The Hindu Business Line : Understanding different values

A good part of the balance-sheet carries values which are different from the actual costs. There are several pronouncements on the values of assets as well as liabilities to be carried in the financial statements of an entity.

Accounting Standards 2, 10, 13 and 26 issued by the ICAI and later adopted by NACAS (National Advisory Committee on Accounting Standards) provide the guidelines to carry the values of inventories, fixed assets, and intangible assets on the financial statements of an entity. Different terms have been used in different pronouncements.

One should understand the meaning and connotation of each of them so as to make the financial statements more meaningful and to ensure that they comply with the broad accounting framework.

Definition of cost

The term cost represents the entire amount incurred to bring the asset to the present state.

In the case of inventories (AS 2), cost represents the purchase price in case of goods traded. For manufacturing concerns, cost includes that of raw materials and the additional expenditure incurred for value addition, such as labour, power, intermediaries, etc.

The standard specifically excludes interest on working capital, being purely of financial nature. However, an interpretation of AS 16 on borrowing costs is that it does not exclude stocks or current assets, so long as they conform to the definition of “qualifying asset”. It is possible in the case of stocks taking a long time to come to a saleable condition, such as housing colony and liquor, to include the interest element in the cost of goods.

In the case of fixed assets (AS 10), all the expenditure incidental to acquiring the asset is treated as cost, and includes borrowing costs also as per AS 16.

In addition to borrowing costs, the term ‘cost’ would include: purchase consideration; cost of accessories; stamp duty, registration, etc; transport costs in case of movable assets; transit insurance; all the expenditure directly incurred to acquire the asset such as travel, inspection, duties and taxes (to the extent they are not recoverable); a reasonable apportionment of the overheads attributable to the asset based on realistic estimation; any expenditure incurred to improve the value of the asset or to put it to a better usable condition; any expenditure incurred to further secure the title on the goods.

The list goes on depending on a case-to-case basis.

However, the grants or subsidies received if any (AS 12), Cenvat credit receivable, VAT credit which can be set off, etc., are to be deducted from the cost of the asset.

In the case of investments (AS 13) the term cost represents the total cost paid to acquire the investments which includes: consideration paid; brokerages; other charges levied by the stock brokers such as stamp duty, etc.

Other expenses such as service tax, securities transaction tax are to be excluded since they are eligible for set off or adjustable against tax payable. If the entity is not liable for service tax, service tax is includable in the cost of investments since it is incidental for acquiring the investments.

In the case of intangible assets (AS 26) too, the accounting standard lays down similar guidelines.

Cost could have different meanings in different circumstances.

Historic cost is the cost at which the asset has been acquired plus any capital expenditure to improve the asset.

Cost of production is more a costing terminology meaning the costs incurred to produce the goods. To this cost, if general overheads and distribution costs such as transportation to the selling point are added, it becomes cost of sales.

Coming to value

The term value indicates the amount at which the asset can be exchanged. Values are also of different types:

Market value is the value at which similar goods are available in the market.

Book value is the value at which the asset is carried in the books of account.

Fair market value is the one at which the goods can be exchanged between two willing and knowledgeable persons in an arm’s length transaction.

Net realisable value is one at which the goods can be exchanged for cash less any further expenditure incurred to complete the transaction.

The carrying values of different assets are as follows:

Fixed assets: AS 10 requires the fixed assets to be carried at historic cost less depreciation.

In case fixed assets are either held for sale or scrapped, depreciation cannot be provided. These assets are to be carried at book value (as on the date the assets are identified to be scrapped or decided to be sold) or net realisable value, whichever is low.

In the case of jointly owned assets, the carrying value will be so much of the proportion of the ownership as it bears to the total cost, less depreciation applicable to that proportion of the asset.

In case of assets brought on hire purchase, the carrying value shall be historic cash price less depreciation.

Investments

AS 13 requires investments to be classified as current and long term. Current investments are to be carried to the financial statements at fair market value (quoted price), whereas long-term investments are to be carried at historic cost.

Any decline in the value of investments, not being temporary, is to be written off to profit and loss account. At a subsequent date, any increase in the value may be recognised in the year of such increase.

Inventories: AS 2 requires inventories to be carried to the financial statements at cost or net realisable value, whichever is low.

Receivables: There is no specific standard as such governing the receivables. The generally accepted accounting principles operate. The basic accounting assumption of prudence shall operate. Accordingly, the receivables are to be carried to the financial statements at their realizable values. A provision is required to be made though, for the doubtful composition of the debtors.

The prudential norms applicable to banks require a specific provision to be made on advances made by them (which are receivables to the bank) as per the NPA norms.

Intangible assets: AS 26 on intangible assets requires these assets be carried at cost less amortised value.

Unless these practices are implemented, the financial statements cannot be said to be showing a fair view.

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