Tag: Financial Reporting

Bangalore University B.com Notes

Financial Accountancy Bangalore University B.com 1st Semester NEP Notes

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Unit 1 Introduction to Accountancy
Accountancy Introduction, Meaning, Definition of Accounting VIEW VIEW
Uses & Users of Accounting VIEW
Accounting Principles VIEW
Accounting process VIEW
Types of Reconciliation (Concepts) VIEW VIEW
Recognition of Capital & Revenue VIEW
Problems on Accounting Equation (Operating in Spreadsheet) VIEW
Unit 2 Consignment Accounts
Consignment Accounts Introduction, Meaning of Consignment VIEW
Consignment Vs Sales VIEW
Proforma Invoice, Accounts Sales, Types Commission VIEW
Accounting for Consignment Transactions & Events in the books of Consignor only VIEW
Treatment of Normal & Abnormal Loss VIEW
Valuation of Closing Stock VIEW
Goods sent at Cost Price VIEW
Goods sent at Invoice Price VIEW
Unit 3 Accounting for Branches
Introduction, Meaning, Objectives, Types of Branches VIEW VIEW
Meaning and features of Branches VIEW
Meaning and features of Dependent Branches VIEW
Independent Branches, Foreign Branches VIEW
Methods of Maintaining books of Accounts by Head office VIEW
Meaning & Feature of Debtor system, stock & Debtor system VIEW
Wholesale branch system and Final Account system VIEW
Supply of Goods at Cost Price VIEW
Supply of Goods at Invoice Price VIEW
Unit 4 Leasing & Hire Purchase
Leasing, Elements of lease, Major Components of Lease Agreement, VIEW
Types of Leasing VIEW
Leasing Financial institution in India. (Theory) VIEW
Meaning of Hire Purchase and Instalment Purchase System difference between Hire Purchase and Instalment Purchase VIEW VIEW
Important Definitions: Hire Purchase Agreement VIEW
Hire Purchase Price VIEW
Hire Purchase Charges VIEW
Net Hire Purchase Price VIEW
Cash Price, Net Cash Price VIEW
Calculation of Interest VIEW
Calculation of Cash Price VIEW
Journal Entries and Ledger Accounts in the books of Hire Purchaser (Asset Accrual Method only). VIEW
Unit 5 Emerging Trends in Accounting
Digital Transformation of Accounting VIEW
Big Data Analytics in Accounting VIEW
Accounting through Cloud Computing VIEW
Green Accounting VIEW VIEW
Human Resource Accounting VIEW
Inflation Accounting VIEW
Database Accounting VIEW

 

Management Notes

Voucher, Voucher Entry and Types of Vouchers

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Voucher is a fundamental document in accounting that acts as proof of a financial transaction. It records essential details such as the date, parties involved, amount, and nature of the transaction. Vouchers ensure that every transaction has valid authorization and proper documentation, which helps maintain accuracy and transparency in financial records.

In traditional accounting, vouchers are physical documents that support entries in the books of accounts, while in computerized systems like TallyPrime, vouchers are electronic input forms used to record different business transactions. When a voucher is entered in TallyPrime, it automatically updates the relevant ledgers, trial balance, and financial statements, thereby saving time and reducing manual errors.

There are several types of vouchers, such as payment vouchers, receipt vouchers, sales vouchers, purchase vouchers, contra vouchers, journal vouchers, debit notes, and credit notes. Each voucher serves a specific purpose, like recording receipts, payments, adjustments, or stock movements.

Vouchers are significant as they not only provide an audit trail but also ensure compliance with accounting standards and legal requirements. By serving as authentic evidence, vouchers play a crucial role in internal control, financial accuracy, and decision-making in business operations.

Role of Vouchers in Accounting:

  • Source Document for Transactions

Vouchers serve as the primary source document for recording business transactions. They capture all key details, including date, amount, parties involved, and purpose of the transaction, ensuring nothing is overlooked. Since they validate the occurrence of a transaction, they act as the backbone of the accounting process. Without vouchers, entries in the books of accounts would lack evidence, reducing reliability and making financial data questionable for decision-making and audits.

  • Ensuring Accuracy in Accounts

Vouchers help ensure accuracy in recording transactions by minimizing errors and omissions. When a voucher is prepared and cross-verified with supporting documents like invoices or receipts, it confirms the correctness of figures and details. This prevents duplication or misclassification of entries in ledgers. Accurate vouchers also facilitate proper posting in accounting software like TallyPrime, where financial statements are automatically updated. Thus, vouchers safeguard the credibility of accounts by promoting consistency and precision.

  • Supporting Internal Control

Vouchers act as a critical tool of internal control in accounting. Since each voucher must be approved and authorized by designated personnel, it ensures accountability and prevents unauthorized financial activity. For example, a payment voucher requires managerial approval before disbursement, which reduces the risk of fraud or mismanagement. Vouchers also help in segregation of duties, where different individuals prepare, verify, and authorize them, thereby strengthening the overall internal control system of the organization.

  • Legal and Audit Compliance

Vouchers are essential for meeting statutory and audit requirements. During an audit, vouchers provide auditors with concrete evidence of transactions recorded in the books of accounts. They help businesses comply with tax laws, corporate regulations, and accounting standards by maintaining transparency. Since vouchers record details like GST, TDS, or other statutory deductions, they ensure regulatory adherence. Without vouchers, organizations may face legal disputes, penalties, or disallowances of expenses during audits or inspections.

  • Facilitating Transparency

Vouchers promote transparency in financial reporting by providing a clear and documented record of each transaction. Since they can be traced back to original supporting documents like bills, cheques, or invoices, they eliminate doubts about the authenticity of entries. Transparent voucher recording also builds stakeholder confidence, as managers, investors, and auditors can verify financial data easily. In this way, vouchers not only safeguard against disputes but also strengthen the trustworthiness of organizational accounts.

  • Simplifying Audit Trails

One of the most important roles of vouchers is creating a reliable audit trail. Each voucher links transactions with relevant supporting documents, making it easier to trace financial activities step by step. This traceability helps auditors and accountants understand the origin, authorization, and posting of transactions. An organized voucher system reduces the chances of missing information during audits. It ensures accountability and provides a strong foundation for detecting fraud, discrepancies, or financial irregularities.

  • Aiding Management Decisions

Vouchers provide management with authentic and organized financial information that aids decision-making. For example, purchase vouchers show the company’s spending patterns, while sales vouchers highlight revenue streams. By analyzing vouchers, managers can evaluate cash flows, identify cost-saving opportunities, and control unnecessary expenses. Vouchers also help prepare accurate financial reports, which guide strategies related to budgeting, investments, and resource allocation. Thus, vouchers indirectly influence better planning and efficient decision-making in business operations.

  • Record-Keeping and Reference

Vouchers act as permanent records for future reference. They serve as documentary evidence whenever disputes arise with suppliers, customers, or employees. For instance, a payment voucher with signatures and receipts can resolve payment disputes. In computerized systems, vouchers stored digitally can be retrieved quickly for analysis. These records also help track historical financial activities, supporting comparative studies and financial planning. Overall, vouchers ensure systematic record-keeping and provide reliability to financial documentation in accounting.

Types of Vouchers:

1. Payment Voucher

A payment voucher is used to record all business payments made through cash, cheque, or bank transfer. It ensures proper tracking of outflow of funds. Examples include payment to suppliers, rent, salaries, or loan repayments. Each payment entry is supported by receipts or bills to verify the transaction. Payment vouchers help maintain cash flow records and prevent errors or duplication. In TallyPrime, users can select the “Payment Voucher” option and specify ledger accounts like “Bank” or “Cash” and corresponding expense accounts. This voucher is essential for businesses to control expenses and provide an audit trail for payments.

2. Receipt Voucher

Receipt vouchers record money received in the business, whether in cash, cheque, or bank transfers. They capture inflows from customers, loans, advances, or investments. For example, if a customer pays ₹1,00,000 for a sale, it is entered through a receipt voucher. Supporting documents like bank slips or receipts validate the entry. In TallyPrime, receipt vouchers are created by choosing “Receipt” and linking accounts such as “Bank” and “Debtors.” Proper maintenance of receipt vouchers ensures accurate cash flow tracking, reduces chances of misappropriation, and provides transparency. They help reconcile bank balances and strengthen financial reporting.

3. Contra Voucher

A contra voucher is used for transactions involving internal fund transfers within the business. It records transactions where cash is deposited into a bank account, withdrawn from a bank, or transferred between two bank accounts. For instance, depositing ₹20,000 cash into the company’s bank is a contra entry. Since both debit and credit are internal accounts, there is no impact on external parties. Contra vouchers are crucial for maintaining accurate cash and bank balances. In TallyPrime, users can select the “Contra” voucher and update ledger accounts like “Cash” and “Bank.” This prevents confusion and maintains internal financial clarity.

4. Journal Voucher

Journal vouchers are used for adjustments, provisions, and non-cash transactions. They include entries such as depreciation, outstanding expenses, prepaid expenses, or accruals. For example, recording depreciation of ₹10,000 at year-end is done using a journal voucher. These vouchers do not involve immediate cash or bank movement but are vital for proper financial statements. In TallyPrime, the “Journal” voucher option is used where debit and credit accounts are specified. Journal vouchers ensure compliance with accounting standards and accurate reflection of business performance. They help in fair reporting by adjusting books for non-cash and period-end entries.

5. Sales Voucher

Sales vouchers record the sales of goods or services, either on cash or credit. They serve as proof of revenue earned by the business. For instance, selling products worth ₹80,000 to a customer is entered through a sales voucher. Supporting documents like invoices or bills are attached. In TallyPrime, users select the “Sales” voucher, where customer and sales ledger accounts are updated along with inventory items. Sales vouchers are important as they maintain revenue records, track customer transactions, and calculate GST or other applicable taxes. They also help generate accurate profit and loss statements for business analysis.

6. Purchase Voucher

Purchase vouchers record all purchases made by the business, whether raw materials, goods, or services. They can be cash or credit purchases. For example, buying raw materials worth ₹60,000 is entered through a purchase voucher. Supporting invoices or supplier bills are attached for verification. In TallyPrime, “Purchase Voucher” is used where supplier accounts and purchase ledgers are debited and cash/bank accounts credited. Purchase vouchers help track expenses, manage supplier payments, and calculate input GST. Maintaining accurate purchase vouchers also aids in inventory management, cost analysis, and ensures transparency in the procurement process.

7. Debit Note Voucher

A debit note voucher is used when goods purchased are returned to the supplier due to defects, excess supply, or mismatches. For instance, if goods worth ₹10,000 are returned, a debit note voucher records the reduction in purchase and liability. It reflects that the supplier’s account is debited. In TallyPrime, users select “Debit Note” and update supplier and purchase accounts. Debit note vouchers help businesses manage returns effectively, adjust inventory, and claim input tax credit adjustments. They also serve as formal communication to suppliers about reduced obligations, ensuring accurate financial and vendor records.

8. Credit Note Voucher

Credit note vouchers are used when customers return goods due to damage, defects, or other reasons. For example, if a customer returns products worth ₹8,000, a credit note voucher is created to adjust sales and reduce receivables. In TallyPrime, “Credit Note” is used to update customer accounts and sales ledger. These vouchers maintain accurate sales records, adjust taxes, and handle inventory corrections. Credit notes also serve as formal communication to customers acknowledging their returns. They ensure transparency, customer satisfaction, and accurate revenue reporting by reducing overstated sales figures in financial statements.

9. Memo Voucher

A memo voucher is a temporary or non-accounting voucher used for recording transactions that are provisional in nature. These entries do not affect accounts until converted into regular vouchers. For example, recording pending expenses, such as a possible electricity bill of ₹5,000 not yet received, can be done using a memo voucher. In TallyPrime, memo vouchers can later be converted to actual vouchers when confirmed. They help businesses make provisional entries, track pending obligations, and avoid missing transactions. Memo vouchers ensure flexibility in accounting while maintaining control over uncertain or temporary entries.

10. Reversing Journal Voucher

A reversing journal voucher is used to record period-end adjustments that are automatically reversed at the start of the next accounting period. For example, accrued salaries for December may be recorded as an expense and then reversed in January once actual payment is made. In TallyPrime, users can select “Reversing Journal” to create such entries. This prevents duplication of expenses and maintains accuracy in financial statements. Reversing journal vouchers are essential for businesses to manage accrual accounting, handle temporary adjustments, and ensure smooth financial closing without affecting subsequent accounting periods.

Tabular summary of Voucher Types in TallyPrimewith their purpose and usage:

Voucher Type Purpose Usage in TallyPrime
Payment Voucher Records all outgoing payments (cash, cheque, bank). Used to pay suppliers, employees, or service providers and maintain proper expense records.
Receipt Voucher Records all incoming payments to the business. Used for customer receipts, loan received, or income received via cash, cheque, or transfer.
Contra Voucher Records internal fund transfers within the business. Used for bank-to-cash, cash-to-bank, or bank-to-bank transactions.
Journal Voucher Records adjustments, provisions, or error rectifications. Used for depreciation, accruals, or non-cash entries.
Sales Voucher Records sales of goods or services. Used to generate invoices for cash and credit sales.
Purchase Voucher Records purchases of goods or services. Used for both cash and credit purchases from suppliers.
Debit Note Voucher Records purchase returns or excess payments to suppliers. Used to reduce payable amounts to vendors.
Credit Note Voucher Records sales returns or allowances to customers. Used to reduce receivables from customers.
Stock/Inventory Voucher Records stock movements, adjustments, or production. Used to track inventory levels, transfers, and consumption.
Delivery/Receipt Note Voucher Records delivery of goods to customers or receipt from suppliers. Used as proof of delivery/receipt and for inventory reconciliation.
Management Notes

Credit and Debit notes (Sec 34)

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(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.
Management Notes

Ind AS-28: Investments in Associate and Joint Ventures

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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]

Management Notes

Ind AS-17: Leases

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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.
Management Notes

Events after the Balance Sheet Date (IND AS10), Objectives, Scope, Definitions, Recognition, Measurement, Disclosures, Example

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Ind AS 10 prescribes when an entity should adjust its financial statements for events occurring after the reporting period, and the disclosures an entity should give about the date when the financial statements were approved for issue and about events after the reporting period. Events after the reporting period are those events, favourable or unfavourable, that occur between the end of the reporting period and the date the financial statements are approved for issue. The standard classifies these into adjusting events, which provide evidence of conditions existing at the reporting date, and non-adjusting events, which indicate conditions arising after that date, requiring disclosure rather than adjustment.

Objectives of Events after the Balance Sheet Date (IND AS10):

1. Prescribing When Financial Statements Should Be Adjusted

The primary objective of Ind AS 10 is to prescribe when an entity should adjust its financial statements for events after the reporting period, ensuring that conditions existing at the balance sheet date, even if only confirmed or clarified afterward, are appropriately reflected in the year-end figures. This objective ensures financial statements provide the most accurate and complete picture of the entity’s financial position and performance as of the reporting date, incorporating relevant information that becomes available before the statements are finalised, rather than freezing figures based solely on information known strictly at the balance sheet date itself.

2. Distinguishing Adjusting Events from Non-Adjusting Events

Ind AS 10 aims to establish a clear conceptual distinction between adjusting events, which provide evidence of conditions that existed at the end of the reporting period, and non-adjusting events, which are indicative of conditions that arose after the reporting period. This objective ensures a consistent, principle-based framework for classifying subsequent events, preventing arbitrary or inconsistent treatment across entities. By clearly separating these two categories, the standard ensures financial statement figures are adjusted only for genuinely pre-existing conditions, while events arising purely after year-end are appropriately disclosed rather than improperly incorporated into recognised amounts.

3. Prescribing Disclosures about Date of Approval for Issue

A key objective of the standard is to require disclosure of the date when financial statements were approved for issue and who gave that approval, since this date marks the cutoff point up to which subsequent events must be evaluated for potential adjustment or disclosure. This objective ensures users understand precisely how current the financial statements are and can assess whether events occurring after this disclosed approval date might further affect the entity’s financial position, thereby providing an important reference point for evaluating the timeliness and completeness of the reported financial information.

4. Ensuring Disclosure of Material Non-Adjusting Events

Ind AS 10 seeks to ensure that where non-adjusting events after the reporting period are material, an entity discloses the nature of the event and an estimate of its financial effect, or a statement that such an estimate cannot be made. This objective ensures users are not misled by financial statements that appear complete and static as of the reporting date, when significant developments occurring shortly afterward could materially influence their economic decisions, ensuring transparency regarding subsequent developments even though such events do not warrant adjustment to the recognised amounts within the financial statements themselves.

5. Ensuring the Going Concern Assumption Is Appropriately Assessed

The standard aims to ensure that an entity does not prepare its financial statements on a going concern basis if management determines after the reporting period, either that it intends to liquidate the entity or cease trading, or that it has no realistic alternative but to do so. This objective ensures that deterioration in an entity’s going concern status occurring after the reporting date, but before financial statements are approved for issue, is appropriately reflected through a fundamental change in the basis of preparation itself, rather than being treated as a mere subsequent event disclosure matter.

Scope of Events after the Balance Sheet Date (IND AS10):

1. General Applicability

Ind AS 10 applies to the accounting for, and disclosure of, events after the reporting period, covering both adjusting and non-adjusting events occurring between the end of the reporting period and the date the financial statements are approved for issue. It applies uniformly to all entities preparing financial statements under Ind AS, irrespective of industry or sector, ensuring a consistent framework governs the treatment of subsequent events across all reporting entities. This broad applicability ensures that any material development occurring in the period following the balance sheet date, but before finalisation of financial statements, is appropriately captured and addressed.

2. Coverage of the Period Between Reporting Date and Approval for Issue

The standard’s scope specifically covers the period between the end of the reporting period and the date when the financial statements are approved for issue by the board of directors or equivalent governing body. This defined window establishes the precise timeframe within which management must actively monitor for events requiring adjustment or disclosure. Events occurring after the approval date fall outside the scope of Ind AS 10 and would instead be relevant only to the subsequent reporting period, ensuring a clear temporal boundary governs the standard’s applicability to any given set of financial statements.

3. Applicability to Both Adjusting and Non-Adjusting Events

Ind AS 10 applies to both categories of subsequent events: adjusting events, which provide additional evidence of conditions existing at the reporting date and require recognition through adjustment of financial statement amounts, and non-adjusting events, which relate to conditions arising after the reporting date and require disclosure without adjustment. This dual scope ensures the standard comprehensively addresses the full range of possible post-reporting-date developments, providing clear guidance regardless of whether a given subsequent event relates to circumstances that already existed, or represents an entirely new development arising only after the reporting period concluded.

4. Applicability to the Going Concern Assessment

The scope of Ind AS 10 extends to circumstances where events after the reporting period indicate that the going concern assumption is no longer appropriate for the entity as a whole. This means the standard’s applicability is not confined merely to isolated adjusting or disclosure items, but extends to potentially fundamental changes in the basis of preparation of the entire set of financial statements, should management determine after the reporting date that liquidation or cessation of operations is necessary, thereby overriding the going concern assumption that would otherwise underlie the preparation of the financial statements.

5. Exclusion – Matters Governed by Other Specific Standards

While Ind AS 10 provides the general framework for subsequent events, certain specific matters arising after the reporting period, such as the measurement of onerous contracts or specific provisions, may also require reference to other applicable standards like Ind AS 37 (Provisions, Contingent Liabilities and Contingent Assets) for detailed recognition and measurement guidance once an adjusting event is identified. This ensures Ind AS 10 operates in conjunction with, rather than in isolation from, other relevant standards, providing the overarching classification principle while relying on specific standards for the detailed recognition and measurement mechanics of the underlying adjusted item.

Recognition of Events after the Balance Sheet Date (IND AS10):

1. Recognition of Adjusting Events

An entity must adjust the amounts recognised in its financial statements to reflect adjusting events after the reporting period, since these events provide additional evidence of conditions that existed at the end of the reporting period. Recognition in this context means updating recognised assets, liabilities, income, or expenses to incorporate the clearer or confirmatory evidence obtained after year-end, ensuring financial statements reflect the most accurate assessment of conditions genuinely existing as of the reporting date. This recognition principle prevents financial statements from ignoring relevant information simply because it was formally obtained slightly after the balance sheet date itself.

2. Recognition Example – Settlement of Court Case

Where the settlement, after the reporting period, of a court case confirms that an entity had a present obligation at the end of the reporting period, the entity recognises or adjusts an existing provision in accordance with Ind AS 37, rather than merely disclosing a contingent liability. This recognition treatment reflects the principle that the court settlement does not create a new obligation but confirms one that already existed at the reporting date, meaning the financial effect must be incorporated into recognised provisions rather than left as an unrecognised disclosure item relating to a future event.

3. Recognition Example – Evidence of Asset Impairment

Receipt of information after the reporting period indicating that an asset was impaired at the end of the reporting period, such as the bankruptcy of a customer that occurs after the reporting period confirming a loss existed on a trade receivable, or the sale of inventories after the reporting period providing evidence about their net realisable value at year-end, requires recognition of an adjustment. This ensures asset carrying amounts, whether receivables or inventories, are corrected to reflect the true recoverable or realisable value existing at the reporting date itself, based on subsequently obtained confirmatory evidence.

4. Recognition Example – Determination of Purchase/Sale Price of Assets

The determination after the reporting period of the cost of assets purchased, or the proceeds from assets sold, before the end of the reporting period, is recognised as an adjusting event requiring incorporation into the financial statements. Since the underlying transaction (purchase or sale) actually occurred before the reporting date, any subsequent finalisation of price or consideration merely quantifies more precisely a transaction whose economic substance already existed at year-end, and this refined measurement must therefore be reflected in the recognised carrying amounts of the relevant assets or related gain/loss.

5. Recognition Example – Discovery of Fraud or Errors

The discovery of fraud or errors that show the financial statements were incorrect, occurring after the reporting period but relating to conditions existing at or before the reporting date, requires recognition through adjustment of the financial statements. This ensures that once fraud or accounting errors affecting previously reported figures are uncovered, even after the formal year-end, the financial statements are corrected to present an accurate picture of the entity’s actual financial position and performance, rather than allowing known inaccuracies to remain unadjusted merely because their discovery occurred technically after the balance sheet date.

6. Non-Recognition of Non-Adjusting Events

Non-adjusting events, being indicative of conditions arising after the reporting period, are not recognised through adjustment of recognised amounts in the financial statements, since incorporating them would misrepresent conditions actually existing at the reporting date. Instead, such events are addressed purely through disclosure of their nature and estimated financial effect, without any change to recognised assets, liabilities, income, or expenses. This non-recognition principle preserves the integrity of the reporting date cutoff, ensuring financial statements reflect a true snapshot of conditions as they stood at year-end, undistorted by subsequent, unrelated developments.

7. Non-Recognition Example – Decline in Market Value of Investments

A decline in the market value of investments between the end of the reporting period and the date the financial statements are approved for issue is not recognised as an adjustment, since such a decline typically reflects circumstances arising after the reporting period rather than conditions existing at the reporting date itself. This non-adjusting event is instead addressed through appropriate disclosure of its nature and financial effect where material, ensuring users are informed of significant post-year-end market developments without artificially incorporating a value decline that relates to conditions genuinely arising only after the balance sheet date concluded.

Measurement of Events after the Balance Sheet Date (IND AS10):

1. Measurement Basis for Adjusting Events

Where an adjusting event requires recognition, the amounts recognised in the financial statements are measured by incorporating the additional evidence obtained after the reporting period into the original measurement basis applicable to that asset, liability, income, or expense under the relevant Ind AS. This means the standard governing the specific item—such as Ind AS 37 for provisions or Ind AS 2 for inventories—continues to govern the actual measurement methodology, while Ind AS 10 simply mandates that the newly available, more precise or confirmatory information be used to refine that measurement as at the original reporting date.

2. Measurement of Provisions Confirmed by Subsequent Events

When a court case settled after the reporting period confirms a present obligation existed at year-end, the provision is measured in accordance with Ind AS 37, using the best estimate of the expenditure required to settle the obligation. The subsequent settlement amount often becomes the most reliable evidence available for measuring this best estimate, effectively replacing earlier, less certain estimates with the now-known settlement figure. This ensures the recognised provision reflects the most accurate quantification achievable, treating the post-year-end settlement as definitive measurement evidence relating back to the obligation’s existence at the reporting date.

3. Measurement of Impaired Receivables and Inventories

Where subsequent events provide evidence of impairment, such as customer bankruptcy confirming a trade receivable was uncollectible, or a post-year-end sale confirming inventory net realisable value, the carrying amount of the asset is measured using this newly obtained evidence to determine the appropriate write-down as at the reporting date. For receivables, this involves applying the expected credit loss framework under Ind AS 109 informed by the confirmatory event; for inventories, the actual subsequent selling price, less costs to complete and sell, provides direct measurement evidence for determining net realisable value under Ind AS 2 at year-end.

4. Measurement Not Applicable to Non-Adjusting Events

Since non-adjusting events do not result in recognition or adjustment of financial statement amounts, no measurement of their financial effect is incorporated into the recognised carrying values of assets, liabilities, income, or expenses. Instead, where disclosure of a non-adjusting event is required, an estimate of its financial effect is provided purely for disclosure purposes in the notes, distinct from any measurement affecting recognised balance sheet or profit and loss figures. If such an estimate cannot reasonably be made, this fact itself must be stated, without approximating a measurement that lacks reliable estimation basis.

5. Measurement Impact of Going Concern Determination

If management determines after the reporting period that the entity will be liquidated or cease trading, with no realistic alternative, the entire basis of measurement underlying the financial statements changes fundamentally—from the going concern basis to a liquidation or break-up basis. This requires assets to be measured at amounts expected to be realised (often significantly lower than carrying values under the going concern assumption) and liabilities remeasured accordingly, reflecting the fundamentally altered economic reality. This represents the most significant measurement consequence possible under Ind AS 10, extending beyond individual line items to the entire financial statements.

6. Measurement of Dividends Declared After the Reporting Period

If an entity declares dividends to equity holders after the reporting period, the entity does not recognise those dividends as a liability at the end of the reporting period, since no present obligation existed at that date. Consequently, no measurement adjustment is made to recognised liabilities; instead, the amount of the dividend is disclosed in the notes in accordance with Ind AS 1. This ensures liabilities are not measured to include obligations that had not yet crystallised as of the reporting date, maintaining consistency with the general recognition principle governing adjusting versus non-adjusting events.

Disclosures of Events after the Balance Sheet Date (IND AS10):

1. Disclosure of Date of Approval for Issue

An entity must disclose the date when the financial statements were approved for issue and who gave that approval. If the entity’s owners or others have the power to amend the financial statements after issue, this fact must also be disclosed. This disclosure establishes the precise cutoff point up to which management has evaluated subsequent events for potential adjustment or disclosure, giving users a clear reference for assessing how current the financial statements are and whether any further developments occurring after this date might warrant separate consideration or inquiry.

2. Disclosure of Updated Information Received about Conditions at Reporting Date

If an entity receives information after the reporting period, but before the financial statements are approved for issue, about conditions that existed at the end of the reporting period, it must update disclosures relating to those conditions in light of the new information, even where the event itself does not require adjustment of recognised amounts. This ensures narrative disclosures, such as those relating to contingent liabilities or estimates, remain current and reflect the most complete information available at the time of finalisation, rather than being frozen based on knowledge existing strictly at the reporting date.

3. Disclosure of Material Non-Adjusting Events

For each material category of non-adjusting event after the reporting period, an entity must disclose the nature of the event and an estimate of its financial effect, or a statement that such an estimate cannot be made. Examples requiring such disclosure include major business combinations, announcement of a plan to discontinue an operation, major purchases or disposals of assets, destruction of a major production facility by fire, announcement of a major restructuring plan, significant changes in foreign exchange rates, and significant litigation arising solely from events occurring after the reporting period.

4. Disclosure Where Going Concern Basis Becomes Inappropriate

If events after the reporting period indicate that the going concern assumption is not appropriate, an entity must disclose this fact prominently, along with the basis on which the financial statements have instead been prepared and the reason the entity is no longer considered a going concern. This disclosure ensures users are not misled by financial statements prepared on a going concern basis when management has determined, after the reporting date but before approval for issue, that liquidation or cessation of trading is unavoidable, representing one of the most critical disclosures required under the standard.

5. Disclosure of Dividends Proposed or Declared After the Reporting Period

If dividends are proposed or declared after the reporting period but before the financial statements are approved for issue, the amount of such dividends and the fact that no related liability has been recognised at the reporting date must be disclosed in the notes, in accordance with Ind AS 1. This disclosure ensures users are informed of significant post-year-end distributions to shareholders while maintaining consistency with the recognition principle that no present obligation for the dividend existed as of the reporting date itself, since dividends only become a liability once appropriately authorised and declared.

Example of Events after the Balance Sheet Date (IND AS10):

ABC Ltd. prepares its financial statements for the year ended 31 March 2026. On 15 April 2026, before the financial statements are approved, a customer owing ₹5,00,000 is declared bankrupt. The customer was already facing serious financial difficulties on 31 March 2026. This event provides additional evidence about a condition existing at the reporting date.

Under Ind AS 10, it is an adjusting event. The company should adjust the financial statements to recognise the expected credit loss or bad debt relating to the customer.

Particulars Amount
Trade Receivable ₹5,00,000
Amount recoverable ₹1,00,000
Impairment Loss ₹4,00,000

Journal Entry

Particulars Debit Credit
Impairment Loss A/c Dr. ₹4,00,000
To Trade Receivables / Loss Allowance A/c ₹4,00,000

Conclusion: Since the customer’s financial difficulty existed at 31 March 2026, the bankruptcy provides evidence of a condition existing at the reporting date. Therefore, the event is adjusted in the financial statements.

Management Notes

Derivatives and Hedge Accounting

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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.

Management Notes

Impairment, Asset Retirement Obligation

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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.
Management Notes

Revenue recognition Certain Customer Right’s & Obligations

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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.

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