(a) Timing difference considers tax effects of differences
in book income and taxable income. Timing differences get reverted in future
and are taken care of by incorporating Deferred Tax Assets and Deferred Tax
Liability. The permanent differences are due to disallowances. They are
ignored for Deferred Tax treatment.
International Accounting Standard (IAS-12), takes Balance
Sheet approach for deferred tax treatment. Such situation arises in
revaluation of assets, as well as in amalgamations and mergers.
(b) Tax outgoing is treated as an expense chargeable to
Profit & Loss Account. It includes two elements, current tax and deferred tax.
In a situation when there is no profit from current year’s activity, but
surplus in accounts is due to reversal of deferred tax liability. In such case
whether the dividend can be declared out of such surplus ? According to the
speaker, it is permissible.
(c) For determining the liability under MAT, not only
current tax provision but deferred tax provision is also to be added back.
(d) Accounting of Deferred Tax Asset — When turning
differences are having the effect of reducing accounting income below taxable
income, it gives rise to deferred tax asset; whereas when accounting income is
more than tax income, it results in deferred tax liability. For deferred tax
asset, Para 15 and Para 17 of AS-22 are relevant. Para 15 states that if there
is a reasonable certainty of recovering the losses in future, then only
deferred tax asset should be recognised.
Para 17 talks of virtual certainty of future profits
sufficient to absorb current and brought forward losses and depreciation.
Before creating deferred tax asset, the auditor should ask for convincing
evidence about certainty of future profit. Accounting Standard Inter-pretation
(ASI) No. 9 provides guideline for verification of credibility of evidence
propagated by client companies. This factor assumers still greater importance
when the current years’ losses include long-term capital losses. This is
because such losses can be set off only against long-term capital gains.
(e) Financial Report Review Board (FRRB) of the Institute
verifies the published accounts recognising deferred tax assets and ascertains
from concerned members whether due care is taken by them in this regard
i.e., virtual certainty of future profits, particularly when the amount is
material.
(f) Reassessment and review of deferred tax asset created
in earlier years can be made if the circumstances demand such adjustment after
proper review.
(g) In amalgamation of two companies or absorption of
loss-making by profit-making company, the deferred tax assets/liabilities of
loss-making company should be dealt with after considering profits and
profitability of amalgamated company ASI-11 deals with both situations.
If the loss-making company is taken over in amalgamation
scheme and that company has not created deferred tax asset due to
non-existence of virtual certainty of future profits, then the profit-making
company taking over such loss-making company can create deferred tax asset in
its books, since it will be entitled to claim set-off of such losses.
(h) There may be a situation that a newly started company
has losses and unabsorbed depreciation for last 3 years, which gives rise to
deferred tax asset. At the same time, it has provided depreciation in accounts
which is less than depreciation allowable under the IT Act, in such case it
will give rise to deferred tax liability. Therefore both deferred tax asset
and liability will require consideration. Unless there is virtual certainty of
future profits, deferred tax asset should not be accounted. Since to the
extent of deferred tax liability there is certainty, the deferred tax asset
can be accounted to that extent. This issue is covered in background material
of the Institute on AS-22.
(i) As regards tax rate, if at the end of the year the
budget has provided for a change in rate of tax, it should be given effect to.
No discounting of rates is permitted.
j) Presentation of deferred tax asset/liability. Earlier year’s brought forward balances should not be mixed up with current year’s figures and current year asset/liability cannot be net out. In Schedule VI, the deferred tax liability should appear after unsecured loans but before current liabilities and provisions, so also deferred tax asset should appear after investments but before current assets.
k) If deferred tax effect is not accounted in earlier years, but is proposed to be accounted in current year, then such adjustment can be made through revenue reserve. It there is no reserve, then it should be debited to profit and loss account.
l) If a company is having tax holiday for certain years, say, u/s.80IA or u/s.80IB, then though there is timing difference in accounting income and tax income, ASI-3 provides that if out of timing differences, some figures are going to reverse after tax holiday period, it is necessary to provide deferred tax liability only on such amounts. ASI-5 considers the situation where company’s income is covered by exemption u/s.l0A and u/s.l0B.
m) ASI-4 deals with losses under the head Capital gains, which are adjustable only against future capital gains. Therefore normally there cannot be virtual certainty. So ASI-4 advices not to create deferred tax asset with reference to capital loss.
n) ASI-6 considers situation under MAT liability where book profit is higher than taxable income, the tax is payable with reference to book profit @ 7.5% plus surcharge. In such cases, on timing differences the tax at normal rate of” 30% plus surcharge should be considered.
o) In respect of quarterly reporting of income for listed companies, the average rate of tax on an income should be ascertained. Such rate should be applied to the income for the quarter.
II. AS-IO – Fixed Assets – Revised Standard (yet to become effective) :
i) Exposure draft was issued in 2006. After considering the views thereon, Press Note of the Institute, announced in August, 2006 that the draft is finalised. It was proposed to make it effective from 1-4-2009. Yet the effective date is not announced, presumably because the Company Law Board will have to modify the Accounting Standard Rules suitably.
There are some conceptual differences in the Revised Standard. This is so in respect of spares and components which are purchased or in stock at year end. If these components are exclusively for use in plant and machinery, then requirements of Revised Standard will have to be complied with.
ii) The Revised AS-10 will be dealing with Accounting of Fixed Tangible Assets as well as Depreciation Accounting, which was hitherto governed by AS-6. So earlier AS-6 will stand withdrawn after its merger with revised AS-10. From the earlier AS-10, Para 14 & Para 24 will continue. Para 14 deals with assets held for disposal, so also Para 24 deals with non-current assets for disposal.
iii) Institute has issued ASI-2 on machinery spares which has discussed the circumstances when it will be machinery spares and when it will be fixed assets. This interpretation will also become inoperative after revised AS-lO becomes operative. After such date, machinery spares, which can only be used in machinery will be treated as machinery and not as part of inventory spare and components under current assets. So ASI-2 dealing with inventory will not apply to machinery spares.
iv) For real estate developers, the applicable Accounting Standard will be AS-10 and not AS-7. For revised treatment to machinery spares, the test of economic benefits will be required to be satisfied. So also cost thereof should be’ ascertainable. For subsequent expenditure on existing fixed asset, current repairs will be charged to profit and loss account, but substantial expenditure which increases existing capacity of machinery will be capitalised and depreciated thereafter.
v) Revised AS-10 also deals with component accounting. While accounting, the WDV of component replaced should be transferred to profit and loss account and cost of new components should be capitalised and depreciated. Alternatively, old component’s WDV can continue and of new component to be debited to Profit and Loss account. These are the two options given.
vi) Where inspection of useful balance life is a costly affair as in case of aircrafts or where major replacement is a feature of, say, every four years, it was earlier recommended to spread such cost over four years by creating provision every year. But, now it is not permitted by AS-29. This Standard does not permit provision where expenditure is not actually made. Provision can be made for existing obligation and not for future obligation.
vii) The solution is to capitalise such expenditure and then amortise over certain years and write off old unamortised amount. Cost of dismantling of old asset can be added to new asset and depreciated.
viii) On the issue of Revaluation of Fixed Assets, the speaker listed the rules to be followed, viz. :
a) Revaluation should be done uniformly for en-tire class of assets like building machinery, etc. Revaluation at fair value and not any ad-hoc value.
b) Revaluation should be done uniformly every year to arrive at fair value.
c) For depreciation Para 13 of AS-10 dealing with depreciation accounting, the rates should be at prescribed rates unless circumstances warrant higher rates. In any case, lower rate than pre-scribed rate cannot be adopted.
d) Para-16 of AS-10 (revised) describes depreciation as a systematic allocation of cost over useful life. Components, having different useful life, should be depreciated at different rates. The rate and depreciation should be reviewed every year in the light of information about useful life.
e) Method of depreciation should also be reviewed every year. When there is a change in rate, it is change in estimate and not change in accounting policy. When method is changed from SLM to WDV, it is change in accounting policy. For this the change should be prospective.
f) In the past when asset is revalued the book value goes up. Additional depreciation due to revaluation should be adjusted by withdrawing such differential amount from revaluation reserve. However, in Revised Standard, depreciation on revalued asset will appear in profit and loss account – Now withdrawal from revaluation reserve will not be permitted.
III. AS-ll (Revised) Accounting of changes in foreign exchange rates:
This Standard was originally passed in 1993. It was revised in 2003 and made effective from 1-4-2004. In earlier Standard it was provided that increase in liability for repayment of unpaid price of fixed assets like plant and machinery had to be capitalised. A view was taken while finalising the Revised Standard that such change is a finance charge and credit or debit should be taken to profit and loss account. However, as Schedule VI needed capitalisation, the Institute announced that Schedule VI will prevail over Revised Standard i.e., Capitalisation was approved.
Now, this position is again changed. In respect of accounting year commencing on or after 7-12-2006, the Companies Accounting Standard Rules are coming into play. While Government agreeing with the Institute’s views re: finance charge has put a note to Accounting Standard Rules that in spite of Schedule VI, such exchange difference can be taken to profit & loss account. On 17-7-2007 the Institute issued pronouncement that the note to A. S. Rules should be given effect in respect of capitalisation, made between 2004 to 2007. For assets acquired between 1993 to 2003, the position will not be disturbed. Between 1-4-2004 to 6-12-2006, Schedule VI protection is still available. A legal view is taken that since Schedule VI is part of the Companies Act, it will prevail over Rules in spite of the view taken by the Government and the Institute.
IV. AS-15 – Retirement Benefits for Employees:
The Standard was originally issued in 1993 and revised in 200S. The new Standard covers entire gamut of benefits except share-based benefits. This was originally to become effective from 1-4-2006 which date is postponed to the year commencing after 7-12-2006. The issues are:
The liability accrues at the point when the service is rendered and not at the time of payment. The Institute has issued FAQs containing 18 questions and replies thereto. This Standard applies when employer-employee relation subsists.
i) In case of gratuity which becomes payable only after completion of five years still provision has to be made for the liability accruing each year. The liability is to be quantified by actuarial valuation.
ii) Leave encashment is also required to be provided. Maximum accumulation is 240 days whereas availment each year is 30 days. In such case the actuary should evaluate the liability.
iii) As regards P.P. contribution by employer the liability is determined, but as regard gratuity it is to be evaluated.
iv) In revised Accounting Standard AS-IS, the matter is not left entirely to actuary. It now provides that liability to be ascertained by applying Projected Unit Credit method (PUC).
v) As regards VRS benefit, the amount paid is amortised over five years. But the new Standard provides that it is an expenditure of current year and cannot be deferred, because it is not an asset. VRS paid up to 31-3-2009can be amortised, but payments thereafter cannot be amortised but to be wholly debited to profit and loss account, so also earlier year’s amortisation cannot be carried beyond 1-4-2010.
vi) Where earlier year’s liability is sought to be provided for the first time, the prior year’s liability can be debited to revenue reserves or another option of amortisation over five years is given by revised AS-IS. However, such treatment should be reported by way of note as information or disclosure and not as qualification to true and fair view.
v) Derivative Instruments Accounting and Institutes Views:
i) The Institute’s announcement dated 28-3-2008 on issues is applicable for accounting year ended 31-3-2008.
Derivative instruments being financial instruments are covered by Accounting Standard-30 which will be applicable from 1-4-2011. Till then it is recommendatory. The foreign exchange derivative contracts as well as other derivative contracts put the company to huge liabilities. Derivative contracts comprise of index, exchange and commodity derivatives. Though AS-30 is not put in operation, still AS-1 is applicable insofar as concept of prudence, for providing for losses.
ii) Where there is profit in some and losses in other derivatives, whether provision should be made contractwise or classwise or on global basis. The global treatment is certainly not correct. The categorywise treatment is recommended. If net is a loss it should be provided, if net is gain the same is to be ignored.
iii) Hedging transactions – if in underlying contract of purchase/sale there is a loss and in derivative contract there is a gain, then both are to be netted.
(iv) If there are derivative contracts covered by AS-11, Paras 36 and 37 talk about hedging, whereas Paras 38 and 39 talk about derivatives speculation and trading. If on 31st March the position shows a loss, but on subsequent Balance Sheet date, there is a gain, such subsequent event accruing in next year cannot be taken into accounts.
The meeting was terminated with a vote of thanks to the speaker.
