CA Inter Adv Accounting

Valuation of Closing Stock as per AS 2 – Valuation of Inventories

As per AS 2 (Valuation of Inventories), inventories must be valued at the lower of cost or Net Realisable Value (NRV). NRV is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

Step 1 – Determine Cost of Closing Stock:
Total goods purchased at cost = ₹20 lakhs. Since 75% of stocks were sold, the remaining closing stock represents 25% of total purchases.
Cost of closing stock = 25% × ₹20 lakhs = ₹5 lakhs

Step 2 – Determine Net Realisable Value (NRV):
Expected sale value = ₹5.5 lakhs
Less: Commission payable to agent @ 10% on sale = 10% × ₹5.5 lakhs = ₹0.55 lakhs
NRV = ₹5.5 – ₹0.55 = ₹4.95 lakhs

Step 3 – Apply Lower of Cost or NRV:

Conclusion: The closing stock should be valued at ₹4.95 lakhs (being NRV, which is lower than cost). The Company's proposed disclosure of ₹5 lakhs is not correct and does not comply with AS 2. Valuing inventory above NRV would overstate assets and profit, which violates the prudence concept and AS 2 requirements.

Treatment of Refund of Government Grant under AS 12 (Accounting for Government Grants)

Viva Ltd. adopted the Deferred Income Approach (as permitted under AS 12) — the grant of ₹30 lakhs was credited to Deferred Income and the plant was recorded at full cost of ₹150 lakhs.

Relevant provision — AS 12, Para 31: When a government grant related to a specific fixed asset (presented as deferred income) becomes refundable, the refund is recorded by reducing the deferred income balance by the amount refundable. Where the refund exceeds the unamortised deferred income balance, the excess is charged to the Profit & Loss account immediately.

Treatment on Refund in 2021-22:

On the date of refund, the Deferred Income balance stood at ₹21 lakhs (₹30 lakhs less ₹3 lakhs amortised per year × 3 years from 2018-19 to 2020-21). The full grant of ₹30 lakhs is refunded.

- Step 1: Deferred Income balance of ₹21 lakhs is applied against the refund → Deferred Income Account is debited and closed.
- Step 2: Excess of refund over deferred income = ₹30 lakhs − ₹21 lakhs = ₹9 lakhs is charged to Profit & Loss account as an extraordinary item.

Journal Entry:
Deferred Income A/c Dr. ₹21 lakhs
Profit & Loss A/c Dr. ₹9 lakhs
  To Bank A/c ₹30 lakhs

Effect on Cost of Fixed Asset:

Since Viva Ltd. used the Deferred Income approach (grant was not deducted from the cost of plant), the gross block of the plant remains unchanged at ₹150 lakhs. There is no adjustment to the cost of the fixed asset on refund under this approach. The WDV continues at ₹105 lakhs before charging current year depreciation.

Depreciation to be charged in 2021-22:

Depreciation is charged on the WDV of ₹105 lakhs over the remaining useful life of 7 years (10 years − 3 years elapsed). Under the Straight Line Method:

Depreciation = ₹105 lakhs ÷ 7 = ₹15 lakhs for 2021-22.

Note: In a normal year, the annual deferred income credit of ₹3 lakhs would have been recognised in P&L. Since the deferred income is eliminated on refund, this credit will not appear, further increasing the net charge.

Summary of P&L impact in 2021-22:
- Depreciation charged: ₹15 lakhs
- Loss on refund of grant (extraordinary): ₹9 lakhs
- Deferred income credit foregone: ₹3 lakhs
- Total additional burden on P&L compared to a normal year: ₹12 lakhs

Final Answer: Deferred Income of ₹21 lakhs is eliminated; ₹9 lakhs is charged to P&L as loss on grant refund; plant cost remains ₹150 lakhs (WDV ₹105 lakhs); depreciation of ₹15 lakhs is charged to P&L for 2021-22.

Treatment of Renovation Expenditures as per AS 10 — Property, Plant and Equipment

As per AS 10 (Revised) — Property, Plant and Equipment, the cost of an item of PPE comprises all costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. The standard specifically includes costs of employee benefits arising directly from the construction or acquisition of the item as directly attributable costs (AS 10, para 17).

The restaurant acquired at Chandigarh is undergoing renovation for 3 months before it can commence operations. During this period, the asset is NOT yet capable of operating in the manner intended by management. Therefore, expenditure incurred to bring the asset to that operable condition qualifies for capitalisation.

Treatment of Construction and Remodelling Cost — ₹30,00,000:

Construction and remodelling cost is a directly attributable cost as it is incurred specifically to bring the restaurant to the condition necessary for its intended use. As per AS 10, such costs form part of the cost of the PPE. Accordingly, ₹30,00,000 should be capitalised and added to the carrying amount of the restaurant (PPE).

Treatment of Salaries of Staff — ₹7,50,000:

The salaries pertain to staff who are specifically engaged in the preparation of the restaurant before its opening. As per AS 10 para 17(b), employee benefit costs arising directly from construction or renovation of PPE are capitalizable directly attributable costs. Since these staff members are not performing routine or general administrative duties but are directly involved in making the asset ready for its intended use, ₹7,50,000 should be capitalised as part of the cost of the PPE.

Important Distinction: AS 10 para 19 explicitly states that certain costs are not included in the cost of PPE — such as costs of introducing a new product, costs of conducting business in a new location (e.g., staff training), and administration and general overhead costs. However, the staff salaries in the present case are not for training or general administration — they are for preparation activities directly connected to bringing the renovated restaurant into operable condition. Hence, capitalisation is appropriate.

Conclusion: Both expenditures — Construction and Remodelling Cost of ₹30,00,000 and Staff Salaries of ₹7,50,000 — aggregating to ₹37,50,000 should be capitalised as part of the cost of the Chandigarh restaurant under AS 10. Capitalisation should cease when the asset is in the location and condition necessary for it to operate as intended, i.e., when the renovation is complete and the restaurant is ready to open.