Schedule III to the Companies Act 2013 (“the Act”) prescribes the format for the financial statements of a Company registered under the Act. The Schedule III provides the structure in which the items of the financial statements are required to be presented. In addition to the requirements as prescribed by the Schedule III, the relevant Accounting Standards prescribe the norms for recognition, measurement and disclosure of the items covered under the said Accounting Standards.
Based on the review of financial statements of a number of Companies, 10 common reporting errors made by the Companies in respect of one of the major items of a Balance sheet i.e. Property, Plant and Equipment (PPE) are listed out in this article.
Page Contents
- 10 common errors in the reporting of Property, Plant and equipment in the financial statements
- 1. Classification Confusion:
- 2. Lack of Clarity on Asset Titles:
- 3. Failure to Capitalize Expenditure:
- 4. Neglecting Spare Parts:
- 5. Improper Capitalization of Interest:
- 6. Ignoring Component Identification:
- 7. Inaccurate Depreciation:
- 8. Non-Disclosure of Depreciation Methods:
- 9. Neglecting Retired Assets:
- 10. Lack of Details on Retired Assets:
10 common errors in the reporting of Property, Plant and equipment in the financial statements
1. Classification Confusion:
Proper classification is key, but companies often fail to follow the prescribed order for disclosing Property, plant and equipment (PPE) items. The order in which these are to be disclosed in accordance with Schedule III is not followed. Classification of the items into Owned and Leased, and Tangible and Intangible is not made. Tangible and intangible assets as required under the Schedule III are required to be classified in the prescribed order as under –
|
Property, Plant and Equipment / Tangible Assets |
Intangible assets |
| (a) Land | (a) Goodwill |
| (b) Buildings | (b) Brands/Trademarks |
| (c) Plant and Equipment | (c) Computer Software |
| (d) Furniture and Fixture | (d) Mastheads and publishing titles |
| (e) Vehicles | (e) Mining rights |
| (f) Office equipment | (f) Copyrights and patents and other intellectual property rights, services and operating rights |
| (g) Others (to be specified by the nature) | (g) Recipes, formulae, models, designs and prototypes |
| (h) Licenses and franchise | |
| (k) Others (to be specified by the nature) |
Whether the note given in respect of the above row wise or column wise, the above order should be maintained while reporting, however the above order is not followed while presenting these items in the financial statements.
Also Read: Rates of depreciation as per companies act 2013
2. Lack of Clarity on Asset Titles:
Companies sometimes overlook disclosing pending formalities or unclear titles when replacing existing PPE. The failure to derecognize and remove old assets from the PPE block can lead to inaccuracies.
If the assets are not registered in the name of the Company, the fact should be stated. Similarly, a new asset is added by replacing an existing asset i.e. new furniture purchase and the old discarded. But on discarding of the old furniture, the same is not removed from the block of the PPE and though the PPE is not in use and discarded, the same continues in the block of assets.
3. Failure to Capitalize Expenditure:
Capital expenditures that meet recognition criteria, indicating future economic benefits and reliable measurement, are occasionally written off as expenses instead of being capitalized as they should be.
4. Neglecting Spare Parts:
Items of Standby equipment and Service equipment are accounted as Property, Plant and Equipment but the Spare parts of are not, even if separate payment is made for them and erroneously classified as inventories.
The unique spare parts of a Plant or Equipment, which can be used only for that particular plant are in the nature of insurance items, which can be identified separately and are purchased at the time of the acquisition of such plant and equipment. However, the same is taken as spares parts instead of separately recognizing as PPE.
5. Improper Capitalization of Interest:
Interest is capitalised even when the PPE is not a qualifying asset for which there is a borrowing and against which the said PPE is purchased. The criteria for qualifying assets i.e. an asset requiring a significant period of time for completion (significant time usually is to be 12 months) is not considered while capitalizing the interest. If any asset takes more than 12 months i.e. significant time, then only the interest is required to be capitalised. In many cases it is observed that, the above norm is not followed and the interest is capitalised even when the asset is not taking significant time in its construction/preparation.
Disclosure of Component of interest capiltalised and included in the property, Plant and Equipment is not made properly. Especially, in Cash flow Statement, the Interest capitalised is included under the classification of investment activities and included in the cost of the acquisition of property, plant and equipment, which is incorrect. The Interest capitalised should be disclosed in financing activities in the cash flow statement.
6. Ignoring Component Identification:
Identifiable components of property, plant and equipment are not accounted for separately depending on the useful life.
The Accounting Standard requires that where the separate identifiable component having a different estimated useful life can be identified, the same should be accounted separately. Such
Identification of a component having a different useful life is not identified and accounted as a separate item.
Measurement model followed by the Companies is not disclosed i.e. Whether Cost method or replacement method is used in many financial statements.
7. Inaccurate Depreciation:
Depreciation is charged even on the residual values as per the estimated useful life as prescribed in the Schedule II. The schedule prescribes that the residual value of an asset not be more than 5% of the original cost of the asset. It means that the asset can be depreciated at the most up to 95% of its original cost. The residual value of at least 5% is to be maintained. It is noted that many times the entire assets are depreciated which is not as per the rates prescribed under the Schedule II of the Act.
8. Non-Disclosure of Depreciation Methods:
(i) Depreciation method used i.e. Straight line or Written down value, or production units basis is not disclosed.
(ii) If the estimated useful life of the asset is different from as given in Schedule II, then such estimated useful life which is different from the above, and the basis of estimation is not disclosed as required.
9. Neglecting Retired Assets:
Assets retired from active use are not separately disclosed as “Assets retired from active use and held for disposal”. Sometimes assets are not used but depreciation is not provided even though they are ready for use and not retired from the active use.
10. Lack of Details on Retired Assets:
Details about the life of assets retired from active use may be omitted in notes, hindering comprehensive financial reporting.
Conclusion:
In conclusion, the aforementioned errors highlight the critical need for vigilance in financial statement preparation, particularly concerning Property, Plant, and Equipment (PPE). To align with prescribed guidelines and ensure compliance with the established financial framework, companies must exercise utmost care in their reporting.
Accurate reporting of PPE is paramount for transparent financial statements. Companies are urged to make a concerted effort to steer clear of these common pitfalls. This includes meticulous adherence to classification rules, diligent capitalization of expenditures, and precise documentation of asset details. By doing so, businesses can significantly enhance the accuracy and credibility of their financial reporting, fostering trust and confidence among stakeholders.
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very good article sir..