FINANCIAL REPORTING DOSSIER

This article provides key recent updates in
financial reporting in the global space that could soon permeate into Indian
financial reporting; insights into an Ind AS accounting topic, viz., other
comprehensive income, tracing its roots, developments and relevance; compliance
aspects of capital disclosures under Ind AS; and a peek at an international
reporting practice in audit committee reports

1.   KEY RECENT UPDATES

1.1   From disclosing ‘significant accounting
policies’ to disclosing ‘material accounting policies’

The IASB on 1^st
August, 2019, proposed amendments to IAS 1 Presentation of Financial
Statements and IFRS Practice Statement 2 Making Materiality Judgements.
A threshold for disclosing accounting policies is clarified by replacing the
requirement to disclose ‘significant’ accounting policies with ‘material’
accounting policies. Materiality in this context is a threshold that can
influence users’ decisions based on the financial statements.

1.2   Exception to recognising deferred tax upon
first-time recognition of assets or liabilities

The IASB has
proposed amendments to IAS 12 Income Taxes on 17^th July, 2019
clarifying accounting for deferred tax on leases and decommissioning
obligations. IAS 12 exempts recognising deferred tax upon recognition of assets
or liabilities for the first time. As per the exposure draft, this exemption
would not apply to leases and decommissioning obligations – transactions for which
companies would recognise both an asset and a liability. Recognition of
deferred tax on such transactions would therefore be required.

1.3   Useful information on ECL estimation for Ind
AS stakeholders

The FASB has issued
a Staff Q&A on Developing an Estimate of Expected Credit Losses on
Financial Assets. Akin to IFRS 9, USGAAP requires financial assets held at
amortised cost to be subject to impairment testing using the ECL approach. This
approach requires an entity to consider historical experience, current
conditions and reasonable and supportable forecasts. The Q&A issued on 17^th
July, 2019 provides guidance in this area.

1.4   Revisions to the international code of ethics
for professional accountants

The IESBA issued an
Exposure Draft on 31^st July, 2019, Proposed Revisions to Promote
the Role and Mindset Expected of Professional Accountants that inter
alia enhances robustness of the fundamental principles of integrity,
objectivity and professional behaviour.

2.   RESEARCHING – OTHER
COMPREHENSIVE INCOME (OCI)

2.1   Introduction

Comprehensive
income as a reported accounting measure is new in the Indian context. The
notion of income is wider under comprehensive income in comparison with a
narrower income statement (profit and loss) concept.

2.2   Setting the context

Analysis of three
sample companies’ total comprehensive income (TCI) dissecting their composition
and growth in terms of profit after tax (PAT) and other comprehensive income
(OCI) is provided below:

As can be seen from
the table above, Company 1 reported an increase of 20.4% at the TCI layer,
while the PAT witnessed a ‘de-growth’ of 4.3%.

Volatility in OCI could
amplify or mask total comprehensive income. Do investors focus on PAT or TCI as
a measure of financial performance? Is TCI an important measure for investors?

In this section an
attempt is made to address the following questions:

2.3   The current position in India

Other Comprehensive
Income (OCI) as an accounting concept and a reporting measure made its way into
India Inc.’s corporate balance sheets with the introduction of Ind AS. OCI
comprises items of income and expenses that are not recognised in profit or
loss as required or permitted by other Ind ASs.

Ind AS 1 Presentation
of Financial Statements lists the components of OCI that inter alia
include changes in revaluation surplus of items of property, plant and
equipment, gains and losses arising from translating the financial statements
of a foreign operation, gains and losses from investments in equity instruments
designated at FVTOCI, gains and losses on financial assets measured at FVTOCI,
re-measurement of defined benefit plans and the effective portion of gains and
losses on hedging instruments in a cash flow hedge.

Schedule III to the
Companies Act requires Ind AS companies to report other comprehensive income in
the statement of profit and loss as a separate measure. Investors are provided
in a single statement the accounting measures of profit for the period, other
comprehensive income and total comprehensive income.

2.4   Background

2.4.1 India

In the Indian GAAP
(AS) dispensation, revaluation of fixed assets was permitted and the process of
consolidating a foreign subsidiary generated a resulting foreign currency
translation reserve (FCTR). These two line items have been taken up for the
purpose of this discussion.

AS 10 Accounting
for Fixed Assets before it made its way to AS 10 Property, plant and
equipment, permitted an increase in net book value arising on revaluation
of fixed assets to be credited directly to owner’s interests under the head of
revaluation reserve (paragraph 30).

AS 11 the
Effects of changes in Foreign Exchange Rates requires a non-integral
foreign operation to use translation procedures whereby the resulting exchange
differences should be accumulated in an FCTR until disposal of the investment
(paragraph 24).

The concept of
OCI is new in India despite the fact that items like revaluation surplus and
FCTR were also accounted under AS. The AS treatment
for these items bypassed income and had direct entry to the balance sheet,
whereas converged Ind AS does not permit direct entry to the balance sheet.

2.4.2 The United
States

IFRS (IAS in its
previous avatar) was not the first GAAP to introduce the concept of
comprehensive income.

Comprehensive
income was defined for the first time in USGAAP in 1980. Although the term was
defined, reporting standards for the same did not evolve for a considerable
period of time.

The origin of other
comprehensive income reporting in global accounting literature can be traced to
a 1997 USGAAP Statement of Financial Accounting Standard (FAS) – Reporting
Comprehensive Income. This statement issued by the Financial Accounting
Standards Board (FASB) established standards for reporting and presenting
comprehensive income and its components.

The relevant
concepts surrounding how globally accounting income reporting was historically
characterised in terms of a contrast between a ‘dirty surplus’ and a ‘clean
surplus’ income concept is highlighted in the table below:

Until 1997, the
FASB followed the all-inclusive income concept but it did make exceptions by
requiring that certain changes in assets and liabilities not be reported in the
income statement but instead be included in balances within a separate
component of equity in the balance sheet. Some examples include foreign
currency translation, accounting for certain investments in debt and equity
securities akin to Indian GAAP ‘AS’ revaluation gains (AS 10, now replaced) and FCTR treatment (AS 11).

In 1997, as a step
in implementing the concept of comprehensive income, the FASB required that
changes in the balances of items that were reported directly in a separate
component of equity in the balance sheet be reported in a financial statement
that is displayed as prominently as other financial statements, viz.,
‘Comprehensive Income’.

The purpose of
reporting comprehensive income is to report a measure of all changes in equity
of an entity that result from recognised transactions and other economic events
of the period other than transactions with owners in their capacity as owners.

OCI and TCI reporting developed more as a practice
than a concept. Further developments and improvements are expected both under
USGAAP and IFRS.

2.4.3 The United
Kingdom

In 1992, the UK Accounting Standards Board issued a financial reporting
standard – Reporting Financial Performance. It introduced a ‘Statement
of Total Recognised Gains and Losses’ financial statement component that was
analogous to the US comprehensive income.

2.4.4 IFRS

OCI and
Comprehensive income reporting was introduced in IFRS in 2007 with a revision
to IAS 1 Presentation of Financial Statements requiring inter alia
components of OCI to be displayed in the statement of comprehensive income and
total comprehensive income to be presented in the financial statements.

2.5 Recent
developments

The IFRS Conceptual
Summary revised by the IASB in 2018 lends relatively more clarity to the
distinction between net profit and OCI. In the development of standards, the
IASB may now decide in exceptional circumstances that income or expenses
arising from a change in the current value of an asset / liability be included
in OCI when it results in the statement of profit or loss providing more
relevant information or a more faithful representation of financial
performance.

In December,
2018, the ICAI issued an Exposure Draft of AS 1 – Presentation of Financial
Statements, to replace the extant AS 1 – Disclosure of Accounting
Policies. The wider income concepts of OCI and comprehensive income have
been introduced in this IGAAP exposure draft.

2.6   Is OCI relevant to investors?

The IASBs-IFRS
Conceptual Framework (2018 revised) states that an understanding of financial
performance requires analysis of all recognised income and expenses, i.e., PAT
and OCI. The expected focus is therefore on TCI.

Net earnings for
the period as reported by the measure PAT lends itself to assessment of
forecast cash flows from a dividend distribution perspective.

The ground reality
globally is that Alternate Performance Measures (APMs) are fast becoming
mainstream. Progressive companies continue to strive to provide insights into
real value creation using measures that are alternates to accounting measures,
including TCI.

3.  
COMPLIANCE: CAPITAL DISCLOSURES (Ind AS)

Capital
disclosures

This Ind AS
disclosure requirement ensures that users of financial statements are provided
useful information about entity-specific capital strategies.

This disclosure in the notes is mandatory for all entities and, moreover
is in addition to other disclosures related to equity and reserves. The
disclosure requirements are contained in Ind AS 1 Presentation of Financial
Statements (paragraphs 134 to 136). A reporting entity also needs to
consider paragraphs 44A to 44E of Ind AS 7 Statement of Cash Flows
(Changes in Liabilities Arising from Financing Activities) to comply with Ind
AS 1 capital disclosure requirements.

The capital
disclosures are applicable to all companies and not only to companies that are subject
to externally imposed capital requirements like banks / NBFCs.

An entity is required to disclose information that enables users of its
financial statements to evaluate its objectives, policies and processes for
managing capital. In complying with this, qualitative and quantitative
disclosures are required.

Capital for the
purpose of this disclosure has to be understood the way it is considered as
part of corporate financial management text / practices. Capital is not just
share capital or equity but includes liability components, too.

Capital
disclosures should be based on the information provided internally to key
management personnel (KMPs). For instance, some
entities may consider lease liabilities and / or overdrafts as components of
capital for capital management, while others may not.

4. 
GLOBAL ANNUAL REPORT EXTRACTS: AUDIT COMMMITTEE REPORT

Extracts from ‘Audit Committee Report’
Section of Annual Report

Company: BAE Systems PLC (2018
revenues GBP 16.8 billion)

The Audit
Committee reviews all significant issues concerning the financial
statements. The principal matters it considered concerning the 2018
financial statements were (see table below):

5. FROM THE PAST – ‘IMPROVED OUTSIDE AUDITING
IN THE FINANCIAL REPORTING BUSINESS’

The Former
Securities Exchange Commission’s Chairman, Mr. Arthur Levitt’s 1998 remarks (NYU
Center for Law and Business) are relevant even today. Extracts of the same
are reproduced below:

‘As I look at
some of the failures today, I can’t help but wonder if the staff in the
trenches of the profession have the training and supervision they need to
ensure that audits are being done right. We cannot permit thorough audits to
be sacrificed for re-engineered approaches that are efficient, but less
effective.

Numbers in the abstract are just that – numbers. But
relying on the numbers in a financial report are livelihoods, interests and,
ultimately, stories: a single mother who works two jobs so she can save
enough to give her kids a good education; a father who laboured at the same
company for his entire adult life and now just wants to enjoy time with his
grandchildren; a young couple who dreams of starting their own business.

These are the stories of American investors. Our
mandate and our obligations are clear. We must re-dedicate ourselves to a
fundamental principle: markets exist through the grace of investors.’