Sec 138 - companies act, 2013- compulsory internal audit

1. Introduction  and Old Vs New

- Section 138 of the Companies Act deals with Internal Audit of Companies.  This section states that certain classes of Companies shall be required to appoint an internal auditor who shall either be a Chartered Accountant, Cost Accountant orsuch other professional (#) as may be decided by the Board to conduct internal audit of the functions and activities of the Company. 

- This is a new Section where in Internal Audits have been made mandatory for certain categories of Companies.  There is no corresponding old section

Key Aspects

The following class of companies shall be required to appoint an internal auditor or a firm of internal auditors, namely (a) “Every listed company” and (b) Private and unlisted public companies meeting “any” of the following criteria

Criteria	Unlisted Public	Private
Paid up Share Capital	Fifty crore rupees or more during the preceding financial year	No Share capital criteria
Turnover	Two hundred crore rupees or more during the preceding financial year	Two hundred crore rupees or more during the preceding financial year
Outstanding loans or borrowings from banks or public financial institutions	Exceeding one hundred crore rupees or more at any point of time during the preceding financial year	Exceeding one hundred crore rupees or more at any point of time during the preceding financial year
Outstanding deposits	Twenty five crore rupees or more at any point of time during the preceding financial year	No deposit criteria

- Provided that an existing company covered under any of the above criteria shall comply with the requirements of section 138 and this rule within six months of commencement of such section. For the purposes of this rule, (i) the internal auditor may or may not be an employee of the company and (ii) the term “Chartered Accountant” shall mean a Chartered Accountant whether engaged in practice or not. Internal Auditors cannot render Statutory Audit Services for the same Company (Sec 144 of the Act )

- The audit committee of the Company or the Board shall, in consultation with the Internal Auditor, formulate the scope, functioning, methodology and periodicity for the conduct of Internal Audit

- An interesting aspect is whether any professional can be appointed by the Board to conduct Internal Audit.  In this regard, I am advised that the principle of Ejusdem generis ("of the same kinds, class, or nature") would apply and a professional as stated in the section cannot include a Doctor or a Lawyer !

Proposal for Internal Audit Services

1. Executive Summary

XYZ Limited, Chartered Accountants are pleased to propose to offer their services for the conduct of Internal Audit of (name of client) for year 2014-15.  We appreciate the need for this engagement and believe that we possess the relevant skills, expertise and infrastructure to handle this engagement. 

We appreciate the context and relevance of this engagement to client and would bring relevant experience and expertise to enable robust engagement definition and completion

2. Organisation Overview

Give a brief overview of the Organisation to be audited

3. About XYZ & Co

XYZ & Co is a niche practice that seeks to provide new age contemporary risk advisory and internal audit services to clients. 

4. Internal Audit function

The main objective of the Internal Audit process is to provide an assurance on the organisation’s risk management, internal control environment and governance framework through review and appraisal of:

a. Operational control framework including fundamental and basic systems in all areas of the business.  The adequacy of risk identification, assessment and mitigation in the organisation. This shall include fraud risks

b. Extent, adequacy, relevance of, and compliance with existing policy, plans and procedure documents within the SBU

c. The extent of compliance with relevant statutory requirements

d. Status of implementation of internal / external audit recommendations

5. Terms of Reference

Based on mutual discussions the following are agreed as the Broad Areas of Coverage with respect to the Internal Audit Engagement

- Fixed Assets

- Investments

- Inventories and Production Operations

- Cash and Bank

- Revenues and receivables

- Purchases and Payables

- Loans and Advances

- Payroll

- Key Spends

- Safety and Security norms

- Statutory Compliances 

6. Methodology

A Risk Based Internal Audit Approach would be adopted and would comprise of the following

a. Develop an indepth understanding of the clients business process, accounting systems and internal controls

b. Field work as per agreed time lines

c. Define reporting formats for conclusion of audits and corrective action trackers to enable reporting to the audit committee.

d. The key focus areas for the Internal Audit would be also be to perform a robust follow up of previous audit reports on a 2 year rolling basis

e. The  audit frequency will be on a quarterly basis

7. Detailed Coverage

a. Fixed Assets - Including Controls over additions, deletions, scrap, idle – inactive assets review, capitalisation protocols, depreciation accuracy, capital work in progress review, export schemes related to fixed assets, insurance

b. Cash and Bank – Including Controls over receipts, payments, custody, insurance, bank reconciliations, controls over master data creation and amendments

c. Loans and Advances – Including Controls over disbursements, monitoring and recoveries of trade / tooling advances

d. Procurement and Payments for Goods and Services including  - Vendor master data review, Purchase Profiling, Vendor selection, Indenting, Sourcing protocols, Purchase Ordering, Material receipt, Liability Accounting, Payment Processing , Access rights on transactions, Controls over master data creation and amendments

e. Inventories  – Controls over receipt, issues of inventory, physical verification, perpetual verification protocols, inventory adjustments, Bill of material related controls, Scrap, inventory adjustments and review of all unusual transactions in relation to inventory

f. Production – Production orders, material issues, production order closures, quality processes, finished goods booking

g. Payroll  - controls over file maintenance, additions, deletions, changes to payroll masters, attendance , over time controls , Payroll reconciliations

h. Revenues and Receivables – Controls over orders, Order profitability and approvals thereon, costing assumptions review, Invoicing, despatch, Excise duties, Detailed review of Export operations, treasury and forex exposure management , Scrap sales and collections

8. Reporting

Periodic reports as mutually agreed would be issued to the management encapsulating the following

- Audit finding

- Impact of the issue

- Recommendation

- Management Comment

Responsibility / Target date

9.  Fees

Based on our assessment of the work involved, we propose a fee of Rs XXXXXX per annum (plus service tax as applicable)

The fees will be payable on a quarterly basis after submission of draft reports

10.  Confidentiality

We shall ensure strict adherence to data confidentiality requirements. All data received or accessed in the course of the engagement shall be treated as Confidential and we shall ensure the same degree of care in dealing with your data as we would with our own confidential information.

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Questions to ask while designing Employee Incentive Schemes

Performance Incentive Schemes have all along been considered an important tool in the hands of the management, to differentiate between high performers and others, and to suitably reward the former. Where the overall output is dependent on employee group efforts, typically seen in manufacturing environment, group incentive schemes have been considered appropriate. Where individual performance matters, as it happens in some of the Software Services Organizations, Individual Incentive Schemes are popular. I am aware of a Group Incentive Scheme which brought a turnaround in a manufacturing unit. I am also aware of overzealous attempts to realize too many goals through incentives which lead to unmanageable situations. The scheme could not get the “buy-in” of the employees for whom it was meant. In one instance where the organization wanted “margins” to improve, gave additional incentive for “margin improvement” and doled out more money than what the organization gained through such higher margins!

Key messages are: 

i. Keep it simple

ii. Ensure that all stakeholders trust the scheme,

iii. Base it on  data that is quantifiable and

iv. Make prompt disbursement of amounts worked out according to the declared scheme.

We need to know the right questions to ask.

Some of the questions that we need to ask while introducing an incentive scheme are listed here.

1. How many people and at what levels do we want to cover under the Incentive Scheme?

2. What percentage of their pay could be their Variable Pay?

3. In absolute amount, what could be this amount, for the entire organization, at 100% achievement?

4. Do we classify employees into “line” and “staff” functions for this purpose?

5. In the case of “line” what are deliverables? Are they different for different groups like “Sales” and “Project Delivery” teams?

6. Is it Company Level Incentive, Department Level Incentive or Project Level Incentive?

7. Are deliverables clearly defined and are capable of assessment without ambiguity or uncertainty?

8. Do we have data available from authentic sources, and methodologies available for processing such data?

9. Is there a target setting process in place?

10. Which are important? Individual targets or group level targets?

11. Are there any “Key Performance Drivers” (KPIs) like “Gross Margin” which we want to  achieve through the incentive scheme?

12. Are such KPIs within the control of the employees whose incentives are impacted?

13. In relation to point 11 above, out of incremental gains to the organization, how much do  we want to pass on to the employees as incentive?

14. Do we like to make soft skill aspects like “job knowledge”, “team work” part of the criteria, for assessing performance?

15. What is the periodicity of disbursement, monthly, quarterly or annually?

16. Can it be done within a reasonable time, after closure of the period?

17. Do we like to carry forward a part of the incentive earned by an employee, for disbursement in future?

18. Do we like to link the incentive earning to the physical presence of the employee, on duty?

19. How do we want to handle support staff?

20. Finally, can we keep it simple and unambiguous, such that it inspires confidence amongst the employees for whom it is meant?

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New Year Resolution: Have A 'Stop Doing' List

“The difference between successful people and very successful people is that very successful people say ‘No’ to almost everything.” (Warren Buffet)

The new-year 2015 is approaching and as usual we all would start to write down our resolutions for the new year.  If you observe very closely, our resolutions are always on the lines of things that we would do, things that we would finish etc.  As per a research, 75% of the people break their new-year resolutions by the 13th-14th of January, i.e., within a period of 2 weeks.  That’s purely because we resolve to be better by doing more.

However, have you ever felt that in our daily schedule we do so many things that take much of our time, without adding any substantial value in our life.  We spend time watching useless movies, we start our day by first checking our emails and then starting the work, we gossip a lot with our friends and colleagues.  All this leads to a criminal waste of time and hence, our productivity.  What if we make a list of things that ‘we shall stop doing’ so that we can focus only on those activities that make us more productive and provide a real meaning to our life. Steve Jobs in one of his presentations said “Its only by saying NO you can concentrate on the most important things”.

Even I personally believe that by having a ‘Stop Doing’ list, one can really start to be more productive and useful.  If we imagine our day, we can easily identify instances or acts, which if avoided, could have led us performing much better, much more result oriented.  Consequently, if we list down those activities and take a vow that in the coming new year we shall not spend time on them since those activities are not worth spending time, I am sure you are going to be much more productive.

I wanted to share with you an incident that has been narrated by acclaimed business management author Jim Collins who has authored top selling books like ‘Built to last’ and ‘Good to Great’.  He mentions that in his early age of 20s he discovered the power of preparing a ‘stop doing’ list only because his professor once told him the 20-10 story which became a cornerstone of his intent to prepare the ‘stop doing’ list.  The story was as follows:

The professor asked Jim to assume he has got $20million to spend wherever and on whatever he wants.  However, the rider is that he is ill with some disease and has got only 10 years left in his life to spend that money. He then asked him what would you do, or more particularly, what would you stop doing.     

Jim mentions that incident became a turning point of his life and since then he started preparing his new year resolutions around the things he would stop doing, rather than the list of items he would do.

Although, each one of you would have something different to write down, here are few examples I wanted to share with you as things which you might want to stop so that you are super productive and are able to do more meaningful jobs in your life:

If you are a student

1. Not to spend time surfing the net without any objective;

2. Not to day dream;

3. Not to chat with friends on whatsapp or Facebook when studying;

4. Not to chat with family members during the time you are studying;

5. Not to allow the feeling that you aren’t ready for exercise today;

6. Not to snooze the alarm and buy some more time to sleep;

7. Not spending too much time biking around;

8. Not to criticize your luck or your circumstances, because after all no one is perfect in this world other than God;

9. Not spending too much time watching TV and more particularly watching; useless and utterly time wasting programmes such as Big Boss J

10. Not to spend time in office after office hours just for gossip;

11. Not wasting weekends on activities that are unrelated to studies.

I am sure you would have many more things to add.  These were just few things which I stopped doing when I was studying.  In addition to your professional/ academic career related things, you might also want to have a ‘stop doing’ list for your personal life.  It could be anything related to your love life, your family, your friends etc.  Just think of the activities which you feel might not be relevant but you still spend time on them and then put them on your list.  You would be amazed with your new level of productivity.

If you are a professional

1. Stop wasting time checking emails first thing in the morning;

2. Stop snoozing alarm to buy more time to sleep;

3. Stop looking at your phone every time there is a message from Whatsapp;

4. Stop that feeling of not allowing you to exercise any day;

5. Stop spending too much time on water-cooler talks in the office (they just don’t help too muchJ);

6. Stop spending too much time watching TV or surfing net when bored;

7. Stop criticizing, because after all no one is perfect in this world other than God.

The whole idea is to guard your focus so tight that any activity that deviates you from it is completely removed and killed.   Remember – “Wherever your focus goes, your success grows”. You must understand that for anyone to succeed in life he/she should have a burning desire to achieve that success and unless you have a monomaniacal focus, you cannot achieve that success.   Monomaniacal focus can only be achieved when you do not allow any noise to enter your mind and be highly disciplined and only do those activities that are important and critical.

I want to share some quick tips to decide whether you should ‘No’ or not in any circumstance so that you proceed and conquer your share of success.

Have a list prepared for items to be finished and then keep reviewing that list on a continuous basis

Don’t take impulsive decisions

Many a times we have the habit of taking decisions in impulse, i.e., immediately without realizing the future consequences. Thereafter, we realize that it was a mistake that shouldn’t have been done.  Actions taken in impulse should be avoided and one should develop the habit of auctioning only after a due thought is given to the situation.

All ideas don’t work

It is important to understand that all ideas that come to our mind are not always the most brilliant one and should be pursued at all cost. That’s not true. It is good to think and have new ideas in life and in career, but any action on it should only be after weighing the pros and the cons. Don’t worry, the idea will not run away if you don’t action it fast.

I want to end the article with a beautiful quote from Jim Collins:

“Most of us lead busy but undisciplined lives. We have ever-expanding ‘to do’ lists, trying to build momentum by doing, doing, doing—and doing more. And it rarely works. Those who built the good-to-great companies, however, made as much use of ‘stop doing’ lists as ‘to do’ lists”

Wishing you all green lights in life

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TNVAT - How to make E-payment of TNVAT?

Recently, TNVAT Department has made the e-payment of monthly taxes, mandatory in respect of assessees whose turnover during the previous year is more than 1 Crore. As a prelude to the complete computerization and online management system in TNVAT, many assessment circles have issued notices to all assessees irrespective of their turnover to make only e-payment.

How to make e-payment of TNVAT monthly tax payments ?

First the assessee has to log-in to the e-filing website.

After log in, at the bottom of the screen, there will be a link for Activation of epayment. Click that link and activate the e payment option. This is a one time process.

After completion of the above, the e-payment is to be made as per the procedure given below :-

Click here to download the file

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Know Your Bank Balance through Mobile

தற்பொழுது ஒரு மாதத்திற்கு 5 முறை மட்டுமே இலவசமாக ATM எந்திரம் வழியே பணம் எடுக்கவோ அல்லது வங்கி கணக்கில் உள்ள கையிருப்பு பணத்தை பார்க்கவோ முடியும்.

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அதற்கு மேல் பார்த்தால் ஒவ்வொரு முறைக்கும் 20 ரூபாய் பிடித்துக்கொள்ளப்படுகின்றது. இதனால் சாமானிய மக்கள் பாதிக்கப்பட்டுள்ளனர்.

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தற்பொழுது இலவசமாக வங்கி கணக்கில் உள்ள கையிருப்பு பணத்தை அறிந்து கொள்ள இலவச நம்பர் சேவை அறிமுகப்படுத்தப்பட்டுள்ளது.

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கீழே கொடுக்கப்பட்டுள்ள இலவச எண்ணிற்கு கால் செய்தால் போதும், உங்களுடைய போன் எண்ணிற்கு கையிருப்பு தொகையை SMS அனுப்பிவிடுவார்கள்.

உங்கள் நம்பர் பதிவு செய்யப்பட்ட நம்பராக இருக்கவேண்டும்.

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1. Axis bank-------------------- 09225892258

2. Andra bank------------------ 09223011300

3. Allahabad bank-------------09224150150

4. Bank of baroda-------------09223011311

5. Bhartiya Mahila bank----- 09212438888

6. Dhanlaxmi bank----------- 08067747700

7. IDBI bank-------------------- 09212993399

8. Kotak Mahindra bank--- 18002740110

9. Syndicate bank------------ 09664552255

10. Punjab national bank---18001802222

11. ICICI bank----------------- 02230256767

12. HDFC bank-------------- 18002703333

13. Bank of india------------- 02233598548

14. Canara bank------------- 09289292892

15. Central bank of india-- 09222250000

16. Karnataka bank-------- 18004251445

17. Indian bank-------------- 09289592895

18. union bank of india---- 09223009292

19. UCO bank---------------- 09278792787

20. Vijaya bank--------------- 18002665555

21. Yes bank------------------ 09840909000.

22. State Bank of india- Get the balance via IVR
1800112211 and 18004253800

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Five rare benefits of filing regular 'Income Tax Returns'

What is the benefit of filing income tax return? this is the first question when a client ram into the office of a CA or Tax lawyer. Generally professionals have pre-defined answers for this, as it benefits for Loan, CC limit, or being loyal with the govt etc etc . But do every one of us know what are the RARE benefits of filing Income tax returns regularly i.e. without any gap ? Here is the answer

1. For job appointment  in Judicial & class-one  Jobs

Yes, in Judicial jobs or where a Chartered Accountant or Lawyer needs to demonstrate annual professional income for the Judicial/judge’s post or 'Senior Auditors' post, no client data or record of similar work done shall matter to the selection body .It is only the last 5 to 7 years income tax returns (in Judicial appoitments  7 year ITR record is checked in  interview) that shows the candidate’s credibility, for he has done good practice & supposed having huge clientele of that calibre for the judicial post/class one post. 

2. For accidental claim in third party Insurance claim

Life is uncertain, this is one of the rare benefit of filing the  ITR  every year. So do not bother if the income barely touches or crossing  the taxable limit . If you keep filing  ITR of yourself or spouse, just because CA /Lawyer is  your neighbour or charge very nominal fee, it can  help you in future  in case of accidental death of any member/'s of family during roadside accident, because during court trial, insurance company need the proofs of income to arrive at the amount of accidental claim , if any return is missing,  mainly  last 3 years , this could lower the claim amount or even no claim will be given because court take ITR as only evidence. No wealth record, FD’s, business etc is given that much importance  as compared to ITR in the eyes of law. The formula for claim is by multiplying the yearly income in ITR with years of expecting life of deceased .So next  time give special thanks to your tax professional to remind you every year about the regular return filing .

3. For 'Immigration -Profile' obtaining  visa outside India

This is another benefit of filing your ITR regularly. The High Commissions of various countries or VFS centres across India have huge record of fabricated documents in which income tax returns of applicants are one of them. Why, because sometimes travel agents forge it or show it as regular income tax return by charging huge money. Every assessee should file return if intention is in mind to go aboard in future .Use it showing your all genuine source of incomes , because immigration officers give due wheightage to your annual income . Absence of any single year returns can decrease your chances of foreign visa under visitor, investor or work permits category. 

4. For eligibility in all Loan cases from Banks

One of the services of all banks either private or Nationalised is to finance the customers in the shape of bank loans, CC Limit, project funding etc. Income tax returns of last three years are the basic need for it except agriculture limits , secondly the PAN is checked over the CIBIL  website if Individual or corporate body is not a defaulter in any previous bank . The CIBIL  Score plays a critical role in the loan application process .Because this agency keep the record of your instalment  payment nature ,as  it gives the score to your bank which is required for the particular approval of loan case. That is why according to the Supreme court order ,hard recovery of all loans is banned  , especially  in car loans no forceful possession can be taken by the bank . CIBIL just blacklist such customer for all future loans all over India , based on the PAN card number allotted to such loan  defaulter.  

5. For obtaining Govt tenders, registration on panels:

As described in point one earlier, the  value of business profiles of various corporate agencies, contractors, professional service providers or Individuals is dependent on the yearly income tax returns. Sometime contractors have very good history of procuring heavy projects in their line, be it a service or works contract ,but they they lack the knowledge  & benefit to file the returns on time or sometimes the returns were not filed on the factual provisions (i.e defected returns). For contractors, these returns needed not only to be filed on time , but must be very much accurate ,&  audited (if required), these must be signed with necessary documents because in tender- approval meetings or for finalising professional panels, the selection body has ample options to mature the tender in favour of the fittest . Sometimes this work is checked by the tender scrutiny committee and five to seven  years ITRs are considered to see whether  the applicant has done the work of that much amount earlier or not. So next time to enlarge your business horizon and obtaining more tenders from Govt or private bodies, one need to file the regular returns every year.  

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5 Heads of Income Tax in India

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My First Leadership lesson in My Office

The Happiest moment in my office meeting.

I felt a small nervous before all the seniors.

Finally I decided that Pen is better than mouth.

Any-ways, whether good or bad, I used my opportunity. That's all.

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Accounting for Construction Contracts

The following is the text of the Accounting Standard (AS) 7 issued by the Institute of Chartered Accountants of India on 'Accounting for Construction Contracts'. The Standard deals with accounting for construction contracts in the financial statements of contractors.

In the initial years, this accounting standard will be recommendatory in character. During this period, this standard is recommended for use by companies listed on a recognised stock exchange and other large commercial, industrial and business enterprises in the public and private sectors.

Introduction

1. This Statement deals with accounting for construction contracts in the financial statements of enterprises undertaking such contracts (hereafter referred to as 'contractors'). The Statement also applies to enterprises undertaking construction activities of the type dealt with in this Statement not as contractors but on their own account as a venture of a commercial nature where the enterprise has entered into agreements for sale.

2. The feature which characterises a construction contract dealt with in this Statement is the fact that the date at which the contract is secured and the date when the contract activity is completed fall into different accounting periods. The specific duration of the contract performance is not used as a distinguishing feature of a construction contract. Accounting for such contracts is essentially a process of measuring the results of relatively long-term events and allocating those results to relatively short-term accounting periods.

3. For the purposes of this Statement, a construction contract is a contract for the construction of an asset or of a combination of assets which together constitute a single project. Examples of activity covered by such contracts include the construction of bridges, dams, ships, buildings and complex pieces of equipment.

4. Contracts for the provision of services come within the scope of this Statement to the extent that they are directly related to a contract for the construction of an asset. Examples of such service contracts are contracts for the services of project managers and architects and for technical engineering services related to the construction of an asset.

Explanation

5. The principal problem relating to accounting for construction contracts is the allocation of revenues and related costs to accounting periods over the duration of the contract.

6. Types of Construction Contracts

Construction contracts are formulated in a variety of ways but generally fall into two basic types:

(i) fixed price contracts—the contractor agrees to a fixed contract price, or rate, in some cases subject to cost escalation clauses;

(ii) cost plus contracts—the contractor is reimbursed for allowable or otherwise defined costs, and is also allowed a percentage of these costs or a fixed fee.

Both types of contracts are within the scope of this Statement.

7. Accounting Treatment of Construction Contract Costs and Revenues

7.1 Two methods of accounting for contracts commonly followed by contractors are the percentage of completion method and the completed contract method.

7.2 Under the percentage of completion method, revenue is recognised as the contract activity progresses based on the stage of completion reached. The costs incurred in reaching the stage of completion are matched with this revenue, resulting in the reporting of results which can be attributed to the proportion of work completed. Although (as per the principle of 'prudence') revenue is recognised only when realised, under this method, the revenue is recognised as the activity progresses even though in certain circumstances it may not be realised.

7.3 Under the completed contract method, revenue is recognised only when the contract is completed or substantially completed; that is, when only minor work is expected other than warranty obligation. Costs and progress payments received are accumulated during the course of the contract but revenue is not recognised until the contract activity is substantially completed.

7.4 Under both methods, provision is made for losses for the stage of completion reached on the contract. In addition, provision is usually made for losses on the remainder of the contract.

7.5 It may be necessary for accounting purposes to combine contracts made with a single customer or to combine contracts made with several customers if the contracts are negotiated as a package or if the contracts are for a single project. Conversely, if a contract covers a number of projects and if the costs and revenues of such individual projects can be identified within the terms of the overall contract, each such project may be treated as equivalent to a separate contract.

8. Costs to be Accumulated for Construction Contracts

8.1 Costs attributable to a contract are identified with reference to the period that commences with the securing of the contract and closes when the contract is completed.

8.2 Costs not specifically attributable to any contract incurred by the contractor before a contract is secured are usually treated as expenses of the period in which they are incurred. However, if costs attributable to securing the contract can be separately identified and either the contract has been secured or there is a clear indication that the contract will be obtained, the costs are sometimes treated as applicable to the contract and are deferred. As a practical measure, costs directly identifiable with a contract are sometimes deferred until it is clear whether the contract has been secured or not.

8.3 Costs attributable to a contract include expected warranty costs. Warranty costs are provided for when such costs can be reasonably estimated.

8.4 Costs incurred by a contractor can be divided into:

(i) Costs that relate directly to a specific contract;

(ii) Costs that can be attributed to the contract activity in general and can be allocated to specific contracts;

(iii) Costs that relate to the activities of the contractor generally, or that relate to contract activity but cannot be related to specific contracts.

8.5 Examples of costs that relate directly to a specific contract include:

(i) site labour costs, including supervision;

(ii) materials used for project construction;

(iii) depreciation of plant and equipment required for a contract;

(iv) costs of moving plant and equipment to and from a site.

8.6 Examples of costs that can be attributed to the contract activity in general and can be allocated to specific contracts include:

(i) insurance;

(ii) design and technical assistance;

(iii) construction overheads.

8.7 Examples of costs that relate to the activities of the contractor generally, or that relate to contract activity but cannot be related to specific contracts, include:

(i) general administration and selling costs;

(ii) finance costs;

(iii) research and development costs;

(iv) depreciation of plant and equipment that cannot be allocated to a particular contract.

8.8 Costs referred to in paragraph 8.7 are usually excluded from the accumulated contract costs because they do not relate to reaching the present stage of completion of a specific contract. However, in some circumstances, general administrative expenses, development costs and finance costs are specifically attributable to a particular contract and are sometimes included as part of accumulated contract costs.

Basis for Recognising Revenue on Construction Contracts
9. Percentage of Completion Method

9.1 Under the percentage of completion method, the amount of revenue recognised is determined by reference to the stage of completion of the contract activity at the end of each accounting period. The advantage of this method of accounting for contract revenue is that it reflects revenue in the accounting period during which activity is undertaken to earn such revenue.

9.2 The stage of completion used to determine revenue to be recognised in the financial statements is measured in an appropriate manner. For this purpose no special weightage should be given to a single factor; instead, all relevant factors should be taken into consideration; for example, the proportion that costs incurred to date bear to the estimated total costs of the contract, by surveys which measure work performed and completion of a physical proportion of the contract work.

9.3 Progress payments and advances received from customers may not necessarily reflect the stage of completion and therefore cannot usually be treated as equivalent to revenue earned.

9.4 If the percentage of completion method is applied by calculating the proportion that costs to date bear to the latest estimated total costs of the contract, adjustments are made to include only those costs that reflect work performed. Examples of items which may need adjustment include:

(i) the costs of materials that have been purchased for the contract but have not been installed or used during contract performance; and

(ii) payments to subcontractors to the extent that they do not reflect the amount of work performed under the subcontract.

9.5 The application of the percentage of completion method is subject to a risk of error in making estimates. For this reason, profit is not recognised in the financial statements unless the outcome of the contract can be reliably estimated. If the outcome cannot be reliably estimated, the percentage of completion method is not used.

9.6 While recognising the profit under this method, an appropriate allowance for future unforeseeable factors which may affect the ultimate quantum of profit is generally made on either a specific or a percentage basis.

9.7 In the case of fixed price contracts, the conditions which will usually provide this degree of reliability are:

(i) total contract revenues to be received can be reliably estimated;

(ii) both the costs to complete the contract and the stage of contract performance completed at the reporting date can be reasonably estimated; and

(iii) the costs attributable to the contract can be clearly identified so that actual experience can be compared with prior estimates.

9.8 Normally, the profit is not recognised in fixed price contracts unless the work on a contract has progressed to a reasonable extent. Ordinarily, this test is not considered as having been satisfied unless 20 to 25% of the work is completed.

9.9 In the case of cost plus contracts, the conditions which usually provide this degree of reliability are:

(i) costs attributable to the contract can be clearly identified; and

(ii) costs other than those that are specifically reimbursable under the contract can be reliably estimated.

10. Completed Contract Method

10.1 The principal advantage of the completed contract method is that it is based on results as determined when the contract is completed or substantially completed rather than on estimates which may require subsequent adjustment as a result of unforeseen costs and possible losses. The risk of recognising profits that may not have been earned is therefore minimised.

10.2 The principal disadvantage of the completed contract method is that periodic reported income does not reflect the level of activity on contracts during the period. For example, when a few large contracts are completed in one accounting period but no contracts have been completed in the previous period or are to be completed in the subsequent period, the level of reported income can be erratic although the level of activity on contracts may have been relatively constant throughout. Even when numerous contracts are regularly completed in each accounting period, and reported income may appear to reflect the level of activity on contracts, there is a continuous lag between the time when work is performed and the related revenue is recognised.

11. Selection of Method

11.1 The selection of a method of accounting for a construction contract depends on considerations discussed earlier. The contractor may use both methods simultaneously for different contracts depending upon circumstances.

11.2 When a contractor uses a particular method of accounting for a contract, then in respect of all other contracts that meet similar criteria, the same method is used.

11.3 The methods of accounting used by the contractor and the criteria adopted in selecting the method/s represent an accounting policy.

12. Change in Accounting Policy

When there is a change in the accounting policy used for construction contracts, there is disclosure of the effect of the change and its amount. If the contractor changes from the percentage of completion method to the completed contract method, it is sometimes not possible to quantify the full effect of the change in the current accounting period. In such cases, there is disclosure of at least the amount of attributable profits reported in prior years, in respect of contracts in progress at the beginning of the accounting period.

13. Provision for Foreseeable Losses

13.1 When current estimates of total contract costs and revenues indicate a loss, provision is made for the entire loss on the contract irrespective of the amount of work done and the method of accounting followed. In some circumstances, the foreseeable losses may exceed the costs of work done to date. Provision is nevertheless made for the entire loss on the contract.

13.2 When a contract is of such magnitude that it can be expected to absorb a considerable part of the capacity of the enterprise for a substantial period, indirect costs to be incurred during the period of the completion of the contract are sometimes considered to be directly attributable to the contract and included in the calculation of the provision for loss on the contract.

13.3 If a provision for loss is required, the amount of such provision is usually determined irrespective of:

(i) whether or not work has commenced on the contract; and

(ii) the stage of completion of contract activity; and

(iii) the amount of profits expected to arise on other unrelated contracts.

13.4 The determination of a future loss on a contract may be subject to a high degree of uncertainty. In some of these cases, it is possible to provide for the future loss and in other cases only the existence of a contingent loss is disclosed .

14. Claims and Variations Arising Under Construction Contracts

14.1 Amounts due in respect of claims made by the contractor and of variations in contract work approved by the customer are recognised as revenue in the financial statements only in circumstances when, and only to the extent that, the contractor has evidence of the final acceptability of the amount of the claim or variation.

14.2 Claims or penalties payable by the contractor arising out of delays in completion or from other causes are provided for in full in the financial statements as costs attributable to the contract. Claims in the nature of contingency are treated as indicated in Accounting Standard 4 on 'Contingencies and Events Occurring After the Balance Sheet Date'.

15. Progress Payments, Advances and Retentions

15.1 Progress payments and advances received from customers in respect of construction contracts in relation to the work performed thereon are disclosed in financial statements either as a liability or shown as a deduction from the amount of contract-work-in-progress.

15.2 In case progress payments and advances received from customers in respect of construction contracts are not in relation to work performed thereon, these are shown as a liability.

15.3 Amounts retained by customers until the satisfaction of conditions specified in the contract for release of such amounts are either recognised in financial statements as receivables or alternatively indicated by way of a note.

Accounting Standard

(The Accounting Standard comprises paragraphs 16–21 of this Statement. The Standard should be read in the context of paragraphs 1–15 of this Statement and of the 'Preface to the Statements of Accounting Standards'.)

16. In accounting for construction contracts in financial statements, either the percentage of completion method or the completed contract method may be used. When a contractor uses a particular method of accounting for a contract then the same method should be adopted for all other contracts which meet similar criteria.

17. The percentage of completion method can be used if the outcome of the contract can be reliably estimated.

17.1 In the case of fixed price contracts this degree of reliability would be provided if the following conditions are satisfied:

(i) total contract revenues to be received can be reliably estimated;

(ii) both the costs to complete the contract and the stage of contract performance completed at the reporting date can be reasonably estimated; and

(iii) the costs attributable to the contract can be clearly identified so that actual experience can be compared with prior estimates.

17.2 Profit in the case of fixed price contracts normally should not be recognised unless the work on a contract has progressed to a reasonable extent.

17.3 In the case of cost plus contracts this degree of reliability would be provided only if both the following conditions are satisfied:

(i) costs attributable to the contract can be clearly identified; and

(ii) costs other than those that are specifically reimbursable under the contract can be reliably estimated.

17.4 While recognising the profit under percentage of completion method an appropriate allowance for future unforeseeable factors should be made on either a specific or a percentage basis.

18. The costs included in the amount at which construction contract work is stated should comprise those costs that relate directly to a specific contract and those that are attributable to the contract activity in general and can be allocated to specific contracts.

19. A foreseeable loss on the entire contract should be provided for in the financial statements irrespective of the amount of work done and the method of accounting followed.

Disclosure

20. There should be disclosure in the financial statements of

(i) the amount of construction work-in-progress;

(ii) progress payments received and advances and retentions on account of contracts included in construction work-in-progress; and

(iii) the amount receivable in respect of income accrued under cost plus contracts not included in construction work-in-progress.

If both the percentage of completion method and the completed contract method are simultaneously used by the contractor the amount of contract work described in (i) above should be analysed to disclose separately the amounts attributable to contracts accounted for under each method.

21. Disclosure of changes in an accounting policy used for construction contracts should be made in the financial statements giving the effect of the change and its amount. However if a contractor changes from the percentage of completion method to the completed contract method for contracts in progress at the beginning of the year it may not be possible to quantify the effect of the change. In such cases disclosure should be made of the amount of attributable profits reported in prior years in respect of contracts in progress at the beginning of the accounting period.

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Update on Indirect Tax - Service Tax and Excise for the month of Dec 2014

A. Service Tax

1. Service Tax payment for the month of November, 2014 is due for payment on 6th December, 2014 for assesses excluding Individual, Proprietary Firm, Partnership Firm or LLP. It is now mandatory for all assesses w.e.f. October 1, 2014, to pay their dues through internet banking (e-payment) (In case the assessee wants to use any mode other than internet banking, a specific permission may be taken from the Assistant Commissioner/ Deputy Commissioner).

2. ST 3 Return – Half Yearly Service Tax Return (ST-3) for the period April – September 2014 was due on October 25th, 2014. The Excel Utility can be downloaded from www.aces.gov.in/ downloads. The Government had extended the date for filing of returns till November 14, 2014 (Order No.2/2014-ST, Dated 24-10-2014). In case return has not been filed till date, it is advisable to file the same as early as possible, with applicable late fee.

3. Payment under VCES – Assesses who had opted for the recently concluded VCES would have paid the 2nd and final instalment by 30-6-14 (without interest). In case the same has not been paid in full, the balance can be paid till 31-12-14 (with interest).

4. VCES 3 – Assessees who had availed the VCES scheme and have done their payments in full, need to apply to the Department for VCES 3 (Discharge Certificate) giving copy of VCES 2 and all Challans. The Department has started issuing VCES 3 for assessees who have applied.

5. The old service specific codes have been restored thus assesses are required to classify the services rendered by them as per the new notification and pay accordingly in the respective accounting codes. 

6. Please note that in case you are liable to pay Service Tax (in case of services under reverse charge), you are not allowed to set it off against available balance of CENVAT credit. You need to pay the same. You can however avail CENVAT credit of this payment as in normal cases.

7. Amendment in the registration certificate is mandatory to reflect the complete set of services provided/ availed under reverse charge as per the new accounting codes.

8. CENVAT can now be availed only for the last 6 months in the normal case, other than cases of re-credit, as clarified by the Government. Thus you are advised to avail and utilise CENVAT and not keep it accumulated beyond 6 months, as that would become ineligible.

B. Central Excise

1. Excise payment for the month of November, 2014 is due for payment on 6th December, 2014 for assesses excluding SSIs. It is now mandatory for all assesses w.e.f. October 1, 2014, to pay their dues through internet banking (e-payment) (In case the assessee wants to use any mode other than internet banking, a specific permission may be taken from the Assistant Commissioner/ Deputy Commissioner).

2. Excise Returns – Last date for filing of ER 1, ER 2 and ER 6 is 10th December, 2014.

3. CENVAT can now be availed only for the last 6 months in the normal case, other than cases of re-credit, as clarified by the Government. Thus you are advised to avail and utilise CENVAT and not keep it accumulated beyond 6 months, as that would become ineligible.

C. Major Amendments in Nov 2014

Service Tax

1. Constitution of Review Committee of Chief Commissioners of Central Excise & Chief Commissioners of Service Tax – Review committee for making an appeal to the Appellate Tribunals have been reconstituted (Office Order 10, Dated 12-11-2014)

2. Conditions for allowing Cenvat Credit - Clarification on availment of Cenvat Credit after Six Months as per Rule 4 of the Cenvat Credit Rules, 2004 – The Department has clarified in certain cases wherein original credit has been taken within 6 months and if the same is reversed as per provisions and a recredit is taken after 6 months of the original date, the same shall be allowed. (Circular No.990/14/2014-CX-8, Dated 19-11-2014)

Central Excise

1. Special Audit in Certain Cases - Clarification on Splitting up of Rebate Claims to avoid Pre-Auditing – It has been found that some assesses are splitting their claim for rebate to keep the same below 5 lakhs so as to avoid pre-audit. Instructions have been issued to the officers that they may use their discretionary powers to club such claims and order pre-audit of the same (Instruction [F.NO.206/05/2014-CX.6], Dated 3-11-2014)

2. Constitution of Review Committee of Chief Commissioners of Central Excise & Chief Commissioners of Service Tax – Review committee for making an appeal to the Appellate Tribunals have been reconstituted (Office Order 10, Dated 12-11-2014)

3. Conditions for allowing Cenvat Credit - Clarification on availment of Cenvat Credit after Six Months as per Rule 4 of the Cenvat Credit Rules, 2004 – The Department has clarified in certain cases wherein original credit has been taken within 6 months and if the same is reversed as per provisions and a recredit is taken after 6 months of the original date, the same shall be allowed. (Circular No.990/14/2014-CX-8, Dated 19-11-2014)

4. Procedure of service tax refund/exemption to SEZ – It has been clarified that units in SEZ and the Developer can now route their excise related forms and refunds through a specified officer in the SEZ. (F.No.B1/6/2013-TRU)

    

 This is for your kind information.

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Depreciation Rate Chart

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Cash flow statement and its usefulness

MANU		CONVERSATION BETWEEN MANU AND VINU ABOUT CASH FLOW STATMENT AND ITS USEFULNESS	VINU
Manu	Hi Vinu! How are you?
Vinu	Fine Manu!
Manu	How is your Financial Analysis Job going on?
Vinu	Manu, now I am in the process of analysing Financial Statements of a particular customer. His Financials vis-a-viz reality is taking me for a ride!
Manu	Why? What’s the problem?
Vinu	He is showing good progress in his business with Growth in Sales and Profits. But that’s on papers. In reality, - He doesn’t have sufficient funds to meet his expenses. - He couldn’t service Bank Loans on time. - Many of his cheques issued to suppliers get bounced. - He pays salary to his employees with great delay. How all these can happen if he is making so much profit? I have a doubt whether he is giving bogus financial report?
Manu	Vinu! I don’t know what the exact background of your customer is. But one thing I can tell you! It is not necessary that he should have cash to meet his expenses / requirements, since because he is making profit.
Vinu	That sounds strange!!!!
Manu	But that’s the reality! Profit is not cash!
Vinu	Come on yaar! What are you talking?
Manu	True Vinu! Profits are not cash and register it in your mind strongly!
Vinu	Ok! I understand that if you say something, it would be with logic. But tell me that logic!
Manu	Ok. Answer this simple question: Let’s say you have the following Profit and Loss Statement:                                                    Rs. In Crs Sales 100.00 Less: Raw Material Consumed (60.00) Labour Cost (10.00) Power and Fuel (5.00) Depreciation (5.00) What should be profit?
Vinu	Sales is 100.00 Crs expenses are 80.00 Crs So profits should be 20.00 Crs.
Manu	Fine! With this limited information, tell me what could be the cash balance?
Vinu	Sales             100.00 Crs Expenses      80.00 Crs So Cash Balance should also be 20.00 Crs
Manu	This is your mistake! Don’t you remember Financials are prepared following accrual concept wherein - Expenses will be accounted when accrued, whether it is paid or not; - Income will be recognised whether it is received or not.
Vinu	Yes. Agreed. But here we don’t have any such item or you have not told me anything about that!
Manu	True! But you also didn’t notice the effect of depreciation. Whether depreciation has cash outflow?
Vinu	No! It is only book entry to account for fixed assets by charging against profits over the period of its life.
Manu	So what could be the profit before depreciation?
Vinu	It may be Profit 20.00 Add: Depreciation 5.00 Profit before Depreciation 25.00
Manu	Ya! That’s correct and that profit can be called as Cash Profit!
Vinu	Oh! Is this the cash balance?
Manu	Don’t jump for conclusion. Again I am repeating! Profit is not cash!
Vinu	Ok! Ok!
Manu	Do you think all the sales can be made for cash?
Vinu	No! In order to be competitive and attract new customers, credit should be given!
Manu	Correct! Let’s say, 75% of sales are on credit!
Vinu	Then in that case, 100 Crs x 75% = 75 Crs should be credit sales.
Manu	So, what is your Cash Sales?
Vinu	Total Sales 100.00 Less: Credit Sales 75.00 Cash Sales 25.00
Manu	When you give credit, you can also get credit! Is it not?
Vinu	Sure!
Manu	But it happens in market that you give more credit to attract customers but you receive only less credit from your suppliers! Because, suppliers would be generally big players and they go by fixed norms! Your other expenses would be basically power, labour, and other operating expenses where you cannot have much credit.
Vinu	True!
Manu	So let us assume, 50% of your expenses are on credit.
Vinu	My total expenses are Rs.80 Crs. So 50% of it is................
Manu	Stop! Don’t consider all expenses. It includes depreciation also which is a non cash item.
Vinu	Correct! Total expenses are Rs.75 Cr (excluding depreciation of 5 Crs). 50% of 75 Crs is Rs.37.50 Crs
Manu	So, what is your Cash Payments?
Vinu	Total Expenses 75.00 Less: Credit available for expenses (50%) 37.50 Cash Expenses 37.50
Manu	Now you have both your Cash Expenses and Cash Sales. Can you prepare a Comparison table?
Vinu	Ya! I can do that. Particulars As per P&L Account Actual Cash Flow Sales 100.00 +25.00 Less: Raw Material Consumed (60.00) -37.50 Labour Cost (10.00) Power and Fuel (5.00) Depreciation (5.00) No Cash Flow
Manu	Look at the table! You made sales of Rs.100 Crs where as you received only Rs.25 Crs. You have incurred expenses of 75 Crs (excluding depreciation) where as you paid only 37.50 Crs. So what is your cash balance?
Vinu	Cash balance? a) Cash Sales                          25.00 b) Less: Cash Expenses (37.50) c) Shortage (a-b) -12.50 I don’t have cash balance!!!!!!
Manu	But you had profit of Rs.20 Crs!
Vinu	Ha ha! I am caught! Now I understand profit has no relevance to cash balance or cash generation!!!
Manu	No! Modify that statement! Profit has relevance but it alone does not decide cash balance or say cash generation!
Vinu	Ok! In this case, how come cash balance can be negative? It is Negative 12.50 Cr.
Manu	Don’t say Negative 12.50 Cr. Cash can never be negative figure. What happened to you is you realised Rs.25 Crs from cash sales and PAID cash expenses of Rs.37.50 Crs. You cannot pay 37.50 Crs without cash with you. Yes or No?
Vinu	Yes! I cannot pay 37.50 Crs without cash with me. But how I got 37.50?
Manu	You generated 25 Crs. You had shortage of Rs.12.50 Cr You should have managed that shortage with some other sources!
Vinu	Some other sources?? How come?
Manu	Common yaar! Do you think, cash is generated or brought into the business only through sales? There are various other ways for mobilising cash for the business.
Vinu	Correct! Cash can be brought into the business through a. Raising Capital; b. Raising Long Term Loans; c. Raising Short Term Loans; d. Selling Assets; e. Selling Investments.
Manu	Good! What was your Shortage from Operations?
Vinu	It was Rs.12.50 Cr
Manu	Now let us assume, you have funded this shortage by bringing in capital of Rs.25 Crs
Vinu	Rs.25 Crs???
Manu	Yes! Now arrive at your cash position
Vinu	It is a) Cash Sales 25.00 b) Less: Cash Expenses 37.50 c) Shortage (a-b) -12.50 d) Add: Fresh Capital 25.00 e) Surplus 12.50 I have surplus of Rs.12.50.
Manu	Correct! Now also assume you purchase Plant and Machinery for Rs.20 Crs and work out your cash position.
Vinu	It should be a) Cash Sales 25.00 b) Less: Cash Expenses 37.50 c) Shortage (a-b) -12.50 d) Add: Fresh Capital 25.00 e) Surplus 12.50 f) Less: Purchase of P&M 20.00 g) Shortage -7.50 Again I am landing in shortage.
Manu	Don’t worry! Raise loan for Rs.7.50 Crs and work out your cash position.
Vinu	a) Cash Sales 25.00 b) Less: Cash Expenses 37.50 c) Shortage (a-b) -12.50 d) Add: Fresh Capital 25.00 e) Surplus 12.50 f) Less: Purchase of P&M 20.00 g) Shortage -7.50 h) Bank Loan 7.50 i) Cash Balance -
Manu	Did you noticed, your balance is Nil now.
Vinu	Yes! Now i understand. I had shortage of 12.50 Cr from Operations. But that was supported out of fresh capital of 25 Crs. With the balance money available (25-12.50=12.50), I went for purchasing Plant and Machinery 20 Crs. Again I faced shortage of Rs.7.50 Crs. So, I had to finance the shortage through Bank Loan of Rs.7.50 Crs
Manu	Correct! The cash you generated from running or operating your business is called as Cash Generated from Operating Activity. In your case, it is deficit of Rs.12.50 Cr.
Vinu	True!
Manu	To Support cash deficit in operations and also to support purchase of plant and machinery, you raised finance from two sources Capital – 25 Crs Loan – 7.50 Crs They are Cash Generated from Financing Activity
Vinu	Correct!
Manu	You have invested Rs.20 Crs in purchase of P&M. So you have not generated any cash from Investment Activity but rather consumed cash.
Vinu	Correct!
Manu	Can you capture all these cash flows as per activities
Vinu	Cash Flow from Operating Activity -12.50 Cash Flow from Investing Activity -20.00 Cash Flow from Financing Activity 32.50
Manu	Good! This is you abridged Cash Flow Statement. It tells that, you have mobilised 32.50 Crs and have used 20 Crs for Investing Activity and 12.50 Crs for Operating Activity. Now you will appreciate why the companies can suffer despite making profits.
Vinu	Yes! In this case, though I have made profit but have not generated cash. I was functioning only with the support of capital funds provided by financing activity. Apart from that I also used all the balance capital funds for acquiring Plant and Machinery along with Bank Loan.
Manu	Correct! Now you are getting the pulse of it. This is the purpose of preparing Cash Flow Statement. It would give much information which P&L and Balance Sheet will not give on the face of reading. That’s why Cash Flow Statement and its Analysis are given high importance by Investors and all stake holders.
Vinu	So, how ideal Cash Flow should be?
Manu	In the initial period, cash can be provided by Financing Activity to Operating Activity and Investment Activity. But gradually, the cash flow from Operating Activity should become positive and it should provide for repaying financing cash flows and also support Investment activities.
Vinu	Ya! Cash flow from operating activity should be positive and it indicates the very purpose of running any business. If this cash flow is positive, we will have source for funding investment and financing activities.
Manu	Correct!
Vinu	But Manu, the cash flow statements which I have seen are lengthy in nature. It would not be like the one which we have discussed.
Manu	We have discussed the cash flow which can be prepared under direct method. But what we see in Industry would be cash flow prepared in Indirect Method.
Vinu	What was that?
Manu	Those cash flow statements are prepared from the information available in Profit and Loss Statement and Balance Sheet in Indirect Way. Profit and Loss Statement will be perused to find out the cash profits. Profits reported in P&L Statement are computed using accrual and matching concept. So, that profit is after providing for various non cash items.
Vinu	Non Cash items like?
Manu	Non Cash Items like a. Credit Sales b. Credit Purchases c. Outstanding Expenses d. Accrued Incomes
Vinu	Correct!
Manu	These items will also have presence in Balance Sheet in the form of current assets and current liabilities in various names. So movement of those items will also be provided in Cash Flow Statement to know the exact cash generated from operating activity.
Vinu	Ya! In our example Sales were Rs.100 Crs. whereas Debtors created out of Sales is 75 Crs. Our profit is 20 Crs, No No...Cash profit is 25 Crs but it is calculated based on Total Sales (cash & credit) and so it will not reflect cash generation. So we have to deduct non- cash sales from Cash Profits which is in the form ofDebtors - 75 Crs. Is that right?
Manu	You are right! By deducting increase in current asset (in our case, debtors) from cash profits, we are communicating to the readers, that though our company has earned cash profit of Rs.25 Crs from Sales of Rs.100 Crs, please bear in mind we have not realised 75 Crs worth of Debtors. So we are deducting it!!!
Vinu	Very true!
Manu	In the same way, if we carry creditors, or say, creditor’s increases, then to that extent there is no cash outflow. So, that will be added with cash profits to communicate to the readers, cash position is more than the cash profits!
Vinu	Correct! In our case, cash profit is Rs.25 Crs. We also have unpaid expenses (creditors) of Rs.37.50 Crs. So this should be added to cash profits!
Manu	You are right! Can you tabulate cash generated from your operating activity based on our discussion?
Vinu	Ya! Profit 20.00 Add: Depreciation 5.00 Less: Increase in Current Assets (Debtors) (75.00) Add: Increase in Current Liabilities (Creditors) 37.50 Net Cash from Operating Activities (12.50) Is it correct?
Manu	Very Much! Also remember you will see some more additions and subtractions in real cash flow statements.
Vinu	Like?
Manu	Additions for - Interest Expenses; - Loss on Sale of Asset; Deductions for - Interest Income; - Dividend Income; - Profit on Sale of Asset;
Vinu	When these items obviously decide the profits, whey these should be added back or deducted?
Manu	I agree that they decided profits! But they are not out of operational activities of the business. In cash flow from operating activity, focus is on finding cash generated from operating activity. So any activity, which is not part of operating activity, but already included in profits will be removed by either adding back or deducting!
Vinu	Ok! Let me understand that! Interest is paid on Financing Source – So it is a Financing Activity. But it is already considered as expense for arriving at profit. So, we remove this interest by adding back! Is that right?
Manu	Correct! Loss / Profit on Sale of Asset are result of Investing Activity! So we remove them from profits either by adding / deducting under Cash Flow from Operating Activities.
Vinu	True! Dividend / Interest income are also part of Investing Activity! So we should remove them from profits by deducting under Cash Flow from Operating Activities.
Manu	So remember, when you do this adjustment (adding / deducting) under Operating Activity, you are doing it, because you want to show them under respective activity!
Vinu	Ya! Interest added back in Operating Activity should be shown as deduction in Financing Activity. Dividend / Interest Income deducted in Operating Activity should be shown as addition in Investing Activity.
Manu	Very Good! So now you know how to prepare Cash Flow Statement too!
Vinu	How about the other activities Manu?
Manu	Other activities don’t involve much complication! You have to ensure only cash flows are captured and non-cash items are ignored. Sometimes assets can be purchased by issue of shares instead of cash. Then in those cases, purchase of asset will not figure under Investment activity.
Vinu	Understood! What would be the effect, if a company issues bonus shares?
Manu	In that case also, there is no cash flow. Because of Bonus Issue, there may be increase in Share Capital but there will not be any cash inflow. So that will not find place in Cash Flow Statement!
Vinu	Understood! So the focus is on cash inflows and outflows and all non-cash items are knocked off!
Manu	Exactly! Cash flow statement is a great tool for Investors, Bankers and other stake holders! It would communicate, whether you generate funds from business or you are dependent on Investment and Financing Activities for running your operations!
Vinu	True! If business is run with support of cash inflows from Investment activities it indicates company is selling its assets to fund its operations! So it would raise serious question on Going Concern right?
Manu	Yes! Similarly, if cash flows from Financing Activities continuously increases to support operating activity, it is also not a healthy sign because company is dependent on other funds to support its operations and it would become dangerous if the company is too dependent on borrowed funds.
Vinu	Ya! I think single reading of Cash Flow Statement would give complete cash flow movement of business.
Manu	Absolutely and it is very important for any stake holder to read cash flow statement before investing or lending, because CASH IS KING.

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