different designated categories:

Cash flow hedge: Designated for a highly probable forecasted transaction, a firm commitment (not recorded on the balance sheet), foreign currency cash flows of a recognised asset or liability, or a forecasted intercompany transaction.

Fair value hedge: Designated for a firm commitment (not recorded) or foreign currency cash flows of a recognized asset or liability.

Net investment hedge: Designated for the net investment in a foreign operation.

Impairment

In accounting, the decrease in the net asset value of an asset due to the carrying amount of the asset exceeding the recoverable amount thereof. The effect of impairment constitutes the decrease in asset values per the Statement of Financial Position and a corresponding amount recognised through profit or loss in respect of the impairment loss.

Impairment describes a permanent reduction in the value of a company’s asset, typically a fixed asset or an intangible asset. When testing an asset for impairment, the total profit, cash flow, or other benefit expected to be generated by that specific asset is periodically compared with its current book value. If it is determined that the book value of the asset exceeds the future cash flow or benefit of the asset, the difference between the two is written off and the value of the asset declines on the company’s balance sheet.

Impairment is commonly used to describe a drastic reduction in the recoverable amount of a fixed asset. Impairment may occur when there is a change in legal or economic circumstances surrounding a company or a casualty loss from unforeseen devastation.

Factors could lead to the value of the asset declining:

Change in legal climate: It’s also possible that a lawsuit, court case, or some other change to the general business/legal climate could cause a reduction in value of the asset. For example, if a worker gets injured while using your equipment and sues your company, you may not be able to use the asset until the legal situation is resolved.

Market downturn: If the market takes a dip, then the fair market value of an asset may end up being less than its book value. For example, if the real estate market experiences a downturn, then any land or property that you’re holding as an asset could decline in value.

Escalating costs: You may experience a situation where the running costs to maintain an asset are more than you were expecting when you made the initial investment, or the running costs have simply escalated over time, leading to a reduction in overall value.

Impairment vs. Depreciation and Amortization

Impairment of assets may sound similar to the accounting processes of depreciation and amortization (a reduction in the value of an asset over the course of its useful life). While there are some relatively clear similarities between the two concepts, there’s one key distinction: impairment denotes a sudden, irreversible drop in value, whereas depreciation/amortisation reduces the value of the asset over its entire lifetime. So, whereas impairment accounts for unusual drops in an asset’s value, depreciation and amortisation is generally used for standard wear and tear.

Fixed assets, such as machinery and equipment, depreciate in value over time. The amount of depreciation taken each accounting period is based on a predetermined schedule using either straight line or one of multiple accelerated depreciation methods. Depreciation schedules allow for a set distribution of the reduction of an asset’s value over its entire lifetime. Unlike impairment, which accounts for an unusual and drastic drop in the fair value of an asset, depreciation is used to account for typical wear and tear on fixed assets over time.

Asset Retirement Obligation

An Asset Retirement Obligation (ARO) is a legal obligation associated with the retirement of a tangible long-lived asset in which the timing or method of settlement may be conditional on a future event, the occurrence of which may not be within the control of the entity burdened by the obligation. In the United States, ARO accounting is specified by Statement of Financial Accounting Standards (SFAS, or FAS) 143, which is Topic 410-20 in the Accounting Standards Codification published by the Financial Accounting Standards Board. Entities covered by International Financial Reporting Standards (IFRS) apply a standard called IAS 37 to AROs, where the AROs are called “provisions”. ARO accounting is particularly significant for remediation work needed to restore a property, such as decontaminating a nuclear power plant site, removing underground fuel storage tanks, cleanup around an oil well, or removal of improvements to a site. It does not apply to unplanned cleanup costs, such as costs incurred as a result of an accident.

Firms must recognize the ARO liability in the period in which it was incurred, such as at the time of acquisition or construction. The liability equals the present value of the expected cost of retirement/remediation. An asset equal to the initial liability is added to the balance sheet, and depreciated over the life of the asset. The result is an increase in both assets and liabilities, while the total expected cost is recognized over time, with the accrual steadily increasing on a compounded basis.

An asset retirement obligation (ARO) is a legal obligation that is associated with the retirement of a tangible, long-term asset. It is generally applicable when a company is responsible for removing equipment or cleaning up hazardous materials at some agreed-upon future date.

The purpose of asset retirement obligations is to act as a fair value of a legal obligation that a company undertook when it installed infrastructure assets that must be dismantled in the future (along with remediation efforts to restore their original state). The fair value of the ARO must be recognized immediately, so the present financial position of the company is not distorted; however, it must be done reliably.

AROs ensure that known future problems are planned for and resolved. In the real world, they are utilized mainly by companies that typically use infrastructure in their operations. A good example is oil and gas companies.

Calculating AROs

When a company installs a long-term asset with future intentions of removing it, it incurs an ARO. To recognize the obligation’s fair value, CPAs use a variety of methods; however, the most common is to use the expected present value technique. To use the expected present value  technique, you will need the following:

• Discount Rate

Acquire a credit-adjusted, risk-free rate to discount the cash flows to their present value. The credit rating of a business may affect the discount rate.

• Probability Distribution

When calculating the expected values, we need to know the probability of certain events occurring. For example, if there are only two possible outcomes, then you can assume that each outcome comes with a 50% probability of happening. It is recommended you use the probability distribution method unless other information must be considered.

To calculate the expected present value of an ARO, companies should observe the following iterative steps:

• Estimate the timing and cash flows of retirement activities.
• Calculate the credit-adjusted risk-free rate.
• Note any increase in the carrying amount of the ARO liability as an accretion expense by multiplying the beginning liability by the credit-adjusted risk-free rate for when the liability was first measured.
• Note whether liability revisions are trending upward, then discount them at the current credit-adjusted risk-free rate.
• Note whether liability revisions are trending downward, then discount the reduction at the rate used for the initial recognition of the related liability year.

IFRS 15 specifies how and when an IFRS reporter will recognise revenue as well as requiring such entities to provide users of financial statements with more informative, relevant disclosures. The standard provides a single, principles based five-step model to be applied to all contracts with customers.

IFRS 15 was issued in May 2014 and applies to an annual reporting period beginning on or after 1 January 2018. On 12 April 2016, clarifying amendments were issued that have the same effective date as the standard itself.

Contracts with customers will be presented in an entity’s statement of financial position as a contract liability, a contract asset, or a receivable, depending on the relationship between the entity’s performance and the customer’s payment.

A contract liability is presented in the statement of financial position where a customer has paid an amount of consideration prior to the entity performing by transferring the related good or service to the customer.

Where the entity has performed by transferring a good or service to the customer and the customer has not yet paid the related consideration, a contract asset or a receivable is presented in the statement of financial position, depending on the nature of the entity’s right to consideration. A contract asset is recognised when the entity’s right to consideration is conditional on something other than the passage of time, for example future performance of the entity. A receivable is recognised when the entity’s right to consideration is unconditional except for the passage of time.

Contract assets and receivables shall be accounted for in accordance with IFRS. Any impairment relating to contracts with customers should be measured, presented and disclosed in accordance with IFRS 9. Any difference between the initial recognition of a receivable and the corresponding amount of revenue recognised should also be presented as an expense, for example, an impairment loss.

Disclosures

The disclosure objective stated in IFRS 15 is for an entity to disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Therefore, an entity should disclose qualitative and quantitative information about all of the following:

• Its contracts with customers;
• The significant judgments, and changes in the judgments, made in applying the guidance to those contracts;
• Any assets recognised from the costs to obtain or fulfil a contract with a customer.

Entities will need to consider the level of detail necessary to satisfy the disclosure objective and how much emphasis to place on each of the requirements. An entity should aggregate or disaggregate disclosures to ensure that useful information is not obscured.

In order to achieve the disclosure objective stated above, the Standard introduces a number of new disclosure requirements.

Recoupment of Short workings refers to the process by which a tenant can recover the difference between the minimum rent (dead rent) and the actual royalty payment when production or output falls short. There are two primary methods for recouping short workings: the Fixed Method and the Floating Method. Each method has its unique characteristics, applications, and implications for both the landlord and the tenant.

Fixed Method

Fixed Method of recoupment involves a straightforward approach to recovering short workings. Under this method, the tenant is allowed to offset the short workings against future royalty payments based on a fixed formula. Here’s how it works:

When the actual royalty earned in a given period is less than the minimum rent due, the short workings are calculated as follows:

Short Workings = Minimum Rent − Actual Royalty Earned

For example, if the minimum rent is ₹100,000, and the actual royalty earned during the period is ₹70,000, the short workings would amount to ₹30,000.

Recoupment Process:

In subsequent periods, the tenant can recoup the short workings amount by reducing their royalty payments. The amount recouped each period is fixed and agreed upon in advance, meaning that the tenant can offset a specific portion of the short workings against their future royalty liabilities.

If, in the next period, the tenant earns ₹120,000 in royalty, they would pay only ₹90,000 (₹120,000 – ₹30,000) after recouping the short workings.

Advantages

• Predictability:

The fixed amount allows both parties to predict future cash flows, making it easier for the tenant to manage cash flow and budgeting.

• Simplicity:

The fixed method is straightforward to implement, requiring less complex calculations compared to other methods.

Disadvantages

• Limited Flexibility:

This method can be restrictive for tenants with fluctuating output levels. If a tenant experiences significantly higher production levels in subsequent periods, they may prefer a more flexible recoupment approach.

• Potential for Underpayment:

If the fixed recoupment is too conservative, the landlord may receive less than expected in royalties if production is consistently high.

Floating Method

Floating Method of recoupment offers more flexibility in recovering short workings by allowing the tenant to adjust the amount of short workings to be recouped based on actual production levels in future periods. This method takes a more dynamic approach compared to the fixed method.

Similar to the fixed method, short workings are calculated in the same manner. However, under the floating method, the tenant can recoup short workings based on a percentage of the output or sales in future periods. The tenant may adjust the recoupment amount depending on their actual performance.

For example, if a tenant has short workings of ₹30,000 and the actual royalty earned in the next period is ₹150,000, the tenant might decide to recoup a percentage of that amount instead of a fixed sum.

Recoupment Process:

The tenant can recoup a variable amount of short workings in future periods based on their revenue. This flexibility allows them to manage their cash flow according to their production capabilities. If the tenant earns ₹150,000 in royalties, they might recoup 50% of their short workings, amounting to ₹15,000, leaving them to pay ₹135,000.

Advantages:

• Flexibility:

The floating method allows tenants to adjust the recoupment based on their financial performance, accommodating fluctuations in production or sales.

• Maximized Payments:

Tenants can maximize their payments in high-production periods while still recovering short workings, ensuring that the landlord receives appropriate compensation based on actual usage.

Disadvantages:

• Complexity:

The floating method requires more detailed tracking and calculations, which may lead to increased administrative costs for both parties.

• Uncertainty for Landlords:

Landlords may face uncertainty regarding their cash flow, as recoupment amounts can vary significantly based on tenant performance.

Royalty accounts refer to the financial records and statements that track royalty payments made by a licensee to a licensor for the use of intellectual property or natural resources. They ensure accurate accounting of revenues, expenses, and obligations.

1. Landlord (Lessor)

Landlord, also known as the lessor, is the owner of the property, asset, or natural resource being leased. In royalty agreements, the landlord grants the tenant the right to extract resources (such as minerals or oil) or use intellectual property in exchange for royalty payments. The landlord benefits by receiving periodic payments based on the usage or output from the leased property or asset.

2. Tenant (Lessee)

Tenant, also referred to as the lessee, is the party that obtains the right to use the landlord’s property, resource, or asset by making royalty payments. The tenant may be a company or an individual that uses the property or asset for activities like mining, production, or intellectual property usage. The tenant’s obligation is to pay royalties to the landlord based on an agreed formula, typically related to production or revenue.

3. Output

Output refers to the total quantity of production or extraction that occurs from the resource or asset being leased. For example, in a mining operation, the output could refer to the quantity of minerals extracted from the mine. The royalty payments made by the tenant to the landlord are often calculated as a percentage of this output, or based on the revenue generated from the sale of the output.

4. Minimum Rent (Dead Rent)

Minimum Rent, also known as Dead Rent, is the minimum amount of royalty the tenant must pay to the landlord, regardless of the level of production or output. Even if the output is low or zero, the tenant is obligated to pay this minimum amount. The purpose of dead rent is to ensure that the landlord receives a guaranteed payment, even during periods of low production. In years of high output, royalties are calculated based on production, but if production falls short, the tenant still pays the minimum rent.

5. Short Workings

Short Workings occur when the actual royalty based on output is less than the minimum rent (dead rent) payable by the tenant. In such cases, the tenant is still required to pay the minimum rent, but the difference between the minimum rent and the actual royalty is referred to as short workings. Short workings can sometimes be recovered or adjusted in future periods if production increases.

6. Recoupment of Short Workings

 Recoupment of Short Workings is a provision in royalty agreements that allows the tenant to recover or adjust the short workings against future royalty payments when output levels increase. If the actual royalty in subsequent periods exceeds the minimum rent, the tenant can offset the previous short workings by paying the lower royalty amount until the short workings are fully recouped. There is usually a time limit within which short workings can be recouped, beyond which they are considered irrecoverable.

Example:

Suppose the minimum rent is set at ₹100,000 per year, and the actual royalty based on output in a particular year is ₹80,000. The short workings will be ₹20,000 (₹100,000 – ₹80,000). If in the following year the royalty exceeds the minimum rent, say it is ₹120,000, the tenant can recoup the ₹20,000 short workings from the previous year and pay only ₹100,000.

Cost Price Method

The consignor wants to know two things which are:

(1) To ascertain profit or loss when goods on consignment sold by the consignee.

(2) To know the settlement of account by the consignee i. e. to know the amount due by or due to consignee.

The consignment account is opened by the consignor to know profit or loss on each consign­ment. Each consignment is distinguished from the other by naming it in respect to place, examples, Consignment to Madras, Consignment to Bombay etc.

If there are a number of consignments in one place, then the name of the consignee is added to the consignment account, for example: Consign­ment to Ramu Account, Consignment to Krishna Account etc. For that, he opens a Consignment Account for each consignment.

It is revenue (Nominal) Account. It is a special Trading and Profit and Loss Account. Consignee Account is prepared to know the amount due by or due to the Con­signee. It is a personal account.

Journal Entries:

Following are the set of journal entries in the books of Consignor:

(1) When the Goods are Sent on Consignment:

Consignment Account Dr

  To Goods Sent on Consignment A/c

(Being the cost of goods sent on Consignment)

(2) When Expenses are Incurred by the Consignor:

Consignment Account Dr.

  To Bank/Cash Account

(Being the expenses incurred on Consignment)

(3) When Advance is Received from Consignee:

Cash/Bank/Bill Receivable Account Dr.

  To Consignee Account

(Being the amount of advance received from Consignee)

(4) When the Bill is Discounted by the Consignor with his Banker:

Bank Account Dr.

Discount Account Dr.

  To Bills Receivable A/c

(Being the Bill is discounted)

Note: The Discount on Bills can be transferred to Profit and Loss Account or to the Consignment Account. Since it is a cost of raising finance, it can be transferred to Profit and Loss Account.

After the Consignee sends the Account Sales:

(5) When the Gross Sales Proceeds are Reported by the Consignee:

Consignee Account Dr.

  To Consignment Account

(Being the gross sales proceeds reported by the Consignee)

(6) For Expenses Incurred by the Consignee:

Consignment Account Dr.

  To Consignee Account

(Being the expenses incurred by the Consignee)

(7) For Commission Payable to the Consignee:

Consignment Account Dr.

  To Consignee Account

(Being the Commission due to Consignee)

(8) For Unsold Stock Remaining with the Consignee:

Consignment Stock Account Dr.

  To Consignee Account

(Being the value of unsold stock)

(9) For Transferring the Profit or Loss to Profit and Loss:

For Profit:

Consignment Account Dr.

  To Profit and Loss Account

(Being the profit transferred to Profit & Loss Account)

For Loss:

Profit and Loss Account Dr.

  To Consignment Account

(Being the loss on consignment transferred to Profit & Loss A/c)

(10) For Settlement of Account by the Consignee:

Generally, the balance amount is settled by the Consignee when he sends the Account Sales:

Bank/Cash/Bill Receivable Account Dr.

  To Consignee Account

(Being the amount due from Consignee is received)

(11) When Goods Sent on Consignment Account is Closed:

Goods sent on Consignment Account Dr.

  To Trading/Purchase Account

(Being the amount of goods sent on Consignment)

Note: If it is a manufacturing concern, then the Goods sent on Consignment account is closed by transfer­ring it to Trading Account. If it is a trading concern, then it is closed by transferring it to Purchase Account.

Invoice Price Method

The preparation of journal entries and ledger accounts under invoice price method is much similar to the cost price method, except for some adjusting entries that are required to remove excess price on goods and bringing their value down to the cost. The removal of excess price or loading is essential to know the actual profit earned by the consignment.

The journal entries that are made in the books of consignor under cost price method have been given here. In this article, we will discuss only those entries that are required to eliminate the impact of excess price or loading.

The Consignor, instead of sending the goods on consignment at cost price, may send it at a price higher than the cost price. This price is known as Invoice Price or Selling Price. The difference between the cost price and the invoice price of goods is known as loading or the higher price over the cost. This is done with a view to keep the profits on consignment secret.

As such, consignee could not know the actual profit made on consignment. Hence the consignor sends the Proforma invoice at a higher price than the cost price. When the consignor records the transaction in his book at invoice price, some additional entries have to be passed in order to eliminate the excess price and to arrive at the correct profit or loss on consignment.

Items on Which Excess Price is to be Calculated:

Excess Price or Loading is to be calculated on the following items:

1. Consignment stock at the beginning
2. Goods sent on consignment
3. Goods returned by the consignee
4. Consignment stock at the end of the period

(a) To Remove the Excess Price in the Opening Stock:

Consignment Stock Reserve A/c Dr.

  To Consignment Account

(Being the excess value of opening stock is brought down to cost price)

(b) To Remove the Excess Price in the Goods Sent on Consignment:

Goods sent on Consignment Account Dr.

  To Consignment Account

(Being the difference between the invoice price and cost price is adjusted)

(c) To Remove the Excess Price in Goods Return:

Consignment Account Dr.

  To Goods sent on Consignment A/c

(Being to bring down the value of goods to cost price)

(d) To Remove the Excess Price in Closing Stock:

Consignment Account Dr.

  To Consignment Stock Reserve A/c

(Being the excess value of stock is adjusted)

But these adjustments are not needed in consignee’s book. Invoice price does not affect the consignee. When the stock is shown in the Balance Sheet, in Consignor’s Book, the Consignment Stock Reserve is deducted.

Entries

1. Journal entry for adjusting the value of opening stock

Stock reserve [Dr]

Consignment [Cr]

2. Journal entry for adjusting the value of goods sent on consignment:

Goods sent on consignment [Dr]

Consignment [Cr]

3. Journal entry for adjusting the value of abnormal loss:

Consignment [Dr]

Abnormal loss [Cr]

4. Journal entry for adjusting the value of stock on consignment:

Consignment [Dr]

Stock reserve [Cr]

When balance sheet is prepared at the end of accounting period, the balance of the stock reserve account is shown as deduction from the value of stock on consignment.