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

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

Scenario. Rudraksh Manufacturing Ltd is finalising its financial statements for the year ended 31 March 2026. The accountant placed the following items before the CFO for advice on recognition and measurement: (i) The company spent ₹8,50,000 on a specialised training programme for Mr. Sharma, its star engineer. Management argues that Mr. Sharma's enhanced skills will generate future economic benefits and wants to capitalise the amount as an intangible asset. (ii) On 1 April 2025, Rudraksh took machinery on finance lease from Pinnacle Leasing Ltd. The fair value of the machinery is ₹24,00,000, with annual rentals of ₹6,00,000 over 5 years. Legal title remains with Pinnacle, but Rudraksh controls the use of the machinery. (iii) A customer filed a damages suit for ₹12,00,000 against Rudraksh. Legal counsel estimates a 70% probability that the company will lose the case, with a reliable most reliable estimate of ₹9,00,000. (iv) Rudraksh entered into a binding agreement to purchase a custom-made machine for ₹15,00,000. Before delivery, the company changed its production method, and the machine will be scrapped after delivery. The scrap value is nil. (v) Rudraksh holds a bank loan of ₹40,00,000 at 12% p.a. Interest of ₹4,80,000 for the year was not recognised because the corresponding asset (advances to a related party) is a non-performing asset, and the flow of economic benefits is not probable. (vi) The opening equity was ₹85,00,000 (assets ₹1,50,00,000 less liabilities ₹65,00,000). During the year, income of ₹21,00,000 and expenses of ₹11,00,000 (excluding items above) were recorded. The owner introduced ₹5,00,000 and withdrew ₹2,00,000. Closing assets are ₹1,74,00,000 and closing liabilities are ₹76,00,000, giving closing equity of ₹98,00,000.

How should Rudraksh treat the ₹8,50,000 spent on Mr. Sharma's specialised training programme?

1. Recognise ₹8,50,000 as an intangible asset, since the training generates future economic benefits.
2. Recognise it as an expense, because the company has insufficient control over the employee's skills. (correct answer)
3. Recognise ₹8,50,000 as a prepaid expense and amortise it over the expected service period of 5 years.
4. Recognise ₹4,25,000 as an asset and expense the remaining amount as training cost.

Answer: B — Recognise it as an expense, because the company has insufficient control over the employee's skills.

Explanation. An asset requires sufficient control over the resource. The enterprise does not control the employee's specialised skills because the employee can leave. The Framework specifically states that specific management or technical talent of an employee cannot be recognised as an asset due to insufficient control. The training cost is therefore expensed. Capitalising it or amortising it treats the spend as an asset despite the control failure.

Where it goes wrong. Confusing future economic benefit with the asset definition; benefit alone is insufficient without control.

Authority. ICAI Framework paras 49-50 (asset definition — control); AS 26 para 6

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

How should Rudraksh recognise the machinery taken on finance lease from Pinnacle Leasing Ltd?

1. Do not recognise the machinery, because legal title is with Pinnacle Leasing Ltd.
2. Recognise only the annual rental of ₹6,00,000 as a lease expense in the statement of profit and loss.
3. Recognise the machinery as an asset at ₹24,00,000 and a corresponding lease liability. (correct answer)
4. Recognise the machinery as an asset at ₹6,00,000, being one year's rental paid.

Answer: C — Recognise the machinery as an asset at ₹24,00,000 and a corresponding lease liability.

Explanation. Under the Framework, an asset is a resource controlled by the enterprise, not necessarily owned. In a finance lease, the lessee controls the right to use the asset and enjoys substantially all risks and rewards of ownership. Hence Rudraksh recognises the machinery as an asset at fair value of ₹24,00,000 with a corresponding lease liability, notwithstanding Pinnacle's legal title. Treating it as an operating rental or ignoring it entirely misapplies the control principle.

Where it goes wrong. Equating asset recognition with legal ownership and ignoring the substance-over-form principle in finance leases.

Authority. ICAI Framework para 50 (control); AS 19 para 8 (finance lease)

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

What is the correct accounting treatment of the customer damages suit of ₹12,00,000?

1. Recognise a provision of ₹9,00,000, since the loss is probable and a reliable estimate exists. (correct answer)
2. Disclose the suit as a contingent liability only, because the court has not passed a final order.
3. Recognise a provision of ₹12,00,000, being the full amount claimed by the customer.
4. Recognise a provision of ₹8,40,000, being 70% of the claim, as the expected loss.

Answer: A — Recognise a provision of ₹9,00,000, since the loss is probable and a reliable estimate exists.

Explanation. A provision is recognised when a present obligation exists, an outflow is probable (more likely than not), and a reliable estimate can be made. With a 70% chance of loss, the obligation is probable. The most reliable estimate of ₹9,00,000 is used, not the ₹12,00,000 claim or a mechanical 70% of the claim. Mere disclosure is insufficient once the recognition criteria are satisfied.

Where it goes wrong. Using the claim amount or computing 70% of the claim instead of using the reliable most reliable estimate.

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

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

How should Rudraksh account for the binding agreement to purchase the custom-made machine for ₹15,00,000 that will be scrapped after delivery?

1. No liability arises, because the machine has not yet been delivered.
2. Recognise the machine as an asset and a liability of ₹15,00,000 when it is delivered.
3. Disclose the agreement as a contingent liability only, since it is an executory contract.
4. Recognise a liability of ₹15,00,000 and an expense, because no future economic benefit is expected. (correct answer)

Answer: D — Recognise a liability of ₹15,00,000 and an expense, because no future economic benefit is expected.

Explanation. The binding agreement creates a present obligation to pay ₹15,00,000 to the supplier; the obligation is not avoided by the machine having no future use. Since no future economic benefit is expected from the machine, the entire purchase price is recognised as an expense. Delaying recognition until delivery ignores the irrevocable agreement. A contingent liability is inappropriate because the outflow is not merely possible — it is committed.

Where it goes wrong. Treating an executory contract as creating no obligation and postponing recognition until physical delivery.

Authority. ICAI Framework paras 60-64 (liability definition); AS 29 para 14

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

Scenario. Vardhan Chemicals Ltd acquired a specialised reactor on 1 April 2021 for ₹12,00,000. The reactor has a useful life of 10 years and is depreciated on a straight-line basis with no residual value. On 31 March 2026, the following information is available: (i) The current market price of a new reactor of equivalent capacity is ₹18,00,000. (ii) The reactor can be sold in an orderly disposal for ₹4,50,000 after incurring selling expenses of ₹30,000. (iii) The reactor is expected to generate net cash inflows of ₹3,00,000 per year for the remaining 5 years. The appropriate discount rate is 10%. The present value annuity factor for 5 years at 10% is 3.791. Additionally, Vardhan commenced business on 1 April 2025 with ₹20,00,000 represented by 10,000 units of a product at ₹200 per unit. During the year, it sold all units at ₹250 per unit and withdrew ₹3,00,000. The general price index at the beginning was 100 and at the end of the year was 125. The specific price index applicable to the product was 140 at the end of the year. The company wants to understand the Framework's measurement bases and capital maintenance concepts. The accountant is confused about the various measurement bases permitted by the Framework and how the choice of basis affects the reported profit and capital maintenance. The CFO has asked for a detailed analysis of the carrying amounts under each basis and the retained profit under different capital maintenance concepts.

What is the carrying amount of the reactor on 31 March 2026 under the historical cost measurement basis?

1. ₹12,00,000
2. ₹9,00,000
3. ₹6,00,000 (correct answer)
4. ₹4,50,000

Answer: C — ₹6,00,000

Explanation. Under historical cost, the asset is recorded at the acquisition price of ₹12,00,000. Depreciation for 5 years (1 April 2021 to 31 March 2026) at ₹1,20,000 per year on a straight-line basis totals ₹6,00,000. The carrying amount is therefore ₹12,00,000 − ₹6,00,000 = ₹6,00,000. The other options reflect current cost, acquisition cost without depreciation, or realisable value, not historical cost.

Where it goes wrong. Using the current market price or acquisition cost without accumulated depreciation.

Authority. ICAI Framework para 100 (historical cost)

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

What is the carrying amount of the reactor on 31 March 2026 under the current cost measurement basis?

1. ₹18,00,000
2. ₹6,00,000
3. ₹9,00,000 (correct answer)
4. ₹4,50,000

Answer: C — ₹9,00,000

Explanation. Current cost is the amount that would have to be paid if the same or an equivalent asset were acquired currently. A new equivalent reactor costs ₹18,00,000. Since the existing reactor has 5 years of remaining useful life out of 10 years, its depreciated current cost is ₹18,00,000 × 5/10 = ₹9,00,000. Using the full ₹18,00,000 ignores accumulated depreciation; using ₹6,00,000 applies historical cost.

Where it goes wrong. Applying the full current replacement price without adjusting for the asset's remaining useful life.

Authority. ICAI Framework para 101 (current cost)

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

What is the present value of the future net cash inflows expected from the reactor as on 31 March 2026?

1. ₹3,00,000
2. ₹15,00,000
3. ₹6,00,000
4. ₹11,37,300 (correct answer)

Answer: D — ₹11,37,300

Explanation. Present value is obtained by discounting future net cash inflows at the required rate. The reactor is expected to generate ₹3,00,000 per year for 5 years at a 10% discount rate. Using the annuity factor of 3.791, the present value is ₹3,00,000 × 3.791 = ₹11,37,300. Undiscounted annual inflow or total undiscounted inflows ignore the time value of money entirely.

Where it goes wrong. Ignoring discounting and using the annual inflow or total undiscounted cash flows.

Authority. ICAI Framework para 103 (present value)

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

What is the retained profit or loss for FY 2025-26 under financial capital maintenance at current purchasing power?

1. Profit of ₹2,00,000
2. Loss of ₹3,00,000 (correct answer)
3. Loss of ₹6,00,000
4. Profit of ₹5,00,000

Answer: B — Loss of ₹3,00,000

Explanation. Opening equity is ₹20,00,000. Restated at closing prices using the general index: ₹20,00,000 × 125/100 = ₹25,00,000. Closing equity is cash of ₹25,00,000 − ₹3,00,000 drawings = ₹22,00,000. Retained profit = ₹22,00,000 − ₹25,00,000 = negative ₹3,00,000, i.e. a loss. Comparing nominal opening and closing equity gives a false profit of ₹2,00,000, which ignores the fall in purchasing power.

Where it goes wrong. Comparing nominal opening and closing equity without restating opening equity by the general price index.

Authority. ICAI Framework paras 104-106 (capital maintenance)

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

Scenario. A bank has classified a loan as a non-performing asset and concludes that the flow of economic benefits from the borrower beyond the current accounting period is not probable. Should the bank recognise interest income on this loan for the year?

A bank has classified a loan as a non-performing asset and concludes that the flow of economic benefits from the borrower beyond the current accounting period is not probable. Should the bank recognise interest income on this loan for the year?

1. Yes, interest must be recognised on the accrual basis because it has been earned under the loan contract.
2. Yes, but only if the loan is fully secured by collateral of sufficient value.
3. No, because income cannot be recognised unless a corresponding increase in an asset or decrease in a liability can be recognised. (correct answer)
4. No, interest on non-performing assets can only be recognised on the cash basis when received.

Answer: C — No, because income cannot be recognised unless a corresponding increase in an asset or decrease in a liability can be recognised.

Explanation. Income is recognised only when it is accompanied by an increase in an asset or a decrease in a liability. For a non-performing asset, the corresponding increase in advances cannot be recognised because future economic benefit is not probable. Therefore, the bank does not recognise interest income. The accrual basis does not override the recognition criteria for the underlying asset. Collateral security does not create an asset increase.

Where it goes wrong. Applying accrual mechanically and ignoring that income recognition requires a corresponding asset increase that meets recognition criteria.

Authority. ICAI Framework para 92 (income recognition); AS 9 para 10

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

Scenario. Rudraksh Manufacturing Ltd is finalising its financial statements for the year ended 31 March 2026. The accountant placed the following items before the CFO for advice on recognition and measurement: (i) The company spent ₹8,50,000 on a specialised training programme for Mr. Sharma, its star engineer. Management argues that Mr. Sharma's enhanced skills will generate future economic benefits and wants to capitalise the amount as an intangible asset. (ii) On 1 April 2025, Rudraksh took machinery on finance lease from Pinnacle Leasing Ltd. The fair value of the machinery is ₹24,00,000, with annual rentals of ₹6,00,000 over 5 years. Legal title remains with Pinnacle, but Rudraksh controls the use of the machinery. (iii) A customer filed a damages suit for ₹12,00,000 against Rudraksh. Legal counsel estimates a 70% probability that the company will lose the case, with a reliable most reliable estimate of ₹9,00,000. (iv) Rudraksh entered into a binding agreement to purchase a custom-made machine for ₹15,00,000. Before delivery, the company changed its production method, and the machine will be scrapped after delivery. The scrap value is nil. (v) Rudraksh holds a bank loan of ₹40,00,000 at 12% p.a. Interest of ₹4,80,000 for the year was not recognised because the corresponding asset (advances to a related party) is a non-performing asset, and the flow of economic benefits is not probable. (vi) The opening equity was ₹85,00,000 (assets ₹1,50,00,000 less liabilities ₹65,00,000). During the year, income of ₹21,00,000 and expenses of ₹11,00,000 (excluding items above) were recorded. The owner introduced ₹5,00,000 and withdrew ₹2,00,000. Closing assets are ₹1,74,00,000 and closing liabilities are ₹76,00,000, giving closing equity of ₹98,00,000.

Based on the equity data in Rudraksh's scenario, what is the profit for the year ended 31 March 2026?

1. ₹10,00,000 (correct answer)
2. ₹13,00,000
3. ₹8,00,000
4. ₹15,00,000

Answer: A — ₹10,00,000

Explanation. Using the equity equation: Profit = Closing equity − Opening equity − Capital introduced + Drawings = ₹98,00,000 − ₹85,00,000 − ₹5,00,000 + ₹2,00,000 = ₹10,00,000. This also equals income minus expenses of ₹21,00,000 − ₹11,00,000 = ₹10,00,000. Option b omits capital and drawings; option c omits drawings; option d adds drawings instead of subtracting capital.

Where it goes wrong. Forgetting to adjust the change in equity for capital introduced and drawings, or treating drawings as capital.

Authority. ICAI Framework para 95 (equity equation)

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

Scenario. An asset is expected to generate net cash inflows of ₹80,000 per year for 5 years and a residual inflow of ₹1,00,000 at the end of year 5. The discount rate is 8%. The present value annuity factor for 5 years at 8% is 3.993 and the present value factor for year 5 is 0.681. What is the present value of the asset?

An asset is expected to generate net cash inflows of ₹80,000 per year for 5 years and a residual inflow of ₹1,00,000 at the end of year 5. The discount rate is 8%. The present value annuity factor for 5 years at 8% is 3.993 and the present value factor for year 5 is 0.681. What is the present value of the asset?

1. ₹3,19,440
2. ₹4,19,440
3. ₹3,68,100
4. ₹3,87,540 (correct answer)

Answer: D — ₹3,87,540

Explanation. Present value = PV of annuity + PV of residual inflow = (₹80,000 × 3.993) + (₹1,00,000 × 0.681) = ₹3,19,440 + ₹68,100 = ₹3,87,540. Option a ignores the residual inflow; option b fails to discount the residual; option c uses incorrect factors. Discounting is required for all future cash flows, including the terminal residual amount.

Where it goes wrong. Ignoring the residual inflow or failing to discount it to present value.

Authority. ICAI Framework para 103 (present value)

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

Scenario. Vardhan Chemicals Ltd acquired a specialised reactor on 1 April 2021 for ₹12,00,000. The reactor has a useful life of 10 years and is depreciated on a straight-line basis with no residual value. On 31 March 2026, the following information is available: (i) The current market price of a new reactor of equivalent capacity is ₹18,00,000. (ii) The reactor can be sold in an orderly disposal for ₹4,50,000 after incurring selling expenses of ₹30,000. (iii) The reactor is expected to generate net cash inflows of ₹3,00,000 per year for the remaining 5 years. The appropriate discount rate is 10%. The present value annuity factor for 5 years at 10% is 3.791. Additionally, Vardhan commenced business on 1 April 2025 with ₹20,00,000 represented by 10,000 units of a product at ₹200 per unit. During the year, it sold all units at ₹250 per unit and withdrew ₹3,00,000. The general price index at the beginning was 100 and at the end of the year was 125. The specific price index applicable to the product was 140 at the end of the year. The company wants to understand the Framework's measurement bases and capital maintenance concepts. The accountant is confused about the various measurement bases permitted by the Framework and how the choice of basis affects the reported profit and capital maintenance. The CFO has asked for a detailed analysis of the carrying amounts under each basis and the retained profit under different capital maintenance concepts.

What is the retained profit or loss for FY 2025-26 under financial capital maintenance at historical cost?

1. Profit of ₹2,00,000 (correct answer)
2. Loss of ₹3,00,000
3. Profit of ₹5,00,000
4. Loss of ₹6,00,000

Answer: A — Profit of ₹2,00,000

Explanation. Under financial capital maintenance at historical cost, opening and closing equity are stated at historical costs without restatement. Opening equity = ₹20,00,000. Closing equity = ₹25,00,000 − ₹3,00,000 = ₹22,00,000. Retained profit = ₹22,00,000 − ₹20,00,000 = ₹2,00,000. A loss under CPP or physical maintenance reflects price-level effects, not the historical-cost measurement.

Where it goes wrong. Confusing historical-cost capital maintenance with current purchasing power or physical capital maintenance.

Authority. ICAI Framework para 104 (financial capital maintenance at historical cost)

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

What is the retained profit or loss for FY 2025-26 under physical capital maintenance at current costs?

1. Loss of ₹3,00,000
2. Loss of ₹6,00,000 (correct answer)
3. Profit of ₹2,00,000
4. Loss of ₹8,00,000

Answer: B — Loss of ₹6,00,000

Explanation. Physical capital maintenance restates opening equity using the specific price index applicable to the asset. Opening equity restated = ₹20,00,000 × 140/100 = ₹28,00,000. Closing equity = ₹25,00,000 − ₹3,00,000 = ₹22,00,000. Retained profit = ₹22,00,000 − ₹28,00,000 = negative ₹6,00,000, a loss. Using the general index of 125 gives the CPP result of ₹3,00,000 loss, not physical maintenance.

Where it goes wrong. Using the general price index instead of the specific price index applicable to the product.

Authority. ICAI Framework paras 104-106 (physical capital maintenance)

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

Scenario. Which of the following should be recognised as an expense immediately under the Framework?

Which of the following should be recognised as an expense immediately under the Framework?

1. Loss on disposal of equipment that has no future economic benefit (correct answer)
2. Depreciation on a factory building used in production over its useful life
3. Cost of machinery purchased by a dealer for resale to customers
4. Prepaid insurance premium relating to the next financial year

Answer: A — Loss on disposal of equipment that has no future economic benefit

Explanation. An expense is recognised immediately when an item no longer meets, or ceases to meet, the definition of an asset, or when no future economic benefit is expected. A loss on disposal of equipment with no future benefit is expensed immediately. Depreciation is a systematic allocation over several periods; dealer machinery for resale is inventory; prepaid insurance is an asset until the coverage period expires.

Where it goes wrong. Treating depreciation or inventory purchases as immediate expenses, or deferring a loss that has no future benefit.

Authority. ICAI Framework para 96 (expense definition)

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

Scenario. Which of the following can be recognised as an asset under the Framework?

Which of the following can be recognised as an asset under the Framework?

1. Specific management talent of a highly skilled employee
2. Machinery taken on finance lease, where legal title rests with the lessor (correct answer)
3. Expected future economic benefits from a contract that has not yet been signed
4. Internally generated goodwill created through advertising and brand promotion

Answer: B — Machinery taken on finance lease, where legal title rests with the lessor

Explanation. An asset requires control arising from past events, probable future economic benefit, and reliable measurement. Finance-lease machinery satisfies these criteria because the lessee controls its use despite the lessor holding legal title. Employee talent lacks sufficient control; unsigned contracts lack past events; internally generated goodwill is not reliably measurable and is not recognised. Legal ownership is not the decisive test.

Where it goes wrong. Equating asset recognition with legal ownership and ignoring the control criterion.

Authority. ICAI Framework para 49 (asset definition — control and past events)