Chapter 4: Presentation & Disclosure Based Standards - Test 1: answer key

Question 1 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · medium

Scenario. Sterling Garments Ltd., an export-oriented apparel manufacturer, is finalising its financial statements for the year ended 31 March 2026. Selected balance-sheet figures (₹ lakh) are: property, plant and equipment 2,140; inventories 610; trade receivables 425; cash and bank 75; trade payables 380; term borrowings 950; and equity and reserves 1,920. The figures are extracts and the listed asset and funding balances reconcile. On 20 March 2026, after two lenders withdrew committed facilities and the principal customer cancelled its long-term contract, the Board approved an orderly sale of the business and cessation of all operations by 30 September 2026. Shareholders approved the plan on 28 March, and no refinancing or alternative operating plan was available. Nevertheless, the draft accounts have been prepared on the usual going-concern basis. From 1 April 2025, the company changed its inventory cost formula from FIFO to weighted average because automated batch production materially changed the pattern in which materials are consumed. At year-end, FIFO cost was ₹610 lakh, weighted-average cost was ₹586 lakh and net realisable value was ₹635 lakh. The finance team can reliably quantify the effect of the change. A major product claim filed in February 2026 is assessed by external counsel as having a 70% likelihood of an adverse outcome; the most reliable estimate of the settlement is ₹8 lakh, although the claimant has demanded ₹12 lakh. The directors propose only a note because the final court order is pending. Separately, they propose a general reserve of ₹45 lakh (1.5% of sales) for a possible downturn, although no present liability or identified loss supports it. At one factory, the accountant has continued to record electricity expense only when paid. At 31 March, ₹18 lakh of electricity had been consumed but remained unpaid; rental income of ₹11.5 lakh had been earned and was reasonably certain but had not been received. The directors propose retaining this cash-based treatment.

Considering the events occurring before 31 March 2026, which conclusion should Sterling Garments Ltd. draw regarding the fundamental accounting assumption of going concern?

1. Retain the going-concern basis because the company will trade until September 2026.
2. Retain the going-concern basis until a court formally orders winding up.
3. Disclose that going concern is not followed and state the alternative basis adopted. (correct answer)
4. Disclose only the planned closure date without changing the stated accounting basis.

Answer: C — Disclose that going concern is not followed and state the alternative basis adopted.

Explanation. AS 1 paragraphs 9 and 10(a) presume continuation of operations for the foreseeable future without an intention or necessity of liquidation or material curtailment. The approved cessation plan, withdrawal of financing and absence of an alternative operating plan establish that the assumption is inappropriate. Under paragraph 27, the non-following of the going-concern assumption must be disclosed. The alternative basis of preparation should also be explained. The trap is assuming that temporary continuation of trading establishes going concern.

Where it goes wrong. Confusing temporary continuation of operations with the going-concern assumption.

Authority. AS 1 paras 9, 10(a) and 27

Question 2 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · medium

What is the appropriate closing inventory amount and disclosure of the effect of the change in inventory valuation method for the year ended 31 March 2026?

1. ₹586 lakh; disclose the change, its reason and the ₹24 lakh reduction in inventory and profit. (correct answer)
2. ₹610 lakh; retain the previous carrying amount and disclose only the new valuation method.
3. ₹586 lakh; disclose the change but omit its quantified effect on the financial statements.
4. ₹635 lakh; recognise net realisable value and disclose the resulting expected selling margin.

Answer: A — ₹586 lakh; disclose the change, its reason and the ₹24 lakh reduction in inventory and profit.

Explanation. Weighted-average cost of ₹586 lakh is lower than NRV of ₹635 lakh and is therefore the closing inventory amount under the newly adopted policy. The earlier FIFO cost was ₹610 lakh. Consequently, the change reduces inventory and profit before tax by ₹610 lakh minus ₹586 lakh, or ₹24 lakh. Since the change better reflects material consumption, it is justifiable. AS 1 paragraph 22 requires disclosure of the change and its ascertainable effect. The trap is substituting NRV for cost.

Where it goes wrong. Using NRV as inventory value or failing to quantify the effect of the policy change.

Authority. AS 1 paras 16, 17 and 22; AS 1 para 26

Question 3 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · medium

Which treatment most clearly demonstrates the proper application of prudence to the product claim and proposed general reserve?

1. Recognise the claimant's demand of ₹12 lakh and additionally recognise the ₹45 lakh reserve.
2. Disclose the estimated claim of ₹8 lakh without recognising any provision until the court decides.
3. Recognise the general reserve of ₹45 lakh and disclose the specific claim as contingent.
4. Recognise a provision of ₹8 lakh and reject the unsupported general reserve of ₹45 lakh. (correct answer)

Answer: D — Recognise a provision of ₹8 lakh and reject the unsupported general reserve of ₹45 lakh.

Explanation. AS 1 paragraph 17(a) requires provision for known liabilities and losses using the most reliable estimate available, even when the precise amount remains uncertain. With a 70% likelihood of an adverse outcome, the estimated liability of ₹8 lakh should be recognised rather than ignored because a court order is pending. The unsupported ₹45 lakh reserve is not a known liability or identified loss. Prudence does not permit hidden reserves or deliberate understatement of profit. The trap is confusing conservatism with excessive provisioning.

Where it goes wrong. Treating prudence as permission to create hidden reserves or postpone recognition of probable losses.

Authority. AS 1 para 17(a)

Question 4 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · medium

What adjustment and disclosure are appropriate regarding the factory's cash-based recognition of electricity expenses and rental income?

1. Retain cash-basis accounting because disclosing the accounting policy makes it acceptable.
2. Recognise both accruals; continued cash-basis treatment requires disclosure and breaches Section 128(1). (correct answer)
3. Accrue only the electricity expense because rental income remains unrealised until receipt.
4. Retain both cash amounts because the transactions relate to separate factory operations.

Answer: B — Recognise both accruals; continued cash-basis treatment requires disclosure and breaches Section 128(1).

Explanation. Under accrual accounting, revenue is recognised when earned and expenses when incurred, regardless of cash settlement. Therefore, rental income of ₹11.5 lakh and electricity expense of ₹18 lakh belong to FY 2025-26. AS 1 paragraph 27 requires disclosure if accrual is not followed. Section 128(1) of the Companies Act, 2013 mandates accrual accounting and double-entry bookkeeping. Disclosure cannot regularise a statutory departure. The trap is treating cash settlement as the recognition criterion.

Where it goes wrong. Confusing recognition on an accrual basis with actual receipt or payment of cash.

Authority. AS 1 paras 9, 10(c) and 27; Section 128(1) of the Companies Act, 2013

Question 5 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · medium

Scenario. Vardhan Chemicals Ltd., a non-financial manufacturing company, is preparing its cash flow statement for the year ended 31 March 2026. Selected figures from its books (₹ lakh) are set out below. Profit before tax is 18.40. It includes depreciation of 4.20, a gain of 0.60 on disposal of plant, interest expense of 1.20, interest income of 0.45 and dividend income of 0.30. Income tax of 3.10 was paid during the year. Opening and closing balances were: trade receivables ₹10.20 lakh and ₹12.30 lakh; inventories ₹8.80 lakh and ₹8.00 lakh; and trade payables ₹6.00 lakh and ₹7.40 lakh. Revenue from operations was ₹96 lakh and cost of goods sold was ₹55 lakh. There were no bad debts, non-cash write-offs or acquired balances affecting these movements. During the year, the company paid ₹9.60 lakh for a new processing line and received ₹3.00 lakh on disposal of an old machine whose carrying amount was ₹2.40 lakh. It acquired long-term quoted shares for ₹4.00 lakh and sold long-term bonds for ₹1.80 lakh. The shares and bonds were held as investments, not for dealing or trading. It also issued equity shares for cash of ₹5.00 lakh, repaid bank-loan principal of ₹3.00 lakh and paid dividends of ₹1.10 lakh. The ₹1.20 lakh interest expense was paid in cash. The treasury note confirms that the entity is not a bank, finance company or investment dealer. All investing and financing transactions above were settled in cash, and no receipts or payments were made on behalf of customers. Management is considering presenting only a single net figure for purchases and disposals of plant and investments to make the statement shorter.

What is the net cash generated from operating activities of Vardhan Chemicals Ltd. under the indirect method after considering all the information provided?

1. ₹19.05 lakh
2. ₹22.55 lakh
3. ₹19.45 lakh (correct answer)
4. ₹18.75 lakh

Answer: C — ₹19.45 lakh

Explanation. Start with PBT ₹18.40 lakh. Add depreciation ₹4.20 lakh and interest paid ₹1.20 lakh; deduct disposal gain ₹0.60 lakh, interest income ₹0.45 lakh and dividend income ₹0.30 lakh. The adjusted figure is ₹22.45 lakh. Working-capital changes are −₹2.10 lakh + ₹0.80 lakh + ₹1.40 lakh = +₹0.10 lakh. Cash generated is ₹22.55 lakh; deduct tax paid ₹3.10 lakh to obtain ₹19.45 lakh. The trap is omitting tax paid.

Where it goes wrong. Stopping at cash generated from operations without deducting income tax actually paid.

Authority. AS 3 paras 13, 18 and 20

Question 6 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · medium

How should the interest and dividend cash flows of Vardhan Chemicals Ltd. be classified in accordance with AS 3?

1. Interest and dividends paid are financing outflows; interest and dividends received are investing inflows. (correct answer)
2. Interest and dividends paid are operating outflows; interest and dividends received are investing inflows.
3. Interest paid is operating; interest received and dividends paid are financing cash flows.
4. Interest and dividends paid and received are all classified as operating cash flows.

Answer: A — Interest and dividends paid are financing outflows; interest and dividends received are investing inflows.

Explanation. Vardhan Chemicals Ltd. is a non-financial enterprise. Under AS 3 paragraph 30, interest paid is a financing outflow, while interest and dividends received are investing inflows. Dividends paid are also financing outflows. Thus, interest paid of ₹1.20 lakh and dividends paid of ₹1.10 lakh are financing activities; interest income of ₹0.45 lakh and dividend income of ₹0.30 lakh are investing activities. The trap is applying the financial-enterprise classification to a manufacturing company.

Where it goes wrong. Applying the financial-enterprise classification of interest and dividend cash flows to a non-financial company.

Authority. AS 3 para 30

Question 7 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · medium

After considering the capital expenditure, disposal proceeds, investment transactions, interest received and dividend received, what is the net cash flow from investing activities?

1. Net outflow of ₹6.85 lakh
2. Net outflow of ₹8.35 lakh
3. Net outflow of ₹7.75 lakh
4. Net outflow of ₹8.05 lakh (correct answer)

Answer: D — Net outflow of ₹8.05 lakh

Explanation. Investing inflows are disposal proceeds ₹3.00 lakh, bond-sale proceeds ₹1.80 lakh, interest received ₹0.45 lakh and dividend received ₹0.30 lakh, totalling ₹5.55 lakh. Investing outflows are PPE acquisition ₹9.60 lakh and long-term share acquisition ₹4.00 lakh, totalling ₹13.60 lakh. Net investing cash flow is ₹5.55 lakh minus ₹13.60 lakh = negative ₹8.05 lakh. AS 3 requires separate gross disclosure of major classes. The trap is netting only disposal and acquisition proceeds incorrectly.

Where it goes wrong. Incorrectly netting unrelated capital purchases and disposal proceeds before classification.

Authority. AS 3 paras 15, 16, 21 and 30

Question 8 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · medium

Under the direct method, what are the cash received from customers and the cash paid to suppliers respectively during FY 2025-26?

1. ₹96.00 lakh and ₹54.20 lakh
2. ₹93.90 lakh and ₹52.80 lakh (correct answer)
3. ₹93.90 lakh and ₹54.20 lakh
4. ₹91.80 lakh and ₹52.80 lakh

Answer: B — ₹93.90 lakh and ₹52.80 lakh

Explanation. Cash received from customers equals revenue ₹96 lakh less the increase in receivables of ₹2.10 lakh, giving ₹93.90 lakh. Purchases equal cost of goods sold ₹55 lakh less the inventory reduction of ₹0.80 lakh, giving ₹54.20 lakh. Cash paid to suppliers is purchases ₹54.20 lakh less the increase in trade payables ₹1.40 lakh, giving ₹52.80 lakh. AS 3 paragraph 19 permits adjustments for operating receivables, inventories and payables. The trap is confusing purchases with supplier payments.

Where it goes wrong. Ignoring changes in inventories or trade payables while converting expenses into cash payments.

Authority. AS 3 paras 18 and 19

Question 9 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · medium

Scenario. Zenith Technologies Ltd., an Indian non-financial company, operates a software-export division and prepares its financial statements to 31 March 2026. Its selected balance-sheet balances include domestic demand deposits of ₹12 lakh and a foreign-currency bank account. The foreign account opened on 1 April 2025 with USD 20,000, translated at ₹82 per dollar. During the year, the company received USD 40,000 from a customer on 1 December 2025 when the rate was ₹84.50, received a further USD 20,000 on 31 March 2026 at ₹86, and paid a foreign supplier USD 30,000 on 28 February 2026 at ₹85. The closing rate on 31 March was ₹86 per dollar. There were no other movements in that account. On 15 February 2026, the treasury department acquired a highly liquid 60-day Government bill for ₹25 lakh to meet an identified short-term cash commitment. It is readily convertible into a known amount and carries insignificant value risk. On the same date, it also bought listed equity shares for long-term strategic holding at ₹18 lakh. A separate bank deposit acquired on 1 January 2026 matures on 30 April 2026; although only one month remains at the reporting date, the deposit was originally placed for a fixed investment return. On 1 March 2026, Zenith acquired a machine valued at ₹12 lakh by issuing debentures directly to the vendor. On 20 March 2026, it converted debentures of ₹4 lakh into equity shares. A bonus issue of 1,00,000 shares was also approved and allotted without cash consideration. None of these three transactions involved cash or cash equivalents. The finance controller proposes including the machine and debt conversion as cash investing and financing flows because they changed the asset and capital balances.

What amount should Zenith Technologies Ltd. report as cash inflows from the two foreign-currency customer receipts during FY 2025-26?

1. ₹51.00 lakh (correct answer)
2. ₹50.00 lakh
3. ₹52.10 lakh
4. ₹49.50 lakh

Answer: A — ₹51.00 lakh

Explanation. AS 3 paragraph 25 requires translation at the exchange rate on the date of each cash flow. The first receipt is USD 40,000 × ₹84.50 = ₹33.80 lakh. The second receipt is USD 20,000 × ₹86 = ₹17.20 lakh. Total translated cash inflows are ₹51.00 lakh. A weighted-average rate may be used only when it approximates the actual transaction-date rates under paragraph 26. The trap is translating every transaction at the year-end closing rate.

Where it goes wrong. Using the closing exchange rate instead of the transaction-date rates for foreign-currency cash flows.

Authority. AS 3 paras 25 and 26

Question 10 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · medium

What exchange-rate effect should be presented separately while reconciling Zenith's opening and closing foreign-currency cash balances?

1. ₹0.50 lakh, included in investing cash flows
2. ₹2.10 lakh, included in operating cash flows
3. ₹1.10 lakh, shown separately in the cash reconciliation (correct answer)
4. ₹1.10 lakh, included in financing cash flows

Answer: C — ₹1.10 lakh, shown separately in the cash reconciliation

Explanation. Opening foreign bank balance is USD 20,000 × ₹82 = ₹16.40 lakh. Cash receipts total ₹51.00 lakh and supplier payment equals USD 30,000 × ₹85 = ₹25.50 lakh. The expected closing balance before exchange effects is ₹41.90 lakh. Actual closing cash is USD 50,000 × ₹86 = ₹43.00 lakh. The difference of ₹1.10 lakh is the exchange effect. AS 3 paragraph 27 requires separate reconciliation, not classification as an activity cash flow.

Where it goes wrong. Including unrealised exchange gains as operating, investing or financing cash inflows.

Authority. AS 3 paras 25 and 27

Question 11 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

How should Zenith treat the machine acquired by issuing debentures, the debenture-to-equity conversion and the bonus issue in its cash flow statement?

1. Show the machine as investing outflow and the debenture conversion as financing outflow.
2. Exclude all three from the cash flow statement and disclose them elsewhere in the financial statements. (correct answer)
3. Show the machine as investing outflow and the bonus issue as financing inflow.
4. Show the debenture conversion as financing inflow and the bonus issue as financing outflow.

Answer: B — Exclude all three from the cash flow statement and disclose them elsewhere in the financial statements.

Explanation. The three transactions involve no cash or cash equivalents. The machinery was acquired directly against debentures, existing debt was converted into equity, and bonus shares were allotted without consideration. AS 3 paragraphs 40 and 41 specifically exclude investing and financing transactions without cash movements from the cash flow statement. Relevant information should instead be disclosed elsewhere in the financial statements. The trap is classifying transactions by their effect on assets or capital rather than by actual cash movement.

Where it goes wrong. Treating a non-cash change in assets, borrowings or equity as a cash flow.

Authority. AS 3 paras 40 and 41

Question 12 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Which treasury investment qualifies for inclusion in Zenith Technologies Ltd.'s cash and cash equivalents at 31 March 2026?

1. The ₹18 lakh listed equity shares acquired for long-term strategic holding.
2. The bank deposit acquired on 1 January 2026, having only one month remaining.
3. Both the Government bill and the bank deposit, since both mature shortly.
4. The ₹25 lakh Government bill acquired for a 60-day short-term cash commitment. (correct answer)

Answer: D — The ₹25 lakh Government bill acquired for a 60-day short-term cash commitment.

Explanation. AS 3 paragraphs 5.2 and 6 require a cash equivalent to be short-term, highly liquid, readily convertible into a known amount and subject to insignificant risk of value changes. It must be held to meet short-term cash commitments and normally have maturity of three months or less from acquisition. The 60-day bill qualifies. The four-month deposit does not qualify based on its remaining maturity. Equity shares are normally excluded. The trap is measuring maturity from the reporting date.

Where it goes wrong. Applying residual maturity instead of original maturity from the acquisition date.

Authority. AS 3 paras 5.2, 6 and 7

Question 13 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Scenario. Mira Engineering Ltd. reports cash sales of ₹4.80 lakh and credit sales of ₹36 lakh. Trade receivables were ₹5.20 lakh at the beginning and ₹7.60 lakh at the end of the year. There were no bad debts or other adjustments. What cash receipts from customers should be reported under the direct method?

Mira Engineering Ltd. reports cash sales of ₹4.80 lakh and credit sales of ₹36 lakh. Trade receivables were ₹5.20 lakh at the beginning and ₹7.60 lakh at the end of the year. There were no bad debts or other adjustments. What cash receipts from customers should be reported under the direct method?

1. ₹38.40 lakh (correct answer)
2. ₹40.80 lakh
3. ₹36.00 lakh
4. ₹43.60 lakh

Answer: A — ₹38.40 lakh

Explanation. Under the direct method, cash receipts comprise cash sales plus collections from credit customers. Credit collections equal opening receivables ₹5.20 lakh plus credit sales ₹36 lakh minus closing receivables ₹7.60 lakh, giving ₹33.60 lakh. Adding cash sales of ₹4.80 lakh gives total cash receipts of ₹38.40 lakh. AS 3 paragraphs 18 and 19 permit presentation of gross operating cash receipts. The trap is reporting total sales revenue as cash received.

Where it goes wrong. Ignoring the increase in trade receivables when calculating customer collections.

Authority. AS 3 paras 18 and 19

Question 14 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Scenario. Arjun Foods Ltd. reports revenue from operations of ₹72 lakh. An individual expenditure item is ₹95,000, while a separately identified employee fraud loss is ₹32,000 and reveals a serious internal-control weakness. Which disclosure conclusion is most appropriate?

Arjun Foods Ltd. reports revenue from operations of ₹72 lakh. An individual expenditure item is ₹95,000, while a separately identified employee fraud loss is ₹32,000 and reveals a serious internal-control weakness. Which disclosure conclusion is most appropriate?

1. Both items are automatically material because each exceeds one per cent of revenue.
2. Neither item requires disclosure because both amounts are below one lakh rupees.
3. The expenditure is below the specific threshold, but the fraud loss may be qualitatively material. (correct answer)
4. Only the expenditure must be disclosed because fraud losses are never separately material.

Answer: C — The expenditure is below the specific threshold, but the fraud loss may be qualitatively material.

Explanation. One per cent of revenue from operations of ₹72 lakh is ₹72,000. Schedule III Division I requires additional disclosure of an item exceeding the higher of ₹72,000 and ₹1,00,000, namely ₹1,00,000. The ₹95,000 expenditure does not cross that specific threshold. However, AS 1 paragraph 17(c) considers whether knowledge of an item could influence users' decisions. The ₹32,000 fraud may therefore be material qualitatively. The trap is treating numerical thresholds as absolute limits on materiality.

Where it goes wrong. Assuming that an item below a quantitative disclosure threshold can never be material.

Authority. AS 1 para 17(c); Schedule III, Division I, Part II, General Instructions for Preparation of Statement of Profit and Loss, item 5(c)

Question 15 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Scenario. Pragati Finance Ltd. is a financial enterprise. During the year it paid interest on deposits of ₹6 lakh, received interest on loans of ₹3.20 lakh, received dividend income of ₹1.40 lakh and paid dividends of ₹80,000. Which classification is correct?

Pragati Finance Ltd. is a financial enterprise. During the year it paid interest on deposits of ₹6 lakh, received interest on loans of ₹3.20 lakh, received dividend income of ₹1.40 lakh and paid dividends of ₹80,000. Which classification is correct?

1. All interest and dividend receipts are investing; both payments are financing.
2. Interest and dividend receipts and interest paid are operating; dividends paid are financing. (correct answer)
3. Interest receipts are operating; dividend receipts are investing; both payments are operating.
4. All four transactions are classified as operating cash flows.

Answer: B — Interest and dividend receipts and interest paid are operating; dividends paid are financing.

Explanation. For a financial enterprise, AS 3 paragraph 30 classifies interest paid and interest and dividends received as operating cash flows. Dividends paid remain financing cash outflows. Accordingly, the ₹6 lakh interest payment and ₹3.20 lakh interest and ₹1.40 lakh dividend receipts are operating cash flows, whereas the ₹80,000 dividend payment is financing. The classification reflects the nature of a financial enterprise's principal revenue-producing activities. The trap is applying the non-financial enterprise treatment uniformly.

Where it goes wrong. Applying non-financial enterprise rules to a financial institution.

Authority. AS 3 paras 30, 32 and 33

Question 16 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Scenario. A company registered as a dormant company under Section 455 of the Companies Act, 2013, is finalising its annual financial statements. It is neither an OPC nor a small company. Which statement regarding its cash flow statement is correct?

A company registered as a dormant company under Section 455 of the Companies Act, 2013, is finalising its annual financial statements. It is neither an OPC nor a small company. Which statement regarding its cash flow statement is correct?

1. It must prepare a cash flow statement because every company is mandatorily covered.
2. It may omit the cash flow statement only when its closing cash balance is nil.
3. It may omit the cash flow statement only after obtaining prior Tribunal approval.
4. It may omit the cash flow statement under the statutory definition of financial statements. (correct answer)

Answer: D — It may omit the cash flow statement under the statutory definition of financial statements.

Explanation. Section 2(40) defines financial statements to include a cash flow statement but expressly permits an OPC, small company or dormant company to exclude it. The company's dormant status independently qualifies it for this statutory relaxation. This exemption does not depend on a nil closing cash balance or prior Tribunal approval. Section 129(1) governs preparation and presentation of financial statements. The trap is treating the general requirement as overriding the specific statutory exception.

Where it goes wrong. Overlooking the express cash flow statement exemption for dormant companies.

Authority. Section 2(40) of the Companies Act, 2013; Section 129(1) of the Companies Act, 2013

Question 17 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Scenario. Mitra Metals Ltd. has identified a probable warranty-related loss with a most reliable estimate of ₹26 lakh. Management additionally proposes creating a provision of ₹75 lakh for a possible economic slowdown in the next financial year, although no present liability or specific loss exists. What is the appropriate treatment under AS 1?

Mitra Metals Ltd. has identified a probable warranty-related loss with a most reliable estimate of ₹26 lakh. Management additionally proposes creating a provision of ₹75 lakh for a possible economic slowdown in the next financial year, although no present liability or specific loss exists. What is the appropriate treatment under AS 1?

1. Recognise ₹75 lakh because a larger provision always reflects greater prudence.
2. Recognise both provisions because future economic uncertainty requires maximum provisioning.
3. Recognise the ₹26 lakh estimate and reject the unsupported ₹75 lakh general provision. (correct answer)
4. Recognise neither amount because both losses depend on future commercial conditions.

Answer: C — Recognise the ₹26 lakh estimate and reject the unsupported ₹75 lakh general provision.

Explanation. AS 1 paragraph 17(a) requires recognition of known liabilities and losses on the basis of the most reliable estimate available, even when the precise amount is uncertain. The identified warranty-related loss therefore supports a provision of ₹26 lakh. The additional ₹75 lakh is merely a general reserve for a possible future downturn and is not supported by a present liability or identified loss. Prudence cannot justify hidden reserves or understated profits. The trap is interpreting prudence as maximum possible provisioning.

Where it goes wrong. Creating excessive provisions for unidentified future losses under the guise of prudence.

Authority. AS 1 para 17(a)

Question 18 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Scenario. BluePeak Ltd. transfers legal title to machinery to a financier on 30 March 2026 and receives ₹50 lakh. However, a binding agreement requires the company to repurchase the same machinery after 11 months at the original price plus a fixed return. The financier cannot use or sell the machinery during this period. What treatment most appropriately reflects AS 1?

BluePeak Ltd. transfers legal title to machinery to a financier on 30 March 2026 and receives ₹50 lakh. However, a binding agreement requires the company to repurchase the same machinery after 11 months at the original price plus a fixed return. The financier cannot use or sell the machinery during this period. What treatment most appropriately reflects AS 1?

1. Treat the arrangement as financing, retain the machinery and recognise a financial liability. (correct answer)
2. Recognise an outright sale because legal ownership has formally transferred to the financier.
3. Recognise sale revenue immediately and provide for the expected repurchase amount separately.
4. Recognise a disposal loss because the company has temporarily surrendered possession of the machinery.

Answer: A — Treat the arrangement as financing, retain the machinery and recognise a financial liability.

Explanation. AS 1 paragraph 17(b) requires accounting treatment to reflect the substance and financial reality of a transaction rather than merely its legal form. The fixed-price repurchase obligation, restriction on the financier's use of machinery and predetermined return indicate a financing arrangement, not a substantive disposal. Accordingly, the machinery remains recognised and the amount received is treated as borrowing, with the financing cost recognised appropriately. The trap is treating legal transfer of title as conclusive evidence of a sale.

Where it goes wrong. Allowing the legal form of a transaction to override its underlying economic substance.

Authority. AS 1 para 17(b)

Question 19 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Scenario. A manufacturing company acquires a 90-day Treasury bill on 1 January 2026, specifically to meet short-term cash commitments. It is readily convertible into a known amount and carries insignificant risk of changes in value. Which conclusion is correct at acquisition?

A manufacturing company acquires a 90-day Treasury bill on 1 January 2026, specifically to meet short-term cash commitments. It is readily convertible into a known amount and carries insignificant risk of changes in value. Which conclusion is correct at acquisition?

1. It is an investing asset because every Government security is excluded from cash equivalents.
2. It is an operating investment because the company expects to realise it within its operating cycle.
3. It is a financing asset because Government securities represent borrowed funds of the issuer.
4. It qualifies as a cash equivalent because its original maturity is three months or less. (correct answer)

Answer: D — It qualifies as a cash equivalent because its original maturity is three months or less.

Explanation. AS 3 paragraph 6 states that an investment normally qualifies as a cash equivalent when it has a short maturity of, say, three months or less from the date of acquisition. It must also be highly liquid, readily convertible into a known amount, carry insignificant value risk and be held for short-term cash commitments. The stated 90-day Treasury bill satisfies these conditions. The trap is classifying every investment as investing activity regardless of its maturity and purpose.

Where it goes wrong. Ignoring the original acquisition-date maturity and purpose of holding an investment.

Authority. AS 3 paras 5.2 and 6

Question 20 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Scenario. Nexus Industrial Ltd., a non-financial enterprise, reports profit before tax of ₹28 lakh. This includes depreciation ₹5 lakh, gain on sale of machinery ₹1.20 lakh, interest expense ₹1.80 lakh and interest income ₹60,000. During the year, trade receivables decreased by ₹1.50 lakh, inventories increased by ₹2 lakh and trade payables increased by ₹90,000. Income tax paid was ₹4 lakh. Calculate net cash from operating activities under the indirect method.

Nexus Industrial Ltd., a non-financial enterprise, reports profit before tax of ₹28 lakh. This includes depreciation ₹5 lakh, gain on sale of machinery ₹1.20 lakh, interest expense ₹1.80 lakh and interest income ₹60,000. During the year, trade receivables decreased by ₹1.50 lakh, inventories increased by ₹2 lakh and trade payables increased by ₹90,000. Income tax paid was ₹4 lakh. Calculate net cash from operating activities under the indirect method.

1. ₹28.20 lakh
2. ₹29.40 lakh (correct answer)
3. ₹30.60 lakh
4. ₹25.80 lakh

Answer: B — ₹29.40 lakh

Explanation. Start with PBT ₹28 lakh. Add depreciation ₹5 lakh and interest expense ₹1.80 lakh; deduct the disposal gain ₹1.20 lakh and interest income ₹0.60 lakh. Adjusted profit is ₹33 lakh. Working-capital adjustments are +₹1.50 lakh for lower receivables, −₹2 lakh for higher inventories and +₹0.90 lakh for higher payables, giving ₹33.40 lakh. Deduct tax paid ₹4 lakh to obtain ₹29.40 lakh. The trap is reversing the inventory adjustment.

Where it goes wrong. Incorrectly treating an increase in inventories as a cash inflow under the indirect method.

Authority. AS 3 paras 18 and 20

Question 21 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Scenario. A non-financial enterprise paid total interest of ₹5 lakh during the year. ₹2 lakh was charged to the Statement of Profit and Loss, while ₹3 lakh was capitalised as part of the cost of a self-constructed asset. What amount and classification should appear in the cash flow statement?

A non-financial enterprise paid total interest of ₹5 lakh during the year. ₹2 lakh was charged to the Statement of Profit and Loss, while ₹3 lakh was capitalised as part of the cost of a self-constructed asset. What amount and classification should appear in the cash flow statement?

1. Only ₹2 lakh as financing outflow because the remaining interest is capitalised.
2. ₹3 lakh as investing outflow and ₹2 lakh as operating outflow because of accounting treatment.
3. Total interest of ₹5 lakh as financing outflow, disclosed irrespective of capitalisation. (correct answer)
4. Total interest of ₹5 lakh as operating outflow because it affects the asset's construction.

Answer: C — Total interest of ₹5 lakh as financing outflow, disclosed irrespective of capitalisation.

Explanation. AS 3 paragraph 31 requires disclosure of the total interest paid during the period, whether charged to the Statement of Profit and Loss or capitalised as part of an asset. As the company is non-financial, paragraph 30 classifies interest paid as financing cash flow. Hence the complete ₹5 lakh is disclosed as financing outflow. The capitalisation of ₹3 lakh does not remove it from the cash flow statement. The trap is equating capitalisation with absence of a cash payment.

Where it goes wrong. Excluding capitalised interest from cash flows or presenting it as an investing cash outflow.

Authority. AS 3 paras 30 and 31

Question 22 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Scenario. During FY 2025-26, a company acquired machinery worth ₹20 lakh by directly assuming a related loan liability, converted debentures of ₹6 lakh into equity shares and issued fully paid bonus shares. None of these transactions involved cash or cash equivalents. What should be their treatment?

During FY 2025-26, a company acquired machinery worth ₹20 lakh by directly assuming a related loan liability, converted debentures of ₹6 lakh into equity shares and issued fully paid bonus shares. None of these transactions involved cash or cash equivalents. What should be their treatment?

1. Exclude all three transactions from the cash flow statement and disclose them elsewhere. (correct answer)
2. Show machinery acquisition as investing outflow and the bonus issue as financing inflow.
3. Show the loan assumption as financing inflow and the debt conversion as financing outflow.
4. Show the machinery acquisition as operating outflow and the bonus issue as investing inflow.

Answer: A — Exclude all three transactions from the cash flow statement and disclose them elsewhere.

Explanation. The acquisition of machinery through assumption of liability, conversion of debentures into equity and issue of bonus shares are non-cash transactions. AS 3 paragraphs 40 and 41 specifically exclude investing and financing transactions that do not involve cash or cash equivalents from the cash flow statement. Such transactions are disclosed elsewhere to provide relevant information about changes in asset and capital structure. The trap is reporting the gross value of a non-cash acquisition as a cash outflow.

Where it goes wrong. Reporting non-cash investing or financing transactions as actual cash receipts or payments.

Authority. AS 3 paras 40 and 41

Question 23 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Scenario. A company has an opening foreign bank balance of USD 10,000 translated at ₹81 per USD. During the year it receives USD 10,000 on each of three dates when the rates are ₹82, ₹84 and ₹86 respectively. At year-end, the closing balance of USD 40,000 is translated at ₹85 per USD. What exchange-rate effect should be disclosed separately in the cash reconciliation?

A company has an opening foreign bank balance of USD 10,000 translated at ₹81 per USD. During the year it receives USD 10,000 on each of three dates when the rates are ₹82, ₹84 and ₹86 respectively. At year-end, the closing balance of USD 40,000 is translated at ₹85 per USD. What exchange-rate effect should be disclosed separately in the cash reconciliation?

1. ₹0.70 lakh as operating cash inflow
2. ₹0.70 lakh separately in the reconciliation of cash balances (correct answer)
3. ₹0.70 lakh as financing cash inflow
4. ₹0.70 lakh as investing cash inflow

Answer: B — ₹0.70 lakh separately in the reconciliation of cash balances

Explanation. The three receipts translate to ₹8.20 lakh, ₹8.40 lakh and ₹8.60 lakh, totalling ₹25.20 lakh. Opening balance is ₹8.10 lakh and closing balance is USD 40,000 × ₹85 = ₹34 lakh. Therefore, the exchange effect is ₹34 lakh − ₹8.10 lakh − ₹25.20 lakh = ₹0.70 lakh. AS 3 paragraph 27 requires this exchange-rate effect to be presented separately in the cash reconciliation. The trap is treating unrealised exchange gains as operating cash inflows.

Where it goes wrong. Classifying exchange differences on foreign-currency cash balances as activity cash flows.

Authority. AS 3 paras 25, 26 and 27

Question 24 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Scenario. Harsha Tools Ltd. issued 40,000 equity shares of ₹10 each at a premium of ₹5 per share for cash. It also obtained a fresh bank loan of ₹8 lakh, repaid existing term-loan principal of ₹2.50 lakh and paid dividends of ₹1.20 lakh. Calculate net cash flow from financing activities.

Harsha Tools Ltd. issued 40,000 equity shares of ₹10 each at a premium of ₹5 per share for cash. It also obtained a fresh bank loan of ₹8 lakh, repaid existing term-loan principal of ₹2.50 lakh and paid dividends of ₹1.20 lakh. Calculate net cash flow from financing activities.

1. ₹11.50 lakh
2. ₹8.30 lakh
3. ₹6.00 lakh
4. ₹10.30 lakh (correct answer)

Answer: D — ₹10.30 lakh

Explanation. Cash proceeds from share issue are 40,000 × ₹15 = ₹6 lakh, including the securities premium. Add fresh bank borrowing of ₹8 lakh. Deduct repayment of loan principal ₹2.50 lakh and dividends paid ₹1.20 lakh. Net financing cash flow is ₹6 lakh + ₹8 lakh − ₹2.50 lakh − ₹1.20 lakh = ₹10.30 lakh inflow. AS 3 paragraphs 17 and 33 classify share proceeds, borrowings, repayments and dividends paid as financing activities. The trap is using face value alone.

Where it goes wrong. Ignoring the securities premium received or misclassifying dividends paid as operating cash flow.

Authority. AS 3 paras 17, 30 and 33

Question 25 · 2 marks · Chapter 4: Presentation & Disclosure Based Standards · hard

Scenario. A private company is neither an OPC, small company nor dormant company. It has been formally recognised as a start-up under the applicable DPIIT notification. Which statement correctly describes the statutory exemption from preparing a cash flow statement?

A private company is neither an OPC, small company nor dormant company. It has been formally recognised as a start-up under the applicable DPIIT notification. Which statement correctly describes the statutory exemption from preparing a cash flow statement?

1. Every private company may omit the cash flow statement irrespective of start-up recognition.
2. Only a private company with no operating receipts may omit the cash flow statement.
3. An eligible recognised start-up private company may omit the cash flow statement under the applicable exemption. (correct answer)
4. A private company may omit the cash flow statement only after obtaining specific NFRA approval.

Answer: C — An eligible recognised start-up private company may omit the cash flow statement under the applicable exemption.

Explanation. The proviso to Section 2(40) permits an OPC, small company or dormant company to exclude the cash flow statement. Additionally, the exemption notification G.S.R. 583(E) dated 13 June 2017 extends this relaxation to a private company recognised as a start-up under the applicable DPIIT notification. The exemption is not available to every private company merely because of its legal form. The trap is overlooking the specific recognition requirement for start-up private companies.

Where it goes wrong. Assuming that all private companies are automatically exempt from preparing cash flow statements.

Authority. Section 2(40) of the Companies Act, 2013; Section 462 exemption notification G.S.R. 583(E) dated 13 June 2017