IFRS
IFRS Convergence in India has gained significant momentum due
to the issuance of the Press Announcement by the Ministry of Corporate Affairs
(MCA) in January and March 2010 and subsequent clarifications issued in May
2010.
The Institute of Chartered Accountants of India (ICAI), on
its part, has issued 38 exposure drafts of ‘Ind-AS’ — i.e., the converged
accounting standards, in line with the IFRSs.
ICAI has also issued a document identifying areas where
provisions of the Companies Act, 1956 (‘the Act’) need to be changed to bring it
in line with IFRS. This article attempts to discuss those areas (listed below)
and the recommendations proposed by ICAI :
-
Proposed dividends
-
Accounting of
depreciation
-
Restatement of prior
years’ numbers
-
Presentation of financial
statements
-
Financial instruments and
preliminary expenses
-
Definition of ‘Control’
-
Accounting for business
combinations
Proposed dividends :
Paras 12 and 13 of IAS 10 Events after the reporting
period state that proposed dividend does not meet the criteria of a present
obligation in IAS 37 (Provisions, Contingent Liabilities and Contingent Assets)
and hence it shall not be recognised as a liability, but disclosed in
notes.
The Company Law department via circular no. 3/124/75-CL-V,
dated November 22, 1976 had expressed its views that proposed dividends
should be shown as ‘Current liabilities and provisions’ and part I of the
Schedule VI also requires proposed dividends to be shown as ‘Current liabilities
and provisions’.
Actions required to comply with IFRS :
The said Circular should be suitably amended. Also, Schedule
VI should be revised (ICAI has already submitted the proposed revisions to
Schedule VI to the Ministry of Corporate Affairs).
Other matters to be considered :
Under the present provisions of the Act, profits reported as
per books of account can be utilised for declaration of dividend, provided
adequate depreciation as required by the Act, has been provided for.
Under IFRS there are situations (illustrated below) where the
Company has to record unrealised gains/losses in the financial statements.
1. Unrealised gains/losses on fair value of equity
investments classified as fair value through profit and loss
account and derivatives
2. Revenue recognised during the construction period for a
public private service concession arrangement.
Though, in such situations, the Company would have reported
profits which can be utilised for dividend, the Company may not have sufficient
cash flows to fund the same and at the same time maintain adequate liquidity in
the system.
Similarly, there are situations where the Company has
received the cash flows, however is not permitted to recognise revenue, for
example,
1. For real estate sale contracts, revenue is generally
recognised on transfer of possession of property as against the current practice
of recognising revenue on a proportionate completion basis. Though, in such
situations, the Company would have sufficient liquidity, since collections are
made on achievement of individual milestones, the Company would not have
sufficient profits, since all revenue will be recognised only at the end on
transfer of possession of the property.
Further, under IFRS there are certain gains/losses which are
not accounted in the profit and loss account, but in the ‘other comprehensive
income’ statement, such as :
1. Mark to market of derivatives designated as hedging
instruments (for all effective hedges)
2. Fair value changes of financial instruments classified
as available for sale securities
Regulators will need to consider, whether such items need to
be adjusted to compute profit available for distribution as dividends to
shareholders.
Accounting of depreciation :
1. Component accounting :
Para 43 (read with BC 26 and 27) of IAS 16 ‘Property,
Plant and Equipment’ (PPE) states that each part of an item of PPE
with a cost that is significant in relation to the total cost of the item shall
be depreciated separately. For example, the engine of an aircraft needs
to be separately depreciated from its body.
The Act, on the other hand, does not indicate any such
requirement.
2. Depreciation rates :
Paras 50 and 53 of IAS 16 ‘Property, Plant and Equipment’
state that the depreciable amount of an asset, determined after reducing its
residual value from its cost, shall be allocated on a systematic basis over
its useful life. Further, para 51 requires annual review of useful life
and residual value.
The Act, under Schedule XIV, prescribes minimum rates of
depreciation for different classes of assets based on shift working and does not
recognise allocation of depreciation based upon the useful life of an asset and
deduction of residual value of the asset from its cost for arriving at the
depreciable amount. Further, S. 205(2) and S. 205(5) of the Act permits
depreciation to be provided either for 100% of the cost of the asset or 95% of
the cost of the asset and also allows the Central Government to approve any
basis of providing depreciation on assets for which no rate has been laid down
in the Act.
3. Depreciation
method?:
Paras 60 to 62 of IAS 16 ‘Property, Plant
and Equipment’ state that the depreciation method used shall reflect the
pattern in which the asset’s future economic benefits are expected to be
consumed by the entity. The depreciation method applied shall be reviewed
annually. Further, it allows ‘units of production method’ as a method of
depreciation along with ‘straight-line method (SLM)’ and ‘diminishing balance
method (WDV)’.
The Act, under Schedule XIV, specifies
depreciation rates as per SLM and WDV methods only.
Actions required to comply with IFRS?:
Schedule XIV should be revised. It should
prescribe only industry-specific guidelines for indicative rates. These shall
serve as industry-specific benchmarks. It should state that the manner of
computing depreciation on assets, whether specified in the Schedule or not,
shall be as per the requirements of the accounting standards prescribed by the
Central Government referred to in S. 211(3C) of the Act. These shall be the
general guidelines and used as rebuttable presumptions.
The Ministry of Corporate Affairs has
already issued a draft Schedule XIV which is placed on their website. ICAI is
involved in the process of revising the same to make it consistent with IFRS.
The proviso (a), (b) and (c) u/s.205(1) and
item 3(iv) of Schedule VI-PART II — that recognises non-provision of
depreciation — should be repealed. Also, clauses (b), (c) and (d) of S. 205(2)
and S. 205(5) — that permit 95% of the cost to be depreciated and allows the
Central Government to approve any basis — should be repealed.
Restatement of prior years’ numbers:
Para 19 of IAS 8 Accounting policies,
changes in accounting estimates and errors requires an entity to apply any
changes in accounting policies retrospectively. As per para 22, when a change
in accounting policy is applied retrospectively, the entity shall adjust the
opening balance of each affected component of equity for the earliest prior
period presented and the other comparative amounts disclosed for each prior
period presented as if the new accounting policy had always been applied.
Similarly, para 42 requires correction of
material prior period errors retrospectively by restating the prior period
numbers. Further, para 46 requires exclusion of correction of a prior period
error from profit or loss for the period in which error is discovered.
As per the Circular No. 1/2003, dated
January 13, 2003 issued by the erstwhile Company Law Board, a company could
reopen and revise its accounts even after their adoption in the annual general
meeting only to comply with technical requirements of taxation laws and
of any other law to achieve the object of exhibiting true and fair view. It
does not permit revision for changes in accounting policies or prior period
errors. All such adjustments and corrections have to be included in the current
year’s profit or loss.
Actions required to comply with IFRS:
The Circular issued by the Company Law
Board should be revised to allow re-statement of the numbers in order to comply
with the requirements of IFRS.
The Circular should further state that the
financial statements presented shall be deemed to be in agreement with the
books of account to the extent of such re-statement for all such periods.
It should also allow the amount of net
profit, assets and liabilities as per the approved audited accounts for all
such periods to be considered as final for the purpose of the computation of
the total managerial remuneration payable u/s.198, u/s.199 and u/s.349 of the
Act or any provision u/s. 205 of the Act relating to declaration of any
dividend or any other such provision of the Act i.e., the managerial
remuneration, dividend paid as per profits reported in the prior years need not
change because of restatements in any of the subsequent periods.
Presentation of financial statements:
The existing form of balance sheet
(statement of financial position) set out in part I of Schedule VI and the
requirements as to Profit and loss account set out in part II of Schedule VI do
not comply with the requirements set out in IAS 1 Presentation of financial
statements regarding the presentation of financial statements, as mentioned
below?:
1. A
separate statement of changes in equity (SOCIE) presenting all owner
changes in equity is not permitted under the Act
2. The
concept of Comprehensive Income and Other Comprehensive Income (OCI)
is not recognised in the Act
3. Distinction
between owner changes in equity
(SOCIE) and non-owner changes in equity
(OCI) is not recognised in the Act
4. As
per para 39 of IAS 1, when an entity applies an accounting policy
retrospectively or makes a retrospective restatement of items in its financial
statements, it shall present, as a minimum, three statements of financial
position (as at the end of the current period, the end of the previous period
and the beginning of the earliest comparative period).
The Act does not mandate presentation of a
third statement of financial position.
5. As
per para 60 of IAS 1 Presentation of Financial Statements, an entity shall
present current and non-current assets and liabilities in its statement of
financial position except when a presentation based on liquidity provides
information that is reliable and more relevant. For example, in case of
long-term borrowings, the amount repayable within 12 months from the reporting
date shall be presented as current and the balance as non-current liabilities.
The form of balance sheet set out in Part I
of Schedule VI does not consider current/ non-current classification of
assets/liabilities.
6. Extraordinary
items?:
As per para 87 of IAS 1, an entity shall
not present any items of income or expense as extraordinary items.
Whereas, as per part II(3)(xii)(b) of the
Schedule VI, the profit and loss account shall disclose profits or losses in
respect of transactions of a kind, not usually undertaken by the company or
undertaken in circumstances of an exceptional or non-recurring nature,
if material in amount.
Actions required to comply with IFRS:
Schedule VI would need to be revised.
Further regulators will also need to consider that the companies in India would
be converging with IFRS in a phased manner, with only approximately 500+
companies converging from 1 April 2011 (phase 1). Hence, regulators may need to
consider two parts of Schedule VI — one that complies with the requirements of
IFRS and other which will be applicable to companies either covered in later
phases or exempt from convergence (i.e., companies not covered in any of the
phases).
Financial instruments and preliminary
expenses?:
1. Substance
v. legal form?:
As per para 18 of IAS 32 Financial
Instruments: Presentation, substance of a financial instrument, rather than its
legal form, governs its classification in the entity’s balance sheet. For
example, compulsorily convertible debenture is an equity instrument and
compulsorily redeemable preference share is a financial liability.
However, the Act mandates classification
based on legal form only i.e., as per S. 86 of the Act, share capital shall be
of two kinds — equity and preference.
2. Dividends
on capital designated as financial liability?:
As per IFRS, interest, dividends, losses
and gains relating to a financial liability shall be recognised as income or
expense in profit or loss. Distributions to holders of an equity instrument
shall be debited directly to equity.
However, as per the Act, dividend on all
types of capital is to be presented only as an appropriation of profit.
3. Transaction
costs?:
As per IFRS, transaction costs of an equity
transaction shall be accounted for as a deduction from equity, net of any
related income tax benefit.
However, as per the Act, these have to be
presented as Miscellaneous Expenditure on the assets side of the balance sheet.
They can also be written off against the securities premium account, as per S.
78(2)(c) of the Act.
4. Premium
on redemption of preference shares?:
As per IFRS, gains and losses associated
with redemptions or refinancings of financial liabilities are recognised in
profit or loss.
However, proviso (C) u/s.80(1) and u/s.78(2)(d)
of the Act permits writing off premium on redemption of preference shares
against the securities premium account.
Similarly, losses and expenses relating to
other financial liabilities like debentures may be allowed to be written off
against securities premium as per S. 78(2)(d) of the Act, but shall be
recognised in the profit or loss as per para 36 of IAS 32.
5. Preliminary
expenses?:
As per para 69 of IAS 38 Intangible Assets,
expenditure on start-up activities shall be recognised as an expense when
incurred. Start-up costs may consist of establishment costs such as legal and
secretarial costs incurred in establishing a legal entity.
However, the Act permits such costs to be
carried forward as Miscellaneous Expenditure (part I of the Schedule VI) or be
written off against securities premium account [S. 78(2)(b) of the Act].
Actions required to comply with IFRS:
Proviso (C) u/s.80(1) and u/s.78(2)(b), (c)
and (d), regarding utilisation of securities premium, should be suitably
amended.
Definition of ‘Control’:
Para 4 of IAS 27 Consolidated and Separate
Financial Statements define ‘control’ as the power to govern the financial and
operating policies of an entity so as to obtain benefits from its activities.
Further, as per para 13 of IAS 27, control is presumed to exist when the parent
owns, directly or indirectly through subsidiaries, more than half of the voting
power of an entity. Also, as per para 14 of IAS 27, the existence and effect of
potential voting rights that are currently exercisable or convertible,
including potential voting rights held by another entity, are considered when
assessing whether an entity has the power to govern the financial and operating
policies of another entity.
However, as per S. 4(1) of the Act, a
company shall be deemed to be a subsidiary of another if, but only if:
(a) that
other controls the composition of its Board of directors
(b) that
other?:
(ii) where
the first-mentioned company is any other company, holds more than half in
nominal value of its equity share capital;
(c) the
first-mentioned company is a subsidiary of any company which is that other’s
subsidiary.
Hence, the definition of ‘control’ as per
IAS 27 is wider in scope than the definition as per S. 4(1) of the Act.
Further, para 4 of IAS 27 defines
‘subsidiary’ as an entity including an unincorporated entity, such as
partnership, that is controlled by another entity (known as parent). However,
as per S. 4(1), only a company can be a subsidiary of another company.
Actions required to comply with IFRS:
The Act should be suitably amended to
facilitate preparation of Consolidated Financial Statements under the
principles prescribed under IFRS. However, the definition of a subsidiary
company presently given u/s.4 of the Act should not be used as it is rule-based
and different from AS 27 Consolidated and Separate Financial Statements. The
definition should be revised to be in line with the definition of ‘control’ as
under IAS 27.
Accounting for business combinations:
As per para 18 of IFRS 3 Business
Combinations, the acquirer shall measure the identifiable assets acquired and
the liabilities assumed at their acquisition-date fair value.
However, in accordance with clause (vi)
u/s.394(1) of the Act, the order of the Court may provide for such incidental,
consequential and supplemental matters concerning mergers and acquisitions
which may not be as per the recognition, measurement and disclosure
requirements of IFRS.
Further, as per IFRS the acquisition date
is to be factually determined i.e., the date on which an acquirer obtains
control of the acquiree, which is generally the date on which the acquirer
legally transfers the consideration, acquires the assets and assumes the
liabilities of the acquiree.
Conversely, the order of the Court, in accordance
with the powers granted under the clause (vi) u/s.394(1) of the Act, may
provide for any other date as the acquisition date.
Actions required to comply with IFRS:
Clause (vi) u/s.394(1) should be amended to
state that such incidental, consequential and supplemental matters shall not be
in conflict with the requirements of the accounting standards.
The Proviso u/s.391(2) should be amended to
require a certificate by the company that the scheme is not in conflict with
the requirements of the accounting standards. This is now required by SEBI for
listed companies, as per amendment to clause 24 of the Equity Listing
Agreement.
India has come a long way along the journey
of convergence with IFRS, increasing the confidence about the transition. The
regulators need to address some of these important matters to ensure a smooth
transition and ensure that an entity that complies with IFRS should not be in
non-compliance with other regulatory requirements in that process.
Implementation of the Converged Accounting Standards in the absence of
corresponding changes in the statute will dilute the implementation/convergence
process.
