Worked Solution
✓ VerifiedNote: All five sub-parts are solved below. Attempt any four in the exam.
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(a) AS-29 — Warranty Provision and Right of Reimbursement
The statement made by the company is incorrect and not in compliance with AS 29 (Provisions, Contingent Liabilities and Contingent Assets).
Under AS 29, a provision must be recognised when: (i) the enterprise has a present obligation as a result of a past event; (ii) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and (iii) a reliable estimate of the amount can be made.
When goods are sold with a warranty, a present obligation arises on the date of sale. The company's obligation to customers for warranty claims clearly satisfies all three conditions — it is a present obligation, outflow is probable (past experience of warranty claims), and the amount can be estimated. Therefore, provision for warranty must be recognised.
The right to recover warranty costs from the original supplier is a separate matter. As per AS 29, where some or all expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognised as a separate asset — and only when it is virtually certain that reimbursement will be received upon settlement of the obligation. Even then, the amount of reimbursement shall not exceed the provision.
The provision and the reimbursement asset cannot be netted against each other (except in the Statement of Profit and Loss, where the net amount may be presented). Accordingly, the company must make full provision for warranty costs regardless of its right to claim from the supplier. The right to claim, if virtually certain, may be shown as a separate asset.
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(b) Royal Bank — Provision Computation (₹ in Lakhs)
Provisions are computed as per RBI Prudential Norms on Income Recognition, Asset Classification and Provisioning (IRAC Norms).
Standard Assets (@ 0.40%): 25,000 × 0.40% = ₹100 lakhs
Sub-Standard Assets (Total ₹15,000 lakhs):
- Secured portion = 15,000 − 8,000 = ₹7,000 lakhs @ 15% = ₹1,050 lakhs
- Unsecured portion = ₹8,000 lakhs @ 25% = ₹2,000 lakhs
- Sub-total = ₹3,050 lakhs
Doubtful Assets:
(i) Up to 1 year (Total ₹4,500; Security ₹2,200):
- Secured: 2,200 × 25% = ₹550 lakhs
- Unsecured: (4,500 − 2,200) × 100% = 2,300 × 100% = ₹2,300 lakhs
- Sub-total = ₹2,850 lakhs
(ii) 1 to 3 years (Total ₹3,200; Security ₹1,200):
- Secured: 1,200 × 40% = ₹480 lakhs
- Unsecured: (3,200 − 1,200) × 100% = 2,000 × 100% = ₹2,000 lakhs
- Sub-total = ₹2,480 lakhs
(iii) More than 3 years — No security (₹1,300):
- Unsecured: 1,300 × 100% = ₹1,300 lakhs
Doubtful Assets Total = ₹6,630 lakhs
Loss Assets (@ 100%): 530 × 100% = ₹530 lakhs
Total Provision to be charged to P&L = 100 + 3,050 + 6,630 + 530 = ₹10,310 lakhs
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(c) AS-7 (Revised) — Construction Contract
Contract Price = ₹170 lakhs; Cost incurred = ₹129.98 lakhs; Additional cost = ₹64.02 lakhs; Total Estimated Cost = ₹194 lakhs.
Total Estimated Loss = 194 − 170 = ₹24 lakhs
Since total estimated cost exceeds contract revenue, it is a loss contract. As per AS 7 (Revised), the expected loss must be recognised immediately as an expense in full, regardless of the stage of completion.
Stage of Completion = Cost incurred ÷ Total estimated cost = 129.98 ÷ 194 = 67%
Contract Revenue recognised = 170 × 67% = ₹113.90 lakhs
Contract Cost recognised in P&L = Contract Revenue + Total Expected Loss = 113.90 + 24.00 = ₹137.90 lakhs
(Alternatively: Costs incurred ₹129.98 + foreseeable future loss ₹7.92 = ₹137.90 lakhs)
Loss recognised in P&L = ₹24 lakhs (entire expected loss recognised in FY 2019-20 itself).
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(d) AS-15 / ICAI Guidance Note — ESOP Compensation Expense
Under the Fair Value Method (ICAI Guidance Note on Accounting for Employee Share-based Payments), compensation expense is recognised over the vesting period based on expected outcomes.
Year 1: Earnings rose 12%; earnings target (avg 10% p.a.) expected to be met → Fair value = ₹16 (exercise price ₹30)
- Cumulative charge = 10,000 × ₹16 × 1/3 = ₹53,333
- P&L charge Year 1 = ₹53,333
Year 2: Earnings rose 13%; earnings target still expected to be met → Fair value = ₹16
- Cumulative charge = 10,000 × ₹16 × 2/3 = ₹1,06,667
- P&L charge Year 2 = 1,06,667 − 53,333 = ₹53,334
Year 3: Earnings rose only 3%; target NOT achieved → Exercise price reverts to ₹40; Fair value = ₹12
- Cumulative charge = 10,000 × ₹12 × 3/3 = ₹1,20,000
- Already charged = ₹1,06,667
- P&L charge Year 3 = 1,20,000 − 1,06,667 = ₹13,333
Total compensation expense = ₹53,333 + ₹53,334 + ₹13,333 = ₹1,20,000 (= 10,000 × ₹12, being the fair value at the actual exercise price of ₹40).
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(e) AS-18 — Related Party Identification
Under AS 18 (Related Party Disclosures), the shareholding structure is:
- Maya Ltd. → 61% → Sheetal Ltd. (Maya controls Sheetal)
- Sheetal Ltd. → 51% → Fair Ltd. (Sheetal controls Fair)
- Care Ltd. → 49% → Fair Ltd. (Care has significant influence; not control)
Maya Ltd. (Reporting Entity):
- Sheetal Ltd. — Subsidiary (Maya directly holds 61%)
- Fair Ltd. — Indirect Subsidiary (Maya → Sheetal → Fair; Maya is ultimate holding company)
Sheetal Ltd. (Reporting Entity):
- Maya Ltd. — Holding Company (holds 61% of Sheetal)
- Fair Ltd. — Subsidiary (Sheetal holds 51%)
- Maya Ltd. and Fair Ltd. are thus both related parties of Sheetal Ltd.
Care Ltd. (Reporting Entity):
- Fair Ltd. — Associate (Care holds 49%; significant influence but not control)
Fair Ltd. (Reporting Entity):
- Sheetal Ltd. — Holding Company (holds 51%)
- Maya Ltd. — Ultimate Holding Company (controls Sheetal which controls Fair)
- Care Ltd. — Investor exercising significant influence (holds 49%; related party under AS 18 as it participates in financial and operating policy decisions)
Note: Care Ltd. and Maya Ltd. are not directly related parties of each other as there is no ownership, control, or significant influence between them directly.
Write it like this
1The skeleton
- Pick your 4 in the first 30 seconds — scan all five, lock in the ones where you know the rates/formula cold (provisioning norms and AS-7 loss contract are the fastest marks here), and write your choice at the top so the examiner sees it immediately.
- Lead every sub-part with the Standard reference in line 1 — write 'As per AS 29 / AS 7 (Revised) / RBI IRAC Norms' before anything else; examiners are instructed to check for this and it anchors your entire answer.
- In the bank provisioning question (b), draw a columnar working — four rows (Standard, Sub-Standard, Doubtful, Loss), show Asset Total | Security | Unsecured | Rate | Provision for each row; this format alone gets you presentation marks even if one rate slips.
- For AS-7 loss contract (c), write the conclusion first — state 'Total estimated cost exceeds contract revenue, hence it is a loss contract and the entire foreseeable loss of ₹X is recognised immediately' before showing stage-of-completion; this signals you know the key rule upfront.
- In ESOP (d), show the cumulative charge logic explicitly — write 'Cumulative charge up to Year N = ..., Less: already charged = ..., P&L charge this year = ...' for each year; skipping the subtraction step is where marks leak.
- Close AS-18 (e) with a relationship map in 3-4 lines — list each entity and its relationship tag (Holding / Subsidiary / Associate / Significant Influence) in bullet form; a prose paragraph here is the slowest way to present this and risks missing one link.
2Examiner-rewarded phrases
3Common trap
Heads up — in the AS-7 loss contract, almost everyone calculates the loss recognised as 'expected loss × stage of completion' and writes ₹16.08 lakhs instead of the full ₹24 lakhs; the rule is the entire foreseeable loss hits P&L immediately, and the stage of completion only drives revenue recognition, not loss recognition. Getting this backwards costs you 3-4 marks even if your stage-of-completion maths is perfect.