The Hindu Business Line : Interest capitalisation on interrupted construction

ABC Ltd commenced construction of a flyover in Mumbai in January 2004 under the build-own-lease-transfer (BOLT) scheme. The same was completed in February 2005. Due to heavy seasonal rains in July 2004 in the area, the work on the flyover had to be suspended. Borrowing costs of Rs 12.50 lakh for that month were not capitalised.

Answer: Accounting Standard (AS) 16 lays down the circumstances under which borrowing costs can be suspended. The period wherein no activity takes place for obtaining the qualifying asset is to be excluded for capitalisation. In case of interruption of activities, too, capitalisation is to be suspended. However, when the work is suspended for reasons beyond the control of the management — such as seasoning time, hold up in transit, substantial advancement in technology and changes in administration — capitalisation need not be suspended. Similarly, where there is a temporary hold up in the work or delay, capitalisation is not suspended.

In the given question, the construction company building the flyover had to suspend work for a month (July 2004) because of heavy rains. This was for a short period and beyond the control of the company. Therefore, suspension of capitalisation is not justified.

The auditor should advise the company accordingly and insist on capitalising the borrowing costs.

Breach in branch audit

P LTD, of whom you are the statutory auditor, appoints M/s. XYZ as branch auditors for one of its branches. XYZ conducted the audit of the branch without visiting the branch and getting the books at the head-office. XYZ has submitted its branch audit report to you.

Answer: AAS 10, on relying upon other auditors, casts a responsibility on the principal auditor before relying upon the auditor of a component. AAS 6 requires the auditor to evaluate his audit risk before designing the nature, extent and timing of the audit procedures to be carried out.

In the given case, the auditor of a component did not carry out the audit according to the generally accepted audit procedures. Such a situation would enhance the detection risk of the auditor.

Under company law, the liability for misstatements in the financial statements is the primary responsibility of the branch auditor. The statutory auditor would not, under normal circumstances, be liable for any misstatements in the branch financial statements. But since, in the instant case, he knew that the branch auditor did not do a proper job, the statutory auditor should have taken precautions that there were no material misstatements in the financial statements.

Notwithstanding that another auditor audited the branches, the statutory auditor has a right under company law to visit those branches, which were audited by XYZ (if they are situated in India).

The statutory auditor may visit the branches, call for the records as well carry out the audit all over, ignoring the work of the branch auditor.

Unrealised profit

LM LTD has two divisions, L and M. The finished products of division L are transferred to division M where further processing is carried out before sale to customers. To achieve transparency and accountability between the divisions, division L raises an invoice on division M at cost plus normal margins. At the year-end, the unrealised profits on inter-division stocks are eliminated. However, the transfers are recorded at the invoice value of sales and purchases in the respective divisions for the purpose of preparing the profit and loss (P&L) account. Suitable disclosures for this are given in the `Notes of Accounts'.

Answer: According to AS 1, prudence is one of the considerations for evolving an accounting policy. A company cannot have an accounting policy that does not conform to the basic accounting assumptions and the three considerations of formulating an accounting policy.

AS 2 requires the inventories to be disclosed at historic cost price or the net realisable value, whichever is less.

Unless the financial statements are drawn up in accordance with the accounting standards and other requirements of GAAPs, financial statements cannot be said to be disclosing a true and fair view.

The practice followed by the company is not in compliance with the requirements of AS 1 and AS 2. This practice does not eliminate the unrealised profit from the financial statements. Consequently, both the balance-sheet and P&L account would give a distorted view. Consequently, the financial statements cannot be said to be showing a true and fair view.

As an auditor, he should bring this to the notice of the management and insist on making necessary adjustments.

With the amendment to company law in 2000, the auditor is required to state in bold letters or italics if there is any non-compliance with the applicable accounting standards. He should also quantify the effect on the financial position.

Therefore, if the management does not accept his suggestion, the auditor should qualify the report appropriately and also mention therein in bold letters about non-compliance with the requirements of AS 1.

AS 20 applicability

T PVT LTD is an unlisted closely held company with turnover less than Rs 50 crore. While finalising the accounts, the Director (finance), Mr M, disputed the applicability of AS 20 to the company.

Answer: Accounting Standard 20 on EPS is applicable to all listed companies whose equity shares or potential equity shares are listed in any recognised stock exchange in India. In the given question, T is a private limited company and cannot be listed. Turnover of less than Rs 50 crore is not a criterion. Hence, the requirements of AS 20 are not applicable and the director is justified in disputing the applicability of AS 20. The auditor should, therefore, not insist on EPS.

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