Chapter 2: Framework for Preparation and Presentation of Financial Statements - Test 1: answer key

Question 1 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · hard

Scenario. Sterling Ornamental Steels Ltd is a listed non-Ind AS company preparing its financial statements for the year ended 31 March 2026. Extracts show revenue ₹2,100 lakh, profit before tax ₹84 lakh, total assets ₹1,260 lakh, current assets ₹410 lakh and current liabilities ₹456 lakh. On 28 March 2026, Sterling sold finished goods to Aarohan Traders for ₹18 lakh on 90-day credit. A side letter required Sterling to repurchase the same goods in June 2026 for ₹19.10 lakh. The goods were physically transferred and invoiced, and the accountant recognised revenue of ₹18 lakh and profit of ₹4.50 lakh. In February 2026, a customer filed a claim for defective goods amounting to ₹7.20 lakh. Legal counsel estimates a 60% chance that Sterling will lose the case and a reliable most reliable estimate of ₹5 lakh. No provision was made, and only a note was given. On 31 March 2026, Sterling breached a term-loan covenant; the bank had not waived the breach, and no refinancing was approved. Management still prepared the accounts on a going-concern basis relying on a proposed rights issue not yet approved. The accountant also omitted electricity expense of ₹1.26 lakh, saying it was only 1.5% of profit before tax and therefore automatically immaterial.

In respect of the sale of finished goods to Aarohan Traders, what is the most appropriate accounting treatment under the Framework and AS 9?

1. Recognise revenue of ₹18 lakh and profit of ₹4.50 lakh; the repurchase is a separate future transaction.
2. Do not recognise revenue; treat ₹18 lakh as a secured borrowing and retain inventory, recognising no sale profit. (correct answer)
3. Recognise revenue of ₹18 lakh but defer ₹1.10 lakh repurchase premium over the 90-day credit period.
4. Recognise revenue only for the net amount of ₹16.90 lakh after deducting the repurchase premium.

Answer: B — Do not recognise revenue; treat ₹18 lakh as a secured borrowing and retain inventory, recognising no sale profit.

Explanation. A sale with a fixed-price repurchase side letter does not transfer all significant risks and rewards of ownership. In substance, the arrangement is financing secured by inventory, so revenue and sale profit cannot be recognised. The ₹18 lakh received is treated as a liability, and inventory remains an asset until the repurchase is settled. The physical transfer and invoice are not decisive.

Where it goes wrong. Students often treat physical delivery and invoicing as conclusive evidence of sale, ignoring the repurchase side agreement.

Authority. AS 9 para 6; ICAI Framework para 35 (substance over form)

Question 2 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · medium

How should the customer claim of ₹7.20 lakh be treated in Sterling's financial statements for FY 2025-26?

1. Disclose only as a contingent liability because the court has not decided the case.
2. Recognise a provision of ₹7.20 lakh because that is the amount claimed by the customer.
3. Recognise a provision of ₹5 lakh, being the reliable most reliable estimate of a probable obligation. (correct answer)
4. Ignore the claim until the court verdict, as no present obligation exists.

Answer: C — Recognise a provision of ₹5 lakh, being the reliable most reliable estimate of a probable obligation.

Explanation. A provision is recognised when a present obligation exists, an outflow is probable, and a reliable estimate can be made. A 60% chance of loss is more likely than not, so the obligation is probable. The most reliable estimate is ₹5 lakh, not the ₹7.20 lakh claimed. Mere disclosure is insufficient once the recognition criteria are met.

Where it goes wrong. Using the claim amount as the provision, or treating a probable loss as only a contingent liability.

Authority. AS 29 paras 14-15; ICAI Framework paras 60-64 (liability recognition)

Question 3 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · hard

Given the covenant breach and unapproved rights issue, which treatment is most appropriate if management concludes the going-concern basis is not appropriate?

1. Prepare accounts on a break-up/NRV basis, state the departure from going concern and disclose the basis used. (correct answer)
2. Continue on a going-concern basis without disclosure because going concern is an implicit assumption.
3. Continue at historical cost and disclose the issue only in the directors' report.
4. Recognise the proposed rights issue as a receivable asset and continue on a going-concern basis.

Answer: A — Prepare accounts on a break-up/NRV basis, state the departure from going concern and disclose the basis used.

Explanation. Going concern is a fundamental accounting assumption. If the enterprise will not continue in operation for the foreseeable future, assets and liabilities are stated on an appropriate non-going-concern basis, such as realisable and settlement values. The departure from the going-concern assumption must be disclosed. A proposed rights issue not yet approved cannot be treated as an asset.

Where it goes wrong. Assuming going concern is automatic and need not be disclosed, or capitalising an unapproved future issue.

Authority. AS 1 para 10; ICAI Framework para 23 (going concern)

Question 4 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · medium

The accountant omitted electricity expense of ₹1.26 lakh as it was 1.5% of profit before tax. Which statement is correct under the Framework?

1. The omission is automatically immaterial because it is below 2% of profit before tax.
2. The omission is material only if it changes the cash tax payable for the year.
3. Materiality is judged solely by total assets, so the expense can be ignored.
4. Materiality depends on size and nature; a 1.5% profit omission may still be material if it influences users' decisions. (correct answer)

Answer: D — Materiality depends on size and nature; a 1.5% profit omission may still be material if it influences users' decisions.

Explanation. Materiality is a threshold judged by the size and nature of the item or error in the specific circumstances. There is no automatic percentage cut-off. An omission of ₹1.26 lakh equal to 1.5% of profit before tax may be material if it could influence economic decisions, especially if profit is otherwise marginal or the item is sensitive.

Where it goes wrong. Applying a rigid percentage rule without considering qualitative factors and the specific circumstances.

Authority. ICAI Framework paras 29-30 (materiality)

Question 5 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · hard

Scenario. Vardhan Retail Ventures Ltd is a non-Ind AS company preparing financial statements for the year ended 31 March 2026. Its accounts show revenue ₹980 lakh, profit before tax before the following issues ₹45 lakh, total assets ₹620 lakh and inventory ₹118 lakh. In April 2026, before the accounts were approved, Vardhan changed its inventory cost formula from FIFO to weighted average because the new formula was considered more appropriate. The change increased closing inventory and profit before tax by ₹6.80 lakh. The accountant applied it prospectively and made no disclosure, arguing that the effect was only 15.1% of profit before tax. Rent for March 2026 of ₹1.80 lakh was due under the lease agreement; the invoice was received on 10 April 2026 and paid on 25 April 2026, and no accrual was recorded. A customer owing ₹4.50 lakh was declared insolvent on 20 May 2026 and recovery is expected to be nil; the accounts were approved on 30 June 2026, but no adjustment was made. The directors delayed approval of the financial statements until 30 September 2026 to await a supplier confirmation, stating that reliability always overrides timeliness. Users had already made lending decisions using interim information.

How should Vardhan treat the change in inventory cost formula from FIFO to weighted average?

1. The change is automatically prohibited; the company must revert to FIFO.
2. The change may be made if it is more appropriate; the nature and effect should be disclosed to maintain comparability. (correct answer)
3. Apply it prospectively with no disclosure because the effect is below 20% of profit before tax.
4. Adjust opening reserves only and make no disclosure in the current financial statements.

Answer: B — The change may be made if it is more appropriate; the nature and effect should be disclosed to maintain comparability.

Explanation. A change in accounting policy is permitted if required by statute or an Accounting Standard, or if it results in a more appropriate presentation. Comparability requires disclosure of the nature and financial effect of the change. Applying it silently, or relying only on a size threshold, prevents users from comparing results across periods.

Where it goes wrong. Confusing consistency with rigid uniformity and omitting disclosure because the change is considered more appropriate.

Authority. AS 5 paras 15-19; ICAI Framework paras 39-42 (comparability)

Question 6 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · medium

What is the correct treatment of the March 2026 rent of ₹1.80 lakh?

1. No accrual is needed; record it on 25 April 2026 when paid.
2. Accrue it only if the invoice had been received before 31 March 2026.
3. Accrue ₹1.80 lakh and reduce FY 2025-26 profit, even though payment is made later. (correct answer)
4. Treat it as prepaid and defer it to FY 2026-27.

Answer: C — Accrue ₹1.80 lakh and reduce FY 2025-26 profit, even though payment is made later.

Explanation. Under the accrual basis, expenses are recognised when incurred, not when paid. The March 2026 rent relates to FY 2025-26 and is due under the lease, so it must be accrued and charged to that year even though the invoice and payment occur in April. Deferring it would overstate profit.

Where it goes wrong. Recording expenses only on cash payment or invoice receipt, which is cash-basis thinking.

Authority. AS 1 para 11; Section 128(1) of the Companies Act, 2013

Question 7 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · hard

The inventory policy change increases profit before tax by ₹6.80 lakh on a base of ₹45 lakh. Which conclusion is most appropriate?

1. The ₹6.80 lakh effect is material at 15.1% of profit before tax; the change and effect must be disclosed and appropriately applied. (correct answer)
2. Since the change is more appropriate, no disclosure is needed.
3. Since the effect is below 20% of profit before tax, it is immaterial.
4. Disclose it only in the directors' report, not in the financial statements.

Answer: A — The ₹6.80 lakh effect is material at 15.1% of profit before tax; the change and effect must be disclosed and appropriately applied.

Explanation. The effect is 15.1% of profit before tax, which is significant. More importantly, a change in accounting policy requires disclosure of its nature and effect so users can assess comparability. The absence of a fixed statutory percentage does not make the item immaterial. Disclosure in the directors' report alone does not satisfy financial statement requirements.

Where it goes wrong. Treating materiality as a mechanical 20% threshold and ignoring the specific disclosure requirement for policy changes.

Authority. AS 5 paras 15-19; ICAI Framework para 30 (materiality)

Question 8 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · medium

How should the directors' decision to delay approval until 30 September 2026 be assessed under the Framework?

1. Delay always improves reliability, so no qualitative constraint is violated.
2. Timeliness is irrelevant for listed companies preparing annual statements.
3. Reliability always overrides timeliness, so any delay is justified.
4. Undue delay can impair relevance; management must balance timeliness and reliability to meet users' needs. (correct answer)

Answer: D — Undue delay can impair relevance; management must balance timeliness and reliability to meet users' needs.

Explanation. Timeliness is a constraint on relevant and reliable information. Undue delay may make information lose relevance even if it becomes more reliable. Management must balance timely reporting with reliable information; neither characteristic automatically overrides the other. Users had already made decisions using interim information.

Where it goes wrong. Assuming reliability always prevails, or treating timeliness as irrelevant for annual financial statements.

Authority. ICAI Framework para 43 (timeliness)

Question 9 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · hard

Scenario. Zenith Services Pvt Ltd received subscription ₹12,00,000 in FY 2025-26, including ₹1,50,000 for FY 2026-27; ₹2,40,000 relating to FY 2025-26 was receivable but not received. Expenses paid were ₹7,20,000, including ₹90,000 prepaid for next year and ₹60,000 outstanding for the current year. What is accrual-basis profit?

Zenith Services Pvt Ltd received subscription ₹12,00,000 in FY 2025-26, including ₹1,50,000 for FY 2026-27; ₹2,40,000 relating to FY 2025-26 was receivable but not received. Expenses paid were ₹7,20,000, including ₹90,000 prepaid for next year and ₹60,000 outstanding for the current year. What is accrual-basis profit?

1. ₹6,60,000
2. ₹6,00,000 (correct answer)
3. ₹7,20,000
4. ₹5,40,000

Answer: B — ₹6,00,000

Explanation. Accrual revenue = ₹12,00,000 − ₹1,50,000 + ₹2,40,000 = ₹12,90,000. Accrual expenses = ₹7,20,000 − ₹90,000 + ₹60,000 = ₹6,90,000. Accrual profit = ₹12,90,000 − ₹6,90,000 = ₹6,00,000. Cash received or paid is adjusted for unearned, receivable, prepaid and outstanding items.

Where it goes wrong. Ignoring the receivable or outstanding expense, or adding prepaid amounts instead of deducting them.

Authority. AS 1 para 11; Section 128(1) of the Companies Act, 2013

Question 10 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · hard

Scenario. A company has profit before tax ₹32 lakh, revenue ₹640 lakh and total assets ₹480 lakh. It omitted accrued expenses of ₹2.40 lakh. Which statement is most appropriate?

A company has profit before tax ₹32 lakh, revenue ₹640 lakh and total assets ₹480 lakh. It omitted accrued expenses of ₹2.40 lakh. Which statement is most appropriate?

1. The omission is material because it is 7.5% of profit before tax and may influence decisions. (correct answer)
2. The omission is immaterial because it is only 0.375% of revenue.
3. The omission is immaterial because it is 0.5% of total assets.
4. The omission is material only if it converts profit into a loss.

Answer: A — The omission is material because it is 7.5% of profit before tax and may influence decisions.

Explanation. Materiality is judged by size and nature in the specific circumstances. ₹2.40 lakh is 7.5% of profit before tax, a significant proportion, and could influence users' decisions. Revenue or total assets are not the only relevant bases. Materiality does not require that the item turn profit into loss.

Where it goes wrong. Using revenue or total assets mechanically, or requiring a loss-making outcome before treating an item as material.

Authority. ICAI Framework para 30 (materiality)

Question 11 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · medium

Scenario. Which user group is most directly concerned with information that helps assess the risk and return of an investment and the enterprise's ability to pay dividends?

Which user group is most directly concerned with information that helps assess the risk and return of an investment and the enterprise's ability to pay dividends?

1. Employees, who are primarily concerned with dividend-paying ability.
2. Customers, who are primarily concerned with taxation policies.
3. Investors, as providers of risk capital, who assess risk, return and dividend-paying ability. (correct answer)
4. Governments, who are primarily concerned with warranty provisions.

Answer: C — Investors, as providers of risk capital, who assess risk, return and dividend-paying ability.

Explanation. Investors provide risk capital and are concerned with the risk inherent in and return provided by their investments. They need information to assess the enterprise's ability to pay dividends. Employees are interested in stability, profitability, remuneration and employment opportunities; governments are interested in resource allocation, regulation and taxation.

Where it goes wrong. Confusing investors with employees or governments, whose information needs differ.

Authority. ICAI Framework para 9 (users and their information needs)

Question 12 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · hard

Scenario. Nivaan Ltd takes machinery on finance lease and records the machinery as an asset and the lease obligation as a liability, although legal title remains with the lessor. Which qualitative characteristic is most directly supported?

Nivaan Ltd takes machinery on finance lease and records the machinery as an asset and the lease obligation as a liability, although legal title remains with the lessor. Which qualitative characteristic is most directly supported?

1. Comparability
2. Understandability
3. Timeliness
4. Reliability through substance over form (correct answer)

Answer: D — Reliability through substance over form

Explanation. Reliability requires that transactions be reported according to their substance and economic reality, not merely their legal form. In a finance lease, the lessee controls the right to use the asset and bears the risks and rewards of ownership, so recognising the asset and liability is reliable representation. Legal title with the lessor does not override substance.

Where it goes wrong. Focusing on legal ownership and treating a finance lease as a simple operating rental.

Authority. ICAI Framework para 35 (substance over form); AS 19 para 8

Question 13 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · medium

Scenario. Mirage Ltd has book assets ₹180 lakh and liabilities ₹110 lakh. If it is not a going concern, assets are realisable at ₹142 lakh and liabilities require ₹118 lakh to settle. What is equity on going-concern and non-going-concern bases respectively?

Mirage Ltd has book assets ₹180 lakh and liabilities ₹110 lakh. If it is not a going concern, assets are realisable at ₹142 lakh and liabilities require ₹118 lakh to settle. What is equity on going-concern and non-going-concern bases respectively?

1. ₹70 lakh and ₹24 lakh (correct answer)
2. ₹70 lakh and ₹32 lakh
3. ₹38 lakh and ₹24 lakh
4. ₹70 lakh and ₹28 lakh

Answer: A — ₹70 lakh and ₹24 lakh

Explanation. Going-concern equity = ₹180 lakh − ₹110 lakh = ₹70 lakh. On a non-going-concern basis, assets are measured at realisable value and liabilities at settlement amounts, so equity = ₹142 lakh − ₹118 lakh = ₹24 lakh. The difference reflects the effect of the change in measurement basis.

Where it goes wrong. Using book liabilities or book assets on the non-going-concern basis, or reversing the asset and liability figures.

Authority. AS 1 para 10; ICAI Framework para 23 (going concern)

Question 14 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · hard

Scenario. Rohan commenced business with 50,000 units costing ₹18 each. He sold all units for cash at ₹25 each and withdrew ₹2,10,000. What is retained profit if financial capital is maintained at historical cost?

Rohan commenced business with 50,000 units costing ₹18 each. He sold all units for cash at ₹25 each and withdrew ₹2,10,000. What is retained profit if financial capital is maintained at historical cost?

1. ₹2,10,000
2. ₹3,50,000
3. ₹1,40,000 (correct answer)
4. ₹4,40,000

Answer: C — ₹1,40,000

Explanation. Opening capital = 50,000 × ₹18 = ₹9,00,000. Closing cash before drawings = 50,000 × ₹25 = ₹12,50,000. Capital to be maintained is ₹9,00,000. Retained profit after actual drawings = ₹12,50,000 − ₹2,10,000 − ₹9,00,000 = ₹1,40,000. Maximum permissible drawings would have been ₹3,50,000.

Where it goes wrong. Reporting maximum permissible drawings instead of retained profit after actual drawings.

Authority. ICAI Framework capital maintenance paras 102-104

Question 15 · 2 marks · Chapter 2: Framework for Preparation and Presentation of Financial Statements · hard

Scenario. Opening equity is ₹6,00,000 when the price index is 120. Closing equity is ₹7,20,000 when the closing price index is 150. What is retained profit or loss under financial capital maintenance at current purchasing power?

Opening equity is ₹6,00,000 when the price index is 120. Closing equity is ₹7,20,000 when the closing price index is 150. What is retained profit or loss under financial capital maintenance at current purchasing power?

1. Profit ₹1,20,000
2. Loss ₹30,000 (correct answer)
3. Loss ₹1,20,000
4. Profit ₹30,000

Answer: B — Loss ₹30,000

Explanation. Opening equity restated at closing prices = ₹6,00,000 × 150/120 = ₹7,50,000. Closing equity at closing prices is ₹7,20,000. Retained profit/loss = ₹7,20,000 − ₹7,50,000 = negative ₹30,000, i.e. a loss. The nominal increase of ₹1,20,000 is not sufficient to maintain capital in purchasing-power terms.

Where it goes wrong. Comparing nominal opening and closing equity and ignoring restatement by the price index.

Authority. ICAI Framework capital maintenance paras 104-106