Introduction
The application of the deemed cost
exemption to fixed assets and intangible assets has led to peculiar issues and
challenges. Let us first consider the wording of the exemption followed by the
clarifications provided by the Ind AS Transition Facilitation Group (ITFG).
Paragraph D7AA of Ind AS 101
D7AA – Where there is no change in
its functional currency on the date of transition to Ind ASs, a first-time
adopter to Ind ASs may elect to continue with the carrying value for all of its
property, plant and equipment as recognised in the financial statements as at
the date of transition to Ind ASs, measured as per the previous GAAP and use
that as its deemed cost as at the date of transition after making necessary
adjustments for decommissioning liabilities. If an entity avails the option, no
further adjustments to the deemed cost of the property, plant and equipment so
determined in the opening balance sheet shall be made for transition
adjustments that might arise from the application of other Ind ASs. This option
can also be availed for intangible assets covered by Ind AS 38, Intangible
Assets and investment property covered by Ind AS 40 Investment Property.
Salient features of the exemption
1. The
entity can continue with the carrying amount under previous GAAP for all of its
fixed assets, investment property and intangible assets after making necessary
adjustment for decommissioning liabilities. The ITFG opined that if a first
time adopter chooses the D7AA option, then the option of applying this on
selective basis to some of the items of property, plant and equipment and using
fair value for others is not available.
2. The exemption is
available to an entity only where there is no change in the functional currency
on the date of transition to Ind AS.
3. No further adjustments to
the deemed cost so determined in the opening balance sheet shall be made for
transition adjustments that might arise from the application of other Ind ASs
4. The exemption is an
additional option under Ind AS. An entity may choose not to use this option,
and instead use other first time adoption options. For example, in the case of
fixed assets, an entity may choose to:
a. state retrospectively all
the fixed assets in accordance with Ind AS principles
b. selectively choose to
fair value some fixed assets and use Ind AS principles for other fixed assets.
ITFG Clarification Bulletin 3 – Issue 9
The Company has chosen to continue
with the carrying value for all of its property, plant and equipment as recognised
in the financial statements as at the date of transition to Ind AS, measured as
per the previous GAAP. The Company has recorded capital spares in its previous
GAAP financial statements as a part of inventory, which under Ind AS would
qualify to be classified as fixed assets. Would such a reclassification be
required under Ind AS? Would such a reclassification taint the deemed
cost exemption?
As per paragraph D7AA, once the
company chooses previous GAAP as deemed cost as provided in paragraph D7AA of Ind
AS 101, it is not allowed to adjust the carrying value of property, plant and
equipment for any adjustments other than decommissioning costs. In this case, a
question arises whether the company may capitalise spares as a part of
property, plant and equipment on the date of transition to Ind AS. It may be
noted deemed cost exemption as the previous GAAP is in respect of carrying
value of property, plant and equipment capitalised under previous GAAP on the
date of transition to Ind AS. The ITFG opined that this condition does not
prevent a company to recognise an asset whose recognition is required by Ind AS
on the date of transition. The ITFG opined that the Company should recognise
‘capital spares’ if they meet definition of PPE as on the date of transition,
in addition to continuing carrying value of PPE as per paragraph D7AA of Ind AS
101.
ITFG Clarification Bulletin 5 – Issue 4
The Company has chosen to continue
with the carrying value for all of its property, plant and equipment as
recognised in the financial statements as at the date of transition to Ind AS,
measured as per the previous GAAP. The company has previously taken a loan for
construction of fixed assets and paid processing fee thereon. The entire
processing fees on the loan were upfront capitalised as part of the relevant
fixed assets as per the previous GAAP. The loan needs to be accounted for as
per amortised cost method in accordance with Ind AS 109, Financial
Instruments. Whether the Company is required to adjust the carrying amount
of fixed assets as per the previous GAAP to reflect accounting treatment of
processing fees as per Ind AS 109?
When the option of deemed cost
exemption is availed for property, plant and equipment under paragraph D7AA of
Ind AS 101, no further adjustments to the deemed cost of the property, plant
and equipment shall be made for transition adjustments that might arise from
the application of other Ind AS. Thus, once the entity avails the exemption
provided in paragraph D7AA, it will be carrying forward the previous GAAP
carrying amount.
Paragraph 10 of Ind AS 101, inter
alia, provides that Ind AS will be applied in measuring all recognised
assets and liabilities except for mandatory exceptions and voluntary exemptions
other Ind AS. Processing fees is required to be deducted from loan amount to
arrive at the amortised cost as per the requirements of Ind AS 109. In view of
this, with respect to property, plant and equipment, the company shall continue
the carrying amount of PPE as per previous GAAP on the date of transition to
Ind AS since it has availed the deemed cost option provided in paragraph D7AA
of Ind AS 101 for PPE. In the given case, the Company need to apply the
requirements of Ind AS 109 retrospectively for loans outstanding on the date of
transition to Ind AS at amortised cost. The ITFG opined that the adjustments
related to the outstanding loans to bring these in conformity with Ind AS 109
shall be recognised in the retained earnings on the date of transition. Consequently,
the carrying value of PPE as per previous GAAP cannot be adjusted to reflect
accounting treatment of processing fees.
ITFG Clarification Bulletin 5 – Issue 5
The Company received government
grant to purchase a fixed asset prior to Ind AS transition date. The grant
received from the Government was deducted from the carrying amount of fixed
asset as permitted under previous GAAP, i.e. AS 12, Accounting for Government
Grants. The Company has chosen to continue with carrying value of property,
plant and equipment as per the previous GAAP as provided in paragraph D7AA of
Ind AS 101. As per Ind AS 20, Accounting for Government Grants and
Disclosure of Government Assistance, such a grant is required to be
accounted by setting up the grant as deferred income on the date of transition
and deducting the grant in arriving at the carrying amount of the asset is not
allowed.
In this situation, whether the
Company is required to add to the carrying amount of fixed assets as per
previous GAAP and reflect the addition as deferred income in accordance with
Ind AS 20?
The ITFG opined that when the
option of deemed cost exemption under paragraph D7AA is availed for property,
plant and equipment, no further adjustments to the deemed cost of the property,
plant and equipment shall be made for transition adjustments that might arise
from the application of other Ind AS. Accordingly, once an entity avails the
exemption provided in paragraph D7AA, it will have to be carry forward the
previous GAAP carrying amounts of PPE. Consequently, the company shall
recognise the asset related government grants outstanding on the transition
date as deferred income in accordance with the requirements of Ind AS 20, with
corresponding adjustment to retained earnings.
Salient feature of the ITFG responses
The ITFG has provided conflicting
responses. In the context of accounting for the government grants and
processing fees, the ITFG opined that the impact of accounting for government
grants and processing fees should be adjusted against retained earnings.
Consequently, the previous GAAP carrying amount of fixed assets should not be
tampered with in order to comply with the requirements of D7AA. On the other
hand, the ITFG in the context of reclassification between inventory and fixed
assets, opined that the reclassification was necessary, and that such
reclassification would not result in non-compliance of D7AA.
The author also feels that too much
focus has been put on complying with the technical requirement of D7AA rather
than on the substance and the spirit of the exemption. This has led to a very
absurd interpretation. For example, in the case of fixed asset related
government grants, the grant amount was deducted from fixed assets under Indian
GAAP. However, the ITFG requires an entity to ignore the same and recreate the
deferred income on grant by adjusting the retained earnings. In subsequent
years, the deferred income would be released to the P&L account under Ind
AS. This effectively means that the government grant gets accounted twice; once
under Indian GAAP by deducting the grant amount from fixed assets and again
under Ind AS through creation of deferred income on Ind AS transition date.
Similarly the ITFGs response in the case of processing fee results in its being
treated as borrowing cost twice – once under Indian GAAP and again under Ind
AS.
Practical issue not dealt with by ITFG
Whether D7AA exemption is available
to service concession arrangements (SCA)?
Paragraph D22 of Ind AS 101
requires an operator of SCA to apply SCA accounting retrospectively. If it is
not practical to apply SCA accounting retrospectively, then the operator may
use the previous GAAP carrying amounts as the carrying amount at that date.
Assuming that there is no change in functional currency, whether in addition to
the above exemption, D7AA option is available?
One argument is that since
paragraph D22 contains specific requirements for intangible assets recognised
in accordance with the standard, the transitional provisions in D22 will apply
to intangible assets arising under the SCA. For all other intangible assets,
exemption in paragraph D7AA may be used.
The second argument is that there
is nothing in paragraph D7AA to suggest that it does not apply to SCAs. Hence,
the company can apply exemption under paragraph D7AA to all intangible assets,
i.e., SCA related intangible assets as well as all other intangible assets
covered within the scope of Ind AS 38.
The application of second view will
give rise the following additional issues:
– While the company continues the same carrying
amount as under previous GAAP, it will need to reclassify those amounts based
on requirements of Ind AS. For e.g., toll road classified as PPE under Indian
GAAP will be reclassified as intangible or financial asset, as applicable, at
the Indian GAAP carrying amount.
– Accounting for premium payable by operator to
grantor (negative grant): Companies may have followed one of the following
treatment under Indian GAAP:
• Certain companies have
created liability at undiscounted amount.
• Certain companies have
not created liability for negative grant under Indian GAAP.
In both the above cases, the
related question would be when the financial liability amount is reflected as
per Ind AS 109, whether the corresponding adjustment should be made to retained
earnings or to the intangible asset. Some may even argue that the strict
requirements of D7AA means that no adjustment is made to the financial
liability amount and consequently the corresponding adjustment is also not
made.
Conclusion
There are numerous questions around
the practical application of D7AA. These issues were not probably conceived
when D7AA was hurriedly introduced in Ind AS 101. The drafting of D7AA has
resulted in numerous unanswered questions. The ITFG has also provided
conflicting guidance on the subject. Besides some of the recommendations, for
example, in the case of processing fees and government grant accounting are
counter-intuitive and are against the spirit and intention of the exemptions.
In light of the above, the author would recommend that a broader view may be
taken on this issue, and in light of the lack of clarity arising from a not so
clear drafting of D7AA, companies may be allowed more room for different
interpretations. _
