CA Inter Advanced Accounting MCQ Test 13: answer key

Question 1 · 2 marks · Leases · hard

Scenario. Prism Lease Finance Limited is engaged in leasing industrial equipment to manufacturing companies. Its financial statements are prepared annually on 31 March. On 1 April 2026, Prism entered into a three-year lease agreement with Orion Components Limited for a specialised production press. The fair value of the press at inception was ₹16,00,000, and its estimated economic life was three years. The agreement requires Orion to pay three annual rentals of ₹6,00,000 each, payable on 31 March every year. There is no estimated residual value accruing to the lessor. The internal rate of return implicit in the lease is 10% per annum. The relevant present value factors at 10% are 0.9091, 0.8264 and 0.7513 for years one, two and three respectively. Prism incurred ₹48,000 towards legal documentation and commission specifically while negotiating and arranging the lease. The company has adopted a policy of charging such lessor initial direct costs to the Statement of Profit and Loss immediately. Separately, Orion is developing a proprietary industrial-control software package. During April to June 2026, it incurred ₹5,40,000 on original scientific and technical investigation. Further expenditure of ₹4,80,000 was incurred between July and September while the project was still being assessed and the recognition conditions had not been demonstrated. On 1 October 2026, technical feasibility, intention and ability to complete and use the software, probable future economic benefits, availability of resources and reliable measurement of attributable expenditure were demonstrated together. Additional development expenditure of ₹12,00,000 was incurred from October to January. The software became available for use on 1 February 2027. Its estimated useful life is four years. There is no third-party purchase commitment or active market expected to exist at the end of its useful life. The companies require advice on lease accounting and the carrying amount of the internally generated intangible asset at 31 March 2027.

Calculate the present value of the minimum lease payments at the commencement of the lease from the lessor's perspective, using the internal rate of return implicit in the lease.

1. ₹14,92,080 (correct answer)
2. ₹16,36,380
3. ₹15,67,200
4. ₹13,56,420

Answer: A — ₹14,92,080

Working. Year 1 PV = ₹6,00,000 × 0.9091 = ₹5,45,460. Year 2 PV = ₹6,00,000 × 0.8264 = ₹4,95,840. Year 3 PV = ₹6,00,000 × 0.7513 = ₹4,50,780. Total PV of minimum lease payments = ₹5,45,460 + ₹4,95,840 + ₹4,50,780 = ₹14,92,080.

Explanation. The present value is calculated by discounting each annual minimum lease payment at the implicit rate of 10%. The three discounted amounts are ₹5,45,460, ₹4,95,840 and ₹4,50,780, aggregating to ₹14,92,080. The undiscounted rental total of ₹18,00,000 is not the present value. Applying the first-year factor to every rental also ignores the different payment dates.

Where it goes wrong. Adding the three nominal rentals without discounting, or applying the same discount factor to payments due on different dates.

Authority. AS 19 (interest rate implicit in the lease and present value of minimum lease payments; paragraph: check)

Question 2 · 2 marks · Leases · medium

How should Prism classify the lease of the production press under AS 19?

1. Operating lease because legal ownership remains with Prism.
2. Finance lease because the lease term covers the asset's economic life. (correct answer)
3. Operating lease because rentals are payable annually.
4. Finance lease only if the lessee receives legal ownership.

Answer: B — Finance lease because the lease term covers the asset's economic life.

Working. Economic life of production press = 3 years. Lease term = 3 years. Lease term therefore covers the entire estimated economic life. This is an indicator that substantially all risks and rewards incidental to ownership are transferred. Classification: Finance lease.

Explanation. AS 19 classifies a lease by considering whether substantially all risks and rewards incidental to ownership are transferred. A lease term covering the entire three-year economic life is an indicator of a finance lease. Legal ownership remaining with the lessor does not by itself establish an operating lease. Similarly, annual payment frequency does not determine the classification.

Where it goes wrong. Treating legal ownership or the frequency of lease rentals as the decisive classification factor.

Authority. AS 19 (indicators and classification of finance leases; paragraph: check)

Question 3 · 2 marks · Leases · medium

What amount should Prism charge to the Statement of Profit and Loss for the lessor's initial direct costs in the current period, considering its stated accounting policy?

1. Add ₹48,000 to the production press's carrying amount.
2. Defer ₹48,000 as a separate lease liability.
3. Recognise ₹48,000 as an immediate expense. (correct answer)
4. Add ₹48,000 to the minimum lease payments.

Answer: C — Recognise ₹48,000 as an immediate expense.

Working. Initial direct costs incurred by Prism = ₹48,000. Accounting policy elected by Prism = immediate recognition in Statement of Profit and Loss. Current-period expense = ₹48,000.

Explanation. Under AS 19, initial direct costs incurred by a lessor in arranging a finance lease may either be recognised immediately in the Statement of Profit and Loss or allocated against finance income over the lease term. Prism has expressly adopted immediate recognition. Accordingly, the entire ₹48,000 is charged in the current period. The asset-related treatment applicable to the lessee should not be substituted.

Where it goes wrong. Applying the lessee's initial direct cost treatment to the lessor or ignoring the stated accounting policy.

Authority. AS 19 (accounting for initial direct costs in the books of the lessor; paragraph: check)

Question 4 · 2 marks · Intangible Assets · hard

What should be the carrying amount of the internally generated software intangible asset in Orion's books as at 31 March 2027?

1. ₹10,50,000
2. ₹12,00,000
3. ₹16,80,000
4. ₹11,50,000 (correct answer)

Answer: D — ₹11,50,000

Working. Research expenditure = ₹5,40,000; expense when incurred. Development expenditure before recognition conditions were demonstrated = ₹4,80,000; expense when incurred. Capitalisable development expenditure from 1 October = ₹12,00,000. Residual value = Nil. Amortisation for February and March = ₹12,00,000 ÷ 4 years × 2/12 = ₹50,000. Carrying amount at 31 March 2027 = ₹12,00,000 − ₹50,000 = ₹11,50,000.

Explanation. Research expenditure and development expenditure incurred before the recognition conditions are demonstrated are charged to expense and cannot subsequently be reinstated. Only the ₹12,00,000 incurred after 1 October is capitalised. The residual value is presumed to be nil because neither exception in AS 26 applies. Amortisation starts when the software is available for use on 1 February, giving two months' amortisation of ₹50,000 and a closing carrying amount of ₹11,50,000.

Where it goes wrong. Capitalising pre-recognition expenditure, reinstating research costs, assuming a positive residual value without the required basis, or amortising before the asset is available for use.

Authority. AS 26 (research phase, development phase, cost of internally generated intangible assets and residual value; paragraphs: check)

Question 5 · 2 marks · Accounting for Investments · hard

Scenario. Citrine Textiles Limited holds 1,000 equity shares of Nova Weaves Limited as a current investment. The shares were acquired in two lots: 600 shares at ₹100 each and 400 shares at ₹115 each. At the time of a subsequent partial disposal, the market value was ₹126 per share, which was higher than the acquisition cost. Citrine sold 300 shares at ₹122 per share and incurred brokerage of ₹2 per share. The shares were held as an investment and not as stock-in-trade. The accountant proposes to use the acquisition price of the oldest lot to calculate the carrying amount of the shares disposed of. Determine the gain or loss to be recognised under AS 13.

What gain or loss should Citrine Textiles Limited recognise on the partial disposal of its current investment?

1. Gain of ₹4,200 (correct answer)
2. Gain of ₹4,800
3. Gain of ₹6,000
4. Gain of ₹3,600

Answer: A — Gain of ₹4,200

Working. Total acquisition cost = (600 × ₹100) + (400 × ₹115) = ₹60,000 + ₹46,000 = ₹1,06,000. Average carrying amount per share = ₹1,06,000 ÷ 1,000 = ₹106. Carrying amount allocated to 300 shares = 300 × ₹106 = ₹31,800. Net disposal proceeds = 300 × (₹122 − ₹2 brokerage) = ₹36,000. Gain = ₹36,000 − ₹31,800 = ₹4,200.

Explanation. AS 13 requires the carrying amount allocated to a part disposal of an individual investment to be determined using the average carrying amount of the total holding. The average cost is ₹106 per share, giving an allocated carrying amount of ₹31,800. Net disposal proceeds after brokerage are ₹36,000, producing a gain of ₹4,200. FIFO would be inappropriate for this investment holding; the cost-formula footnote concerns securities held as stock-in-trade.

Where it goes wrong. Using FIFO for an individual investment instead of the average carrying amount, or calculating the gain before deducting brokerage.

Authority. AS 13 (disposal of part of an individual investment and footnote on cost formulas for stock-in-trade; paragraph: check)

Question 6 · 2 marks · Construction Contracts · hard

Scenario. Halcyon Civil Projects Limited undertook a fixed-price construction contract on 1 April 2026 for the construction of a logistics terminal for Meridian Ports Limited. The original contract price was ₹18 crore. An agreed cost-escalation clause entitles Halcyon to an additional ₹1.20 crore. During execution, the customer approved variation work worth ₹90 lakh, which is probable to result in revenue and can be measured reliably. The contract also provides an early-completion incentive of ₹60 lakh. By 31 March 2027, the specified performance standards have been achieved and receipt of the incentive is probable and reliably measurable. Halcyon has also submitted a separate claim of ₹45 lakh, but customer acceptance is not considered probable. The contract outcome and estimated remaining costs can be measured reliably, and the economic benefits are expected to flow to Halcyon. The total estimated contract cost is ₹16 crore. Of the expenditure incurred by 31 March 2027, ₹5.60 crore relates to construction work actually performed. A further ₹1.20 crore was spent on materials delivered to the site but not yet installed or used, and ₹80 lakh was advanced to a subcontractor for work scheduled for the following period. The total estimated contract cost of ₹16 crore includes these amounts and the estimated future expenditure of ₹8.40 crore. Customer progress billings during the year amounted to ₹7 crore. In a separate transaction, Halcyon dispatched goods worth ₹56 lakh on consignment to a dealer on 1 February 2027. The dealer had sold 65% of these goods to third parties by 31 March 2027, with the remainder still held in stock. On 1 October 2026, Halcyon also sold industrial server units for a cash selling price of ₹12 lakh. The customer paid ₹6 lakh immediately and agreed to pay the remaining ₹6 lakh on 31 March 2027, together with interest at 12% per annum for the six-month credit period. The sale was completed on 1 October and collection was not considered uncertain.

What is the total contract revenue that Halcyon Civil Projects Limited should consider under AS 7 for the year ended 31 March 2027?

1. ₹20.10 crore
2. ₹20.70 crore (correct answer)
3. ₹21.15 crore
4. ₹19.80 crore

Answer: B — ₹20.70 crore

Working. Initial contract price = ₹18.00 crore. Add agreed cost escalation = ₹1.20 crore. Add approved variation = ₹0.90 crore. Add eligible early-completion incentive = ₹0.60 crore. Exclude separate claim of ₹0.45 crore because acceptance is not probable. Total contract revenue = ₹18.00 crore + ₹1.20 crore + ₹0.90 crore + ₹0.60 crore = ₹20.70 crore.

Explanation. Contract revenue comprises the initial agreed price and eligible escalation, variations, claims and incentives. The agreed escalation of ₹1.20 crore, approved variation of ₹0.90 crore and incentive of ₹0.60 crore meet the required probability and reliable-measurement conditions. The separate ₹45 lakh claim is excluded because customer acceptance is not probable. Accordingly, revenue is ₹20.70 crore.

Where it goes wrong. Including a claim merely because it has been quantified, or omitting an eligible incentive payment.

Authority. AS 7 (contract revenue, price escalation, variations, claims and incentive payments; paragraph: check)

Question 7 · 2 marks · Construction Contracts · hard

Using the cost-to-cost method, what contract revenue should Halcyon recognise for the year ended 31 March 2027?

1. ₹9.8325 crore
2. ₹6.3000 crore
3. ₹7.2450 crore (correct answer)
4. ₹8.2800 crore

Answer: C — ₹7.2450 crore

Working. Contract costs incurred for work performed = ₹5.60 crore. Unused materials = ₹1.20 crore; subcontractor advance for future work = ₹0.80 crore. These amounts are not included in the numerator for work performed. Estimated total contract cost = ₹16.00 crore. Stage of completion = ₹5.60 crore ÷ ₹16.00 crore × 100 = 35%. Revenue recognised = ₹20.70 crore × 35% = ₹7.245 crore.

Explanation. AS 7 measures the stage of completion under the cost-to-cost method by comparing costs incurred for work performed with estimated total contract costs. The ₹1.20 crore of unused materials and ₹80 lakh subcontractor advance relate to future activity and are not work performed at the reporting date. Thus the relevant numerator is ₹5.60 crore, not the full ₹7.60 crore expenditure. Applying 35% to contract revenue of ₹20.70 crore gives ₹7.245 crore.

Where it goes wrong. Using all cash expenditure or customer progress billings as the measure of work performed.

Authority. AS 7 (percentage completion method and determination of stage of completion; paragraph: check)

Question 8 · 2 marks · Revenue Recognition · medium

How much revenue should Halcyon recognise from the consignment transaction for the year ended 31 March 2027?

1. ₹56,00,000
2. ₹19,60,000
3. ₹47,60,000
4. ₹36,40,000 (correct answer)

Answer: D — ₹36,40,000

Working. Goods sent on consignment = ₹56,00,000. Proportion sold to third parties = 65%. Revenue recognised = ₹56,00,000 × 65% = ₹36,40,000. Unsold goods = ₹56,00,000 × 35% = ₹19,60,000; no revenue is recognised for this portion.

Explanation. Under AS 9, dispatching goods on consignment does not itself transfer the significant risks and rewards to the ultimate customer. Revenue is recognised when the consignee sells the goods to a third party. Since 65% of the goods valued at ₹56 lakh were sold, the recognised revenue is ₹36.40 lakh. Recognising the full dispatch value would wrongly treat unsold consignment stock as completed sales.

Where it goes wrong. Recognising revenue when goods are dispatched to the consignee instead of when they are sold to third parties.

Authority. AS 9 (recognition of revenue from consignment sales; paragraph: check)

Question 9 · 2 marks · Revenue Recognition · medium

What amounts should Halcyon recognise separately as sales revenue and interest revenue in respect of the server-unit sale by 31 March 2027?

1. Sales revenue ₹12,00,000; interest income ₹36,000 (correct answer)
2. Sales revenue ₹12,36,000; interest income Nil
3. Sales revenue ₹6,00,000; interest income ₹36,000
4. Sales revenue ₹12,00,000; interest income ₹72,000

Answer: A — Sales revenue ₹12,00,000; interest income ₹36,000

Working. Cash selling price = ₹12,00,000. Sales revenue recognised on 1 October 2026 = ₹12,00,000. Outstanding amount = ₹6,00,000. Interest period = 6 months. Interest income = ₹6,00,000 × 12% × 6/12 = ₹36,000. Separate recognition: sales revenue ₹12,00,000 and interest income ₹36,000.

Explanation. The sale of goods is recognised when the sale performance conditions are fulfilled and collection is not unreasonably uncertain. The cash selling price of ₹12 lakh is therefore recognised as sales revenue. Interest is a separate return from the use of enterprise resources and is recognised on a time-proportion basis considering the amount outstanding and applicable rate. Six months' interest on ₹6 lakh at 12% is ₹36,000.

Where it goes wrong. Including the interest component in sales revenue or calculating interest on the full cash selling price rather than the outstanding balance.

Authority. AS 9 (timing of recognition of sales revenue and time-proportion basis for interest; paragraph: check)

Question 10 · 2 marks · AS 24 Discontinuing Operations · hard

Scenario. On 31 January 2027, Northstar Publishing Limited's Board considered withdrawing from its regional printing operation. The operation has a separate production facility, employees, customer contracts and identifiable operating activities. Management has considered two possible courses: disposing of the entire operation as one business unit to an interested purchaser, or permanently discontinuing production and disposing of individual machines and other assets separately. The Board has asked the finance department to assess the accounting implications of the proposed withdrawal and the distinction between a sale of the operation and abandonment under AS 24.

Under AS 24 'Discontinuing Operations', what constitutes the 'initial disclosure event' that triggers mandatory disclosures in the financial statements?

1. The occurrence of the earlier of: entering into a binding sale agreement for substantially all assets, or the Board approving a detailed formal plan and making an announcement of the plan. (correct answer)
2. The date on which all operating assets are fully decommissioned or physical production completely ceases.
3. The passing of a special resolution by shareholders approving the discontinuance in a general meeting.
4. The end of the financial year in which the decision to discontinue was taken by management.

Answer: A — The occurrence of the earlier of: entering into a binding sale agreement for substantially all assets, or the Board approving a detailed formal plan and making an announcement of the plan.

Working. AS 24 paragraph 15 explicitly defines initial disclosure event as earlier of binding sale agreement or Board approval plus public announcement of detailed formal plan. Correct option is a.

Explanation. Under AS 24 paragraph 15, the initial disclosure event is the occurrence of one of the following, whichever occurs earlier: (a) the enterprise has entered into a binding sale agreement for substantially all of the assets attributable to the discontinuing operation; or (b) the enterprise's board of directors has both approved a detailed, formal plan for the discontinuance and made an announcement of the plan.

Where it goes wrong. Assuming board approval of a plan is sufficient to trigger discontinuing operation disclosure for an abandonment.

Authority. AS 24 Discontinuing Operations, Paragraph 13

Question 11 · 2 marks · Amalgamation of Companies · medium

Scenario. On 1 July 2026, Saffron Engineering Limited acquired the business of Loomworks Limited through an amalgamation. The arrangement does not satisfy all the conditions for an amalgamation in the nature of merger: only 86% of the face value of Loomworks' equity shares will become equity shares of Saffron, and part of the consideration will be discharged in cash. Accordingly, the amalgamation is in the nature of purchase. Saffron has decided to allocate the consideration to the identifiable assets and liabilities acquired on the basis of their agreed fair values at the date of amalgamation. The book values and agreed fair values of Loomworks' assets are as follows, in ₹ lakh: land and building, 18 and 22; plant and machinery, 15 and 14; inventory, 10 and 11; trade receivables, 8 and 7.5; and bank balance, 3 and 3. The liabilities taken over comprise trade payables of ₹9 lakh, 12% debentures of ₹5 lakh and a provision of ₹3 lakh. Saffron will issue 3,00,000 equity shares of ₹10 each, valued at ₹10 per share, to the shareholders of Loomworks. In addition, it will pay ₹4 lakh in cash to equity shareholders and ₹2 lakh to preference shareholders. Saffron will also discharge the debentures and other liabilities taken over. The transferor company's books contain a General Reserve of ₹3 lakh and an Investment Allowance Reserve of ₹2 lakh. The latter must retain its identity for a further three years under the relevant statutory requirement, and the conditions for recording it in Saffron's books have been complied with. Saffron has separately agreed to pay ₹1 lakh directly towards the liquidation expenses of Loomworks. The finance team must calculate the purchase consideration, the fair value of net identifiable assets and the resulting reserve balances.

What is the purchase consideration payable by Saffron Engineering Limited under AS 14?

1. ₹42 lakh
2. ₹37 lakh
3. ₹36 lakh (correct answer)
4. ₹30 lakh

Answer: C — ₹36 lakh

Working. Equity shares issued = 3,00,000 × ₹10 = ₹30,00,000. Cash paid to equity shareholders = ₹4,00,000. Cash paid to preference shareholders = ₹2,00,000. Purchase consideration = ₹30,00,000 + ₹4,00,000 + ₹2,00,000 = ₹36,00,000. Debentures assumed = ₹5,00,000, excluded. Liquidation expenses = ₹1,00,000, excluded.

Explanation. Under AS 14, purchase consideration comprises the aggregate of shares and other securities issued and cash or other assets paid by the transferee company to the shareholders of the transferor company. The equity-share issue of ₹30 lakh and cash payments of ₹6 lakh to shareholders are included. Debentures assumed and liquidation expenses paid directly are not payments to shareholders and are excluded.

Where it goes wrong. Adding assumed debentures or liquidation expenses to the amount paid to shareholders.

Authority. AS 14 (meaning and calculation of consideration for amalgamation; paragraph: check)

Question 12 · 2 marks · Amalgamation of Companies · hard

What is the amount of net identifiable assets acquired by Saffron after applying the agreed fair values to the assets and deducting the liabilities taken over?

1. ₹39.50 lakh
2. ₹41.50 lakh
3. ₹42.50 lakh
4. ₹40.50 lakh (correct answer)

Answer: D — ₹40.50 lakh

Working. Fair value of land and building = ₹22.00 lakh. Fair value of plant and machinery = ₹14.00 lakh. Fair value of inventory = ₹11.00 lakh. Fair value of trade receivables = ₹7.50 lakh. Bank balance = ₹3.00 lakh. Total fair value of assets = ₹57.50 lakh. Liabilities taken over = ₹9.00 lakh + ₹5.00 lakh + ₹3.00 lakh = ₹17.00 lakh. Net identifiable assets = ₹57.50 lakh − ₹17.00 lakh = ₹40.50 lakh.

Explanation. Under the purchase method, Saffron has elected to allocate the consideration to identifiable assets and liabilities using their agreed fair values at the amalgamation date. The aggregate fair value of assets is ₹57.50 lakh, and the liabilities taken over total ₹17 lakh. The resulting net identifiable assets are ₹40.50 lakh. Retaining the transferor's old book values would ignore the agreed fair-value allocation method.

Where it goes wrong. Using the transferor's book values instead of the agreed fair values, or omitting a liability taken over.

Authority. AS 14 (purchase method and allocation of consideration to identifiable assets and liabilities; paragraph: check)

Question 13 · 2 marks · Amalgamation of Companies · hard

After accounting for liquidation expenses paid directly by Saffron, what amount of Capital Reserve should appear in its books?

1. ₹3.50 lakh (correct answer)
2. ₹4.50 lakh
3. ₹2.50 lakh
4. ₹5.50 lakh

Answer: A — ₹3.50 lakh

Working. Net identifiable assets acquired = ₹40.50 lakh. Purchase consideration = ₹36.00 lakh. Capital Reserve before liquidation expenses = ₹40.50 lakh − ₹36.00 lakh = ₹4.50 lakh. Liquidation expenses paid by Saffron = ₹1.00 lakh. Closing Capital Reserve = ₹4.50 lakh − ₹1.00 lakh = ₹3.50 lakh.

Explanation. The fair value of net identifiable assets acquired exceeds the purchase consideration by ₹4.50 lakh, resulting in Capital Reserve. Where the transferee pays the transferor's liquidation expenses, AS 14 requires the amount to be debited to Goodwill or Capital Reserve, as applicable. Since the transaction produces Capital Reserve, the ₹1 lakh expense reduces it to ₹3.50 lakh.

Where it goes wrong. Ignoring the liquidation expenses or adding them to purchase consideration instead of charging the resulting Capital Reserve.

Authority. AS 14 (purchase method, resulting Capital Reserve and liquidation expenses; paragraph: check)

Question 14 · 2 marks · Amalgamation of Companies · hard

How should Saffron account for Loomworks' Investment Allowance Reserve and General Reserve under the purchase method?

1. Carry only the ₹4 lakh Capital Reserve; no statutory reserve is retained.
2. Carry Investment Allowance Reserve ₹2 lakh and a separate debit Amalgamation Adjustment Reserve ₹2 lakh. (correct answer)
3. Carry General Reserve ₹3 lakh and Investment Allowance Reserve ₹2 lakh without adjustment.
4. Offset Investment Allowance Reserve against Capital Reserve without a separate adjustment line.

Answer: B — Carry Investment Allowance Reserve ₹2 lakh and a separate debit Amalgamation Adjustment Reserve ₹2 lakh.

Working. Investment Allowance Reserve to be maintained = ₹2,00,000. Credit Investment Allowance Reserve = ₹2,00,000. Corresponding debit to Amalgamation Adjustment Reserve = ₹2,00,000. Both are presented as separate line items. General Reserve of ₹3,00,000 is not preserved under the purchase method. The Capital Reserve arising from the acquisition is separately ₹3,50,000 after liquidation expenses.

Explanation. Under the purchase method, the identity of transferor reserves is generally not preserved. An exception applies to statutory reserves whose identity must continue under the relevant statute, provided its recording conditions are complied with. The statutory reserve is retained in the same form, with a corresponding debit to a separate Amalgamation Adjustment Reserve account. The transferor's General Reserve does not retain its identity.

Where it goes wrong. Either eliminating the statutory reserve despite the continuing statutory requirement or retaining non-statutory reserves under the purchase method.

Authority. AS 14 (adjustments to reserves on amalgamation in the nature of purchase and statutory reserves; paragraph: check)

Question 15 · 2 marks · AS 3 Cash Flow Statements · medium

Scenario. Asha Machine Tools Limited, a manufacturing company, is preparing its Cash Flow Statement for the year ended 31 March 2027. During the year, it paid income taxes, received interest on bank deposits, received dividends on equity investments, paid interest on borrowings and distributed dividends to its shareholders. The finance department is required to classify the transactions in the Cash Flow Statement under AS 3, taking account of the distinction between a financial enterprise and a non-financial enterprise.

For Asha Machine Tools Limited (a non-financial enterprise), what is the correct classification of interest received on bank deposits and interest paid on borrowings under AS 3?

1. Interest received is operating cash inflow; interest paid is operating cash outflow.
2. Interest received is financing cash inflow; interest paid is investing cash outflow.
3. Interest received is investing cash inflow; interest paid is financing cash outflow. (correct answer)
4. Interest received is investing cash inflow; interest paid is operating cash outflow.

Answer: C — Interest received is investing cash inflow; interest paid is financing cash outflow.

Working. Manufacturing company = non-financial enterprise. Interest received = Investing cash inflow. Interest paid = Financing cash outflow. Correct option is c.

Explanation. Under AS 3 'Cash Flow Statements', for a manufacturing / non-financial enterprise, cash flows arising from interest received on bank deposits represent cash returns on investments and are classified as investing activities. Interest paid represents the cost of obtaining financial resources and is classified as financing activities. Only for financial enterprises is interest received/paid classified under operating activities.

Where it goes wrong. Treating interest received or paid as operating cash flows, which is only applicable to financial enterprises.

Authority. AS 3 Cash Flow Statements, Paragraphs 30-33