INTRODUCTION With the notification of the roadmap by the
Ministry of Corporate Affairs for adoption of International Financial
Reporting Standards (IFRS) converged Indian Accounting Standards (Ind
AS) by all listed companies and large unlisted companies, the adoption
of the same will lead to many changes in the financial statements of
companies, both in terms of presentation and numbers.
Apart from
changes in the accounting, there are several other areas where there
would be an impact, some of which are highlighted hereunder:
Impact of transition on the profit/loss, financial position and net worth of the entity.
Communication with the Board and/or Audit Committee.
Increased volatility in the results.
Increased
disclosure requirements, both quantitative and qualitative which would
result in greater transparency. There would be significantly detailed
disclosures about management judgements and estimates.
Changes in existing information systems requirements.
Impact on reporting on Internal Financial Controls.
Need for increased availability of and enhanced capability of resources.
Greater
alignment with business operations due to increased focus on substance
rather than legal form. There would be greater emphasis on the
underlying business rationale and true economics of various transaction.
Tax implications of and the cost associated with the transition
Loan covenants
Dividend distribution
Investor relations.
An
attempt has been made in the foregoing paragraphs to briefly examine
the various practical considerations in the transition to and adoption
of Ind AS by corporates.
PREPARA TION OF IND-AS OPENING BALANCE SHEET
The
first and foremost consideration in the transition to Ind-AS is the
preparation of the opening Balance sheet. Whilst preparing the Opening
Ind-AS Balance Sheet, subject to the mandatory exceptions and
exemptions, an entity would normally require to ascertain the
adjustments under the following broad headings:
Not to recognise items as assets and liabilities, if Ind-AS does not permit their recognition.
Recognise all assets and liabilities whose recognition is required by Ind-AS.
Reclassify assets, liabilities, and items of equity as per Ind-As requirements.
Measure all assets and liabilities in accordance with Ind-AS.
Let us now examine some of the common adjustments which may be required under each of the above heads.
Not to recognise items as assets and liabilities if Ind- AS does not permit their recognition:
Some of the common adjustments which may be required in this respect are briefly discussed hereunder:
Ind-AS-10 Events after the Reporting Period does not permit recognition of proposed dividends as
an adjusting event and hence the same is not to be presented as a
liability as is the case with AS-4. The proposed dividend is only
required to be disclosed as a note.
Any deferred income or expenditure
such as premium/discount on issue/redemption of debentures / bonds or
expenses on issue of debentures or bonds recognised in terms of the
special dispensation under AS-26, and which are an integral part of the
amortised cost of financial assets and liabilities should be factored in
to determine the effective interest rate and reversed in the opening
balance sheet.
The carried forward balance of any share issue expenses
which are amortised in terms of the special dispensation under AS-26
are required to be eliminated whilst preparing the opening balance
sheet. (The treatment to be adopted if already adjusted against Securities premium Account is not clear).
Any contingent assets or reimbursements like insurance or other claims which are not virtually certain and do not meet the recognition criteria under Ind-AS-37 should be reversed in the opening balance sheet.
In the opening consolidated financial statements, assets and liabilities of joint ventures which are included under the Proportionate Consolidated method should be reversed since the same is no longer permissible
Any held for sale subsidiary, associate or joint venture should be eliminated from consolidation and disclosed as a separate disposal group.
Recognise all assets and liabilities whose recognition is required by Ind-AS.
Some of the common adjustments which may be required in this respect are briefly discussed hereunder:
All derivative financial assets and liabilities and embedded derivatives shall be recognised if not done earlier.
Certain
provisions in the nature of restructuring obligations, onerous
contracts, decommissioning liabilities, site restoration, warranties,
litigation etc. need to be recognised based on constructive obligations, which may not have been recognised earlier or were disclosed as contingent liabilities.
Various intangible assets
like brands, customer lists etc. acquired in a business combination,
which earlier were part of goodwill need to be recognised if
retrospective application of Ind-AS 103 is opted for.
Recognition of certain new investment properties
in view of the differences in the recognition criteria e.g land held
for long term capital appreciation, building that is vacant but is held
to be leased under one or more operating leases etc.
Deferred tax assets and liabilities would need to be recognised based on the Balance sheet approach.
In the consolidated financial statements investments in joint ventures need to be recognised based on the equity method.
Assets
and liabilities of any held for sale subsidiary, associate or joint
venture would need to be recognised and presented as a disposal group.
Reclassify assets, liabilities, and items of equity as per Ind-As requirements.
Some of the common adjustments which may be required in this respect are briefly discussed hereunder:
Classification of financial liabilities and equity should be based on the substance
rather than legal form e.g. redeemable preference shares would need to
be reclassified as debt, fully convertible debentures would need to be
reclassified as equity etc.
Compound financial instruments need to be split into debt and equity components e.g. partly / optionally convertible bonds.
Financial assets, notably investments, need to be reclassified into amortised cost, fair value through profit and loss, fair value through other comprehensive income etc.
Certain intangible assets acquired as part of earlier business combinations may not meet the definition of intangible assets and hence need to be included as part of goodwill e.g. certain acquisition cost, promotional cost etc.
An entity preparing consolidated financial statements
for the first time or which has not consolidated any subsidiary under
AS-21 e.g. where the control is exercised through the power to govern
the operating policies and business decisions rather than through
shareholding alone would need to incorporate the relevant assets and
liabilities.
Measure all assets and liabilities in accordance with Ind-AS.
Some of the common adjustments which may be required in this respect are briefly discussed hereunder:
In case of purchase of inventories, fixed assets and intangible assets on deferred settlement terms, the interest element would need to be segregated.
In case of fixed assets, if the fair value model is opted for, it would necessitate a remeasurement.
Government grants in the form of non-monetary assets or concessional loans are to be measured at the fair value.
Borrowing cost are to be calculated using the effective interest rate method.
Where the time value of money is material, provisions should be on a discounted basis.
Share based payment transactions need to be recognised on a fair value basis.
Assets and liabilities acquired in a business combination need to be measured at fair value.
Non-current assets held for sale and Discontinued Operations need to be measured at fair value less costs to sell.
All
Financial assets and liabilities to be initially recognised at fair
value and subsequently measured based on their classification as above.
As
part of the transition to Ind-AS entities are also required to evaluate
the various exemptions, both mandatory and voluntary, which are
provided for under Ind-AS-101, the important ones of which are briefly
discussed hereunder:
MANDATORY EXEMPTIONS TO RETRO – SPECTIVE APPLICATION OF IND-AS
A first time adopter is provided with the following key mandatory exemptions to retrospective application of certain Ind-AS:
Derecognition of Financial Assets and Liabilities
There
is no need to recognise any financial asset or liability which is
already derocognised under local GAAP. Alternatively, the entity may
apply derecognition criteria retrospectively by choosing a cut off date.
Hedge Accounting
Any transactions entered into before the date of transition are not to be retrospectively designated as hedges.
Classification and Measurement of Financial Assets and Liabilities
The
determination of cash flows for time value measurement of financial
assets on the date of transition is not required when it is
impracticable to assess the same retrospectively, subject to adequate
disclosures being made till their derecognition.
For measurement
of existing financial assets and liabilities on the date of transition,
if it is impracticable to determine effective interest rate
retrospectively, the fair value on the date of transition shall be the
new gross carrying amount or the new amortised cost for applying the
effective interest method.
Embedded Derivatives
A
first time adopter shall assess whether an embedded derivative is
required to be separated from the host contract on the basis of
conditions that existed at the later of the date it first became a party
to the contract and the date of reassessment.
Government Loans
The
benefit of a government loan at below market rate of interest is not
required to be recognised as a government grant on the date of
transition.
VOLUNTARY EXEMPTIONS TO RETRO – SPECTIVE APPLICATION OF IND-AS
A
first time adopter is provided with the following key voluntary
exemptions to retrospective application of certain Ind-AS. Understanding
the same is of critical importance since it could impact comparability
of results of entities in the same sector.
Share based Payment Transactions
Voluntary
retrospective application of fair valuation in respect of equity
instruments granted, vested and not settled or any modification made
before the date of transition is available. Similar considerations apply
to any liabilities arising out of such transactions which are settled
before the date of transition. However, an entity may adopt earlier
application if fair value disclosures have been publicly made.
Deemed Cost of Property, Plant and Equipment and Intangible Assets
The
entity can opt for the previous GAAP carrying amount as deemed cost.
Alternatively, the fair value on the date of transition can also be
considered as the deemed cost provided it is comparable with what is
required under Ind-AS. In certain cases, an event driven fair value used
during a privatisation, IPO etc. can also be considered as a deemed
cost. In case fair value is taken as deemed cost, the same should be
allocated component wise and depreciation shall be calculated
accordingly.
Deemed Cost of Investment Property
These
may be identified on the date of transition based on Ind-AS criteria of
these being used to earn rentals or for capital appreciation as against
the AS-13 criteria of it not being intended to be used or occupied
substantially in the operations of the enterprise.
Leases
Separate
classification where lease includes both land and building into the
finance (normally for land) and operating lease, as applicable on the
date of transition is permissible where there is a composite lease of
land and building.
Determining whether an arrangement contains a lease on the date of transition based on the specific assets test – fulfilment of the arrangement is dependent on the use of a specific asset or right to use of an asset.
Cumulative Translation Differences
Cumulative
translation differences for all foreign operations (Ind-AS does not
distinguish between integral and non-integral operations) on the date of
translation shall be zero; and
Gains and losses on subsequent
disposal of foreign operations shall exclude translation differences
prior to the date of transition.
Long Term Foreign Currency Monetary Items
If these are reflected under FCMDTA account, similar treatment can continue on the date of transition.
In
case these are adjusted against the carrying value of the fixed assets,
similar treatment can continue only if the entity adopts the deemed
cost model as discussed above.
Investments in Subsidiaries, Associates and Joint Ventures
Deemed
cost as per previous GAAP (i.e. fair value in the separate financial
statements on date of transition or previous GAAP carrying amount) on
the date of transition can be used.
Assets and Liabilities of Subsidiaries, Associates and Joint Ventures
If
an entity adopts Ind-AS before or simultaneously with the
parent/investor, no adjustments required. However, if the entity adopts
Ind-AS later than the parent/investor, respective carrying amounts on
the date of the investor’s/ parent’s transition can be considered.
Compound Financial Instruments
An
entity is required to split into liability and equity components
retrospectively unless liability component is no longer outstanding on
date of transition.
Designation of Previously Recognised Financial Instruments
All Financial assets are required to be classified into three types, as under:
Fair value through Profit and Loss in
cases where the holding of the financial asset helps to eliminate or
significantly reduce measurement or recognition uncertainty or holding
period is less than 12 months. It can be used irrespective of the
business model discussed below.
Fair value through other comprehensive income in
cases where the business model involves collection of contractual cash
flows either through selling the asset or through principal and interest
payments.
Amortised cost, in cases where the business model involves collection of contractual cash flows of interest and principal.
All Financial liabilities are required to be classified into two types, as under:
1. Fair value through Profit and Loss (very selectively)
2. A mortised cost.
The above designations can be either at initial recognition or on the date of transition.
The
amortised cost of financial assets and liabilities shall be determined
on the basis of the benchmark interest rate on the date of transition,
if it is impractical to determine the same retrospectively.
All
Equity instruments always to be classified at fair value – either
through Profit & Loss or through Other Comprehensive Income and no
recycling permissible if option of classifying through OCI is selected –
No specific impairment analysis required
Fair Value Measurement of Financial Assets and Liabilities on Initial Recognition
This may be applied prospectively to transactions entered into on or after the date of transition.
Decommissioning Liabilities included in Cost of Fixed Assets
Where exemption from retrospective application is sought, following needs to be done:
Measure the liability on the date of transition as per Ind-AS 37.
To
the extent it is to be included in the cost of the asset, the amount
should be estimated based on the assumption that it would be included
when the liability first arose and then discounted accordingly, using
historical risk adjusted discount rates (based on average annual
inflation, and incremental borrowing rates).
Calculate accumulated depreciation on the above amount using current estimated useful life.
Service Concession Arrangements
Recognise financial assets and intangible assets on the date of transition.
Use the previous GAAP carrying amounts.
Test for impairment at the date of transition unless impractical to do so.
Joint Venture Accounting – Transition from Proportionate Consolidation to Equity Method
Business Combinations
An entity may choose not to apply Ind-AS-3 to business combinations that occurred before the date of transition.
However, if it decides to restate any past business combinations, it should restate all business combinations after that date.
Apart from the various exemptions, certain other key considerations under various Ind-AS are discussed hereunder:
OTHER KEY CONSIDERATIONS IN TRANSITION Ind-AS-2 Inventories
In
respect of inventories acquired on deferred settlement basis, the
interest element thereon shall be excluded. This needs to be adjusted on
the date of transition.
Sale of inventories after the reporting
period would be an adjusting event under Ind-AS 10 discussed below
which would need to be adjusted on the date of transition.
Ind-AS10 Events After Reporting Period
Any
provision for proposed dividend and related dividend distribution tax
after the reporting period shall be reversed and added back to retained
earnings.
Settlement of a court case after reporting period
confirms the existence of a present obligation and accordingly the
previously created provision needs to be adjusted or fresh provision
need to be created in terms of Ind-AS-37.
An entity shall adjust
cost of assets purchased based on information available after reporting
period if it opts for carrying value as the deemed cost.
On the
date of transition any legal and/or constructive obligations after the
reporting period shall be taken into account if not considered under
previous GAAP. (see discussion on Ind-AS 19 on Employee Benefits below)
Ind-AS 19 on Employee Benefits
Actuarial
gains and losses arising on defined benefit plans and other long term
employee benefits should be recognised in the Statement of Other
Comprehensive Income and cannot be recycled to the Profit and Loss
Account.
All past service costs need to be immediately expensed off.
Instead
of recognising interest cost in the Profit and Loss Account, Ind- AS-19
requires recognition of net interest cost based on the net defined
benefit asset or liability and the discount rate at the beginning of the
year.
Other miscellaneous adjustments in the actuarial assumptions.
Revised actuarial valuation would be required.
More
specific guidance on accounting for constructive obligations i.e. as a
result of informal practices. These would need to be henceforth
recognised in the financial statements
Ind-AS 23 on Borrowing Costs
Inventories
which are manufactured or otherwise produced in large quantities on a
repetitive basis are not considered as qualifying assets even if they
take a substantial period of time to get ready for their intended use or
sale. e.g wines, cheese etc.
Borrowing costs shall be measured
applying effective interest rate method from the date transition date.
Accordingly, ancillary borrowing cost written off earlier need to be
amortised. Earlier period borrowing costs should not be restated.
Dividend payable in respect of compulsorily redeemable preference shares
would also need to be considered as borrowing costs eligible for
capitalisation depending on the specific circumstances.
Ind-AS 12 Income
Taxes
Balance Sheet method to be adopted for computation of deferred
tax asset or liability by which the tax base is compared with accounting
base. Primary impact would be in respect of business combinations and
consolidation adjustments.
Tax base of an asset is the amount
deductible for tax purposes against any taxable economic benefits that
would flow to the entity when it recovers the carrying amount of the
asset. e.g depreciable assets, uncollected income taxed on a cash basis,
assets measured at fair value where the fair value gain is not taxed or
fair value loss is disallowed.
Tax base of a liability is its
carrying amount, less any amount deductible for tax purposes. E.g.
income received in advance taxed at a later date, loan payable having an
amortised cost.
A first time adopter would have to establish the
history of items that give rise to temporary differences and adopt
retrospective application.
Implications vis-à-vis ICDS needs to be
considered?
Ind-AS 38 Intangible Assets
Unamortised share issue
expenses need to be charged off. Amounts in the nature of transaction
cost need to be reduced from equity.
Any unamortised borrowing costs
need to be analysed. Initial transaction cost need to be reduced from
the borrowings and any ancillary cost needs to be considered in the
calculating the effective interest rate.
Revenue based amortisation
of toll roads would not be permitted for toll roads arising after the
transition date.
Amortisation of intangible assets with indefinite
useful life not permitted. E.g., Right of Way, Stock Exchange broking
card etc. These would however need to be tested for impairment.
Implications vis-à-vis adjustment against Securities Premium Account to be considered.
Ind-AS 21 Effects of Changes in Foreign Exchange Rates
The concept of functional currency introduced for the first time. No first time exemption provided. It is the currency of the primary economic environment
in which the entity operates. It is normally the currency which
influences the income and expenses the most. e. g. shipping company.
Ind-AS 37 Provisions, Contingent Liabilities and Contingent Assets
Specific
requirement to recognise provisions in respect of constructive
obligations. AS-29 does not specifically refer to the same. It only
refers to creation of provisions arising out of normal business customs
and practices, to maintain business relations etc.
Restructuring provisions need to be made based on constructive obligations as against legal obligations in terms of AS-29.
Discounting of provisions where effect of time value of money is material.
OTHER AREAS HAVING SIGNIFICANT IMPACT
FINANCIAL INSTRUMENTS
Recognition and Measurement
Greater use of fair value – use of judgement and valuation tools in many cases.
Impairment to be calculated on the Expected Credit Loss Model.
–
Assessment of whether there is a significant increase in the credit
risk since initial inception or there is a low credit risk; in which case
12 months expected credit losses are recognised.
– Where
significant increase in credit risk since initial inception and no
objective evidence of impairment, in which case life time expected
credit losses to be recognised on a PD basis
– Where there is
objective evidence of impairment, life time expected credit losses are
recognised and interest income is computed on the net basis (i.e. net of
credit allowances)
– The above will have a big impact on financial institutions and NBFCs which are covered at a later date. However, in the interim any loans granted by non- financial entities would still need to be evaluated since currently they are not even covered by the prudential guidelines. Financing of group entities would need closer scrutiny.
Derivative Instruments- Currently, there are diverse practices adopted. Whilst some entities were adopting AS-30 (which is recommendatory in nature), other entities are following the ICAI announcement which requires only losses to be recognised. Post adoption of Ind-AS, consistency would creep in and recognition of both gains and losses either through Profit and Loss or OCI (where hedge accounting is adopted) would be required. The impact would be greater for entities who were hitherto following the ICAI announcement and recognising only losses.
Transaction Costs
– In respect of long term borrowings, these will be recognised over the tenor of the borrowing using the effective interest rate method as against the current practice of charging off.
– In respect of financial assets, these would need to be charged off as against the current practice of capitalising the same, unless these are in respect of financial assets recorded on amortised cost basis, in which case they would need to be adjusted against the carrying value.
BUSINESS COMBINATIONS
Recognition and Measurement
Acquisition Value
– Assets and liabilities to be recognised at fair value.
– Contingent Liabilities and Intangible Assets not recognised in the acquiree’s financial statements would also need to be recognised at fair value.
– Non controlling interests to be measured at fair value.
– Significant changes in the value of goodwill reflecting a more accurate depiction of the premium paid on acquisition even though the legal form of the acquisition has not changed.
– Recording of assets at fair value will normally result in higher depreciation and amortisation – In case of intangibles with indefinite useful life or with higher useful life lower or no amortisation.
– Goodwill will not have to be amortised but tested for impairment.
– In case of a business combination in stages, the previously held equity interest to be measured at acquisition date fair value, with resultant gain or loss recognised in the Profit and Loss resulting in greater volatility in the Income Statement.
Accounting for Transaction Costs
– These need to be charged off as against the current practice of generally capitalising them.
Accounting vis-à-vis High Court Orders
– Under the Companies Act, 2013, certificate from the auditors required whether scheme is in accordance with the Accounting Standards thereby doing away with the leeway provided under the Companies Act, 1956.
– Position in the intervening period till the notification of the relevant sections under the Companies Act, 2013, especially for non-listed companies not clear.
CONSOLIDATED/GROUP ACCOUNTS
Recognition and Measurement
Preparation of Consolidated Financial statements – Many additional SPEs would get consolidated and there could be deconsolidation of certain subsidiaries since two companies cannot consolidate the same subsidiary since control can be exercised only by one entity. Investment entities are also not required to be consolidated.
– Consolidation mandated under the Companies Act, 2013 of associates and joint ventures even if there are no subsidiaries.
– Proportionate consolidation method no longer permissible.
– Definition of control is different. An investor is deemed to control an enterprise only when he has the power over the entity or when he has exposure or rights to variable returns from its involvement with the investee and has the ability/power the affect these returns. Such powers can be exercise even when there is no majority ownership. Even potential voting rights are relevant.
– Changes in ownership interest that do not result in loss of control should be adjusted against equity. No guidance under current GAAP and hence differing practices were adopted.
– Losses incurred by the subsidiary to be allocated between the controlling and non-controlling interest as against the practice under Indian GAAP of adjusting these against the majority, unless there is a binding obligation to make good the losses.
Uniform Accounting Policies
– Not very rigid and strictly enforceable under current GAAP. – Challenges could be encountered especially in case of associates over which control is not exercised.
– Many group entities would be required to change their policies, the individual impact of which would need to be evaluated.
Uniform Financial Year
– Maximum gap reduced to three months as against six months. – On adoption many entities would be compelled to change their year ends.
INCOME TAXES
Recognition and Measurement
Recognition based on Balance Sheet method for taxable temporary differences as against timing differences under the current GAAP.
Recognition of deferred tax on business combinations.
Recognition of deferred tax assets on losses is not very stringent.
Deferred tax liability required to be recognised in consolidated financial statements for all taxable temporary differences in connection with group investments unless the investor is able to control the timing of the reversal in the foreseeable future.
Significantly detailed disclosures and reconciliations.
EMPLOYEE BENEFITS AND SHARE BASED PAYMENTS
Recognition and Measurement
Actuarial gains and losses to be taken to Other Comprehensive Income which will reduce volatility.
Employee benefits are required to be recognised based on constructive obligation as against the current practice of generally recognising the same based on legal obligation.
ESOPS to be mandatorily recorded on a fair value basis which would result in increased charges and hence have a significant impact on key performance indicators like EPS.
Share based payments to non-employees like vendors against supply of goods and services would need to be recorded on a fair value basis in all cases, which is currently missing. Only fixed assets so acquired are accounted for at fair value in terms of AS-10. This could have a negative impact on the financial results and other performance indices, dividend servicing abilities and loans covenants, amongst others.
PROPERTY, PLANT AND EQUIPMENT
Recognition and Measurement
Mandatory Component Accounting
– Any cost which is significant in relation to the total cost and has a separately defined useful life need to be separately identified and depreciated accordingly.
– Residual value calculations and estimates need to be evaluated afresh.
– Even companies not adopting Ind-AS need to adopt the same in terms of the Companies Act, 2013.
– Expected to a have a material and significant impact on highly capitalised manufacturing entities and IT technology companies.
– Could have a significant impact on insurance, asset backed financing, amongst other matters.
Revaluation of Assets
– No selective revaluation permitted.
– Updation of revaluation on a regular basis.
– Depreciation charge to be charged off to Income Statement. Even companies not adopting Ind- AS need to follow the same in terms of the Companies Act, 2013
– Since it is an option it can affect comparability of results of the same class of companies and hence uniformity in terms of loan covenants including security cover etc. would be an issue.
–For companies adopting the revaluation route whilst the asset base would be higher, there would also be a higher corresponding depreciation charge
Repairs and Overhaul expenditure
– Needs to be capitalised if it satisfies the recognition criteria.
– Corresponding decapitalisation of the replaced parts.
– Closer scrutiny of the renewal and asset maintenance policies of companies, especially those which are asset heavy.
Unrealised Exchange Differences
– These are required to be charged off in all cases prospectively.
– Companies who have opted for the transitional relief for continuing treatment of capitalisation in terms of para 46A of AS-11 till the tenor of the loans or till FY 2020. This would impact comparability of results.
– Greater volatility in the results of companies who have large overseas borrowings.
INTANGIBLE ASSETS
Recognition and Measurement
Intangible assets can have indefinite useful lives, identification of which should be adequately and appropriately demonstrated and justified. Such assets need to be subjected to an annual impairment assessment.
Fair valuation is now permissible especially if an active market exists.
CONCLUSION
The above assessment is just the tip of the ice-berg and in actual practice there could be many other issues, challenges and implications which would merit a detailed assessment.
