Common Non-Compliances in Financial Statements of Companies as per AS

Table of Contents

1. Non-Compliances Relating to Accounting Standards
2. Non-Compliances Relating to Standards of Auditing
3. Non-Compliances Relating to Companies Act

1. Non-Compliances Relating to Accounting Standards

1.1 AS – 1 Disclosure of Accounting Policies

Case:

Certain companies omit to disclose significant accounting policies with regard to the following:

• Borrowing Costs
• Valuation of Inventories
• Accounting for Investments
• Employee Benefits
• Accounting for taxes on income
• Impairment of Assets
• Provisions, Contingent liabilities and Contingent Assets

Principle:

Paragraphs 24 of AS 1

Observation:

It was observed that company in general, may have borrowed funds, inventories, investments, employees, taxes on income and assets which may be subject to impairment. Further, there is always a need to carry certain provisions for meeting the contingent liabilities. As per Paragraph 24 of AS 1, all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. Accordingly, subject to circumstances, a company is expected to disclose the accounting policies as adopted by it with regard to each of them.

1.2 AS – 2 Inventories

Case: Incorrect disclosure of valuation of Inventories:

The accounting policies regarding valuation of inventories as disclosed in the Annual Report of several companies are listed below:

• Stocks of Cards are valued at Cost and on FIFO basis and include all applicable overheads in bringing the inventories to their present location and condition. Work in progress is valued at Cost.
• Work -in -Progress is valued at direct raw material cost and appropriate cost of completed process.
• Raw materials are valued at average cost. Raw materials at bonded warehouse stores, spares, consumables, packing material, coal & fuel are valued at cost.
• Work in Process is valued at raw material cost.
• Cost of finished goods and work in progress are determined on estimated cost basis.
• Cost is determined by using the first in first out formula. Cost comprises all.

Principle:

Paragraphs 3.2, 5 and 6 of AS 2

Observation:

Inventories to be measured at lower for cost and net realisable value. Cost of inventories should comprise cost purchase, cost of conversion and other costs.

Case: Incorrect disclosure of cost formula of Inventories:

From the Annual Reports of some companies following accounting policies have been noted:

• Inventories are stated at lower of cost and net realisable value. Cost is determined on weighted average/first-in firstout (FIFO) basis, as considered appropriate by the Company.
• Cost of inventories is computed on weighted average/FIFO basis.

Principle:

Paragraph 16 and 26 of AS 2

Observation:

26. The financial statements should disclose (a) the accounting policies adopted in measuring inventories, including the cost formula used

It was viewed that although cost formula has been given in these cases, however, it would be more appropriate to disclose which cost formula has been used for which class of inventories.

1.3 AS – 9 Revenue Recognition

Case:

The accounting policy of revenue recognition as given in the Annual Report of a company inter alia states that revenue from online educational services (if charged) is recognised upon receipt of subscription fee (in case of non-refundable) otherwise apportioned over the subscription period.

In the Annual Report of another company, the following accounting policy has been disclosed:

“Revenue from online educational services is recognised upon receipt of subscription fees. …”

Principle:

Paragraph 7.1 of AS 9

Observation:

From the above, it was viewed that the period when services are rendered should be considered for recognition of revenue.

Accordingly, if revenue is received it should be deferred and recognised over the period when services are rendered.

It was further viewed that the subscription fee for online educational services should be recognised apportioned over the service period.

Accordingly, it was viewed that the accounting policy followed in these cases is not in line with the requirements of AS 9.

Case:

From the Annual Report of a company, it has been noted that the company has recognised as income the entire cost of garments destroyed by fire under other operating income (stock loss claim) based on filing of insurance claim. With regard to partially damaged stocks, the related inventory has been valued at net realisable value and insurance claim
against the same is taken as other income. Insurance claim against loss of fixed assets has also been recognised based on the claim filed with the insurance company. The note further states said income has been recognised as per the AS 9.

Principle:

Paragraph 4.1 and 9.2 of AS 9

Observation:

It was noted that insurance claims do not fall within the definition of ‘Revenue’ as given in AS 9. However, it was viewed that as in the case of sale of goods or rendering of services, the recognition of insurance claims also requires that the amount realisable is measurable and it is not unreasonable to expect ultimate collection. Accordingly, recognising insurance claims at the time of filing the claims with the insurance company without considering the uncertainty relating to its measurability is not appropriate.

Accordingly, it was viewed that recognition of revenue at the time of filing of claims is not in line with the principles of AS 9.

Case:

The accounting policies regarding recognition of dividend income has been disclosed as follows in the Annual Reports of some companies:

• Dividend is accounted as and when received.
• Income & Expenditures are recognised on accrual basis except dividend on shares and units of Mutual Funds, which are recognised on cash basis

Principle:
Paragraph 13 of AS 9

Observation:
It was observed that the dividend income has been recognised on receipt basis while paragraph 13 of AS 9 requires recognition of dividend income when the right to receive payment is established.

Accordingly, it was viewed that the recognition of dividend income on receipt basis is not in line with the requirements of AS 9.

Case:
The following accounting policies on Revenue Recognition have been disclosed in the Annual Reports of some companies:

• Revenue (income) is recognised when no significant uncertainty as to measurability or collectability exists.
• Revenue/Income and Cost/Expenditure are accounted for on accrual basis.
• Sales are accounted for on dispatch of products.

Principle:

Paragraph 11 of AS 9

Observation:

It was observed in the first case that revenue has been recognised when there is no uncertainty as to measurability and collectability whereas in the second case it simply states accrual basis. However, in none of these cases the timing of recognition of revenue i.e. when the enterprise has transferred significant risk and reward to the buyer has been
disclosed. In the last case also, it was not clear whether significant risk and rewards associated with the ownership of goods stands transferred when the products are dispatched.

Thus, it was viewed that the accounting policies for revenue recognition as disclosed in the financial statements are not in line with the requirements of paragraph 11 of AS 9.

1.4 AS – 15 Employee Benefits

Case:

From the financial statements of certain companies it has been noted that they do not provide the accounting policy on employee benefits (including defined benefit plans) and in many of the cases reviewed by the FRRB, the disclosures required under Paragraph 120 were not given or partially given by the enterprises.

Principle:

Paragraph 119 and 120 of AS 15

Observation:

In majority of the cases it was observed that enterprises have not disclosed the basic information about the defined benefit plan as required under paragraph 119. Further, the description of defined benefit plan and accounting policy adopted for actuarial gains and losses including various other disclosures of paragraph 120 are, inter alia, the commonly found mistakes in the financial statements of enterprises.

Relaxation from AS-15 compliance for Small Medium size Companies (SMC)

• Short term accumulating compensated absences which are not vesting
• No discounting required for Payment to Defined Contribution Plan and Termination Benefits that falls due more than 12 months after BS date
• Defined benefit plans and Other long term employee benefits

1. 1. Recognition and measurement principles not mandatory
   2. Mandatory to provide for accrued liability based on actuarial valuation using PUC method
   3. Disclosure requirements not mandatory however actuarial assumptions to be disclosed

Relaxation from AS-15 compliance for Non-Company entities

(A) Entities whose average number of persons employed during the year is 50 or more

(B) Entities whose average number of persons employed during the year is less than 50

1.5 AS – 18 Related Party Transactions

Case:

Non disclosure of Related Party Transactions

Principle:

Paragraphs 23 of AS 18

Observation:

The following information/transactions have been noted from Notes to Accounts, Cash Flow Statement, Director’s Report, Corporate Governance Report given in the Annual Reports of different companies:

• Advances given to directors;
• Application money received from KMP for preferential allotment;
• Equity shares allotted to KMP on conversion of warrants;
• Dividend paid to the holding company;
• Loans and advances given to as well as repaid by the subsidiary;

It was viewed that all these transactions are in the nature of related party transactions and although these transactions have been reported in various parts of the Annual Reports, no disclosure has been made under Related Party Disclosures.

1.6 AS – 26 Intangible Assets

Case:

From the accounting policy on ‘Deferred Revenue Expenditure’ given in the Annual Report of a company it was noted that expenditure incurred on factory license fees, trade mark fee, seed marketing expenses, public/capital issue expenses, preliminary expenses and rental paid for pre-commencement of retail stores, factories has been treated as deferred revenue expenditure which are being amortised over the life of the concerned items.

Principle:

Paragraph 6.2 of AS 26

Observation:

• The expenditure incurred on rental paid for pre-commencement of retail stores, factories, seed marketing expenses, public/capital issue expenses, preliminary expenses cannot be considered to be a ‘resource’ being controlled by the enterprise and hence, such expenses do not meet criteria of term ‘asset’ and therefore, they cannot be treated as asset. Accordingly, should be expensed as and when it is incurred.
• With regard to factory license fees, trade mark fees, these expenditure gives rise to intangible assets. Accordingly, they should be disclosed under the head of ‘intangible assets’ rather than ‘deferred revenue expenditure’.
• With regard to software development expense and product development expense, it was viewed that if it meets the definition of asset as stated in paragraph 6.2 of AS 26, the same should also be recognised as an ‘intangible asset’, otherwise it should be expensed in the Statement of Profit and Loss in the year in which the expenditure is incurred.

Case:

The accounting policy of fixed assets given in the Annual Report of a company read as follows:

‘Intangible assets are identified when they are expected to provide future enduring economic benefits. The assets are identified in the year in which the relevant asset is put to use. (emphasis added)’

Principle:

Paragraph 57 of AS 26

Observation:

As per aforesaid principle, internally generated asset can be capitalised and the capitalised cost, comprises expenditure that are directly attributable for making the asset ready for its intended use. However, in the given case the intangible assets are identified in the year in which the relevant asset is put to use. It was viewed that this is not in line with requirement of AS 26 which requires recognition with reference to the date when an intangible asset is available for use rather than when it is put to use.

1.7 AS – 29 Provisions, Contingent Liabilities and Contingent Assets

Case:

In the Annual Report of a company, one of the note in Notes to Accounts stated as follows:

‘In accordance with Accounting Standard 29, the following is considered as Contingent Liabilities: Guarantees given by bankers for performance of contracts & others.’

Principle:

Paragraph 10.4 of AS 29 and paragraph 8.8.7.2 of Guidance Note on Schedule III to the Companies Act, 2013

Observation:

It was noted that guarantees given by bankers for the performance of contracts have been disclosed as contingent liabilities of the company. It was viewed that guarantees given against own performance of the company do not give rise to any contingent liability because the company in any case holds an obligation to perform the event against which
guarantee is given which is also supported by paragraph 8.8.7.2 of Guidance Note on Schedule III to the Companies Act, 2013.

Hence, such performance guarantees do not meet the definition of ‘Contingent Liabilities’ given in paragraph 10.4 of AS 29.

Case:

In the Annual Report of company, it was noted from notes relating to Long-term Provisions and Short-term Provisions that “Provision for Expenses” has been included under these heads.

Principle:

Paragraphs 12 of AS 29

Observation:

As per paragraph 12 of AS 29, provisions are made for those liabilities, the measurement of which involves substantial degree of estimation and which will be settled in future. Expenses are generally considered as accrued against services that have been received but not settled. Therefore, it was viewed that the disclosure of unpaid expenses under the head of provisions is not in accordance with paragraph 12 of AS 29.

Case:

Noted in the Annual Report of a company:

‘The Company has not provided for moping up of subsidy on raw materials of fertilizer in terms of office memorandum issued by the Ministry of Chemicals & Fertilizers, Govt of India, which is being reconsidered and decided not to effect recovery till a policy in this regard is formulated. This has strengthened the management’ view for not providing the same.’

Principle:

Paragraph 68 and 71 of AS 29

Observation:

As per paragraph 71 of AS 29, where any of the information required by paragraph 68 is not disclosed because it is not practicable to do so, that fact should be stated. While disclosing details of contingent liablities, an estimate of its financial effect should be given unless it is not practical to do so. In the latter case, the fact should be accordingly disclosed.

2. Non-Compliances Relating to Standards of Auditing

2.1 Observations on Standards of Auditing

Auditor’s Report related

• Separate headings – Management Responsibility of the financial statements, Auditor’s Responsibility, Opinion etc.
• Title – Auditor’ Report – Independent Auditor’s Report
• Cash flow statement not referred in the Auditor’ report even though provided
• Under the heading “Report on other Legal and Regulatory Requirements” the auditor has reported:

“Accounting Standards 15 on Employee Benefits, the Company has been providing for gratuity liability on an ad-hoc basis but not as stipulated by the Standard (Refer Note 29.2.ii)”

– Not clear whether it is emphasis of matter or modified opinion

• Significant Accounting Policies and Notes on Accounts on letterhead of the firm
• In the annual report of a Company note given

“Related parties and transactions with them as specified in Accounting Standards 18. “Related party disclosures” issued by ICAI has been identified and given below on the basis of information available with the Company and the same have been relied upon by the auditors”

3. Non-Compliances Relating to Companies Act

3.1 Observations on Companies Act

• Significant accounting policy to interest states that “Interest earned on trade dues is netted against interest expense under finance cost”
• Bank and other finance charges specified as line item under Finance Cost
• Long term borrowings – terms of repayment of term loan and other loans to be disclosed: Terms of repayment include period of maturity, number and amount of instalments due and other applicable rate of interest and other significant relevant terms if any
• Under Other Current liabilities – Others was mentioned. As per Schedule III of Companies Act, 2013, nature of other payables is required to be disclosed
• Export benefits, Profit on sale of assets were included as part of Revenue from Operations – it should be disclosed as other operating revenue, other income respectively
• Capital advances disclosed in short term loans and advances

3.2 Relevant ICAI Publications