MULTIPLE KEY AUDIT MATTERS IN INDEPENDENT AUDITORS’ REPORTS
RELIANCE INDUSTRIES LTD. (31st MARCH, 2019)
From Auditor’s Report on Consolidated Financial Statements
KEY AUDIT MATTERS
Key Audit Matters are those matters that, in our professional judgement, were of most significance in our audit of the Consolidated Financial Statements for the financial year ended 31st March, 2019. These matters were addressed in the context of our audit of the Consolidated Financial Statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. For each matter below, our description of how our audit addressed the matter is provided in that context. We have determined the matters described below to be the Key Audit Matters (KAMs) to be communicated in our report.
We have fulfilled the responsibilities described in the auditor’s responsibilities for the audit of the Consolidated Financial Statements section of our report, including in relation to these matters. Accordingly, our audit included the performance of procedures designed to respond to our assessment of the risks of material misstatement of the Consolidated Financial Statements. The results of audit procedures performed by us and by other auditors of components not audited by us, as reported by them in their audit reports furnished to us by the management, including those procedures performed to address the matters below, provide the basis for our audit opinion on the accompanying Consolidated Financial Statements.
KAM: Capitalisation of property, plant and equipment, intangible assets and related depreciation and amortisation
The holding company has identified capitalisation of property, plant and equipment as a KAM. As a part of the gasification project, the holding company has incurred additional capital expenditure for modification of power plant equipments, i.e., gas turbines, auxiliary boilers, HRSGs, process furnaces, etc., to make them compatible with multiple feedstock, including those received from petcoke gasifier. Currently, all units of the gasification complex, its associated utilities and offsites have been started and the complex is under stabilisation. The testing phase of the project is under progress as at 31st March, 2019 as it has not achieved the quality and efficiency parameters. Accordingly, significant level of judgement is involved to ensure that capitalisation of property, plant and equipment meet the recognition criteria of Ind AS 16 Property, Plant and Equipment, specifically in relation to determination of the trial run period and costs associated with trial runs for it to be ready for intended use. As a result, the aforesaid matter was determined to be a KAM.
The auditors of Reliance JioInfocomm Limited (‘RJIL’), a subsidiary of the holding company, have reported a KAM on capitalisation of property, plant and equipment / intangible assets and amortisation / depreciation of spectrum costs and related tangible assets as it is a material item on the balance sheet of the subsidiary in value terms. The property, plant and equipment and intangible assets of the subsidiary as at 31st March 2019 is Rs. 134,000 crores. While the subsidiary has capitalised the wireless telecommunication project, it continues to augment capacity therein and continues to invest in setting up the wireline telecommunication project. Items of property, plant and equipment and intangibles are capitalised when they are ready for use as intended by the management.
Further, spectrum costs and the related tangible assets are amortised / depreciated to appropriately reflect the expected pattern of consumption of expected future economic benefits from continued use of the said assets (Refer Note B.3 [e] of the Consolidated Financial Statements). Determination of timing of capitalisation as well as rate of amortisation / depreciation in order to ensure compliance with the stipulation of the applicable Accounting Standards involve estimates, significant use of technology and significant judgement. Accordingly, valuation and completeness are key assertions related to capitalisation of property, plant and equipment and intangible assets, while accuracy is the key assertion in respect of depreciation / amortisation charge.
How our audit addressed the KAM
Our audit procedures included and were not limited to the following:
Assessing the nature of the costs incurred to substantially modify the existing power plants to test whether such costs are incurred specifically for trial runs and meet the recognition criteria as set out in paras 16 to 22 of Ind AS 16.
Evaluating the assessment provided by third-party vendors involved in the construction and testing process to determine whether capitalisation ceased when the asset is in the location and condition necessary for it to be capable of operating in the manner intended by the management.
In respect of the KAM reported by the auditors of RJIL, we performed inquiry of the audit procedures performed by them to address the same. As reported by the subsidiary auditor, the following procedures have been performed by them:
(i) Testing the design, implementation and operating effectiveness of controls in respect of review of capital work in progress, particularly in respect of timing of the capitalisation with source documentation;
(ii) Testing controls over determination of expected economic benefits from the use of relevant assets and monitoring actual consumption thereof to true-up (sic) the expected pattern of consumption during an accounting period;
(iii) Testing, including substantial involvement of internal telecom and information technology specialists, to validate the expected pattern of consumption of the economic benefits emanating from the use of the relevant assets, as well as testing the relevant application systems used in monitoring of actual consumption of the expected economic benefits;
(iv) Substantive testing procedures, including testing necessary authorisations for capitalisation of items of PPE and intangible assets, testing supporting documentation for consumption of capital goods inventory, comparison of actual pattern of consumption of benefits for the current year with the budget and testing the mathematical accuracy of computation of amortisation / depreciation charge for the year.
Obtained and read the financial statements of RJIL to identify whether disclosure for capitalisation of property, plant and equipment and intangible assets including spectrum and related amortisation / depreciation has been appropriately disclosed in the consolidated financial statements of the group.
KAM: Changes in useful life and residual value of plant and machinery
As at 31st March, 2019 the holding company had a gross block of Rs. 228,340 crores in plant and machinery which constitutes 52.1% of the property, plant and equipment. In the current year, the holding company has revised the useful life and residual value of the plant and machinery used in the refining segment. Assessment of useful lives and residual values of plant machinery in an integrated and complex plant involves management judgement, consideration of historical experiences, anticipated technological changes, etc. (Refer Note 1.7 of the Consolidated Financial Statements). Accordingly, it has been determined as a KAM.
How our audit addressed the KAM
Our audit procedures included and were not limited to the following:
(a) Evaluating the reasonableness of the assumptions considered by the management in estimation of useful life and residual values;
(b) Examining the useful economic lives and residual value assigned with reference to the holding company’s historical experience, technical evaluation by third party and our understanding of the future utilisation of assets by the holding company;
(c) Assessing whether the impact on account of the change has been appropriately recognised in the financial statements;
(d) Review of the disclosures made in the financial statements in this regard.
KAM: Estimation of oil reserves and decommissio-ning liabilities
Refer to Note 30.2 on proved reserves and production, both on product and geographical basis, and Note C(A) on estimation of oil and gas reserves, Note C(C) on depreciation, amortisation and impairment charges and Note B.3(k) on provisions. The determination of the holding company’s oil and natural gas reserves requires significant judgements and estimates to be applied. Factors such as the availability of geological and engineering data, reservoir performance data, acquisition and divestment activity, drilling of new wells and commodity prices, all impact the determination of the holding company’s estimates of oil and natural gas reserves. The holding company bases its proved reserves estimates considering reasonable certainty with rigorous technical and commercial assessments based on conventional industry practice and regulatory requirements. Estimates of oil and gas reserves are used to calculate depletion charges for the holding company’s oil and gas assets.
The impact of changes in estimated proved reserves is dealt with prospectively by amortising the remaining carrying value of the asset over the expected future production. Oil and natural gas reserves also have a direct impact on the assessment of the recoverability of asset’s carrying values reported in the financial statements. Further, the recognition and measurement of decommissioning provisions involves use of estimates and assumptions relating to timing of abandonment of well and related facilities which would depend upon the ultimate life of the field, expected utilisation of assets by other fields, the scope of abandonment activity and pre-tax rate applied for discounting. Accordingly, the same is considered as a KAM. The auditors of Reliance Holding USA Inc. (‘RHUSA’), a subsidiary of the holding company, have also reported a KAM on the aforesaid topic.
How our audit addressed the KAM
Our procedures have focused on the management’s estimation process in the determination of oil and gas reserves and decommissioning liabilities. Our work included, and was not limited to, the following procedures:
(I) Understand the holding company’s process and controls associated with the oil and gas reserves estimation process;
(II) Evaluate the objectivity, independence and competence of the internal specialists involved in the oil and gas reserves estimation process;
(III) Test that the updated oil and gas reserve estimates were included appropriately in the holding company’s consideration of impairment, accounting for amortisation / depletion and disclosures of proved reserves and proved developed reserves in the financial statements;
(IV) Test the assumptions used in determining the decommissioning provisions. And compare these assumptions with the past year and inquire for reasons for any variations;
(V) In respect of the KAM reported to us by the auditors of RHUSA, we performed an inquiry of the audit procedures performed by them to address the same. As reported to us by the subsidiary auditor, they have performed procedures in relation to the approach used; test of controls performed with regard to data input into the system for calculation of oil and gas reserves; audit report issued by external experts appointed by the subsidiary relating to the audit of the key data and assumptions used by the management for estimating the oil and gas reserve and the future net income as at the year-end; competence and objectivity of the external experts; calculation of the depletion charge and future net income and reasonableness of the discount rate used by the subsidiary for calculating the future net income for impairment calculation;
(VI) With respect to RHUSA, obtain and read its financial statements to identify whether the disclosures on estimation of oil reserves have been included in the Consolidated Financial Statements of the group.
KAM: Litigation matters (oil and gas)
The holding company has certain significant open legal proceedings under arbitration for various complex matters with the Government of India and other parties, continuing from earlier years, which are as under:
(i) Disallowance of certain costs under the production-sharing contract relating to Block KG-DWN-98/3 and consequent deposit of differential revenue on gas sales from D1D3 field to the gas pool account maintained by Gail (India) Limited (Note 30.3 and 30.4 [b]);
(ii) Claim against the holding company in respect of gas said to have migrated from neighbouring blocks (KGD6) (Note 30.4 [a]);
(iii) Claims relating to limits of cost-recovery, profit-sharing and audit and accounting provisions of the public sector corporations, etc., arising under two production-sharing contracts entered into in 1994 (Note 30.4 [c]);
(iv) Suit for specific performance of a contract for supply of natural gas before the Hon’ble Bombay High Court (Note 30.4 [d]). Due to the complexity involved in these litigation matters, management’s judgement regarding recognition and measurement of provisions for these legal proceedings is inherently uncertain and might change over time as the outcomes of the legal cases are determined. Accordingly, it has been considered as a KAM.
How our audit addressed the KAM
Our audit procedures included, and were not limited to, the following:
(a) Assessing management’s position through discussions with the in-house legal expert and external legal opinions obtained by the holding company (where considered necessary) on both the probability of success in the aforesaid cases and the magnitude of any potential loss;
(b) Discussion with the management on the developments in these litigations during the year ended 31st March, 2019;
(c) Roll out of inquiry letters to the holding company’s legal counsel (internal / external) and studying the responses received from them. Assessing that the accounting / disclosures made by the holding company are in accordance with the assessment of the legal counsel;
(d) Review of the disclosures made in the financial statements in this regard;
(e) Obtaining a representation letter from the management on the assessment of these matters.
KAM: IT systems and controls over financial reporting
We identified IT systems and controls over financial reporting as a KAM for the holding company because its financial accounting and reporting systems are fundamentally reliant on IT systems and IT controls to process significant transaction volumes, specifically with respect to revenue and raw material consumption. Automated accounting procedures and IT environment controls, which include IT governance, IT general controls over programme development and changes, access to programmes and data and IT operations, IT application controls and interfaces between IT applications, are required to be designed and to operate effectively to ensure accurate financial reporting.
How our audit addressed the KAM
Our procedures included and were not limited to the following:
(I) Assessing the complexity of the IT environment by engaging IT specialists and through discussions with the head of IT;
(II) Assessing the design and evaluation of the operating effectiveness of IT general controls over programme development and changes, access to programmes and data and IT operations by engaging IT specialists;
(III) Assessing the design and evaluation of the operating effectiveness of IT application controls in the key processes impacting financial reporting of the holding company by engaging IT specialists;
(IV) Assessing the operating effectiveness of controls relating to data transmission through the different IT systems to the financial reporting systems by engaging IT specialists.
KAM: Impairment of goodwill
The group’s balance sheet includes Rs. 11,997 crores of goodwill, representing 1% of its total assets. In accordance with Ind AS, goodwill is allocated to cash generating units (CGUs) which are tested annually for impairment using the discounted cash-flow approach of each CGU’s recoverable value compared to the carrying value of the assets. A deficit between the recoverable value and the CGU’s net assets would result in impairment. The impairment test includes sensitivity testing of key assumptions, including revenue growth, operating margin and discount rate. The annual impairment testing is considered a significant accounting judgement and estimate and a KAM because the assumptions on which the tests are based are highly judgemental and are affected by future market and economic conditions which are inherently uncertain.
How our audit addressed the KAM
With respect to goodwill relating to material subsidiaries, our audit procedures included and were not limited to
the following:
(i) Obtaining and reading the financial statements of the material subsidiaries. Assessing the appropriateness of the methodology applied in determining the CGUs to which goodwill is allocated;
(ii) Assessing the assumptions around the key drivers of the cash flow forecasts including discount rates, expected growth rates and terminal growth rates used, including engaging valuation specialists in certain cases;
(iii) Assessing the recoverable value headroom by performing sensitivity testing of key assumptions used;
(iv) Discussing potential changes in key drivers as compared to previous year / actual performance with management in order to evaluate whether the inputs and assumptions used in the cash flow forecasts were reasonable.
KAM: Revenue recognition
The accounting policies of the group for revenue recognition are set out in Note B3(p) to the Consolidated Financial Statements. The auditors of Reliance JioInfocomm Limited (‘RJIL’), a subsidiary of the holding company, have reported revenue recognition as a KAM due to the high volume of the transactions, the high degree of IT systems involvement and considering that accounting for certain tariff schemes involves exercise of judgements and estimates, thereby affecting occurrence, cut-off and accuracy assertions in respect of revenue recognition. Reliance Retail Ventures Limited (‘RRVL’), a subsidiary of the holding company, trades in various consumption baskets on a principal basis and recognises full value of consideration on transfer of control of traded goods to the customers which most of the time coincides with collection of cash or cash equivalent. The auditors of the subsidiary have reported revenue recognition as a KAM due to the high volume of the transactions and reconciliation of mode of payments with revenue recognised.
How our audit addressed the KAM
Our audit procedures included and were not limited to the following:
(a) Obtaining and reading the financial statements of RJIL and RRVL to identify whether the revenue recognition policies are included in the consolidated financial statement of the group;
(b) In respect of the KAM reported by the auditors of RJIL, we performed an inquiry of the audit procedures performed by them to address the same. As reported by the subsidiary auditor, the following procedures have been performed by them:
(i) involvement of IT specialists and testing of the IT environment inter alia for access controls and change management controls over the subsidiary company’s billing and other relevant support systems;
(ii) evaluation and testing of the design and operating effectiveness of the relevant business process controls, inter alia controls over the capture, measurement and authorisation of revenue transactions and involvement of IT specialists for testing the automated controls therein;
(iii) evaluation of substantive testing involved, testing collections, customer ratings for new products and tariffs introduced in the year, testing the reconciliation between revenue as per the billing system and the financial records and testing supporting documentation for manual journal entries posted in revenue to ensure veracity thereof;
(iv) validation of the judgements and estimates exercised by the management regarding the application of revenue recognition accounting standard with respect to certain tariff schemes, particularly in view of adoption of Ind AS 115;
(c) In respect of the KAM reported to us by the auditors of RRVL, we performed an inquiry of the audit procedure performed by them to address it. As reported to us by the subsidiary auditor, the following procedure had been performed by them:
(v) Evaluation of the design, testing of the implementation of internal controls and review of the operating effectiveness of the controls relating to reconciliation of consideration with store sales by selection of samples from different stores and dates throughout the period of audit and re-performance of the reconciliation between store sales and the mode of payment collection report.
KAM: Inventory
The auditors of Reliance Retail Ventures Limited (‘RRVL’), a subsidiary of the holding company, have reported existence of inventory as a KAM due to involvement of high risk on the basis of and the nature of the retail industry wherein value per unit is relatively insignificant but high volumes are involved which are dispersed across different points of sale and warehouses. Refer Note B.3(i) to the Consolidated Financial Statements of the group.
How our audit addressed the KAM
Our audit procedures included and were not limited to the following:
In respect of the KAM reported to us by the auditors of RRVL, we performed an inquiry of the audit procedures performed by them to address the same. As reported to us by the subsidiary auditor, the following procedures have been performed by them:
(I) Evaluation of the design and testing of the implementation of internal controls relating to physical inventory counts on a test basis;
(II) Performance of test of controls over verification of documentary evidence of controls including the calculation of shrinkages;
(III) Performance of test of details through sample selection of stores as part of the inventory verification programme, including verification of inventory from floor to documentary evidence and vice versa and verification of shrinkage.
KAM: Transfer of the fibre undertakings
Pursuant to a Composite Scheme of Arrangement between Reliance JioInfocomm Ltd. (RJIL), Jio Digital Fibre Private Limited (JDFPL) and Reliance JioInfratel Private Limited (RJIPL) (the Scheme), RJIL has demerged its optic fibre cable undertaking to JDFPL upon the scheme becoming effective on 31st March, 2019. As per the scheme, RJIL transferred the undertaking to JDFPL at book value and adjusted the carrying amount of net assets in reserves. Further, JDFPL applied the purchase method of accounting in accordance with Ind AS 103 as mentioned in the scheme and recorded assets and liabilities of the undertaking at their respective fair values and issued equity shares of Rs. 3 crores (fair value Rs. 497 crores) and optionally convertible preference shares with surplus rights (OCPS) of Rs. 544 crores (fair value Rs. 77,701 crores) to the company, being the shareholders of RJIL. Pursuant to the receipt of these equity shares and OCPS, the holding company in its standalone financial statements (SFS) has allocated its cost of investments in RJIL to RJIL and JDFPL and elected to value its investment in OCPS at fair value through other comprehensive income (FVTOCI).
Subsequently, the holding company sold its controlling equity stake in JDFPL to Digital Fibre Infrastructure Trust resulting in a gain of Rs. 246 crores recognised in the consolidated statement of profit and loss. The management has determined that the holding company has no control or significant influence over JDFPL post the controlling stake sale. Further, the remaining equity investment in JDFPL is measured at FVTPL and OCPS is measured at FVTOCI in the Consolidated Financial Statements (Refer Note 2.2 of the same). The auditors of RJIL have also reported a KAM in respect of the accounting treatment applied for the scheme in its financial statements. The above is considered as a KAM as the same has been reported as a significant transaction that occurred during the current year which involves exercise of judgement and interpretation of the relevant Indian Accounting Standards and applicable tax and other statutes / regulations.
How our audit addressed the KAM
Our audit procedures included and were not limited to the following:
(i) Obtaining and reading the composite scheme of arrangement for demerger of the optic fibre cable undertaking;
(ii) Obtaining the memo prepared by the holding company in consultation with external experts (including related assumptions and accounting policy choice) on the accounting treatment to be applied in the financial statements;
(iii) Evaluating whether the accounting treatment of the said transaction is in line with the applicable Indian Accounting Standards;
(iv) Performing substantive testing procedures, including involvement of valuation specialists for testing of the valuation reports provided by the management for appropriateness of assumptions involved and testing of the computation;
(v) Assessing whether the accounting entries recorded in the books are in line with the accounting treatment assessed above, including the arithmetical accuracy of the same;
(vi) In respect of the KAM reported by the auditors of RJIL, we performed inquiry of the audit procedures performed by them to address the same.
As reported by the subsidiary auditor, the following procedures have been performed by them:
(I) Evaluation and testing of the internal controls over the management’s assessment of the accounting treatment of the said transaction in terms of the applicable Indian Accounting Standards and applicable tax and other statutes / regulations, identification of assets and liabilities related to each of the two undertakings;
(II) Substantive testing procedures including involvement of tax specialists to validate the management position on tax implications of the transaction and testing of tax computation for appropriate application of tax laws, involvement of valuation specialists for testing of the valuation reports provided by the management for appropriateness of assumptions involved and testing of the computation, accounting of the transactions and the disclosures for compliance with the requirements of the applicable accounting standards.
KAM: Impairment of assets of subsidiaries of Reliance Industrial Investments and Holding Limited
The auditors of Reliance Industrial Investments and Holdings Limited (‘RIIHL’), a subsidiary of the holding company, have reported a KAM on the impairment of investment and loans given to subsidiaries as the recoverability assessment involves significant management judgement and estimates (Refer Note B.3 [j] of the Consolidated Financial Statements). Though these investments and loans are eliminated at the consolidated level, the assets of the RIIHL subsidiaries are included on a line-by-line basis in the Consolidated Financial Statements. Accordingly, the impairment of these assets is considered to be a KAM.
How our audit addressed the KAM
Our audit procedures included and were not limited to the following:
(a) Obtaining and reading the financial statements of RIIHL and its subsidiaries to identify whether any impairment has been recorded in the current year;
(b) In respect of the KAM reported to us by the auditors of RIIHL, we performed an inquiry of the audit procedures performed by them to address the KAM. As reported to us by the subsidiary auditor, the following procedures have been performed by them for material subsidiaries:
(i) Assessment of the net worth of RIIHL subsidiaries / associates on the basis of latest available financial statements;
(ii) Assessment of the methodologies applied to ascertain the fair value or, as the case may be, value in use of the assets of the subsidiaries / associates, where the net worth was negative;
(iii) Assessment of the accuracy and reasonableness of the input data and assumptions used to determine the fair value of subsidiaries’ assets, cash flow estimates, including sensitivity analysis of key assumptions used.