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Thread: 01 Accounting Standard 1 - Disclosure of Accounting Policies - AS 1

  1. #11
    Accounting Standards
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    Default Disclosure of provisions for certain expenses of Accounting Standard 1 - Disclosure of Accounting Policies - AS 1

    A. Facts of the Case

    1. A company is engaged in the manufacture and trading of pharmaceuticals and chemicals. It also exports certain bulk drugs and formulations.


    2. According to the querist, the company makes provisions for the following in the books of account as at the end of an accounting period.

    (i) Since 1994, the company, though disputing, has been providing for Entry Tax as per the provisions of the Karnataka Tax On Entry of Goods Act, 1979. As per the querist, this matter is at various stages of appeal in the court, both by the company and by the government.

    (ii) The sales personnel of the company are sent abroad on a business meet in the ensuing year for their performance in the current year. The travel expenditure is provided for in the current year on the basis of a reasonable estimate.


    (iii) Leave encashment is provided for on the basis of actuarial valuation of the leave days outstanding as on the closing date in accordance with the provisions of Accounting Standard (AS) 15, ‘Accounting for Retirement Benefits in the Financial Statements of Employers’.


    3. As per the querist, all the above provisions are stated separately in one of the Schedules to Accounts, viz., ‘Schedule 11: Provisions’ under the sub-heading ‘Other Provisions’. According to the querist, this disclosure is being made in accordance with the requirements of Schedule VI to the Companies Act, 1956.


    4. During the audit for the year 1997, the company had a difference of opinion with the auditors regarding the disclosure of the above provisions. According to the querist, the auditors were of the opinion that apart from being disclosed in Schedule 11, the above provisions should also be disclosed as a note under the respective schedules to accounts viz., ‘Schedule 15: Materials’ and ‘Schedule 16: Operating and Other Expenses’. As per the auditors, the note should state that ‘Materials include a provision of Rs. xxx’ (in respect of entry tax) and ‘Operating and Other Expenses include a provision of Rs. xxx’ (in respect of travel expenditure and leave encashment).

    B. Query

    5. The querist has sought the opinion of the Expert Advisory Committee as to whether the disclosure of the above provisions is required at two places, viz., once under ‘Schedule 11: Provisions’ and again under the respective expense schedule, viz., ‘Schedule 15: Materials’ and ‘Schedule 16: Operating and Other Expenses’.

    C. Points Considered by the Committee

    6. The Committee notes that the querist has sought the opinion with regard to disclosure of provisions for certain expenses in respective schedules. The Committee, in expressing its opinion, is restricting itself only to this issue and is not expressing any opinion on the appropriateness of making a provision with regard to these expenses.


    7. The Committee notes that Schedule VI to the Companies Act, 1956, lays down the disclosure requirements in relation to balance sheet and profit and loss account. Apart from these legal requirements, the disclosures to be made in the financial statements are also affected by generally accepted accounting principles, e.g., the accounting standards issued by the Institute of Chartered Accountants of India contain requirements for certain disclosures in addition to those required by Schedule VI. Accounting Standard (AS) 1, ‘Disclosure of Accounting Policies’, issued by the Institute of Chartered Accountants of India, deals with the disclosure of significant accounting policies followed in preparing and presenting financial statements. This Standard requires, inter alia, that financial statements should disclose all ‘material’ items, i.e., items the knowledge of which might influence the decisions of the users of the financial statements.


    8. The Committee notes that Part II of Schedule VI to the Companies Act, 1956, which lays down the disclosure requirements relating to the profit and loss account, requires the disclosure of expenditure under various account heads. The Schedule does not require separate disclosure, under each respective head, of the provisions made in relation to that account head. For example, under the head “salaries, wages and bonus”, all salaries, wages and bonus pertaining to the year have to be included, irrespective of whether they have been actually paid during the year or accounted for as a provision; the Schedule does not require disclosure of the amount of any provision included under the aforesaid head.



    9. The query relates to separate disclosure of provisions made in respect of entry tax, travel expenditure and leave encashment, under the relevant expense schedule (viz., ‘Schedule 15: Materials’ and ‘Schedule 16: Operating and Other Expenses’). The Committee is of the view that as per the legal requirements discussed above and also on consideration of materiality as per AS 1, separate disclosure of the provisions under the respective expense schedule is not required.

    D. Opinion

    10. On the basis of the above, the Expert Advisory Committee is of the opinion that the disclosure of provisions under ‘Schedule 11: Provisions’ under the sub-heading ‘Other Provisions’ is adequate. The disclosure of the same again under the respective expense schedule, i.e., ‘Schedule 15: Materials’ and ‘Schedule 16: Operating and Other Expenses’ is not required.

    Opinion finalised by the Committee on 4.3.1999.

  2. #12
    Accounting Standards
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    Default Accounting treatment of unencashable portion of sick leave of Accounting Standard 1 - Disclosure of Accounting Policies - AS 1

    A. Facts of the Case

    1. A consultancy and engineering company provides different types of leave to its employees, one of which is sick leave. Every employee is entitled to 12 days’ of sick leave for an year. Sick leave can be accumulated upto 180 days during the service period, out of which leave upto 120 days is encashable at the time of retirement or death.


    2. According to the querist, the company follows an integrated cost and financial accounting system. Leave accrued per employee is credited to a provision for leave account every month. The company observes 5 working days in a week, i.e., 40 hours per week. These 40 hours are allocated to jobs/leave (depending upon whether the employee has worked on job or has availed leave) and booked to respective job/provision for leave account. Such allocation and accounting are also done on a monthly basis. The company considers that every employee will avail of the leave due to him before his retirement. Accordingly, the company makes leave provision at the end of the year for the unavailed leave upto the ceiling of 180 days. For this purpose, at the end of the year (in March), the leave appearing in the individual’s account is valued at March payroll. The value so arrived represents the year-end provision for leave and the provision for leave account is adjusted by debit or credit to the payroll cost.


    3. The government auditors are of the view that the provision for sick leave should be restricted to the extent of encashable ceiling of 120 days. The government auditors’ observations on the subject, as stated by the querist, are as below:
    “Current Liabilities & Provisions (Schedule F), Provision - Rs. 34,651.19 lakh
    Provision for Leave Salary – Rs. 6,711.56 lakh.
    The above is overstated by Rs. 95.20 lakh due to provision of sick leave in excess of 120 days, which is encashable at the time of retirement, in contravention of Accounting Standard (AS) 15, ‘Accounting for Retirement Benefits in the Financial Statements of Employers’.
    This has resulted into overstatement of Provision for Leave Salary encashment and understatement of profit by Rs. 95.20 lakh.”



    4. As per the querist, if the company follows the government auditors’ observations, it may tantamount to under-provisioning to the extent of 60 days (i.e., 180 days - 120 days), which would not be in line with the requirement of section 209(3) of the Companies Act, 1956 to maintain books of account on accrual basis.

    B. Queries

    5. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

    (a) Whether the company should make the provision for liability towards sick leave to the extent of leave accrued (180 days) or to the extent of encashable leave (120 days) at the end of each year.

    (b) If the accounting treatment adopted by the company is correct, whether any disclosure is required under AS 15.

    (c) If the accounting treatment adopted by the company is not correct, how should the balance 60 days’ leave, which the employee can avail at any time before retirement, be treated in accounts.

    C. Points Considered by the Committee

    6. The Committee notes that AS 15 deals with accounting for retirement benefits in the financial statements of employers. ‘Retirement benefit schemes’ have been defined in AS 15 as below:
    “Retirement benefit schemes are arrangements to provide provident fund, superannuation or pension, gratuity, or other benefits to employees on leaving service or retiring or, after an employee’s death, to his or her dependants.”

    Since the unencashable part of the sick leave can be availed of at any time during the period of service and not necessarily on retirement, the Committee is of the view that it is not a retirement benefit and is, accordingly, not covered by AS 15.


    7. The Committee notes paragraph 12 of AS 15, which states as under:

    “12. The cost of retirement benefits to an employer results from receiving services from the employees who are entitled to receive such benefits. Consequently, the cost of retirement benefits is accounted for in the period during which these services are rendered. Accounting for retirement benefit cost only when employees retire or receive benefit payments (i.e., as per pay-as-you-go method) does not achieve the objective of allocation of those costs to the periods in which the services were rendered.”

    The Committee is of the view that though the above paragraph deals with retirement benefits only, the principle underlying this paragraph is equally applicable to other employee benefits. Thus, the cost of providing benefits to employees in return for the services rendered by them in an accounting period should be accounted for in that period.


    8. Sick leave being granted to employees is in consideration for services rendered by them. An employee is entitled to twelve days of sick leave for one year of service. Based on the observations made in paragraph 7 above, the Committee is of the view that from the view point of the employer, the cost of receiving an employee’s services for a year comprises not only the salaries and wages payable for the year but also the estimated cost of sick leave to which the employee is entitled.


    9. The Committee is of the view that from an accounting angle, the nature of unencashable portion of sick leave is similar to that of the encashable portion, insofar as both entitle an employee to receive salary or wages for a period during which he does not render any services to the employer. However, in the case of unencashable sick leave, there may often be a significant uncertainty as to whether it would be actually availed of or not. In such a situation, it may not be possible to make a reasonable estimate of the employer’s obligation in respect of accumulated unencashable sick leave.


    10. Based on the considerations set forth in paragraphs 8 and 9 above, the Committee is of the view that it is appropriate to make a provision in respect of accumulated unencashable sick leave if a reasonable estimate of the employer’s obligation in this behalf can be made (subject, of course, to consideration of materiality). The provision so created should be adjusted at the time the employee actually avails the leave.


    11. According to the querist, the company considers that every employee will avail of the leave due to him before his retirement. The Committee presumes that this estimate is reasonable under the facts and circumstances of the case.


    12. The Committee notes that the method followed by the company for creating provision in respect
    of accumulated unencashable sick-leave and its adjustment are in line with what has been stated in paragraph 10 above.


    13. Accounting Standard (AS) 1, ‘Disclosure of Accounting Policies’, requires that “all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed” (paragraph 24). The manner of treatment of unencashable sick leave constitutes an accounting policy and would therefore need to be disclosed in accordance with AS 1, if significant.

    D. Opinion

    14. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 5:

    (a) Under the circumstances of the case, it is appropriate to make provision in respect of unencashable sick leave also. (It is presumed that it is reasonable to expect that the employees would avail of such leave before their retirement, as stated in the query.)

    (b) The accounting policy followed by the company in respect of unencashable sick leave should be disclosed in accordance with Accounting Standard 1, ‘Disclosure of Accounting Policies’, if significant.

    (c) See (a) above.

    Opinion finalised by the Committee on 23.10.1999.

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