Chapter 3: Applicability of Accounting Standards - Test 1: answer key

Question 1 · 2 marks · Chapter 3: Applicability of Accounting Standards · medium

Scenario. Tristar Components Ltd is an unlisted public company engaged in manufacturing auto components. It is not a bank, financial institution or insurance company, and it is not a holding or subsidiary of any non-SMC company. For the immediately preceding accounting year 2024-25, its turnover excluding other income was ₹242 crore and its borrowings, including public deposits, peaked at ₹48 crore. It prepares financial statements for FY 2025-26 and wants to claim the exemptions and relaxations available to a Small and Medium-sized Company (SMC) under the Companies (Accounting Standards) Rules, 2021. The company has a funded gratuity defined benefit plan, operating leases with disclosure requirements under AS 19, and it wants to present only basic EPS. It is also considering whether AS 17 Segment Reporting can be avoided. Its CFO argues that because Tristar is an unlisted public company and not a private company, it cannot be treated as an SMC. The auditor has asked for a technical note on SMC classification and the precise exemptions available for FY 2025-26.

For FY 2025-26, how should Tristar Components Ltd be classified for applicability of Accounting Standards?

1. It is a non-SMC because its turnover is below ₹250 crore only marginally.
2. It is an SMC because it is unlisted, not a bank/FI/insurance company, turnover is within ₹250 crore, borrowings are within ₹50 crore and it is not a holding/subsidiary of a non-SMC. (correct answer)
3. It is a non-SMC because its borrowings exceed ₹50 crore at peak.
4. It is a non-SMC because an unlisted public company can never be classified as an SMC.

Answer: B — It is an SMC because it is unlisted, not a bank/FI/insurance company, turnover is within ₹250 crore, borrowings are within ₹50 crore and it is not a holding/subsidiary of a non-SMC.

Explanation. An SMC under the Companies (Accounting Standards) Rules, 2021 must be unlisted, not a bank/FI/insurance company, have turnover excluding other income not exceeding ₹250 crore in the immediately preceding accounting year, borrowings not exceeding ₹50 crore at any time in that year, and must not be a holding or subsidiary of a non-SMC. Tristar satisfies all these conditions for FY 2024-25, so it is an SMC for FY 2025-26. Being an unlisted public company does not disqualify it.

Where it goes wrong. Assuming only private companies can be SMCs, or confusing the ₹250 crore turnover limit with the ₹50 crore borrowing limit.

Authority. Companies (Accounting Standards) Rules, 2021 - SMC criteria; Study Material Chapter 3, paras 2.3 and 2.3.2

Question 2 · 2 marks · Chapter 3: Applicability of Accounting Standards · hard

Under the Companies (Accounting Standards) Rules, 2021, which Accounting Standard is not applicable in its entirety to an SMC?

1. AS 3 Cash Flow Statements
2. AS 20 Earnings per Share
3. AS 24 Discontinuing Operations
4. AS 17 Segment Reporting (correct answer)

Answer: D — AS 17 Segment Reporting

Explanation. For companies classified as SMCs, AS 17 Segment Reporting is not applicable in its entirety under the Companies (Accounting Standards) Rules, 2021. AS 3, AS 20 and AS 24 are not wholly exempt for SMC companies under these Rules; AS 20 has only a limited exemption from disclosure of diluted EPS. The full exemption of AS 3, AS 17, AS 20 and AS 24 applies to non-company MSMEs, not to SMC companies.

Where it goes wrong. Importing the non-company MSME exemption list into corporate SMC classification.

Authority. Companies (Accounting Standards) Rules, 2021 - SMC exemptions; Study Material Chapter 3, para 2.3.2

Question 3 · 2 marks · Chapter 3: Applicability of Accounting Standards · medium

What is the correct position regarding AS 20 Earnings per Share for Tristar as an SMC?

1. No EPS disclosure at all is required for an SMC.
2. Only the disclosure of diluted EPS, both including and excluding extraordinary items, is exempted; basic EPS is still required. (correct answer)
3. Both basic and diluted EPS are wholly exempted for an SMC.
4. Only EPS excluding extraordinary items is exempted; diluted EPS including extraordinary items is mandatory.

Answer: B — Only the disclosure of diluted EPS, both including and excluding extraordinary items, is exempted; basic EPS is still required.

Explanation. The SMC relaxation under AS 20 is limited: disclosure of diluted earnings per share, both including and excluding extraordinary items, is exempted for SMCs. Basic EPS is still required. AS 20 is not wholly exempt for SMC companies. Therefore, Tristar cannot avoid EPS presentation altogether; it can only avoid the diluted EPS disclosure relaxation covered by the SMC scheme.

Where it goes wrong. Treating AS 20 as fully exempt for SMCs, or thinking basic EPS is also exempt.

Authority. AS 20 Earnings per Share; Companies (Accounting Standards) Rules, 2021 - SMC relaxations

Question 4 · 2 marks · Chapter 3: Applicability of Accounting Standards · hard

For the gratuity defined benefit plan, which treatment is permitted to Tristar as an SMC under the AS 15 relaxations?

1. Actuarially determine the liability using the Projected Unit Credit Method and government bond yield, and disclose actuarial assumptions as per para 120(l). (correct answer)
2. Use a simple rational method based on year-end salaries and ignore actuarial assumptions.
3. Ignore the defined benefit obligation entirely because detailed paras 50–116 are not applicable.
4. Use the PUC Method but need not disclose any actuarial assumptions because all disclosure paras are exempt.

Answer: A — Actuarially determine the liability using the Projected Unit Credit Method and government bond yield, and disclose actuarial assumptions as per para 120(l).

Explanation. For SMCs, the detailed recognition and measurement requirements for defined benefit plans and certain disclosures are relaxed. However, the company must still actuarially determine the accrued liability using the Projected Unit Credit Method, with the discount rate based on market yields on government bonds, and must disclose actuarial assumptions as per para 120(l). The simple rational method is a relaxation available to non-company MSMEs, not to SMC companies.

Where it goes wrong. Applying the non-company MSME rational-method relaxation to an SMC company.

Authority. AS 15 Employee Benefits paras 50–116, 117–123 and 120(l); Companies (Accounting Standards) Rules, 2021 - SMC relaxations

Question 5 · 2 marks · Chapter 3: Applicability of Accounting Standards · hard

Scenario. Kavya Traders LLP is a non-company entity. It is an unlisted LLP, not a bank, financial institution or insurance company, and it is not a holding or subsidiary of any other entity. Its financial data are: FY 2023-24 turnover ₹300 crore and borrowings ₹60 crore; FY 2024-25 turnover ₹240 crore and borrowings ₹45 crore; FY 2025-26 turnover ₹230 crore and borrowings ₹40 crore. It first satisfied all MSME conditions at the end of FY 2024-25 and continued to satisfy them at the end of FY 2025-26. For FY 2025-26, the partners want to avail the exemptions available to Micro, Small and Medium-sized Entities (MSMEs) under the revised ICAI scheme effective from accounting periods commencing on or after 1 April 2024. The LLP has related party transactions, an impairment assessment for a packaging plant, and provisions for warranty. The partners have asked whether they can skip AS 3, AS 17, AS 18 and AS 28 in FY 2025-26, and what disclosures would be needed if partial exemptions are later availed.

Can Kavya Traders LLP avail MSME exemptions for FY 2025-26?

1. Yes, because it satisfies all MSME thresholds in both FY 2024-25 and FY 2025-26.
2. No; since it newly qualified in FY 2024-25, it must first remain an MSME for two consecutive years, so full AS compliance applies in FY 2025-26. (correct answer)
3. Yes, but only AS 3 and AS 17 exemptions can be availed in FY 2025-26.
4. No; an LLP can never be classified as an MSME for Accounting Standard applicability.

Answer: B — No; since it newly qualified in FY 2024-25, it must first remain an MSME for two consecutive years, so full AS compliance applies in FY 2025-26.

Explanation. Under the revised ICAI scheme for non-company entities, an entity that was previously not an MSME and later becomes one cannot avail MSME exemptions until it remains an MSME for two consecutive years. Kavya first qualified at the end of FY 2024-25, so FY 2025-26 is only the second year. It cannot avail exemptions in FY 2025-26; it must comply fully with applicable AS and can claim MSME exemptions only after completing two consecutive years as an MSME.

Where it goes wrong. Availing exemptions immediately in the first or second year of MSME qualification.

Authority. ICAI revised MSME scheme effective 1 April 2024, Additional Requirements (3); Study Material Chapter 3, para 2.1 and Additional Requirements

Question 6 · 2 marks · Chapter 3: Applicability of Accounting Standards · medium

If Kavya were an MSME eligible for exemptions, which of the following Accounting Standards is not exempt in its entirety for all MSMEs?

1. AS 3 Cash Flow Statements
2. AS 17 Segment Reporting
3. AS 24 Discontinuing Operations
4. AS 18 Related Party Disclosures (correct answer)

Answer: D — AS 18 Related Party Disclosures

Explanation. AS 3, AS 17, AS 20 and AS 24 are not applicable in their entirety to all MSMEs. AS 18 is not applicable in its entirety only to smaller MSMEs whose turnover does not exceed ₹50 crore, borrowings do not exceed ₹10 crore and which are not a holding/subsidiary of an MSME not covered by that threshold. Kavya has turnover of ₹230 crore and borrowings of ₹40 crore, so AS 18 would be applicable if it were eligible for MSME exemptions.

Where it goes wrong. Assuming AS 18 is wholly exempt for every MSME, ignoring the lower ₹50 crore/₹10 crore threshold.

Authority. ICAI revised MSME scheme, Annexure 1, para 2(A); AS 18 Related Party Disclosures

Question 7 · 2 marks · Chapter 3: Applicability of Accounting Standards · hard

Assuming Kavya later becomes eligible as an MSME, how should AS 28 Impairment of Assets apply to its packaging plant?

1. AS 28 is not applicable at all because Kavya is an MSME.
2. AS 28 applies in full with no relaxation because turnover exceeds ₹50 crore.
3. AS 28 applies; Kavya may measure value in use by a reasonable estimate instead of the present value technique and need not give the para 121(g) disclosure. (correct answer)
4. AS 28 applies only if Kavya is listed; otherwise no impairment testing is required.

Answer: C — AS 28 applies; Kavya may measure value in use by a reasonable estimate instead of the present value technique and need not give the para 121(g) disclosure.

Explanation. MSMEs that are not otherwise exempt from AS 28 may measure value in use on the basis of a reasonable estimate instead of computing present value. Consequently, provisions such as the discount rate need not be applied, and the entity need not disclose the information required by para 121(g). Kavya's turnover and borrowings exceed the small-MSME threshold for full AS 18/AS 28 exemption, so AS 28 applies, but this measurement relaxation is available.

Where it goes wrong. Believing AS 28 is wholly exempt for all MSMEs, or that the present value technique is always mandatory.

Authority. ICAI revised MSME scheme, Annexure 1, para 2(B)(vii); AS 28 Impairment of Assets

Question 8 · 2 marks · Chapter 3: Applicability of Accounting Standards · medium

If Kavya avails only some MSME exemptions and not others, what disclosure is required?

1. No disclosure is needed because partial exemption is automatic.
2. Disclose only that the financial statements are prepared on a going concern basis.
3. Disclose that it has complied fully with all Accounting Standards and no exemption has been availed.
4. Disclose that it is an MSME and specify the Standards for which exemption/relaxation has been availed. (correct answer)

Answer: D — Disclose that it is an MSME and specify the Standards for which exemption/relaxation has been availed.

Explanation. An MSME availing exemptions or relaxations must disclose by way of a note that it is an MSME and that it has complied with the Accounting Standards insofar as they are applicable to an MSME. If it opts not to avail exemptions for some Standards but avails them for others, it must disclose the Standards for which exemption/relaxation has been availed. It cannot state that it has complied fully with all AS if exemptions are used.

Where it goes wrong. Thinking partial exemption requires no disclosure, or that a full-compliance statement is still correct.

Authority. ICAI revised MSME scheme, Additional Requirements (1) and (4); Study Material Chapter 3, Additional Requirements

Question 9 · 2 marks · Chapter 3: Applicability of Accounting Standards · hard

Scenario. Vardhan Chemicals Ltd is unlisted, not a bank/FI/insurance company, and not a holding/subsidiary of a non-SMC. For FY 2024-25, turnover excluding other income was ₹249 crore; borrowings at peak comprised term loans of ₹44 crore and public deposits of ₹7 crore. Is it an SMC for FY 2025-26?

Vardhan Chemicals Ltd is unlisted, not a bank/FI/insurance company, and not a holding/subsidiary of a non-SMC. For FY 2024-25, turnover excluding other income was ₹249 crore; borrowings at peak comprised term loans of ₹44 crore and public deposits of ₹7 crore. Is it an SMC for FY 2025-26?

1. Yes, because turnover is below ₹250 crore.
2. No, because borrowings including public deposits exceed ₹50 crore at peak. (correct answer)
3. No, because an unlisted company cannot be an SMC.
4. Yes, because public deposits are excluded from borrowings for SMC classification.

Answer: B — No, because borrowings including public deposits exceed ₹50 crore at peak.

Explanation. For SMC classification, borrowings include public deposits and must not exceed ₹50 crore at any time during the immediately preceding accounting year. Vardhan's peak borrowings are ₹44 crore + ₹7 crore = ₹51 crore, which exceeds the limit. Therefore, it fails the borrowing condition and is not an SMC for FY 2025-26, even though turnover is within ₹250 crore.

Where it goes wrong. Excluding public deposits from borrowings, or checking only year-end borrowings instead of peak borrowings.

Authority. Companies (Accounting Standards) Rules, 2021 - SMC criteria; Study Material Chapter 3, para 2.3

Question 10 · 2 marks · Chapter 3: Applicability of Accounting Standards · hard

Scenario. Meghna Ltd was an SMC in FY 2024-25. For FY 2025-26, its turnover excluding other income was ₹280 crore and borrowings were ₹40 crore. How should it comply for FY 2026-27?

Meghna Ltd was an SMC in FY 2024-25. For FY 2025-26, its turnover excluding other income was ₹280 crore and borrowings were ₹40 crore. How should it comply for FY 2026-27?

1. Apply full AS from FY 2026-27; prior year figures are not revised merely because it ceased to be an SMC. (correct answer)
2. Continue SMC exemptions in FY 2026-27 and revise FY 2025-26 comparatives.
3. Apply full AS only from FY 2027-28 after two consecutive non-SMC years.
4. Continue the AS 17 exemption forever because it was an SMC in FY 2024-25.

Answer: A — Apply full AS from FY 2026-27; prior year figures are not revised merely because it ceased to be an SMC.

Explanation. SMC classification for a year depends on the immediately preceding accounting year's turnover and borrowings, among other conditions. Meghna's FY 2025-26 turnover of ₹280 crore exceeds ₹250 crore, so it is a non-SMC for FY 2026-27 and must apply all applicable AS in full from that year. There is no requirement to revise the previous year's figures merely because the company ceased to be an SMC.

Where it goes wrong. Applying a two-consecutive-year waiting rule to corporate SMC cessation, or revising comparatives unnecessarily.

Authority. Companies (Accounting Standards) Rules, 2021 - SMC criteria based on preceding year; Study Material Chapter 3, para 2.3

Question 11 · 2 marks · Chapter 3: Applicability of Accounting Standards · medium

Scenario. A company with annual revenue of ₹800 crore paid a ₹40,000 penalty for breach of law. How should this be treated for AS applicability?

A company with annual revenue of ₹800 crore paid a ₹40,000 penalty for breach of law. How should this be treated for AS applicability?

1. Club it with legal charges because ₹40,000 is below 1% of revenue.
2. Ignore it because materiality is based only on size and ₹40,000 is small.
3. Show it separately as a material item because its omission or misstatement can affect users' economic decisions; materiality is not merely size. (correct answer)
4. Treat it as an extraordinary item and disclose only in the directors' report.

Answer: C — Show it separately as a material item because its omission or misstatement can affect users' economic decisions; materiality is not merely size.

Explanation. Accounting Standards apply to material items. Materiality depends on the information content and whether omission or misstatement is likely to affect users' economic decisions; it is not necessarily a function of size. A penalty for breach of law can be material even if small in amount because of what it conveys. It should be shown separately and not clubbed with legal charges.

Where it goes wrong. Using a fixed percentage-of-revenue materiality test, or assuming small amounts are always immaterial.

Authority. AS 1 Disclosure of Accounting Policies - materiality; Study Material Chapter 3, financial items to which AS apply

Question 12 · 2 marks · Chapter 3: Applicability of Accounting Standards · hard

Scenario. Under AS 19, a lessee charges depreciation on an asset taken on finance lease in its books. For income tax, depreciation is allowed to the lessor as legal owner. What is the correct implication?

Under AS 19, a lessee charges depreciation on an asset taken on finance lease in its books. For income tax, depreciation is allowed to the lessor as legal owner. What is the correct implication?

1. Since depreciation is charged in the lessee's P&L under AS 19, it is automatically deductible for income tax in the lessee's hands.
2. AS 19 requires the lessee to claim tax depreciation, so no timing difference arises.
3. The lessee should not recognize lease expense in books if tax depreciation is allowed to the lessor.
4. Accounting treatment under AS 19 does not determine tax deductibility; the lessee may charge depreciation in books while tax depreciation is allowed to the lessor as legal owner. (correct answer)

Answer: D — Accounting treatment under AS 19 does not determine tax deductibility; the lessee may charge depreciation in books while tax depreciation is allowed to the lessor as legal owner.

Explanation. Accounting Standards aim to reduce diversity in accounting principles and improve comparability and transparency. They do not override tax law. An expense required to be taken to the Statement of Profit and Loss by an AS is not automatically deductible for income tax. Therefore, finance-lease depreciation may be charged by the lessee under AS 19, while tax depreciation may be allowed to the lessor as legal owner.

Where it goes wrong. Assuming book accounting treatment automatically governs income-tax deductibility.

Authority. AS 19 Leases; Income Tax Act, 1961 - depreciation and taxable income

Question 13 · 2 marks · Chapter 3: Applicability of Accounting Standards · hard

Scenario. A charitable trust collects donations and distributes them to flood-affected people. It also runs a small commercial printing unit. Do Accounting Standards apply to the trust?

A charitable trust collects donations and distributes them to flood-affected people. It also runs a small commercial printing unit. Do Accounting Standards apply to the trust?

1. Yes, Accounting Standards apply to all its activities, including charitable activities, because a small proportion of its activities is commercial. (correct answer)
2. No, Accounting Standards do not apply because the trust is charitable and donations are not business income.
3. Accounting Standards apply only to the commercial printing unit and not to donation activities.
4. Accounting Standards apply only if the trust is registered under Section 8 of the Companies Act, 2013.

Answer: A — Yes, Accounting Standards apply to all its activities, including charitable activities, because a small proportion of its activities is commercial.

Explanation. Accounting Standards apply to any enterprise engaged in commercial, industrial or business activities, whether or not profit-oriented and even if established for charitable or religious purposes. Exclusion is permissible only if no part of the activity is commercial, industrial or business in nature. Even if a very small proportion is commercial, AS apply to all activities, including those that are not commercial.

Where it goes wrong. Excluding the entire trust merely because its main object is charitable, despite a commercial activity.

Authority. Preface to the Statements of Accounting Standards; Study Material Chapter 3, enterprises to which AS apply

Question 14 · 2 marks · Chapter 3: Applicability of Accounting Standards · hard

Scenario. Which assessee is not required to follow the notified Income Computation and Disclosure Standards (ICDSs) for computation of business income?

Which assessee is not required to follow the notified Income Computation and Disclosure Standards (ICDSs) for computation of business income?

1. A company following the mercantile system and covered by tax audit under Section 44AB.
2. A partnership firm following the mercantile system and covered by tax audit under Section 44AB.
3. An individual or HUF not required to get accounts subject to tax audit under Section 44AB and following the mercantile system. (correct answer)
4. An LLP following the mercantile system and covered by tax audit under Section 44AB.

Answer: C — An individual or HUF not required to get accounts subject to tax audit under Section 44AB and following the mercantile system.

Explanation. The Central Government has notified ten ICDSs under Section 145(2) of the Income Tax Act, 1961, to be followed by all assessees following the mercantile system, except an individual or HUF who is not required to get accounts subject to tax audit under Section 44AB. Companies, firms and LLPs covered by tax audit and following mercantile system are generally required to apply ICDSs for computation of income under the relevant heads.

Where it goes wrong. Assuming every individual or HUF is automatically exempt, or that ICDSs apply only to companies.

Authority. Section 145(2) of the Income Tax Act, 1961; ICDS applicability - study material Chapter 3

Question 15 · 2 marks · Chapter 3: Applicability of Accounting Standards · medium

Scenario. Which of the following is a valid relaxation available to an SMC under the Companies (Accounting Standards) Rules, 2021?

Which of the following is a valid relaxation available to an SMC under the Companies (Accounting Standards) Rules, 2021?

1. AS 29 paragraphs 66 and 67 relating to disclosures are not applicable to an SMC. (correct answer)
2. AS 3 is not applicable to an SMC company under the Companies (Accounting Standards) Rules, 2021.
3. AS 17 is fully applicable to an SMC with no exemption.
4. AS 28 impairment loss need not be recognized by an SMC in any case.

Answer: A — AS 29 paragraphs 66 and 67 relating to disclosures are not applicable to an SMC.

Explanation. SMCs are exempt from certain disclosure requirements of AS 29, specifically paragraphs 66 and 67 relating to disclosures. AS 17 is not applicable in its entirety to SMCs, so option c is incorrect. AS 3 remains applicable to SMC companies under these Rules. AS 28 is not wholly dispensed with for SMCs; only limited measurement/disclosure relaxations are available.

Where it goes wrong. Confusing SMC corporate relaxations with the full AS 3 exemption available to non-company MSMEs, or treating AS 28 as wholly exempt.

Authority. Companies (Accounting Standards) Rules, 2021 - SMC relaxations; AS 29 Provisions, Contingent Liabilities and Contingent Assets paras 66-67