Accounting Standards: AS-3, AS-12, AS-19, and Internal Reconstruction
Cash Flow Statements (AS-3)
Introduction
This standard deals with the financial statement, which summarizes for a given period the sources and applications of funds of an enterprise. This standard supersedes Accounting Standard (AS) 3, *’Changes in Financial Position’*, issued in June 1981. Cash flows are to be classified into three categories: operating activities, investing activities, and financing activities.
Meaning
A cash flow statement provides additional information to the user of a financial statement. This statement exhibits the flow of incoming and outgoing cash. It assesses the ability of the enterprise to generate cash and to utilize the cash. This statement is one of the tools for assessing the liquidity and solvency of the enterprise.
Applicability
This standard applies to the following enterprises:
- Those which have a turnover of more than ₹50 crores in a preceding financial year.
- Non-SMC.
- Those borrowing more than ₹10 crores at any time during the accounting period.
Features
Cash Flow Statement explains cash movement under the following three different heads:
- Cash flow from Operating Activities
- Cash flow from Investing Activities
- Cash flow from Financing Activities
The sum of these three types of cash flow reflects the net increase or decrease of cash and cash equivalents. Following are certain important terms indicating their features which are commonly used in AS-3 Cash Flow Statement.
AS-12: Accounting for Government Grants
Introduction
This standard deals with the accounting for Government Grants. Government Grants are sometimes called by other names such as subsidies, cash incentives, duty drawbacks, etc.
This standard does not deal with:
- The special problems arising in accounting for government grants in financial statements reflecting the effects of changing prices or in supplementary information of a similar nature.
- Government assistance other than in the form of government grants.
- Government participation in the ownership of the enterprise.
Definitions
The following terms are used in this standard with the meaning specified:
- Government: Government refers to government, government agencies, and similar bodies whether local, national, or international.
- Government Grants: Government grants are assistance by the government in cash or kind to an enterprise for past or future compliance with certain conditions. They exclude those forms of government assistance which cannot reasonably have a value placed upon them and transactions with the government which cannot be distinguished from the normal trading transactions of an enterprise.
AS-19: Leases
This standard deals with the accounting treatment of transactions related to lease agreements. For this purpose, the standard divides the agreements into operating and financing leases. A finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset. An operating lease is a lease other than a financial lease.
Meaning
A lease is an arrangement by which the lessor gives the right to use an asset for a given period of time to the lessee on rent. It involves two parties, a lessor and a lessee, and an asset which is to be leased. The lessor who owns the asset agrees to allow the lessee to use it for a specified period in return for periodic rent payments. The lease transaction derives its accounting treatment from the substance of the transaction rather than its legal form. The lease can be structured to take tax benefits. It can be used to transfer ownership of the leased asset, and it can also be used to transfer the risk of ownership.
In any event, the substance of transactions dictates the accounting treatment. The lease transaction (finance lease) is probably the best example of the accounting profession’s substance over legal form.
If the transactions effectively transfer ownership to the lessee, then the substance of the transaction is that of a sale and should be recognized as such, even though transactions take the form of a lease.
Definitions
The terms used in AS-19 are defined specifically as summarized below:
Lease: It is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.
Finance Lease: It is a lease that transfers substantially all the risks and rewards incident to ownership of an asset along with the right to use an asset but not the legal ownership.
Operating Lease: It is a lease other than a finance lease, which does not transfer all the risks and rewards incidental to ownership.
Fair Value: It is the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm’s length transaction.
Sale and Lease Back Transaction: It is a transaction which involves the sale of an asset by the vendor and the leasing of the same asset back to the vendor.
Types of Lease
For the purpose of accounting, the lease is classified into two categories as i) Finance Lease and ii) Operating Lease.
i) Finance Lease
It is a lease which transfers substantially all the risks and rewards incidental to ownership of an asset to the lessee by the lessor but not the legal ownership. In the following situations, the lease transactions are called finance leases:
- The lessee will get the ownership of the leased asset at the end of the lease term.
- The lessee has an option to buy the leased asset at the end of the term at a price which is lower than its expected fair value on the date on which the option will be exercised.
- The lease term covers the major part of the life of the asset.
- At the beginning of the lease term, the present value of minimum lease rental covers substantially the initial fair value of the leased asset.
- The asset given on lease to the lessee is of a specialized nature and can only be used by the lessee without major modification.
ii) Operating Lease
It is a lease which does not transfer substantially all the risks and rewards incidental to ownership. Classification of a lease is made at the inception of the lease; if at any time the lessee and lessor agree to change the provision of the lease and it results in a different category of lease, it will be treated as a separate agreement.
Internal Reconstruction
The process of changing the capital structure of a company without its liquidation is termed Internal Reconstruction. It is a particular scheme carried out by means of reduction of capital.
Meaning
In the case of Internal Reconstruction, the company’s existing financial structure is reorganized without dissolving the existing company and without forming a new company. Taking a wider meaning of the term ‘Internal Reconstruction’ it includes:
- Alteration of Share Capital under Sections 94 to 97.
- Reduction of Share Capital under Sections 100 to 105.
- Variation of Shareholders’ Right under Section 106.
- Scheme of Compromise or Arrangement under Sections 391 to 393 and 394 A.
Legal Requirements
A) Legal requirements in connection with the “Alteration of Share Capital”:
The main legal requirements in connection with the alteration of Share Capital are summarized as under:
a) Authorized by Articles: A Company may alter the Capital Clause of its memorandum only if it is authorized by its Articles of Association to do so.
B) Manner: A Company may alter the Capital Clause in the following manner:
i. by increasing its share capital by the issue of new shares: for example, from ₹1 crore to ₹5 crores.
ii. by consolidating the existing shares into shares of a larger amount than its existing shares [e.g. Conversion of Shares of ₹10 each into shares of ₹100 each].
iii. by subdividing the existing shares into shares of a smaller amount than its existing shares; [e.g. Conversion of Shares of ₹100 each into shares of ₹10 each].
iv. by converting fully paid shares into stock or vice-versa.
v. by canceling its unissued shares.
C) Ordinary Resolution: An ordinary resolution must be passed at a general meeting.
D) Notice: A notice specifying alteration made must be given to the Registrar within 30 days of alteration.