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Non-Compliance with Reporting Obligations observed by the Financial Reporting Review Board

Written By Admin on Monday, 10 December 2012 | Monday, December 10, 2012



Accounting Standards

AS 1, Disclosure of Accounting Policies

1.    Certain enterprises merely states in its accounting policy relating to revenue recognition that the revenue has been recognised on the basis as stipulated under the AS 9, Revenue Recognition. Such disclosure can not be considered as adequate disclosure under the AS 1. The accounting policy as adopted by the enterprise with respect to timing of recognition of revenue arising from sales revenue, interest income, royalty income and dividend income should be considered as one of the most important accounting policies for any organisation and it should be disclosed separately.

2.    Paragraph 10 (a) of the AS 1 provides that “the enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations”. Further, it may be noted that Paragraph 27 of the AS 1 provides that if the fundamental accounting assumptions, viz. going concern, consistency and accrual, are followed in financial statements, specific disclosure is not required. If a fundamental accounting assumption is not followed, the fact should be disclosed.

      However, while reviewing the financial statement of an enterprise, it has been noted that it is continuously incurring losses and its net worth has become significantly negative. Further, certain relief measures are also being granted to it, so that the enterprise may be able to continue its operation, still, it fails to do so. It is also disclosed in the notes to accounts that even if the enterprise is able to continue some of its operations, it would be required to curtail its operations materially.

      Despite all such facts, if the financial statements of such enterprise are prepared on a going concern basis, than, it is not as per the requirement of the AS 1. Also, it is not appropriate for such enterprise to simply prepare its financial statements on a going concern basis without disclosing this fact on the face of auditor’s report.

3.    Paragraph 24 of the AS 1 requires that all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. The financial statements of the enterprises provide a detailed note on accounting policies as adopted by them. However, they often omit to disclose accounting policies with regard to the borrowing costs, valuation of inventories, accounting for investments, impairment of assets, provisions, contingent liabilities and contingent assets. It was felt that enterprises normally, borrow funds, hold inventories as well as investments and also possess certain assets which may be subject to impairment. Further, there is always a need to carry certain provisions for meet their future liabilities. Accordingly, subject to circumstances, enterprises are expected to also disclose the accounting policies as adopted by them with regard to borrowing costs, valuation of inventories, accounting for investments, impairment of assets and provisions, contingent liabilities and contingent assets.

4.    Some enterprises report significant amounts of income earned by way of interest, royalties, and dividend. However, they do not disclose their accounting policy adopted for reporting the same. This is not as per the requirement of paragraph 24 of AS 1, Disclosure of Accounting Policies, which requires that ‘All significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed’

AS 2, Valuation of Inventories

5.    As per AS 2, Valuation of Inventories, the cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. As per the Guidance Note on Accounting Treatment for Excise Duty, which is based on AS 2, excise duty is a cost incurred in bringing the inventories to their present location and condition. Accordingly, a provision needs to be created for excise duty payable on goods manufactured during the year and lying in the stock at the end of the year. Certain enterprises are not creating provision for excise duty payable on finished goods lying in the stock. This treatment results in understatement of liabilities as well as value of inventories and it is contrary to AS 2 as well as the Guidance Note on Accounting Treatment for Excise Duty.

6.    AS 2, Valuation of Inventories requires all inventories, including raw materials, packing materials and consumables & stores, to be valued at lower of cost and net realisable value. In few cases, the accounting policy of few enterprises provides that raw materials, packing materials and consumables & stores are valued at the cost/ weighted average cost. In other words, some enterprises do not consider net realisable value in the valuation of raw materials, packing materials and consumables & stores, which is contrary to the requirements of AS 2.

7.   Paragraph 26 of the AS 2, Valuation of Inventories, dealing with disclosure requires that the financial statements should disclose:

·         the accounting policies adopted in measuring inventories, including the cost formula used; and
·         the total carrying amount of inventories and its classification appropriate to the enterprise.

      In contravention to AS 2, some enterprises do not disclose the method of valuation of inventories i.e. whether FIFO/ LIFO or other method in their accounting policy on Inventories. Other enterprises simply state that the value of inventory is determined by using FIFO or Specific Identification method as applicable.  The usage of term ‘as applicable’ is not correct. Such general statement on the method of valuation seems to be ambiguous. The enterprise should specifically state the method of valuation for each class of inventory viz raw material and components, work in progress, finished goods, stores and spares, and loose tools.

8.   Inventories of raw materials, work-in-progress, stores and spares parts, goods-in-progress and by-products have been valued at cost. The policy indicates that apparently the enterprise is not considering the net realisable value (NRV) in the valuation of raw materials work-in-progress. This is not as per AS 2. Paragraph 5 of AS 2 requires all inventories, including raw materials, and work-in-progress to be valued at the lower of cost and net realisable value. As per paragraph 24 of AS 2, net realisable value of raw materials and work-in-progress is taken into consideration in the following manner:

      “Materials and other supplies held for use in the production of inventories are not written down below cost if the finished products in which they will be incorporated are expected to be sold at or above cost. However, when there has been a decline in the price of materials and it is estimated that the cost of the finished products will exceed net realisable value, the materials are written down to net realisable value. In such circumstances, the replacement cost of the materials may be the best available measure of their net realisable value.”

9.   Paragraph 26(a) of AS 2, Valuation of Inventories, inter alia, requires disclosure of cost formula used for valuation of inventories but many enterprises fail to disclose the cost formula.

10. Some of the enterprises are not creating provision for excise duty on finished stock lying in the stock. This treatment results in understatement of liabilities as well as value of inventories. It is contrary to AS 2 as well as the Guidance Note on Accounting Treatment for Excise Duty.

      As per paragraph 6, Valuation of Inventories, of AS 2 “the cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.” Further, as per Guidance Note on Accounting Treatment for Excise Duty, which is based on AS 2, excise duty is a cost incurred in bringing the inventories to their present location and condition.

11. Some enterprises recognise the custom duty on inventory as and when the goods are cleared from custom warehouse. As such, no provision for customs duty is made on the goods lying in the warehouse. It is contrary to the requirement of the AS 2. It may be noted that as per Paragraph 6 of the AS 2, the cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Since the customs duty is a cost incurred in bringing the goods to its present location and condition, therefore, the liability to pay such duty should be recognised as and when the goods enter the territorial waters of the country.

12. Certain enterprises disclose the amount of the MODVAT credit receivables as well as Excise duty on finished goods as separate sub-heads under the head of ‘Inventories’. It may be noted that the Guidance note on Accounting Treatment for Excise Duty provides that the excise duty should be considered as a manufacturing expense and like other manufacturing expenses, it should be considered as an element of cost for inventory valuation. Therefore, ‘excise duty on finished goods’ should be included in the value of finished goods instead of separately disclosing the same as a separate sub-head under the head of ‘Inventory’. Further, as per Paragraph 16 of the Guidance note on Accounting Treatment for MODVAT/CENVAT provides that the debit balance in the MODVAT/CENVAT credit receivable (inputs) account should be shown on the asset side under the head of ‘advances’.


AS 3, Cash Flow Statements (revised 1997)

13. Certain companies which are disclosing dividend paid under the heading ‘Cash Flow from Financing Activities’, have disclosed ‘tax on dividend paid (corporate dividend tax)’ under the heading ‘Cash Flow from Operating Activities’. It may be noted that the tax on dividend paid (corporate dividend tax) is related to distribution of profits. The Guidance Note on Accounting for Corporate Dividend Tax requires the corporate dividend tax to be disclosed along with the dividend paid in the profit and loss account, ‘below the line’. Applying the same principle, tax on dividend paid (corporate dividend tax) should be shown along with the dividend paid in the Cash Flow Statement under the heading ‘Cash Flow from Financing Activities’. It is not correct to show this amount as ‘Cash Flow from Operating Activities’ while dividend paid is disclosed as ‘Cash Flow from Financing Activities’.

14. As per paragraph 30 of AS 3, Cash Flow Statements, interest paid has to be classified as cash flow from financing activities. Few enterprises have shown interest paid as cash flow from investing activities, which is not as per AS 3.

AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies

15. Paragraph 15 of AS 5 requires that the nature and amount of prior period items should be separately disclosed in the statement of profit and loss in a manner that their impact on the current profit or loss can be perceived. However, certain enterprises disclose prior period items in their profit and loss account but fail to mention the nature, i.e., the exact reason for arising of these items either in the profit and loss account or in the schedules or in the notes.

16. As per AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies, prior period items are income or expense which arises in the current period as a result of error or omissions in the preparation of the financial statements of one or more prior periods. Some enterprises have adjusted the Balances/Liabilities that are no longer required relating to earlier years or written off in earlier years under the head prior period adjustments in the profit & loss account, which is contrary to AS 5.

AS 6, Depreciation Accounting

17. Certain enterprises do not provide depreciation on their plant and machinery for the shut down period. This is not as per AS 6 (revised 1994), Depreciation Accounting. As per the definition of the term ‘Depreciation’ given in the AS 6, depreciation is, inter alia, a measure of the loss of value arising from effluxion of time. Keeping this in view, depreciation for the shutdown period needs to be provided.

18. Paragraph 21 of Accounting Standard (AS) 6, Depreciation Accounting, requires that any deficiency or surplus arising from retrospective re-computation of depreciation should be adjusted in the statement of profit and loss. However, certain enterprises transfer an amount equivalent to differential depreciation pertaining to earlier years on account of change in the method of charging depreciation, from general reserve to the profit and loss account, above the line. This treatment has the effect of negating the requirement of paragraph 21 of AS 6 since the profit and loss account for the year is not affected by the amount of depreciation arising from retrospective re-computation of depreciation. Thus, this practice is contrary to the requirements of AS 6.

19. It was observed that some of the enterprises adopt depreciation rates, for certain assets that are different from the rates as specified in Schedule XIV to the Companies Act, 1956. Further, the enterprises also do not disclose the useful lives or the depreciation rates that have been adopted for such assets. It is a non compliance of the Companies Act, 1956 as well as AS 6. It may be mentioned that Note No.5 of Schedule XIV to the Companies Act, 1956 provides as follows:
     
      The following information should be disclosed in the accounts:

(i)    depreciation methods used; and

(ii)   depreciation rates or the useful lives of the assets, if they are different from the principal rates specified in the Schedule XIV. Further, paragraph 17 of AS 6, Depreciation Accounting also states that

      “…The depreciation rates or the useful lives of the assets are disclosed only if they are different from the principle rates specified in the statute governing the enterprises.”

      Thus, if on the basis of bona fide technological evaluation, higher rates of depreciation are justified, they may be provided with proper disclosure of the same in the notes forming part of financial statements.

AS 9, Revenue Recognition

20. Accounting Standards Interpretation (ASI) 14, ‘Disclosure of Revenue from Sales Transactions’ (Re. AS 9, Revenue Recognition) requires that the amount of turnover should be disclosed in the following manner on the face of the statement of profit and loss:
     
                                Turnover (Gross)                                     xx
                                Less: Excise Duty                                   xx
                                Turnover (Net)                                         xx

      Some enterprises disclose sales (net of excise duty) on the face of the profit and loss account and the amount of excise duty is shown as deduction from sales in the Schedule to the profit and loss account, which is contrary to the Accounting Standards Interpretation (ASI) 14.

21. Some enterprises include two amounts of excise duty, relating to both opening stock as well as closing stock, in the statement of profit and loss but fail to give any explanatory note in note to accounts to explain their nature. It may be mentioned that as per paragraph 3 of ASI 14 of Accounting Standard 9, Revenue Recognition, requires that “The excise duty related to the difference between the closing stock and opening stocks should be recognised separately in the statement of profit and loss, with an explanatory note in the notes to accounts to explain the nature of two amounts of excise duty”.

AS 10, Accounting for Fixed Assets

22. Some enterprises include in the Schedule of Inventory those items of fixed assets which have been retired from active use and are held for disposal as an inventory item. It is not in line with Accounting Standard (AS) 10, Accounting for Fixed Assets and Accounting Standard (AS) 2, Inventory Valuation. Paragraph 14.2 of AS 10, Accounting for Fixed Assets, requires that the “Items of fixed assets that have been retired from active use and are held for disposal are stated at the lower of their net book value and net realisable value and are shown separately in the financial statement”. Further, paragraph 3 of AS 2 defines ‘Inventories’ as assets “held for sale in the ordinary course of business”. However, the sale of fixed assets cannot be treated as sale arising from the ordinary course of business. Accordingly, such items should be included in the Schedule of fixed assets as per the principle suggested in AS 10.

AS 11 (revised 1994), Accounting for the Effects of Changes in Foreign Exchange Rates

23. Certain enterprises recognise exchange differences arising on foreign currency transactions on realisation basis, i.e., upon the final settlement of the foreign currency assets and liabilities resulting into such differences. This is contrary to AS 11 (revised 1994) which requires gains as well as losses on account of foreign exchange rate fluctuations, except differences arising on liabilities requires gains as well as losses on account of foreign exchange rate fluctuations, except exchange differences arising on liabilities incurred for the purpose of acquiring fixed assets, to be recognised immediately in the statement of profit and loss.

AS 13, Accounting for Investments

24. In a few cases, provision for diminution in the value of investments has been charged directly to the Investment Fluctuation Reserve, without even routing it through the profit and loss account. This is not as per paragraph 33 of AS 13, Accounting for Investments, which requires that any reduction in the carrying amount of any investment should be charged to the profit and loss statement.

25. Paragraph 26 of AS 13 requires that an enterprise should disclose current investments and long-term investments distinctly in its financial statements. However, certain enterprises do not disclose the same either in the Schedule ‘Investments’ or in the notes which is a violation of AS 13.

26. AS 13, Accounting for Investments, requires provision to be created to recognise a decline, other than temporary, in the value of long-term investments. Some enterprises use the term permanent diminution instead of other than temporary, which is contrary to the requirement of AS 13. It may be noted that there is a difference between ‘permanent diminution in the value of investments’ and ‘other than temporary diminution in value of investments’ and normally, no diminution in value of investments may be termed as permanent.

27. The balance sheet of certain enterprises shows the Investments as part of their assets and classifies the same as per the requirements of Schedule VI of the Companies Act, 1956. However, they do not disclose any accounting policy regarding the Investments, which is not as per the requirements of AS 1 and AS 13. It may be mentioned that as per paragraph 24 of AS 1, Disclosure of Accounting Policy, ‘All significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed’. Further, as per clause (a) of paragraph 35 of AS 13, Accounting for Investments, along with other disclosure an enterprise is also required to state the accounting policy adopted for determination of carrying amount of both the long term investments as well as current investments.

28. Some enterprises in their balance sheet classify the Investments as per the requirements of Schedule VI of the Companies Act, 1956 but do not classify these Investments as per the requirement of clause (b) and clause (e) of paragraph 35 of AS 13, Accounting for Investments, either in the Schedule ‘Investments’ or in the notes. It is not as per the requirement of AS 13. It may be noted that as per paragraph 35(b) and 35 (e), an enterprise should disclose current investments and long term investments distinctly in its financial statements and the aggregate amount of quoted and unquoted investments, giving the aggregate market value of quoted investments, respectively.

AS 15, Accounting for Retirement Benefits in the Financial Statements of Employers

29. In the financial statement of certain enterprises it has been observed that the deferred expenditure on retirement benefit is carried forward beyond the maximum period specified in Paragraph 146 of Accounting Standard 15, i.e. 1st April 2010, which is contrary to the provisions of paragraph 146 of Accounting Standard 15, Employee Benefit. It states that “This Statement requires immediate expensing of expenditure on termination benefits (including expenditure incurred on voluntary retirement scheme (VRS)). However, where an enterprise incurs expenditure on termination benefits on or before 31st March, 2009, the enterprise may choose to follow the accounting policy of deferring such expenditure over its pay-back period. However, the expenditure so deferred cannot be carried forward to accounting periods commencing on or after 1st April 2010”.

AS 17, Segment Reporting

30. Certain enterprises which do not have any separate business segments have stated that they consider business segment to be primary segment. They have disclosed the information about the geographical segments as secondary segments and made disclosures accordingly, which are less than disclosures required for primary segments. This is not strictly in accordance with AS 17. In case an enterprise does not have separate business segments but has separate geographical segments, geographical segments should constitute primary segments for the enterprise.

AS 18, Related Party Disclosures

31. ASI 23 ‘Remuneration Paid to Key Management Personnel – Whether a related party transaction’ (Re: AS – 18 ‘Related Party Disclosures’) requires that since key management personnel are related parties as per the provisions of AS 18, remuneration paid to key management personnel is a related party transaction requiring disclosures under AS 18. Some enterprises do not disclose Remuneration to key management personnel in related party disclosure as required by ASI-23, which is not as per the requirements of ASI-23.

AS 19, Leases

32. Some enterprises, while complying with the requirements of paragraph 22 of AS 19, Leases, disclose the information required by clause (a) to (e) of paragraph 22 of AS 19, however, they do not disclose general description of the lessee’s significant arrangements as required by paragraph 22 (f) of AS 19. It may be mentioned that the disclosure requirement under clause (f) is also an important requirement and therefore the lessee should disclose, amongst the other disclosures of paragraph 22, a general descriptions of the lessee’s significant arrangements including, but not limited to, the following:

a.    the basis on which contingent rent payment are determined;

b.    the existence and terms of renewal of purchase options and escalation clauses: and

c.    restrictions imposed by lease arrangements, such as those concerning dividends, additional debts, and further leasing.

AS 20, Earnings Per Share

33. Accounting Standard (AS) 20, Earnings Per Share, requires that the enterprises whose equity shares or potential equity shares are listed on a recognised stock exchange in India, should disclose the basic as well as diluted Earnings Per Share on the face of the statement of profit and loss also. However, certain enterprises whose equity shares are listed on recognised stock exchanges have not disclosed the same on the face of the profit and loss account.

34. As per paragraph 48 of AS 20, Earnings Per Share, the nominal value of shares is required to be disclosed alongwith the earning per share figures. However, some enterprises do not comply with this requirement of AS 20.

35. As per paragraph 48 (ii) (b) of AS 20, Earnings Per Share, an enterprise alongwith other disclosures should also disclose “the weighted average number of equity shares used as the denominator in calculating basic and diluted earnings per share and a reconciliation of these denominators to each other.” Some enterprises disclose the numerators and denominators used in calculating basic and diluted earnings per share but do not disclose the reconciliation between the two denominators, which is not as per the requirement of AS 20.

36. In calculating the basic earning per share, the net profit for the year is used as the numerator and the number of equity shares as denominator. The policy indicates that apparently the enterprise is not considering weighted average number of equity shares outstanding during the period. This is not as per AS 20.  Paragraph 15 of AS 20 requires that “for the purpose of calculating basic earnings per share, the number of equity shares should be the weighted average number of equity shares outstanding during the period.”

37. In other cases, the enterprise determine the weighted average number of equity shares outstanding during the period considering the number of equity shares outstanding as at the beginning as well as at the end of the period but not adjusting the same for the effects of all dilutive potential equity shares. For instance, along with issue of equity shares during the period it has also issued the warrants which can be converted into certain number of equity shares. The enterprise has determined the weighted average number of equity shares with due consideration of the number of equity shares outstanding as at the beginning as well as at the end of the period but it has not considered the effects of additional equity shares which would have been outstanding assuming the conversion of all dilutive potential equity shares. This is not as per AS 20, Earnings Per Share. As per paragraph 26, AS 20, diluted earning per share is determined in the following manner:

      “For the purpose of calculating diluted earnings per share, the net profit or loss for the period attributable to equity shareholders and the weighted average number of shares outstanding during the period should be adjusted for the effects of all dilutive potential equity shares”

AS 22, Accounting for Taxes on Income

38. Certain enterprises have disclosed deferred tax credit under the heading ‘Reserves and Surplus’. This is not as per Accounting Standard (AS) 22, Accounting for Taxes on Income as well as Accounting Standards Interpretation (ASI) 7 on ‘Disclosure of deferred tax assets and deferred tax liabilities in the balance sheet of a company’ (Re. AS 22, Accounting for Taxes on Income). As per AS 22, deferred tax credit (deferred tax liability) is a liability of the enterprise and, therefore, it cannot be disclosed as a part of ‘Reserves and Surplus’. ASI 7 requires that deferred tax liabilities should be disclosed on the face of the balance sheet separately after the head Unsecured Loans.
           
39. Certain companies disclose deferred tax asset after the heading ‘Net Current Assets’,   which is contrary to ASI 7. As per ASI 7, deferred tax asset should be disclosed on the face of the balance sheet separately after the head Investments.

40. As per AS 22, Accounting for Taxes on Income, in case any announcement of tax rates and tax laws by the government has the substantive effect of actual enactment, deferred tax assets and liabilities should be measured using such announced tax rates and tax laws. However, certain enterprises calculate deferred tax asset or liability using the tax rates enacted by the balance sheet date and fail to consider the substantively enacted tax rates and tax laws for calculation of deferred tax asset or liability.

41. A few enterprises have charged tax expense, comprising current tax and deferred tax, to the profit and loss account, below the line, i.e., after crediting profit brought forward from earlier years. This is contrary to AS 22, Accounting for Taxes on Income, which provides that tax expense for the period, comprising current tax and deferred tax, is an actual expense and should be included in the determination of the net profit or loss for the period, i.e., above the line.

42. Some enterprises having unabsorbed depreciation or carry forward of losses under tax laws have mentioned in their accounting policies that the deferred tax asset is recognised and carried forward only to the extent that there is a reasonable certainty that the asset will be adjusted in future. This is not as per AS 22, Accounting for Taxes on Income. Paragraph 17 of AS 22 requires that where an enterprise has an unabsorbed depreciation or carry forward of losses under tax laws, deferred tax assets should be recognised only to the extent that there is virtual certainty supported by convincing evidence that sufficient future taxable income will be available against which such deferred tax assets can be realised. As per the said paragraph, in case an enterprise has unabsorbed depreciation or carry forward of losses, it is required to consider virtual certainty supported by convincing evidence for recognition of all deferred tax assets and not only for the deferred tax assets arising from unabsorbed depreciation or carry forward of losses.

43. Certain enterprises disclose advance income tax paid (current tax asset) and provision for income tax (current tax liability) separately in their balance sheets, i.e., they do not offset the amounts. This is contrary to AS 22, Accounting for Taxes on Income. Paragraph 27 of AS 22 requires that an enterprise should offset assets and liabilities representing current tax if the enterprise:

a.    has a legally enforceable right to set off the recognised amounts; and

b.    intends to settle the asset and the liability on a net basis.

      It may be noted that under the Income-tax Act, 1961, advance tax representing current tax is paid against provision for income tax representing current tax liability. Under the said Act, an enterprise has a legal right to set off the two amounts and normally, the enterprises settle these amounts on net basis only. Keeping this in view, the enterprise should offset advance income tax paid against provision for income tax and show only the net amount in the balance sheet. Disclosing two amounts separately is contrary to AS 22.

44. Paragraph 32 of AS 22, Accounting for Taxes on Income, requires that “The nature of the evidence supporting the recognition of deferred tax assets should be disclosed, if an enterprise has unabsorbed depreciation or carry forward of losses under tax law”. It has been observed in the case of few enterprises, that the balances of unabsorbed depreciation and/or losses are being carried forward under tax law due to which the deferred tax asset has been recognised in the financial statements. However, it omits to disclose the nature of evidence that supports the recognition of such deferred tax assets with virtual certainty.

45. Paragraph 31 of AS 22, Accounting for Taxes on Income, requires that “The break-up of deferred tax assets and deferred tax liabilities in to major components of the respective balances should be disclosed in the notes to accounts”.

      In case of the financial statement of few enterprises it is observed that, it has disclosed only the opening balance, addition during the year and the closing balance of the deferred tax assets and liabilities and there is no disclosure of the break-up of the deferred tax assets and liabilities into their major components which is not as per the requirement of AS 22.


AS 26, Intangible Assets

46. As per AS 26, Intangible Assets, expenditure on research and development should be classified into expenditure on research phase and on development phase. Expenditure on research should be recognised as an expense immediately and expenditure incurred in development should be recognised as an intangible asset, if the recognition criteria given in paragraph 44 of AS 26 are satisfied. Some enterprises do not bifurcate between expenditure incurred on research phase and development phase and all revenue expenses incurred, including expenditure incurred on development phase are written off in the year in which it is incurred, which is contrary to AS 26. In some cases the enterprises do not give the accounting policy regarding the ‘Research and Development’ in clear manner.

47. Product Development Expenditure is stated to be amortised over the estimated period of benefit. Such disclosure of accounting policy as adopted by the enterprise seems to be ambiguous. It may be noted that such expenditure is treated as expenditure incurred on intangible asset during ‘development stage’ provided it meets the criteria laid in paragraph 44 of AS 26, Intangible Assets. Further, paragraph 90 of AS 26, inter alia requires that the financial statements should disclose the useful lives or the amortisation rates used as well as the amortisation method used by the enterprise.

AS 28, Impairment of Assets

48. In few cases, the enterprises club amortisation; diminution in the value of assets and write down of assets, which are in the nature of impairment of assets with the depreciation. Impairment losses are distinct from depreciation and, therefore, should be recognised separately and it is not appropriate to club the same with the depreciation charge.

AS 29, Provisions, Contingent Liabilities and Contingent Assets

49. There are financial statements of the enterprises that contain provisions of various natures that are often carried by them from period to period. However, they omit to comply with the disclosure requirements of AS 29, Provisions, Contingent Liabilities and Contingent Assets. As per paragraph 66 of AS 29, Provisions, Contingent Liabilities and Contingent Assets, “For each class of provision, an enterprise should disclose:

a)    the carrying amount at the beginning and end of the period;

b)    additional provisions made in the period, including increases to existing provisions;

c)    amounts used (i.e., incurred and charged against the provision) during the period; and

d)    unused amount reversed during the period.

      Further, Paragraph 67 of AS 29 requires that “An enterprise should disclose the following for each class of provision:

a)    a brief description of the nature of the obligation and the expected timing of any resulting outflow of economic benefits;

b)    an indication of uncertainties about those outflows. Where necessary to provide adequate information, an enterprise should disclose the major assumptions made concerning future events, as addressed in paragraph 41; and

c)    the amount of any expected reimbursement, stating the amount of any assets that has been recognised for that expected reimbursement.

      The enterprises often creaters and carry the provisions in the schedules to profit and loss account and balance sheet but they neither comply with the disclosure requirement as stated in Paragraphs 66 and 67 of AS 29 nor they disclose their accounting policy with regard to the same.


Announcement on Preparation of Financial Statements on Letter-Heads and Stationery of Auditors

1.    The Research Committee of the Institute has issued an Announcement on ‘Preparation of Financial Statements on Letter-Heads and Stationery of Auditors’ (published in the August, 1982 issue of ‘The Chartered Accountant’ p. 175), which provides that practice of preparing financial statements on the letter-head/ stationery of the auditor is liable to be misinterpreted and, therefore, should be avoided. Despite this, some auditors have prepared the financial statements of their clients on their letter-heads.

Auditing and Assurance Standard (AAS) 28, The Auditor’s Report on Financial Statements

1.    In contravention of AAS 28, the Auditors' Report on Financial Statements, in the auditors' report of some enterprises, the partner/proprietor, who has signed the audit report, does not mention his membership number in the report. AAS 28 requires that the report should be signed by the auditor in his personal name. Where the firm is appointed as the auditor, the report should be signed in the personal name of the auditor and in the name of the audit firm. The partner/proprietor signing the audit report should also mention the membership number assigned by the Institute of Chartered Accountants of India.

2.    In the auditor’s report of some enterprises it has been observed that, the qualification given by the auditor is not clear and specific. If an auditor provides his opinion subject to the entire schedule containing the accounting policies adopted by the company for the preparation and presentation of the financial statements then it is regarded as an ambiguous qualification. Such qualification does not state clearly the schedule or the accounting policy that has been regarded as the subject matter of his qualification. Paragraph 4 of Auditing and Assurance Standard 28, The Auditor’s Report on Financial Statements, require that “The auditor’s report should contain a clear written expression of opinion on the financial statement taken as whole.” Accordingly, if the auditor provides his opinion subject to any qualification, it should be clear and specific. Such ambiguous qualification may raise doubt in the mind of a reader regarding the accounting policies adopted by the company in the preparation and presentation of the financial statements.

Companies (Auditor's Report) Order, 2003 (CARO 2003)

1.    Paragraph 4(iv) of CARO, 2003 requires the auditor to comment on "Is there an adequate internal control procedure commensurate with the size of the company and the nature of its business, for the purchase of fixed assets and for the sale of goods and services. Whether there is a continuing failure to correct major weaknesses in internal control system." In case of some enterprises, auditors comment only on the first aspect but omit to comment on the second aspect of this clause. It may be mentioned that these are two distinct aspects of the clause. The first requires the auditor to comment on the adequacy of the internal controls in regard to purchase of inventories, purchase of fixed assets and sale of goods and services whereas the second aspect requires the auditor to comment whether there was a continuing failure to correct a major weakness in such internal controls. Since these two aspects are not related to each other, it cannot be concluded that if no major weakness was reported during the period covered by the audit report, the internal control system is adequate or vice versa. Therefore, the auditor is required to comment on both aspects of the clause.

2.     In case of few enterprises, the auditors address the Statement on the Companies (Auditor's Report) Order (CARO) to the directors instead of addressing the same to the members of the enterprise. It may be mentioned that CARO is prepared in pursuant to sub-section (4A) of Section 227 of the Companies Act, 1956 and as per Section 227(2) of Companies Act, 1956“TheAuditor shall make a report to the members of the company on, the accounts examined by him and on every balance sheet and profit and loss account and on every other document declared by Act to be part of or annexed to the balance sheet or profit and loss account………”. Therefore, the reports prepared in pursuance of Sec 227 of the Companies Act, 1956 should be addressed to the members of the enterprise.

3.     In case of a few enterprises, when certain clauses of Companies (Auditor Report) Order, 2003, are not applicable to them then the Auditors opt to directly report the clause number, as stated in CARO, 2003, which are not applicable to the company. For instance, the report states that “Matters specified in items x, xii, xviii, xix, xx of clause of paragraph 4 of Companies (Auditor's Report) Order, 2003 do not apply to the Company." Paragraph 80 of the Statement on the Companies (Auditor’s Report) Order, 2003, as issued by the Institute of Chartered Accountants of India, states that there may be situation where one or more of the clauses are not applicable. In such situations, it would be appropriate for the auditor to make a suitable comment in his report bringing out the fact of non-applicability of a particular clause. To illustrate, where the maintenance of cost record has not been prescribed by the Central Government under section 209(1) (d) of the Act, the auditor may state:

      “The Central Government has not prescribed maintenance of cost records under section 209(1) (d) of the Companies Act, 1956 for any of the product of the company”.

      Thus, the auditor should make a suitable comment in his report bringing out the fact of non-applicability of some of the clauses of CARO, 2003 rather than simply mentioning the concerned clause numbers.

4.    In pursuance to the Statement on the Companies (Auditor’s Report) Order, 2003 the auditor’s report of few enterprises states that “…. We are informed that the fixed assets have been physically verified by the management…..” It may be mentioned that such language creates an impression that no documentary evidence was available to the auditors to substantiate the physical verification of the fixed assets, and that the auditor has relied wholly on management representation. This practice of preparing report has potential of being misinterpreted and therefore, it should be avoided.

5.    Paragraphs 4(iii)(a) and 4(iii)(e) of the Order requires that in case the company has granted or taken any loans, secured or unsecured to and/or from companies, firms or other parties covered in the register maintained under section 301 of the Companies Act, 1956, then the auditor is also required to disclose the “amount involved” in such transactions. In response to this clause, the auditors of few enterprises disclose only the year end balances.

      It may be noted that as per clause (f) of Paragraph 50 of Statement on the Companies (Auditor’s Report) Order, 2003 issued by the ICAI, “Since the order does not clarify what constitutes “amount involved” it would be proper if the auditor discloses the maximum amount involved during the year in the transactions covered by this clause.” Thus, while commenting on these clauses, the auditor should disclose both the amounts of maximum amount involved as well as the year end balance in his audit report.

6.    Clause 4(ix)(b) of CARO, 2003 requires disclosure, inter alia, of the amount involved and the period to which disputed amount of Income Tax/Sales Tax/Service Tax/Customs Duty/Wealth Tax/Excise Duty/Cess relates. Ideally, as per the Statement on the Companies (Auditor’s Report) Order, 2003 issued by the ICAI, the auditor should disclose the name of the statute, the nature of the dues, the amount, the period to which such amount relates as well as the forum where dispute is pending. In case of some enterprises it has been observed that the information about the disputed statutory dues reported in the auditor’s report is not complete. They either omit to specify the period to which the amount of statutory dues are related or the forum where the dispute is pending.


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