Fixed assets are acquired for purpose of business with the object of earning revenue in the ordinary course of business ; these are intended to be used and not sold, e.g., land, building, machinery, etc. Almost all fixed assets (except land and goodwill) suffer depletion or exhaustion due to efflux of time and their use or exploitation. In addition, almost all assets are subject to impairment taking into consideration its recoverable value in future. Mines and quarries are notable examples of the class of assets that are described as wasting assets, denoting that their value diminishes on exploitation, in contradistinction to the loss of value through use or obsolescence that takes place in the case of other assets. Floating assets are acquired for resale with a view to earning profits or are those that come into existence during the processes of trade or manufacture. All those, in the normal course of business, are
quickly convertible into cash, e.g., stock-in-trade, book debts, bills receivable, etc.
Fixed Assets : Fixed assets are included in the Balance Sheet at their cost less depreciation and impairment loss. Cost includes all expenditure necessary to bring the assets into existence and to put them in working condition. It would be incorrect to value them at their sale price since these are not intended to be sold. For the very same reason, the fluctuation in the market values are ignored even when these are permanent. If these were taken into account, it would result in either under or over allocation of their cost. In case any government grant has received in relation to specific fixed assets then either the grant can be shown as deduction from lost of the asset or grant can be treated as deferred income which is recognised in Profit and Loss Account.
Wasting Assets : More as a result of custom than financial expediency, no specific provision to reduce the value of wasting assets exists in the Companies Act, 1956. For the first time, this matter was considered by the Court in the case Lee v. Neuchatel Asphalt Company Limited and it was held that it was not necessary for a company to provide depreciation on wasting assets to arrive at the amount of profits which it could distribute. It cannot, however, be contended that the value of wasting assets remains unaltered despite their exploitation year after year. On a consideration of this position, the Institute of Chartered Accountants in England and Wales, as early as 1944, recommended that provision for depreciation or depletion should be made in respect of every wasting assets, such as mine, on the basis of the estimated physical exhaustion that takes place. The amount that must be provided can be determined on ascertaining the proportion that the quantity of the output during the year bears to the total quantity that the mine is expected to yield during its normal working life. The unit for such a computation should be the unit of the refined produce and not that of the raw one. In terms of the clarification issued by the Company Law Board, it seems that even wasting assets need to be depreciated for the purpose of section 205 of Companies Act. Section 205(2)(d) of the Act covers cases in respect of which no rate of depreciation is provided by the Companies Act. On the very same consideration, if a mine has been acquired on a lease, the total amount paid for the lease should preferably be amortised over the period of the lease in proportion to the output in each year. This may sometimes appear impracticable; under such a situation, amortisation on a time basis may be considered.
Floating assets : In the case of these assets the attempt is to include them in the Balance-sheet at their realisable value. These, therefore, are valued either at cost or market value whichever is less. The term ‘cost’ refers to purchase price including duties and taxes, freight inwards and other expenditure directly attributable to acquisition less trade discount, rebates, duties drawbacks and subsidies, in the year in which they are accounted, whether immediate or deferred in respect of such purchase. The term ‘market value’ may either refer to “Net realisable value” or the replacement cost.
1. “Net Realisable value” : Net Realisable value is the estimated selling price in the ordinary course of business less estimated costs of completion and the estimated costs necessarily to be incurred in order to make the sale.
2. Replacement Cost : It refers to the price which would have to be paid for acquiring the same assets at the current market rate on the date of the Balance-sheet. The replacement cost is determined by taking into account the price that would have to be paid for purchasing the assets from normal sources
of supply. In case free market for the assets does not exist it may not be possible to determine the replacement cost. It may be noted here that in case of valuation of inventories, only net realisable value as a variant of market value has to be considered. This is in accordance with the Accounting Standard 2 (Revised) on ‘Valuation of Inventories’.
Stock-in-Trade : It is a current asset held for sale in the ordinary course of business or in the process of production for such sale or for consumption in the production of goods or service for sale. The normally accepted accounting principle of valuation of stock-in-trade is at cost or net realisable value whichever is lower. This principle is in accordance with the AS 2 (Revised) on ‘Valuation of Inventories’. This general principle applies to valuation of all inventories including stock-in-trade except inventories of the following to which special considerations apply.
- Work-in-progress arising under construction contracts, including directly related service contracts (see Accounting Standard (AS) 7 (Revised), “Accounting for Construction Contracts”);
- Work-in-progress arising in the ordinary course of business of service providers;
- Shares, debentures and other financial instruments held as stock-in-trade; an
- Producers’ inventories of livestock, agricultural and forest products, and mineral oils, ores and gases to the extent that they are measured at net realisable value in accordance with well established practices in those industries.
The inventories referred to in 4 above are measured at net realisable value at certain stages of production. This occurs, for example, when agricultural crops have been harvested or mineral oils, ores and gases have been extracted and sale is assured under a forward contract or a Government guarantee, or when a homogenous market exists and there is a negligible risk of failure to sell. These inventories are excluded from the scope of this statement. For instance, in the case of stock of tea, coffee and rubber, held by the plantations which have produced them, with a view to showing in their annual accounts the true profits in respect of each crop, it is valued at the date of the Balance Sheet at the price at which it has been sold subsequently, reduced either by actual or estimated selling expenses pertaining thereto. And where stocks are held for maturing (e.g., rice, timber and wine), though their value increases substantially with the passage of time, these are usually valued at an amount which is equal to their cost plus storage charges. Where during storage the weight shrinks, an allowance for this factor is also made. In no case, however, the price applied is allowed to exceed the current market (selling) price of similar goods less costs necessarily to be incurred in order to make the sale. Following the fundamental accounting assumption of consistency, whatever basis of valuation is adopted, it should be consistent from one period to another to prevent distortion of trading results disclosed by the annual accounts. Therefore, any change in the accounting policy relating to inventories (including the basis of comparison of historical cost with net realisable value and the cost formulae used) which has a material effect in the current period or which is reasonably expected to have a material effect in later periods should be disclosed. In the case of a change in accounting policy which has a material effect in the current period the amount by which any item in the financial statements is affected by such change should also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact should be indicated.
Different connotations of ‘Cost’ : The significance of this term varies in different circumstances on account of the nature of goods and the methods by which cost has been computed. Essentially, it refers to an appropriate combination of the cost of purchase, cost of conversion and other costs incurred in the normal course of business in bringing the inventories up to the present location and condition. In determining the cost of inventories, it is appropriate to exclude certain costs and recognise them as expenses in the period in which they are incurred. Examples of such costs are:
- abnormal amounts of wasted materials, labour, or other production costs;
- storage costs, unless those costs are necessary in the production process prior to a further production stage;
- administrative overheads that do not contribute to bringing the inventories to their present location and condition; and
- selling and distribution costs.
The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects should be assigned by specific identification of their individual costs. The cost of inventories, other than those dealt with in paragraph 14 of AS-2, should be assigned by using the first-in, first-out (FIFO), or weighted average cost formula. The formula used should reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition.
Valuation of inventories below historical cost : The historical cost of inventories may at times not be realised, e.g., if their selling prices have significantly declined, or if they become wholly or partially obsolete, or if the quantity of inventories is so large that it is unlikely to be sold/utilised within the normal turnover period and there exists a genuine risk of physical deterioration, obsolescence or loss on disposal. In such circumstances, it becomes necessary to write down the inventory to ‘net realisable value,’ in accordance with the principle of conservatism which requires that current assets should not be carried in the financial statements in excess of amounts expected to be realised in the ordinarily course of business. However, if 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 realizable value, the materials are written down to net realizable value.
Disclosure : 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.
Investments : Fundamentally, the basis of valuation of investments depends on the purpose for which these are held. If investments constitute a floating asset, these are valued at cost or at fair value whichever is lower. Where, however these are treated as a fixed asset i.e. an asset held to earn permanent income, these are valued at cost. The Companies Act, 1956 has introduced a new concept – that of trade investments. These are investments made by a company in the shares and in debentures of another, not sufficiently large as to make the other a subsidiary. Such investments are always valued at cost since the basic consideration in making the investment associates in trade.
The market value of shares or debentures of a company which are not quoted on the Stock Exchanges in ascertained on a consideration of the financial position of the company as disclosed by its last Balance Sheet and Profit and Loss Account. For this purpose, the dividend policy and the price at which
shares have changed hands in the previous months also are taken into account. It may, however, be noted that listing of all public issues have been made compulsory with the recognised stock exchange by the Companies (Amendment) Act, 1988. Where shares or debentures have been acquired by a concern in lieu of services rendered in the promotion of a company (e.g., in pursuance of an underwriting contract) or in the part payment of purchase consideration, these are included in the Balance Sheet at cost, determined on a reference to the relative agreement in pursuance whereof the allotment has been made. For example, where shares have been allotted in consideration of subscription obtained to loans or debentures, these are valued at the amount paid for them, reduced by the amount of underwriting commission earned; the shares allotted in pursuance to a vendor’s agreement are valued at the price specified in the agreement. As per AS-13, the cost of an investment should include acquisition charges such as brokerage, fees and duties. If an investment is acquired, or partly acquired, by the issue of shares or other securities, the acquisition cost should be the fair value of the securities issued (which in appropriate cases may be indicated by the issue price as determined by statutory authorities).
The fair value may not necessarily be equal to the nominal or par value of the securities issued. If an investment is acquired in exchange for another asset, the acquisition cost of the investment should be determined by reference to the fair value of the asset given up. Alternatively, the acquisition cost of the investment may be determined with reference to the fair value of the investment acquired if it is more clearly evident. When an investment is sold for determining the amount of profit or loss resulting on its sales, it is necessary to first ascertain its cost. While doing so, a distinction is made between capital and revenue expenses and receipts. For instance the amount of brokerage paid on purchasing investment (Government Securities or debentures) is added to their cost. Costs such as transfer fees, stamp duty, etc. should be capitalised. But the amount, if any, paid on account of interest which had accrued due till the date of transaction is not taken into account for it is recoverable. Likewise, the value of bonus shares allotted subsequent to the purchase of the shares is not added to their cost. Then the cost of the original requisition would represent the cost for the total holding including bonus shares. However, the amount received on sale of ‘right’ in respect of new shares offered by the company may be deducted from the value of shares held, it being a capital receipt. On the very same consideration, any dividend received on shares for a period which had closed before the date of acquisition is treated as a capital receipt. As per AS-13, interest, dividend and rentals receivables in connection with an investment are generally regarded as income, being the return on the investment. However, in some circumstances, such inflows represent a recovery of cost and do not form part of income. For example, when unpaid interest has accrued before the acquisition of an interest-bearing investment and is therefore included in the price paid for the investment, the subsequent receipt of interest is allocated between pre-acquisition and post-acquisition periods; the pre-acquisition portion is deducted from cost. When dividends on equity are declared from pre-acquisition profits, a similar treatment may apply. If it is difficult to make such an allocation except on an arbitrary basis, the cost of investment is normally reduced by dividends receivable only if they clearly represent a recovery of a part of the cost.
As per AS-13 on “Accounting for Investments, “an enterprise should disclose current investments and long term investments distinctly in its financial statements”. Regarding valuation, it states as under:
“31. Investments classified as current investments should be carried in the financial statements at the lower of cost and fair value determined either on an individual investment basis or by category of investment, but not on an overall (or global) basis.
32. Investments classified as long term investments should be carried in the financial statements at cost. However, provision for diminution shall be made to recognise a decline, other than temporary, in the value of the investments, such reduction being determined and made for each investment
33. Any reduction in the carrying amount and any reversals of such reductions should be charged or credited to the profit and loss statement.
34. On disposal of an investment, the difference between the carrying amount and net disposal proceeds should be charged or credited to the profit and loss statement.”