(a) Briefly explain the significance of Accounting Standard-7 (AS-7). (10 marks) (b) Explain why the companies issue right…

(a) Significance of Accounting Standard-7 (AS-7)

Accounting Standard-7 (revised), issued by the Institute of Chartered Accountants of India (ICAI), governs the accounting treatment for construction contracts in the financial statements of contractors. Because construction activities typically span across multiple accounting periods, the standard addresses the challenge of periodic allocation of contract revenue and contract costs.

AS-7 mandates the Percentage of Completion Method (PoCM) for revenue recognition when the outcome of a construction contract can be estimated reliably. Under PoCM, contract revenue and associated costs are recognized in the profit and loss statement in proportion to the stage of completion of the contract activity, strictly discarding the Completed Contract Method. The stage of completion is determined by contract costs incurred to date relative to estimated total costs, surveys of work performed, or physical completion. Furthermore, if total contract costs are expected to exceed total contract revenue, the anticipated loss must be recognized immediately as an expense. AS-7 mandates extensive disclosures, including aggregate costs incurred, recognized profits, advances received, and gross amounts due from or to customers, ensuring transparency and preventing revenue manipulation in long-term infrastructural and commercial projects. AS-7 applies to entities following the Companies (Accounting Standards) Rules; companies under Ind AS now account for such contracts under Ind AS 115, which likewise recognises revenue over time as performance obligations are satisfied.

(b) Right Shares: Objectives and Distinction from Bonus Shares

Under Section 62 of the Companies Act, 2013, a company issues right shares to raise fresh equity capital while preserving the pre-emptive rights of existing equity shareholders. Companies issue right shares because it enables capital mobilization without diluting the existing control, voting power, or proportionate shareholding of existing investors. Moreover, right shares are typically offered at a discount to the prevailing market price, reducing issue underwriting expenses and floatation costs.

Right shares fundamentally differ from bonus shares across key parameters:

Capital Infusion and Consideration: Right shares represent a fresh infusion of cash capital by existing shareholders at a specified price. Conversely, bonus shares under Section 63 involve no cash inflow, as they are issued free of cost through the capitalization of free reserves, securities premium, or the capital redemption reserve.

Shareholders' Discretion: A shareholder receiving a right offer can subscribe, reject, or renounce the right in favour of another person. Bonus shares are credited automatically to the demat account without any renunciation option.

Regulatory Governance: Right issues must comply with SEBI (Issue of Capital and Disclosure Requirements) Regulations concerning minimum subscription and pricing, whereas bonus issues are governed by strict prohibitions against issuing bonus shares in lieu of dividends.

(c) Main Aspects of Audit of a Banking Company in India

The statutory audit of a banking company in India is governed by the Banking Regulation Act, 1949, the Companies Act, 2013, and prudential guidelines issued by the Reserve Bank of India (RBI). The primary aspects comprise:

Appointment and Reporting: Under Sections 29–30 of the Banking Regulation Act, the auditor of a banking company is appointed with the prior approval of the RBI, and the audit covers the balance sheet and profit and loss account in the forms of the Third Schedule. Large banks are audited branch by branch (central and branch auditors).

Prudential Norms and Asset Classification: The auditor evaluates compliance with RBI’s Income Recognition and Asset Classification (IRAC) norms. Advances must be accurately classified into Standard, Sub-Standard, Doubtful, and Loss categories, verifying that adequate provisioning is computed against Non-Performing Assets (NPAs).

Income Recognition: The auditor verifies that income on performing assets is recognized on an accrual basis, whereas interest on NPAs is strictly accounted for on a cash realization basis, requiring reversal of unrealized accrued interest.

Statutory Liquidity Compliance: The auditor examines the periodic computation and maintenance of the Cash Reserve Ratio (CRR) under the RBI Act, 1934, and the Statutory Liquidity Ratio (SLR) under Section 24 of the Banking Regulation Act.

Verification of Cash, Gold and Investments: The auditor physically verifies cash balances and gold, and examines the valuation and classification of investments in line with RBI norms.

Internal Controls and Fraud Reporting: The auditor reviews the effectiveness of concurrent audit systems, treasury operations, and inter-branch reconciliation, and reports frauds noticed in the course of audit to the Central Government under Section 143(12) of the Companies Act, while the bank itself reports frauds to the RBI. Besides the main report, the auditor submits a Long Form Audit Report (LFAR) in the format prescribed by the RBI, covering advances, deposits, investments and internal controls.

(d) Fair Rent and Annual Rent under Income from House Property

Under Section 23(1) of the Income Tax Act, 1961, income from house property is assessed based on its Gross Annual Value (GAV).

Fair Rent (FR) is the reasonable rent that a similar property with similar specifications, size, and amenities can fetch in the same or similar locality. It serves as a benchmark to ensure actual rent is not understated.

Annual Rent (or Actual Rent Received/Receivable) is the actual consideration agreed upon and received or receivable by the owner from the tenant for letting out the property during the previous year, excluding unrealized rent.

To determine GAV: First, compute the Expected Rent (ER), which is the higher of Municipal Value (MV) and Fair Rent (FR), restricted to Standard Rent (SR) fixed under the Rent Control Act. Second, compare Expected Rent with Actual Rent Received/Receivable (AR). The higher of the two is the GAV (subject to adjustments for vacancy loss).

Illustration: Municipal Value = ₹1,20,000 Fair Rent = ₹1,40,000 Standard Rent = ₹1,30,000 Annual Rent Received = ₹1,50,000

Step 1: Higher of MV (₹1,20,000) and FR (₹1,40,000) is ₹1,40,000, but restricted to SR (₹1,30,000). Thus, Expected Rent = ₹1,30,000. Step 2: GAV is the higher of Expected Rent (₹1,30,000) and Annual Rent Received (₹1,50,000). Hence, GAV = ₹1,50,000. Step 3: If the owner pays municipal taxes of ₹10,000, Net Annual Value = ₹1,40,000. Standard deduction u/s 24(a) at 30% = ₹42,000, so income from house property = ₹98,000 (before interest on borrowed capital u/s 24(b)).

(e) Job Costing and its Distinction from Process Costing

Job costing is a specific order costing method applied where work is executed against individual customer specifications and orders. Under this method, each job is treated as a separate, identifiable cost unit. A dedicated Job Cost Sheet is maintained to accumulate direct materials, direct labour, and allocated production overheads from the commencement of the job until its final completion. It is applied in industries such as printing presses, machine tool manufacturing, interior decoration, and repair workshops.

Job costing differs from process costing in the following respects:

Nature of Production: Job costing applies to discontinuous, heterogeneous, and non-standardized production tailored to customer orders. Process costing is employed in continuous, large-scale mass production of standardized, homogeneous goods (e.g., chemical plants, oil refineries, cement, textiles).

Cost Accumulation: In job costing, costs are collected and traced to each individual job. In process costing, costs are accumulated by distinct processes or departments for a specific accounting period.

Unit Cost Determination: In job costing, unit cost is calculated upon completion of that specific job by dividing total job cost by units produced in that batch. In process costing, unit cost is an average periodic cost computed using the concept of Equivalent Production Units to value work-in-progress.