The final Indian Accounting Standards (Ind-ASs) have been notified by the Ministry of Corporate Affairs (MCA) vide its announcement dated 25th February 2011. With the announcement, the final position of Ind-ASs, including key carveouts, has become clear. However, the MCA announcement does not convey the effective dates for the application of the Ind-ASs, giving an impression to industry that the implementation of Ind-AS is deferred. However, such an interpretation may be made with caution, as the final notified date of transition may not be too far.
The adoption of Ind-AS will have an impact on financial reporting of many entities, some of which are sector-specific, while some may be entityspecific. This article attempts to analyse some of the key impact areas on transition to Ind-AS for the retail industry and summarises the carve-outs vis-à-vis the IFRS.
Revenue recognition:
Principal v. Agent: Many a time, the retailer permits another entity to operate from its retail outlet. Under such cases, the retailer should closely evaluate its risks emanating from the arrangement to determine whether the retailer is ultimately selling the goods to the customer in his own capacity or the retailer is only facilitating the sale of goods in his capacity as an agent.
Under the current practice, a retailer invariably recognises the gross value of sales proceeds as revenue in the absence of clear guidance in distinguishing a principal from an agent.
Ind-AS provides more elaborate guidance on classification between a principal and an agent. It clarifies that if the retailer carries significant risks (such as inventory risk and price risk) and determines the price of goods, it is considered a principal, or else an agent. If the retailer is acting as the agent, then only the commission earned should be booked as revenues.
Customer loyalty programmes: Most retailers use consumer promotional schemes to increase business opportunities. These promotions typically include offers such as award credits or points through a loyalty scheme or the provision of a future discount through vouchers or coupons. Award credits may be linked to individual purchases or group of purchases. The customer may redeem the award credits for free or discounted goods or services.
Under current practice, there is no specific guidance on accounting for customer loyalty programmes. Certain entities recognise the cost of discounted/ free goods along with cost of sales, while certain entities present such costs as sales promotion expense. Further certain entities recognise the cost upfront based on estimates, while certain entities recognise the cost on incurrence.
Under Ind-AS, the revenue transactions under customer loyalty programmes are considered to have multiple elements, where the revenue attributable to the sale of goods either free of cost or at discounted price in future is recognised separately from the current sale transaction. The principles of recognition of customer loyalty programmes are as under:
An entity recognises the award credits as a separately identifiable component of revenue and defers the recognition of revenue related to the award credits until its utilisation.
The revenue attributed to the award credits takes into account the expected level of redemption.
The consideration received or receivable from the customer is allocated between the current sales transaction and the award credits by reference to their fair values.
The fair value is determined based on relative fair value method (where the benefit under the award is charged proportionately to each component).
The above guidance shall lead to initial deferral of revenue attributable to the award credits.
Product warranties: In the retail industry, the retailers often provide warranty on sale of products of its own brand. Currently such warranty obligations are accounted for through full recognition of revenue and an accrual of estimated costs, irrespective of the duration of the warranty period. Under Ind-AS, where the normal warranty offered by entities is for a duration of more than a year, the warranty provision would be recognised at its discounted value. The provisions would accrete over the expected term of the provision leading to an interest expense.
Thus the warranty costs to the extent of time value of money would be recognised as interest cost.
Leases:
Often the lease arrangements involve an initial fit-out period before commencement of the retail store’s operation, during which the retailer may be offered a rent-free right to use the leased premise. The rent would commence on the commencement of the operations. In the absence of elaborate guidance on such arrangements, currently the lease rent is usually recognised based on the commencement of the lease payments.
The Ind-ASs provide specific guidance on treatment of such lease incentives as part of the net consideration agreed for the use of the leased asset, irrespective of the incentive’s nature or form or timing of payments. As such, the retailer (lessee) shall recognise the incentives as a reduction of rental expense over the lease term on a straightline basis, unless another systematic basis is representative of the time pattern of the lessee’s benefit from the use of the leased asset.
Thus, the lease rent shall be recognised even for the period when there were no lease rentals payable, leading to a higher lease rental during the initial rent-free period. However, the subsequent lease rental charge would decline on account of the lease incentives being recognised as a reduction of lease rent expense over the lease term.
Interest-free lease deposits: The retail outlets are invariably taken on a noncancellable operating lease with an interest-free lease deposit. Under the current practice, the interest-free deposits are recognised as such at their transaction values.
Under the Ind-ASs, such interest-free deposits are classified as financial assets, which are required to be recognised at its fair value on initial recognition and at its amortised cost subsequently. These interest-free deposits are recognised at their discounted values and the difference between the contractual amount and discounted values represent the prepaid lease rent. The lease deposits would accrete over the lease term to match the undiscounted amount, leading to interest income, while the prepaid lease rent would be amortised as lease rent over the lease term on a straight-line basis.
As such, the accounting treatment under Ind- AS would lead to grossing up of lease rent and interest income. However, as the lease rents would be charged on straight-line basis and the interest income on effective interest rate basis, the higher lease rents may not exactly offset the interest income for the intervening reporting periods, though they would exactly offset when the entire lease term is considered together.
Asset retirement obligations: The retailers that acquire their stores on lease invariably are obligated to return the leased premises to the lessor on completion of the lease term on an ‘as-is’ basis. The retailer is obligated to remove its fixed assets, especially the leasehold improvements, on completion of the lease term.
Ind-ASs, in line with the current practice, require the creation of a provision for asset retirement obligations when there is an obligation for outflow of economic resources that is probable and can is reliably measurable. However, it is not common to find entities, other than exploration companies, that recognise the asset retirement obligations under the current practice on account of lack of elaborate guidance under the current GAAP.
Ind-AS requires a provision (and a corresponding asset) to be created at the initial stage by discounting the eventual estimated liability to its present value. The discount is unwound by way of recognising an interest expense over the life of the asset. Further, the provision is required to be re-estimated every reporting date. Apart from re-estimating the amount and timing of the outflow of economic resources, even the discounting factor is also re-estimated at each reporting period and is accounted as a change of estimates.
Application of Ind-AS will lead to an increase in the depreciation charge related to the cost capitalised and higher finance costs on account of unwinding the discount over the life of the asset.
Key carve-outs:
The final Ind AS includes several ‘carve-outs’ (deviations) from IFRS as issued by the International Accounting Standards Board (IASB). The Indian standard-setters have examined individual IFRS and modified the requirements where deemed necessary to suit Indian conditions. ‘Carve-outs’ are generally perceived as non-desirable, since they would dilute the key purpose of converging with IFRS (i.e., to have a common set of accounting standards across countries; provide seamless access to international capital markets; provide comfort to investors).
An analysis of the Ind AS carve-outs reveal that while some of the carve-outs are mandatory and represent clear deviations from IFRS, several of the carve-outs represent removal of policy choices under IFRS in certain areas or conversely provide alternate policy choices under Ind AS for certain other areas.
Let us start with the first category of carve-outs (mandatory deviations). The significant mandatory deviations from IFRS that an Indian company cannot avoid are a handful. These include revenue recognition for real estate sales on the basis of percentage completion method (IFRS requires revenue recognition when the final possession is given to the customer) and accounting for the equity conversion option of a foreign currency convertible bond (FCCB) as an equity component (IFRS requires the equity conversion option to be periodically marked-to-market). Our experience indicates that these carve-outs are not expected to impact a wide cross-section of companies. There are some other, less substantive, mandatory deviations (for example, use of a government bond rate for discounting employee benefit obligations as opposed to corporate bond rates required by IFRS or excluding own credit risk in fair valuation of certain financial liabilities).
Let us now examine the second category of carve-outs (removal of policy choices). There are several areas where IFRS offers multiple policy choices, while Ind AS prescribes one of these policy choices. Such carve-outs include (1) Single statement presentation of the income statement (IFRS permits the statement of comprehensive income to be presented separately) (2) Classification of expenses in the profit and loss account by their nature (IFRS permits classification by function) (3) Classification of interest and dividend as financing/ investing cash flows (IFRS permits operating classification) (4) No choice to carry investment property at fair value (IFRS permits this) (5) Recognition of actuarial gains and losses directly in reserves (IFRS permits alternatives including recognition in the profit and loss account) and Recomputation of borrowing costs capitalisable (IFRS permits prospective application).
This category of carve -outs does not result in deviations from IFRS, as they represent permitted policy choices. These could pose a challenge for Indian companies, if global peers follow other alternative policies; if such companies are a part of a global group that follows other alternative policies; or if the Indian company has previously followed other alternative policies for IFRS reporting to overseas stakeholders.
The third category of carve-outs (additional policy choices) represent an area where a company can either elect to follow policies aligned to IFRS, or alternate policies that diverge from IFRS. Such carve-outs include (1) Choice to defer exchange differences on long-term foreign currency assets and liabilities, and recognise such differences over the period of the underlying asset/liability (IFRS requires all such differences to be immediately charged to the profit and loss account) (2) Choice to consider Indian GAAP carrying values as ‘deemed cost’ for fixed assets acquired prior to transition date (IFRS offers no such choice on transition — retrospective IFRS values or ‘fair values’ are the two choices on transition; Ind-AS offers a third choice). This category of carve-outs represents an area where each individual company needs to apply careful thought and consideration. While assessing these policy choices, companies need to evaluate not just their current environment, but future plans (for example, plans for a future overseas listing).
The notified converged standards have also deferred the applicability of guidance on accounting for embedded leases and service concession arrangements.
These carve-outs could have been avoided, but the Government has adopted a practical approach to implement a significant and complex change in the accounting framework. It is now up to each company to choose whether they want to fully converge with IFRS (subject to the mandatory deviations discussed above) or take a simpler way out to manage the transition.
Ind-AS financial statements for subsequent periods can be made compliant with IFRS if a company chooses optimal accounting policies and does not adopt the prescribed alternatives available under Ind AS (other than those impacted by mandatory deviations).
