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Category: Accountancy and Audit

Godrej Consumer Products Ltd. (31-3-2010)

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Section A : Disclosures on Clause 21 of CARO, 2003 regarding
fraud noticed or reported on or by the company during the year


9. Godrej Consumer Products Ltd. (31-3-2010)

From Auditor’s Report :

Based upon the audit procedures performed by us, to the best
of our knowledge and belief and according to the information and explanations
given to us by the management, no fraud on or by the Company has been noticed or
reported during the year except in one case where certain claims amounting to
Rs.2,424.18 lakhs have been made on the Company on account of the unauthorised,
illegal and fraudulent acts of one of its employee whose services have since
been terminated. The Company has been legally advised that it has a strong legal
case in the matter.


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Kingfisher Airlines Ltd. (31-3-2010)

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Section A : Disclosures on Clause 21 of CARO, 2003 regarding
fraud noticed or reported on or by the company during the year


8. Kingfisher Airlines Ltd. (31-3-2010)

From Auditor’s Report :

As per the information and explanations furnished to us by
the management, no material frauds on or by the Company and causing material
misstatements to financial statements have been noticed or reported during the
course of our audit, except for charge backs received by the Company aggregating
to Rs.475.44 lacks from the credit card service providers due to misutilisation
of credit cards by third parties.

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Thomas Cook (India) Ltd. (31-12-2009)

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Section A : Disclosures on Clause 21 of CARO, 2003 regarding
fraud noticed or reported on or by the company during the year


7. Thomas Cook (India) Ltd. (31-12-2009)

From Auditor’s Report :

During the course of our examination of the books and records
of the Company carried out in accordance with the Auditing Standards generally
accepted in India, we have neither come across any instance of fraud by the
Company noticed or reported during the year, nor have been informed of such case
by the management. Fraud on the Company or misappropriation of assets
aggregating to Rs.49,87,000 by employees of the Company were noticed and
reported. The management has since recovered Rs.7, 50,000 of the total amount
[Refer Note 2(t) of the Schedule Q].

From Notes to Accounts :

Employees of the Company and other parties misappropriated
assets aggregating to Rs. 4,987,000 (previous year Rs.7,251,682) during the
year. The cases are under investigation and the Company has taken steps for
recovering the balance amount. There is no open exposure on the profit for the
year in respect of misappropriated assets except for Rs. Nil (previous year
Rs.751,100).

 

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Companies Act, 1956 and IFRS Convergence — An overview

IFRS

IFRS Convergence in India has gained significant momentum due
to the issuance of the Press Announcement by the Ministry of Corporate Affairs
(MCA) in January and March 2010 and subsequent clarifications issued in May
2010.

The Institute of Chartered Accountants of India (ICAI), on
its part, has issued 38 exposure drafts of ‘Ind-AS’ — i.e., the converged
accounting standards, in line with the IFRSs.

ICAI has also issued a document identifying areas where
provisions of the Companies Act, 1956 (‘the Act’) need to be changed to bring it
in line with IFRS. This article attempts to discuss those areas (listed below)
and the recommendations proposed by ICAI :

  • Proposed dividends


  • Accounting of
    depreciation


  • Restatement of prior
    years’ numbers


  • Presentation of financial
    statements


  • Financial instruments and
    preliminary expenses


  • Definition of ‘Control’


  • Accounting for business
    combinations







Proposed dividends :

Paras 12 and 13 of IAS 10 Events after the reporting
period state that proposed dividend does not meet the criteria of a present
obligation in IAS 37 (Provisions, Contingent Liabilities and Contingent Assets)
and hence it shall not be recognised as a liability, but disclosed in
notes.

The Company Law department via circular no. 3/124/75-CL-V,
dated November 22, 1976 had expressed its views that proposed dividends
should be shown as ‘Current liabilities and provisions’ and part I of the
Schedule VI also requires proposed dividends to be shown as ‘Current liabilities
and provisions’.

Actions required to comply with IFRS :

The said Circular should be suitably amended. Also, Schedule
VI should be revised (ICAI has already submitted the proposed revisions to
Schedule VI to the Ministry of Corporate Affairs).

Other matters to be considered :

Under the present provisions of the Act, profits reported as
per books of account can be utilised for declaration of dividend, provided
adequate depreciation as required by the Act, has been provided for.

Under IFRS there are situations (illustrated below) where the
Company has to record unrealised gains/losses in the financial statements.

1. Unrealised gains/losses on fair value of equity

investments classified as fair value through profit and loss
account and derivatives

2. Revenue recognised during the construction period for a
public private service concession arrangement.

Though, in such situations, the Company would have reported
profits which can be utilised for dividend, the Company may not have sufficient
cash flows to fund the same and at the same time maintain adequate liquidity in
the system.

Similarly, there are situations where the Company has
received the cash flows, however is not permitted to recognise revenue, for
example,

1. For real estate sale contracts, revenue is generally
recognised on transfer of possession of property as against the current practice
of recognising revenue on a proportionate completion basis. Though, in such
situations, the Company would have sufficient liquidity, since collections are
made on achievement of individual milestones, the Company would not have
sufficient profits, since all revenue will be recognised only at the end on
transfer of possession of the property.

Further, under IFRS there are certain gains/losses which are
not accounted in the profit and loss account, but in the ‘other comprehensive
income’ statement, such as :

1. Mark to market of derivatives designated as hedging
instruments (for all effective hedges)

2. Fair value changes of financial instruments classified
as available for sale securities

Regulators will need to consider, whether such items need to
be adjusted to compute profit available for distribution as dividends to
shareholders.

Accounting of depreciation :


1. Component accounting :


Para 43 (read with BC 26 and 27) of IAS 16 ‘Property,
Plant and Equipment’ (PPE) states that each part of an item of PPE
with a cost that is significant in relation to the total cost of the item shall
be depreciated separately. For example, the engine of an aircraft needs
to be separately depreciated from its body.

The Act, on the other hand, does not indicate any such
requirement.

2. Depreciation rates :


Paras 50 and 53 of IAS 16 ‘Property, Plant and Equipment’
state that the depreciable amount of an asset, determined after reducing its
residual value from its cost, shall be allocated on a systematic basis over
its useful life. Further, para 51 requires annual review of useful life
and residual value.

The Act, under Schedule XIV, prescribes minimum rates of
depreciation for different classes of assets based on shift working and does not
recognise allocation of depreciation based upon the useful life of an asset and
deduction of residual value of the asset from its cost for arriving at the
depreciable amount. Further, S. 205(2) and S. 205(5) of the Act permits
depreciation to be provided either for 100% of the cost of the asset or 95% of
the cost of the asset and also allows the Central Government to approve any
basis of providing depreciation on assets for which no rate has been laid down
in the Act.

3.         Depreciation
method?:

Paras 60 to 62 of IAS 16 ‘Property, Plant
and Equipment’ state that the depreciation method used shall reflect the
pattern in which the asset’s future economic benefits are expected to be
consumed by the entity. The depreciation method applied shall be reviewed
annually. Further, it allows ‘units of production method’ as a method of
depreciation along with ‘straight-line method (SLM)’ and ‘diminishing balance
method (WDV)’.

The Act, under Schedule XIV, specifies
depreciation rates as per SLM and WDV methods only.


Actions required to comply with IFRS?:

Schedule XIV should be revised. It should
prescribe only industry-specific guidelines for indicative rates. These shall
serve as industry-specific benchmarks. It should state that the manner of
computing depreciation on assets, whether specified in the Schedule or not,
shall be as per the requirements of the accounting standards prescribed by the
Central Government referred to in S. 211(3C) of the Act. These shall be the
general guidelines and used as rebuttable presumptions.

 The Ministry of Corporate Affairs has
already issued a draft Schedule XIV which is placed on their website. ICAI is
involved in the process of revising the same to make it consistent with IFRS.

 The proviso (a), (b) and (c) u/s.205(1) and
item 3(iv) of Schedule VI-PART II — that recognises non-provision of
depreciation — should be repealed. Also, clauses (b), (c) and (d) of S. 205(2)
and S. 205(5) — that permit 95% of the cost to be depreciated and allows the
Central Government to approve any basis — should be repealed.

 

Restatement of prior years’ numbers:

Para 19 of IAS 8 Accounting policies,
changes in accounting estimates and errors requires an entity to apply any
changes in accounting policies retrospectively. As per para 22, when a change
in accounting policy is applied retrospectively, the entity shall adjust the
opening balance of each affected component of equity for the earliest prior
period presented and the other comparative amounts disclosed for each prior
period presented as if the new accounting policy had always been applied.

Similarly, para 42 requires correction of
material prior period errors retrospectively by restating the prior period
numbers. Further, para 46 requires exclusion of correction of a prior period
error from profit or loss for the period in which error is discovered. 

As per the Circular No. 1/2003, dated
January 13, 2003 issued by the erstwhile Company Law Board, a company could
reopen and revise its accounts even after their adoption in the annual general
meeting only to comply with technical requirements of taxation laws and
of any other law to achieve the object of exhibiting true and fair view. It
does not permit revision for changes in accounting policies or prior period
errors. All such adjustments and corrections have to be included in the current
year’s profit or loss.

Actions required to comply with IFRS:

The Circular issued by the Company Law
Board should be revised to allow re-statement of the numbers in order to comply
with the requirements of IFRS.

The Circular should further state that the
financial statements presented shall be deemed to be in agreement with the
books of account to the extent of such re-statement for all such periods.

It should also allow the amount of net
profit, assets and liabilities as per the approved audited accounts for all
such periods to be considered as final for the purpose of the computation of
the total managerial remuneration payable u/s.198, u/s.199 and u/s.349 of the
Act or any provision u/s. 205 of the Act relating to declaration of any
dividend or any other such provision of the Act i.e., the managerial
remuneration, dividend paid as per profits reported in the prior years need not
change because of restatements in any of the subsequent periods.


Presentation of financial statements:

The existing form of balance sheet
(statement of financial position) set out in part I of Schedule VI and the
requirements as to Profit and loss account set out in part II of Schedule VI do
not comply with the requirements set out in IAS 1 Presentation of financial
statements regarding the presentation of financial statements, as mentioned
below?:

1.         A
separate statement of changes in equity (SOCIE) presenting all owner
changes in equity is not permitted under the Act

2.         The
concept of Comprehensive Income and Other Comprehensive Income (OCI)
is not recognised in the Act

3.         Distinction
between owner changes in equity

(SOCIE) and non-owner changes in equity
(OCI) is not recognised in the Act

4.         As
per para 39 of IAS 1, when an entity applies an accounting policy
retrospectively or makes a retrospective restatement of items in its financial
statements, it shall present, as a minimum, three statements of financial
position (as at the end of the current period, the end of the previous period
and the beginning of the earliest comparative period).

The Act does not mandate presentation of a
third statement of financial position.

5.         As
per para 60 of IAS 1 Presentation of Financial Statements, an entity shall
present current and non-current assets and liabilities in its statement of
financial position except when a presentation based on liquidity provides
information that is reliable and more relevant. For example, in case of
long-term borrowings, the amount repayable within 12 months from the reporting
date shall be presented as current and the balance as non-current liabilities.

The form of balance sheet set out in Part I
of Schedule VI does not consider current/ non-current classification of
assets/liabilities.

 

6.         Extraordinary
items?:

As per para 87 of IAS 1, an entity shall
not present any items of income or expense as extraordinary items.

Whereas, as per part II(3)(xii)(b) of the
Schedule VI, the profit and loss account shall disclose profits or losses in
respect of transactions of a kind, not usually undertaken by the company or
undertaken in circumstances of an exceptional or non-recurring nature,
if material in amount.

 

Actions required to comply with IFRS:

 

Schedule VI would need to be revised.
Further regulators will also need to consider that the companies in India would
be converging with IFRS in a phased manner, with only approximately 500+
companies converging from 1 April 2011 (phase 1). Hence, regulators may need to
consider two parts of Schedule VI — one that complies with the requirements of
IFRS and other which will be applicable to companies either covered in later
phases or exempt from convergence (i.e., companies not covered in any of the
phases).

 

Financial instruments and preliminary
expenses?: 

1.         Substance
v. legal form?:

As per para 18 of IAS 32 Financial
Instruments: Presentation, substance of a financial instrument, rather than its
legal form, governs its classification in the entity’s balance sheet. For
example, compulsorily convertible debenture is an equity instrument and
compulsorily redeemable preference share is a financial liability.

However, the Act mandates classification
based on legal form only i.e., as per S. 86 of the Act, share capital shall be
of two kinds — equity and preference.

2.         Dividends
on capital designated as financial liability?:

As per IFRS, interest, dividends, losses
and gains relating to a financial liability shall be recognised as income or
expense in profit or loss. Distributions to holders of an equity instrument
shall be debited directly to equity.

However, as per the Act, dividend on all
types of capital is to be presented only as an appropriation of profit.

 

3.         Transaction
costs?:

As per IFRS, transaction costs of an equity
transaction shall be accounted for as a deduction from equity, net of any
related income tax benefit.

However, as per the Act, these have to be
presented as Miscellaneous Expenditure on the assets side of the balance sheet.
They can also be written off against the securities premium account, as per S.
78(2)(c) of the Act.


4.         Premium
on redemption of preference shares?:

As per IFRS, gains and losses associated
with redemptions or refinancings of financial liabilities are recognised in
profit or loss.

 However, proviso (C) u/s.80(1) and u/s.78(2)(d)
of the Act permits writing off premium on redemption of preference shares
against the securities premium account.

Similarly, losses and expenses relating to
other financial liabilities like debentures may be allowed to be written off
against securities premium as per S. 78(2)(d) of the Act, but shall be
recognised in the profit or loss as per para 36 of IAS 32.

 

5.         Preliminary
expenses?:

As per para 69 of IAS 38 Intangible Assets,
expenditure on start-up activities shall be recognised as an expense when
incurred. Start-up costs may consist of establishment costs such as legal and
secretarial costs incurred in establishing a legal entity.

However, the Act permits such costs to be
carried forward as Miscellaneous Expenditure (part I of the Schedule VI) or be
written off against securities premium account [S. 78(2)(b) of the Act].


Actions required to comply with IFRS:

Proviso (C) u/s.80(1) and u/s.78(2)(b), (c)
and (d), regarding utilisation of securities premium, should be suitably
amended.

 

Definition of ‘Control’:

Para 4 of IAS 27 Consolidated and Separate
Financial Statements define ‘control’ as the power to govern the financial and
operating policies of an entity so as to obtain benefits from its activities.
Further, as per para 13 of IAS 27, control is presumed to exist when the parent
owns, directly or indirectly through subsidiaries, more than half of the voting
power of an entity. Also, as per para 14 of IAS 27, the existence and effect of
potential voting rights that are currently exercisable or convertible,
including potential voting rights held by another entity, are considered when
assessing whether an entity has the power to govern the financial and operating
policies of another entity.

However, as per S. 4(1) of the Act, a
company shall be deemed to be a subsidiary of another if, but only if:

(a)        that
other controls the composition of its Board of directors

(b)        that
other?:

(ii)        where
the first-mentioned company is any other company, holds more than half in
nominal value of its equity share capital;

(c)        the
first-mentioned company is a subsidiary of any company which is that other’s
subsidiary.

Hence, the definition of ‘control’ as per
IAS 27 is wider in scope than the definition as per S. 4(1) of the Act.

Further, para 4 of IAS 27 defines
‘subsidiary’ as an entity including an unincorporated entity, such as
partnership, that is controlled by another entity (known as parent). However,
as per S. 4(1), only a company can be a subsidiary of another company.

 

Actions required to comply with IFRS:

The Act should be suitably amended to
facilitate preparation of Consolidated Financial Statements under the
principles prescribed under IFRS. However, the definition of a subsidiary
company presently given u/s.4 of the Act should not be used as it is rule-based
and different from AS 27 Consolidated and Separate Financial Statements. The
definition should be revised to be in line with the definition of ‘control’ as
under IAS 27.

Accounting for business combinations:

As per para 18 of IFRS 3 Business
Combinations, the acquirer shall measure the identifiable assets acquired and
the liabilities assumed at their acquisition-date fair value.

 

However, in accordance with clause (vi)
u/s.394(1) of the Act, the order of the Court may provide for such incidental,
consequential and supplemental matters concerning mergers and acquisitions
which may not be as per the recognition, measurement and disclosure
requirements of IFRS.

 

Further, as per IFRS the acquisition date
is to be factually determined i.e., the date on which an acquirer obtains
control of the acquiree, which is generally the date on which the acquirer
legally transfers the consideration, acquires the assets and assumes the
liabilities of the acquiree.

 

Conversely, the order of the Court, in accordance
with the powers granted under the clause (vi) u/s.394(1) of the Act, may
provide for any other date as the acquisition date.

 

Actions required to comply with IFRS:

Clause (vi) u/s.394(1) should be amended to
state that such incidental, consequential and supplemental matters shall not be
in conflict with the requirements of the accounting standards.

 

The Proviso u/s.391(2) should be amended to
require a certificate by the company that the scheme is not in conflict with
the requirements of the accounting standards. This is now required by SEBI for
listed companies, as per amendment to clause 24 of the Equity Listing
Agreement.

 

India has come a long way along the journey
of convergence with IFRS, increasing the confidence about the transition. The
regulators need to address some of these important matters to ensure a smooth
transition and ensure that an entity that complies with IFRS should not be in
non-compliance with other regulatory requirements in that process.
Implementation of the Converged Accounting Standards in the absence of
corresponding changes in the statute will dilute the implementation/convergence
process.

Convergence with International Financial Reporting Standards (‘IFRS’) — Impact on fundamental accounting practices and regulatory framework in India

IFRS — fast gaining adoption and acceptance globally :

The use of International Financial Reporting Standards (IFRS) as a universal financial reporting language is gaining momentum across the globe, especially as compared to a few years ago where a number of different national accounting standards existed. More than 100 countries now require or allow use of IFRS and by 2011 the number is expected to increase to 150. Some of the major countries that are seeking to converge/adopt IFRS by 2011 include Canada, Korea, India and Brazil.

The last two years have also seen significant momentum in the United States on converging from US GAAP to IFRS. The momentum started with the US Securities and Exchange Commission allowing foreign companies listed in the US to file financial statements prepared in accordance with IFRS (without a reconciliation to US GAAP) and continued with a proposal to evaluate IFRS convergence for all US Listed companies between 2014 and 2016.

Convergence with IFRS in India :

In line with the global trend, the Institute of Chartered Accountants of India (ICAI) has proposed a roadmap for convergence with IFRS for certain defined entities (listed entities, banks and insurance entities and certain other large-sized entities) with effect from accounting periods commencing on or after April 1, 2011. Large-sized entities are defined as entities with turnover in excess of Rs.100 crores or borrowings in excess of Rs.25 crores.

Accordingly, as part of its convergence strategy, the ICAI has classified IFRS into the following broad categories :

Category I : IFRS which can be adopted immediately or in the immediate future in view of no or minor differences (for example, construction contracts, borrowing costs, inventories).

Category II : IFRS which may require some time to reach a level of technical preparedness by the industry and professionals, keeping in view the existing economic environment and other factors (for example, share-based payments).

Category III : IFRS which have conceptual differences with the corresponding Indian Accounting Standards and where further dialogue and discussions with the IASB may be required (consolidation, associates, joint ventures, provisions and contingent liabilities).

Category IV : IFRS, the adoption of which would require changes in laws/regulations because compliance with such IFRS is not possible until the regulations/laws are amended (for example, accounting policies and errors, property and equipment, first-time adoption of IFRS).

Impact of IFRS convergence on fundamental accounting practices :

Harmonising existing Indian accounting standards with IFRS will have an impact on some fundamental accounting practices followed in India. A few of these are enumerated below:

Use of fair value concept :

Indian GAAP requires financial statements to be prepared on historical cost except for fixed assets which could be selectively revalued. Use of fair value is presently limited for testing of impairment of assets, measurement of retirement benefits and ‘mark-to-market’ accounting for derivatives. Under IFRS, there is a growing emphasis on fair value. In addition to the requirements under Indian GAAP, the carrying amounts of the following assets and liabilities are based on fair value under IFRS :

  •     Initial recognition of all financial assets and financial liabilities is at fair value

  •     Subsequent measurement of all derivatives, all financial assets and financial liabilities held for trading or designated at fair value through profit or loss, and all financial assets classified as available-for-sale, are measured at fair value

  •     Non-current provisions are measured at fair value, which is derived by discounting estimated future cash flows

  •     Share-based payment awards are measured at fair value

  •     Option available for measurement of property, plant and equipment at fair value, subject to certain conditions

  •     Option available for measurement of intangible assets at fair value, subject to certain conditions

  •     Option available for measurement of Investment property at fair value.

Substance over form :

Considering the overall theme of substance over form, IFRS mandates preparation of consolidated financial statements to reflect the true picture of the net worth to various stakeholders. Exceptions for preparation of consolidated financial statements are very limited. In India, currently consolidated financial statements are mandatory only for listed companies and that also only for the annual financial statements and not the interim financial statements.

Similarly, Indian accounting continues to be driven by the written contract and the form of the transaction – as opposed to the substance. Consider, upfront fees charged by a telecom service provider. Under Indian GAAP, several companies recognise such up front fees as income because it is contractually non-refundable and is contractually received as fees for the activation process. Under IFRS, the fee is accounted for in accordance with the sub-stance of the transaction. Under this approach, the customer pays the upfront activation fee not for any service received by the customer, but in anticipation of the future services from the telecom company. Thus, despite the non-refundable nature of the fees, revenue recognition would be deferred over the estimated period that telecom services will be provided to the customer.

Inconsistencies with existing laws and regulations:

As per the preface to the Indian accounting standards, if a particular accounting standard is found to be not in conformity with a law, the provisions of the said law will prevail and the financial statements shall be prepared in conformity with such law. However, under IFRS, the entity needs to comply with all the accounting standards and other authoritative literature issued by IASB in order to comply with IFRS. If entities adopt accounting practice as approved by another regulatory authority or in conformity with a law, which is not in accordance with IFRS, the financial statement so prepared would not be considered to be in compliance with IFRS.

Disclosures:

In India, Schedule VI to the Companies Act, 1956, which prescribes a detailed format for preparation and disclosure of financial statements, lays great emphasis on quantitative information such as quantitative details of sales, amount of transactions with related parties, production capacities, CIF value of imports and income and expenditure in foreign currency, etc. Contrary to the same, IFRS is more focused on qualitative information for the stakeholders, such as terms of related party transactions, risk management policies, currency exposure for the entity with sensitivity analysis,etc. To more correctly report the liquidity position of the entity, IFRS also . requires segregation of all assets/liabilities into current and non-current portions. Presently under Indian GAAP even long-term deposits and advances are disclosed under current assets, loans and advances, thereby not reflecting the true position.

Exceptional  and extraordinary    items:

Indian GAAP requires companies to disclose significant events which are not in the ordinary course of business as extraordinary items and material items as exceptional to facilitate the reader to consider the impact of these items on the reported performance. Under IFRS there is no concept of extraordinary or exceptional since all events/transactions are in the normal course of business and if an item is material, it can be disclosed separately, but cannot be termed as ‘extraordinary’ or ‘exceptional’.

Restatement of financial statements:

Under Indian GAAP, changes in accounting policies or rectification of errors (prior period items) are recognised in the current year’s profit and loss account (for errors) and are generally recognised prospectively (for changes in accounting policies). Under IFRS, the prior period comparatives are re-stated in both cases. Indian GAAP does not have the concept of restatement of comparatives except in case of special-purpose financial statements prepared for public offering of securities.

Determination of functional currency:
 
Entities in India prepare their general purpose financial statements in Indian rupees. However under IFRS, an entity measures its assets, liabilities, revenues and expenses in its functional currency, which is the currency that best reflects the economic substance of the underlying events and circumstances relevant to the entity i.e.,the currency of the primary economic environment in which the entity operates. Functional currency of an entity may be different from the local currency.

For example, consider an Indian entity operating in the shipping industry. For such an entity it is possible that a significant portion of revenues may be derived in foreign currencies, pricing is determined by global factors, assets are routinely acquired from outside India and borrowings may be in foreign currencies.  All these factors need  to be considered to determine  whether  the Indian rupee is indeed the functional   currency  or whether   another  foreign currency  better  reflects the economic  environment that most impacts  the entity.

Other significant aspects  :

Under Indian GAAP, provision has to be made for proposed dividend, although it may be declared by the entity and approved by the shareholders after the balance sheet date. Under IFRS, dividends that are proposed or declared after the balance sheet date are not recognised as liability at the balance sheet date. Proposed dividend is a non-adjusting event and is recorded as a liability in the period in which it is declared and approved.

Impact  of existing laws  and  regulations:

Accounting standard-setting in India is subject to direct or indirect oversight by several regulators, such as the National Advisory Committee on Accounting Standards (NACAS) established by the Ministry of Corporate Affairs, the Reserve Bank of India (RBI),the Insurance Regulatory and Development Authority (IRDA) and the Securities and Ex-change Board of India (SEBI). Further, the Indian Companies Act, ;1956 (the Act) directly provides guidance on accounting and financial reporting matters. Courts in India also have the powers to endorse accounting for certain transactions – even if the proposed accounting treatment may not be consistent with Generally Accepted Accounting Principles.
 
Companies Act:

The requirements of Schedule VI of the Act, which currently prescribes the format for presentation of financial statements for Indian companies, is substantially different from the presentation and disclosure requirements under IFRS. For example, the Act determines the classification for redeemable preference shares as equity of an entity, whereas these are to be considered as a liability under IFRS. Also, Schedule XIV of the Act provides minimum rates of depreciation – such minimum depreciation rates are also inconsistent with the provisions of IFRS.

Regulatory  guidelines  :

The Reserve Bank of India (RBI) and Insurance Regulatory and Development Authority (IRDA) regulate the financial reporting for banks, financial institutions and insurance companies, respectively, including the presentation format and accounting treatment for certain types of transactions. For example, the RBI provides detailed guidance on provision relating to non-performing advances, classification and valuation of investments, etc. Several of these guidelines currently are not consistent with the requirements of IFRS.

The Securities and Exchange Board of India has also prescribed guidelines for listed companies with respect to presentation formats for quarterly and annual results and accounting for certain transactions, some of which are not in accordance with IFRS e.g., Clause 41 of the Listing Agreement permits companies to publish and report only standalone quarterly financial results, however IFRS considers only consolidated financial statements as the primary financial statements for reporting purpose.

Court procedures:

Courts in India commonly approve accounting under amalgamation/restructuring schemes, which may not be in accordance with the accounting principles/standards. Under the current accounting/ legal framework such legally approved deviations from the accounting standards/principles are acceptable.

Income tax:

Computation of taxable income is governed by detailed provisions of the Indian Income Tax Act, 1961. Convergence with IFRS will require significant changes/ clarifications from the tax authorities on treatment of various accounting transactions.

For example, consider unrealised losses and gains on derivatives that are required to be marked-to-market under IFRS. Different taxation frameworks are possible for the tax treatment of such unrealised losses and gains. The treatment of such unrealised losses/ gains will need to be addressed in line with the convergence time frame. It is imperative that tax authorities are engaged sufficiently in advance to decide on such critical aspects of taxation.

One of the risks of IFRS convergence without adequate involvement of all stakeholders and adequate regulatory changes is that financial statements prepared using the’ converged’ Indian standards may still not fully comply with IFRS issued by the International Accounting Standards Board (IASB). This would be very unfortunate as Indian entities that may be required to present IFRS-compliant financial statements to stakeholders outside India (overseas stock exchanges, overseas regulators, investors and alliance partners) would still need to reconcile with such’ converged’ IFRS financial statements prepared using the Indian framework, with IFRS financial statements that are globally accepted.

Accordingly, at the onset of the convergence, there is a need to develop an enabling regulatory frame-work and infrastructure that would assist and facilitate IFRS convergence. The Government would need to frame and revise laws in consultation with the NACAS and the ICAL Similarly, regulators such as the RBI, IRDA and SEBI would need to consider accepting IFRS in substitution of the present set of specific accounting rules prescribed by them.

As the timelines for convergence approach, all entities will have to consider their own roadmap and gear up for complying with the GAAP differences. Convergence to IFRS will be time-consuming, challenging and will require complete support and sponsorship of the Board of Directors/Members of Audit Committee/Senior Management. Given the task and challenges, all entities should ensure that their convergence plans are designed in a manner to achieve the objective of doing it once, but doing it right.

How will convergence with IFRS affect audit procedures ?

IFRS

The use of International Financial Reporting Standards (IFRS)
as a universal financial reporting language is gaining momentum across the globe
especially from the position only seven years ago where numerous different
national standards existed.

In line with the global trend, the Ministry of Corporate
Affairs (MCA) has notified a plan for convergence with IFRS in a phased manner.

Convergence with IFRS will also need careful analysis of the
present auditing standards. Auditing standard-setters may also need to assess
the requirement of auditor obtaining requisite IFRS knowledge which can be
evidenced through a certification process.

Auditing standard-setters will need to address the impact on
auditing procedures for the changes proposed in the accounting principles due to
convergence with IFRS.

Under IFRS, management is required to make several estimates
in the below-mentioned areas in applying accounting policies that have a
significant effect on the amounts recognised in the financial statements.

Audit of non-current assets :

Property, plant and equipment :

IFRS requires an asset to be depreciated over its own useful
life instead of rates suggested under regulations (like Schedule XIV to the
Companies Act). Further, significant components of an asset are depreciated
separately. The estimate of useful life of assets needs to be reassessed at
least once every balance sheet date.

The audit procedures relating to fixed assets would need to
be designed to obtain sufficient appropriate audit evidence whether the
management’s assessment of useful life is appropriate. The auditor may require
performance of inquiry procedures with the plant engineers to assess the
reasonableness of the process for estimating the useful lives and identification
of components within individual assets that have a different useful life and
needs to be separately depreciated. Companies would also need to maintain
suitable audit trail for the basis for estimation of useful life and
identification of components.

Intangible assets :

The depreciation/amortisation of an intangible asset depends
on whether its useful life is finite or indefinite (indefinite does not mean
infinite). An intangible asset has an indefinite useful life when, based on an
analysis of all relevant factors, there is no foreseeable limit to the period
over which the asset is expected to generate net cash inflows for the entity.

An intangible asset with indefinite useful life is not
depreciated; instead it is tested for impairment every balance-sheet date.

Classification of intangible assets acquired in business
combination (like brands, trademarks, customer relationships) needs to be
assessed closely by the auditor. For instance, in assessing whether the useful
life of a brand is indefinite or finite, the auditor may need to assess the
following factors :


  • How well and for how long has the brand been established in the market ?
    If the brand is mature and contributes significant value to the business and
    therefore its abandonment would represent an unrealistic decision, then this
    might be an indicator of an indefinite useful life.




  • How stable is the industry in which the brand is used ? In rapidly
    changing industries it is less likely that a brand will be identified as
    having an indefinite useful life.




  • Is the brand expected to become obsolete at some point in the future ?




  • Is the brand used in a market that is subject to significant, enduring
    entry barriers ?




  • Is the useful life of the brand dependent
    on the useful lives of other assets of the entity ? If so, what are the
    useful lives of those assets ?




Embedded leases under IFRIC 4 :

The purpose of IFRIC 4 — ‘Determining whether an arrangement
contains a lease’, is to identify an arrangement which, in substance, is or
contains a lease (even if the contract does not use the term lease). For
instance, A Company has a contract with its supplier (job worker) whereby the
Company is contractually bound to get 10,000 units of goods manufactured by the
supplier. The supplier has installed a machinery to manufacture and supply the
goods for the contract.

Price terms are as under :


  • For first 10,000 units — Rs.22 per unit




  • 10,001 onwards — Rs.10 per unit




  • In case of any shortfall as compared to 10,000 units, a penalty of Rs.12
    per unit of shortfall shall be levied.



An analysis of the arrangement would indicate that up to
initial 10,000 units, the Company is bound to pay Rs.120,000 (10,000 x 12) to
the contract manufacturer (as there is a penalty of Rs.12 per unit for any
shortfall in offtake by the Company up to 10,000 units) and this would be
nothing other than lease rent for the asset being used. The balance amount of
Rs.10 (22 – 12) per unit would be job work charges for the manufacture of goods.

A lease arrangement conveys rights to use an asset for agreed
period of time in return for a payment or series of payments.

The assessment whether an arrangement is or contains a lease
is based on whether :


  • fulfilment of the arrangement is dependent on the use of a specific asset
    or assets; and




  • the arrangement conveys a right to use the asset(s).



A challenge to audit-embedded lease arrangements is to derive sufficient appropriate audit evidence that a specific asset(s) would be used throughout the arrangement. Further, audit procedures need to include determining fair values of embedded lease component and other components of the arrangement. This would involve judgment on the part of the company and a process to be set for determining appropriate audit trail for the basis of determination of fair value.

Appropriate representation may also be needed from the Company for identification of all embedded lease arrangements.

Investment property :
Investment properties include properties that are either held to earn rental income or capital appreciation, or are held with undetermined use. Investment properties are measured at cost or at fair value every balance-sheet date. If the client measures investment properties at cost, it still needs to disclose its fair value.

Audit procedures must include procedures to assess the classification of property as ‘Investment Property’. Further, the audit procedures may be performed on the appropriateness of assumptions/ factors considered in deriving the fair value of the Investment Properties.

Audit of Business Combinations and Consolidation :

Consolidation :
Unlike Indian GAAP, the definition of a subsidiary focusses on the concept of control and has two parts, both of which need to be met in order to conclude that one entity controls another :

  •     the power to govern the financial and operating policies of an entity;   
  •  to obtain benefits from its activities.

Thus, if a Company A holds 80% of the issued share capital of Company B and another investor C holds balance 20% of the share capital and participates in the management (through shareholders agreement) of the Company, then Company A cannot treat Company B as a subsidiary, as it cannot unilat-erally control that Company.

Thus, the auditor needs to verify the shareholder’s rights for classification of an investee as subsidiary.

Appropriate representation may also need to be sought from the company for non-existence of participative rights with minority shareholders.

Consolidation of special purpose entities :
A special purpose entity (SPE) is an entity created to accomplish a narrow and well-defined objective, e.g., a vehicle into which trade receivables are securitised. The principles discussed above for identifying control apply equally to an SPE. The control concept in SIC-12 is based on the substance of the relationship between an entity and an SPE, and considers a number of indicators.

Audit procedures that auditor may need to apply to identify whether the SPE needs to be consolidated need to be established.

Appropriate representation may also need to be sought from the company for identification of all SPEs.

Accounting policies across the Group :
The separate financial statements of subsidiaries, joint ventures and associates are prepared based on their accounting policies. However for the purpose of consolidation with parent company, all the sub-sidiaries, associates, joint ventures and SPEs need to prepare IFRS financial statements with the same accounting policies as that of the parent company.

Auditors need to verify consistency in application of IFRS accounting policies throughout the group. Thus auditors of the parent company may need to engage actively with the management and auditors of the subsidiary, joint ventures and associates to assess application of consistent accounting policies within the group.

Business combinations :

A business combination is defined as ‘a transaction or other event in which an acquirer obtains control of one or more businesses’.

In relation to business combination, the following audit procedures may need to be performed :

  •     Verify the date of actual transfer of control to the acquirer i.e., the date of acquisition. An appointed date as per agreement or court scheme cannot be termed as date of acquisition.

  •     Verify valuation reports as at acquisition date relating to assets transferred, liabilities incurred and equity interests issued by the acquirer. Verify the reasonableness of the assumptions used for valuation purposes.

  •     Verify intangibles assets that qualify for recognition. Verify the reasonableness of the assumptions used in the valuation of assets acquired, liabilities and contingent liabilities assumed.


Audit of income statement items :

Revenue : linked transactions :
In some cases, two or more transactions may be linked so that the individual transactions have no commercial effect on their own. For instance, a Company may enter into a contract to buy 100,000 units of goods from a vendor for Rs.1.5 per unit when market price for the goods is Rs.4 per unit (thus a cost savings of Rs.250,000). At the same time, the Company shall subscribe to the debentures of the vendor for Rs.400,000, whereby the vendor has a call option over the debentures to settle the liability at Rs.150,000 in all. Such transactions are linked transactions as the individual contracts have no commercial effect of their own.

In these cases it is the combined effect of the two transactions together that is accounted for. Audit procedures for linked transactions may include :

  •     Verify whether two or more transactions are linked based on the substance of the transaction.

  •     Verify identification of components in the overall arrangement.

  •     Verify allocation of consideration to the different components of the arrangement either on relative fair value method or on residual fair value method.

  •     Verify the basis for recognition of revenue for every delivered component of the arrangement.

Share-based payments :
Share-based payments under IFRS are measured at fair value, unlike Indian GAAP that allows use of intrinsic value method. The auditors need to verify the underlying assumptions relating to the fair value of the instruments. If the client has subsidiaries, the audit procedures are required to verify the extent of grants given to employees of the subsidiary company.

The auditor needs to verify the classification of the share-based payment into equity-settled and cash-settled share-based payment for the parent and subsidiary. Under certain circumstances, the classification of share-based payment could differ in the books of parent and subsidiary. For instance, subsidiary issues options to its employees that it settles by issuing its own shares. Upon termination of employment, the parent entity is required to purchase the shares of the subsidiary from the former employee. In such cases, as the subsidiary has an obligation to deliver its own equity instruments, the arrangement should be classified as equity-settled in its financial statements. However, the arrangement should be classified as cash-settled in the consolidated financial statements of the parent.

Audit of presentation of financial statements :

Current and non-current classification :
IFRS requires the assets and liability to be segregated into current and non-current assets/liabilities. Thus the audit procedures are required to determine the entity’s business cycle and thereby classification into current/non-current.

Disclosure of segment information :
IFRS requires segment disclosure based on the components of the entity that management monitors in making decisions about operating matters (the ‘management approach’). Such components (operating segments) are identified on the basis of internal reports that the entity’s ‘Chief operating decision maker’ (CODM) reviews regularly in allocating resources to segments and in assessing their performance.

Audit of segment information under IFRS would also lead to additional audit procedures like :

  •     Identification of the entity’s CODM;

  •     Audit of information reviewed by the CODM in the decision-making process; and

  •     Use of accounting policy for internal review.

The auditor might face challenges in performing audit procedures relating to information used by the management for decision-making process, as this information is always considered as strictly confidential and for internal use. Further, the information reviewed by the CODM (for instance, contribution margin analysis) may not be in strict compliance with GAAP. Hence test of completeness and accuracy of such financial information may be difficult.

Others :

Audit of IT system controls :
Entities where the use of Information systems is dominant (ERPs like SAP or Oracle) may require modifications in the IT configuration to track the information as required under IFRS. In such a scenario, the auditor would also require to test the new IT controls.

Audit of opening IFRS balance sheet :
To audit the opening balance sheet of the client, the auditor may prepare an audit programme to assist engagement team in issuing an audit opinion on the opening IFRS balance sheet prepared prior to the first complete set of IFRS financial statements. The audit programme may include the following audit steps :

  •     Understand the client’s transition process

  •     Update the understanding of the client’s business environment for transition matters

  •     Review compliance of the selected IFRS accounting policies with IFRS

  •     Assess the completeness and accuracy of the client’s gap analysis

  •     Identify IFRS balances with significant and/or high-risk gaps

  •     Identify appropriate audit objectives relating to gaps

  •     Evaluate the design and test the effectiveness of relevant internal controls

  •     Evaluate audit evidence and conclude.

Conclusion :
An entity may expect significant changes to its balance sheet and income statement due to transition to IFRS. It is essential for an auditor to carefully evaluate the IFRS impact areas both at the time of first-time adoption of IFRS and on a go-forward basis.

The auditor would need to suitably modify the design of its audit procedures to obtain sufficient appropriate audit evidence that the financial statements are not materially misstated.

Given the enhanced use of fair value in the presentation/preparation of IFRS financial statements and use of management judgment, the auditor will have to constantly be abreast of the client’s products/services, business and the related industry developments.

Full adoption of Accounting Standard 30 Strides Arcolab Ltd. (31-12-2008)

From Accounting Policies

Financial Assets, Financial Liabilities, Financial Instruments, Derivatives and Hedge Accounting

1. The Company classifies its financial assets into the following categories: financial instruments at fair value through profit and loss, loans and receivables, held to maturity investments and available for sale financial assets. Financial assets of the Company mainly include cash and bank balances, sundry debtors, loans and advances and derivative financial instruments with a positive fair value.

Financial liabilities of the Company mainly comprise secured and unsecured loans, sundry creditors, accrued expenses and derivative financial instruments with a negative fair value. Financial assets/liabilities are recognised on the balance sheet when the Company becomes a party to the contractual provisions of the instrument. Financial assets are derecognised when all of risks and rewards of the ownership have been transferred. The transfer of risks and rewards is evaluated by comparing the exposure, before and after the transfer, with the variability in the amounts and timing of the net cash flows of the transferred assets.

Available for sale financial assets (not covered under other Accounting Standards) are carried at fair value, with changes in fair value being recognised in Equity, unless they are designated in a Fair value hedge relationship, where such changes are recognised in the Profit and Loss account.

Loans and receivables, considered not to be in the nature of Short-term receivables, are discounted to their present value. Short-term receivables with no stated interest rates are measured at original invoice amount, if the effect of discounting is immaterial. Non-interest bearing deposits, meeting the criteria of financial asset, are discounted to their present value.

Financial liabilities held for trading and liabilities designated at fair value, are carried at fair value through profit and loss. Other financial liabilities are carried at amortised cost using the effective interest method. The Company measures the short-term payables with no stated rate of interest at original invoice amount, if the effect of discounting is immaterial.

Financial liabilities are derecognised when extinguished.

2. Determining fair value

Where the classification of a financial instrument requires it to be stated at fair value, fair value is determined with reference to a quoted market price for that instrument or by using a valuation model. Where the fair value is calculated using financial markets pricing models, the methodology is to calculate the expected cash flows under the terms of each specific contract and then discount these values back to a present value.


3. Derivative financial instruments

The Company is exposed to foreign currency fluctuations on foreign currency assets and liabilities. The Company limits the effects of foreign exchange rate fluctuations by following established risk management policies including the use of derivatives. The Company enters into forward exchange financial instruments where the counterparty is a bank. Changes in fair values of these financial instruments that do not qualify as a Cash flow hedge accounting are adjusted in the Profit and Loss.

4. Hedge Accounting

Some financial instruments and derivatives are used to hedge interest rate, exchange rate, commodity and equity exposures and exposures to certain indices. Where derivatives are held for risk management purposes and when transactions meet the criteria specified in Accounting Standard 30, the Company applies fair value hedge accounting or cash flow hedge accounting as appropriate to the risks being hedged.


5. Fair value hedge accounting

Changes in the fair value of financial instruments and derivatives that qualify for and are designated as fair value hedges are recorded in the Profit and Loss Account, together with changes in the fair value attributable to the risk being hedged in the hedged assets or liability. If the hedged relationship no longer meets the criteria for hedge accounting, it is discontinued.

From Notes to Accounts

6. Adoption of Accounting Standard-30 : Financial Instruments : Recognition and Measurement, issued by Institute of Chartered Accountants of India

Arising from the Announcement of the Institute of Chartered Accountants of India (ICAI) on March 29, 2008, the Company has chosen to early adopt Accounting Standard (AS) 30 :

‘Financial Instruments : Recognition and Measurement’. Coterminous with this, in the spirit of complete adoption, the Company has also implemented the consequential limited revisions in view of AS 30 to AS 2, ‘Valuation of Inventories’, AS 11’ The Effect of Changes in Foreign Exchange Rates’, AS 21 ‘Consolidated Financial Statements and Accounting for Investments in Subsidiaries in Separate Financial Statements’, AS 23 ‘Accounting for Investments in Associates in Consolidated Financial Statements’, AS 26 ‘Intangible Assets’, AS 27 ‘Financial Reporting of Interests in Joint Ventures’, AS 28 ‘Impairment of Assets’ and AS 29 ‘Provisions, Contingent Liabilities and Contingent Assets’ as have been announced by the ICAI.

Consequent to adoption of AS 30 and the transitional provision under the standard :

The Company has changed the designation and measurement principles for all its significant financial assets and liabilities existing as at January 1, 2008. The impact on account of the above measurement of these is as described below :

6.1 Foreign Currency Convertible Bonds (FCCBs or Bonds)

On adoption of AS 30, the FCCBs are split into two components comprising (a) option component which represents the value of the option in the hands of the FCCB-holders to convert the bonds into equity shares of the Company and (b) debt component which represents the debt to be redeemed in the absence of conversion option being exercised by FCCB-holder, net of issuance costs. The debt component is recognised and measured at amortised cost while the fair value of the option component is determined using a valuation model with the below mentioned assumptions.

Assumptions used to determine fair value of the options:

Valuation and amortisation method – The Company estimates the fair value of stock options granted using the Black Scholes Merton Model and the principles of the Roll-Geske-Whaley extension to the Black Scholes Merton model. The Black Scholes Merton model along with the extensions above requires the following inputs for valuation of options:

Stock Price as at the date of valuation – The Company’s share prices as quoted in the National Stock Exchange Limited (NSE), India have been converted into equivalent share prices in US Dollar terms by applying currency rates as at valuationates. Further, stock prices have been reduced by continuously compounded stream of dividends expected over time to expiry as per the principles of the Black-Scholes Merton model with Roll Geske Whaley extensions.

Strike price for the option – has been computed in dollar terms by computing the redemption amount in US dollars on the date of redemption (if not converted into equity shares) divided by the number of shares which shall be allotted against such FCCBs.

Expected Term – The expected term represents time to expiry, determined as number of days between the date of valuation of the option and the date of redemption.

Expected Volatility – Management establishes volatility of the stock by computing standard deviation of the simple exponential daily returns on the stock. Stock prices for this purpose have been

6.1 Foreign Currency  Convertible Bonds (FCCBs or computed by expressing daily closing prices as Bonds) quoted  on the NSE into equivalent  US dollar terms. For the purpose  of computing  volatility  of stock prices, daily prices for the last one year have been considered as on the respective valuation dates.

Risk-Free Interest Rate – The risk-free interest rate used in the Black-Scholes valuation method is assumed at 7%.

Expected Dividend – Dividends have been assumed to continue, for each valuation rate, at the rate at which dividends were earned by shareholders in the last preceding twelve months before the date of valuation.

Measurement of Amortised cost of debt component:

For the purpose of recognition and measurement of the debt component, the effective yield has been computed considering the amount of the debt component on initial recognition, origination costs of the FCCB and the redemption amount if not converted into Equity Shares. To the extent the effective yield pertains to redemption premium and the origination costs, the effective yield has been amortised to the Securities Premium Account as permitted under section 78 of the Companies Act, 1956. The balance of the effective yield is charged to the Profit and Loss Account.


Consequent to change in policy for accounting of FCCBs,

a) Rs.934.71 Million being the previously accrued Debenture Redemption Reserve out of the Securities Premium Account has been credited back to Securities Premium Account.

b) Rs.124.68 Million being the amount of FCCB issue expenses previously debited to Securities Premium Account has been reversed.

c) Rs.443.20 Million and Rs.546.41 Million has been debited to Securities Premium Account as at December 31, 2007 and during the year 2008, respectively towards the amortised interest attributable to the effective yield pertaining to the redemption premium and FCCB issue expenses.

d) Rs.202 Million being the excess of amortised interest chargeable to Profit and Loss Account as per the policy adopted by the Company over the previously recognised interest cost upto December 31, 2007 has been debited to General Reserve Account.

e) Interest expense for the year debited to Profit and Loss Account is higher by Rs.216.48 Million, and Profit Before Tax for the year is lower by the corresponding amount.

f) The difference between the fair value of the option component on the date of issue of the FCCBs and December 31, 2007 amounting to Rs.427.10 Million has been credited to the General Reserve Account.

g) Rs.452.21 Million being the difference in the carrying amount of the option component between December 31, 2008 and December 31 2007 has been credited to the Profit and Loss Account of the year.

h) Rs.63.31 Million being the incremental exchange difference upto December 31, 2007 arising out of the accounting treatment of FCCBs described above has been debited to General Reserve Account. Exchange loss on restatement of FCCBs is lower and Profit Before Tax for the year is higher by Rs.101.54 Million.

6.2 Consequent to change in policies for accounting for External commercial borrowings (another financial liability), excess of amortised interest cost of Rs.0.53 Million and Rs.0.79 Million chargeable to Profit and Loss Account as per the policy adopted by the Company over the previously recognised interest cost for the period upto December 31, 2007 and for year ended December 31, 2008, respectively, has been debited to General Reserve Account and the Profit and Loss account respectively.

6.3 The financial assets and liabilities arising out of issue of corporate financial guarantees to third parties are accounted at fair values on initial recognition. Financial assets continue to be carried at fair values. Financial liabilities are subsequently measured at the higher of the amounts determined under AS 29 or the fair values on the measurement date. At December 31,2008, the fair values of such financial assets are equal to such liabilities and have been set off in the financial statements.

6.4 As required under the Companies Act, 1956, Redeemable Preference Shares are included as part of share capital and not as debt and dividend on the preference shares will be accounted as dividend as part of appropriation of profits and have not been accrued as interest cost. Further, due to inadequate profits, the Company has not accrued dividend of Rs. 29.50 Million each for the year ended December 31, 2007 and December 31, 2008, and the related Dividend distribution taxes.

6.5 Fully convertible debentures are considered as borrowings and are not disclosed as part of shareholder funds, and interest thereon of Rs.24.73 Million is debited to the Profit and Loss Account as interest cost as required under the Companies Act, 1956 and has not been treated as dividend.


Hedge  Accounting:

The Company had prior to December 31, 2007 designated its investments in Starsmore Limited, Cyprus, Strides Africa Limited, British Virgin islands and Akorn Strides LLC, USA, whose functional currency is US dollars as hedged items in a fair value hedge and to the extent of the hedge items, designated FCCB’s availed in US dollars as hedging instruments, to hedge the risk arising from fluctuations in the foreign exchange rate between the Indian Rupee and the US dollar. The carrying values of the designa ted hedged iterns and the hedging instruments as at December 31, 2008 is USD 100.55 Million and USD 69.20 Million as at December 31, 2007.

Accordingly, applying the fair value hedge accounting principles, the exchange gains/ losses on the hedging instrument is recognised in Profit and Loss Account along with the associated exchange gains/losses on the restatement of the designated portion of the investments. The impact of exchange loss arising on restatement of designated portion of the USD investments as of December 31, 2007 amounted to Rs. 120.42 Million and has been debited to the General Reserve Account.

The exchange gains arising on restatement of designated portion of the USD investments for the year ended December 31, 2008 amounting to Rs. 923.40 Million has been treated as an effective fair value hedge since the loss arising on the dollar loans designated as hedging instruments amounted to a similar amount and such gains have been credited to the Profit and such gains have been credited to the Profit and Loss account for year ended December 31,2008.

Prior to the adoption of the AS 30 ‘Financial Instruments: Recognition and Measurement’, and the limited revisions to AS 21 ‘Consolidated Financial Statements and Accounting for Investments in Subsidiaries in Separate Financial Statements’, investments in subsidiaries were valued at cost less diminution in value that was other than temporary as per the provisions of AS-13 ‘Accounting for Investments’ that was notified under section 21l(3C) of the Companies Act, 1956. As a result of above change in accounting policy, carrying value of investments as at December 31, 2008 is higher by Rs. 802.98 Million, profit for the year is higher by Rs. 923.40 Million and General Reserve is higher by Rs. 802.98 Million.

6.7 The Company has availed Bill Discounting facility from Banks which do not meet the de-recognition criteria for transfer of contractual rights to receive cash flows from the Debtors since they are with recourse to the Company.

Accordingly, as at December 31, 2008, Sundry Debtor balances include such amounts and the corresponding financial liability to the Banks is included as part of short term secured loans.

6.8 All the open derivative positions as on January 1, 2008 not designated as hedging instruments have been classified as held for trading and gains/losses recognised in the Profit and Loss Account. The incremental negative fair value of such derivatives over and above provision carried was Rs. 100.92 Million as at December 31,2007 which has been debited to the General Reserve Account. Incremental negative fair value of the open derivatives position as at December 31, 2008 amounting to Rs. 346.08 Million has been debited to Profi t and Loss Account for the year.

From Notes  to Accounts (con’td.)

33. Disclosures relating to Financial instruments to the extent not disclosed elsewhere in Schedule P

Breakup of Allowance for Credit Losses is as under:


Details on Derivatives Instruments & Unhedged Foreign Currency Exposures

The following derivative positions are open as at December 31, 2008. While these transactions have been undertaken to act as economic hedges for the Company’s exposures to various risks in foreign exchange markets, they have not qualified as hedging instruments in the context of the rigour of such classification under Accounting Standard 30. Theses instruments are therefore classified as held for trading and gains/losses recognised in the Profit and Loss Account.

i. The Company had entered into the following derivative instruments:

a . Forward Exchange Contracts [being a derivative instrument), which are not intended for trading or speculative purposes, but for hedge purposes, to establish the amount of reporting currency required or available at the settlement date of certain payables and receivables.

The following are the outstanding Forward Exchange Contracts entered into by the Company as on December 31, 2008.

  1. b) Interest Rate Swaps to hedge against fluctuations in interest rate changes: No. of contracts: Nil (Previous year: No. of contracts: 3, Notional Principal: USD 20 Million).c) Currency Swaps (other than forward exchange contracts stated above) to hedge against fluctuations in change in exchange rate.of contracts: Nil (Previous Year: No of  contracts 6, Notional Principal: USD 80 Million).ii. The year end foreign currency exposures that have not been hedged by a derivative instrument or otherwise are given below:

iii. Derivative Instruments (causing an un-hedged foreign currency exposure) : Nil (Previous Year USD 8 Million – Sell)

iv. Losses on forward Exchange Derivate contracts (Net) included in the Profit and Loss account for year ended December 31, 2008 amount Rs.454.27 Million.

Categories of Financial Instruments

a) Loans and Receivables:

The following financial assets in the Balance Sheet have been classified as Loans and Receivables as defined in Accounting Standard 30. These are carried at amortised cost less impairment if any. The carrying amounts are as under:

In the opinion of the management, the carrying amounts above are reasonable approximations of fair values of the above financial assets.

b)  Financial Liabilities  Held at Amortised Cost

The following financial liabilities are held at amortised cost. The Carrying amount of Financial Liabilities is as under:

  1. c) Financial Liabilities  Held for Trading

The option component of Foreign Currency Convertible Bonds (FCCBs) has been classified as held for trading, being a derivative under Accounting Standard 30. Refer Note B.6 of Schedule P on FCCBs. The carrying amount of the option component was Rs.134.20 Million as at December 31,2008 and Rs.586.42 Million as at December 31, 2007. The difference in carrying value between the two dates, amounting to Rs.452.21 Million is taken as gain to the Profit and Loss Account of the year in accordance with provisions of Accounting Standard 30.

The fair value  of the  option  component  has been determined using a valuation model. Refer to Note B.6 above on FCCBs for detailed disclosure on the valuation method.

d) There are no financial assets in the following categories:

o Financial assets carried at fair value through profit and loss designated at such at initial recognition.

o Held  to maturity

o Available  for sale

o Financial liabilities carried at fair value through profit and loss designated as such at initial recognition.

Financial    assets pledged

The following financial assets have been pledged:

Financial Asset Carrying value Dec. 31, 2007 Carrying value Dec. 31, 2007 Liability/Contingent Liability for which

pledged as collateral

 Terms and conditions

relating to pledge
I. Margin Money with Banks
A. Margin Money for

Letter of Credit

 80.89 82.87 Letter of Credit The Margin Money is

interest bearing deposit

with Banks. These

deposits can be

withdrawn on the

maturity of all Open

Letters of Credit.
B. Margin   Money   for 26.31 6.29 Bank  Guarantee The Margin Money is
Bank  Guarantee interest bearing deposit
with Banks. These
Deposits are against
Performance Guarantees.
Theses  can be withdrawn
on the  satisfaction  of the
purpose for which the
Guarantee is provided.
C.  Other Margin  Money 11.82 Margin  Money The Margin Money is
as Guarantee   for interest bearing deposit
Loan  to with Banks. This Deposit
Subsidiary is against Guarantees for
Loan advanced to
Subsidiary. This deposit
has been withdrawn on
the repayment of the
Loan by the Subsidiary.
II.  Sundry debtors 974.61 651.61 Bills discounted The Bills discounted  with
Banks  are secured  by the
Receivable.

Nature and extent of risk arising from financial instruments

The  main    financial    risks faced by  the  Company relate to fluctuations in interest and foreign exchange rates, the risk of default by counterparties to financial transactions, and the availability of funds to meet business needs. The Balance Sheet as at December 31, 2008 is representative of the position through the year. Risk management is carried out by a central treasury department under the guidance of the Management.


Interest rate  risk

Interest rate risk arises from long term borrowings. Debt issued at variable rates exposes the company to cash flow risk. Debt issued at fixed rate exposes the company to fair value risk. In the opinion of the management, interest rate risk during the year under report was not substantial enough to require intervention or hedging through derivatives or other financial instruments. For the purposes of exposure to interest risk, the company considers its net debt position evaluated as the difference between financial assets and financial liabilities held at fixed rates and floating rates respectively as the measure of exposure of notional amounts to interest rate risk. This net debt position is quantified as under:

Particulars 2008 2007
Fixed
Financial Assets …………………. 301.02 ……… 745.74
Financial liabilities  ……….. (7,123.32) …. (7,665.91)
(6,822.30) …. (6,920.17)
Floating
Financial Assets …………………. 229.20 ……… 196.26
Financial liabilities  ……….. (3,717.10) …. (2,961.78)
(3,487.90) …. (2,769.52)

Credit risk

Credit risk arises from cash and cash equivalents, financial instruments and deposits with banks and financial institutions. Credit risk also arises from trade receivable and other financial assets.

The credit risk arising from receivable is subject to concentration risk in that the receivable are predominantly denominated in USD and any appreciation in the INR will affect the credit risk. Further, the Company is not significantly exposed to geographical distribution risk as the counter-parties operate across various countries across the Globe.

Liquidity risk
Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due. The Company’s approach to managing liquidity is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to Company’s reputation. liquidity risk is managed using short term and long term cash flow forecasts.

The following is an analysis of undiscounted contractual cash flows payable under financial liabilities and derivatives as at December 31, 2008 :

Financial

Liabilities

 Due within
1 year 1 and 2 and 3 and 4 and
2 years 3 years 4 years 5 years
Bank Borrowings 2,860.74 369.43 279.97 182.59 91.29
Interest  payable

on borrowings

 0.08 – – – –
Hire

Purchase  liabilities

 2.48 2.23 0.41 0.13 –
Other

Borrowings

 – 2,306.64 – 4,744.43 –
Trade

and

other

payables

not in

net debt

 1,985.95 – – – –
Fair Value

of Options

embedded

in FCCBs

 – 11.06 – 123.15 –
Fair value

of Forward

exchange

derivative  contracts

 174.12 165.61 – – –
Total 5,023.37 2,689.36 280.38 5,050.30 91.27

For the purposes of the above table, undiscounted cash flows have been applied. Undiscounted cash flows will differ from fair values. Foreign currency liabilities have been computed applying spot rates on the Balance Sheet date.

Foreign exchange risk
The Company is exposed to foreign exchange risk principally via:

o Debt availed in foreign currency

o Net investments in subsidiaries and joint ventures that are made in foreign currencies.

o Exposure arising from transactions relating to purchases, revenues, expenses etc to be settled in currencies other than Indian Rupees, the functional currency of the respective entities.

The Company had designated its investments in certain subsidiaries whose functional currency is US dollars as hedged items in a fair value hedge and certain loans availed in US dollars as hedging instruments to hedge the risk arising from fluctuations in the foreign exchange rate between the Indian Rupee and the US dollar. The carrying values of the financial liabilities designated as hedging instruments as at December 31, 2008 is Rs.4,897.97 Million.

The loss arising on the dollar loans designated as hedging instruments recognised in the Profit and Loss Account for the year ended December 31, 2008 is Rs.923.40 Million. The gain arising from investments in certain subsidiaries designated as hedged items as much as is attributable to the hedged foreign exchange risk recognised in the Profit and Loss Account for the year ended December 31, 2008 is Rs.923.40 Million.

Sensitivity analysis as at December 31, 2008

Financial instruments affected by interest rate changes include Secured Long term loans from banks, Secured Long term loans from others, Secured Short term loans from banks and Secured Short term loans from banks. The impact of a 1% change in interest rates on the profit of an annual period will be Rs.108.29 Million assuming the loans as of December 31, 2008 continue to be constant during the annual period. This computation does not involve a revaluation of the fair value of loans as a consequence of changes in interest rates. The computation also assumes that an increase in interest rates on floating rate liabilities will not necessarily involve an increase in interest rates on floating rate financial assets.

Financial instruments affected by changes in foreign exchange rates include FCCBs, External Commercial Borrowings (ECBs), investments in subsidiaries, loans in foreign currencies to erstwhile subsidiaries and loans to subsidiaries and joint ventures. The company considers US Dollar and the Euro to be principal currencies which require monitoring and risk mitigation. The Company is exposed to volatility in other currencies including the Great Britain Pounds (GBP) and the Australian Dollar (AUD).

For the purposes of the above table, it is assumed that the carrying value of the financial assets and liabilities as at the end of the respective financial years remains constant thereafter. The exchange rate considered for the sensitivity analysis is the Exchange Rate prevalent as a December 31, 2008.

In the opinion of the management, impact arising from changes in the values of trading assets (including derivative contracts, trade receivable, trade payables, other current assets and liabilities) is temporary and short term in nature and would vary depending on the levels of these current assets and liabilities substantially from time to time and even on day to day basis and hence are not useful in an analysis of the long term risks which the Company is exposed to.

This is the first year of adoption of Accounting Standard 3D, consequently comparative figures relating to 2007 in respect of disclosures under Accounting Standard 30 have been provided only where such information is available.

From Auditors’ Report

d) The Company has early adopted Accounting Standard 30 ‘Financial Instruments: Recognition and Measurement’, along with the limited revision to Accounting Standard 2 ‘Valuation of Inventories’, Accounting Standard 11 ‘The Effect of Changes in Foreign Exchange Rates’, Accounting Standard 21 ‘Consolidated Financial Statements and Accounting for Investment in Subsidiaries in Separate Financial Statements’, Accounting Standard 23 ‘Accounting for Investments in Associates in Consolidated Financial Statements’, Accounting Standard 26 ‘Intangible Assets’, Accounting Standard 27 ‘Financial Reporting of Interest in Joint Ventures’, Accounting Standard 28 ‘Impairment of Assets’, and Accounting Standard 29 ‘Provisions, Contingent Assets and Contingent Liabilities, arising from the announcement of the Institute of Chartered Accountants of India on 29 March 2008, as stated in Note B.6 of Schedule P to the financial statements. Pursuant to the above, as detailed in note B.6.6 of Schedule P to the financial statements, certain US Dollar investments in subsidiaries and joint ventures have been designated as hedged items in a fair value hedge for changes in spot rates and have been restated at the closing exchange rate at December 31, 2008 and a credit of Rs. 923.40 Million has been recognised in the Profit and Loss Account, as compared to the earlier policy of valuing these investments at cost less diminution that is other than temporary, as required under Accounting Standard 13 ‘Accounting for Investments’, notified under section 211 (3C) of the Companies Act, 1956.

e) read with our comments in paragraph (d) above, in our opinion, the Balance Sheet, the Profit and Loss Account and the Cash Flow Statement dealt with by this report comply with the Accounting Standards referred to in sub-Section (3C) of Section 211 of the Companies Act, 1956.

From Management Discussions and Analysis

Early adoption of Accounting Standard 30 and IFRS convergence

The Company has early adopted Accounting Standard 30 : Financial Instruments: Recognition and Measurement and the consequential limited revisions to other applicable Accounting Standards as have been announced by the ICAI. Accordingly, the Company has changed the designation and measurement principles for all its significant financial assets and liabilities including FCCBs and ECBs. In case where there are conflicts between provisions of AS 30 and Companies Act, 1956, provisions of Companies Act, 1956 have been followed.

Detailed disclosures in this regard have been made in Note 1.11 of Part A, Note 6 and 33 of Part B of Schedule – ‘P’ to the financial statements forming part of the Annual Report.

Accounting Standards 30, 31 and 32 are new accounting Standards, to be made mandatory from April 01, 2011. These are global standards in line with IAS 39, as a prelude to IFRS Convergence. By adopting Accounting Standard 30 the company is progressing towards IFRS convergence.

Wipro Ltd.

New Page 1

WIPRO LTD. —
(31-3-2008) (consolidated)


From Accounting Policies :

Foreign currency transactions :

The Company is exposed to currency fluctuations on foreign
currency transactions. Foreign currency transactions are accounted in the books
of accounts at the average rate for the month.

 

Transaction :

The difference between the rate at which foreign currency
transactions are accounted and the rate at which they are realised is recognised
in the profit and loss account.

 

Translation :

Monetary foreign currency assets and liabilities at
period-end are translated at the closing rate. The difference arising from the
translation is recognised in the profit and loss account.

 

Derivative instruments and Hedge accounting :

The Company is exposed to foreign currency fluctuations on
foreign currency assets and forecasted cash flows denominated in foreign
currency. The Company limits the effects of foreign exchange rate fluctuations
by following established risk management policies including the use of
derivatives. The Company enters into forward exchange and option contracts,
where the counterparty is a bank. Since March 2004, based on the principles set
out in International Accounting Standard (IAS 39) on Financial Instruments’ the
Company has designated forward contracts and options to hedge highly probable
forecasted transactions as cash flow hedges. The exchange differences relating
to these forward contracts and gains/losses on such options were being
recognised in the period in which the forecasted transactions were expected to
occur. The exchange differences relating to forward contracts/options, other
than designated forward contracts/ options, were recognised in the profit and
loss account as they arose.

 

Effective April 1, 2007, based on the recognition and
measurement principles set out in the Accounting Standard (AS) 30 on Financial
Instruments: Recognition and Measurement, the changes in the fair values of
forward contracts and options designated as cash flow hedges are recognised
directly in shareholders’ funds and are reclassified into the profit and loss
account upon the occurrence of the hedged transaction. The gains/losses on
forward contracts and options designated as cash flow hedges are included along
with the underlying hedged forecasted transactions. The changes in fair value
relating to the ineffective portion of the cash flow hedges and forward
contracts/options not designated as cash flow hedges are recognised in the
profit and loss account as they arise. The Company has also designated forward
contracts and options as hedges of net investment in non-integral foreign
operation. The portion of the changes in fair value of forward contracts and
options that is determined to be an effective hedge is recognised in
shareholders’ fund and would be recognised in profit and loss account on the
disposal of foreign operation. The portion of the changes in fair value of
forward contracts and options that is determined to be an ineffective hedge is
recognised in the profit and loss account.

 

The Institute of Chartered Accountants of India (ICAI) has
recently issued an announcement ‘Accounting for Derivatives’ on accounting for
derivatives and early adoption of AS 30. The Company has already been applying
the principles of AS 30 in accounting for derivative instruments and the
announcement did not have any impact on the Company.

 

Integral operations :

In respect of integral operations, monetary assets and
liabilities are translated at the exchange rate prevailing at the date of the
balance sheet. Non-monetary items are translated at the historical rate. The
items in the profit and loss account are translated at the average exchange rate
during the period. The differences arising out of the translation are recognised
in the profit and loss account.

 

Non-integral operations :

In respect of non-integral operations, assets and liabilities
are translated at the exchange rate prevailing at the date of the balance sheet.
The items in the profit and loss account are translated at the average exchange
rate during the period. The differences arising out of the translation are
transferred to translation reserve.

 

From Notes to Accounts :

The Company designated forward contracts and options to hedge
highly probable forecasted transactions based on the principles set out in
International Accounting Standard (IAS 39) on Financial Instruments :
Recognition and Measurement. Until March 31, 2007, the exchange differences on
the forward contracts and gain/loss on such options were recognised in the
profit and loss account in the periods in which the forecasted transactions were
expected to occur.

 

Effective April 1, 2007, based on the recognition and
measurement principles set out in the Accounting Standard (AS) 30 on Financial
Instruments : Recognition and Measurement, the changes in the derivative fair
values relating to forward contracts and options that are designated as
effective cash flow hedges are recognised directly in shareholders’ funds until
the hedged transactions occur. Upon occurrence of the hedged transactions the
amounts recognised in the shareholders’ funds would be reclassified into the
profit and loss account along with the underlying hedged forecasted
transactions. During the year ended March 31, 2008 the Company has reclassified
net exchange gains of Rs.951 Million along with the underlying hedged forecasted
transaction. In addition, the Company also designates forward contracts as
hedges of the net investment in non-integral foreign operations. The changes in
the derivative fair values relating to forward contracts and options that are
designated as net investments in non-integral foreign operations have been
recognised directly in shareholders’ funds within translation reserve. The
gains/losses in shareholders’ funds would be transferred to profit and loss
account upon the disposal of non-integral foreign operations.


Infosys Technologies Ltd.

New Page 1INFOSYS TECHNOLOGIES LTD.

— (31-3-2008)

From Accounting Policies :

Foreign currency transactions :

Revenue from overseas clients and collections deposited in
foreign currency bank accounts are recorded at the exchange rate as of the date
of the respective transactions. Expenditure in foreign currency is accounted at
the exchange rate prevalent when such expenditure is incurred. Disbursements
made out of foreign currency bank accounts are reported at the daily rates.
Exchange differences are recorded when the amount actually received on sales or
actually paid when expenditure is incurred, is converted into Indian Rupees. The
exchange differences arising on foreign currency transactions are recognised as
income or expense in the period in which they arise.

Fixed assets purchased at overseas offices are recorded at
cost, based on the exchange rate as of the date of purchase. The charge for
depreciation is determined as per the company’s accounting policy.

Monetary current assets and monetary current liabilities that
are denominated in foreign currency are translated at the exchange rate
prevalent at date of the balance sheet. The resulting difference is also
recorded in the profit and loss account.

Forward contracts and options in foreign

currencies :

The company records the gain or loss on effective hedges in
the foreign currency fluctuation reserve until the transactions are complete. On
completion, the gain or loss is transferred to the profit and loss account of
that period. To designate a forward contract or option as an effective hedge,
management objectively evaluates and evidences with appropriate supporting
documents at the inception of each contract whether the contract is effective in
achieving off-setting cash flows attributable to the hedged risk. In the absence
of a designation as effective hedge, a gain or loss is recognised in the profit
and loss account.

From Notes to Accounts :

Forward contracts outstanding :

Reliance Petroleum Ltd.

New Page 1RELIANCE PETROLEUM LTD.

— (31-3-2008)

From Accounting Policies :

Derivative Transactions :

In respect of Derivative Contracts, premium paid, provision
for losses on restatement and gains/losses on settlement are recognised along
with the underlying transactions and charged to Profit and Loss Account/Project
Development Expenditure Account.

 

From Notes to Accounts :

Financial and Derivative Instrument :



(a) Nominal amount of derivative contracts entered into by
the Company for hedging currency and interest rate related risks and
outstanding as on 31st March 2008 amounts to Rs.77330187080 (Previous year
Rs.47122063440). Category wise break-up is given below :

In Rupees


Particulars
 As at
31-3-2008 		As at
31-3-2007
1 Interest
rate swaps 		44132000000
 10867500000
2 Currency
swaps 		14470737830
 10500000000
3 Options
 12053125000
 24114330450
4 Forward
Contracts 		6674324250
 1640232990

(b) All financial and derivative contracts entered into by
the Company are for hedging purposes only.

(c) In respect of outstanding derivative contracts which
are stated in para ‘a’ above, there is a net unrealised gain as on 31st March,
2008 which has not been recognised in the books, considering the principles of
prudence as enunciated in Accounting Standard 1 “Disclosure of Accounting
Policies” notified in the Companies (Accounting Standards) Rules 2006.

(d) Foreign currency exposures that are not hedged by
derivative or forward contracts as on 31st March 2008 amounts to
Rs.108075292858 (Previous year Rs.43470000000).

 

 

levitra

Tata Consulting Services Ltd.

New Page 1TATA
CONSULTING SERVICES LTD.

— (31-3-2008) (Consolidated)

From Accounting Policies :

Foreign currency transactions :

Income and expenses in foreign currencies are converted at
exchange rates prevailing on the date of the transaction. Foreign currency
monetary assets and liabilities other than net investments in non-integral
foreign operations are translated at the exchange rate prevailing on the balance
sheet date. Exchange difference arising on a monetary item that, in substance,
forms part of an enterprise’s net investments in a non-integral foreign
operation are accumulated in a foreign currency translation reserve.

 

Premium or discount on forward contracts and currency options
are amortised and recognised in the profit and loss account over the period of
the contract. Forward contracts and currency options outstanding at the balance
sheet date, other than designated cash flow hedges, are stated at fair values
And any gains or losses are recognised in the profit and loss account.

 

For the purpose of consolidation, income and expenses are
translated at average rates and the assets and liabilities are stated at closing
rate. The net impact of such change is disclosed under Foreign exchange
translation reserve.

 

Derivative instruments and hedge accounting :

The Company uses foreign currency forward contracts and
currency options to hedge its risks associated with foreign currency
fluctuations relating to certain firm commitments and forecasted transactions.
The Company designates these hedging instruments as cash flow hedges applying
the recognition and measurement principles set out in the Accounting Standard 30
‘Financial Instruments : Recognition and Measurement’ (AS-30).

 

The use of hedging instruments is governed by the Company’s
policies approved by the board of directors, which provide written principles on
the use of such financial derivatives consistent with the Company’s risk
management strategy.

 

Hedging instruments are initially measured at fair value, and
are re-measured at subsequent reporting dates. Changes in the fair value of
these derivatives that are designated and effective as hedges of future cash
flows are recognised directly in shareholders’ funds and the ineffective portion
is recognised immediately in profit and loss account.

 

Changes in the fair value of derivative financial instruments
that do not qualify for hedge accounting are recognised in profit and loss
account as they arise.

 

Hedge accounting is discontinued when the hedging instrument
expires or is sold, terminated, or exercised, or no longer qualifies for hedge
accounting. At that time for forecasted transactions, any cumulative gain or
loss on the hedging instrument recognised in shareholder’s funds is retained
there until the forecasted transaction occurs. If a hedged transaction is no
longer expected to occur, the net cumulative gain or loss recognised in
shareholders’ funds is transferred to profit and loss account for the period.

 

From Notes to Accounts :

Derivative financial instruments :

TCS Limited, in accordance with its risk management policies
and procedures, enters into foreign currency forward contracts to mange its
exposure in foreign exchange rates. The counter party is generally a bank. These
contracts are for a period between one day and eight years.

 

During the year ended March 31, 2008, TCS Limited has
re-evaluated its risk management program and hedging strategies in respect of
forecasted transactions. Upon completion of the formal documentation and testing
for effectiveness, TCS Limited has designated certain foreign currency options
in respect of forecasted transactions, which meet the hedging criteria, as Cash
Flow Hedges:

 

TCS Limited has following outstanding derivative instruments
as on March 31, 2008 :

(i) The following are outstanding Foreign Exchange Forward
contracts, which have been designated as Cash Flow Hedges, as on :

The following are outstanding Currency Option contracts, which have been designated as Cash Flow Hedges, as on :

Net loss on derivative instruments of Rs.21.83 crores recognised in Hedging Reserve as on March 31, 2008 is expected to be reclassified to the Profit and loss account by March 31, 2009.

The movement in Hedging Reserve during period ended March 2008, for derivatives designated as Cash Flow Hedges is as follows:

In addition to the above cash flow hedges, the Company has outstanding foreign exchange forward contracts and currency option contracts aggregating Rs.2,141.90 crores (previous year: Rs.2062.61 crores), whose fair value showed a loss of Rs.4.46 crores as on March 31, 2008 (previous year: gain of Rs.9.22 crores) to hedge the future cash flows. Although these contracts are effective as hedges from an economic perspective, they do not qualify for hedge accounting and accordingly these are accounted as derivatives instruments at fair value with changes in fair value recorded in the Profit and Loss Account.

Exchange gain of Rs.283.96 crores (previous year gain of Rs.45.13 crores) on foreign currency forward exchange contracts have been recognised in the period ended March 31, 2008.


Additional non statutory disclosures in Annual Reports

From Published Accounts

Compiler’s Note :


Infosys has over the years been a pioneer in providing
additional relevant information in its annual reports. Keeping up with the same,
the company has, in its annual report for 2010, given (as additional
information), an Intangible Assets Score Card which makes a very interesting
reading. The same is reproduced below.

1 Infosys Technologies Ltd. — (31-3-2010)

Additional information :

Intangible assets score sheet :

We caution investors that this data is provided only as
additional information to them. We are not responsible for any direct, indirect
or consequential losses suffered by any person using this data.

From the 1840s to the early 1990s, a corporate’s value was
mainly driven by its tangible assets — values presented in the corporate Balance
Sheet. The managements of companies valued these resources and linked all their
performance goals and matrices to these assets — Return on investment and
capital turnover ratio. The market capitalisation of companies also followed the
value of tangible assets shown in the Balance Sheet with the difference seldom
being above 25%. In the latter half of the 1990s, the relationship between
market value and tangible asset value changed dramatically. By early 2000, the
book value of the assets represented less than 15% of the total market value. In
short, intangible assets are the key drivers of market value in this new
economy.

A knowledge-intensive company leverages know-how, innovation
and reputation to achieve success in the marketplace. Hence, these attributes
should be measured and improved upon year after year to ensure continual
success. Managing a knowledge organisation necessitates a focus on the critical
issues of organisational adaptation, survival, and competence in the face of
ever-increasing, discontinuous environmental change. The profitability of a
knowledge firm depends on its ability to leverage the learnability of its
professionals, and to enhance the reusability of their knowledge and expertise.
The intangible assets of a company include its brand, its ability to attract,
develop and nurture a cadre of competent professionals, and its ability to
attract and retain marquee clients.

Intangible assets :

The intangible assets of a company can be classified into
four major categories: human resources, intellectual property assets, internal
assets and external assets.

Human resources :

Human resources represent the collective expertise,
innovation, leadership, entrepreneurship and managerial skills of the employees
of an organisation.

Intellectual property assets :

Intellectual property assets include know-how, copyrights,
patents, products and tools that are owned by a corporation. These assets are
valued based on their commercial potential. A corporation can derive its
revenues from licensing these assets to outside users.

Internal assets :

Internal assets are systems, technologies, methodologies,
processes and tools that are specific to an organisation. These assets give the
organisation a unique advantage over its competitors in the marketplace. These
assets are not licensed to outsiders. Examples of internal assets include
methodologies for assessing risk, methodologies for managing projects, risk
policies and communication systems.

External assets :

External assets are market-related intangibles that enhance
the fitness of an organisation for succeeding in the marketplace. Examples are
customer loyalty (reflected by the repeat business of the company) and brand
value.

The score sheet :

We published models for valuing two of our most important
intangible assets — human resources and the ‘Infosys’ brand. This score sheet is
broadly adopted from the intangible asset score sheet provided in the book
titled, The New Organisational Wealth, written by Dr. Karl-Erik Sveiby and
published by Berrett-Koehler Publishers Inc., San Francisco. We believe such
representation of intangible assets provides a tool to our investors for
evaluating our market-worthiness.

Clients :

The growth in revenue is 3% this year, compared to 12% in the
previous year (in US $). Our most valuable intangible asset is our client base.
Marquee clients or image-enhancing clients contributed 50% of revenues during
the year. They gave stability to our revenues and also reduced our marketing
costs.

The high percentage 97.3% of revenues from repeat orders
during the current year is an indication of the satisfaction and loyalty of our
clients. The largest client contributed 4.6% to our revenue, compared to 6.9%
during the previous year. The top 5 and 10 clients contributed around 16.4% and
26.2% to our revenue, respectively, compared to 18.0% and 27.7%, respectively,
during the previous year. Our strategy is to increase our client base and,
thereby reduce the risk of depending on a few large clients.

During the year, we added 141 new clients compared to 156 in
the previous year. We derived revenue from customers located in 66 countries
against 67 countries in the previous year. Sales per client grew by around 3.7%
from US $8.05 million in the previous year to US $8.35 million this year. Days
Sales Outstanding (DSO) was 59 days this year compared to 62 days in the
previous year.

Organisation :

During the current year, we invested around 2.58% of the
value-added (2.37% of revenues) on technology infrastructure, and around 2.09%
of the value-added (1.93% of revenues) on R&D activities.

A young, fast-growing organisation requires efficiency in the
area of support services. The average age of support employees is 30.4 years, as
against the previous year’s average age of 29.6 years. The sales per support
staff has come down during the year compared to the previous year and the
proportion of support staff to the total organisational staff, has improved over
the previous year.

People :

We are in a people-oriented business. We added 27,639 employees this year on gross basis (net 8,946) from 28,231 (net 13,663) in the previous year. We added 4,895 laterals this year against 5,796 in the previous year. The education index of employees has gone up substantially to 2,96,586 from 2,72,644. This reflects the quality of our employees. Our employee strength comprises people from 83 nationalities March 31, 2010. The average age of employees as at March 31, 2010 was 27. Attrition was 13.4% for this year compared to 11.1% in the previous year (excluding subsidiaries).

Notes:

  •     Marquee or image-enhancing clients are those who enhance the company’s market-worthiness, typically, Global 1,000 clients. They are often reference clients for us.

  •     Sales per client is calculated by dividing total revenue by the total number of clients.

  •     Repeat business revenue is the revenue during the current year from those clients who contributed to our revenue during the previous year too.

  •     Value-added statement is the revenue less payment to all outside resources. The statement is provided in the value-added statement section of this document.

  •     Technology investment includes all investments in hardware and software, while total investment in the organisation is the investment in our fixed assets.

  •     The average proportion of support staff is the average number of support staff to average total staff strength.

  •     Sales per support staff is our revenue divided by the average number of support staff (support staff excludes technical support staff).

The education index is shown as at the year end, with primary education calculated as 1, secondary education as 2 and tertiary education as 3.

Toolings classified as Inventories (pending receipt of opinion from EAC of ICAI)

New Page 1

  1. Toolings classified as Inventories (pending receipt of
    opinion from EAC of ICAI)


Vesuvius India Ltd. — (31-12-2008)

From Accounting Policies :

Inventories :

Toolings are considered as inventories and are amortised on
a straight-line basis over a period of three years based on their estimated
useful lives. The Company’s statutory auditors are of the view that such
toolings are in the nature of moulds that are used in the production of
finished goods and hence should be classified as fixed assets and depreciated
over their estimated useful lives of three years. The company is in the
process of obtaining the opinion of the Expert Advisory Committee of the
Institute of Chartered Accountants of India regarding appropriate
classification and accounting of such toolings considering their nature.

 

Had the toolings been classified as fixed assets, the gross
block and net block of fixed assets would have been higher by Rs.140,560
thousand (Previous year Rs.106,881 thousand) and Rs.47,917 thousand (Previous
year Rs.42,564 thousand) respectively, while inventories would have been lower
by Rs.47,917 thousand (Previous year Rs.42,564 thousand).

 

Consequently, the depreciation charge for the year would
have been higher by Rs.26,893 thousand (Previous year Rs.24,961 thousand) and
the tolling charges would have been lower by Rs.26,893 thousand (Previous year
Rs.24,961 thousand).

 

The provisions for current tax and deferred tax release for
the year would have been higher by Rs.2,435 thousand (Previous year Rs.2,451
thousand) and Rs.2,435 thousand respectively. Deferred tax charge for the
previous year would have been lower by Rs.2,451 thousand. Considering the
amount of income taxes deposited by the Company, there will be no dues towards
interest under the provisions of the Income-tax Act, 1961 had these
adjustments been recognised.

 

From Auditors’ Report :

We draw attention to Note 1(iv) on Schedule 14 to the
financial statements. As explained in the note, the Company has classified
toolings as inventory which is being amortised over their estimated useful
lives of 3 years. In our opinion such toolings are fixed assets and should be
depreciated over their useful lives as explained in the aforesaid Note. Had
the toolings been classified as fixed assets, gross block and net block of
fixed assets would have been higher by Rs.140,560 thousand (Previous year
Rs.106,881 thousand) and Rs.47,917 thousand (Previous year Rs.42,564 thousand)
respectively, which inventories would have been lower by Rs.47,917 thousand
(Previous year Rs.42,564 thousand). Consequently, the depreciation charge for
the year would have been higher by Rs.26,893 thousand (Previous year Rs.24,961
thousand) and the tooling charges would have been lower by an equivalent
amount. However, there is no impact on the profit after tax.

 

In view of the significance of the matter, we believe that
the divergent views on the matter need to be resolved through reference to the
Expert Advisory Committee (EAC) of the Institute of Chartered Accountants of
India. The Company is in the process of making such a reference. Accordingly,
the opinion expressed in paragraph 5 below should be considered pending
reference of the matter to the EAC and the confirmation by the EAC of the
classification and accounting followed by the Company.

 

From Directors’ Report :

Difference in opinion expressed by Auditors in para 4(f) of
their Report to Members of the Company dated February 24, 2009 relate to
classification of toolings which according to the Auditors should be
classified under fixed assets. The Company is consistently following the
normal industry practice of classifying them as inventory. In either case
there is no impact on profits after tax.


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Scheme of arrangement with High Court approvals

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  1. Scheme of arrangement with High Court approvals


Nestle India Ltd. — (31-12-2008)

From Notes to Accounts :

During the calendar year 2007, the Company had sought
approval of the Delhi High Court under Sections 391 to 394 of the Companies
Act, 1956 for a Scheme of Arrangement (‘Scheme’) between the Company and its
shareholders and creditors. The Scheme envisaged utilisation of following
amounts for payment to the shareholders, subject to applicable taxes :

(i) An amount of Rs.432,363 thousands as lying in the
Share Premium Account of the Company; and

(ii) An amount of Rs.430,857 thousands from the General
Reserve Account of the Company, which was voluntarily transferred by the
Company in excess of the prescribed 10% of the profits of the Company in
accordance with the provisions of the Companies (Transfer of Profit to
Reserves) Rules, 1975 during the financial years 1981 to 1996.

 


The equity shareholders supported the Scheme at a meeting
held on May 3, 2007 as per directions of the Delhi High Court. Subsequently,
the Delhi High Court vide its Order dated September 30, 2008 sanctioned the
aforesaid Scheme and the Scheme became effective from October 31, 2008 after
filing of the certified copy of the aforesaid Order with the Registrar of
Companies NCT of Delhi and Haryana. Thereafter as per the Scheme, after
deducting applicable corporate dividend tax for the aggregate amount of
Rs.863,220 thousands credited to the Profit and Loss Account, a Special
Dividend of Rs.7.50 (Rupees seven and paise fifty only) per share calculated
by dividing the net amount by the outstanding 96,415,716 equity shares of face
value of Rs.10 each and rounding it off to the nearest half Rupee, was paid on
November 26, 2008 to those shareholders whose name appeared in the Register of
Members/Beneficial Owners on November 17, 2008.

 

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Transactions covered u/s 297 of the Companies Act, 1956

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1. Transactions covered u/s 297 of the Companies Act, 1956

Avaya Global Connect Ltd. — (30-9-2008)

 From Notes to Accounts :

    In respect of contracts for the provision/supply of services/goods, with a private company in which a Director of the Company is Director, the Company is of the view that the provisions of Section 297 of the Companies Act, 1956 are not applicable. However, as a matter of abundant caution, the Board of Directors of the Company in their meeting held on 26th October, 2007 resolved to make an application seeking the approval of the Central Government.

     

    Pursuant to above, Company has filed application under section 621(A) for compounding of offence committed under section 297 of the Companies Act, 1956, for the transactions entered in 2006-07 and in 2007-08 (upto February 24, 2008) for which approval is pending. The Company has obtained Central Government approval for entering into transactions with the above mentioned Company from the date of approval February 25, 2008 to September 30, 1010.

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Disclosures regarding Premium payable on redemption of FCCB

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Section B : Miscellaneous


5 Disclosures regarding Premium payable on redemption of FCCB

WOCKHARDT LTD. — (31-12-2007)

From Notes to Accounts :



(d) 108,500 (previous year — 108,500) Zero-coupon Foreign
Currency Convertible Bonds of USD 1,000 each are :

(i) Convertible by the holders at any time on or after
November 24, 2004 but prior to close of business on September 25, 2009. Each
bond will be converted into 94.265 fully paid-up equity shares with par
value of Rs.5 per share at a fixed price of Rs.486.075 per share.


(ii) redeemable, in whole but not in part, at the option
of the Company at any time on or after October 25, 2007, but not less than
seven business days prior to maturity date i.e., October 25, 2009,
subject to the fulfillment of certain terms and obtaining requisite
approvals.


(iii) redeemable on maturity date at 129.578 percent of
its principal amount, if not redeemed or converted earlier.


 



The bonds are considered as monetary liability. The bonds are
redeemable only if there is no conversion of the bonds earlier. Hence the
payment of premium on redemption is contingent in nature, the outcome of which
is dependent on uncertain future events. Hence no provision is considered
necessary, nor has it been made in the accounts in respect of such premium
amounting to a maximum of Rs.775.98 million. (Previous Year — Rs.581.74 million)

 

From Auditors’ Report :

Without qualifying our opinion, we state that the financial
statements are without provision for premium payable on 108,500 Zero-Coupon
Foreign Currency Convertible bonds of USD 1000 each [refer note 30(d) to the
financial statements] as the premium payable on redemption which is contingent
upon a future uncertain event, namely, the redemption of such bonds is presently
not determinable.

 

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Straight-lining of lease rent pursuant to clarification by EAC of ICAI

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Section B : Miscellaneous


 3 Straight-lining of lease rent pursuant to
clarification by EAC of ICAI


 

BATA INDIA LTD. — (31-12-2007)

From Notes to Accounts :

Pursuant to clarification issued by Expert Advisory Committee
of Institute of Chartered Accountants of India on Accounting Standard-19 on
Leases on recognition of operating lease rent expense, the Company has decided
to recognise the scheduled rent increases over the lease term on a straight-line
basis in respect of all lease rent agreements entered on or after April 1, 2001
and still in force. The total impact in respect of these agreements till
December 31, 2006 of Rs.29,712 (Net of deferred tax impact of Rs.2,540) is
disclosed as ‘Prior period item’ in Schedule-21 in accordance with Accounting
Standard-5 on ‘Net Profit or Loss for the Period, Prior Period items and Changes
in Accounting Policies’.

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Scheme of arrangement for transfer of amalgamation reserve to restructuring reserve and one-time restructuring costs adjusted

New Page 1

Section B : Miscellaneous



4 Scheme of arrangement for transfer of
amalgamation reserve to restructuring reserve and one-time restructuring costs
adjusted

GILLETTE INDIA LTD. — (30-6-2007)

From Notes to Accounts :

Consequent upon the scheme of arrangement u/s. 391 of the
Companies Act, 1956 as approved by the shareholders and confirmed by the Hon’ble
High Court of Rajasthan a sum of Rs.85,00,000 was transferred from the
amalgamation Reserve forming part of the Capital Reserves of the Company to a
Reconstruction Reserve Account. Further, vide a clarification dated December 4,
2006, the Hon’ble High Court has clarified that the transfer of expenses to the
Reconstruction Reserve Account should be gross of tax.

 

A detailed break-up of Rs.65 22 74 068 as has been utilised
towards the Business Restructuring expenses up to June 30, 2007 is given below :


One-time expenditure for the restructuring
Maximum amount as sanctioned by the Court
Actual expenses upto June 30, 2007
  Rs. Rs.

Employee separation, Relocation and related costs 		536000000 490835509

Costs associated with change in Go to Market and Distribution model 		212000000 139415791
Estimated value of
asset write down w.r.t.
the restructure		 43500000 8117433

Transition costs including travel/ training/ communication and other related
costs 		35000000 13905335

Other miscellaneous restructuring items including contingencies 		23500000 —

Total 		850000000 652274068

 

The said Business Restructuring is expected to be completed
during the next financial year.

 

From Auditors’ Report :

Attention is invited to Note B2 of the Schedule 18 annexed to
and forming part of the financial statements regarding charging off of Business
Restructuring expenses to Capital Reserve. Pursuant to the approval given by the
High Court of Rajasthan dated August 22, 2006 and December 04, 2006 to the
Scheme of Arrangement filed by the Company under Section 391 of the Companies
Act, 1956, in respect of charging off of ‘business restructuring expenses —
gross of tax’ to the capital reserve; the Company has been permitted to transfer
an amount of up to Rs.8500.00 lakhs from the Capital Reserve to a
‘Reconstruction Reserve Account’. The total expenses charged off to
Reconstruction Reserve Account for the period from January 01, 2006 to June 30,
2007 amounted to Rs.6522.74 lakhs. Had the restructuring expenses not been
adjusted to Capital Reserve under the order of the High Court of Rajasthan and
debited to the Profit and Loss Account as per the generally accepted accounting
principles, the net profit after tax (inclusive of the effect of deferred tax)
would have been lower and the Capital Reserve been higher for the period from
January 01, 2006 to June 30, 2007 by Rs.5538.72 lakhs.

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Qualifications in certificate on corporate governance

New Page 3

Section B : Miscellaneous


2 Qualifications in certificate on corporate governance

BATA INDIA LTD. — (31-12-2007)

In our opinion and to the best of our information and
according to the explanations given to us, subject to the following :

1. Chairman of Audit Committee Meeting Mr. V. Narayanan was
not present in the Annual General Meeting held on 27th June 2007.

2. Code of conduct and quarterly results are not available
on the website of the company.


We certify that the Company has complied with the conditions
of Corporate Governance as stipulated in the above-mentioned Listing Agreement.

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TRF Ltd. (31-3-2010)

New Page 1

Section A : Disclosures on Clause 21 of CARO, 2003 regarding
fraud noticed or reported on or by the company during the year


6. TRF Ltd. (31-3-2010)

From Auditor’s Report :

To the best of our knowledge and according to the information
and explanations given to us, no material fraud on or by the Company has been
noticed during the year except for the misstatement in the financial reporting
having a net effect of Rs.239.90 lacks as disclosed in Note (xiii) on Schedule
19 which was perpetrated on the Company.

Note (xiii) on Schedule 19 :

Certain contract costs recorded without underlying
transactions in earlier years were noted during years ended March 31, 2010 and
March 31, 2009. Management has now initiated an investigation into the matter as
well as payments made thereagainst, if any. Pending completion of investigation,
such wrong costs and consequential revenues recorded in the earlier years have
been reversed in the current year and the previous year to the extent identified
by management as summarised below :

Profit & Loss Account :

Prior period
items

31-3-2010

31-3-2009

 

Rs. in lakhs

Rs. in lakhs

Sales & services erroneously
recognised in previous year, reversed

1,149.56

4,615.08

Corresponding adjustment/reversal in

 

 

— Raw material and components

60.96

843.88

— Payments to sub-contractors

712.00

—

— Contracts in
progress

136.69

2,439.42

(Net)

(239.91)

(1,331.78)

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SKS Microfinance Ltd. (31-3-2010)

New Page 1

Section A : Disclosures on Clause 21 of CARO, 2003 regarding
fraud noticed or reported on or by the company during the year


5. SKS Microfinance Ltd. (31-3-2010)

From Auditor’s Report :

Based upon the audit procedure performed for the purpose of
reporting the true and fair view of the financial statements and as per the
year, though there were some instances of fraud on the Company by its employees
and borrowers as given below :

(a) Eighty-two cases of cash embezzlements by the employees
of the Company aggregating Rs.15,024,158 were reported during the year. The
services of all such employees involved have been terminated and the Company
is in the process of taking legal action. We have been informed that
thirty-seven of these employees were absconding. The outstanding balance (net
of recovery) aggregating Rs. 8,663,302 has been written off.

(b) Sixty-one cases of loans given to non-existent
borrowers on the basis of fictitious documentation created by the employees of
the Company aggregating Rs.13,645,345 were reported during the year. The
services of all such employees involved have been terminated and the Company
is in the process of taking legal action. The outstanding loan balance (net of
recovery) aggregating Rs. 11,029,667 has been written off; and

(c) Thirty-one cases of loans taken by certain borrowers,
in collusion with and under the identity of other borrowers, aggregating Rs.
6,025,000, were reported during the year. The Company is pursuing the
borrowers to repay the money. The outstanding loan balance (net of recovery)
aggregating Rs.2,359,930 has been written off.


From Directors’ Report :

In terms of the provisions of S. 217(3) of the Companies Act,
1956, the Board would like to place on record an explanation to the Auditors’
comments in their Audit Report dated 4th May 2010 :

(a) There is an inherent risk involved in our operations as
all the transactions at the field are in cash. The Company has taken legal or
remedial action in almost all the cases of embezzlement of cash and issue of
fake loans by employees. The Company has recovered an amount of Rs. 2,226,304
out of cash embezzled from the employees and an amount of Rs.4,134,552 from
the Insurance Company, as the company has the adequate insurance coverage in
place;

(b) To mitigate this risk the Company has formed the policy
which is as follows :



  •   Not to deploy the Sangam Manager in their hometown



  •   Rotate the Centres handled by Sangam Manager’s in every six months



  •   Transfer Sangam Manager/Branch Manager in a span of 9 to 12 months.



In addition to the above, stringent monitoring systems at all
levels have been implemented and checked/verified by risk/audit team on a
monthly basis. Going forward at Head Office level we are implementing automated
dropouts of dormant members month on month to mitigate the risk of fake loans.

(c) While the system of Joint Liability Groups in the
Centre and changing Centre Leader every one year persists, intentional and
fraudulent Centre Leaders have been identified and we have initiated legal
proceedings with the help of Group Leaders and respective members. The net
impact of frauds comes to around 0.029% of the total amount disbursed during
the year. The company is working towards bringing down this percentage to the
least possible by making process improvements, covering the loss by having
adequate insurance policy and by increasing the number of opportunities for
direct contact with our members.

 


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Disclosure regarding Foreign Currency Convertible Bonds (FCCBs) and premium on redemption of FCCB

New Page 1

10 Disclosure regarding Foreign Currency
Convertible Bonds (FCCBs) and premium on redemption of FCCB


Fame India Ltd. — (31-3-2008)


From Notes to Accounts :


On 21 April 2006, the Company, pursuant to a resolution of
the Board of Directors dated 28 January 2006 and by a resolution of the
shareholders dated 8 March 2006, issued

(i) 12000, Zero Coupon Series A Unsecured Foreign Currency
Convertible Bonds (‘Series A Bonds’) of the face value of US $ 1000; and

(ii) 8,000, 0.5% per annum Series B Unsecured Foreign
Currency Convertible Bonds (‘Series B Bonds’) of the face value of US $ 1000
aggregating to USD 20,000,000 (approximately Rs.901,000,000) due in 2011 (the
Series A Bonds and the Series B Bonds are collectively called the ‘Bonds’).
The Series Bonds bear interest at the rate of 0.5% per annum, which accrues
semi-annually in arrears on 31 December and 30 June of each year. Interest
will accrue on each interest payment date and on maturity, accrued interest
will be paid. The Bonds will mature on 22 April 2011.

 


The Bonds are convertible at any time on or after 21 May 2008
and prior to 12 April 2011 at the option of the Bond holders into newly issued,
ordinary equity share of par value of Rs.10 per share (‘Shares‘), at an initial
conversion price of

(i) Rs.90 per share for Series A Bonds; and

(ii) Rs.107 per share for Series B Bonds

(as defined in terms and conditions for the Bonds) at the
rate of exchange equal to the US Dollar to Rupees exchange rate as announced
by the Reserve Bank of India (the ‘RBI’) on the business day immediately prior
to the issue date. The conversion price is subject to adjustment in certain
circumstances.

 


Unless previously converted, redeemed or repurchased and
cancelled,

(i) the Series A Bonds will be redeemed on 22 April 2011 at
137.01% of their principal amount representing a gross yield to maturity of
6.5%; and

(ii) the Series B Bonds will be redeemed on 22 April 2011
at 140.69% of their principal amount representing a gross yield to maturity of
7.5%.

 


During the year 1,504,999 (31 March 2007; Nil) equity shares
of Rs.10 each were allotted against 3000 Series A Foreign Currency Convertible
Bonds (FCCB) of US $ 1,000 each at an exercise price of Rs.90 per share and
1,687,850 (31 March 2007; Nil) equity shares of Rs.10 each were allotted against
4000 Series B FCCB of US $ 1,000 each at an exercise price of Rs.107 per share,
thus aggregating to a total allotment of 3,192,849 equity shares of Rs.10 each
of the Company.

 

Exchange gain/loss arising on such conversion have been
adjusted against share premium reserve. Premium on FCCB amortised and adjusted
to the share premium account up to the date of conversion has been reversed.

 

The Bond issue expenses have been adjusted against share
premium as per the provision of Section 78 of the Act.

 

Utilisation up to 31 March 2008 of the proceeds from the FCCB
issue is as under :

Purpose Amount in Rs.
(a) New cinema
complexes 		705,645,427
(b) Expansion/modernisation
of existing cinema complexes 		83,027,839
(c) FCCB issue
expense 		29,813,462
Total 818,486,728


(Currency :
Indian Rupees)




Balance
unutilised funds have been invested in :		  
(a) Deposit
accounts 		10,180,107
(b) Current
accounts 		 
— in India
 20,832,448
— outside
India 		8,151,235

The proceeds utilised have been converted at an average
exchange rate of Rs.42.58 per US $ and the balance outstanding as at 31 March
2008 is translated at the exchange rate of Rs.39.97 per US $, being the exchange
rate as at 31 March 2008.

 Premium on redemption of Foreign Currency Convertible Bonds (FCCB)

* Premium payable on redemption of FCCB charged to the securities premium account has been provided pro rata for the year. In the event the conversion option is exercised by the holders of FCCB in future, the amount of premium charged to the securities premium account will be suitably adjusted in the respective years.


Opinion of Expert Advisory Committee of ICAI not followed regarding revenue recognition

Opinion of Expert Advisory Committee of ICAI not followed regarding treatment of dredger spares

New Page 1

8 Opinion of Expert Advisory Committee of
ICAI not followed regarding treatment of dredger spares


Dredging Corporation of India Ltd. — (31-3-2008)

From Notes to Accounts :

On a reference made by DCI regarding accounting treatment of
spares issued to dredgers, the Expert Advisory Committee of Institute of the
Chartered Accountants of India gave its opinion on 27th May 2008, which was
received by the Company on 31st May 2008. As per the opinion, if the spares are
of capital nature and purchased subsequent to the acquisition of particular
dredger, these need to be capitalised and depreciated systematically over the
remaining useful life of the particular dredger. In case where the useful life
of the particular dredger has been completed, the same is to be charged to
Profit & Loss A/c through depreciation. Since the opinion has come after the
close of the accounting period and several complexities are involved, no
adjustments have been made in the accounts for the year in this regard. The
Company proposes to implement the same from Financial Year 2008-09 onwards after
examining all the issues involved.

 

From Auditors’ Report :

Reference is invited to Note 9(g) of Notes on Accounts. As
per the Expert Advisory Committee of ICAI’s opinion, the accounting practice of
charging off spares to expenditure as when issued to dredgers is not in
accordance with the provisions of AS- 10 and its effect on current year’s profit
is not quantifiable.

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Section C : Withdrawal of Audit Report issued earlier : Satyam Computer Services Ltd.

New Page 2

Compilers’ Note :


In the case of the above company, Statutory Audit Reports and
Limited Review Reports for the period June 2000 to September 2008 were issued by
the Statutory Auditors as required under the provisions of the Companies Act,
1956 and Clause 41 of the Listing Guidelines. In view of certain developments,
the said reports have been withdrawn by the Statutory Auditors by writing a
letter to the new Board of Directors and the Company Secretary with copies
marked to the ROC, SEBI, RBI, CBDT, BSE, NSE, NYSE. The said letter of the
Statutory Auditors is reproduced below.

 

Dear Sirs,


Re : Our audit of your financial statements


1. As statutory auditors, we performed audits of Satyam
Computer Services Limited (the ‘Company’) from the quarter ended June
2000 until the quarter ended September 30, 2008 (‘Audit Period’).

 

2. The above-referred financial statements were prepared by
the management of the Company.

 

3. We planned and performed the required audit procedures on
such financial statements, and examined the books and records of the Company
produced before us by the Company management. We placed reliance on management
controls over financial reporting, and the information and explanations provided
by the management, as also the verbal and written representations made to us
during the course of our audits.

 

4. As you are aware, vide a letter dated January 7, 2009 (“Chairman’s
Letter”) addressed to the erstwhile Board of Directors of the Company, the
former Chairman of the Company, Mr. Ramalinga Raju has stated that the financial
statements of the Company have been inaccurate for successive years. The
contents of the said letter, even if partially accurate, may have a material
effect (which effect is currently unknown and cannot be quantified without a
thorough investigation) on the veracity of the Company’s financial statements
presented to us during the Audit Period. Consequently, our opinions on the
financial statements may be rendered inaccurate and unreliable. A copy of the
Chairman’s Letter, extracted from the official website of the National Stock
Exchange is annexed hereto as Annexure A, for the sake of record. (not
reproduced here)

 

5. The ICAI has issued a guidance note on revision of audit
reports in January 2003 (‘Guidance Note’), which prescribes steps to be
followed by the auditor to prevent reliance on audit reports in such
circumstances. In view of the contents of the Chairman’s Letter, we hereby, in
accordance with the Guidance Note, state that our audit reports and opinions in
relation to the financial statements for the Audit Period should no longer be
relied upon.

 

6. Such a requirement is also prescribed under the generally
accepted accounting standards in the United States, where, as you are aware, the
American Depository Receipts of the Company are listed. We wish to inform you
that pursuant to Section 10A of the United States Securities and Exchange Act of
1934, the information contained in the Chairman’s Letter indicates that an
illegal act could have occurred. Accordingly, we advise that the Board of
Directors of the Company should promptly commence an independent investigation
pursuant to Section 10A of the United States Securities and Exchange Act of 1934
in order to determine whether such illegal acts occurred and, if so, the nature
and extent of such acts.

 

7. We hope to work with the Company and provide assistance to
the new Board of Directors to address any issues that arise in the course of
such investigation, to enable both the Company and us as your Statutory Auditors
to fulfil obligations under applicable law.

 

8. We wish to advise that the Company should promptly notify
any person or entity that is known to be relying upon or is unlikely to rely
upon our audit report that our audit opinion should no longer be relied upon.

 

9. Consequently, such notification should be made to at least
the Company’s shareholders, lenders, creditors, Indian regulatory authorities
and the United States Securities and Exchange Commission, and indeed to all the
stock exchanges, whether in India or abroad, where such securities of the
company are listed. We expect such notification would be made promptly and
request that the Company advise us as soon as the notification has been made.
Since we are required under the Guidance Note to mark a copy of this letter to
the relevant regulatory authorities, we have done so.

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Section A : Audit Report containing Qualifications on Going Concern, etc.

New Page 1Spicejet Ltd. — (31-3-2008)

From Notes to Accounts :


3. Legal proceeding by and/or against the company

3.1 Share capital includes 11,624,472 equity shares of Rs.10
each (issued at a premium of Rs.30 each) originally allotted to the three
investment companies of S. K. Modi Group (SKM). These shares were partly paid
and were treated as fully paid by adjusting the calls in arrears of Rs.333.18
million against assignment of security deposit of Rs.360 million by Agache
Associates Limited (belonging to SKM) in favour of the said investment
companies. The Security deposit of Rs.360 million was shown payable to Agache
Associates Limited, under a purported lease agreement dated September 11, 1995,
which was to be effective from April 1, 1996 for a property situated at
Calcutta, West Bengal. Subsequently, the Delhi High Court has passed an order on
July 15, 2005 appointing Receivers to sell shares belonging to SKM’s group
companies and deposit the proceeds with the Court. The manner of receipt of
these sale proceeds by the Company shall be decided by the Court in the pending
proceedings. The Company had also filed a criminal complaint in the Court of
Chief Metropolitan Magistrate, New Delhi against some of the erstwhile promoter
directors and ex-employees of the Company for executing the above transaction.

3.3 In respect of ICDs aggregating Rs.100 million, the
Company has not accrued interest payable amounting to Rs.240.95 million up to
March 31, 2008 (previous year Rs.222.15 million), computed based on interest
rates as per original contract terms for reasons explained below :


l
ICD of Rs.50 million in the name of Agache Associates Limited (affiliated to
SKM) being a party to the fraudulent transactions (Refer Note 3.1 above).


l
In a suit filed by one of the ICD lenders (petitioners), the Company had
deposited a sum of Rs.50 million with the Bombay High Court and the Hon’ble
Bombay High Court later allowed the petitioner to withdraw the said amount
upon furnishing an undertaking that the petitioner will restitute the said sum
or such part thereof, with 9% interest, to the Company, if and as directed by
the Court at the time of the final decision of the suit filed by the
petitioner. Accordingly, pending finality of the matter, both the ICD and
deposit with the High Court have been disclosed under the unsecured loans and
advances, respectively.



3.5 The Company has in its possession the bank-statement of
ICICI Bank, New Delhi, which shows a deposit of Rs.34.29 million on account of
refunds from the Income-tax Department on November 6, 2000 and July 2, 2001 and
subsequent withdrawals (details of amounts appropriated not available with the
Company) on various dates aggregating to Rs.34.29 million against cheques/drafts
issued to several parties, including group companies of SKM, by erstwhile
Director(s) and/or some ex-employees of the Company, which amount to fraudulent
preference under Section 531 of the Companies Act, 1956, which was brought to
the notice of the Hon’ble Court vide CA 606of 2003 and CA797 of 2000. The
difference of Rs.34.29 million between balance as per books (since no accounting
entry has been recorded for unauthorised withdrawals) and that confirmed by the
bankers, is being carried as recoverable under Loans and Advances and is pending
appropriate adjustment on outcome of the ongoing cases and has not been provided
for in the accounts.

3.7 The Company has in its possession the bank statement of
Standard Chartered Grindlays Bank, Mumbai, which shows deposits of Rs.14.20
million and withdrawals of Rs.16.01 million through various transactions made
during the period March 1999 to March 2002. However, in the absence of complete
details of these transactions, appropriate accounting entries could not be
recorded in the books in respect of these transactions. The difference of
Rs.1.81 million between the balance as per books and that confirmed by the bank,
is carried as recoverable under ‘Loans and Advances’ and is pending appropriate
adjustment on the outcome of the ongoing litigations with SKM and entities in
which they are interested.

5. The Management and Board of Directors of the Company are
looking at various steps to improve financial performance of the Company by
rationalising network, improve yield and lower non-fuel costs as a result of
industrywide efforts. Steps are also being taken to evaluate various
alternatives for raising funds for which a merchant banker has been appointed.
The Board of Directors expects improvement in the business results in the
forthcoming years. Accordingly, the financial statements have been prepared on
going concern basis.

From Auditors’ Report :

4. Without qualifying our opinion, we draw attention to Note 5in Schedule XVII to the financial statements which indicate that the Company has suffered recurring losses from operations with net loss for the year ended March 31, 2008, without considering the impact of the matters mentioned in paragraph 5 below, amounting to Rs.1,335.07 million, and as of that date, the Company’s accumulated losses amounted to Rs.5,074.52 million, as against the Company’s share capital and reserves of Rs.5,354.33 million. Also, as discussed in Note 3 in Schedule XVII to the financial statements, realisation of the carrying amount of certain receivable amounting to Rs.68.82 million and dismissal of interest liability amounting to Rs.240.95 million is dependent upon success of the claims filed by the Company against some of the erstwhile directors and employees. These conditions raise significant doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 5. The accompanying financial statements do not include any adjustments that might result from the outcome of these uncertainties and also do not include any adjustments relating to the recoverability and classification of asset carrying amount or the amount and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

5. We report  that:

(a) As more fully explained in the Note 3.1 of Schedule XVII to the financial statements, an amount of Rs.360 million, given as security deposit towards lease of a property, is carried as recoverable under the head Loans and Advances, of which an amount of Rs.26.82 million appears to be doubtful for recovery. The Company has not made provision for this doubtful amount in the financial statements.

(b) As more fully explained in the Note 3.3 of Schedule XVII to the financial statements, the Company has not accrued interest in respect of outstanding inter-corporate deposits of Rs.10 million, which as at March 31, 2008 amounts to Rs.240.95 million.

6. (e) Subject to our comments in paragraph 5 above, ….

Impact of IFRS on the real estate sector : Developing a new reporting framework

IFRS

Impact of IFRS on the real estate sector : Developing a new
reporting framework

As Indian companies get poised to converge with IFRS in April
2011, some of the sectors may witness significant changes in the financial
statements used for reporting their performance to various stakeholders. The
foremost amongst them is the real estate industry. This article seeks to discuss
these changes and their related impact in greater detail.

Revenue recognition :

Generally, developers start marketing the project before
construction is complete or perhaps, even before construction has started.
Buyers enter into agreements to acquire a spe+cific unit within the building on
completion of the construction. The contracts may require the buyer to pay a
deposit and progress payments, which are refundable only if the developer fails
to complete and deliver the unit.

Under IFRS, IFRIC 15 Agreements for the Construction of
Real Estate provides detailed guidance on recognition of revenue from real
estate contracts. Under the Indian GAAP, the matter is currently dealt through
the Guidance Note on Accounting for Real Estate Developers issued by the
Institute of Chartered Accountants of India (‘ICAI’).

There are significant differences between the accounting
recommended under the two pronouncements.

Under the Indian GAAP, the ICAI Guidance Note permits the
real estate development contracts to be accounted on percentage of completion
method.

Accounting for real estate construction arrangements under IFRS

An agreement for construction of real estate can be accounted
as :


(a) Construction contract, which is within the scope of
IAS 11 on construction contracts; or

(b) Sale of goods and service, which is within the scope
of IAS 18 on revenue recognition.


An agreement for construction of real estate meets the
definition of a construction contract when the buyer is able to specify major
structural elements of the design of the real estate before construction begins
and/or specify major structural changes once construction is in progress
(whether or not it exercises that ability). In such cases, IAS 11 on
construction contracts applies.

In contrast, an agreement for construction of real estate in
which buyers have only limited ability to influence the design of the real
estate, e.g., to select a design from a range of options specified by the
entity, or to specify only minor variations to the basic design, is an agreement
for sale of goods within the scope of IAS 18. IAS 18 prescribes the following
criteria for revenue recognition — Revenue from the sale of goods shall be
recognised when all the following conditions have been satisfied :


(a) the entity has transferred to the buyer the
significant risks and rewards of ownership of the goods;

(b) the entity retains neither continuing managerial
involvement to the degree usually associated with ownership, nor effective
control over the goods sold;

(c) the amount of revenue can be measured reliably;

(d) it is probable that the economic benefits
associated with the transaction will flow to the entity; and

(e) the costs incurred or to be incurred in respect of
the transaction can be measured reliably.


An analysis of general agreements for sale of real estate in
India shows that the buyers have only limited ability to influence the design of
the real estate, in fact they have no influence over the basic design/layout of
the building/apartment. Hence the sale would generally fall under IAS 18
principles as an agreement for sale of goods.

There could be two scenarios under sale of goods :




? the entity may transfer to the buyer control and the significant risks and
rewards of ownership of the real estate in its entirety at once (e.g.,
at completion, upon delivery). In such cases, the revenue will be recognised
only at the point of completion coupled with delivery.



? the entity may transfer to the buyer control and the significant risks and
rewards of ownership of the work in progress in its current state as
construction progresses, and then the revenue is recognised on percentage
completion method, provided all criteria (mentioned above) of IAS 18 are
satisfied.




Determining continuing managerial involvement :

At the time of signing the provisional letter of allotment or
the agreement for sale, generally the seller has significant pending acts to
perform for completion of its obligations to deliver the apartment. All
decisions related to construction are with the seller and also, the construction
risk is to the account of the seller. This indicates continuing managerial
involvement in the property.

Determining transfer of risks and rewards :

The following indicators in real estate sale agreements
demonstrate that the risk and rewards of ownership are not continuously
transferred to the buyer :


— If the agreement is terminated before completion of the
construction by the buyer, the buyer does not retain the work-in-progress
and the developer does not have the right to be paid for the work performed.
The developer has to refund the money received from the buyer.

— The agreement does not give the buyer the right to take
over the incomplete property in case of default by the developer or
otherwise.


These indicate that the seller effectively retains control
and has continuing managerial involvement over the flats until possession is
transferred.

Hence the completed contract method will have to be applied
and revenue shall be recorded in its entirety on transfer of possession.
Construction costs incurred will be carried in the books of the developer as
work-in-progress under ‘Inventory’.

Difference from accounting for construction contracts :

As discussed above, determining whether an agreement for the
construction of real estate is within the scope of IAS 11 or IAS 18 depends on
the terms of the agreement and all the surrounding facts and circumstances. Such
a determination requires judgment with respect to each agreement.

IAS 11 applies when the agreement meets the definition of a construction contract set out in paragraph 3 of IAS 11: ‘a contract specifically negotiated for the construction of an asset or a combination of assets ….’ An agreement for construction of real estate meets the definition of a construction contract when the buyer is able to specify major structural elements of the design of the real estate before construction begins and/ or specify major structural changes once construction is in progress (whether or not it exercises that ability).

One view could be that IAS 11 should apply to all agreements for the construction of real estate. In support of this view, it is argued that:

    a) these agreements are in substance construction contracts. The typical features of a construction contract — land development, structural engineering, architectural design and construction — are all present

    b) IAS 11 requires a percentage of completion method of revenue recognition for construction contracts. Revenue is recognised progressively as work is performed. Because many real estate development projects span more than one accounting period, the rationale for this method — that it ‘provides useful information on the extent of contract activity and performance during a period’ (IAS 11 paragraph 25) — applies to real estate development as much as it does to other construction contracts. If revenue is recognised only when the IAS 18 conditions for recognising revenue from the sale of goods are met, the financial statements do not reflect the entity’s economic value generation in the period and are susceptible to manipulation.

In reaching the consensus that IAS 11 should apply only when the agreement meets the definition of a construction contract and apply IAS 18 when the agreement does not meet the

definition of a construction contract, the IFRIC noted that:

    a) the fact that the construction spans more than one accounting period and requires progress payments are not relevant features to consider when determining the applicable standard and the timing of revenue recognition;

    b) determining whether an agreement for the construction of real estate is within the scope of IAS 11 or IAS 18 depends on the terms of the agreement and all the surrounding facts and circumstances. Such a determination requires judgement with respect to each agreement. It is not an accounting policy choice;

    c) IAS 11 lacks specific guidance on the definition of a construction contract and further application guidance is needed to help identify construction contracts.

The IFRIC concluded that the most important distinguishing feature is whether the customer is actually specifying the main elements of the structural design. In situations involving the sale of real estate, the customer generally does not have the ability to specify or alter the basic design of the product. Rather, the customer is simply choosing elements from a range of options specified by the seller or specifying only minor variations to the basic design. The IFRIC decided to include guidance to this effect in the Interpretation to help clarify the application of the definition of a construction contract.

Currently under the Indian GAAP, guidance note on recognition of revenue by real estate developers states that revenue can be recognised once significant risks and rewards are transferred. In case of real estate sales, price risk is considered as the most significant risk; and the buyer has the right to sell or transfer his interest in the property without any conditions or with immaterial conditions attached. Thus under the current scenario, revenue from real estate sales can be recognised on the completion of an agreement for sale, even though the legal title or possession has not been delivered.

Consolidation of land acquisition companies:
Real estate companies in India are regulated under the Land Ceiling Act, 1976, which fixes a maximum limit on the area of land that may be owned by one company. To overcome these restrictions, real estate companies float various special purpose entities (SPEs) that purchase land from the market. A real estate company may have differing arrangements with SPEs. These arrangements would have to be closely evaluated and in light of SIC Interpretation 12 Consolidation — Special Purpose Entities.

In certain cases, real estate companies directly or indirectly hold 100% or majority share capital of such SPEs and/or have majority representation on their board of directors. However in other cases, the share capital of SPEs, which is generally a small amount, is held by a third party that also controls the governing body of the SPE. In such cases, the real estate companies are involved with the SPE in various other ways, such as provision of finance to carry out the activities, exclusive rights to develop land, provide guarantee against finance taken by SPEs, guarantee minimum return to the shareholders and/or enter contract, which may restrict the decision-making powers of SPE.

Under the Indian GAAP, companies consolidate only those entities where they directly or indirectly hold majority share capital and/or have majority representation on the board of directors or other governing bodies. However, under IFRS a special purpose entity may have to be consolidated even in cases where a company is not holding majority share or controlling the composition of the governing board of the SPE on account of certain arrangements like provision of finance to carry out the activities, exclusive rights to develop land, etc. which may be indicative of a control. As per SIC 12, the following circumstances, for example, may indicate a relationship in which an entity controls an SPE and consequently should consolidate the SPE?:

  a)  In substance, the activities of the SPE are being conducted on behalf of the entity according to its specific business needs, so that the entity obtains benefits from the SPE’s operation.

b)    In substance, the entity has the decision-making powers to obtain majority of the benefits of the activities of the SPE or, by setting up an ‘autopilot’ mechanism, the entity has delegated these decision-making powers.

   c)  In substance, the entity has rights to obtain majority of the benefits of the SPE and therefore may be exposed to risks incident to the activities of the SPE.

 d)   In substance, the entity retains majority of the residual or ownership risks related to the SPE or its assets in order to obtain benefits from its activities.

Upon transition to IFRS, real estate companies will need to evaluate their relationship with SPEs based on the criteria laid down in SIC 12. Further, real estate companies will also need to examine whether such consolidation may have any legal or other implications.

Structured financing arrangements:

Structured financing arrangements for entities floated by real estate companies for projects, would need to be closely evaluated to identify the substance of the transaction; and accounting will have to reflect this underlying substance. For example, instruments issued for which the entity has an obligation to pay cash would need to be classified as debt and the underlying committed returns or fluctuations in the value of such instruments would have to be recorded in the income statement. This would also increase the volatility of the reported earnings and reduce reported profits.

Impacts of change in financial reporting framework on other operational areas:

Executive compensation plans:

Some real estate companies pay commissions/ variable incentives to employees based on sales or profits. Given the impact of IFRS, there will be a high degree of volatility in the reported revenues and reported profits of companies, thereby impacting these compensation plans. Further in case of payments to directors, which in India is limited to a specified percentage of profits, companies will need to address the impact on managerial remuneration due to insufficient profits in the period when construction activity is ongoing but possession is not transferred, though companies would have positive cash flows.

Tax:

Another important area which deserves attention is the impact on the tax liability for a company due to the change in the accounting framework with special emphasis on changes in revenue recognition. It will be important to understand whether tax authorities will recognise profits under IFRS as taxable profits and thereby postpone the tax incidence till the possession of the property is transferred. Alternatively, the authorities may require the companies to recompute revenue using percentage of completion method for tax purposes. Further, interplay between the minimum alternate tax (MAT) provisions and the reported profits under IFRS would be equally important.

Debt covenants:

In preparing its first IFRS financial statements, an entity recognises all assets and liabilities in accordance with the requirements of IFRS, and derecognises assets and liabilities that do not qualify for recognition under IFRS. Further, the entity would have to reclassify items that it recognised in accordance with previous GAAP as one type of asset, liability or component of equity, but are a different type of asset, liability or component of equity in accordance with IFRS.

This may impact various business ratios like gearing, liquidity and profitability ratios of a first-time adopter. Further, a reclassification of a long-term loan as current due to, say, a default in meeting any covenant (example business ratios) may impact debt covenants of other loans. In extreme situations, it may even impact the company’s ability to continue as a going concern. It would be therefore pertinent to conduct a detailed examination of the various loan and borrowing agreements and identify the covenants which may be impacted by the transition. An early discussion with the lenders of funds around these areas would go a long way in avoiding last minute surprises.

Conclusion:

As convergence with IFRS is inevitable, the key now lies in getting this transition right. The most important factors for real estate companies would be educating their stakeholders including investors, bankers and align internal budgets and performance measurement matrices. Companies would have to closely examine various debt covenants and clearly identify the ones which may be impacted due to the transition and discuss the same with their financiers/ bankers. At the same time, it will have to sensitise the market participants with respect to the unique impact of certain standards on the industry. This in turn would help to realign the valuation matrices based on the different set of accounting policies that will be used by these companies to report their performance results. Given the aforesaid implications, an early start towards the convergence process is pertinent for both preparers and users of financial statements to understand the impact on how the financial performance will be reported going forward.

Consolidation — redefining control and reflecting true net worth

Background :

    Consolidated financial statements in India have traditionally been a reporting requirement only for listed companies. Companies not listed on stock exchanges are not required to prepare or present consolidated financial statements.

    The fundamental change under IFRS is that IFRS recognises consolidated financial statements as the primary set of financial statements for any entity that has subsidiaries or joint ventures or associates. The only exception for an entity not to report consolidated financial statements is if it meets all the following conditions :

    (a) the parent is itself a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements;

    (b) the parent’s debt or equity instruments are not traded in a public market;

    (c) the parent did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market; and

    (d) the ultimate or any intermediate parent of the parent produces consolidated financial statements available for public use that comply with International Financial Reporting Standards.

    In this article we shall discuss the differences in principles of consolidation as laid down in IAS 27 ‘Consolidated and separate financial statements’ under IFRS and AS-21 ‘Consolidated financial statements’ under Indian GAAP. We will cover some of the implementation challenges and impact of the subtle differences in the consolidation standard between Indian GAAP and IFRS in our next article.

Key differences and implication :

Definition of control :

    Under the IFRS framework, consolidation is based on the power to control (i.e., the ability of one entity to control another). Hence, understanding what constitutes ‘control’ is of utmost importance. Control is defined as the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. This definition is not unlike what is stated under AS-21 in Indian GAAP. However, where Indian GAAP takes a narrow view and assumes that holding a majority of the voting interest of an entity automatically results in controlling the entity, IFRS treats the same as a rebuttable presumption. Thus, IFRS provides that control is presumed to exist when the parent owns, directly or indirectly through subsidiaries, more than half of the voting power of an entity, unless in exceptional circumstances, it can be clearly demonstrated that such ownership does not constitute control.

    The implication of the control principles under IFRS is that companies cannot consolidate an entity only based on holding of current voting interests. Since consolidation is based only on control, only one holding entity will practically be able to demonstrate such control and hence there will never be a scenario where the same entity is being consolidated by two separate holding entities as a subsidiary. As a result of the transition to IFRS, the holding in the entity will need to be re-looked for assessment of potential voting rights held and more importantly an evaluation of the nature of any veto rights held by other shareholders, which are discussed below.

Potential voting rights :

    In assessing control, the impact of potential voting rights that currently are exercisable should be considered. Such potential voting rights may take many forms, including call options, warrants, convertible shares, and contractual arrangements to acquire shares. This is because the potential voting rights give the holders the power to control the entity because they can step in and acquire control at any time if they wish to.

    For example, X owns 40% of the voting power in A, Y owns 25% and Z owns the other 35%. Further, X holds a call option to acquire from Y an additional 20% of the voting power in A; the call option can be exercised at any time. Accordingly, it is X that has the power to govern A. Therefore X consolidates A, but reflects 60% as non controlling interest.

Participative rights with other shareholders :

    The presumption of control may be rebutted in exceptional circumstances if it can be demonstrated clearly that such ownership does not constitute control. To ascertain whether ownership constitutes control, the rights of minority interests need to be analysed. In many cases minorities have certain rights even if another party owns the majority of the voting power in an entity. Sometimes these rights are derived from law, and other times from the entity’s constitution.

    IFRSs do not address the issue of minority rights but as discussed above it is necessary to consider the nature and extent of the rights of minority in determining control, including the distinction between participating rights that allow minority to block significant decisions that would be expected to be made in the ordinary course of business, and rights that are protective in nature. Since IFRS does not have specific literature on minority rights, guidance is drawn from EITF 96-16 under US GAAP to determine if certain rights are participative and hence demonstrate absence of control with the majority shareholder. Examples of participative rights are :

  •      Approval from minority shareholders for selecting, terminating, and setting the compensation of management responsible for implementing the investee’s policies and procedures.

  •      Approval from minority shareholders for establishing operating and capital decisions of the investee, including budgets, in the ordinary course of business.

For example, two companies A and B come together to form a company X in which company A holds 75% with 3 directors on the board of company X and company B holds 25% with 2 directors on the board of company X. By virtue of majority holding, company A consolidates company X as a subsidiary under Indian GAAP. The Articles of Association of company X state that for certain decisions, a unanimous approval of the board of directors is required. These decisions include approving the annual and semi-annual budgets of the company and selection and appointment of senior management personnel. In such a case, Under IFRS, company A does not control company X, instead it shares joint control over it along with company B. Hence it shall not consolidate company X as a subsidiary but account for it as a joint venture arrangement.

Indirect holding:

Indirect holding mayor may not result in one entity having control over another. Although the total ownership interest may exceed 50%, this may not mean that the entity has control.

For example, entity L owns 35% of the voting power in entity N, and 40% of the voting power in entity M. M owns 60% of the voting power in N. There-fore, L has, directly and indirectly, a 59% [35% + (60% x 40%)] ownership interest in N.

However, L doesn’t control 59% of the vote because it does not have control over the votes exercised by M; rather, it is limited to significant influence. Therefore, in the absence of any contrary indicators, L does not control N and should  not consolidate  N.

Non-controlling interest (‘NCI’) :

Minority interests are referred as non-controlling interests (‘NCI’) under the revised IAS 27 standard and are presented as a part of consolidated equity. It is defined as ‘the equity in a subsidiary not attributable, directly or indirectly, to a parent’. This is unlike Indian GAAP, where minority interests are reflected outside consolidated equity (generally, as a liability).

Losses applicable to NCI are allocated irrespective of whether the NCI has a contractual obligation to make good such losses to the parent, even if doing so causes the NCI to be in a deficit position. Once again, this is unlike the treatment of excess losses under Indian GAAP.

Changes in controlling interests:

Under IFRS, changes in the  parent’s ownership interest in a subsidiary after control is obtained that do not result in a loss of control need to be accounted for as transactions with owners in their capacity as owners. As a result no gain or loss on such changes is recognised in the income statement. Also, no change in the carrying amounts of assets (including goodwill) or liabilities is recognised as a result of such transactions.

For example, Entity A owns 60% of the shares in Entity B. On 1st January 2010 Entity A acquires an additional 20% of Entity B. The consideration transferred for the additional shares of Entity B is INR 400. The carrying amount of non-controlling interest in the consolidated financial statements of Entity A on 1st January 2Q10 is INR 500.

The acquisition of the 20% interest of the non-controlling interest is recorded as follows:

Entity A recognises the decrease in equity in its consolidated financial statements. No adjustments are made to the recognised amounts of assets and liabilities or to goodwill.

Under Indian CAAP, the above acquisition of 20% additional interest would result in additional good-will for .the difference between the consideration transferred (INR 400) and the book value of the minority interest purchased.

Similarly, a reduction in equity interests from 80% to 60% due to sale of shares to minority interests (however control retained by the Company) would also have been adjusted in equity in the same manner as above, unlike Indian CAAP where a gain or loss on such sale of stake would have been rec-ognised in profit and loss e.g., : If the sale of 20% stake was made for a consideration of INR 500 (thus reducing the overall stake from 80% to 60%), and the net assets of the subsidiary were INR 1500 – Under IFRS, this transaction would result into an additional credit of INR 300 (1500*20%) to non-controlling interests and a credit of INR 200 to other equity, whereas under Indian CAAP the adjustment of INR 200 would have been recognised as a gain in the income statement.

Under IFRS, when a change in controlling interests results in loss of control (e.g., due to sale of investment in the subsidiary, due to which the investee company ceases to be a subsidiary), such a change is accounted for in two parts. Firstly, derecognise the net assets and goodwill of the subsidiary and recognise the relating gain or loss in income statement (by comparing it to the fair value of consideration received). Secondly, recognise any balance investment in the former subsidiary at fair value.

For example, Entity A owns 60% of the shares in Entity B. On 1st January 2010 Entity A disposes of a 20% interest in Entity B and loses control over Entity B. The consideration received for the sale of shares of Entity B is INR 400. At the date that Entity A disposes of a 20% interest in Entity B, the carrying amount of the net assets of Entity B is INR 1,750. The amount of non-controlling interest in the consolidated financial statements of Entity A on 1st January 2010 is INR 700. The fair value of the remaining 40% investment is determined to be INR 800.

Entity A would record the following entry to reflect its disposal of a 20% interest in Entity B at 1st January 2010 :

The gain represents the increase in the fair value of the retained 40% investment of INR 100 [INR 800 – (40% x INR 1,750)], plus the gain on the sale of the 20% interest disposed of INR 50 [INR 400 – (20% x INR 1,750)].

Assuming that the remaining interest of 40% represents an associate, the fair value of INR 800 represents the cost on initial recognition and IAS 28-Accounting for associates applies going forward.

Under Indian CAAP, the gain on sale in the above case would be recognised based on the difference between the consideration received (INR 400) and the proportionate carrying value of the investment in the subsidiary. The carrying value of the balance investment would not be revalued to the fair value
unlike  IFRS.    ‘

Special purpose entities:

Under IFRS, there is no requirement for the parent to have a shareholding in a subsidiary, and this is not a necessary pre-condition for control. Sometimes an entity is created to accomplish a narrow and well-defined objective (e.g., conduct research and development activities, securitise financial assets, or own a specified asset). Such entities are referred to as Special Purpose Entities (SPE) and SIC 12 ‘Consolidation – Special purpose entities’ lays down the guidance for consolidation of SPEs. Important to bear in mind when analysing an SPE is the requirement to account for the substance and economic reality of a transaction rather than only its legal form. Conditions where an entity controls an SPE and hence needs to apply consolidation are given below:

a) in substance, the activities of the SPE are being conducted on behalf of the entity according to its specific business needs so that the entity obtains benefits from the SPE’s operation;

    b) in substance, the entity has the decision-making powers to obtain the majority of the benefits of the activities of the SPE or, by setting up an ‘autopilot’ mechanism, the entity has delegated these decision-making powers;

    c) in substance, the entity has rights to obtain the majority of the benefits of the SPE and there-fore may be exposed to risks incidental to the activities of the SPE; or

    d) in substance, the entity retains the majority of the residual or ownership risks related to the SPE or its assets in order to obtain benefits from its activities.

Using this approach, several SPE’s that have been set up by Indian companies for specific purposes (without any direct holding of voting interest or Board representation) may need to be consolidated, if the conditions of SIC 12 are met. This involves significant use of judgment and an evaluation of all the facts and circumstances of the case. Such entities are typically not consolidated under Indian CAAP. In the Indian context, some of the above parameters may get triggered in arrangements of ‘toll manufacturers’ – a practice which is fairly common in the FMCC and pharmaceuticals industry.

Conclusion:

Consolidation is an area which needs careful evaluation on convergence with IFRS. The changes due to such transition could result in a change in the group i.e., subsidiaries which were earlier part of the group may now become joint ventures or associates; and special purpose entities which were earlier not consolidated would now form part of the consolidation group. Consolidation in IFRS essentially revolves around the concept of unilateral control of the financial and operating policies of the investee company and lays importance on substance over form. It is important to note here that IASB has issued an Exposure Draft ‘ED 10 – Consolidated Financial Statements’ that under one standard now covers concepts of participative and protective rights of non-controlling interest and special purpose entities.

Comparison of IFRS Exposure Draft on Insurance Contracts and Insurance Accounting in India

Comparison of IFRS Exposure Draft on Insurance

On 30 July 2010, the International Accounting Standards Board
(IASB) issued its long-awaited exposure draft on Insurance Contracts. This
Exposure Draft (ED) has been many years in preparation and represents a
significant step forward towards the IASB’s goal of providing comprehensive
guidance for accounting for insurance contracts.

Although IFRS 4 Insurance Contracts (the existing accounting
standard) addressed some of the more urgent issues in insurance contract
accounting, it was only transitionary. It permits a wide variety of existing
accounting practices to continue, which hinders comparability for users.

Given the Indian context and impending convergence with IFRS
from 1 April 2012 for insurance companies in India, the provisions of this ED
are critically important and will guide the corresponding provisions of the
Indian accounting standard to be issued in this regard.

Insurance contracts often expose entities


to long-term and uncertain obligations. There are several complex policies,
principles and calculations involved in measuring these obligations. As a
result, stakeholders need to be informed adequately about the insurer’s business
model, risk management practices, measurement approaches, solvency, asset
management, profitability, etc. The ED is a step in the right direction.

This article is a summary of the ED. It provides an overview
of the main proposals published for public comment by the IASB and the
differences with regards to the existing practice in India for the insurance
industry.

Executive summary of the Exposure Draft on Insurance Contracts :

  • The
    ED proposes a new standard on accounting for insurance contracts which would
    replace IFRS 4 Insurance Contracts.
     


  • The
    ED proposes a comprehensive measurement model for all types of insurance
    contracts issued by entities with a modified approach
    for some short-duration contracts. The measurement model is based on a
    principle that insurance contracts create a bundle of rights and obligations
    that work together to create a package of cash inflows (premiums) and outflows
    (benefits, claims and costs). The measurement model, which applies to that
    package of cash flows, uses the following building blocks :



  • a
    current estimate of future cash flows;


  • a
    discount rate that adjusts those cash flows for the time value of money;


  • an
    explicit risk adjustment; and


  • a
    residual margin.




  • For
    short-duration contracts, a modified version of the measurement
    model applies. As a proxy for the measurement model, during the coverage
    period, the insurer measures the pre-claims liability by allocating premiums
    receivable across the coverage period. For these contracts, the insurer would
    apply the building block measurement model to measure claim liabilities for
    insured events that have already occurred and for onerous contracts.
     


  • The
    ED proposes that an insurer include incremental acquisition costs (i.e.,
    costs of selling, underwriting and initiating an insurance contract) as part
    of the contract’s cash flows. As a result, those costs would generally affect
    profit or loss over the coverage period rather than at inception. All other
    acquisition costs (i.e., fixed salary related to underwriting and
    front-line sales staff) would be expensed when incurred through profit and
    loss account.
     


  • The
    proposals also include revised unbundling criteria for non-derivative
    components of an insurance contract; a revised presentation for the statement
    of financial position and statement of comprehensive income; a building block
    measurement model for reinsurance contracts; an expected loss model for credit
    risk of reinsurance assets; accounting guidance for investment contracts with
    a discretionary participation feature (DPF) including an expanded definition
    of a DPF compared to IFRS 4; revised accounting guidance for business
    combinations and portfolio transfers; and extensive disclosure requirements.
    Below, we consider some of the critical areas in the ED.



Differences between the IFRS ED and existing practice of
recognition and measurement of insurance contracts in the Indian insurance
industry :

The differences are broadly classified and discussed below :


  • Classification of insurance contracts;



  • Measurement of insurance contracts;



  • Treatment of acquisition costs;



  • Unbundling;



  • Embedded derivatives



  • Derecognition;



  • Reinsurance;



  • Presentation, and



  • Disclosure



Classification of insurance contracts :

  • The
    proposals in the ED apply to all insurance contracts (including reinsurance
    contracts) that an entity issues and reinsurance contracts that an entity
    holds. Financial instruments containing a discretionary participation feature
    (DPF) that an entity issues are also in the scope of this proposal.

    Under the proposal, an insurance contract is de-fined as a contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncer-tain future event (the insured event) adversely affects the policyholder. This definition is consistent with the current definition of an insurance contract under IFRS 4.

    Under the proposals, insurers should begin recognising the contract when they are bound by the coverage, which could be prior to the effective date or the date on which a contract is signed (i.e., when there is an unconditional offer extended for coverage) and may be heavily influenced by local regulatory requirements.

Classification of insurance contracts in India:

    There is no specific standard for the purpose of classifying Insurance contracts under Indian GAAP. Currently, traditional, unit-linked insurance plan and pension products are sold by insurance companies and premium received on all these policies are accounted as premium income in revenue account.

    This will be a significant shift in the method of accounting for premium for life insurance companies as pension products having zero death benefits will not fall under the purview of insurance contracts and have to be accounted as Investment contracts and investment component pertaining to ULIP contracts would have to be accounted separately.

    However this will be a P/L neutral adjustment as currently they are adjusted as part of provision for insurance liabilities at the period end.

Measurement of insurance contracts — The building-block approach?:
The proposed model uses a building- block ap-proach to the measurement of insurance contracts The measurement model includes a ‘fulfilment’ objective which reflects the fact that an insurer generally expects to fulfil its liabilities over time by paying benefits and claims to policyholders as they become due, rather than transferring the li-abilities to a third party.

An insurer measures a contract as the sum of

    the present value of the fulfilment cash flows, being the expected present value of the future cash outflows less future cash inflows that will arise as the insurer fulfils the contract, including a risk adjustment for the effects of uncertainty about the amount and timing of those future cash flows; and

    a residual margin that eliminates any gain at inception of the contract. A residual margin arises when the present value of the fulfilment cash flows is less than zero. If the present value of the fulfilment cash flows at inception is positive (i.e., the expected present value of cash outflows plus the risk adjustment is greater than the expected present value of cash inflows), then this amount is immediately recognised as a loss in profit or loss.

The residual margin is determined on initial recognition at a portfolio level for contracts with a similar inception date and coverage period. This residual margin amount is ‘locked-in’ at inception. The residual margin is recognised in profit or loss over the coverage period in a systematic way that best reflects the exposure from providing insurance coverage, either on the basis of the passage of time or on the basis of the expected timing of incurred claims and benefits if that pattern differs significantly from the passage of time. Also, the insurer accretes interest on the carrying amount of the residual margin using the discount rate determined on initial recognition to reflect the time value of money.

The present value of the fulfilment cash flows contains the following ‘building blocks’ and is re-measured at each reporting period.

    an explicit, unbiased and probability-weighted estimate (i.e., expected value) of the future cash outflows less the future cash inflows that will arise as the insurer fulfils the insurance contract;

    a discount rate that adjusts those cash flows for the time value of money; and

    a risk adjustment — an explicit estimate of the effects of uncertainty about the amount and timing of those future cash flows.

Measurement of insurance liabilities by Indian insurance companies?:

The Gross Premium Methodology for life insurance contracts is governed by the IRDA (Assets, Liabilities and Solvency Margin of Insurers), Regulations, 2000 and Guidance Notes GN1, GN2 and GN7 issued by the Institute of Actuaries of India (IAI). The regulations govern the valuation of liabilities for both non -linked and linked business with some additional requirements for linked business.

Mathematical reserves are determined separately for each contract. The valuation method primarily takes into account all prospective contingencies including cost of any options that may be available to the policyholder. The reserves have to be at least as large as any guaranteed surrender value and never less than zero.

In addition, for unit-linked business?:

    The value to be placed on the unit reserve shall be the current value of the assets underlying the unit fund determined in accordance with the IRDA Regulations.

    If unit liabilities are not matched, a mismatch reserve shall be created.

    Separate unit and non-unit reserves shall be held. The sum of these reserves would represent the total reserve for a unit-linked policy.

    The total reserve in respect of a policy shall not be less than the guaranteed surrender value on the valuation date. Neither the unit reserve nor the non-unit reserve in respect of a policy shall be negative.

  • The proposed IFRS measurement model focusses on the key drivers of insurance contract profit-ability, and would provide users with a clearer insight than they gain from today’s patchwork of different models for different types of contract. The same model would apply to all insurance contracts. However a modified version would apply to short duration insurance contracts.


Insurers would present information in the financial statements that focusses on the drivers of performance, i.e.,?:

  •     release from risk, as the risk adjustment decreases


  •     what insurers expect to earn from providing insurance services


  •     investment returns on invested premiums, and


  •     the investment returns provided to policyholders (either implicitly through pricing or explicitly)     differences between expected and actual cash flows and changes in estimates and the discount rate.

The current problem in cash flow estimates is that insurers use ‘locked in’ estimates which do not provide current information about insurance liabilities. However the proposed changes in ED would require changes in cash flow estimates to be reflected in profit or loss in the period in which they arise. This would enhance transparency and provide more relevant information for users.

Pre-claims liabilities for short-duration contracts (General Insurance Contracts):

The proposals contain a modified measurement approach for pre-claim liabilities of short duration contracts. This model is intended to be a proxy for the building-block measurement model in the pre-claims period. In the proposals ‘short-duration’ contracts are defined as insurance contracts with a coverage period of approximately 12 months or less that do not contain any embedded options or derivatives that significantly affect the variability of cash flows.

In this measurement approach an insurer is required to measure its pre-claims obligation at inception as premiums received at initial recognition plus the present value of future premiums within the boundary of the contract less incremental acquisition costs.

This pre-claims obligation is reduced over the coverage period in a systematic way that best reflects the exposure from providing insurance coverage, either on the basis of the passage of time or the expected timing of incurred claims and benefits if this pattern differs significantly. Pre-claims liabili-ties are the preclaims obligation less the present value of future premiums within the boundary of the contract. The insurer is also required to accrete interest on the carrying amounts of the preclaims liabilities. If the contract is onerous, the excess of the present value of the fulfilment cash flows over the carrying amount of the pre-claims obligation is recognised as an additional liability and expense.

Liabilities for claims incurred are measured at the present value of fulfilment cash flows in accor-dance with the general measurement model.

Measurement of general insurance contracts by Indian insurance companies:

For short-duration contracts the IRDA regulations specifies

  •     reserve for unexpired risks as a percentage of the premium, net of reinsurances, received or receivable during the preceding twelve months, and


  •     reserve for outstanding claims reasonably estimated according to the insurer, on a ‘case-by-case method’ after taking into account the explicit allowance for changes in the settlement pattern or average claim amounts, expenses and inflation.


The ED on insurance contract gives a comprehensive measurement model for general insurance contracts as against the existing practice currently followed.

Acquisition costs:

  •     Incremental acquisition costs (costs of selling, underwriting, and initiating an insurance contract that would not have been incurred if the insurer had not issued that particular contract) are included in the present value of the fulfilment cash flows of a contract. All other acquisition costs are expensed when incurred in profit or loss.


  •     Non-incremental acquisition costs would be recognised as an expense.


  •     Indian insurers recognise acquisition costs as an expense immediately. This would result smaller losses at inception than they do today.


Unbundling:
Insurance contracts may include multiple elements, such as insurance coverage, investment compo-nents and embedded derivatives i.e., insurance contracts contain one or more components that would be within the scope of another IFRS if the insurer accounted for those components as if they were separate contracts, e.g., an investment (financial) component or a service component.

If a component is not closely related to the in-surance coverage specified in a contract, the ED proposes that an insurer does unbundle and ac-count separately for that component.

This would require Indian life insurance companies to unbundle the investment component from ULIP contracts from total premium and disclose it sepa-rately since inception. Currently the deposit portion is unbundled only at the end of the reporting period by way of including them in the actuarial reserves and then disclosing them in provision for linked liabilities.

Moreover, the pension and annuity products which are having no risk cover i.e., zero death benefits would not be under the purview of insurance contracts. These would have to be accounted as investment contracts under IAS 39 and the premium received on such contracts would have to separately shown in the balance sheet.

Embedded derivatives

Under the proposals, IAS 39 applies to an embed-ded derivative in an insurance contract unless the embedded derivative itself is an insurance contract. If the economic characteristics and risks of the embedded derivative are not closely related to those of the host insurance contract, the insurer is required to separate the embedded derivative and measure it at fair value with recognition of changes in fair value in profit or loss if the embed-ded derivative meets the following criteria?:

    a) the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host insurance contract

    b) a separate instruments with the same terms as the embedded derivative would meet the definition of a derivative and be within the scope of IAS 39 (e.g., the derivative itself is not an insurance contract).

Derecognition

An insurer shall remove an insurance contract liability (or a part of an insurance contract liability) from its statement of financial position when, and only when it is extinguished, i.e., when the obligation specified in the insurance contract is discharged or cancelled or expires. At that point, the insurer is no longer at risk and is therefore no longer required to transfer any economic resources to satisfy the insurance obligations.

The insurance liability ceases as soon as the policy lapses i.e., if the premium is not honoured on the due date including grace period provided by the insurance company.

However the Indian life insurance companies carry out an analysis of lapsed unit-linked policies not likely to be revived and likely to be revived. For policies not likely to be revived, the insurance reserves are transferred to funds for future appropriation and then to the profit and loss account after a period of two years and for policies likely to be revived the insurance liabilities are still maintained though the policy has lapsed and the risk cover has expired.

It appears that the ED on insurance contracts would require the risk reserves to be derecognised as soon as the policy lapses. Only the deposit component would be maintained as a liability for such policies with corresponding investments.

Reinsurance

At initial recognition, a cedant measures reinsurance contract as the sum of:

  •     the present value of the fulfilment cash flows, which is made up of the expected present value of the cedant’s future cash inflows plus a risk adjustment less the expected present value of the cedant’s future cash outflows less any ceding commissions received; and


  •     a residual margin that eliminates any loss at inception of the contract.


The expected present value of losses from default by the reinsurer or coverage disputes are incorporated in the measurement of reinsurance assets.

The ED on insurance contract requires reinsurance assets and reinsurance liabilities to be shown separately.

However the current practice in India is that the insurance companies net-off the reinsurance receivable and payable and disclose only the net amount as receivable or payable, as the case may be.

Presentation in the statement of financial position and the statement of comprehensive income

Statement of financial position

The ED proposes that an insurer present each portfolio of insurance contracts as a single-line item within insurance contract assets or insurance contract liabilities. It also proposes that an insurer present a pool of assets underlying unit-linked contracts as a single- line item separate from the insurer’s other assets and that the portion of the liabilities linked to the pool be presented as a single-line item separate from the insurer’s other liabilities. Reinsurance assets are not offset against insurance contract liabilities.


Statement of comprehensive income

The ED proposes a presentation model that focuses on margins and other key insurance performance information. The ED proposes a new presentation for the statement of comprehensive income which follows the proposed measurement model. The underwriting margin is subject to disaggregation requirements (in the notes or on the face of the financial statements), disclosing the change in risk adjustment and release of the residual margin. The margin presentation requires insurers to treat all premiums as deposits and all claims and benefits as repayments to the policyholder. An insurer is expected to present at a minimum, the following items?:

  •     Change in the risk adjustments;


  •     The release of the residual margin during the period;


  •     The difference between the expected and the actual cash flows;


  •     Changes in estimates; and


  •     Interest on insurance liabilities.


Other items to be presented in the statement of comprehensive income include?: gains and losses at initial recognition (further disaggregated on the face or in the notes into losses at initial recognition of an insurance contract, losses on insurance contracts acquired in a portfolio transfer, and gains on rein-surance contracts bought by a cedant); acquisition costs that are not incremental at the level of an individual contract; experience adjustments and changes in estimates (further disaggregated on the face or in the notes into experience adjustments, changes in estimates of cash flows and discount rates, and impairment losses on reinsurance as-sets); and interest on insurance contract liabilities. Income and expense from unit-linked contracts are presented as a separate single-line item.

Premiums and claims generally are not presented in the statement of comprehensive income on the basis that they represent settlements of insurance contract assets or liabilities rather than revenues or expenses. However, for short-duration contracts subject to the alternative measurement approach for pre-claims liabilities, the underwriting margin is disaggregated into line items reflecting each of pre-mium revenues, claims and other expenses, amortisation of incremental acquisition costs and changes in additional liabilities for onerous contracts.

Presentation of insurance accounts by Indian insurance companies

The financial presentation format currently comprises the Revenue Account, Profit and Loss Account and Balance Sheet. The Revenue account contains all insurance-related captions and income earned from investments out of policyholders’ funds.?The?Profit and Loss account includes deficit funding if any, profit transfers from revenue account and investment income earned out of shareholders’ funds.

The proposed method of accounting is a complete paradigm shift as compared to the existing financial reporting model.

Disclosures:

To help users of financial statements understand the amount, timing and uncertainty of future cash flows arising from insurance contracts, extensive disclosures are required that include qualitative and quantitative information about the amounts arising from insurance contracts, including?: the reconciliation of contract balances; methods and inputs used to develop the measurements; and the nature and extent of risks arising from insurance contracts.

Currently the insurance disclosures are not very extensive for Indian insurance companies. The current actuarial disclosures merely give basic assumptions, interest rates and references to mortality and morbidity tables published by Life Insurance Corporation of India.

Effective date, transition and impact on other aspects:

The ED does not include an effective date for the proposals or state whether they may be adopted early. The IASB plans an additional consultation, in conjunction with the FASB, on the effective dates of these proposals and other proposed standards to be issued in 2011, including consideration of IFRS 9 Financial Instruments. The Board will con-sider delaying the effective date of IFRS 9 (annual periods beginning on or after 1 January 2013) if the new IFRS on insurance contracts has a mandatorily effective date later than 2013 so that an insurer would not have to face two major rounds of change in a short period.

Additionally, an insurer is exempt from disclosing previously-unpublished information about claims development that occurred earlier than five years before the end of the first financial year in which it applies the proposals. An insurer is required to disclose if it is impracticable to prepare information about claims development that occurred before the beginning of the earliest period presented.

The ED requires that an insurer should measure each portfolio of insurance contracts at the present value of the fulfilment cash flows, starting at the beginning of the earliest period presented. If there is a difference between the new measure-ment amount and the amount under the insurer’s previous accounting policies, the difference should be recognised in retained earnings.

The insurer also should derecognise any existing balances of deferred acquisition costs.

The transition requirements apply both to a first-time adopter of IFRS and to an insurer currently reporting under IFRS.

Example measurement of insurance contracts — Indian GAAP v. IFRS ED:

An insurer issues an insurance contract, receives Rs.50 as the first premium payment and incurs acquisition costs of Rs.70, of which incremental acquisition costs are Rs.40. The insurer estimates an expected present value (EPV) of subsequent premiums of Rs.950 and a risk adjustment of Rs.50. In the example the insurer estimates that the EPV of future claims is Rs.900.

Measurement under Indian GAAP

Particulars

 

Indian
GAAP

 

 

 

 

 

 

 

Premium

 

50

 

 

 

 

 

 

 

Acquisition costs

 

(70)

 

 

 

 

 

 

 

Policy liability reserve (Estimate)

 

(40)

 

 

 

 

 

 

 

Loss
at initial recognition

 

60

 

 

 

 

 

 

 

Liability
at initial recognition

 

(40)

 

 

 

 

 

 

 

Measurement under IFRS ED

 

 

 

 

 

 

 

 

Particulars

 

IFRS
ED

 

 

 

 

 

 

EPV of cash outflows

 

940

 

 

 

 

 

 

Risk adjustment

 

50

 

 

 

 

 

 

EPV of cash inflows

 

(1000)

 

 

 

 

 

 

Present value of the fulfilment

 

 

cash flows

 

(10)

 

 

 

 

 

 

Residual margin

 

10

 

 

 

 

 

 

Liability
at initial recognition

 

0

 

 

 

 

 

 

Loss
at initial recognition

 

 

(Non-incremental acquisition costs)

 

30

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Framework to IFRS : The foundation to financial accounting concepts

IFRS

Purpose and scope of framework :

The Framework to IFRS (‘the framework’) sets out the concepts
that underline the preparation and presentation of financial statements for
external users. The basic purpose of the IFRS framework is to (i) assist the
standard-setting body with the development and review of existing and new
accounting standards; (ii) assist the preparers of financial statements in
applying the IFRS; (iii) assist the auditors to assess whether the financial
statements are prepared in line with IFRS; and (iv) assist the users of
financial statements to interpret the financial statements prepared in
conformity with IFRS.

The framework is not an accounting standard and hence does
not prescribe recognition, measurement and disclosure requirements. As per the
framework, in limited circumstances where there is a conflict between the
framework and the accounting standards, the accounting standard is required to
be followed. Further, the framework is applied in preparation of general-purpose
financial statements, which under IFRS are consolidated financial statements.
This is a significant departure from traditional Indian GAAP where the
general-purpose financial statements are separate financial statements of the
reporting entity.

The framework deals with :


(i) the objective of financial statements;

(ii) the qualitative characteristics that determine the
usefulness of information in financial statements;

(iii) the definition, recognition and measurement of the
elements from which financial statements are constructed; and

(iv) concepts of capital and capital maintenance.



Objective of financial statements :

The objective of the financial statements is to provide
information about the financial position, financial performance and cash flows
of the reporting entity to the users of financial statements.

As compared to Indian GAAP, IFRSs place more emphasis on cash
flows. For instance, the framework states that financial statements provide
information on the ability of an entity to generate cash and cash equivalents
and of the timing and certainty of their generation. Users are better able to
evaluate this ability to generate cash and cash equivalents if they are provided
with information that focusses on the (1) financial position, (2) performance,
and (3) changes in financial position of an entity.

The information about financial position of an entity is
affected by the economic resources it controls, its financial structure, its
liquidity and solvency, and its capacity to adapt to changes in the environment
in which it operates. Information about the performance of an entity, in
particular its profitability, is required in order to assess potential changes
in the economic resources that it is likely to control in the future.
Information concerning changes in the financial position of an entity is useful
in order to assess its investing, financing and operating activities during the
reporting period.

Underlying assumptions :

The framework sets out the underlying assumptions upon which
the IFRS accounting standards are based.

Accrual basis of accounting :

    The financial statements are prepared on the accrual basis of accounting, i.e., the effects of transactions and other events are recognised when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.

Going concern :

    The financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future.

Prudence :

    Unlike Indian GAAP, IFRS does not consider ‘Prudence’ as an underlying assumption. For instance, the unrealised gains on an ‘available-for-sale financial asset’ is required to be recognised under IFRS, whereas the same is prohibited under Indian GAAP on the grounds of prudence. The framework makes it clear that prudence means exercising a degree of caution in making judgments under conditions of uncertainty, but that it should not lead to the creation of hidden reserves or excessive provisions.

Qualitative characteristics of financial statements :

    The qualitative characteristics are the attributes that make the information provided in financial statements useful to users. There are four principal qualitative characteristics
    (1) understandability, (2) relevance, (3) reliability, and (4) comparability, of which some are divided into sub-categories.

1. Understandability :

    Information should be presented in a manner that it is readily understood by users.

2. Relevance :

    Information must be relevant to the decision-making needs of users. Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations. Financial statements must have both predictive value and confirm past events.

Materiality :

    The relevance of information is affected by its nature, and materiality. In some cases the nature of information alone is sufficient to determine its relevance (e.g., managerial remuneration). In other cases both nature and materiality are important (e.g., estimates of provisions that involve significant judgment). Information is material if its omission or misstatement could influence the economic decision of users taken on the basis of the financial statements (e.g., no provision made on non-performing assets in case of banks). As materiality depends on the size and nature of the item or error judged in the surrounding circumstances, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful.

    Either the size or the nature of the item, or a combination of both, could be the determining factor. Consideration of materiality is relevant to judgments regarding both the selection and application of accounting policies and to the omission or disclosure of information in the financial statements.

    Materiality needs to be assessed on disclosures in case when items may be aggregated, the use of additional line items, headings and sub-totals. Materiality also is relevant to the positioning of these disclosures (on the face of the financial statements or in the notes). As such, IFRSs are not intended to apply to immaterial items.

        3. Reliability:

    Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. Information may be relevant but so unreliable in nature or representation that its recognition may be potentially misleading. Reliability depends on:

        a) Faithful representation:
    To be reliable, information must represent faithfully the transactions and other events it either purports to represent or could reasonably be expected to represent, e.g., a statement of financial position should represent faithfully the transactions and other events that result in assets, liabilities and equity at the reporting date which meet the recognition criteria.

        b) Substance over form:
    Information must be accounted for and presented in accordance with its substance and economic reality and not merely its legal form.

        c) Neutrality:
    Information must be free from bias. Financial statements are not neutral, if by the selection or presentation of information, they influence the making of a decision or judgment in order to achieve a predetermined result or outcome.

        d) Prudence:
    Prudence is the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty. However, the exercise of prudence does not allow, for instance, the creation of hidden reserves or excessive provisions, the deliberate understatement of assets or income, or the deliberate overstatement of liabilities or expenses, because the financial statements would not be neutral and, therefore, not have the quality of reliability.

        e) Completeness:
    To be reliable, the information must be complete within the bounds of materiality and cost. An omission can cause information to be false or misleading and thus unreliable and deficient in terms of its relevance.

        4. Comparability:
    Users must be able to compare the financial statements of an entity (a) through time — internal comparability and (b) with different entities — external comparability. The measurement and display of the financial effect of like transactions and other events must be carried out in a consistent manner throughout an entity and over time for that entity and in a consistent manner for different entities. It is important that the accounting policies used and changes to these are disclosed. It also is important that the financial statements present corresponding information for the preceding periods.

    Constraints on relevant and reliable information:

        1. Timeliness:
    If there is undue delay in the reporting of information it may lose its relevance. Management may need to balance the relative merits of timely reporting and the provision of reliable information.

        2. Benefit and cost:
    The benefits of information should be greater than the cost of providing it. The evaluation of benefits and costs is, however, a judgmental process.

        3. Balance between qualitative characteristics:
    In practice, a balancing or trade-off between qualitative characteristics is often necessary. The relative importance of the characteristics in different cases is a matter of professional judgment.

    Definitions of assets, liabilities and equity:

        1. Assets:
    An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. The future economic benefit embodied in an asset is the potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the entity. Like Indian GAAP, the physical form is not essential to the existence of an asset, e.g., patents and copyrights. However, unlike Indian GAAP, the legal ownership is not of primary concern under IFRS; economic ownership is the essential characteristic.

        2. Liabilities:
    A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. It is important to note here the term ‘present obligation’ (as opposed to ‘future commitment’), i.e., a decision by management to buy an asset in the future does not give rise to a present obligation — an obligation normally arises only when the asset is delivered or when management enters into an irrevocable agreement to acquire the asset.

        3. Equity:
    Equity is the residual interest in the assets of the entity after deducting all its liabilities. Although equity is defined as a residual, it may be sub-classified in the balance sheet. For instance, in a corporate entity, funds contributed by shareholders, retained earnings, reserves representing appropriations of retained earnings and reserves representing capital maintenance adjustments may be shown separately.

    Recognition criteria for assets and liabilities: Assets and liabilities must be recognised if the recognition criteria are satisfied. Items are to be recognised as assets or liabilities (or as income and expenses) if:

        1. it is probable that any future economic benefit associated with the item will flow to or from the entity, and

        2. the item has a cost or value that can be measured with reliability.

    The recognition criteria stresses on the ‘probability’ rather than ‘certainty’ of occurrence of future economic benefits. The probability of future economic benefits is to be assessed when the financial statements are prepared. The concept of probability refers to the degree of uncertainty that the future economic benefits associated with the item will flow to or from the entity. Assessments of the degree of uncertainty attaching to the flow of future economic benefits are made on the basis of the evidence available when the financial statements are prepared.
    Specific criteria for recognition of assets:

  •             Probable that future economic benefits will flow to the entity, and
  •             The cost or value can be reliably measured.

    The future economic benefits may flow to the entity in a number of ways. For instance:

  •             Inventories, fixed assets and know-how may be used in the production of goods or services to be sold by the entity;

  •             Cash and cash equivalents, receivables or marketable securities may be exchanged for other assets;

  •             Cash and cash equivalents may be used to settle a liability; or

  •             Cash and cash equivalents may be distributed to the owners of the entity.

    Specific criteria for recognition of liabilities:

  •             Probable outflow of resources will result from settlement of a present obligation, and

  •             The amount can be measured reliably. The settlement of a present obligation usually involves the entity giving up assets in order to satisfy the claim of the other party.

    Settlement may occur in a number of ways, for instance, by:

  •             The payment of cash or cash equivalents as is the case with most payables;
  •             The transfer of other assets, for example, in a barter transaction or in some business combination;

  •             The rendering of services to the other party as is the case with a liability for warranty repairs; or

  •             The replacement of the obligation with another obligation.

    Definition of income and expense:

    Income:
    Income is an increase in economic benefits during the accounting period, in the form of direct inflow, enhancement of assets, or decrease in liabilities; and that results in increase in equity, other than those relating to contributions from equity participants.

    The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an entity, including sales, fees, interest, dividends, royalties and rent. Gains represent other items that meet the definition of income and may not arise in the course of the ordinary activities of an entity (e.g., gains on the disposal of non-current assets). Gains represent increase in economic benefits and as such is no different in nature from revenue. Hence, gains are not regarded as constituting a separate element in the framework. Unlike Indian GAAP, the definition of income also includes unrealised gains (e.g., unrealised gains arising on the revaluation of marketable securities).

    Expense:

    The definition of expenses encompasses losses as well as those expenses that arise in the course of the ordinary activities of the entity. Losses represent other items that meet the definition of expense and may, or may not, arise in the course of the ordinary activities of the entity.

    Recognition criteria for income and expense: The recognition criteria for income and expense are the same as for the recognition of assets and liabilities.

    Income is recognised in the profit and loss account when increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. This means, in effect, that recognition of income occurs simultaneously with the recognition of increase in assets or decrease in liabilities.

    Expenses are recognised in the profit and loss account when decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. This means, in effect, that recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease in assets.

    Measurement of elements of financial statements:
    Different measurement bases mentioned in the framework are historical cost, current cost, realisable (settlement) value and present value.

    Historical cost:
    Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.

    Current cost:
    Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently.

    Realisable (settlement) value:

    Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.

    Present value:

    Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business. This is different from Indian GAAP, where the assets and liabilities are recognised at transaction values without reference to the time value of money.

    Key GAAP differences in the frameworks:

  •             The primary financial statement is consolidated financial statement under IFRS framework, unlike Indian GAAP where the primary financial statement is standalone financial statements.
  •             Unlike Indian GAAP, IFRS does not identify ‘Prudence’ as one of the fundamental accounting assumptions in preparation of financial statements. Thus unrealised gains of available-for-sale securities are recognised under IFRS, unlike Indian GAAP.
  •             As compared to Indian GAAP, IFRS places more importance on the statement of cash flows as it provides information on the ability of an entity to generate cash and cash equivalents and of the timing and certainty of their generation.
  •             Unlike Indian GAAP, the legal ownership is not a criterion for recognition of an asset. IFRS recognises an asset based on the assessment of ‘control’ over the economic benefits accruing from the asset.
  •             Unlike Indian GAAP, certain assets and liabilities are recognised at the present value of future cash flows when the time value of money is significant.

    While barring the above differences, the framework under Indian GAAP and IFRS are similar, the said differences will have far-reaching implications on the Indian industry. Some of the accounting and reporting GAAP differences have their roots in the differences in the underlying frameworks.

Financial instruments : Disclosures — Practical application and challenges

Embedded leases : The scope under IFRS is much wider (IFRIC 4)

IFRS

Background:


It is not uncommon for enterprises to have contracts with
service providers for providing goods/services on a dedicated basis to these
enterprises. As certain assets may be dedicated for use only for a particular
enterprise, binding procurement commitments may be provided to the service
provider to the extent of entire production capacity of the assets. In certain
other cases, the enterprise may provide minimum procurement guarantee whereby it
pays a fixed price per unit of shortfall in procurements. Through these
arrangements the service provider is assured of compensation for the capital
cost incurred.

An entity may enter into an arrangement, comprising a
transaction or a series of related transactions, that does not take the legal
form of a lease but conveys a right to use an asset (e.g., an item of
property, plant or equipment) in return for a payment or series of payments.
Examples of arrangements in which one entity (the supplier) may convey such a
right to use an asset to another entity (the purchaser), often together with
related services, include :

(1) Outsourcing arrangements, and

(2) take-or-pay and similar contracts in which purchasers
must make specified payments regardless of whether they take delivery of the
contracted products or services (e.g., a take-or-pay contract to
acquire substantially all of the output of a supplier’s power plant).

Embedded leases :

IFRIC 4 provides guidance on determining whether an
arrangement is or contains a lease. The following example illustrates
take-or-pay contracts that would be classified as embedded lease :

An entity has a contract with its supplier (job worker)
whereby the entity is contractually bound to get 100,000 units of goods
manufactured by the supplier. The supplier has installed dedicated machinery to
manufacture and supply the goods only to serve the entity. The supplier has no
other machinery that can manufacture these goods.

Price terms are as under :

  • For first 100,000 units —
    Rs.3 per unit


  • 100,001 onwards — Re.1
    per unit;


  • In case of any shortfall
    as compared to 100,000 units, a penalty of Rs.2 per unit of shortfall shall be
    levied.







In the above case, the assets are deployed for use only for
the entity. Further, irrespective of the actual purchase from the supplier, the
entity is bound to pay a fixed charge in the form of per unit charge and
penalty, if applicable (Rs.200,000 in the above example i.e., even if the
purchaser does not purchase at all, a penalty on 100,000 units would be levied
at Rs.2 per unit). This fixed charge, in substance, is a lease arrangement where
the supplier’s machinery is taken on lease for a lease rent of Rs.200,000.

Determining whether an arrangement is, or contains, a lease :

Guidance in IFRIC 4 helps the entity to assess if
outsourcing/service contract is a simple supply contract or whether in substance
there is actually a lease embedded in the contract. The assessment whether the
above arrangement is or contains a lease is based on whether :

  • the fulfilment of the
    arrangement is dependent on the use of a specific asset or assets; and


  • the arrangement conveys a
    right to use the asset(s).



Arrangement dependent on use of a specific asset or assets :

For classifying an arrangement as a lease, one needs to
assess whether the arrangement is dependent on the use of a specific/identified
asset. For an arrangement to be determined as an embedded lease, there needs to
be reasonable certainty at inception of the contract that the same asset would
be used throughout the term of the contract. In other words, the asset needs to
be a ‘specified asset’.

The asset may be a ‘specified asset’ either explicitly by way
of a contract or could be identified impliedly, based on the facts and
circumstances of the case.

Specified assets explicitly identified in an arrangement :

An asset may be explicitly specified in the contract when,
for instance, the service provider’s plant/ warehouse is mentioned in the
agreement along with the address. Thus it is reasonably certain that the same
plant/warehouse shall be used throughout the contract period.

Although a specific asset may be explicitly identified in an
arrangement, it is not the subject of a lease if fulfilment of the arrangement
is not dependent on the use of the specified asset.

Specified assets implied in an arrangement :

An asset has been implicitly specified if, for instance, the
supplier owns or leases only one asset with which to fulfil the obligation and
it is not economically feasible or practicable for the supplier to perform its
obligation through the use of alternative assets.

The entity will have to use its judgment in determining
whether it is economically feasible or practicable to perform obligations
through use of alternative assets, based on the facts and circumstance in each
case. Assessing whether the use of alternative asset is economically feasible
and practical will not always be straightforward.

Fulfilment of the contract is dependent on the use of
specified asset :

If the supplier is obliged to deliver a specified quantity of
goods or services and has the right and ability to provide those goods or
services using other assets not specified in the arrangement, then fulfilment of
the arrangement is not dependent on the specified asset and the arrangement does
not contain a lease.

The arrangement conveys a right to use the asset :

An arrangement conveys the right to use the asset if the arrangement conveys to the purchaser (lessee) the right to control the use of the underlying asset. The right to control the use of the underlying asset is conveyed if any one of the following conditions is met?:

    a) The purchaser has the ability or right to oper-ate the asset or direct others to operate the asset in a manner it determines.
    b) The purchaser has the ability or right to control physical access to the underlying asset.
    c) Facts and circumstances indicate that it is re-mote that one or more parties (other than the purchaser) will take more than an insignificant amount of the output or other utility that will be produced or generated by the asset during the term of the arrangement, and the price that the purchaser will pay for the output is not contractually fixed per unit of output, nor equal to the current market price per unit of output. In the conditions (a) and (b) above, the lessee obtains the right to operate the asset or restrict the physical access of third parties to the asset by way of an explicit contract. In such cases, the lessee need not take the entire output generated from the asset for an arrangement to be a lease.

In the condition (c) above, a purchaser controls the usage of an asset and a lease exists only when the purchaser is taking substantially all of the output i.e., others cannot obtain the output from the specified asset.

However, an exemption was incorporated in the condition (c), so that arrangements in which the price is either contractually fixed per unit of output or equal to the market price per unit of output at the time of delivery of the output should not be ac-counted for as leases, since the payments in such arrangements are considered as a consideration only for ‘use of an asset’ and not for the ‘availabil-ity of an asset’. This exemption should be applied narrowly and only for arrangements in which a pur-chaser clearly pays for the actual output. Thus, if any variability is introduced to the price per unit, such an arrangement contains a lease. There is a strong presumption that any variability in the price per unit that depends on the output of the asset means that the arrangement conveys the right to use the asset.

If the arrangement is based upon a specific asset, the entity must determine whether the arrange-ment conveys a right to use the asset, based on the above guidance. It is often a challenge to determine whether a right to use the item has been conveyed. Consider the terms ‘fixed price per unit of output’ or‘current market price per unit of output at the time of delivery’. In practice, interpretations of these terms widely vary. Some entities interpret the term ‘fixed price’ as absolutely fixed with no variance per unit, based on costs or volumes. However, other en-tities accept certain adjusted prices as fixed, such as fixed price per unit adjusted for inflation or a fixed percentage increase, etc.

Typical clauses that indicate a lease arrangement:
An illustrative list of contract features that indicate lease arrangement is as under:

    a) a contract whereby the purchaser agrees to buy the entire output of a specified asset and requires the asset to be operated at full capacity, then there is a strong presumption that the purchaser has effective control over the use of assets and therefore the arrangement contains a lease.
    b) If in case of dedicated assets, any variability is introduced to the price per unit, then such an arrangement contains a lease. There is a strong presumption that any variability in the price per unit that depends on the output of the asset means that the arrangement conveys the right to use the asset.

    c) If in case of dedicated assets, pricing arrangements include a minimum procurement guarantee (i.e., the purchaser shall pay a penalty if procurement is lower than minimum guaranteed volumes), the price cannot be termed as current market price. Hence these would be classified as leases.

Assessing or reassessing whether an arrangement is, or contains, a lease:

Initial assessment:

The assessment of whether an arrangement contains a lease shall be made at the inception of the arrangement on the basis of all of the facts and circumstances.

Subsequent reassessment:

A reassessment of whether the arrangement contains a lease after the inception of the arrangement shall be made only if any one of the following conditions is met:

    i) There is a change in the contractual terms, unless the change only renews or extends the arrangement.
    ii) A renewal option is exercised or an extension is agreed to by the parties to the arrangement, unless the term of the renewal or extension had initially been included in the lease term in accordance with paragraph 4 of IAS 17 — Leases.

    iii) There is a change in the determination of whether fulfilment is dependent on a specified asset.

    iv) There is a substantial change to the asset, for example, a substantial physical change to property, plant or equipment.

A reassessment of an arrangement shall be based on the facts and circumstances as of the date of reassessment, including the remaining term of the arrangement. Changes in estimate (for example, the estimated amount of output to be delivered to the purchaser or other potential purchasers) would not trigger a reassessment.

Classification of embedded leases — operating or finance:
If an arrangement contains a lease as per guidance provided under IFRIC 4, the parties to the arrangement shall apply the requirements of IAS 17 — Leas-es to the lease element of the arrangement.

Separation of lease payments from other elements of the contract:
For the purpose of applying the requirements of IAS 17 — Leases, payments and other consideration required by the arrangement shall be separated at the inception of the arrangement (or upon a reassessment of the arrangement) into those for the lease and those for other elements on the basis of their relative fair values.

In some cases, separating the payments for the lease from payments for other elements in the arrangement will require the purchaser to use an estimation technique. For example, a purchaser may estimate the lease payments by reference to a lease agreement for a comparable asset that contains no other elements, or by estimating the payments for the other elements in the arrangement by reference to comparable agreements and then deducting these payments from the total payments under the arrangement to determine the lease component.

For instance, a contract for warehouse management services, whereby the vendor shall manage a warehouse on a dedicated basis for a single customer against a fixed monthly fees. The inputs of the vendor includes warehouse premises, assets deployed therein and warehouse labour. Thus, the arrangement may contain a lease of warehouse and warehouse assets. The overall consideration shall be separated into lease rentals for warehouse, lease rentals for warehouse assets and consideration for warehouse management (labour). In practice separation of individual components pose significant challenges to entities.

Impracticality in separation of lease components: If a purchaser concludes that it is impracticable to separate the payments reliably, it shall:

    a) in the case of a finance lease, recognise an asset and a liability at an amount equal to the fair value of the specified asset under the lease. Subsequently the liability shall be reduced as payments are made and an imputed finance charge on the liability recognised using the purchaser’s incremental borrowing rate of interest

    b) in the case of an operating lease, treat all payments under the arrangement as lease payments for the purposes of complying with the disclosure requirements (i.e., applicable to disclosures only) of IAS 17 — Leases, but
    i) disclose those payments separately from minimum lease payments of other arrangements that do not include payments for non-lease elements, and

    ii) state that the disclosed payments also include payments for non-lease elements in the arrangement.

Terms of arrangements:

Cancellation clause in embedded lease:

If an arrangement qualifies for recognition as an embedded lease and the arrangement is cancellable, the assets under such arrangement shall be accounted as taken on a cancellable operating lease. Hence the payments made need to be separated between lease payments and other elements of the contract for recognition purposes.

However, as the arrangement is cancellable, the entity need not provide disclosures in relation to the lease.

Absence of binding contract:

If the entity neither contractually require the job worker to use the asset exclusively for the company, neither does it contractually restrict the access of third parties to the asset, nor has obtained any contractual right to operate the asset, such arrangement shall not be classified as a lease. This would be a normal purchase of goods/services.

Thus, it is essential that there should be contractual arrangement that provides the right to use a specified asset. If there is only a mutual understanding between the two contracting parties relating to minimum guarantee commitments or adjustment to price based on level of output, without a binding contract, then it would not be classified as an embedded lease.

Financial statement impact:

Once, an arrangement is covered under IFRIC 4, an entity needs to determine whether the underlying embedded lease is an operating lease or a finance lease in accordance with IAS 17 — Leases and apply the accounting principles as set out in that standard.

    a) Accounting by lessee — Finance lease:

Initial recognition and measurement:

If the arrangement is or contains a finance lease, the lessee shall recognise finance lease as assets and li-abilities in their statements of financial position at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, each determined at the inception of the lease.

Subsequent measurement:

As mentioned above, the total lease component shall be separated from the non-lease component.

The lease component in case of finance lease would be further separated into payments towards the lease obligation and interest on lease obligation.

The leased asset is depreciated over the asset’s useful life or over the lease period whichever is shorter.

The payments made would be adjusted against the lease obligation and interest thereon.

Impact on Indian companies on adoption of IFRS?: Indian GAAP does not have specific guidance on embedded leases. Thus, the contract payments are recognised, in most cases, as revenue expen-diture (say, job work expenses) on accrual basis. On adoption of IFRS by the Indian companies, such arrangements may be classified as embedded finance leases. Thus the charge to the income statement would be in the form of depreciation on assets taken on finance lease, interest expense on finance lease obligation and job worker charges; instead of the entire amount being treated as job work charges. This may impact the asset base (as the assets are capitalised) and income statement classification of the lessee.


    b) Accounting by lessor — Finance lease:

Initial recognition and measurement:

Lessor shall derecognise assets given under an em-bedded finance lease in their balance sheet and present them as a receivable at an amount equal to the net investment in the lease.

Subsequent measurement:

As mentioned above, the total lease component shall be separated from the non-lease component. The lease component in case of finance lease would be further separated into payments towards the lease receivable and interest on lease receivable.

The recognition of finance income on lease receivable shall be based on a pattern reflecting a con-stant periodic rate of return on the lessor’s net in-vestment in the finance lease.

The receipts from the lessee would be adjusted against the lease receivable and interest thereon.

Impact on Indian companies on adoption of IFRS?: Indian GAAP does not have specific guidance on em-bedded leases. Thus, the actual contract receipts are recognised, in most cases, as revenue (say, job work income) on accrual basis. On adoption of IFRS by the Indian companies, such arrangements may be classified as embedded finance leases.

Thus, such transactions will be treated as sale of as-set with a corresponding debit to lease receivable asset. Unlike Indian GAAP, there will be no impact on the income statement on account of deprecia-tion on fixed assets as they were never recognised. The receipts out of the lease component received from the lessee shall be adjusted against the lease receivable to the extent of the principal and interest income.

This may significantly impact the fixed asset base (as the fixed assets are not recognised), the timing of revenue recognition and the EBIT (on account of in-terest income on lease receivable) of the lessor.

    c) Accounting by lessee and lessor — Operating lease:

Recognition and measurement:

As mentioned above, the lease component would be recognised separately from the non-lease component. Thus, the lessor and lessee shall recognise lease income/expense separately from other revenue/expense, respectively.

Impact on Indian companies on adoption of IFRS: The lessor shall present lease income separately within revenue from non-lease revenue. Similar presentation would be required by the lessee for its payments. However, this would impact only the in-come statement presentation.

The operating lease payments would be required to be recognised on a straight-line basis. This may lead to additional impact on the profits for the year on account of adoption of IFRS.

First-time adoption of IFRS:

IFRIC 4 shall have to apply retrospectively to all agreements existing as on the date of transition. Hence, entities shall have to assess all agreements existing as on the date of transition, irrespective of the year in which the same has been entered into i.e., either before or after the date of applicability of IFRIC 4.

Conclusion:

An entity can expect significant changes to its balance sheet and income statement due to application of IFRIC 4 and it is thus essential for an entity to carefully evaluate its implications at the time of entering into arrangements with dedicated vendors.

Financial Instruments — Indian corporates need to gear up for significant changes in the accounting landscape

IFRS

In recent times, a lot has been written and discussed in the
various forums regarding the role played by financial instruments-related
accounting standards and the contribution of ‘fair value’ accounting to the
current global liquidity crisis.

Accounting for financial instruments in general and fair
value accounting in particular is a highly complex and judgmental area, and
requires a very high degree of understanding and experience to implement and
interpret the guiding principles as envisaged in those standards.

Accounting for Financial Instruments is a complex exercise in
view of the varied kinds of instruments that are emerging in the market in the
recent past. International Financial Reporting Standards (IFRS) encompassing
IAS-32, IAS-39 and IFRS-7 deal with the principles involved in recognition,
measurement, disclosures and presentation of financial instruments. The
Institute of Chartered Accountants of India (ICAI) has also published Accounting
Standards (AS), viz., AS-30 on ‘Financial Instruments — Recognition and
Measurement’ and AS-31 on ‘Financial Instruments — Presentation’ which has been
pronounced and is made recommendatory from 01.04.2009 and mandatory from
01.04.2011. Further, AS-32 Exposure draft on ‘Financial
instruments — Disclosures’ has also been published in December 2007 issue of the
Chartered Accountant Journal. These are largely similar to their IFRS
counterparts. Thus, whether India converges to IFRS from 2011 or not, accounting
for financial instruments will largely be in accordance with the principles of
IAS-39 and IAS-32 from 1 April 2011.

The use of these standards ushers in the concept of fair
valuation, which records financial instruments at fair value and changes thereon
in reported earnings or within shareholders funds, depending on the nature of
the financial instrument. The impact of these standards shall cover a large
number of captions in a corporate financial statement including receivables,
payables, borrowings, loans and advances given, security deposits, investments
and even certain types of ‘equity’ instruments, thereby having a significant
impact on accounting for routine transactions entered into by companies in the
normal course of business. These impacts necessitate careful consideration by
corporates and their impact is not restricted to finance companies and banks.

Definition and classifications

Under IFRS, a financial instrument has been defined as a contract that gives rise to a financial asset in one entity with a corresponding liability or equity in another entity. Most monetary items will get covered by this definition such as trade receivables/payables, investments in shares/debentures, retention money, trade deposits, derivatives, financial guarantees, and loans and advances.

    Under the present Indian GAAP, Accounting Standard (‘AS’) 13 classifies an investment into long-term and current investment. Long-term investments are required to be recorded at cost, less any permanent diminution. Current investments are recorded at lower of cost or market. Detailed classification exists for banks as per RBI guidelines. Loans and receivables are stated at cost. Interest income on loans is recognised based on time-proportion basis as per the rates mentioned in the underlying loan agreement.

    On the other hand under IFRS, all financial assets are required to be initially classified into four categories, comprising (i) fair value through profit or loss (FVTPL), (ii) held-to-maturity (HTM), (iii) loans and receivables, and (iv) available-for-sale (AFS). All financial assets will have to be recorded at respective fair values at the time of initial recognition.

    Further, IAS-39 requires FVTPL and AFS assets to be measured at fair values at each subsequent reporting period. In case of FVTPL assets, the unrealised gain/loss is recognised in the profit and loss account whereas for AFS investments, it is recognised in equity until actually realised, whereupon it is transferred to the income statement. HTM and loans and receivable assets are reflected at amortised cost using effective interest method. However, the rules for classification of an investment as HTM are extremely stringent and any subsequent decision to sell these investments would result in adverse consequences, whereby all other existing HTM investments would need to be fair valued and there would be restrictions on future classifications.

    Financial liability is classified into two categories, viz., (i) financial liability at fair value through profit or loss (ii) residual category. The initial measurement is at cost, being the fair value of a consideration received, less transaction costs. Financial liabilities at fair value through profit or loss (including trading) liabilities are measured at fair value, and the change is recognised in the income statement for the period. All other (non-trading) liabilities are carried at amortised cost. Entities may elect to classify certain liabilities as ‘fair value through profit and loss’ if the liabilities are incurred to hedge certain related financial assets which are required to be recorded at fair value. In such a case, a fair value designation for the liabilities can be used to set off the fair value changes in the assets — a form of economic hedge accounting, without following the complex hedge accounting designation and effectiveness testing rules.

Derivatives

    The current Accounting Standards in India do not have any specific standard providing guidance on the recognition and valuation of derivatives. Accounting for certain plain vanilla foreign exchange forward contracts is based on AS-11. Certain exchange traded futures and options are accounted as per ‘Guidance Note on Accounting for Equity Index and Equity Stock Futures and Options’. As per this Guidance Note, mark-to-market losses are recognised but gains are ignored. Further, some derivative instruments may be required to be accounted as per the March 2008 announcement of the ICAI, whereby derivative instruments are to be mark to market with the resulting losses required to be recognised in the income statement based on the principles of prudence. Effective 1 April 2011, the treatment for the aforesaid transactions will need to comply with AS-30 issued by the ICAI. As stated earlier, the guidance in AS-30 is consistent with the requirements of IAS-39.

    IAS-39 deals with derivative instruments in a very comprehensive manner. A derivative is defined as a financial instrument or other contract with the following three characteristics, namely,

1) its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract (sometimes called the ‘underlying’);

2) it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and

3) it is settled at a future date. Further all derivatives are recorded on balance sheet at fair value with changes in fair value being recognised in income statement unless it satisfies the hedge accounting criteria. This often results in significant volatility in reported income, which is not seen under the current Indian Accounting Standards.

Apart from stand-alone derivatives,  IAS-39 requires derivatives embedded or  contained in other contracts to be separated and accounted separately. For example, for convertible  bonds an investor will have to account for the equity option component separately  from the host debt contract. The value of the equity option component would be initially credited to equity. The resultant discount on the debt host would be amortised over the period of the debt to reflect the real cost of the debt instrument (based on market rates for non-convertible debt). Similarly, if an Indian entity has a contract for supply of goods/services denominated in Euros, with a counterparty based in a non-Euro zone country (for example, the U.S.), then there is an embedded rupee-Euro forward currency derivative, which will need to be separated from the host contract of supply of goods/ services and valued separately. The requirements for embedded derivatives will significantly enhance the valuation and measurement complexity of such instruments from current practice.
 
Hedge  accounting

As seen above, IAS-39 uses a measurement model that sometimes requires the measurement of assets and liabilities on different basis. This results in an accounting mismatch in profit or loss account, which results in volatility in reported results (and does not reflect the true performance of the Company in the income statement). Consequently the standard permits an entity to selectively measure assets, liabilities, firm commitments and certain forecast transactions on a basis different from that prescribed, or to defer /match the recognition of gains or losses on derivatives using hedge accounting.

The hedge accounting rules under IFRS are quite stringent and narrowly defined. Hedge accounting is permitted if at the inception of the hedge and on an ongoing basis, the expectation is that the hedge will be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged  risk during  the period  for which  the of hedge  is designated  and ‘actual’ results  are within the 80-125% range. If the changes  don’t  fall within this  band,  then  the  hedge  is  ineffective and, therefore,  fair value  gains/losses   on the hedging contract   will  have  to be  taken  to  the  income statement. Hedges need to be on specifically identified items as against portfolios and should hedge-specific risks and characteristics identified and documented upfront. Stringent documentation criteria prescribed shall also have to be followed.

Hedge  accounting  is voluntary  and the decision to apply  hedge  accounting   should  be  made  on  a transaction  by transaction  basis. The correct use of hedge accounting  (for example,  designating  foreign currency  forward  contracts  as cash flow hedges  of forecasted  foreign  currency  sales) can ensure  that gains  and  losses  relating  to the  derivatives   are recorded   to reflect  the  economic   rationale   for undertaking  the transaction.  In the absence of hedge accounting,  gains and losses on derivatives  would be recorded  in periods  that may be different  from the periods in which the underlying  transactions  are recorded.

Substance over form

Under Indian GAAP, a financial instrument is v classified as either liability or equity, depending on form  rather  than  substance.

Redeemable preference shares are treated as capital under Schedule VI of the Companies Act,1956, even though in substance it may be a liability. However, under IAS-32, they will get classified as debt in the balance sheet of the issuers, since they meet the characteristic of a liability, i.e., redemption after a fixed period and dividend at a fixed rate. This would result in profit after tax numbers being lower, as preference dividend would be reflected as interest cost. Further, premium on redemption of preference shares will no longer be able to be adjusted in the securities premium account but will have to be recognised as an interest expense in the income statement.

Another significant area of impact would be the accounting for Foreign Currency Convertible Bonds (‘FCCB’). FCCBs are bonds that can be converted into equity by the investors before a certain date, or are repaid at an agreed premium at the end of the tenure. FCCBs (and other debt instruments) may be issued with a structure that allows the borrower to pay the entire interest on the instrument (along with the principal) to the investor only when the bond matures, in the form of a ‘redemption premium’. The Companies Act, 1956, Section 78, permits companies to adjust the redemption premium on debentures just as in equity shares, through the share premium account. This accounting treatment is currently fairly common amongst many Indian companies. This accounting treatment would not be permitted under IFRS, as all cost of issuing an instrument (including the redemption premium) would need to be recorded as interest cost over the life of the debt using the effective interest yield method.

Further, under IFRS, FCCBs will be subjected to split accounting. In accordance with the guidance in IAS-39 on the basis of which the conversion option is separated from the host contract i.e., the debt liability depends on the characteristic of the conversion option. If the conversion option meets the definition of equity, then the fair value of the liability without the conversion option is first determined and the residual amount of proceeds is then allocated to equity. If the conversion option is a derivative (i.e., if the conversion price is determined in a currency other than the functional currency of the Company), the fair value of the derivative is first determined with the residual allocated to the debt amount and the derivative portion is fair valued at every reporting date.

Impairment

In the case of banks, the existing provisions on non-performing assets are based on guidelines laid down by the Reserve Bank of India. IFRS prescribes an impairment model that requires case-by-case (for significant exposures) assessment of the facts and circumstances surrounding the recoverability and timing of the future cash flows relating to the credit exposure. An expectation that all contractual cash flows would not be recovered (or recovered without full future interest applications) will lead to an account being classified as impaired and impairment shall be measured on present value basis using the effective interest rate of the exposure as the discount rate. For groups of loans that share homogenous characteristics (such as mortgage and credit card receivables), impairment can be assessed on a collective basis. General provisions are permissible only to extent that they relate to a specified risk that can be measured reliably and for incurred losses. No provisions are permitted for future or expected losses. Provisioning for standard assets will not be permitted under IFRS.

For investments, a similar analysis is conducted, the key difference being that the fair value of the investment is also considered as an input in addition to the financial! credit standing of the issuer. The application of IAS-39 would also change accounting for items such as financial guarantees. It will affect key ratios and performance indicators for most banks and financial institutions, including capital adequacy ratios.

De-recognition

Under IFRS, de-recognition of financial assets is a complex, multi-layered area with the de-recognition decision dependent largely on whether there has been a transfer of risks and rewards. If the assessment of the transfer of risks and rewards is not conclusive, an assessment of control and the extent of continuing involvement are required to be performed.

Securitisation transactions shall be the most impacted area since most Indian securitisation vehicles are currently structured to meet Indian GAAP de-recognition norms stated under the Guidance Note on Accounting for Securitisation issued byfhe ICAL Substantially, all those securitisation vehicles would collapse into the transferor’s balance sheet and assets would fail the de-recognition test under IFRS. For example, securitisation transactions where credit collaterals are provided/guarantee is provided to cover credit losses in excess of the losses inherent in the portfolio of assets securitised, may not meet the de-recognition principles enunciated in IAS-39. This would lead to more instances of transfers failing the de-recognition criteria, thereby resulting in large balance sheets and capital adequacy requirements, lower return on assets and deferral of gains/losses on such securitisation transactions.

Disclosures

IFRS 7 requires entities to provide detailed disclosures in their financial statements that enable users to evaluate:

a) the significance of financial instruments for the entity’s financial position and performance; and

b) the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the reporting date, and how the entity manages those risks. On 5 March 2009, the IASB has issued Improving Disclosures about Financial Instruments (Amendments to IFRS 7). The amendments require enhanced disclosures about fair value measurements and liquidity risk.

The disclosures required under IFRS 7 include quantitative as well as qualitative information. There is a significant amendment in IT/reporting systems which shall be required as there is no accounting standard in India corresponding to IFRS 7 requiring such extensive disclosures. The Announcement on ‘Disclosure regarding Derivative Instruments’, issued by the ICAI, requires the following disclosures to be made in the financial statements:

a) categorywise quantitative data about derivative instruments that are outstanding at the balance . sheet date,

b) the purpose, i.e., hedging or speculation, for which such derivative instruments have been acquired, and

c) the foreign currency exposures that are not hedged by a derivative instrument or otherwise.

Netting assets and liabilities will also be less common as the rules will require more conditions to be met before assets and liabilities can be offset. A mere right to set off will not be adequate and needs to be supplemented with a right and an intention to settle on a net basis the assets and liabilities under consideration.

To conclude, the advent of IFRS shall thus represent a significant challenge to preparers, auditors, accountants, regulators and analysts. As the complexity of accounting increases, focus on need for increased education and training on areas relating to the valuation and accounting for financial instruments increases. Accounting for financial instruments will not only lead to a major impact on measurement of results, but also impact the existing functionalities of the IT systems and processes of companies.

The Countdown to Ind-AS — careful evaluation of policy choices

IFRS

On January 14, 2011, the Institute of Chartered Accountants
of India (ICAI) issued the much-awaited ‘near final’ version of the
IFRS-converged Indian Accounting Standards (Ind-AS). The issuance of these
standards brings us closer to answering the question — would the Indian version
of IFRS be different from the international version of IFRS?

An analysis of these near-final Ind-AS brings out that whilst
every effort seems to have been made to keep these standards as close to IFRS,
we have also chosen a different approach in the application of a few of these
standards, to suit our economic scenario, and to address the concerns raised by
Indian companies. This article segregates these deviations into four categories:
clear deviations from IFRS, removal of certain choices given under IFRS,
optional deviations from the application of IFRS and additional guidance under
Ind-AS.

Deviations from IFRS:


The exclusion/inclusion of these principles in the Ind-AS
standards have created an anomaly with the IFRS-equivalent standards, making
companies affected by these principles clearly non-compliant with IFRS. These
deviations (carve-outs) have been summarised below:

  • The near-final Ind-AS
    standard on revenue recognition has not adopted IFRIC 15 for revenue
    recognition from real estate development. Consequently, these agreements have
    been included in the scope of construction contracts, making it mandatory for
    real estate developers in India following Ind-AS to recognise revenue using
    the percentage completion method. This also means that Ind-AS financial
    statements of such real estate developers cannot be considered as
    IFRS-compliant.


  • Ind-AS, in its definition
    of equity instruments, includes the equity conversion option embedded in a
    foreign currency convertible bond (FCCB). FCCBs will be considered compound
    financial instruments under Ind-AS and split between the liability and equity
    component at inception, as opposed to being split between liability and
    derivative component under IFRS. This would ensure that the issuer’s income
    statement is not volatile due to changes in value of the conversion option
    driven by changes in the market price of its own equity shares.


  • Ind-AS requires that the
    measurement of fair value of financial liabilities designated at fair value
    through profit and loss at inception should not include fair value changes
    arising out of changes in the entity’s own credit risk. However, since the
    option to designate financial liabilities as at fair value through profit and
    loss at inception is not widely exercised, this is expected to impact only the
    few entities which exercise this option.


  • Ind-AS requires the
    recognition of bargain purchase gain on day one accounting for a business
    combination in capital reserve, as opposed to profit or loss account under
    IFRS. This is also consistent with the existing principles under Indian GAAP
    enunciated in the current accounting standards on amalgamations and
    consolidation. Our experience indicates that such situations will be rare.


  • Ind-AS requires the use
    of government bond rate as discount rate for measurement of employee benefit
    obligations, as opposed to a highly rated corporate bond rate required under
    IAS 19 (unless a deep corporate bond market does not exist). One of the key
    reasons for this deviation is in the argument that a deep bond market does not
    exist in India.


  • IFRS 1 mandatorily
    requires a company to present comparative financial statements on first-time
    adoption. Ind-AS gives companies a choice in presenting comparative financial
    statements on first-time adoption. However, the choice to present comparatives
    for the prior year is also only on a memoranda basis and hence would not meet
    the IFRS 1 requirements. Clearly then, an Indian company’s first-time-adopted
    Ind-AS financial statements will not be IFRS 1-compliant financial statements.
    However, this specific carve-out will not impact Ind-AS financial statements
    beyond the first period of transition.


Eliminations of certain options available under IFRS:


The removal of the following choices given under IFRS from
the relevant Ind-AS standards does not result in non-compliance with IFRS, but
merely restricts choices for Indian companies:

  • Ind-AS 1 requires
    entities to present analysis of expenses in the profit and loss account only
    by nature of expenses, e.g., personnel costs, depreciation and amortisation,
    removing the option of reporting expenses by function under IFRS. This is
    expected to be further clarified by the format of financial statements in the
    revised Schedule VI.


  • Ind-AS removes the choice
    of subsequently measuring investment property at fair values and requires
    these to be subsequently measured using only the cost model. This may not have
    a significant implication, since companies generally would be inclined to
    adopt the cost model to reduce the volatility in the income statement.


  • Ind-AS requires the
    recognition of all actuarial gains and losses arising from employee benefits
    directly in equity, unlike the corridor approach or recognition directly in
    the profit and loss account which are also permitted by IFRS. This is a
    deviation from the current Indian GAAP practice of recognising these directly
    in the profit and loss account. This will reduce the volatility in the income
    statement due to fluctuations in various actuarial assumptions, such as
    discount rate, salary escalation rate, employee attrition rate, etc.

  •     Ind-AS removes the option of deducting capital grants from the government from the cost of the underlying fixed asset and allows it only to be set up as deferred income. It also removes the option of initially measuring non-monetary government grants at their nominal value and requires such grants to be measured only at their fair value at inception. This will result in grossing up the balance sheet.

  •     IAS 27 includes in its scope an exemption for entities from preparing consolidated financial statements if certain criteria are met. This exemption has not been included in Ind-AS, making it mandatory for all companies to present consolidated financial statements. Currently, under Indian GAAP, only listed companies are required to prepare consolidated financial statements. However, the scope of entities covered in this standard is much wider and covers all unlisted and private companies, including subsidiaries of listed companies.


Optional    deviations from application of IFRS:

The adoption of the following options permitted by Ind-AS would result in non-compliance with IFRS as issued internationally. These anomalies with IFRS can be avoided by companies by choosing optimal accounting policies that are aligned to IFRS.

  •     Ind-AS gives a choice on first-time adoption whereby the carrying value as on the transition date for all property, plant and equipment capitalised before 1st April, 2007, can be the ‘deemed cost’ for first-time adoption of Ind-AS. This exemption entails that all depreciation adjustments to these assets would be applied from the date such deemed cost has been established. Since this is an option, companies may alternatively choose to restate their property, plant and equipment to comply with principles laid in Ind-AS on a retrospective basis, making adjustments for decapitalisation of preoperative expenses, foreign exchange differences and depreciation methods to ensure compliance with international IFRS as well. Entities choosing the carrying value exemption will need to make certain disclosures till the time significant value of the block of existing fixed assets is retained in the books of accounts.


  •     Ind-AS gives entities a policy choice to defer the recognition of foreign exchange fluctuations on long-term monetary assets and liabilities over the period of their maturity in an appropriate manner. IAS 21 requires full recognition of such exchange differences in the income statement in the period when incurred. The option under Ind-AS is a one-time accounting policy choice with Indian entities on the date of transition. This policy choice needs careful evaluation, since this will also impact other aspects of accounting, such as capitalisation of borrowing costs and application of hedge accounting principles.


  •     Derecognition provisions for financial assets can be applied prospectively from the transition date. Companies who choose to take this exemption will be non-compliant with IFRS till such time that the underlying financial assets continue in the books.


  •     Ind-AS also gives an additional ‘impracticability’ exemption for financial instruments to be carried at amortised cost, i.e., if it is impracticable for the effective interest rate or impairment requirements under Ind-AS 39 to be applied retrospectively from the date of the financial instrument. In such a case, for financial assets, the fair value as on the transition date would be the deemed cost as on the transition date.



Additional guidance under Ind-AS where IFRS currently has no guidance:

  •     Ind-AS gives additional guidance on accounting for common control transactions which are currently excluded from the scope of IFRS 3 — Business Combinations. Ind-AS requires accounting for these transactions as per the pooling of interest method and requires the acquisition to be accounted for at book values of the acquiree entity on the combination date. All reserves of the acquiree entity will be carried forward in the acquiring entity with any difference between the book value of net assets and consideration recorded as goodwill or capital reserve, as the case may be. Further, this transaction needs to be reflected from the beginning of the earliest period presented in the financial statements, and financial statements in respect of prior periods should be accordingly restated.


Since IFRS currently has no guidance on this topic, companies take the option of either accounting for such transactions at book values or at fair values under IFRS. However, this topic is currently an open project at the IASB level, and the deviation from IFRS would be clearly understood only when final guidance under IFRS is issued.

  •     There is additional guidance under Ind-AS 33 Para 12, on earnings per share ‘Where any item of income or expense which is otherwise required to be recognised in profit or loss in accordance with Indian Accounting Standards is debited or credited to securities premium account/other reserves, the amount in respect thereof shall be deducted from profit or loss from continuing operations for the purpose of calculating basic earnings per share.’ This guidance has been added since Indian laws may continue to override accounting standards. Accordingly, if companies are permitted to account for income/expenses directly in reserves pursuant to any law, the impact of the same is appropriately captured in the EPS (a key performance metric for companies).


In summary, barring certain transactions summarised in part 1 of this discussion, Indian companies can choose to be compliant with IFRS through making optimal accounting policy choices on transition. It should be recognised that while the carve-outs discussed above would ease the transition process, the management of each company needs to give careful thought in deciding on accounting policy choices on transition to Ind-AS. The reporting strategy would depend on whether a company wishes to be fully compliant with IFRS on an ongoing basis and fully benefit from the advantages of convergence, i.e., achieve comparability with global peers, avoid dual reporting for raising capital overseas and move towards international quality of financial reporting.

Revenue recognition principles under IFRS for Real Estate Industry

IFRS

Background


Around the world, real estate development and sale
transactions are structured with various permutations and combinations, in order
to comply with local tax regulations, local practices and other market
conditions. As a result, a sale deed may be entered on the date of allotment or
it can be entered into on the date of delivery. Many geographies also permit the
developers to sell the underlying land first to be followed by the development
of land.

The divergence in the manner in which real estate
transactions are carried out was also reflected in the accounting principles
applied by companies prior to the introduction of IFRIC 15 in respect of revenue
recognition from real estate development. Some developers accounted for such
agreements under IAS 18 Revenue, i.e., revenue is recognised when the completed
real estate is delivered to the buyer. Other developers accounted for them under
IAS 11 Construction Contracts, i.e., revenue is recognised by reference to the
stage of completion as construction progresses.

The International Accounting Standards Board (‘IASB’) noted
that divergence in practice exists in these circumstances with regard to the
identification of the applicable accounting standard for the construction of
real estate and the timing of the associated revenue recognition. To address
this, IFRIC 15 – Agreements for the construction of real estate, was issued on 3
July 2008 and is effective for annual periods beginning on or after January
2009.

IFRIC 15 addresses this divergence and provides guidance on
the accounting for agreements for the construction of real estate with regard
to:

  • the accounting standard to
    be applied (IAS 11 or IAS 18); and


  • the timing of revenue
    recognition.


The scope of the interpretation also includes agreements that
are not solely for the construction of real estate, but which include a
component for the construction of real estate.

Revenue recognition

Broadly, the analysis required by IFRIC 15 has four possible
outcomes with the following revenue recognition requirements in each case:


(1) Agreements meet the definition of a construction
contract in accordance with IAS 11 Construction Contracts – revenue recognised
by reference to the stage of completion of the contract activity (“stage of
completion approach”).

Example:
Company A, owner of the land, appoints Company B to construct a residential
property for a fixed sum of INR 1 million. Company A decides the technical
specifications of the residential property and will remain the owner of the
land as well as the constructed property. This will be a contract specifically
negotiated for construction of an asset as specified in paragraph 3 of IAS 11.

Accordingly, revenue will be recognised by the stage of
completion set out in IAS 11.

(2) Agreements which are only for rendering of services in
accordance with IAS 18 Revenue – stage of completion approach.

If an entity is not required to acquire and supply
construction materials, the agreement may be only an agreement for the
rendering of services, which need to be accounted for under IAS 18. For
example: an agreement to maintain a real estate property.

(3) Agreements for the sale of goods but the
revenue recognition criteria of IAS 18.14 are met continuously as construction
progresses – stage of completion approach.

Example: Company A, a real estate developer, who owns a
piece of land, enters into an agreement with Company B to construct a bungalow
on the aforementioned land for a fixed sum of INR 1 million. As per the terms
of the agreement, the title and risk and rewards of the land as well as the
property under construction get transferred to Company B.

This principle is discussed in further detail in the
following paragraphs. In case a transaction meets the continuous transfer of
risk and rewards criteria, Company A will recognise revenue by the stage of
completion approach set out in IAS 11.

(4) Agreements for the sale of goods other than those in
type 3 – revenue recognised when all of the criteria of IAS 18.14 are
satisfied (“sale of goods approach”).

Example:
Company A, a real estate developer, who owns a piece of land, enters into an
agreement with Company B to construct a bungalow on the aforementioned land
for a fixed sum of INR 1 million. The title to the land and the property under
construction gets transferred to Company B. However, Company A still continues
to have managerial involvement and control over the property under
construction (for e.g. Company A controls the design and specifications of the
property, Company B’s right to sell / let / sub-let the property is
established only on physical completion of the property etc.).



Principle of continuous transfer of risk and rewards

One of the practical difficulties faced in the above assessment is the identification of agreements, which will fulfil the continuous transfer of risk and rewards and control (i.e. those which fall with in type 3 above), and so qualify for stage of completion accounting on the grounds that the revenue recognition criteria of IAS 18.14 are met continuously as construction progresses.

The approach of meeting the revenue recognition criteria in IAS 18.14 on continuous basis has not previously been common under IFRS. Historically, it was generally assumed that the stage-of-completion method for construction of real estate was only ap-plicable if the activity fell within the scope of IAS
11. However, other GAAPs (like Indian GAAP for example) have permitted stage-of-completion basis more readily than was generally the case under IFRS, prior to IFRIC 15. IFRIC 15 itself does not provide extensive guidance on identifying when this approach may be appropriate, though it includes some simplistic illustrative examples.

Paragraph 17 of IFRIC 15 states the following:

“The entity may transfer to the buyer control and the significant risks and rewards of ownership of the work in progress in its current state as con-struction progresses. In this case, if all the criteria in paragraph 14 of IAS 18 are met continuously as construction progresses, the entity shall recognise revenue by reference to the stage of completion using the percentage of completion method. The requirements of IAS 11 are generally applicable to the recognition of revenue and the associated expenses for such a transaction”.

Paragraph 14 of IAS 18 states the following:

“14    Revenue from the sale of goods shall be recognised when all the following conditions have been satisfied:

  •     the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;

  •     the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;

  •     the amount of revenue can be measured reliably;

  •     it is probable that the economic benefits associated with the transaction will flow to the entity; and

  •     the costs incurred or to be incurred in respect of the transaction can be measured reliably.”

Identifying indicators of continuous transfer under IAS 18.14

In the context of the requirement of paragraph 14 above, it will be important to identify which indicators / factors are more important to assess the question of whether continuous transfer is, or is not, occurring while the con-struction activity progresses.

Some factors, collectively or individually, may in-dicate that continuous transfer is occurring while construction progresses:

  •     The construction activity takes place on land owned by the buyer and the buyer has clear title to the land and the construction work in progress;

  •     The buyer cannot cancel the contract before the construction is complete;

  •     If the agreement is terminated before construc-tion is complete, the buyer retains the work in progress and the entity has the right to be paid for the work performed; and

  •     The agreement gives the buyer the right to take over the work in progress (albeit with a penalty) during construction, e.g., to engage a different entity to complete the construction.

Some other factors, collectively or individually, may indicate that continuous transfer is not occurring while construction progresses:

  •     The sales agreement gives the buyer the right to acquire a specified unit in an apartment building when it is ready for occupation;

  •     The sales agreement restricts the right of the buyer to sell / let or sub-let the property while under construction, or requires the developer’s explicit permission;

  •     The deposit paid by the buyer is refundable if the entity fails to deliver the completed unit in accordance with the contractual terms;

  •     The developer is required to perform significant obligations (for e.g. rental guarantee commitment) subsequent to completion of the property; and

  •     the balance of the purchase price is paid only on contractual completion, when the buyer obtains possession of its unit.

 

Other factors to be considered

It will be important to consider all the relevant facts and circumstances of the agreement before reaching a conclusion on which category the sale agreement should fall into. In addition to the illustrative examples set out in IFRIC 15, the following questions, collectively or individually, may provide indicators as to whether the continuous transfer of risk and rewards and control is met during the construction phase:

  •     Which party is able to sell / let / sublet or mortgage the property under construction?

  •     What are the rights of the buyer in case the developer is unable to complete the construction (i.e. if the developer files for bankruptcy)?

In such a case, will the buyer be able to enforce his rights on the property under construction? Will the buyer have preferential rights over other parties i.e. creditors of the developer?

  •     Are the payments made by the buyer to the developer held in an escrow account to be used solely for the construction of the property? Or are these funds available for the developer to fund his other projects?

  •     Which party bears the construction risk and which party bears the market risk related to the value of the property?

  •     Who bears the risk of loss or damage to the construction in progress and who pays the insurance cost of damage to the construction work? Who bears the loss in case the actual loss exceeds the insurance cover?

  •     Which party has the right to cancel / withdraw from the contract?

  •     Does the buyer have the right to complete the construction by replacing the developer?

Accounting for real estate development under current Indian GAAP

Based on the Guidance note on recognition of revenue by real estate developers issued by the Institute of Chartered Accountants of India, on the seller transferring all significant risks and rewards of ownership to the buyer, revenue can be recognised at that stage, provided the following conditions of AS 9, Revenue recognition, are fulfilled:
    a) no significant uncertainty exists regarding the amount of the revenue; and

    b) it is not reasonable to expect ultimate collection, provided the seller has no further substantial acts to complete under the contract.

However, in case the seller is obliged to perform any substantial acts after the transfer of all significant risks and rewards of ownership, revenue is recognised by applying percentage of completion method as stated under AS 7, Construction Contracts.

In India, the title to the property is considered to be transferred on entering into a sale deed / agreement to sell with the buyer. However, the developer retains control and has managerial involvement in the property under development till physical possession is handed over to the buyer. The developer also retains the significant obligation of completing and handing over the property to the buyer.

As the developer still retains the obligation to construct and deliver the property, revenue is generally recognised on stage of completion basis under Indian GAAP. However, the Guidance note on recognition of revenue by real estate developers does not explicitly require the entity to consider if the risk and rewards and control over the property under construction have been transferred to the buyer on a continuous basis throughout the construction period, as required by IAS 18 and IFRIC 15.

Summary

To summarise, under IFRS, there is specific guidance on when one can use the completed contract method vis -à-vis the stage of completion method, in order to recognise revenue from real estate development held for sale. IFRS lays emphasis on absence of continuing managerial involvement to the degree usually associated with ownership and effective control over the constructed real estate, which impact the timing of revenue recognition.

Further, determining whether an agreement falls within one of the four categories outlined earlier is not a matter of accounting policy choice, but rather an application of a single accounting policy to specific facts and circumstances. That is, the specific terms of each agreement should be analysed in the context of the relevant legal jurisdiction in
order to determine which of the aforementioned categories it falls into.

In case an entity wants to continue the current Indian GAAP mode of recognising revenue on percentage of completion basis (as per the Guidance note on recognition of revenue by real estate developers), it will have to make a positive assertion in respect of continuous transfer of risk and rewards and control (to be classified as a type 3 arrangement mentioned earlier) based on the various indicators discussed earlier in this article. This positive assertion will be based on facts and circumstances specific to each arrangement, taken individually or collectively. Such judgements in the application of the accounting policy will need to be disclosed in accordance with IFRIC 15.20(a).

Currently there is limited guidance available on ‘continuous transfer’ requirements in the nature of illustrative examples and this will be developed over a period of time. In the interim, there will continue to be some divergence in actual implementation of IFRIC 15, based on the legal laws practised in different geographies. Due to the practical challenges in being able to demonstrate continuous transfer of risk and rewards and control, IFRIC 15 will prompt more and more entities to recognise revenue on completion or delivery of the projects.

Taxing times — IFRS and Taxation

IFRS

On 22 January 2010, the Ministry of Corporate Affairs (MCA)
in India issued a press release setting out the roadmap for International
Financial Reporting Standards (IFRS) convergence in India.

It is now a widely held view that in addition to accounting
issues, transition to IFRS would trigger implications under various
legislations, including taxes, corporate laws and other regulations.

Through this article we aim to bring to light a few key
direct tax issues that are likely to arise when companies transition to IFRS.

Potential additional areas of differences between book
profits (per IFRS) and taxable profits :

Accounting policies and practices for many transactions will
change on convergence with IFRS. The discussion below provides an illustrative
listing of items involving a change in accounting, where the tax implications of
the change need to be evaluated. Several additional changes may require a
similar assessment from a taxation perspective.


  • Treatment of dividend and premium on redemption of preference shares :



Currently preference shares are treated as part of share
capital, consequently the dividend on preference shares is charged to the
profit and loss appropriation account. Under IFRS, preference shares will be
treated as a financial liability and dividend thereon will be in the nature of
a finance expense. Under Indian GAAP, the premium or discount on redemption of
preference shares is adjusted from the securities premium account. IFRS
requires such premium or discounts to be charged to the income statement.

Presently, dividend and premium on redemption of preference
shares is considered to be capital in
nature and hence not tax deductible.

The Government would need to clarify whether such costs
charged to income statement would be allowed as a tax deductible expense.

Also, this would lead to reduction in the tax liability of
a company under MAT provisions. The Government would need to clarify whether
this would be acceptable from a tax perspective.


  • Stock compensation cost :



Under Indian GAAP, the employee stock options are
recognised at their intrinsic value. IFRS requires the stock options to be
recognised at their fair value. The impact of the same will be in the employee
cost.

The Government would need to clarify whether the employee
costs resulting from fair valuation of the stock option will be a deductible
expense.

Cost of stock options granted by a related entity to
employees of the reporting entity would need to be recorded e.g. : companies
would need to accrue for notional compensation cost for options granted by
parent to subsidiary employees with a corresponding impact on the cost of
investments or dividend distribution, respectively.

The Government would need to consider the deductibility of
such compensation cost in the hands of the entity receiving the grant and
impact on cost of acquisition for tax purposes to compute capital gain tax or
tax impact on dividend distribution in the hands of the entity giving the
grant.


  • Unrealised gains and losses :



IFRS requires all financial assets and liabilities to be
measured initially at fair value. Subsequent measurement of the financial
instrument would depend on their classification. This accounting treatment
results in unrealised gains and losses in the income statement. For instance —
all derivatives will have to be fair valued at each reporting date and the
gain or loss on such fair valuation is charged to the income statement (unless
hedge accounting is followed).

The Government would need to clarify whether the unrealised
gains and losses will be taxable in the reporting period in which they arise.
This may pose difficulty to entities, given that they may not have the
liquidity to settle the tax dues on these unrealised gains. Alternatively, the
Government could tax these instruments based on the actual realised gains or
losses.

Further, the Government would also need to consider the tax
implications of unrealised gains/losses on financial instruments which are
permitted to be adjusted directly in the reserves without impacting the income
statement. For example : Unrealised gains/losses related to available for sale
(AFS) securities and effective portion of cash flow hedges are recognised
through other comprehensive income within equity.


  • Taxation of notional gains and expenses :



In many instances, the accounting treatment envisaged by
IFRS could result in recognition of notional gains and expenses. The following
are examples of instruments which could give rise to notional gains or
expenses :

(1) Low interest or interest-free loans to employees —
Loans given to employees at lower than market interest rates should be
measured at fair value which is the present value of anticipated future cash
flows discounted using a market interest rate. Any difference between the fair
value of the loan and the amount advanced shall be a prepaid employee benefit.
The Government will need to consider implication of tax deducted at source on
salaries.

(2) Inter-group loans, advances and deposits at
concessional interest rates — If low interest/interest-free loans and
deposits have been forwarded among group entities, the loan or deposit is
initially measured at fair value using market rate of interest. Thus, where
the parent has granted a loan to the subsidiary, in the separate financial
statements of the parent, the difference between the nominal value and fair
value of the loan should be recognised as an additional investment in the
subsidiary and notional interest income is recognised by the parent and
corresponding interest expense by the subsidiary during the loan period. On
the other hand, where a loan has been given by the subsidiary to the parent,
in the separate financial statements of the subsidiary, the difference shall
be accounted for as dividend distribution to the parent and notional interest
income is recognised by the subsidiary and interest expense by the parent
company.

The Government will need to consider the taxation aspects of these notional interest and expenses and also implications on provision for tax deducted at source for such interest. Authorities will also need to consider impact on cost of acquisition for tax purposes to compute capital gain tax or tax impact on dividend distribution in the hands of the entity giving the loan at concessional interest rate.

    Interest-free security deposit on leasing arrangements — If an interest-free deposit is given as part of leasing transaction, the interest-free deposit will have to be discounted at the market rate and the difference will be treated initially as prepaid rent. The prepaid rent will be amortised to the income statement over the life of the lease.

The Government will have to clarify the tax treatment for such notional gains and expenses. Also the Government will need to consider implications on provision for tax deducted at source on rent.

    Revenue recognition :

Some of the revenue recognition principles under IFRS are different and will need to be carefully evaluated from tax perspective. For example :

    Under IFRS, if a contract contains multiple elements which have stand-alone value to the customer, the contract will have to be split and only revenue relating to the delivered component will be recorded in the reporting period. Further, the split of revenue between components will have to be done based on their relative fair values. For instance, if an entity sells machinery along with operations and maintenance services (O&M) for the machinery, the entity can recognise the fair value of the machinery in the reporting period in which the risk and rewards of the machinery are transferred to the buyer and the revenue from operations and maintenance will be deferred and recognised over the life of the O&M contract. The Government would need to clarify whether the entity will be taxed upfront only on the revenue recognised in a reporting period, or also on the deferred portion of the contract or will the tax impact of the deferred income also be deferred and taxed in the year in which such income is recognised in the accounts.

    In some cases two or more transactions may be linked so that the individual transactions have no commercial effect on their own. In these cases, IFRS requires that the combined effect of the two transactions together is ac-counted for. For instance a telecom company may sell mobile subscription to the customer and charge them the activation fees and talk time separately. However, in practice, these are linked transaction and the activation fee does not have any stand-alone value to the customer (in absence of the talk time or subscription agreement). Thus the telecom operator cannot recognise the activation revenue upfront and will have to defer it over the average life of the subscription agreement. The Government would need to clarify the method of taxation in such cases and consider to defer the tax implications in consonance with the deferral of revenue.

    IFRS provides guidance on accounting treat-ment of service concession agreements. For concession agreements, the contractor recognises certain profit (unrealised) dur-ing the construction phase and the balance during the operations phase when realised e.g., Company incurs cost of Rs.1,000 for construction of road and in consideration for the same has received a right to charge toll of Rs.30 on all vehicles plying on that road for 30 years (after which the road is handed over to the Government body). Under Indian GAAP, Company would capitalise Rs.1,000 as a fixed asset and depreciate it over 30 years.

However under IFRS, Company would need to accrue a notional margin on the construction activity as well and the cost of Rs.1,000 plus 10% margin (assumption) i.e., Rs.1,100 will be accounted as an intangible asset and amor-tised over 30 years. Although the manner of accounting will not result in any change in the total amount of profit or loss from the contract during the concession period (since the notional gain of 10% margin is offset by higher amortisation charge over the concession period), the proportion of the profit or loss over different reporting periods within the concession arrangement may differ.

The Government would need to consider the method of taxation in such cases. In this in-stance, entities may need to recognise profit margins upfront, though they would not have received cash inflows from the customers, thus entities may not have sufficient liquidity to settle tax dues, in case tax is charged based on the net profit reported in the financial statements.

Minimum Alternate Tax (‘MAT’) :

In case companies in India do not have sufficient taxable profits in India, as per the Income-tax Act companies are required to pay MAT as a specified percentage of book profits. Further, the new direct tax code proposes to charge MAT as a specified percentage of the total assets of the company.

Various differences discussed above and in particular the fair value implications and notional gains/ losses would have substantial impact on the reported profits or reported assets by companies.

The Government would need to assess the implications of such impacts on the tax liability arising due to provision of MAT, given that companies may find it difficult to pay tax dues (actual cash outflow) on unrealised gains which have not yet resulted in cash inflows for the company.

Further the proposal to charge MAT as a percentage of asset poses the following challenges for companies converging with IFRS, which need to be considered by tax authorities in formulating appropriate provisions :
    IFRS provides an option to account for its property, plant and equipment and investment properties at fair value at each reporting date. This could also result in increase in tax liability without any cash inflow to the company.

    Under IFRS, companies may need to account for certain embedded leases in normal sale/ purchase transactions e.g., Company has contracted to buy the entire output from suppliers production line and also given a minimum commitment to reimburse the fixed cost including capital cost of the supplier (these arrangements are commonly used as take or pay arrangement), in such cases, companies will need to account the production plant of the supplier as its own plant. This would increase the gross asset base of the Company and the corresponding MAT liability.

The above, being notional accounting aspects would cause significant issues for companies, if these are considered for taxing the entities and result in potential cash outflows.

The taxation model needs to be framed to ensure that companies that are required to follow the IFRS converged standards are not at a disadvantage as compared to other entities that are not required to follow the IFRS converged standards from April 1, 2011.

Matters for consideration by the Government :

Overall the Government will need to consider how to incorporate the implications of IFRS in the tax rules to be applied by companies, such that they do not result in unintended difficulties and adverse cash flow implications for companies.

The options to be considered to manage this transition :

Option 1 — Taxation based on current Indian accounting standards :
Require companies to prepare reconciliation of profit reported/assets reported under IFRS with profits and assets per the current accounting standards. Taxation based on such reconciled profits, assets and book balances. This is also generally followed in many of the European countries where taxation is determined based on the GAAP of the respective countries. For example : Germany, Spain.

Option 2 — Taxation based on IFRS with additional differences between IFRS financial statements and taxable income :

IFRS financial statements as a starting point for taxation. However, tax laws to be modified to identify additional areas where taxation (both current taxation and MAT) will be different from the basis used in the IFRS financial statements. These areas may be limited in number, and would not necessarily cover all differences that arise due to transition from current accounting standards to the IFRS converged standards. Additionally, under Option 2, the Government would need to determine how the one-time adjustments recorded in the books of accounts to transition to IFRS are treated for tax purposes.

It is important to note that the Income-tax Act in India applies to all entities i.e., corporate, partnership firms, trusts, individuals, etc. and IFRS will be applicable from 1st April 2011 only for a limited number of companies covered by Phase 1. If Option 2 is followed, this would result in different IFRS-based taxable models for some entities and a different model for other entities (that are not required to converge with IFRS immediately).

While Option 1 appears to be attractive, it poses challenges relating to maintaining two sets of records — one under IFRS and the other under current accounting standards. The benefits and costs of each of these options may need to be further debated to decide the best option from an Indian perspective.

Section A : Notes regarding Revenue Recognition Disputed Interest income 59

New Page 1Hotel Leelaventure Ltd. — (31-3-2008)

From Notes to Accounts :

The Honourable Supreme Court of India has upheld the interest
claim of the Company against HUDCO vide their order dated 12th February 2008.
The Company has recognised interest income of Rs.46.15 crores (Previous years
Rs.10.63 crores) during the year under review. Computation of interest payable
is disputed by HUDCO and the matter is pending before the Execution Court
i.e., The High Court of Delhi. Total disputed interest income recognised by
the Company till 31st March 2008 amounted to Rs.110.30 crores.

From Auditors’ Report :



(f) In our opinion, and to the best of information and
according to the explanation given to us, the said accounts, give the
information required by the Companies Act, 1956 in the manner so required,
subject to our inability to express an opinion on the impact of disputed
interest income recognised as referred to in Note 10 of Schedule K to the
accounts and read with other notes, give a true and fair view :


Recognition of Sales on despatch of goods from works


Setco Automotive Ltd. — (31-3-2008)


From Accounting Policies :




(i) Sales and services are accounted for on dispatch of
products from the works.


From Notes to Accounts :

The sales determined in accordance with the accounting policy
followed (Refer Note 7, Schedule 17) include Rs.954.80 lacs (Rs.312.55 lacs)
being sales value of dispatches in transit as on 31st March 2008. The inventory
value thereof amounts to Rs.690.83 lacs (Rs.223.47 lacs).

From Auditors’ Report :

In our opinion, the Balance Sheet, Profit & Loss Account and
Cash Flow Statement dealt with by this report comply with the accounting
standards referred to in sub-section (3C) of Section 211 of the Companies Act,
1956; except as regards :

(i) Accounting Standard-9, which provides for recognition of
revenue from sales only on transfer of significant risks and rewards of
ownership to the buyer, whereas the Company has been recognising sales on
dispatch of goods from works. As a result, goods in transit valued at Rs.690.83
lacs have been recognised as sales at a value of Rs.954.80 lacs. [Refer
Accounting Policy 7(i) of Schedule 17 and Note 08 of Schedule 18]


levitra

Disclosures regarding Amalgamation

From Published Accounts

1 TV Today Network Ltd.
(31-3-2010)

From Notes to
Accounts :

Pursuant to the
Composite Scheme of Arrangement under the provisions of the Companies Act,
1956 (The Scheme), approved by the shareholders, sanctioned by the High Court
at Delhi and the Ministry of Information and Broadcasting on November 21,
2009, February 24, 2010 and May 20, 2010, respectively, the undertaking of the
radio broadcasting business of Radio Today Broadcasting Limited, a company
engaged in the radio broadcasting and trading business (the Transferor
Company), was transferred to and vested in the Company (the Transferee
Company) with effect from 1st April, 2009 (Appointed Date). ‘The Scheme’, a
copy of which was filed with the Registrar of Companies subsequent to the
year-end on 13th April, 2010, is an amalgamation in the nature of merger and
has been given effect to in these accounts under pooling of interest method.

In accordance
with ‘The Scheme’, the Company will issue 1,655,999 equity shares of Rs.5 each
as fully paid up to the equity shareholders of Radio Today Broadcasting
Limited, in the ratio of 1 equity share of Rs.5 each fully paid up of the
Company for every 6 equity shares of the face value of Rs.10 each fully paid
up, held in Radio Today Broadcasting Limited towards consideration for the
aforesaid transfer and vesting of radio business, which will be credited in
its books at face value, pending issuance of the shares as at the year-end,
the face value of Rs.8,279,995 has been credited to Share Capital Suspense.

In accordance
with ‘The Scheme’, all assets and liabilities pertaining to the radio
broadcasting business of the Transferor Company, as on the appointed date,
have been incorporated in the books of the Company at book value and the
excess of the Share Capital Suspense over the book value of net assets
acquired, amounting to
Rs.423,622,791, has been adjusted against Securities Premium Account of the
Company. The unamortised licence fees pertaining to the Transferor Company and
transferred to the Company pursuant to the Scheme, amounting to Rs.244,229,509
has also been adjusted against the Securities Premium Account. Further, the
Company has determined the deferred tax assets, amounting to Rs.249,529,332,
based on the assets and liabilities of the radio broadcasting business which
has been adjusted with the General Reserve Account.

The accounting
treatment in respect of excess of Share Capital Suspense over the book value
of net assets acquired and unamortised licence fee are different from that
prescribed by the Accounting Standard (AS) 14, Accounting for Amalgamations,
notified u/s.211(3C) of the Companies Act, 1956 with respect of Amalgamation
in the nature of Merger. AS-14 requires the difference between the amount
recorded as share capital and the amount of share capital of the transferor
company to be adjusted against reserve.

The difference
in accounting treatment as above, in compliance with the High Court Order, is
as permitted by paragraph 42 of the AS-14. As the said paragraph 42 of AS-14
requires disclosure of the impact of the amalgamation on all accounts, had the
accounting treatment as per AS-14 been followed, this is given below for
information.

Had the
accounting treatment prescribed in AS-14 been followed, amortisation of
intangible assets would have been higher by Rs.27,990,000 with its
consequential impact on the profit of the Company, General Reserve would have
been lower by Rs.423,622,791, Unamortised Licence Fees would have been higher
by Rs.216,239,509 and Share Premium Account would have been higher by
Rs.667,852,300.

2. Titagarh Wagons Ltd.
(31-3-2010)

From Notes to Accounts :

25. (a) Pursuant to a
Scheme of Amalgamation (the Scheme) sanctioned by the High Court of Calcutta
by order dated September 14, 2009, Titagarh Steels Limited (TSL) and Titagarh
Biotec Private Limited (TBPL) were amalgamated with the Company with effect
from April 1, 2009 (the appointed date). The amalgamation has been accounted
for under the Pooling of Interest Method as prescribed by the Institute of
Chartered Accountants of India (ICAI). TSL was in the business of
manufacturing of steel castings and TBPL was in the process of setting up
biotech business. The transferred companies carried on all their businesses
and activities for the benefit of and in trust for, the Company from the
Appointed Date. Thus, the profit or income accruing or arising to or
expenditure or losses arising or incurred by the transferred companies from
the Appointed Date are treated as the profit or income or expenditure or loss,
as the case may be, of the Company. The Scheme has accordingly been given
effect to in these accounts upon filing of certified copy of the Order of the
High Court at Calcutta on November 27, 2009 (the Effective Date).

(b) In terms of the
Scheme, the following assets and liabilities of TSL and TBPL have been
transferred to and stand vested with the Company at their respective book
values with effect from 1st April 2009:

 

 

(Rs. in lacs)

Particulars

TSL

TBPL

 

 

 

Fixed Assets (Net, including

1,804.35

Nil

Capital work in progress)

 

 

 

 

 

Current Assets, Loans and

 

 

Advances

4,858.09

2.09

 

 

 

Total Assets

6,662.44

2.09

 

 

 

Less
:

 

 

Current Liabilities and

 

 

Provisions

4,033.32

0.28

 

 

 

Loans

914.55

Nil

 

 

 

Total
Liabilities

4,947.87

0.28

 

 

 

Net
Assets

1,714.57

1.81

 

 

 

    c) The Company has issued 3,66,954 equity shares of Rs.10 each aggregating to Rs.36.70 lakhs to the shareholders of TSL on January 16, 2010, while in case of TBPL which was a wholly-owned subsidiary of the Company, all the shares held by the Company in TBPL were cancelled and extinguished.

    d) A sum of Rs.1288.85 lakhs being the difference between the amounts recorded as additional shares of the Company and the total share capital of TSL and TBPL has been adjusted and reflected as general reserve, instead of capital reserve as prescribed under Accounting Standard-14 in terms of the above court order.

    e) To make the accounting policies followed by TSL fall in line with those of the Company, a sum of Rs. 411.13 lakhs as on April 1, 2009 representing the impact of following accounting policy differences has been adjusted against General Reserve which as per Accounting Standard-5 should have been charged to Profit and Loss Account:

Particulars

Amount

 

(Rs. in lacs)

 

 

Depreciation

77.09

 

 

Liquidated damages (Net of Taxes)

334.04

 

 

Total

411.13

 

 

    f) Certain immoveable properties, investments, licences, contracts/agreements which were acquired pursuant to the above Scheme are in the process of registration in the name of the Company.

3    HCL Infosystems Ltd. (30-6-2010)
From Notes to Accounts:
    The Scheme of Amalgamation (‘Scheme’) for merging the wholly-owned subsidiary Natural Technologies Private Limited (NTPL) with the Company u/s.391 to u/s.394 of the Companies Act, 1956 sanctioned by the High Courts of Delhi and Rajasthan vide their respective orders dated 11-8-2008 and 29-5-2009 has come into effect on July 6, 2009 from the appointed date of 1-7-2008. On the scheme becoming effective NTPL stands dissolved without winding up in the previous year.

Pursuant to the Scheme:

The amalgamation of erstwhile NTPL with the Company was accounted for under the ‘pooling of interest method’ in the manner specified in the Scheme and complies with the Accounting Standard notified u/s.211(3C) of the Companies Act, 1956 and the following balances as at July 1, 2008 of erstwhile NTPL was adjusted with the profit and loss account forming part of reserves of the Company

 

(Rs. crores)

 

 

Assets

 

Fixed assets (including Capital

 

Work-in-progress Rs.0.80 crore)

4.09

 

 

Deferred Tax Assets

0.13

 

 

Sundry Debtors

3.34

 

 

Cash & Bank Balance

0.78

 

 

Other Current Assets

2.19

 

 

Loans & Advances

0.03

 

 

Total

10.56

 

 

Liabilities

 

Current Liabilities and Provisions

3.68

 

 

Secured Loan

1.52

 

 

Unsecured Loan

1.34

 

 

Total

6.54

 

 

Net
Assets acquired on

 

amalgamation
(a)

4.02

 

 

Transfer of balances of

 

Amalgamated Company

 

 

 

Securities Premium Account

0.45

 

 

Profit and Loss

0.55

 

 

Revaluation Reserve

2.54

 

 

Total
Reserves and Surplus (b)

3.54

 

 

Less
:

 

Adjustment for cancellation of

 

Company’s investment in Transferor

 

Company (c)

8.41

 

 

Shortfall
arising on Amalgamation

(7.93)

(a)
– (b) – (c) = (d)

 

 

 

Adjusted with :

 

— Revaluation Reserve

5.70

 

 

— Profit and Loss Account

2.23

 

 

Total

7.93

 

 


4. Godrej Consumer Products Ltd. (31-3-2010)
From Notes to Accounts:

    a) A Scheme of Amalgamation (‘the Scheme’) for the amalgamation of Godrej Consumer Biz Ltd. (GCBL) [a 100% subsidiary of Godrej & Boyce Manufacturing Company Ltd. (G&B)] and Godrej Hygiene Care Ltd. (GHCL) [a 100% subsidiary of Godrej Industries Ltd. (GIL)] together called ‘the Transferor Companies’, with Godrej Consumer Products Limited (the Transferee Company), with effect from June 1, 2009, (‘the Appointed Date’) was sanctioned by the High Court of Judicature at Bombay (‘the Court’), vide its Order dated October 8, 2009 and certified copies of the Order of the Court sanctioning the Scheme were filed with the Registrar of Companies, Maharashtra on October 15, 2009 (the ‘Effective Date’).

    b) The amalgamation has been accounted for under the ‘pooling of interests’ method as prescribed by AS-14 — Accounting for Amalgamations and the specific provisions of the Scheme. Accordingly, the Scheme has been given effect to in these accounts and all assets and liabilities of the Transferor Companies stand transferred to and vested in the Transferee Company with effect from the Appointed Date and are recorded by the Transferee Company at their book values as appearing the books of the Transferor Companies.

    c) The value of Net Assets of the Transferor Companies taken over the Transferee Company on Amalgamation are as under :
   

 

 

 

(Rs. in lac)

 

 

 

 

 

Particulars

GHCL

GCBL

Total

 

 

 

 

 

 

Investments in

 

 

 

 

Godrej Sara Lee

 

 

 

 

Limited

4,741.61

14,958.91

19,700.52

 

 

 

 

 

 

 

 

Cash and Bank

 

 

 

 

Balances

1.34

15.02

16.36

 

 

 

 

 

 

Loans and Advances

—

0.30

0.30

 

 

 

 

 

 

Advance Taxes Paid

—

1.03

1.03

 

 

 

 

 

 

Current Liabilities

 

 

 

 

and Provisions

(2.94)

(15.31)

(18.25)

 

 

 

 

 

 

Provision for taxes

—

(1.20)

(1.20)

 

 

 

 

 

 

Net Assets

4,740.01

14,958.74

19,698.76

 

 

 

 

 

 

    d) GCBL and GHCL held 29% and 20%, respectively, in Godrej Saralee Ltd., which is a 49 : 51 unlisted joint venture company between the Godrej Group and Saralee Corporation, USA. As a result of the amalgamation, Godrej Sara Lee Limited has become a joint venture between the Company and Sara Lee Corporation USA.

    e) In accordance with the Scheme of Amalgamation, the Company has issued and allotted 30,296,727 equity shares having a face value of Re.1 each to G&B and 20,939,409 equity shares having a face value of Re.1 each to GIL, being 10 equity shares in the Transferee Company for every 11 equity shares held by them in GCBL an GHCL, respectively, as consideration for the transfer. Consequently, the issued, subscribed and paid up equity shares capital of the Company stands increased to 308,190,044 equity shares having a face value of Re.1 each aggregating Rs.3,081.90 lac.

    f) The excess of book value of the net assets of the Transferor Companies taken over, amounting to Rs.18,455.25 lac, after adjusting the expenses and cost of the Scheme which amounted to Rs.731.15 lac, over the face value of shares issued as consideration to the Members of the Transferor Companies has been credited to the General Reserve as per the Scheme.

    g) Had the Scheme not prescribed the above treatment, the balance in Security Premium Account would have been higher by Rs.19,165.65 lac, investments would have been higher by Rs.731.15 lac, Capital Reserve would have been higher by Rs.51.24 lac, the Profit and Loss Account and the General Reserve would have been lower by Rs.30.50 lac and Rs.18,455.25 lac, respectively.

    h) Since the aforesaid Scheme of amalgamation of GCBL and GHCL with the Company, which is effective from June 1, 2009, has been given effect to in these accounts, the figures for the current year to that extent are not comparable with those of the previous year.

Illustration of an audit report containing large number of qualifications : Mahanagar Telephone Nigam Limited (31-3-2009)

Business Combinations (IFRS 3) — Accounting to reflect the economic substance

IFRS impact on fixed assets — More than just a change in name

Accounting for property, plant and equipment

    IAS 16 deals with accounting for property plant and equipment; widely referred to as PPE under IFRS. PPE comprises tangible assets held by a company for use in production or supply of goods or services, for rental to others, or for administrative purposes, that are expected to be used for more than one period. PPE is recognised only if it is probable that future economic benefits associated with the asset will flow to an entity and the cost of the asset can be reliably measured. IAS 16 requires PPE to be initially recognised at cost plus ‘directly attributable’ expenses incurred to bring an asset to the location and condition necessary for its ‘intended use’.

    In practice there may be situations where the determination of what comprises ‘directly attributable cost’ would involve exercise of judgment.

Directly attributable costs :

    At a general level, the concept of directly attributable costs in AS 10 is broadly consistent with what is provided by IAS 16. IAS 16 has provided examples of directly attributable costs. Some of these include :

  •      Installation and assembly cost

  •      Site preparation

  •      Fees paid to professionals e.g. towards legal assistance for title report on land

  •      Cost of employee benefits incurred for acquisition/construction of an asset e.g. share based payments provided to employees who have worked on the construction/acquisition of an asset

  •      Interest and other borrowing costs can be capitalised as part of the cost of a qualifying asset

    These costs need to be incremental or external to be considered as directly attributable. For example : if a company is installing a machine in its factory and one of its engineers has been assigned this task on a full time basis then the cost of the engineer including employee benefits during the period of installation should be included in the cost of the machine even though this cost may have been incurred in any event. In any case, the cost of an asset can include expenditure only if an asset is acquired e.g. if a broker is paid fees to identify property, such fees can be added to the cost of property which is acquired since it is directly attributable to the acquisition of property, fees paid for other properties not acquired needs to be expensed.

    Care should be taken to ensure that expenses which are in the nature of administrative costs are not capitalised since these cannot be considered as directly attributable to acquisition of an asset. Also, abnormal amounts of material/labour/other costs that maybe incurred while constructing an asset cannot be added to the cost of that asset. These will have to be expensed in the period in which these have been incurred. The determination of what comprises ‘abnormal’ is subjective. For example, if the normal commissioning time for an asset is two weeks but it takes four weeks because a trainee engineer had installed a machine incorrectly or because site management forgot to schedule machine operators for the testing phase, then additional costs incurred as a result of such events should be considered ‘abnormal’ and expensed as incurred. However, the assessment of what is abnormal can be made by considering the level of technical difficulty associated with a project, timelines/estimates made at the time of planning etc. Having said that, there may be circumstances where there might be a delay in the process of constructing an asset due to some unexpected technical difficulties. This delay may give rise to additional costs being incurred which should then be capitalised and not expensed.

    As is the case with AS 10, IAS 16 also permits subsequent expenditure to be capitalised only if it is probable that future economic benefits associated with them will flow to the entity and its cost can be reliably measured.

Areas of GAAP difference : AS 10 v. IAS 16 :

    The accounting for PPE as required by IAS 16 is similar to accounting for fixed assets as per AS 10 in certain areas, while there are certain important differences such as :

  •     Foreign exchange differences and preoperative expenses capitalised under Indian GAAP
  •      Accounting for decommissioning costs
  •     Depreciation
  •      Component accounting
  •      Revaluation approach for subsequent measurement of PPE

Foreign exchange differences and preoperative expenses capitalised under Indian GAAP :

    Under Indian GAAP, (based on principles laid out in the Companies Act 1956), companies have traditionally capitalised foreign exchange differences on monetary items relating to fixed assets as part of the acquisition cost. This has been recently amended by the Accounting Standard Rules 2006. However, prior capitalisation of foreign exchange differences still forms a part of the cost of fixed asset. On adoption of IFRS, companies need to strip out these capitalised exchange differences on the transition date so as to bring the cost of assets in line with IAS 16 and also rework depreciation for future years accordingly.

    It is important to note here that as per the recent March 2009 notification issued by the Ministry of Company Affairs, Indian companies have an option to adjust exchange differences arising on reporting of long term foreign currency monetary items to the cost of the fixed asset where they relate to the acquisition of a depreciable capital asset and consequently depreciated over the asset’s balance life. Such an option would not be available under IFRS and hence such capitalisation would also need to be adjusted on transition to IFRS.

The same rule applies to general and administrative overheads relating to start up activities capitalised under Indian GAAP as per Guidance note on expenditure during construction period, until the year 2008. These would also have to be stripped out from the cost of the PPE with a corresponding impact on opening reserves on the transition date.

Decommissioning:

Under IFRS, the cost of an asset also includes  the estimated cost of dismantling an asset and restoring the site. For example, consider that the installation and testing of a company’s new chemical plant results in contamination of the ground at the plant. The company will be required to clean up the contamination caused by the installation when the plant is dismantled. Hence it will recognise a provision for restoration, which is capitalised as part of the cost of the asset. Subsequent changes to these estimates due to change in the amount or timing of the expenditure are required to be accounted as change in estimates. Although AS 10 does not provide guidance on accounting for decommissioning costs, Appendix C to AS 29 provides an example of cost of restoring an oil rig at the end of production. Such costs are required to be included as part of the cost of oil rig. The key GAAP differences here are:

  • IFRS requires recognition of provisions based on constructive obligations also as opposed to only contractual obligations under Indian GAAP

  • Under  IFRS, such  provisions  need  to be recorded based on their discounted  values

Depreciation:   

Under IFRS,entities will have to estimate depreciation based on the estimated useful life of an asset. This is different from the current practice of using rates prescribed by Schedule XIV to the Companies Act, 1956 as the minimum rates for providing depreciation. IFRS does not prescribe any particular method of calculating depreciation but permits use of the straight line method, diminishing balance method and sum of units method. IAS 16 also requires a review of the estimated useful life of an asset, estimated residual value of an asset and the method of depreciation at each balance sheet date. Although AS 6 also requires estimated useful life ot'” major classes of depreciable assets to be periodically reviewed, given the current practice of using Schedule XIV rates for providing depreciation, this may be an area of focus for preparers and auditors while signing off on financial statements prepared under IFRS. Based on our recent conversion experiences we have noted differences in depreciation because the useful life of major property, plant and machinery is longer than the maximum lives permitted under Schedule XIV. In other cases, companies may not necessarily have estimated useful lives, but may have adopted the Schedule XIV rates, which may not correctly reflect the useful lives (for example, furniture and vehicles being depreciated over inappropriately long lives). In such cases, application of IFRS would result in assessment of useful lives and higher depreciation rates and depreciation charge.

Irrespective of the method of depreciation followed, entities will have to ensure that the cost or revalued amount of an asset is allocated on a systematic basis over the useful life of an asset.

The residual value, the useful life and the depreciation method used must be reviewed at least at each financial year-end. Any changes are accounted for prospectively by adjusting the depreciation charge for current and future periods from the date of the change in estimate. It is noteworthy here that if a change of depreciation method has to be made, the change should be accounted for as a change in accounting estimate, and not as a change in accounting policy, and the depreciation charge for the current and future periods should be adjusted accordingly.

Component accounting:

IAS 16 requires component accounting to be fol-lowed for assets which have individual significant components and for which different rates or methods of depreciation are appropriate. The separate component may be a physical component or non physical component. An example of a physical component is an aircraft engine. An aircraft engine is a significant physical component with a distinctly different useful life. Whilst an aircraft is depreciated over its useful life, its engine is separately depreciated on the basis of estimated flying hours. An example of a non physical component is where major overhaul costs are required to be incurred on a periodic basis. If a ship costing Rs.I00 is acquired with a useful life of 15 years and if it has to be dry-docked after every three years for a major overhaul at a cost of Rs 30 then the cost of ship is split into two components i.e. non physical component of Rs 30 and other components aggregating to Rs 70. The non physical component in this case is depreciated over its useful life of 3 years and the other components will be depreciated over their useful life of 15 years.

Component accounting does not apply only to specific assets like ships or aircrafts. A single plant and machinery comprising of different parts such as melting furnace, grinders, rolling mills, etc. could have different useful lives for these parts and hence need to follow component accounting. Similarly, a building can be broken into different components
 
like the roof top, basic structure and interior improvements which could have different useful lives. The key here is to assess firstly whether there are different components in one asset and then whether these different components have significantly different useful lives.

In many cases an entity acquires an asset for a fixed sum without knowing the cost of the individual components. In such cases, the cost of individual components should be estimated either by reference to current market prices (if possible), in consultation with the seller or contractor, or using some other reasonable method of approximation.

Generally Indian companies have depreciated all assets within a class using a uniform depreciation rate (for example, a single rate for all plant and machinery). However, useful lives of different types of plant and machinery may be different – and hence the need to use different depreciation rates under IFRS.

Revaluation approach for subsequent measurement of PPE:

PPE can be measured at fair value if its fair value can be reliably measured. If the revaluation approach is chosen then:

  • All assets in that class of assets (being revalued) will have to be revalued. Class of assets would include assets which are of a similar nature and use in an entity’s operations

  • Carrying value of assets under the revaluation model should not be materially different from their fair values

Any surplus arising on the revaluation is recognised directly in the revaluation reserve within equity except to the extent that the surplus reverses a previous revaluation deficit on the same asset recognised in profit and loss, in which case the credit to that extent is recognised in profit and loss. Any deficit on revaluation is recognised in profit or loss except to the extent that it reverses a previous revaluation surplus on the same asset, in which case it is taken directly to the revaluation reserve. Therefore, revaluation increases and decreases cannot be offset, even within a class of assets.

Fair value of an asset is its market value and is the highest possible price that could be obtained for that asset without regard to its existing use.

The frequency of revaluations depends upon the volatility of the movements in the fair values of the items of PPE being revalued. Revaluations every year are unnecessary for items of PPE with only insignificant movements in fair value. For items that usually experience significant and volatile movements in fair value, annual revaluations are necessary. It is important that revalued amounts do not differ materially from fair values as at the balance sheet date.

Comparison of the cost model with revaluation model:

Illustration:

Depreciation is charged on a straight line basis over the useful life of the asset. The residual value is Rs. nil
Depreciation charge for the subsequent year 2012 under revaluation model shall be Rs.115 (i.e. the carrying value of Rs.920 amortised over balance period of asset 8 years)

Intangible    assets:

IAS 38 deals with accounting for intangible assets. An intangible asset is an identifiable non monetary asset without physical substance. It is identifiable (only) if it is separable or arises from contractual or other legal rights. An intangible asset should be controlled by the entity and should expect to get future economic benefits.

Initial recognition:

Like PPE, an intangible asset is initially measured at cost plus directly attributable expenditure incurred in preparing the asset for its intended use. Expenses incurred in training, initial operating losses should  be expensed as incurred.

An entity may either acquire or internally generate an intangible asset. An intangible asset maybe internally generated through research and development. Research costs are required to be expensed as incurred. If an internally generated intangible asset arises from development phase of a project, directly attributable expenses should be capitalised from the date that the entity is able to demonstrate:

  • The technical feasibility of completing the intangible asset so that it will be available for use or sale;

  • Its intention to complete the intangible asset and use or sell it;

  • Its ability to use or sell the intangible  asset;

  • How the intangible asset will generate probable future economic benefits;

  • The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and

  • Its ability to measure reliably the expenditure attributable to the intangible asset during its development.

Expenses on internally generated brands,”r’ mastheads, publishing titles, customer lists are ‘not capitalised since such expenditure cannot be distinguished from developing the business as a whole. However, such intangibles are recognised when acquired in a business combination (acquisition). Hence, such internally generated, technology related or customer-related intangibles could form a part of the consolidated books of the acquirer entity although they do not meet the recognition criterion in the separate financial statements of the acquired entity. These principles are set out in IFRS 3 — ‘Accounting for business combinations’ .

There are certain expenses which should be expensed as incurred regardless of whether the criteria for recognition appear to be met:

  • Internally generated goodwill
  •  Training activities
  •  Start up costs
  • Advertising and promotional costs
  • Expenditure on relocating or reorganising part or all of an entity

Principally, there are no differences between IAS 38 and AS 26 relating  to the identification  and recognition of intangible  assets. However,  with IFRS 3 in the picture,  the recognition  of some intangibles  in the consolidated financial statements of a group due to fair  value accounting  for business  combinations lead to differences between the two GAAPs.

Subsequent measurement:

The key difference between Indian GAAP and IFRS here is that IFRS recognises that an intangible may have an indefinite useful life and hence need not be amortised. However, the term ‘indefinite’ does not mean ‘infinite’. An intangible asset has an indefinite useful life when, based on an analysis of all the relevant factors (e.g., legal, regulatory, contractual), there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows ‘for the entity.

Under Indian GAAP, an intangible asset has to be amortised over a maximum period of ten years unless a longer period can be justified. However, it does not give the option of not amortising the intangible altogether or considering an indefinite useful life.

An intangible asset with a finite useful life is sub-sequently amortised on a systematic basis over its useful life. Goodwill and intangible assets with an indefinite useful life are measured at cost or revalued amount less accumulated impairment charge. If an intangible asset is not amortised, its useful life must be reviewed at each annual reporting date to determine if the useful life continues to be indefinite.

The method of amortisation used should reflect the pattern of consumption of economic benefits. The method of amortisation used should be reviewed at each annual reporting date and any change in method should be accounted for prospectively as a change in estimate.

Intangible assets may subsequently be measured at fair value only if there is an active market. An active market exists if the items traded are homo-geneous, there are willing buyers and sellers and information on price is available. Under Indian GAAP, revaluation of intangible assets is not permitted. However, in practice, since an active market for intangible assets does not exist for most intangible assets, revaluation would typically not be permitted in the Indian context.

Acquired goodwill and intangible assets with an indefinite useful life will have to be tested annually for impairment or whenever there is a trigger for impairment. In a subsequent article, we will discuss the various impairment monitoring and measurement requirements under IFRS (IAS 36).

Conclusion:

The basic principles of accounting for PPE and intangibles under IFRS are not new to Indian GAAP. Concepts like component accounting and revaluations have been existing in the current Indian accounting framework. However, IFRS gives out clear principles and guidance in these matters. It aims at consistency in application of policies and accounting for PPE based on their composition.

PPE is one area that would need significant efforts and time for computations in order to converge with IFRS.

IFRS and Indirect Taxes : Need for Dual Reporting !

IFRS

The corporate sector is closely monitoring the changes in the
accounting and tax frameworks — Implementation of International Financial
Reporting Standards (IFRS), and Goods and Services Tax (GST).

Interestingly, IFRS (for large entities) and GST
principles/rules apply with effect from a common date i.e., 1 April 2011. While
the changes in the accounting and tax frameworks would have a substantial impact
on the Indian industry, there is a need felt for more clarity on some of these
impact areas. Further, the differences in recognition and measurement principles
under the revised accounting and tax frameworks would lead to additional efforts
of maintaining different accounting records — one for accounting purposes and
the other for tax purposes. This article attempts to illustrate some of the
practical challenges relating to the adoption of IFRS and GST frameworks.

Date on which the tax will be levied :

Under current excise law, the levy of excise duty is at the
point of manufacture of goods. However under GST framework, the levy of tax will
be on ‘sale’ of goods. However, it is unclear today whether the date of levy of
GST will be the date of invoice, date of dispatch of goods or the date on
recognition of revenue as per books of accounts (i.e., depending on the delivery
terms in the sales contract).

If the levy of tax will be on the date of recognition of
revenue in the books of the entity, then the date of levy of GST might differ
depending on whether the entity follows Indian GAAP or IFRS. Under IFRS, apart
from the transfer of risk and rewards to the buyer along with effective control,
IFRS also prescribes an additional condition in relation to the continuing
managerial involvement to the degree usually associated with ownership of goods.
Thus revenue recognition under IFRS might be later than that under Indian GAAP.

If the levy of GST is based on the invoice date or the
dispatch date, then under certain circumstances the timing of revenue
recognition under IFRS may not be the same as the date of levy of GST. This
difference in recognition of revenue under the accounting and taxation
frameworks will need to be periodically reconciled.

Barter sales :

Unlike Indian GAAP, IFRS prescribes specific accounting
guidance on barter transactions. Under IFRS, a barter transaction shall be
recognised as such only when there is an exchange of dissimilar goods. As such
there is no accounting implication in case of exchange of similar goods.

It is widely anticipated that the GST framework shall levy
tax on barter transactions. However, more clarity is awaited on whether GST
would be applicable on exchange of similar goods, even though these are not
recognised as sale for accounting purposes.

Intangible asset model under service concession arrangements
:

Under IFRS, IFRIC 12 provides guidance on accounting by
private sector entities (operators) for public-to-private service concession
arrangements.

In some arrangements, the operator is not awarded a fixed
consideration, but is awarded a right to collect toll fees for a fixed period of
time. Accounting under IFRS for such arrangements is similar to the barter
transactions, whereby the operator renders construction services (and recognises
construction revenue) in lieu of a right to collect toll fees from the users of
the infrastructure facility (i.e., intangible asset which is depreciated over
the concession period). Thus the construction service (revenue) is exchanged for
an intangible asset that provides the operator the right to collect toll
revenue. This accounting treatment is akin to accounting for barter
transactions. The subsequent collection of toll revenue is recognised as
separate revenue, while the depreciation on the intangible asset represents the
cost for the operator.

Currently no indirect taxes are levied on the construction
services provided by the operator under a service concession arrangement. The
indirect tax incidence, if any, is on the collection of toll revenue. It would
be interesting to see whether the GST framework shall also view such service
concession arrangements as barter revenue in line with IFRS accounting. If the
current indirect tax treatment is retained under GST framework, the revenue from
construction and other services needs to be periodically reconciled with the
revenue for accounting purposes.

Branch transfers :

As widely deliberated, GST will also be levied on the stock
transfers from one location of the entity to the other. Like Indian GAAP, IFRS
shall not recognise the branch transfers as revenue of the company. This
difference in recognition of branch transfers under the accounting and taxation
frameworks needs to be periodically reconciled.

Discounts and rebates :

IFRS requires all discounts including cash discounts given by
way of separate credit notes, free goods to the buyer to be reduced from
revenue. Further, the cash discounts and volume rebates need to be recognised on
an estimated basis as at the date of sale. Like the current indirect taxes, GST
is expected to be levied on the transaction value as per the invoice after
deduction of discount as specified on the invoice. This difference in
recognition of discounts under the accounting and taxation frameworks needs to
be periodically reconciled.

Customer loyalty programmes :

Customer loyalty programmes, comprising offering of loyalty
points or award credits, are offered by a diverse range of businesses, such as
supermarkets, retailers, airlines, telecommunication operators, credit card
providers and hotels. Award credits may be linked to individual purchases or
groups of purchases, or to continued custom over a specified period. The
customer can redeem the award credits for free or discounted goods or services.

IFRS requires an entity to recognise the award credits as a
separately identifiable component of revenue and to defer the recognition of
revenue related to the award credits. 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 fair values. The component of
the revenue pertaining to award credits is deferred until the redemption of the
award credit against the future sale.Cash flow from operations — in terms of stabil-ity, timing and certainty — if the target does not prepare a cash flow statement merely because it is not mandatorily required to do so, it is no excuse for the FDD team not to carry out this analysis. The FDD team would be well advised to develop the cash flow statement of the business with the aid of two balance sheets and the profit and loss account for the intervening period and to then analyse the same. One lesson that the Enron debacle has taught us is that ‘Cash is king’ and that if one is able track where cash is being generated and where it is deployed, potential accounting ‘juggleries’ tend to get exposed.

Like the current indirect tax treatment, the GST may be levied on the transaction value of the goods. Thus on the initial sale transaction, GST may be levied on the entire sale value, whereas the accounting revenue as per IFRS would be lower to the extent of the fair value of award credits (that is deferred). Subsequently, as the buyer is provided other goods free of charge in lieu of the award credit, GST may not be levied as there is no sale consideration. For accounting purposes, the fair value of the award credit that was deferred on initial recognition will now be recognised as revenue. Thus the accounting revenue would be recognised subsequently, though there would be no revenue for GST purposes.

This difference in recognition of benefits provided under customer loyalty programmes under the accounting and taxation frameworks needs to be periodically reconciled.

Multiple deliverables within a contract :

Oftentimes a contract involves multiple deliverables such as sale of goods, installation services, warranty benefit and maintenance services. For revenue recognition, IFRS requires identification of different revenue components, allocation of the contractual revenue to each component based on their relative fair values and recognition of revenue for each component based on compliance with the revenue recognition criteria for each such component. The timing and amount of revenue recognition may not strictly follow the contractual arrangement.

GST is expected to be levied on the transaction value that is based on the contract. Hence there will be a need for reconciliation between the revenue as per IFRS and revenue as per GST. An entity may be required to maintain this reconciliation on a periodic basis.

Sales on deferred payment terms :

Deferred payment term is a credit term that is higher than the normal credit term. In case of deferred payment term, IFRS requires the sales to be recognised by discounting the future receivables to its present value. The difference between the nominal value and discounted value shall be recognised as interest income over the credit term.

Under the GST framework, if the levy of tax would be on the invoice value, then it might be viewed as if GST is levied on interest income as well (From an accounting perspective under IFRS, the invoice value comprises two parts — Revenue and Interest Income). More clarity is required on the assessable value of goods and services for GST purposes.

Lease deposits received by lessor :

Under IFRS, lease deposits are classified as financial instruments that are measured at fair value on initial recognition. When a lessor provides a leased asset to a lessee on a non-cancellable operating lease, the fair value of interest-free lease deposits is not equal to the nominal value (i.e., face value). The fair value of the lease deposit would be the present value of the future cash flows under the contract discounted at the market interest rate. The difference on initial recognition between the nominal value and the fair value of the lease deposits would be recognised as lease income received in advance. This advance lease income is recognised on straight-line basis over the lease term. Correspondingly the deposit liability would accrete interest expense over the lease term. Thus the lease income as per IFRS would be higher than the contractual lease rent.

Like the practice under current indirect tax laws, GST may be levied on the contractual lease rent without the impact of the notional lease rent on account of interest-free lease deposit. Thus the lessor will need to reconcile the lease revenue between IFRS and GST on a periodic basis. This would have a substantial impact on leasing companies.

Embedded leases :

Under IFRS, there is specific guidance on accounting for certain arrangements which include lease components. If the contract involves use of dedicated assets by a service provider, then such contract needs to be assessed from the perspective of a lease. Determining whether an arrangement is, or contains, a lease shall be based on the substance of the arrangement and requires an assessment of whether : (a) fulfilment of the arrangement is dependent on the use of a specific asset or assets (the asset); and (b) the arrangement conveys a right to use the asset.

For the purpose of applying the requirements of lease accounting, payments and other consideration required by the arrangement shall be separated at the inception of the arrangement into those for the lease and non-lease elements on the basis of their relative fair values.

Further, the entity may need to determine the classification of lease into operating or finance lease. In case of operating lease, the entity needs to recognise the lease component of the non-cancellable arrangement on a straight-line basis. In case of finance lease, the lessor would recognise the sale of the leased assets upfront and interest income over the lease period. The lessor shall recognise the non-lease components based on the accounting guidance from other relevant IFRS standards.

While the accounting for embedded leases could get complicated in practice, the GST is expected to be levied based on the same principles that are currently in existence i.e., transaction values. Thus when an arrangement is classified as a finance lease under IFRS, the earnings would comprise sale of ‘leased’ asset and interest income, whereas it would be taxed as job work charges in the hands of the service provider. The entity needs to periodically reconcile the impact of different measurement principles relating to revenue recognition under IFRS and GST.

Interest-free loan to job worker :

Under IFRS, loans are financial instruments that are initially recognised at fair value. In case of interest-free loans, the loans are initially recognised at fair value by discounting the future cash flows. The discounted value accretes interest expense over the term of the loan. The difference between the nominal value and fair value is recognised as notional job work charges over the tenure of the loan.

Under the current excise valuation rules, where a customer provides an interest-free loan to the job worker and the loan has influenced the price charged, then a notional interest is added to the assessable value of the goods sold by the job worker.

The GST framework so far is silent on the assessable value of goods/services. It would be interesting to see whether the notional interest and the notional job work charges are also to be added to the computation of assessable value for the purpose of levy of tax.

While industry believes that the changes in the accounting and taxation frameworks are steps in the right direction, they are unable to estimate the exact impact on their business. Further, unless some more clarity emerges in the near future, the industry shall face challenges around maintaining an efficient and planned tax structure. Further, some of the apparent transition implications, where the IFRS and tax treatment is relatively clear, indicate maintenance of two sets of records — one for accounting purpose and the other for tax purposes.

The financial and taxation aspects relating to the IFRS/ GST convergence need to be planned and tested in advance of the implementation date. In view of this, the Industry needs to start their transition process early, preferably now. Global experience has shown that the early adopters are generally more successful in managing the overall IFRS and GST transition. The early-mover advantage not only provides adequate time to carry out required changes, but protects critical decisions being taken within the constraints of time and resources.

Impact of IFRS on the telecom sector : Dialling a new reporting framework

IFRS

Impact of IFRS on the telecom sector : Dialling a new reporting
framework


As Indian companies get poised to converge with IFRS
commencing April 1, 2011, one of the industries which will witness significant
changes in the financial statements is the telecom industry. This article seeks
to discuss these changes and their related impact in greater detail.

Revenue recognition :

Presently in India, revenue recognition is governed by the
principles outlined in AS-9 ‘Revenue Recognition’. The corresponding standard
under IFRS — IAS 18 ‘Revenue’ along with related IFRICs serve as the required
starting point for developing accounting policies, even if they are not
necessarily specific to the telecom sector. The key changes from the present
accounting practices with respect to revenue recognition are as follows :

Arrangements involving more than one component (Bundled
arrangements) :

Telecom companies often offer customers bundled products,
which involve multiple components such as sale of equipment when the customer
signs up for a service contract. A typical example of this would be the schemes
where companies offer mobile handsets, modems, set top boxes, etc. (either at
full price or subsidised prices or at no separate price) when the customer signs
up for the respective services.

Under IFRS, IAS 18 has detailed guidance for identification
of arrangements having more than one component and their consequent separation
for the purposes of revenue recognition. Due to limited guidance available under
Indian GAAP for the same, entities presently account for such arrangements based
on their legal form and not based on the substance of such transactions.

IAS 18 requires that two or more transactions be considered a
single arrangement “when they are linked in such a way that the commercial
effect cannot be understood without reference to the series of transactions as a
whole.”

Having identified the transactions which are part of a single
arrangement, the standard requires entities to identify the various components
of the arrangement and account for the respective component based on the
applicable revenue recognition criteria.

For the purposes of separation of components the following
criteria is required to be fulfilled :



  •  the component has stand-alone value to the customer, and



  •  the
    fair value of the component can be measured reliably.


There is no specific guidance in IAS 18 for allocation of the
overall consideration to the respective components. However, based on the
guidance available in IFRIC 13 revenue could be allocated to components using
either of the following methods :



  •  Relative fair values, or



  •  Fair value of the undelivered components (residual method)


Using the relative fair values, the total consideration is
allocated to the different components based on the ratio of the fair value of
the components relative to each other. Using the residual method, the
undelivered components are measured at fair value and the remainder of the
consideration is allocated to the delivered components.

Telecom companies generally charge less for deliverables in a
bundled arrangement than they charge for each component separately. The relative
fair value method allocates this discount across all separately identifiable
components while the residual method would result in allocation of the discount
to undelivered components.

Customer incentives in the form of free minutes :

Telecom companies generally offer customers bonus talktime
without any additional revenue for the same. Presently under Indian GAAP,
revenue recognition is based on actual utilisation of talktime by the customer
with no revenue being recognised while the bonus talktime is being used. Under
IFRS, revenue recognition per minute is to be adjusted for the impact of the
bonus talktime (after considering the impact of forfeiture).

For example, Telecom T runs a promotion for its prepaid
telecom base. A customer purchasing a standard prepaid card for Rs.50 normally
would receive 100 minutes of calling time. However, during the promotion the
customer receives an additional 20 bonus minutes.

The revenue per minute of airtime is Rs.0.42 (50/120).
Therefore T will recognise revenue of Rs. 0.42 for every minute of airtime used
by the customer assuming that the customer shall use the bonus minutes entirely.

Activation revenue :

Activation revenue is normally collected from customers at
the point of their entry into the network. Accounting practices under Indian
GAAP varies with some companies recognising the activation revenue upfront,
while others recognising it over the expected life of the customer on the
network.

Under IFRS, such revenue is recognised over the expected life
of the customer and is not permitted to be recognised upfront.

Customer loyalty programs :

Telecom companies often offer customer loyalty points for
amounts spent on airtime and a customer can redeem those points for money off
their monthly bill or obtain a handset upgrade. Presently under Indian GAAP, due
to limited guidance telecom companies do not defer any revenue on account of the
loyalty points.

IFRIC 13 provides specific guidance with respect to
accounting for customer loyalty programs with the following features:



  •  Telecom companies grant award credits to a customer as part of a sales
    transaction; and



  •  Subject to meeting of other conditions, the customer can redeem the award
    credits for free or discounted goods or services in the future.


In addition to loyalty points offered by telecom companies,
IFRIC 13 would cover a wide range of sales incentives that might include, for
example, vouchers, coupons and discounts or renewals.

In summary, IFRIC 13 requires revenue to be deferred to account for an entity’s future obligation in respect of loyalty programs awarded. Recognition of revenue in accordance with IFRIC 13 would require allocation of revenue to award credits. Allocation of revenue is to be based on either relative fair value method or fair value of the award credits (i.e., residual value method). In estimating the fair value credits the telecom company is required to consider the following:

  •    Fair value of the goods and services that can be obtained from the exercise of the award credits, and

  •     The proportion of award credits granted that are expected not to be redeemed i.e., expected forfeitures.

Revenue from award credits is recognised as the telecom company fulfils its obligations to provide the free or discounted goods or services or as the obligation lapses.

Gross v. net presentation of revenue:

IAS 18 provides specific guidance for determination of gross or net presentation of revenue. For example, arrangement with respect to content available for downloads, involve the telecom companies earning a commission based on user access to the content. Typically such arrangements do not result in the telecom companies acquiring content rights. Accordingly, an assessment shall be required to be performed for gross v. net presentation based on the specific features of the arrangements.

Capacity transactions:

Telecom companies often enter into arrangements whereby they convey to other telecom companies ‘the right to use’ equipment, fibres or capacity (bandwidth) for an agreed period of time, in return for a payment or a series of payments. In relation to such capacity transactions, the telecom companies can be either providers (sellers) or customers or both. The capacity sellers usually retain the ownership of the network assets and convey the ‘right to use’ the asset to the customer for an agreed period of time. An agreement that conveys the exclusive right to use is generally referred to as ‘indefeasible right of use’ (IRU) in the telecom industry.

IRU contracts may not be described explicitly as lease contracts, but what matters is the substance of the agreement, which should be evaluated to determine whether the arrangement constitutes a lease. The analysis is based on the requirements of IFRIC 4 and accordingly based on the fulfilment of the following conditions:

  •     Whether the provision of a service depends on the use of one or more specific assets; and

  •     Whether a right of use of these assets is conveyed through the arrangement.

For the purpose of determining whether the arrangement conveys a right of use for specified assets, the telecom companies shall be required to assess whether:

(a)    the customer has the ability or right to operate the asset (including to direct how others should operate the asset), and at the same time obtain or control more than an insignificant amount of the asset’s output;

(b)    the customer has the ability to control physical access to the asset while obtaining more than an insignificant amount of the asset’s output;

(c)    the possibility of another party taking more than an insignificant amount of the asset’s output during the term of the arrangement is remote, and if yes, whether the customer pays a fixed price per unit of output which is not based on market price.

The facts and circumstances of the case would determine whether the customer acquires the right to use interchangeable capacity from an overall physical telecom asset; or whether the customer acquires the right to use a specific portion of the physical asset (for example, a physically identifiable portion of the wavelength) . Generally, rights to use ‘general capacity’ would not qualify as leases. However, rights to use specific telecom assets/portion of telecom assets may qualify as leases.

Property plant and equipment:
Depreciation:

Presently in India, telecom companies depreciate their fixed assets primarily based on the rates prescribed in Schedule XIV of the Companies Act, 1956. However, some companies depreciate certain fixed assets at rates based on the respective useful lives of the assets.

Under IFRS, companies are required to depreciate property plant & equipment based on their useful lives. The revised draft of Schedule XIV prescribes indicative useful lives and unlike its predecessor, is not expected to represent the minimum rates. Accordingly, all companies including the telecom companies will have to charge depreciation based on the useful lives of the related item of property plant and equipment.

Components of cost of property plant and equipment:

Presently, under Indian GAAP, companies capitalise costs which may not be directly attributable to bringing the fixed asset into its present location and condition. E.g., foreign exchange fluctuations related to long-term borrowing with respect to fixed assets are currently permitted to be capitalised under Indian GAAP.

However, under IFRS, only those costs which are directly attributable to bringing the asset into its present location and condition are permitted to be capitalised. Accordingly, items like foreign exchange fluctuation, administrative expenses, etc. shall not be permitted to be capitalised to the cost of property plant and equipment.

Asset retirement obligations:

As per the requirement of AS-29 ‘Provisions, Contingent Liabilities and Contingent Assets’, companies are required to recognise the entire undiscounted value of asset retirement obligation as a part of the cost of the related item of property plant and equipment.

However, under IFRS, IAS 37, the corresponding standard, requires the obligation to be discounted and accordingly, the present value of the asset retirement obligation is required to be included in the cost of the asset.

Deferred credit arrangements:

Telecom companies often have arrangements with creditors for purchase of property plant and equipment requiring payment on deferred terms i.e., on deferred credit terms. Under Indian GAAP, no specific adjustment is required for such arrangements and accordingly the related item of property plant and equipment is capitalised at the gross value of the amount payable to the creditor.

However, under IFRS, since all financial instruments have to be fair valued on initial recognition, the liabilities towards purchase of property plant and equipments (being financial liabilities) are required to be discounted on initial recognition. Accordingly, the related item of property, plant and equipment shall be capitalised at the present value of the amount payable to the creditor at the end of the extended credit period. The unwinding shall be through accrual of interest expense on the discounted liability for each reporting period.

Conclusion:

As the convergence date with IFRS is approaching, telecom entities have to be well prepared to ensure that the transition is smooth. Entities also have to be mindful of the ‘carve-outs’ (areas where accounting treatment under the IFRS converged standards in India may differ from IFRS issued internationally) which are being presently considered by the regulators.

Lastly, telecom companies would need to carefully consider the impact of IFRS convergence on their IT systems. This is especially true for changes impacting revenue recognition, given that revenue recognition in the telecom industry is highly technology-intensive.

IFRS 8 : Operating Segments

Background information :

IFRS 8 on ‘Operating Segments’ sets out requirements for disclosure of information about an entity’s operating segments and also about the entity’s products and services, the geographical areas in which it operates, and its major customers.

(1) Core principle :

    The core principle of IFRS 8 is that an entity shall disclose such information as to enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates.

(2) Applicability of IFRS 8 :

    IFRS 8 shall apply to the separate/individual/consolidated financial statements of an entity. IFRS 8 is not applicable to all entities. It is applicable only to those companies whose securities are either listed or are in the process of listing in a public market.

(3) Management approach :

(a) Management approach :

    IFRS requires segment disclosure based on the components of the entity that management monitors in making decisions about operating matters (the ‘management approach’). Such components (operating segments) are identified on the basis of internal reports that the entity’s Chief Operating Decision Maker (‘CODM’) reviews regularly in allocating resources to segments and in assessing their performance.

    The management approach is based on the way in which management organises the segments within the entity for making operating decisions and in assessing performance. Consequently, the segments are evident from the structure of the entity’s internal organisation and the information reported internally to the CODM. The adoption of the management approach results in the disclosure of information for segments in substantially the same manner as they are reported internally (and used by the entity’s CODM) for purposes of evaluating performance and making resource allocation decisions. In that way, financial statements users are able to see the entity ‘through the eyes of management’.

(b) Identifying the CODM :

    The term CODM refers to a function, rather than to a specific title. The function of the CODM is to allocate resources to the operating segments of an entity and to assess the operating segments’ performance. The CODM usually is the highest level of management (e.g., CEO or COO), but the function of the CODM may be performed by a group rather than by one person (e.g., a board of directors, an executive committee or a management committee).

    For example, an entity has a CEO, a COO and a president. These individuals comprise the executive committee. The responsibility of the executive committee is to assess performance and to make resource allocation decisions related to the individual operations of the entity, and each of these individuals has an equal vote. The executive committee is the CODM because the committee is the highest level of management that performs these functions. The segment financial information provided to and used by the executive committee to make resource allocation decisions and to assess performance is the segment information that would be the basis for disclosure for external financial reporting purposes.

    However, the mere existence of an executive committee, management committee or other high-level committee does not necessarily mean that one of those committees constitutes the CODM. Assume the same fact pattern as in the previous example except that the managing director can override decisions made by the executive committee. Because the managing director essentially controls the committee and therefore has control over the operating decisions that the executive committee makes, the managing director will be the CODM for purposes of applying IFRS 8.

(4) Identifying operating segments :

    An operating segment is a component of an entity :

    (a) that engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity),

    (b) whose operating results are regularly reviewed by the entity’s CODM to make decisions about resources to be allocated to the segment and assess its performance, and

    (c) for which discrete financial information is available.

    An operating segment generally has a segment manager. Essentially, the segment manager is directly accountable for the functioning of the operating segment and maintains regular contact with the CODM to discuss operating activities, forecasts and financial results. Like the CODM, a segment manager is a function, rather than a specific title.

    (a) Business activity is essential :

        A corporate headquarters would carry out some, or all, of the functions in the treasury, legal, accounting, information systems and human resources areas. However, corporate activities generally would not qualify as operating segments under IFRS 8, because typically they are not business activities from which the entity earns revenues.

    (b) Multiple segment information reviewed by CODM :

        Apart from the core principle as mentioned above, the additional factors that can be considered in determining the appropriate operating segments are as under :

        (a) the nature of the business activities of each component;

        (b) the existence of managers responsible for the components;

        (c) information presented to the board of directors; and

        (d) information provided to external financial analysts and on the entity’s website.

Some entities use a ‘matrix’ form of organisation, whereby business components are managed in more than one way. For example, some entities have segment managers who are responsible for geo-graphic regions, and different segment managers who oversee products and services. If the entity generates financial information about its business components based on both geography and products or services (and the CODM reviews both types of
information, and both have segment managers), then the entity determines which set of components constitutes the operating segments by reference to the core principle to IFRS 8 as mentioned above.

For example, an entity has six business components (A, B, C, D, E and F). Three of these business components (A, B and C) are located in India and each manufactures and sells a different product to customers in India. The CEO (who is the CODM) assesses performance, makes operating decisions and allocates resources to these business components based on financial information presented on a product-line basis. The entity also has three business components in the U.S. (D, E and F), which are organised to mirror the India operations (i.e., each manufactures and sells its products to customers located in the U.S.). However, the CODM assesses performance, makes operating decisions and allocates resources based on the financial information presented for the U.S. as a whole. The entity’s presi-dent of the U.S. operations is responsible for assessing performance, making operating decisions and allocating resources to the business components within the U.S. The entity’s president of the U.S. operations also is directly accountable to the CODM. The entity therefore has four operating segments: Segments A, B and C, which are determined on a product-line basis, and Segment U.S., which consists of business components D, E and F and is determined on a geographic basis. There is no requirement to disaggregate information for segment reporting purposes if it is not provided to the CODM in a disaggregated form on a regular basis.

Further, determination of the industry in which a business component of an entity operates generally is not decisive for purposes of identifying properly all of the operating segments under IFRS 8. For example, an entity historically reported that it had one industry segment (mining), but presented financial information in its MD&A and press releases on the following business components: gold, copper and coal. The entity determines that the CODM does, in fact, make resource allocation decisions based on the financial performance of each of these three business components. Accordingly, each of the three business components is an operating segment under IFRS 8, despite the fact that they all are in the mining industry.

c) Discrete and sufficient financial information :

In order to assess performance and to make resource allocation decisions, the CODM must have financial information about the business component. This information must be sufficiently detailed to allow the CODM to assess performance and to make resource allocation decisions. For example, an entity’s CODM receives revenue information for three different services delivered by segment A (Segment A is one of the five operating units of the entity). However, its operating expenses are reported to the CODM on a combined basis for the entire segment. Because a measure of profit or loss by service is not presented, the CODM might not have enough information to assess the performance or make resource (capital) allocation decisions regarding the individual services. Thus Segment A, in aggregate, is likely to be one operating segment, as opposed to the three individual services delivered by the Segment A.

5) Aggregation of segments :

Two or more operating segments may be aggregated into a single operating segment if

a) aggregation is consistent with the core principle of IFRS 8,

b) the segments have similar economic characteristics, and

c) the segments are similar in each of the following respects :

  •     the nature of the products and services;

  •     the nature of the production processes;

  •     the type or class of customer for their products and services;

  •     the methods used to distribute their products or provide their services; and

  •     if applicable, the nature of the regulatory environment, for example, banking, insurance or public utilities.

    6) Reportable segments :

    a) Quantitative thresholds :

An entity shall report separately information about an operating segment that meets any of the following quantitative thresholds :

    a) Its reported revenue, including both sales to external customers and inter-segment sales or transfers, is 10% or more of the combined revenue, internal and external, of all operating segments.

    b) The absolute amount of its reported profit or loss is 10% or more of the greater, in absolute amount, of

  •     the combined reported profit of all operating segments that did not report a loss and
  •     the combined reported loss of all operating segments that reported a loss.

    c) Its assets are 10% or more of the combined assets of all operating segments.

Operating segments that do not meet any of the quantitative thresholds may be considered reportable, and separately disclosed, if management believes that information about the segment would be useful to users of the financial statements or more reportable segments need to be identified until at least 75% of the entity’s revenue is included in reportable segments.

The term ‘combined’ in each of the three tests as mentioned above means the total amounts for all operating segments before the elimination of intra-group transactions and balances (i.e., not the entity’s financial statement amounts). It does not include reconciling items and activities that do not meet the definition of an operating segment under IFRS 8 (e.g., corporate activities).

b) Use of different accounting policies for segment reporting :

The measures of the segment amounts are based on the amounts reported to the CODM. As a result, the entity can measure the segment amounts based on segment accounting policies that may be different from the entity’s accounting policy for preparation of financial statements. In such cases, the entity measures the segment amounts based on segment accounting policies and provides additional disclosure reconciling the segment amounts to the entity’s financial statements.

c) Measures for profits, assets or liabilities :

The segment information is based on the actual measure of segment profit or loss that is used by the CODM for purposes of evaluating each reportable segment. Adjustments and eliminations made in preparing the entity’s financial statements, as well as allocations of revenue, expenses, gains or losses, are included in the reported segment profit or loss only if these items are included in the segment profit or loss measure used by the CODM. Additionally, the allocation of amounts included in the measure of segment profit or loss must be on a reasonable basis.

d) Use of multiple measures of profits, assets or liabilities for different segments :

If the CODM uses more than one measure of a segment’s profit or loss, or more than one measure of a segment’s assets or the segment’s liabilities, then the measure disclosed in reporting segment profit or loss, or segment assets or liabilities, should be the measure that management believes is determined in accordance with the measurement principle most consistent with the corresponding amounts in the entity’s financial statements.

For instance, the CODM receives and uses the operating profit, operating profit less corporate charges and operating profit less corporate charges and an allocated cost of capital measures of segment profit or loss for each of the operating segments, the measure of segment profit or loss used to report segment profit or loss should be operating profit because this measure is most consistent with the corresponding amounts in the entity’s financial statements.

e) Operating segments below quantitative thresholds :

An entity is allowed to combine information about two or more such operating segments that do not meet the quantitative thresholds (as discussed above) to produce a reportable segment only if the operating segments have similar economic characteristics and share a majority (but need not be all) of the aggregation criteria listed in point 5 above.

If the total of external revenue reported by operating segments constitutes less than 75% of total consolidated revenue, then additional operating segments are identified as reportable segments (even if they do not meet the quantitative threshold criteria) until at least 75% of the total consolidated revenue is included in reportable segments.

Information about other business activities and operating segments that are not reportable shall be combined and disclosed in an ‘all other segments’ category separately from other reconciling items. The sources of the revenue included in the ‘all other segments’ category shall be described.

7. Change in reportable segments :

a) Operating segment becomes reportable segment only in current period :

If an operating segment is identified as a reportable segment in the current period in accordance with the quantitative thresholds, segment data for a prior period presented for comparative purposes shall be restated to reflect the newly reportable segment as a separate segment, even if that segment did not satisfy the criteria for reportability in the prior period, unless the necessary information is not available and the cost to develop it would be excessive.

b) Operating segment was reportable segment in previous period but does not meet quantitative thresholds in current period :

An operating segment that historically has been a reportable segment might not exceed any of the quantitative thresholds in the current period. In this situation if management expects it to be a reportable segment in the future, then the entity should continue to treat that operating segment as a reportable segment in order to maintain the inter-period comparability of segment information.

c) Change in composition of operating segments :

If an entity changes the structure of its internal organisation in a manner that causes the composition of its reportable segments to change, the corresponding information for earlier periods, including interim periods, shall be restated unless the information is not available and the cost to develop it would be excessive. Following a change in the composition of its reportable segments, an entity shall disclose whether it has restated the corresponding items of segment information for earlier periods.

The entity shall disclose segment information for the current period on both the old basis and the new basis of segmentation, unless the necessary information is not available and the cost to develop it would be excessive.

    8) Disclosure of segment information :

    a) Disclosures :

An entity shall disclose the following for each period for which a statement of comprehensive income is presented :

  •     general information as described in point b below

  •     information about reported segment profit or loss, including specified revenues and expenses included in reported segment profit or loss, segment assets, segment liabilities (refer point c below) and the basis of measurement (refer point d below) and

  •     reconciliations of the totals of segment revenues, reported segment profit or loss, segment assets, segment liabilities and other material segment items to corresponding entity amounts. Reconciliations of the amounts in the statement of financial position for reportable segments to the amounts in the entity’s statement of financial position are required for each date at which a statement of financial position is presented. (refer point e below).


b) General information :

IFRS 8 requires an entity shall disclose the following general information about its segments :

  •     factors used to identify the entity’s reportable segments, including the basis of organisation (for example, whether management has chosen to organise the entity around differences in products and services, geographical areas, regulatory environments, or a combination of factors and whether operating segments have been aggregated), and

  •     types of products and services from which each reportable segment derives its revenues.

c) Information about profit or loss, assets and liabilities : Segment profit or loss disclosures :

IFRS 8 requires an entity to report a measure of profit or loss and total assets for each reportable segment, and a measure of liabilities for each reportable segment if such an amount is provided regularly to the CODM. It also requires that an entity disclose the following about each reportable segment if the specified amounts are included in the measure of segment profit or loss reviewed by the CODM or are otherwise provided regularly to the CODM, even if not included in that measure of segment profit or loss :

  •     revenues from external customers;

  •     revenues from transactions with other operating segments of the same entity;

  •     interest revenue;

  •     interest expense;

  •     depreciation and amortisation;

  •     material items of income and expense disclosed in accordance with paragraph 97 of IAS 1 Presentation of Financial Statements (as revised in 2007);

 

  •     the entity’s interest in the profit or loss of associates and joint ventures accounted for by the equity method;

  •     income tax expense or income; and

  •     material non-cash items other than depreciation and amortisation.

If the amounts specified above are inherent in the measure of segment profit or loss used by the CODM, then those amounts are required to be disclosed even if they are not provided explicitly to the CODM.

Segment asset disclosures :

IFRS 8 requires an entity to disclose the following about each reportable segment if the specified amounts are included in the measure of segment assets reviewed by the CODM or are otherwise regularly provided to the CODM, even if not included in the measure of segment assets :

  •     the amount of investment in associates and joint ventures accounted for by the equity method, and

  •     the amounts of additions to non-current assets (i.e. PPE and Intangible assets) other than financial instruments, deferred tax assets, post-employment benefit assets and rights arising under insurance contracts.

d) Disclosure of measurement basis :

IFRS 8 requires an entity to provide an explanation of the measurements of segment profit or loss, segment assets and segment liabilities for each reportable segment. At a minimum, an entity shall disclose the following :

  •     the basis of accounting for any transactions between reportable segments;

  •     the nature of any differences between the measurements used for segments reporting (i.e. for profits or losses, assets and liabilities) and the entity’s financial statements (if not apparent from the reconciliations as required under point e below). Those differences could include accounting policies and policies for allocation of common items of income, expenses, assets and liabilities that are necessary for an understanding of the reported segment information.

  •     the nature of any changes from prior periods in the measurement methods used to determine re-ported segment profit or loss and the effect, if any, of those changes on the measure of segment profit or loss.

  •     the nature and effect of any asymmetrical allocations to reportable segments. For example, an entity might allocate depreciation expense to a segment without allocating the related depreciable asset to that segment.

e) Reconciliation disclosures :

IFRS 8 requires an entity to provide reconciliations of all of the following :

  •     the total of the reportable segments’ revenues to the entity’s revenue.

  •     the total of the reportable segments’ measures of profit or loss to the entity’s profit or loss before tax and discontinued operations. However, if an entity allocates to reportable segments items such as tax expense (tax income), the entity may reconcile the total of the segments’ measures of profit or loss to the entity’s profit or loss after those items.

  •     the total of the reportable segments’ assets to the entity’s assets

  •     the total of the reportable segments’ liabilities to the entity’s liabilities

  •     the total of the reportable segments’ amounts for every other material item of information disclosed to the corresponding amount for the entity.

All material reconciling items shall be separately identified and described. For example, the amount of each material adjustment needed to reconcile reportable segment profit or loss to the entity’s profit or loss arising from different accounting policies shall be separately identified and described.

9) Entity-wide disclosures :

Entity-wide disclosures about products and services (refer point a below), geographic areas (including country of domicile and individual foreign countries, if material) (refer point b below) and major customers (refer point c below) for the entity as a whole are required, regardless of whether the information is used by the CODM in assessing segment performance. These disclosures apply to all entities subject to IFRS 8, including entities that have only one reportable segment. However, information required by the entity-wide disclosures need not be repeated if it is included already in the segment disclosures.
 
a) Information about products and services :

There might be situations in which additional disclosures of external revenue from products and services are necessary on an entity-wide basis when those revenues are not evident from the operating segment disclosures (including situations in which the operating segment disclosures are determined by products and services). For example, an entity might not be organised on the basis of related products and services, and therefore its individual reportable segments include revenues from a broad range of essentially different products and services. In this situation supplemental disclosure of revenues by groups of similar products and services is required, unless the necessary information is not available and the cost to develop it would be excessive. In this case that fact is disclosed.

b) Information about geographical areas :

An entity is required to report the following geo-graphical information :

    1. revenues from external customers :

  •     attributed to the entity’s country of domicile and

  •     attributed to all foreign countries in total from which the entity derives revenues. If revenues from external customers attributed to an individual foreign country are material, those revenues shall be disclosed separately. An entity shall disclose the basis for attributing revenues from external customers to individual countries.

    2. non-current assets other than financial instruments, deferred tax assets, post-employment benefit assets, and rights arising under insurance contracts :

  •     located in the entity’s country of domicile and

  •     located in all foreign countries in total in which the entity holds assets. If assets in an individual foreign country are material, those assets shall be disclosed separately.

c) Information about major customers :

Revenue from individual external customers that represents 10% or more of an entity’s total revenue must be disclosed. Specifically, the total amount by significant customer and the identity of the segment that includes the revenue must be disclosed. However, IFRS 8 does not require the identity of the customer or the amount of revenues that each segment reports from that customer to be disclosed.

d) Measure of segment profits, assets and liabilities for entity-wide disclosures :

The entity-wide disclosures should be based on the same financial information that is used to produce the entity’s financial statements (i.e., not based on the management approach). Accordingly, the revenue reported for these disclosures should equal the entity’s total revenue. Further, if the necessary information is not available and the cost to develop it would be excessive, that fact shall be disclosed.

10) Issues on first-time adoption :

There is no specific first-time adoption exemption within IFRS 1 for presentation of segment information. However, the reportable segments which, in the past, were identified based on management’s assessment of dominant source and nature of entity’s risks and returns, shall now be identified based on the manner in which the entity’s Chief Operating Decision Maker (‘CODM’) reviews the business components regularly in allocating resources to segments and in assessing their performance.

11) Summary of key differences compared to AS 17 :


Conclusion :

The management needs to reassess the identified business segments based on the manner in which the entity’s Chief Operating Decision Maker (‘CODM’) reviews the business regularly in allocating resources to segments and in assessing their performance.

Is this move to a management approach a good thing ? There is some risk that moving to a management approach may reduce comparability between entities because entity-specific measures override ‘normal’ measurement requirements. But this risk will be offset by the user understanding how does the management assess their own performance and see the business ‘through the eyes of the management’.

IFRS 9: Financial Instruments: The new “Avatar”

IFRS

1. Background information



The IASB has undertaken a project to replace the existing IAS
39 on Financial
Instruments: Recognition and Measurement
in order to improve the usefulness of financial statements for users by
simplifying the classification and measurement requirements for financial
instruments. The accounting standard on financial instruments is large and
complex; hence the International Accounting Standard Board (‘IASB’ or ‘the
Board’) has decided to replace the IAS 39 in three phases:


  • Classification and
    measurement of financial instruments:
    IFRS 9 was published in November 2009. This standard is currently applicable
    for financial assets only. The Exposure draft (ED) on financial liabilities is
    expected in 2010.


  • Impairment of
    financial assets:
    The IASB has issued an ED in November 2009


  • Hedge Accounting:
    An ED is expected in the first quarter of 2010


Apart from the above, the IASB has also issued an exposure
draft relating to Derecognition and Fair Value Measurements that would either be
part of, or relevant to, accounting for financial instruments.

IFRS 9 currently is applicable only to financial assets
(accordingly, this article covers only financial assets within the scope of IFRS
9). Financial liabilities are currently removed from the scope of IFRS 9 due to
concerns raised on entity’s own credit risk in liability measurement. IASB needs
more time for deliberation and exploring alternative approaches to account for
financial liabilities.



2. Scope and recognition principle for financial assets

The objective of IFRS 9 is not to dramatically change the
accounting for financial instruments, but to simplify the accounting. Hence, the
standard has not modified the scope of financial assets under IAS 39.

3. Measurement principle for financial assets

3.1. Initial measurement

Like IAS 39, all financial assets under IFRS 9 shall be
initially recorded at fair value plus, in case of assets not classified as ‘fair
value through profit or loss’ (FVTPL), transaction costs directly attributable
to its acquisition.

3.2. Subsequent measurement

Like IAS 39, IFRS 9 has retained the ‘mixed model approach’
whereby, at inception, the financial assets are categorized into those that will
be subsequently remeasured at (a) amortised cost or (b) fair value. Thus IFRS 9
has eliminated the three categories of financial assets viz loans and
receivables, held to maturity (HTM) and available for sale, while the FVTPL
category is retained.





4. Principles for classification of financial assets

4.1. Classification criterion

An entity shall classify financial assets (as subsequently
measured) at either amortised cost or fair value on the basis of both (a) the
entity’s business model for managing the financial assets; and (b) the
contractual cash flow characteristics of the financial asset. The standard aims
at aligning the accounting in line with how management deploys assets in its
business, while also considering its characteristics.

4.2. Amortised Cost

Unlike IAS 39, the revised standard has laid down specific
criteria for classification of financial assets at amortised cost. A financial
asset shall be measured at amortised cost if the following two conditions are
met:

(a) the asset is held within a business model whose objective
is to hold assets in order to collect contractual cash flows.

(b) the contractual terms of the financial asset give rise on
specified dates to cash flows that are solely payments of principal and interest
on the principal amount outstanding.

If both the above criteria for amortised cost accounting are
not met, then it is measured at fair value.

4.3. Business Model

The Board clarified that an entity’s business model does not
relate to a choice (i.e. it is not a voluntary designation) but rather, it is a
matter of fact that can be observed by the way an entity is managed and
information is provided to its management. IFRS 9 requires the key managerial
personnel (as defined in IAS 24 on Related Party Disclosures) to determine the
objective of the business model. The entity’s business model is not determined
at the level of every instrument, but is determined at a higher level. An entity
may also have more than one business model for managing financial assets. For
example, a bank’s retail banking division may hold its loan assets and manage
the same in order to collect contractual cash flows while its investment banking
business has the objective to realise fair value changes through the sale of
loan assets prior to their maturity.

4.4. Cash flow characteristics

For amortised cost measurement, the cash flows from financial asset should represent solely payments of principal and interest on the principal amount outstanding on specified dates. Interest here means the consideration for the time value of money and for the credit risk associated with the principal amount outstanding during a particular period of time.

Leverage is not consistent with the ‘solely payments of principal and interest’ criterion. Leverage is described as increasing the variability of the contractual cash flows such that they do not have the economic characteristics of interest. The standard lists

freestanding swaps, options and forwards as instruments that contain leverage.
Examples

The following are examples when both the above conditions are met and hence the financial asset is subsequently remeasured at amortised cost:

    A bond with variable interest rate and an interest cap;

    A fixed interest rate loan;

    Zero coupon bond;

    Variable interest loans including an element of fixed credit spread which is determined at inception e.g. LIBOR + 300 bps;

    Purchase of impaired / discounted loans which are then held to collect the contractual cash flows.

On the other hand, an investment in a convertible loan note would not qualify for amortised cost measurement because of the inclusion of the conversion option which is not deemed to represent payment of principal and interest. Similarly, an inverse floating interest loan which has an inverse relationship to market rates does not represent consideration for the time value of money and credit risk.

4.5. Impact of sale of financial assets on business model

Under IAS 39, subject to certain exemptions, if the entity sells / reclassifies held-to-maturity assets before maturity, tainting provisions under paragraph 9 to IAS 39 shall apply. Under IFRS 9, not all of the assets in a portfolio have to be held to maturity in order for the objective of the business model to qualify as holding assets to collect contractual cash flows. A sale of financial asset may not preclude subse-quent measurement at amortised cost if, for example, a financial asset is sold as per entity’s investment policy when the credit rating of the financial asset declined below certain threshold or a financial asset is sold to fund capital expenditures. The standard does not give any bright line or indicator as to what frequency of anticipated sales would preclude an amortised cost classification.

IAS 39 prescribed very limited circumstances under which sale of financial assets within HTM category were permitted without attracting tainting provisions. Under IFRS 9, portfolio of financial assets continue to be measured at amortised cost as long as the sale of financial assets is infrequent in number. Thus the scope for permitted sales of financial assets is much wider for the reporting entities.

4.6. Contractually linked instruments especially for securitisation transactions

An entity may have prioritised payments to holders of multiple ‘contractually linked’ instruments that create concentrations of risk e.g. the tranches of securitised debt. The complexity arises because the junior tranches provide credit protection to the more senior tranches and the characteristics of the tranches depend on the underlying instruments held. The holder should ‘look through’ the structure until the underlying pool of instruments that are creating (rather than passing through) the cash flows are identified for assessment for solely pay-ments of principal and interest, instruments which reduce cash flow variability and exposure to credit risk. Determining whether a tranche has a lower credit risk than that of the underlying instruments should, in many cases, be straightforward. The most senior tranches will qualify, while the most junior tranches will not. For the tranches in between, the entity may have to evalu-ate on a quantitative basis. E.g. Tranches with underlying instruments where the interest rate is linked to a commodity index would not have contractual cash flows that are solely payments of principal and interest.

When it is impracticable to assess the underlying pool of instruments, the test is deemed to fail and the tranche must be measured at FVTPL.

In practice, significant management judgement shall be required for classifying a financial asset where sale of some of these assets is anticipated. In such cases, management needs to determine whether the particular activity involves one business model with some infrequent sale of assets, or whether there are two business models where one is held for collecting contractual cash flows while the other could be sold in future. However, an entity that actively manages a portfolio in order to realise fair value changes, or a portfolio that is managed and whose performance is evaluated on a fair value basis, does not hold the asset under a business model to collect contrac-tual cash flows. Such instruments would not qualify for amortised cost measurement; hence the portfolio would be subsequently remeasured at fair value every reporting date.


5.    Option to designate financial asset at FVTPL

Like IAS 39, an entity can choose to designate a financial asset which otherwise would qualify for amortised cost accounting as measured at FVTPL only if it eliminates or significantly reduces a recognition or measurement inconsistency that otherwise would arise from measuring financial assets or liabilities, or recognising gains or losses on them, on a different basis. The election is available only on initial recognition of the asset and is irrevocable.

For instance, an entity may have issued foreign currency convertible bonds (FCCB) that is measured at fair value in entirety. These funds were utilised in investment of fixed rate bonds and met the amortised cost criteria in accordance with IFRS 9. This would lead to accounting mismatch as the liability is mea-sured at fair value while the asset is measured at amortised cost. This accounting mismatch can be significantly reduced by designating the financial asset at fair value through profit or loss as per IFRS 9.

IAS 39 also permitted an entity to designate a financial asset at FVTPL in two other scenarios.

    IAS 39 permitted designating financial asset at FVTPL if the portfolio consists assets managed on a fair value basis. For instance, an entity may hold a portfolio of debt securities. The entity manages the portfolio to maximise its returns (i.e. interest and fair value changes) and evaluates its performance on that basis. In such a case, IAS 39 permitted the entity to designate the portfolio as FVTPL.

As discussed above, these assets cannot qualify for amortised cost measurement under IFRS 9 and therefore are required to be measured at fair value.

  a)  IAS 39 permitted hybrid instruments (containing an embedded derivative and the host contract) to be designated as FVTPL. Under IFRS 9, hybrid instrument as a whole is assessed for classification as amortised cost or FVTPL. If not classified as at amortised cost, entire instrument is measured at fair value through profit or loss. Point 9.4 below explains the difference in the accounting treatment under IAS 39 and IFRS 9 with an example.

    Option to designate investment in equity shares at fair value through other comprehensive income (FVOCI)

6.1. Initial designation

The standard allows an entity, at initial recognition only, to elect to present changes in fair value of an investment in an equity instrument (not held for trading) in ‘Other comprehensive income’ (‘OCI’). The election is irrevocable and can be made on an instrument-by-instrument basis. However, investments in associates and joint ventures for venture capital organizations, mutual funds, unit trusts are not permitted such an option on account of equity accounting or proportional consolidation.

6.2. Subsequent measurement of equity instruments

IFRS 9 requires all investments in equity instruments (including unquoted equity instruments) to be measured at fair value. IFRS 9 permits cost to be an appropriate estimate of fair value of unquoted equity instruments in very limited circumstances.

6.3. Accounting implications on profit or loss

The amounts recognised in OCI are not recycled to profit or loss on disposal of the investment. However, dividend income on these investments continues to be recogn-ised in profit or loss, unless the dividend clearly represents a repayment of part of cost of the investment. Under IFRS 9, no separate impairment loss is to be recognised in profit or loss even if the equity invest-ment is designated as FVOCI.
 

7.    Reclassifications

7.1. Change in business model

Classification of financial instruments is determined on initial recognition. Subsequent reclassification is prohibited. However, when an entity changes its business model in a way that is significant to its operations, a re-assessment is required of whether the initial classification remains appropriate. The standard expects such changes to be very infrequent and demonstrable to external parties.

7.2. New carrying value

If a financial asset is reclassified from fair value measurement to amortised cost measurement, then the fair value at the reclassification date becomes the new carrying amount. Conversely, if a financial asset is reclassified from amortised cost measurement to fair value measurement, then the fair value at the reclassification date becomes the new carrying amount and the difference between amortised cost and fair value is recognised in profit or loss.

7.3. Reclassification date

The reclassification date is the first day of the next reporting period. The reason that the reclassification date is different from the actual date of change in business model is that the IASB did not want to allow entities to choose a reclassification date to achieve an accounting result. Thus, from the date of change in business model until the reclassification date, financial assets continue to be accounted as if the business model has not changed.

8.    Embedded derivatives

8.1. Embedded derivatives on financial asset host

Under IAS 39, embedded derivatives on financial assets hosts are assessed whether they need to be accounted separately. If the embedded derivative is separated from the host contract, the embedded derivative is measured at fair value while the host could be measured at amortised cost. IFRS 9 requires an entity to assess whether the hybrid instrument (i.e. host with embedded derivative) being a financial asset within the scope of the standard meets the criteria provided in the standard for amortised cost measurement. If the amortised cost measurement criteria are fulfilled, the entire hybrid instrument is measured at amortised cost (Refer 9.4 below). Else, the entire hybrid instrument is measured at fair value (Refer 9.3 below). However, in both cases, the embedded derivative is not separated.

8.2. Embedded derivatives on non-financial asset host

IFRS 9 does not change the accounting prescribed under IAS 39 for embedded derivatives with host contracts that are not financial assets within the scope of the standard. E.g. rights under leases, insurance contacts, financial liabilities and other non-financial assets

9.    Examples for classification under IFRS 9 and IAS 39

9.1. Investment in quoted as well as unquoted equity instruments

    Under IAS 39, the investments shall be classified as Available-for-sale (AFS), unless held for trading, and measured at fair value every reporting date. The fair value changes shall be recognised in OCI. The entity may also have recorded the unquoted equity instrument at cost based on the exemption given in IAS 39.

    Under IFRS 9, the investment does not meet the criteria for amortised cost measurement. Hence they will be measured at fair value at every reporting date. The fair value changes shall be recognised in profit or loss, unless the entity elects to recognise the same in OCI.

9.2. Investment in quoted debt securities

    Under IAS 39, an investment in a debt instrument quoted in active market is not permitted to be classified as loans and receivable category. Hence, these investments shall be classified as Available for sale unless there is a stated intent and ability to hold the instrument to maturity (in which case, the instrument would be classified as Held to Maturity and measured at amortised cost)

    Under IFRS 9, if the objective of the business model is to collect solely principal and interest on the principal, then the instrument shall be subsequently measured at amortised cost. Thus, the fact that the debt instrument is quoted in active market has no impact on classification of financial asset.

9.3. Investment in Convertible bonds (at the option of investor)

    Under IAS 39, the presence of the con-version feature that is exercisable by the investor precludes classification as HTM category. Such convertible bonds are clas-sified as AFS by the investor. Further, the embedded conversion option shall have to be separately accounted for.

    Under IFRS 9, the conversion option shall preclude the amortised cost measurement as the investment shall not be considered to collect solely principal and interest. The entire instrument shall be classified at fair value through profit or loss (FVTPL) with fair value changes reported in income state-ment.


9.4. Prepayment options with reasonable additional compensation for early termination

    Under IAS 39, if a debt instrument has a prepayment option that permits the holder to redeem the debt instrument for an amount that is approximately equal on each exercise date to the amortised cost of the debt instrument, such option is deemed to be closely related to the host and does not require separation.

    IFRS 9 does not preclude amortised cost classification for a financial asset with a prepayment option when the prepayment amount substantially represents unpaid amounts of principal and interest, including reasonable additional compensation for early termination. Thus, in some cases, amortised cost accounting may be possible for the entire hybrid contract under IFRS 9, while separation of prepayment option may be required under IAS 39.

9.5. Term extending options

    Under IAS 39, term extending option is an embedded derivative. The embedded derivative does not require separation if the rate of interest for the extended period approximates to the market rate of interest at the time of obtaining extension. Else, the derivative would require separation.

    Under IFRS 9, amortised cost classification
 

for a term extension option is not precluded if the instrument is held under a business model whose objective is to collect contractual cash flows. Thus in such cases, the entire hybrid instrument shall be carried at amortised cost.
 

    Summary of key differences between IAS 39 and IFRS 9

Particulars

IAS 39

IFRS 9

1.

Categories  of

There are four categories of financial

There are two categories of
financial assets:

 

financial assets

assets:
(a) Held-to-maturity; (b) Loans

(a) Fair value through profit or loss and

 

 

and
receivables, (c) Available for sale,

(b)
Amortised cost

 

 

(d) Fair value through profit or loss.

 

 

 

 

 

2.

Embedded
de-

Under
IAS 39, the embedded derivative

Under
IFRS 9, the hybrid instrument shall

 

rivatives
on a

is
assessed whether it is closely related

be assessed for amortised
cost classification

 

financial asset

to the
host contract. If closely related,

in its
entirety. If the amortised cost clas-

 

 

the
embedded derivative is accounted

sification criteria are met, the entire instru–

 

 

separately
from the host contract at

ment is
measured at amortised cost. Else,

 

 

fair
value.

the
entire hybrid instrument is measured

 

 

 

at fair
value.

 

 

 

 

3.

Equity
instru-

All
equity instruments that are classi-

All instruments, other than those classified

 

ments

fied as AFS securities are subsequently

as
amortised cost, shall be classified as

 

 

measured
at fair value with changes

FVTPL.
However, in case of investment in

 

 

recognised
in OCI. On disposal of

equity
instruments, an entity has an option

 

 

AFS
securities, the fair value changes

to
designate individual equity instruments

 

 

recognised
in OCI are recycled to the

as
FVOCI. In such case, the fair value

 

 

income
statement.

changes
are recognised in OCI. However,

 

 

 

these
fair value changes are not recycled

 

 

 

to the
income statement on disposal.

 

 

 

 

4.

Designation
of

Apart
from accounting mismatch, IAS

IFRS 9
provides an option to designate any

 

financial assets

39 permits designating financial assets

financial asset at FVTPL only to eliminate

 

as
FVTPL

as at
FVTPL in two other scenarios: (a)

or
substantially reduce accounting mis-

 

 

the portfolio
of assets is managed on

match. As discussed above, the classifica–

 

 

a fair
value basis and performance is

tion in case of a portfolio of financial
assets

 

 

evaluated
on that basis; or (b) it is a

managed
on fair value bases and a hybrid

 

 

hybrid
instrument

instrument
(i.e. embedded derivative on a

 

 

 

financial asset) shall be
classified as FVTPL

 

 

 

(without
providing any option).

 

 

 

 

The standard is effective for annual periods beginning on or after 1 January 2013. Early application is permitted.
 

The standard has given certain transitionary provisions which provide guidance on how companies who are currently following IAS 39 principles can transition to IFRS 9 within the period when the standard is issued and the effective date of application referred above.

The transitionary provision also provides guidance on classification and measurement of financial as-sets existing on the date of initial application of IFRS 9.

IFRS – Is it a smooth drive for auto companies?

IFRS

IFRS – Is it a smooth drive for auto companies?


Notwithstanding the recent representation by a leading
industry body to defer the implementation of IFRS in India, the automotive
industry is watching closely, as the events unfold on the roadmap for IFRS
transition in India. Several phase 1 auto companies that are in the advanced
stage of IFRS transition realise that some of the IFRS related changes could
have a significant impact on the financial and business parameters. This article
attempts to highlight some of the key IFRS impact areas for the auto industry in
relation to (a) Revenue recognition; (b) Property, plant and equipment, (c)
capital structure and (d) group structure.

Revenue recognition

Timing of recognition of revenues

Currently under Indian GAAP (hereafter referred to as IGAAP),
many auto companies recognise revenues on dispatch of the product for sale from
the production unit, which coincides with transfer of legal title of goods.
However, as per IFRS, revenue can be recognised only when significant risk and
rewards are transferred to the buyer and the seller does not retain managerial
involvement or effective control over the goods sold.

For example, for domestic sales, if the company bears the
risk of damage/loss to vehicles before it reaches the dealer/customer, then
revenue recognition may need to be deferred till delivery.

In the auto sector, a significant proportion of revenue comes
from month-end billings. There is a possibility that revenues from such
month-end billing may get deferred to the next quarter or fiscal year when the
revenue recognition criteria are met. This may result in a one-time impact (but
will be balanced out on an ongoing basis) on the company’s financials due to the
IFRS transition. Companies may have to align their internal processes so that
they can fulfill the revenue recognition criteria as prescribed under IFRS.

Customer incentives and discounts

Auto companies offer a range of dealer discounts and
incentives (including free service coupons to ultimate customers) to boost their
sales. Under IGAAP, the majority of such discounts and incentives are recognised
as sales promotion expenses, while the sales are reported gross of such
incentives. Under IFRS, all forms of discounts and incentives to the dealers are
recognised as a reduction of revenue. As such, revenues are presented net of
related discounts/incentives. Though such IFRS adjustment may not have an impact
on the profits for the year, they do impact the revenues and key ratios related
to revenue (for example, gross profit margins).

Warranties

Auto companies usually offer two types of warranties (i)
initial warranty that is bundled along with every vehicle sold without any
additional cost and (ii) extended warranty (commencing after expiry of initial
warranty) that is offered to the customer as per their choice and for a price.

Under IGAAP, as the initial warranty is not identified as a
separate element of the contract, sales are recorded for the full amount at the
time of the delivery of the vehicle. Correspondingly, a provision (calculated at
the amount of expected undiscounted cost to be incurred on meeting the warranty
obligation) is recognised upfront. Under IFRS, similar accounting treatment is
required for ‘normal’ warranties, except that the provision is required to be
discounted.

In case of ‘extended’ warranties, the contract contains
multiple elements i.e. sale of vehicles and sale of extended warranty. Under
IGAAP, there is no specific guidance on accounting for multiple elements in a
contract, and practice varies. Under IFRS, the price attributable to the
extended warranty is required to be deferred and recognised in income statement
over the extended warranty period.

The revenue attributable to the extended warranty may be
calculated based on the relative fair value method (relative fair values of sale
of vehicle and the extended warranty) or the residual fair value method (the
fair value of extended warranty is deferred).

Property, plant and equipment

Component approach for depreciation

Currently, most companies apply schedule XIV rates for
providing depreciation on assets. As such, the entire depreciable amount (i.e.
cost less residual value) is depreciated over the useful life estimated under
Schedule XIV to the Companies Act, 1956. Any replacement of significant
component is generally charged to profits as repairs cost.

Under IFRS, companies would be required to depreciate an
asset over its useful life, which may be different from industry benchmarks.
Further, if the asset includes a component, that can be readily identifiable; is
of significant value in relation to the asset; and has a significantly different
useful life; IFRS requires to treat such components as akin to separate assets.
Such components are depreciated over the component’s useful life and the
replacement of such a component is treated as akin to replacement of an asset
(i.e. disposal and fresh purchase).

As depreciation under IFRS may undergo a change, a
corresponding impact may also arise on valuation of inventories.

Contracts with suppliers

Automobile companies maintain vendor parks where suppliers
are in close proximity to the main plant to supply components used in the
manufacture of vehicles. Most of these vendors exclusively serve the plant, and
the automobile company enters into take-or-pay arrangements (such as a minimum
procurement guarantee or a per unit fee along with a fixed annual fee), whereby
the vendor will recover their capital costs irrespective of the actual off-take
from the company. In substance, under IFRS, maintaining exclusive assets against
fixed recoveries of capital costs make it a lease arrangement where the auto
companies are deemed to have taken the vendor’s assets on lease. Under IGAAP,
such contracts are not construed as a lease. Once the arrangement is classified
as a lease, it is further classified as an operating or financial lease
depending on the terms.

If the arrangement contains a financial lease, the fair value
of the asset is recognised on the automobile company’s balance sheet, increasing
its asset base and debt levels, while the impact on the income statement will be
in the form of depreciation on the leased asset and interest payment for the
lease. Under IGAAP, such expenditure would be recognised as part of operating
expenses. This treatment would have a positive impact on the EBITDA of the
company.

From the perspective of inventory valuation for the auto company, the entire payments may be construed as the cost of inventories under IGAAP. However, under IFRS, as charge to the income statement over a period of time would be in the form of depreciation on the leased assets and interest on lease obligation, the interest component may not be considered as cost of inventories.

Intangibles with indefinite useful lives

IGAAP requires all intangibles to be amortised over their useful life, though there is a rebuttable presumption that the useful life of an intangible asset will not be greater than ten years. Under IFRS, there is an additional category of intangible asset i.e. intangible assets with indefinite useful life. The term ‘indefinite’ here does not denote ‘infinite’; instead it denotes a useful life that is relatively long and is not certain eg: brands if they meet certain conditions as detailed in the standard. Such intangible assets are not amortised; rather they are tested for impairment atleast once annually.

Capital structure and borrowing costs
Sales tax deferral loan

Auto companies that have set up plants in certain notified areas are eligible to collect sales tax from customers and are required to pay the same after a few years without any interest charge, based on their total investment in the region. Under IGAAP, such interest-free loans are recognised at the amount collected throughout the tenure of the loan.

Under IFRS, such loans would be considered as financial liabilities and hence recognised at the present value of future cash flows. The difference between the nominal value (i.e., the amount collected from customers) and the present value of the loan would be recognised as a deferred government grant. The difference between the present value and the nominal value of the loan would be recognised as reduction in the value of the underlying fixed assets, or as a deferred income over the depreciable life of the underlying asset.

Borrowing costs

The borrowing costs under IGAAP are primarily determined based on the coupon rates on the financial instrument. As such, the borrowing costs in most cases represent an actual and separately earmarked cash outflow.

Under IFRS, the borrowing cost also includes the effects of routine non-lending transactions that also comprise a financing element. Consider, for instance, the above mentioned sales tax deferral loan. As stated above, the loan liability, which is initially calculated at the present value of future cash flows, shall subsequently be measured at amortised cost and the effects of unwinding of the discount would be recognised as borrowing costs.

Further, if the borrowing cost is attributable to the construction of a qualifying asset as defined under IAS 23, then such effects of unwinding of the loan liability shall also be capitalised to the carrying value of qualifying asset though there is no separate payment of interest made on the loan.


Securitisations

Stringent conditions for securitisation of loans will impact the financing arms of auto companies. Under IGAAP, an entity may de-recognise its assignments of loans and advances with credit enhancements as a ‘sale’ transaction.

Under IFRS, the assessment of retention or transfer of risks and rewards is a critical criterion to determine if de-recognition is appropriate. Legal transfer is not sufficient criteria to achieve ‘sale’ accounting.

Qualitative factors such as credit enhancement facilities provided by the originator to the special purpose trust or to a counterparty in the case of a direct assignment will also have to be evaluated to assess if the de-recognition criteria is met.

This may result in grossing-up of the balance sheet for ‘sold’ assets and related debt (sale proceeds). This, in turn, may impact debt equity ratios.

Group structure
Joint arrangements Under IFRS, consolidation is based on the control (both direct and indirect) over the entity rather than ownership. This may result in consolidation of some current JVs and associates and de-consolidation of certain JVs and subsidiaries based on contractual arrangements.

In the auto industry, the partnerships between Indian and foreign auto companies, where the Indian company may hold a majority stake but has shared control with the foreign company, may be impacted under IFRS eg: veto power with the foreign partner for approval of annual budgets and operating plans etc.

Based on the above guidance, if the consolidated entity is classified as an associate or a joint venture, the company would not be able to disclose the entire revenue of the investee in its consolidated financial statements.

Special Purpose Entity (SPE)

IFRS provides indicators to determine whether an entity controls an SPE, including an assessment of an entity’s exposure to the majority of risks and rewards of ownership of the SPE. Therefore, if the ‘control’ criteria over the SPE are met, the entity will be required to consolidate the SPE in its financial statements, even though it may have no legal ownership of the equity shares of the SPE.

In the automotive sector, the entity operates through a wide network of auto component manufacturers that work on an auto-pilot mechanism or are funded by the automotive company. Such arrangements need to be assessed for SPEs. If such entities are classified as SPEs and meet certain criterias, the SPEs are consolidated with the entity. Thus, all the assets and liabilities of these SPEs are recognised in the entity’s consolidated financial statements, thereby affecting key ratios of the entity. IGAAP does not provide for such guidance.

The financial and non-financial aspects relating to IFRS convergence need to be planned and tested in advance of the implementation date. Global experience has shown that the early adopters are generally more successful in managing the overall IFRS transition. The early-mover advantage not only provides adequate time to carry out required changes, but protects critical decisions being taken within the constraints of time and resources.

IFRS reconstructs the accounting for Public Private Partnerships (‘PPP’)

IFRS

In India, many infrastructure contracts are executed on BOT
(build, operate and transfer) terms under which a company enters into a
contractual agreement with the government or any quasi-government agency to
construct an asset (for example, a road) and to operate it for a specified time
period, before transferring the asset back to the government at the end of the
contracted term.

BOT arrangements are common in areas such as roads, bridges,
airports and power plants. Under such arrangements, there are mainly two types
of contracts : (1) a fixed annuity-based contract under which the operator
company builds the infrastructure asset and gets annuity from the grantor (i.e.,
government body); and (2) a usage based (i.e., toll-based) contract under
which the operator builds the infrastructure asset and collects toll from users.

Under existing Indian GAAP (‘IGAAP’), companies recognise the
infrastructure asset as their own fixed asset, and depreciate it over the
concession period. The amount received from the government and the users of the
infrastructure asset is recognised as income over the period of the concession.
The accounting treatment for such contracts will change under International
Financial Reporting Standards (‘IFRS’). IFRIC 12 (IFRICs are interpretations to
IFRS) on Service Concession Arrangements provides guidance on accounting for
such
arrangements.

Scope of IFRIC 12 :

IFRIC 12 applies to public-to-private service concession
arrangements in which the grantor controls and/or regulates the services
provided and the price, and controls any significant residual interest in the
infrastructure.

Whether or not an arrangement is within the scope of IFRIC 12
will affect the nature of the assets that the operator recognises. For example,
for an arrangement that is within the scope of IFRIC 12, the operator does not
recognise public service infrastructure as its property, plant and equipment (PPE).

Public-to-private service concession arrangements :

While IFRIC 12 does not define public-to-private service
concession arrangements, it does describe the typical features of such
arrangements. Typically a public-to-private service concession arrangement
within the scope of IFRIC 12 will involve most of the following :

(a) Infrastructure is used to deliver public services :

IFRIC 12 states that a feature of public-to-private
arrangements is the public service nature of the obligation undertaken by the
operator.

(b) A contractual arrangement between the grantor and
the operator :


This is the agreement, often termed as concession
agreement, under which the grantor specifies the services that the operator is
to provide and which governs the basis upon which the operator will be
remunerated.

(c) Supply of services by the operator :


These services may include the construction/upgrade of the
infrastructure and the operation and maintenance of that infrastructure.

(d) Payment of the operator over the term of the
arrangement :


In many cases the operator will receive no payment during
the initial construction/upgrade phase. Instead, the operator will be paid by
the grantor directly or will charge users during the period that the
infrastructure is available for use.

(e) Return of the infrastructure to the grantor at the
end of the arrangement :


For example, even if the operator has legal title to the
infrastructure during the term of the arrangement, then legal title may
transfer to the grantor at the end of the arrangement, often for no additional
consideration. In most such arrangements in India, legal title does not pass
on to the operator even during the concession period.

Public-to-private service concession arrangements within the
scope of IFRIC 12 :

The scope of IFRIC 12 is defined by reference to control of
the infrastructure. An arrangement is within the scope of IFRIC 12 if :

(a) the grantor controls what services the operator must
provide with the infrastructure (control of services);

(b) the grantor controls to whom it must provide them
(control of services);

(c) the grantor controls at what price services are charged
(control of pricing); and

(d) the grantor controls through ownership, beneficial
entitlement or otherwise, any significant residual interest in the
infrastructure at the end of the term of the arrangement (control of the
residual interest).


Control of services :

The grantor may control the services to be provided by the
operator in a number of ways. For example, the services may be specified through
the terms of the concession agreement and/or a licence agreement and/or some
other form of regulation. All of these forms of control are consistent with the
scope criteria of IFRIC 12. Furthermore, the degree of specification of the
services may vary in practice. In some cases the grantor will specify the
services to be provided in detail and by reference to specific tasks to be
undertaken by the operator. In other cases the grantor will specify the services
that the infrastructure should have the capacity to deliver.

Control of pricing :

The grantor may control or regulate the pricing of the
services to be provided using the infrastructure in a variety of ways. The
criterion in IFRIC 12 is generally satisfied when the service concession
involves explicit and substantive control or regulation of prices.

In some cases, particularly when the grantor pays the
operator directly, prices (or a price formula) may be set out in the concession
agreement. In other cases prices may be re-set periodically by the grantor, or
the grantor may give the operator discretion to set unit prices but set a
maximum level of revenue or profits that the operator may retain. All of these
forms of arrangement are consistent with the control criteria in IFRIC 12.

Control of residual interest :

The simplest way in which the grantor may control the residual interest is for the concession agreement to require the operator to return all concession assets to the grantor, or to transfer the infrastructure to a new operator, at the end of the arrangement for no consideration. Such a requirement is a common feature of service concession arrangements involving concession assets with long useful lives, such as road and rail infra-structure. However, other forms of arrangement also are within the scope criteria of IFRIC 12.

‘Whole-of-life’ arrangements, that is, arrangements for which the residual interest in the infrastructure is not significant, are within the scope of IFRIC 12 if the other scope criteria are met.

Accounting for public service infrastructure cost and related revenue:
Accounting for construction/upgrade of infra-structure:
Under IGAAP, the operator recognises the infra-structure as its PPE. However for arrangements within the scope of IFRIC 12 under IFRS, the operator does not recognise public service infrastructure as its PPE, as the operator does not control the public service infrastructure. The control require-ment is determinative irrespective of the extent to which the operator bears the risks and rewards of ownership of the infrastructure.

IFRIC 12 characterises operators as ‘service providers’, who should recognise revenue in accordance with the stage of completion of the services as measured by reference to the fair value of the consideration receivable. This is irrespective of whether the sale consideration is guaranteed by the grantor or is variable based on the usage of infrastructure asset.

Accounting for sale consideration:

The operator recognises consideration received or receivable for providing construction/upgrade services as a financial asset and/or as an intangible asset depending upon the assessment of demand risk.

The operator recognises a financial asset to the extent that it has an unconditional right to receive cash from the grantor irrespective of the usage of the infrastructure.
The operator recognises an intangible asset to the extent that it has a right to charge fees for usage of the infrastructure.

Assessment of demand risk:

The grantor bears the demand risk to the extent it guarantees certain minimum sale consideration irrespective of the usage of the asset. To the extent the grantor bears the demand risk, the operator recognises a financial asset.

Where an arrangement does not guarantee sales consideration and the consideration is linked to the usage of the infrastructure, the demand risk rests with the operator. In such cases, the operator recognises an intangible asset. Even in cases where the arrangement provides a cap on total consideration to be collected from users but does not guarantee minimum sales consideration, the operator shall recognise an intangible asset.

Impact of borrowing costs:

Under IGAAP, borrowing costs incurred during the construction phase are capitalised as part of qualifying fixed assets. Under IFRS, the treatment of borrowing costs differs depending on whether the arrangement qualifies under the financial asset model or the intangible asset model (as discussed above) . In the intangible asset model, the borrowing costs are required to be capitalised to the intangible asset. However, in the financial asset model, the borrowing costs are charged to profits, as financial assets cannot be qualifying assets under borrowing cost standard (i.e., IAS 23).

Recognition and measurement of revenue:

We look at the recognition and measurement of revenue under both the above scenarios — financial asset model and intangible asset model.

Financial asset model:

When the demand risk is with the grantor (i.e., the grantor guarantees the collections that will be recovered over the concession arrangement), the arrangement is said to contain deferred payment terms where the construction revenue is recognised at fair value. It is subsequently measured at amortised cost; i.e., the amount initially recognised plus the cumulative interest on that amount cal-culated using the effective interest method minus repayments. Thus, the overall consideration is broken down into revenue and interest income.

Intangible asset model:

For arrangements where the operator earns revenue purely from collection of tolls that are not guaranteed by the grantor, the right to collect the toll revenue is obtained as a consideration for rendering construction services to the grantor. For accounting purposes, these transactions are treated as barter arrangements. Thus, for such infrastructure projects, companies are required to recognise construction revenue (corresponding amount is debited to the intangible asset i.e., right to collect toll revenue from users) during the course of the construction period; and the toll revenue is recognised separately on collection. The intangible asset is amortised to the income statement over its useful life.

As such, the total amount of revenue recognised over the term of the arrangement is greater than the cash flows received during the period.

Subsequent measurement of financial asset:

The operator accounts for any financial asset it recognizes in accordance with the financial instruments standards (i.e., IAS 39) . There are no exemptions from these standards for operators. As such, the operator is required to classify the financial asset as a loan or receivable, available-for-sale, or at fair value through profit or loss if so designated. Generally, such assets are recorded as loans and receivables.

Subsequent measurement of intangible asset:

IAS 38 allows intangible assets to be measured using either the cost model or the revaluation model. The revaluation model is permitted to be used only if there is an active market for that asset. In most cases there will be no active market for intangible assets recognised under service concession arrangements, and therefore the cost model will be used.

Under the cost model the intangible asset is measured at its cost less any accumulated amortisation and any accumulated impairment losses. The depreciation is based on the asset’s economic useful life, which is generally the concession period.

Financial statement impact for operators on transition to IFRS:
Construction phase of the arrangement:

Under IGAAP, the operator recognises the cost of construction of infrastructure as part of its fixed assets. The fixed assets are depreciated over its useful life (usually over the concession period). Under IFRS, the costs incurred during the construction phase are recognised in income statement as construction

costs (along with the corresponding construction revenue). As the construction cost is recognised upfront in income statement, there would be no impact of depreciation in future years. Thus cost recognised in income statement during initial years is higher under IFRS as compared to IGAAP. Further under IGAAP, no revenue is recognised during the course of the construction phase of the concession arrangement. Under IFRS, revenue is recognised during the course of construction activities (in line with construction cost, based on percentage of completion method). Thus, companies will recognise higher revenues and costs (and higher profits) during the construction period.                

Operation revenue:                
                
Under IGAAP, revenue is recognised during the operations phase based on the terms of the concession arrangement. Under IFRS, revenue is recognised depending on whether the concession arrangement falls into financial asset model or intangible asset model. When the operator recognises an intangible asset during the construction phase (i.e., it receives a right to collect fees that are contingent upon the extent of use of the public service), it recognises operation revenue as it is earned i.e., the toll collection is recognised as revenue. Thus there is no impact of IFRS transition on revenue recognition during operations phase. The intangible asset recognised during the construction phase is amortised to income statement over the term of the concession arrangement. Further unlike IGAAP where the fixed asset is capitalised at cost, IFRS requires capitalisation of the intangible asset based on the fair value of construction services. Thus in most cases, the carrying value of intangible asset and related depreciation/amortisation would be higher under IFRS.


When the operator recognises a financial asset during the construction phase (i.e., it receives an unconditional right to receive cash that is not dependent upon the extent of use of the public service), a portion of payments received during the operation phase is allocated to reduce this financial asset (including related imputed interest income. Thus revenue recognition during the operations phase is severely impacted, as a portion of the revenues currently recognized during the operations phase would be adjusted as a recovery of the financial asset.

The table alongside provides a summary impact of the service concession arrangements on transition to IFRS.

Impact of IFRS beyond accounting:

Indian Industry is cautious of the financial statement impact on account of transition to IFRS. However, contrary to the general belief, the impact of transition to IFRS is not restricted to impact on profits and equity.

Financial budget:

On account of transition to IFRS, the financial budgets and performance matrices would undergo a change. Consider, for instance, revenue recognition under financial asset model where the construction revenue is recognised during the course of the construction phase and only interest income/operations revenue recognised during the term of the concession arrangement. This may impact key performance indicators which form a basis on incentive payments to senior employees and also bank covenants (asset cover age ratio, etc.).

Communication with stakeholders:

Management would need to keep stakeholders informed on the change in profitability due to transition related issues.

Contractual impact:

Certain grantors charge companies a certain revenue share every year (which is a percentage of the reported revenues). In case of PPP arrangements accounted under the intangible asset model, total reported revenue is much higher than cash flows earned (as explained above), since the revenue reported during the construction phase is notional. This may lead to higher leakage of regulatory dues which are based on reported revenues.

Similarly, even in the case of a financial asset model, acceleration of revenue recognition (during the construction period) would result in acceleration of contractual cash payments for revenue share (even though the revenues reported have not been realized in cash).

Taxes:

There is a need felt for more clarity on taxation matters vis-à-vis IFRS transition, especially around GST and MAT.

Regulatory:

It remains to be seen whether the statutory financial statements that will now be prepared under IFRS will be accepted for the purposes of filing business plans with banks for borrowing purposes and with RBI/FIPB for investment purposes.

Redefining the systems, processes and data points:

Capturing information under IFRS at a transaction level would pose a significant challenge, atleast in the initial years. The biggest hindrance will be faced on reconfiguration of IT systems, where the investment of time, cost, resources and complexity should not be underestimated. Further, the entity needs to be relook at the process of collecting additional data required under IFRS and make consequential amendment to the internal controls.

While industry believes that the change in the accounting framework is a step in the right direction, they are in the process of estimating the exact impact on their business. The financial and non-financial aspects relating to the IFRS convergence need to be planned and tested in advance of the implementation date. Global experience has shown that the early adopters are generally more successful in managing the overall IFRS transition. The ear-ly-mover advantage not only provides adequate time to carry out required changes, but protects critical decisions being taken within the constraints of time and resources.

succession, survivorship, inheritance, purchase, partition, mortgage, gift, lease, etc., in any land, then he must give a notice of the same to the Talathi within three months of such event.

The Talathi would then enter such changes in a Register of Mutations which would alter the original record of rights.

5.4 Any person buying land especially in a rural or semi-urban area would be well advised to do a thorough title search by checking the Record of Rights, Register of Mutations, etc., which would show whether or not the land in question is an agricultural land, who is the owner, what important developments have taken place in respect of the land, etc.

5.5 In the next Article we shall look at the process for converting an agricultural land into a non-agricultural land.

IFRS — Closer to economic substance of the transaction

IFRS

One of the important aspects of convergence is that financial
reporting will be better aligned to the true economic substance of a
transaction. ‘Substance over form’ is one of the most important principles on
which International Financial Reporting Standards (‘IFRS’) are based. Detailed
Implementation Guidance (IG) and Basis of Conclusion (BC) for the accounting
treatment prescribed in the respective standards explain the underling economic
rationale for such treatment, which acts as a guide in implementation of the
intent behind the standards.

In general, Indian GAAP also tends to be principle focussed.
However, there are a number of areas where accounting guidance deviates from the
underlying economic substance (e.g., accounting for business
combinations, service concession arrangements or multiple element deliverables)
or in other situations tends to be prescriptive in nature (e.g.,
accounting for loan impairment losses by a bank, accounting for depreciation on
property, plant and equipments based on minimum rates prescribed). Similarly,
accounting is often governed by the terms of the legal contract.

This article highlights some of the important areas where the
accounting under IFRS is closer to the economic substance of the transactions as
compared to Indian GAAP.

Revenue arrangements with multiple deliverables (IAS 18) :

IAS 18 requires, in certain circumstances, to apply the
recognition criteria to each separately identifiable component of a single
transaction in order to reflect the underlying substance of the transaction.
Thus, under IFRS, multiple deliverable transactions (e.g., product sales
and subsequent servicing) are viewed from the perspective of the customer. What
does customer believe that he is buying ? If the customer believes that he is
buying a single product, the recognition criteria should be applied to the
transaction as a whole. Conversely, if the customer believes that there are a
number of elements to the transaction, then the revenue recognition criteria is
applied to each element separately.

Similarly, in certain cases the standard requires the
recognition criteria to be applied to two or more transactions together when
they are linked in such a way that the commercial effect cannot be understood
without reference to the series of transactions as a whole. Once again, the
focus is on the substance and the economic rationale for the transactions.

Example

Entity A sells software with an annual maintenance service
for a total consideration of Rs.1000. Entity A also provides similar annual
maintenance service to other customers at a consideration of Rs.200. In this
case, the sale of the software and maintenance contract would be regarded as
separate components. Revenue from the sale of the software Rs.800 (1000 — 200)
will be recognised when the software is delivered and other revenue recognition
principles are met, and revenue from rendering of maintenance services will be
recognised on a straight-line basis over one year. Now consider a situation
where the same contract is structured in a different manner and the sales
contract itself provides that the ‘price’ of the software is Rs.900 and the
price of the annual maintenance service is Rs.100. Typical practice under Indian
GAAP is to recognise revenue of Rs.900 upfront and recognise only Rs.100 as the
revenue over the maintenance period. Thus, what gets accounted is the legal form
of the contract and not the true economic substance of the sale transaction.
However under IFRS these two transactions will be linked together and each
component i.e., sale of software and annual maintenance service will be
accounted at its fair value i.e., Rs.800 and Rs.200 irrespective of the
values denominated in the contract, thereby reflecting the true economic
substance.

Consolidation based on control (IAS 27, IAS 28 and IAS 31) :

Definition of control under Indian GAAP is different from the
definition under IFRS. Indian GAAP permits consolidation based on the
ownership of majority of voting power or the ability to control the
composition of Board of Directors. Thus, under Indian GAAP it is possible for
two entities to have ‘control’ over one investee company and both companies will
need to account the investee as a subsidiary.

The definition of control under IFRS has two parts, both of
which need to be met in order to conclude that one entity controls another :

(a) ‘the power to govern the financial and operating
policies of an entity’

(b) so as to obtain benefits from its activities.

The implication of the control principles under IFRS is that
companies cannot consolidate an entity only based on holding of current voting
interests. Since consolidation is based only on control, only one holding entity
will practically be able to demonstrate such control and hence there will never
be a scenario where the same entity is being consolidated by two separate
holding entities as a subsidiary.

Under IFRS, rights of each shareholder need to be carefully
evaluated by examining the shareholder’s agreement to determine the entity,
which has control, for consolidation. For example, an entity may own more than
50% of the voting rights in another entity and accordingly is able to
consolidate that entity with itself, currently under Indian GAAP. However due to
certain veto rights given to minority shareholders contractually, it may not be
in a position to unilaterally control that entity, and therefore may not be able
to consolidate that entity under IFRS as a subsidiary.

Example :

Two companies A and B come together to form a company X in
which company A holds 75% with 3 directors on the board of company X and company
B holds 25% with 2 directors on the board of company X. By virtue of majority
holding, company A consolidates Company X as a subsidiary under Indian GAAP. The
Articles of Association of company X states that for certain decisions, a
unanimous approval of the board of directors is required. These decisions
include approving the annual and semi-annual budgets of the company and
selection and appointment of senior management personnel. In such a case, under IFRS, company A does not control company
X, instead it shares joint control over it along with company B. Hence it shall
not consolidate company X as a subsidiary but account for it as a joint venture
arrangement. However, under Indian GAAP, A would continue to consolidate X,
though it does not have control over the operations, which do not reflect the
true economic substance of the transaction.

Acquisition method of accounting for business combinations (IFRS 3) :

Business combinations are the acquisitions of controlling stakes in entities and businesses like mergers, acquisition of a subsidiary or purchase of net assets of a division. Indian GAAP has limited guidance on the first-time accounting for such transactions and allows the pooling of interests method or the purchase method of accounting; IFRS recognises only the acquisition method for accounting for these transactions. Hence under IFRS, all business combinations are accounted for at fair value as on the acquisition date (excluding the specific scope ex-emptions given in the standard). This process involves the identification of intangibles subsumed within goodwill like customer relationships, favourable leases; fair valuation of contingent liabilities, contingent consideration and all other acquired assets and liabilities whether recognised or unrecognised in the acquiree’s balance sheet.

The objective of this accounting is to ensure that all items where the acquirer saw value and hence paid for it, are brought onto the books of accounts at their fair values. This would ensure appropriate reflection of the factors that affected the negotiation process of the transaction in the financial statements and bring accounting closer to the economic attributes inherent in the business combination.

Initial recognition of financial assets and liabilities at fair value (IAS 39) :

Under IFRS, initial recognition of all financial assets and liabilities is mandatorily required at its fair value. This helps in reflecting the true substance of a particular transaction. Consider the following situations:

  • Low interest loans given to subsidiary: Under Indian GAAP these are accounted at transaction value, however, under IFRS these are recorded at the fair value and the initial loss is considered as an investment in the subsidiary and the subsidiary accounts for it as a capital contribution. In the subsequent years the unwinding of the initial fair value loss is treated as an interest income by the parent and interest expense by the subsidiary.

  • Low interest loans given to employees: Under Indian GAAP these are accounted at transaction value, however, under IFRS these are recorded at the fair value and the initial loss is accounted as an employee cost based on the loan terms, thereby reflecting the true intent of compensating the employees in the financial statements.

  • Interest-free  security deposit for leased premises: Under Indian GAAP these are accounted at transaction value, however, under IFRS these are recorded at the fair value and the initial loss is accounted as a prepaid rent, which is amortised over the lease period, thereby reflecting the true operating expense (rental expenditure) in the financial statements.

  • Sales tax deferral schemes: Under Indian GAAP these are accounted at transaction value, however, under IFRS these are recorded at the fair value and the initial gain is accounted as a government grant, which is deferred over the grant period, thereby reflecting the true operating results of the company each year.

Contracts denominated in ‘third currencies’ (IAS 39) :

Sale or purchase contracts in the ordinary course of business may include payment terms denominated in a third currency i.e., a currency which is not the currency of either of the contracting parties. In such circumstances, the foreign currency element in the contract should be accounted for separately from the underlying contract, unless the payments required under the contract are denominated in one of the following currencies:

  •     the currency’ in which the price of the related goods or service being delivered under the contract is routinely denominated in commercial transactions around the world; and

  •     the currency that is commonly used in contracts to purchase or sell non-financial items in the economic environment in which the transaction takes place.

‘Routinely denominated’, as noted under the first bullet above, should be interpreted narrowly, so that an oil transaction denominated in U.S. dollars is one of the few transactions that qualifies for this exemption.

The separation of foreign currency derivatives would reflect the true risks that the entity has indirectly exposed itself to, on entering into the host contract. Such an embedded derivative is carried at fair value through profit and loss account.

Example:

An Indian entity contracts to lease an aircraft from a US entity for 12 months with prices denominated in Euros. Since Euro is not the functional currency of either of the contracting parties, both the seller and the buyer are indirectly exposing themselves to fluctuations of a foreign currency by way of the underlying contract to lease the aircraft. This would be considered an embedded derivative which requires separation and would be carried at fair value in the financial statements of both the contracting parties until the settlement of the underlying contract i.e., every month the fluctuation in exchange rates attributable to unpaid lease rentals will be recognised in the income statement (like accounting for a notional forward cover to buy Euros for the remaining period) and the monthly lease payments will be recorded based on the INR/ Euro exchange rate on the contract date.

Hence although the host contract would not specify the existence of a derivative; looking at the transaction in substance would result in the identification of an embedded foreign currency derivative (notional forward) and reflect the foreign currency risk that the entity is indirectly exposed to due to the arrangement. The ultimate reporting in the financial statement would result accounting for lease rentals at a fixed rate on the contract date (which is the real commercial transaction) and all other fluctuations in the exchange rate from the contract date to the monthly payment dates will be classified as a foreign exchange gain/loss.

Embedded lease contract (IFRIC 4) :

Companies sometimes enter into normal business transactions that share many features of a lease (lease is defined in paragraph 4 of IAS 17 Leases as ‘an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time’).

Unlike Indian GAAP, under IFRS, all arrangements meeting the definition of a lease should be accounted for in accordance with IAS 17 regardless of whether they take the legal form of a lease. This determination is based on the assessment of whether:

i) the fulfillment of the arrangement (commercial transaction) is dependent on the use of a specific asset or assets; and

ii) the arrangement conveys a right to use the asset.

Examples  of such transactions    include:

  • outsourcing arrangements,

  • take or pay contracts in which purchasers make specified payments regardless of whether they take delivery of the contracted products or services.

Example:

Company A enters in a purchase contract with company B to purchase 1,000 units of C every month @ Rs.25 per unit. Product C can be manufactured on a specific machine M by company B. In case of shortfall every month, company B will compensate company A Rs.10 per unit of short-fall and entire output from machine M is availed by company A.

Under Indian GAAP, the above transaction is accounted as a normal purchase transaction @ Rs. 25 per unit. In case there is a shortfall, the payment amount is expensed as a penalty.

Under IFRS, this transaction is broken into its two constituents i.e.,

1) Lease of machine M given that company A is in substance paying a fixed amount of Rs 10 per unit to company A towards availability of machine for company A

2) Processing charges for manufacture of product C

Service  concessions    arrangement (IFRIC 12) :

IFRS contains specific guidance on public-to-private service concession arrangements under IFRIC 12. It applies to arrangements, wherein the public entity (referred to as grantor) is able to control the use of the infrastructure by specifying the nature of service, the recipient of the service and the price to be charged, and to retain significant residual interest in the infrastructure. In such cases, infrastructure is not recognised as property, plant and equipment of the private entity (referred to as operator) as the arrangement does not convey the use of the public service infrastructure to the operator. The operator, in turn, recognises and measures revenue in accordance with IAS 11 or IAS 18 for the service it performs i.e., construction, up gradation, operation, etc. The operator recognises the consideration receivable based on its nature as a financial asset or intangible asset or partly a financial asset and partly as intangible, based on the specific terms of the arrangement.

Under Indian GAAP, there is no specific guidance and this has resulted in varied practices. Generally, the operator capitalises the infrastructure cost in its books as fixed asset and revenue is recognised as services are rendered with the infrastructure. This asset is depreciated in accordance with the company’s depreciation policy or over the period of the service concession arrangement. Thus the revenue is not recognised as and when the efforts are expended and increases the volatility in the income statement with losses in initial period of a service concession arrangement and higher margins in the later period, which may not reflect the correct economic activity for a given period.

Example:

A grantor awards a concession to an operator to build and operate a new road. The grantor transfers to the operator the land on which the road is to be constructed, together with adjacent land that the operator may redevelop or sell at its discretion. Construction is expected to take 5 years, after which the operator will operate the road for 25 years. During these 25 years the operator has a contractual obligation to perform routine maintenance on the road and to resurface it as necessary, which is expected to be three times. At the end of the arrangement the road will revert to the grantor. The road is to be used by the general public. Toll for use of the road is set annually by the grantor. This arrangement is a public-to-private arrangement as the road is constructed pursuant to general transport policy and is to be used by the public. This would fall under the scope of IFRIC 12. Accordingly the operator will not recognise the road as property, plant and ‘ equipment; however he will recognise an intangible asset for the right to operate the road and collect toll from it.

Deferred taxes on unrealised profits of joint ventures/associates (IAS 12) :

Currently,    under    Indian    GAAP,    profits    of subsidiaries, branches, associates and joint ventures (‘investee companies’) are included in consolidated profits of the parent company. The consolidated performance results and net worth are accordingly reported to the shareholders of the parent under Indian GAAP. However one important aspect that is not reported is the impact of tax leakage when the profit earned by the investee companies will be transferred to the parent. Accordingly the consolidated profit and the net worth reported under Indian GAAP is grossed up to that extent, since the overall tax impact on the consolidated profit available to the parent company is not completely recorded in the books of account. Such deferred tax impact is accounted for in the consolidated financial statements under IFRS.

For example:

Parent company P consolidates undistributed profits of Rs.100 crores of associate company A in its consolidated financial statements. The dividend distribution tax rate in A’s jurisdiction is 15% and dividend received is exempt from tax in the hands of P. In this case, P should recognise a deferred tax liability of Rs.15 crores (at a rate of 15% on Rs.100 crares) in its consolidated financial statements which will ensure a correct presentation of the net worth to the shareholders.

Presentation of financial statements:

In India, Schedule VI of the Companies Act, 1956, which prescribes a detailed format for preparation and disclosure of financial statements, lays great emphasis on quantitative information such as quantitative details of sales, COGS, production capacities, amount of transactions with related parties, CIF value of imports and income and expenditure in foreign currency, etc. Contrary to the same, IFRS if more focussed on qualitative information for the stakeholders such as terms of related party transactions, risk management policies, currency exposure for the Company with sensitivity analysis, etc. To more correctly report the liquidity position of the Company, IFRS requires disclosure of all assets/ liabilities, whether they are current or non-current. Presently under Indian GAAP even long-term deposits and advances are disclosed under current assets,loans and advances, thereby not disclosing the true liquidity profile of the entity.

Conclusion:

IFRS aims to present  financial  statements  which are a reflection of the business and economic environment in which a company operates. The standard-setters strive to formulate principles which would help a company in applying judgment and reaching the ultimate goal of accounting which is closer to the economic value of transactions. This is clearly evident in the above discussions of accounting for business combinations, consolidation, embedded leases, embedded derivatives, etc. However, to achieve this goal, it is important that the principles are applied in their true spirit and in the manner in which they are intended.

Convergence brings a new perspective for Indian companies from the traditional Indian GAAP. It challenges them to look beyond the legal language of arrangements, shifting the focus to the substance of arrangements. Indian companies need to be prepared to face this new age of accounting and keep up with the evolving changes that are taking place in IFRS itself.

Disclosures regarding provisions for liabilities (as per AS-29)

2. Nestle India Ltd. — (31-12-2009)

From Notes to Accounts :
The Company has created a contingency provision of Rs.457,181 thousands (previous year Rs.325,882 thousands) for various contingencies resulting mainly from matters, which are under litigation/dispute and other uncertainties requiring management judgment. The Company has also reversed/utilised contingency provision of Rs.133,980 thousands (previous year Rs.20,966 thousands) due to the satisfactory settlement of certain disputes for which provision was no longer required. The details of classwise provisions are given below :

Notes:
(a) `Litigations and related disputes — represents estimates made mainly for probable claims arising out of litigations/disputes pending with authorities under various statutes (i.e., Income Tax, Excise Duty, Service Tax, Sales and Purchase Tax, etc.). The provability and the timing of the outflow with regard to these matters depend on the ultimate settlement/conclusion with the relevant authorities.

(b) Others — include estimates made for products sold by the Company which are covered under free replacement warranty on becoming unfit for human consumption during the prescribed shelf life, investments held by the employee benefit trusts and other uncertainties requiring management judgment. The timing and probability of outflow with regard to these matters will depend on the external environment and the consequent decision/conclusion by the management.

3. Fulford India Ltd. — (31-12-2009)

From Notes to Accounts :

Provisions, Contingent Liabilities and Contingent Assets Disclosure for the year December 31, 2009 :

The Company has an understanding with trade associations, based on prevailing trade practices, for the replacement of its date-expired and damaged products upon return of such products subject to certain terms and conditions. With effect from the current financial year; the Company has also opted to replace such products by way of credit notes issued. Provision for replacement of such products of the Company is made, based on the best estimates of the management taking into consideration the type of products sold, the likely returns and the costs required to be incurred for such replacements.

The movement in the provision for such costs is as under :


4. Pfizer Ltd. — (30-11-2009)

From Notes to Accounts :

Personnel-related provisions :

Personnel-related provision at the beginning of the year have been settled based on completion of negotiations and execution of the new contract.

The Company has made provision for pending   assessment in respect of duties and other levies, the outflow of which would depend on the outcome of the respective events.

The movement in the above provisions are summarised as under :

Section B : Assurance Statement for Sustainability Reporting : Infosys Technologies Ltd.

Compiler’s Note :

    Sustainability Reporting is a global development which is fast gaining importance and momentum in India. Infosys Technologies Ltd. has published its first Sustainability Report for 2007-08 which presents an account of economic performance, innovations in solutions, services and products, environmental initiatives, people engagement, and social responsibility in accordance with the Global Reporting Initiative (GRI) framework. An Assurance Statement on the same was also obtained by the company. The same is reproduced below. (Names of the firm/s giving the report have been omitted).

Introduction

    XYZ has been commissioned by the management of Infosys Technologies Limited (‘Infosys’) to carry out an assurance engagement on the Infosys Sustainability Report, 2007-08 (‘the Report’).

    Infosys is responsible for the collection, analysis, aggregation and presentation of information within the Report. Our responsibility in performing this work is to the management of Infosys only and in accordance with terms of reference agreed with the Company. XYZ disclaims any liability or responsibility to a third party for decisions, whether investment or otherwise, based upon this assurance statement.

Scope of Assurance :

    The scope of work agreed upon with Infosys includes the following :

  • The full Report as well as references made in the Report to the annual report and corporate website;

  •  Review of the Report against Global Reporting Initiative (GRI) Sustainability Reporting Guidelines, 2006 and confirmation of the application level;

  •  Reporting boundary as set out in the Report;

  • Visits to the Infosys head-office in Bangalore and two development centres in India.

    The verification was carried out between April and July 2008.

Independence

    XYZ did not provide any services to Infosys during 2007-08 that could conflict with the independence of our work. XYZ was not involved in the preparation of any statements or data included in the Report except for this Assurance Statement.

Verification Methodology

    Our assurance engagement was planned and carried out in accordance with the XYZ Protocol for Verification of Sustainability Reporting, which is based both on the GRI Guidelines and the AA1000 Assurance Standard. XYZ took a risk-based approach throughout the assurance engagement, concentrating on the issues that we believe are most material for both Infosys and its stakeholders.

    As part of the verification we have :

  •  Challenged the sustainability-related statements and claims made in the Report and assessed the robustness of the data management system, information flow and controls;

  • Examined and reviewed documents, data and other information made available to XYZ by Infosys;

  • Visited the head-office and two development centres located in Banagalore and Chennai;

  • Conducted interview with 42 representatives (including data owners and decision-makers from different divisions and functions) of Infosys;

  • Performed sample-based audits of the mechanisms for implementing the Company’s own sustainability-related policies, as described in the Report;

  • Performed sample-based review of processes for determining material issues to be included in the Report.

  • Performed sample-based audits of the processes for generating, gathering and managing the quantitative and qualitative data included in the Report;

  •  Reviewed the process of acquiring information and economic/financial data from the company’s 2007-08 certified consolidated Balance Sheet.

Conclusions

    In XYZ’s opinion, the Infosys Sustainability Report 2007-08 provides a fair representation of the Company’s policies, strategies, management systems, initiatives and projects. The Report meets the general content and quality requirements of the GRI Sustainability Reporting Guidelines, 2006, and XYZ confirms that the GRI requirements for application Level ‘A+’ have been met.

Materiality : Infosys has demonstrated a formal approach to assessing material aspects and indicators for reporting. XYZ recommends that Infosys identifies more indicators, other than GRI indicators, representing material issues for the Information Technology (IT) sector, and that they are incorporated in the future sustainability strategy.

 Completeness : Within the reporting boundary defined by Infosys, we do not believe that the Report omits relevant information that would influence stakeholder assessments of decisions or that reflect significant economic, environmental and social impacts.

Accuracy : XYZ has not found material inaccuracies in the data verified or instances where data is presented in a way which significantly affects the comparability of data.

Neutrality : XYZ considers that the information contained in the Report is balanced. The emphasis on various topics in the Report is proportionate to their relative materiality.

 Comparability : XYZ recognises that this is the first Sustainability Report published by Infosys, and we commend the Company for its commitment to reporting accurate and comparable data. The Report clearly states that for many indicators, especially the Environment Health and Safety (EHS) indicators, the reported information will be the baseline.

Responsiveness : Infosys demonstrates an active commitment to dialogue on sustainability issues with stakeholders. The expectations expressed by stakeholders through different engagement channels have generally been addressed in the Report.

Opportunities for Improvement

The following is an excerpt from the observations and opportunities reported back to the management of Infosys. However, these do not affect our conclusions on the Report, and they are indeed generally consistent with the management objectives already in place.

(b) An internal verification mechanism should be developed to further improve the reliability of data as well as help improve internal communication on sustainability reporting.

(b) Systems and processes should be strengthened to better facilitate reporting on global operations.

(b) The materiality assessment approach should be further developed and refined to identify appropriate indicators for all material issued identified.

Extracts from Certificate on Corporate Governance

New Page 1Section B :
Miscellaneous

Extracts from Certificate on Corporate Governance

Based on such a review and to the best of our information and
according to the explanations given to us, in our opinion, the Company has
complied with the conditions of Corporate Governance as stipulated in Clause 49
of the Listing Agreement of the Stock Exchange of India, except the following :

I. The Company has not applied certain Accounting Standards
as referred to Para 3(d) of our Audit Report dated 31st July 2007;

II. Two complaints of shareholders could not be resolved by
the Company within a reasonable time period of 1 month.


Since the relevant records were not made available to us, we
are unable to comment on the disclosure of all the pecuniary relationships and
transactions of the Company with the Directors.


levitra

Disclosure of Accounting Policies by Professional Bodies

5 International Accounting Standards Committee (IASC) Foundation — (31-12-2009)

    Accounting Policies :

    (a) Basis of preparation :

    These financial statements have been prepared in accordance with International Financial Reporting Standards, on the historical cost basis, as modified by the revaluation of financial assets and liabilities, including derivative financial instruments, at fair value through profit or loss. The policies have been consistently applied to all years presented, unless otherwise stated.

    For the purposes of organising the financial information the IASC Foundation has categorised income and expenses into two categories. Standard-setting and related activities include all activities associated with standard-setting and support functions required to achieve the organisations objectives. Publications and related activities include information related to the sales of print and electronic IFRS materials, educational activities and Extensible Business Reporting Language (XBRL).

    (b) Contributions :

    Contributions are recognised as revenue in the year designated by the contributor.

    (c) Publications and related revenue :

    Subscriptions to the IASC Foundation’s comprehensive package and eIFRS products are recognised as revenue on a time-apportioned basis over the period covered by the subscriptions. Royalties are recognised as revenue on an accrual basis. Publications’ direct cost of sales comprises printing, salaries, promotion, computer and various related overhead costs.

    (d) Inventories :

    Inventories of current publications are valued at the lower of net realisable value and the cost of printing the publications, on a first-in-first-out basis. Inventories that have been superseded by new editions are written off.

    (e) Depreciation :

    Leasehold improvements and furniture and equipment are initially measured at cost, and depreciated on a straight-line basis (in the case of leasehold improvements over the period of the lease). All other assets are depreciated over 5 years, except computer equipment, which is depreciated over 3 years.

    (f) Foreign currency transactions :

    The IASC Foundation’s presentational and functional currency is sterling. Transactions denominated in currencies other than sterling are recorded at the exchange rate at the date of the transaction. Differences in exchange rates are recognised in the Statement of Comprehensive Income. Monetary assets and liabilities are translated into sterling at the exchange rate at the end of the reporting period.

    (g) Operating leases — Office accommodation :

    Lease payments for office accommodation are recognised as an expense on a straight-line basis over th e non-cancelable term of the lease. Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. The aggregate benefit of lease incentives is recognised as a reduction of the rental expense over the lease term on a straight-line basis.

    (h) Financial assets :

    Regular purchases and sales of financial assets are recognised on the trade date, the date on which the IASC Foundation is committed to purchase or sell the asset. Investments are recognised initially at fair value plus transaction costs for all financial assets not carried at fair value through profit or loss. Financial assets are derecognised when the rights to receive cash flows from the investments have expired or have been transferred and the IASC Foundation has transferred substantially all risks and rewards of ownership. The IASC Foundation classifies financial assets as subsequently measured at either amortised cost or fair value based on its business model for managing the financial assets and the contractual cash flow characteristics of the financial asset. All financial assets, except for bonds and derivatives, are carried at amortised cost as the objective is to hold these assets in order to collect contractual cash flows and those cash flows are solely principal and interest. Investments in bonds are classified as subsequently measured at fair value through profit or loss, and the corresponding gains or losses are included within profit (loss) before tax. Bond holdings are discussed more fully in Note 10.

    (i) Derivative financial assets and liabilities :

    The IASC Foundation uses contributions, primarily in US dollars and euro, to fund a portion of sterling obligations arising from its activities. In accordance with its financial risk management policy, the IASC Foundation does not hold or issue derivative financial instruments for trading purposes; the forward foreign currency hedges are entered into to provide certainty regarding funding to protect against currency fluctuation on future cash flows that are designated in US dollars and euro. Derivative financial instruments are recognised and subsequently measured at fair value. The corresponding gains or losses are included within profit (loss) before tax.

    (j) Provisions and contingencies :

    Provisions are recognised when the following three conditions are met — the IASC Foundation has a present obligation (legal or constructive) as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. The amount of the provision represents the best estimate of the expenditure required to settle the obligation at the end of the reporting period. Provisions are measured at the present value of the expenditure expected to be required to settle the obligation using a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the obligation. The increase in the provision due to the passage of time is recognised as interest expense.

    (k) Critical accounting estimates and judgments :

    The IASC Foundation makes estimates and assumptions regarding the future. In the future, actual experience may differ from those estimates and assumptions. The Trustees consider there are none that are material to the preparation of the financial statements.

        l) New standards and interpretations issued:

    The financial statements have been drawn up on the basis of accounting standards, interpretations and amendments effective at the beginning of the accounting period on 1 January 2009, except for that explained below. The IASC Foundation has concluded that there are no other relevant standards or interpretations in issue not yet adopted.

    l Standard adopted early IFRS 9 Financial Instruments was issued in November 2009 and is required to be applied from 1st January 2013. The presentation of the IASC Foundation’s financial statements has not significantly changed as a result of the early adoption of the new standard as it did not change the measurement of any assets.

        m) Reclassification of items in the financial statements:

    In order to conform to the current year’s presentation in the financial statements, the following comparative amounts were reclassified. The changes in presentation are to improve the information provided :

        Recruitment expenses are included in Other Costs and listed in Note 9. The prior year amount of £ 126,000 was presented as follows : £ 121,000 was included in salaries, wages and benefits; £ 5,000 was included in Trustees’ fees. A corresponding change has been made to the statement of cash flows and the details of salaries, wages and benefits as disclosed in Note 5.

        Fundraising expenses are included in Other Costs and listed in Note 9. In the prior year, £ 36,000 was listed separately in the statement of comprehensive income.

        The details of accommodation expenses presented in Note 8(a) has been expanded to disclose the amount included in publication costs.

        The details of cash holdings presented in Note 10(a) have been clarified by listing currencies irrespective of their country location.

    6. The Institute of Chartered Accountants of  India — (31-3-2009)

    Statement on Significant Accounting Policies:

    I.    Accounting convention:

    These accounts are drawn up on historical cost basis and have been prepared in accordance with the applicable Accounting Standards issued by the Institute of Chartered Accountants of India and are on accrual basis unless otherwise stated.

    II) Revenue recognition:

        a. Membership Fee

    i. The Entrance Fee is collected at the time of admission of a person as a member and one-third thereof is recognised as income in that year.

    ii. Annual Membership and Certificate of Practice Fee(s) are recognised in the year as and when these become due.

    b. Distant Education and Post-Qualification Course Fee are recognised over the duration of the course.

    c.Examination Fee is recognised on the basis of conduct of examination.

    d. Subscription for Journal is recognised in the year as and when it becomes due.
    e. Revenue from Sale of Publications is recognised at the time of preparing the sale bill i.e., when the property in goods as well as the significant risks and rewards of the property get transferred to the buyer.

    Income from Investments:

        i. Dividend on investments in units is recognised as income on the basis of entitlement to receive.

        ii.     Income on Interest-bearing securities and fixed deposits is recognised on a time-proportion basis taking into account the amount out-standing and the rate applicable.

    III. Allocations/transfer to reserves & surplus and earmarked fund :

    a) Admission Fee from Fellow Members and brd portion of the Entrance Fee from persons ad-mitted as Members are taken to Infrastructure Reserve.

    b) Donations received during the year for build-ings and for research purpose are accounted for directly under the respective Reserves Account.

    c) 25% of the Distant Education Fee not ex-ceeding 50% of the net surplus of the year is transferred to Education fund.

    d) 0.75% of Membership Fee (Annual and Certificate of Practice Fee) received from the members during the year is allocated to the Employees’ Benevolent Fund.

    e) Transfer to Education Reserve from the following earmarked funds :

 

    f) Income from investments of Earmarked Funds is allocated directly to Earmarked Funds on opening balances of the respective Earmarked Funds on the basis of weighted average method.

    IV.    Fixed assets/depreciation and amortisation :

    a) Fixed Assets excluding land are stated at historical cost less depreciation.

    b) Freehold land is stated at cost. Leasehold land is stated at the amount of premium paid for acquiring the lease rights. The premium so paid is amortised over the period of the lease.

    c) Depreciation is provided on the written down value method at the following rates as approved by the Council based on the useful life of the respective assets :

  

       
    d) Depreciation on additions is provided on monthly pro-rata basis.

    e) Library books are depreciated at the rate of 100% in the year of purchase.

    f) Intangible Assets (Software) are amortised equally over a period of three years.

        V) Investments:

    a. Long-term investments are carried at cost and diminution in value, other than temporary is provided for.

    b. Current investments are carried at lower of cost or fair value.
     

    VI.    Inventories:

    Inventories of paper, consumables, publications and study material are valued at lower of cost or net realisable value. The cost is determined on FIFO Method.

    VII. Foreign currency transactions:

        a) Foreign currency transactions are recorded on initial recognition in the reporting currency by applying to the foreign currency amount at the exchange rate prevailing on the date of transaction.

        b) All incomes and expenses are translated at average rate. All monetary assets/liabilities are translated at the year-end rates whereas non-monetary assets are carried at the rate on the date of transaction.

        c) Any income or expense on account of ex-change rate difference is recognised in the Income and Expenditure Account.

    VIII.    Employee benefits:

        a) Short-term employee benefits are charged off in the year in which the related service is rendered.

        b) Post-employment and other long-term employee benefits are charged off in the year in which the employee has rendered services. The amount charged off is recognised at the present value of the amounts payable determined on the basis of actuarial valuation. The actuarial valuation is done as per Projected Unit Credit Method. Actuarial gain and losses in respect of post-employment and other long-term benefits are charged to Income & Expenditure Account and are not deferred.

        c) Retirement benefits in the form of Provident Fund are a defined contribution scheme and the contribution to the Provident Fund Trust is charged to the Income and Expenditure Account for the period when the contribution to the respective fund is due.

    IX.    Impairment of assets:

        a) The carrying amounts of assets are reviewed at each Balance Sheet date if there is any indication of impairment based on internal/ external factors. An impairment loss is recognised wherever the carrying amount of an asset exceeds its recoverable amount. The recoverable amount is higher of asset’s net selling price and value in use. In assessing the value in use, the estimated future cash flows are discounted to their present value at the weighted cost of capital.

        b) After impairment, depreciation is provided on the revised carrying amount of the assets over its remaining useful life.

        x. Provisions:

    A provision is recognised when an enterprise has a present obligation as a result of past events; it is probable that an outflow of resources will be required to settle the obligation, in respect of which a reliable estimate can be made. Provisions are not discounted to its present value and are determined based on best estimates required to settle the obligations at the Balance Sheet date. These are reviewed at each Balance Sheet date and adjusted to reflect the current best estimates.

    7. Bombay Chartered Accountants’ Society — (31-3-2010)

    Significant accounting policies:

        a) Method of Accounting:

    Accounts are maintained on accrual basis.

        b) Fixed Assets and Depreciation:

    Fixed assets are stated at cost. Depreciation is provided on fixed assets as per the written-down value method at the rates prescribed in the Income Tax Rules except for books on which depreciation is provided at the rate of 50% per annum.

        c) Investments:

    Investments are stated at cost of acquisition less permanent diminution (if any) in compliance with AS-13 issued by The Institute of Chartered Accountants of India.

        d) Inventories:

    Inventories are stated at cost.

        e) Life Membership & Entrance Fees:

    Life Membership fees and Entrance fees are credited to Corpus Fund.

        f) Gratuity:

    The premium payable each year on the Group Gratuity Policy taken with Life Insurance Corporation of India is recognised as Gratuity expenses of that year.

Section A : Treatment of Profit/loss on Derivative Transactions

From Published Accounts

Compiler’s Note :


Also refer BCAJ June 2008 for other disclosures on the above.

&
Hexaware Technologies Ltd. — (31-12-2007)


From Notes to Accounts :

The Company, in the month of November 2007, reported about
having entered into foreign currency transactions (financial derivatives) which
were not communicated to the senior management and the Board of Directors. These
transactions have since been settled and the net loss on account of such
transactions aggregates Rs.1,029.95 million at the year end. The Company’s
profit for the year, turned into a loss, consequent to the loss on such foreign
currency transactions. The said loss being one-time and non-recurring has been
considered and disclosed as an exceptional item in the Profit and Loss account.

The Company, during the year, suffered a foreign exchange
loss of Rs.750.05 million, which is aggregate of foreign exchange gain (net) of
Rs.279.90 million and exceptional foreign exchange loss (net) of Rs.1,029.95
million as stated in the Note No. 7 of schedule 12(B). Considering the aggregate
loss on foreign currency transactions during the year as aforesaid, the foreign
exchange loss of exceptional nature of Rs.1,029.95 million has been disclosed as
stated in the Note No. 7 of Schedule 12(B) and the balance amount of Rs.279.90
million (gain) has been disclosed under ‘Administration and other expenses’ and
previous year’s figures have been accordingly regrouped.

&
The Great Eastern Shipping Co Ltd.


— (31-3-2008)

From Notes to Accounts :

Hedging Contracts :

The Company uses foreign exchange forward contracts, currency
and interest swaps and options to hedge its exposure to movements in foreign
exchange rates. The use of these foreign exchange forward contracts, currency
and interest swaps and options reduce the risk or cost to the Company and the
Company does not use the foreign exchange forward contracts, currency and
interest swaps and options for trading or speculation purposes.


(i) Derivate instruments outstanding:

(a) Commodity futures contracts for import of Bunker :

Details not reproduced

(b) Forward exchange contracts :

Details not reproduced

(c) Forward Exchange Option contracts :

Details not reproduced

(d) Interest rate swap contracts :

Details not reproduced

(e) Currency Swap Contract :

Details not reproduced


(ii) Un-hedged foreign currency exposures as on March 31 :

Details not reproduced

(iii) The above-mentioned derivative contracts having been
entered into, the hedge foreign currency risk and the exposure to bunker price
risk, are being accounted for on settlement as per the accounting policy
consistently being followed by the Company for the past several years. The
mark-to-market (loss)/gain on the foreign exchange derivative contracts and the
mark-to-market gain on the commodity futures outstanding as on March 31, 2008
amounted to Rs.(5520) lakhs and Rs.17 lakhs, respectively. The said losses and
gains have not been provided for in the accounts for the year ended March 31,
2008.

From Auditors’ Report

(e) Without qualifying our opinion, we draw attention to :

(iii) Note 17(iii) of Schedule 20, Notes to Accounts
regarding derivative contracts entered into by the Company to hedge foreign
currency risks and bunker price risk. As per the policy consistently followed
by the Company in the past, such derivative contracts are accounted only on
settlement and the mark-to-market (loss)/ gain thereon amounting to Rs.(5520)
lakhs and Rs.17 lakhs, respectively has not been provided for in the accounts
for the year ended March 31, 2008.


&
Mangalore Refinery and Petrochemicals Ltd.


— (31-3-2008)

From Notes to Accounts :

Forward Contracts to cover Forex Risk :

Forward contracts to the tune of US$ 208 million are
outstanding as on 31st March 2008, which were entered into to hedge the risk of
changes in foreign currency exchange rates on future export sales against
existing long-term export contract. The notional mark-to-market loss on these
unexpired contracts as on 31-3-2008 amounting to Rs.120.47 million has not been
considered in the financial statements. The actual gain/loss could vary and be
determined only on settlement of the contract on their respective due dates.

&
ALSTOM Projects India Ltd. — (31-3-2008)


From Significant Accounting Policies :




2.8.4 Forward Exchange Contracts not intended for trading
or speculation purposes

The premium or discount arising at the inception of
forward exchange contracts is amortised as expense or income over the life
of the contract. Exchange differences on such contracts are recognised in
the statement of profit and loss in the year in which the exchange rates
change. Any profit or loss arising on cancellation or renewal of forward
exchange contract is recognised as income or as expense for the year.



Derivative instruments :

The Company uses derivative financial instruments such as forward exchange contracts to hedge its risks associated with foreign currency fluctuations. Accounting policy for forward exchange contracts is given in note 2.8.4.

The foreign exchange contracts other than those covered under AS-l1, enter,ed for non-speculative purposes, including the underlying hedged items, are valued on the basis of a fair value on marked-to-market basis and any loss on valuation is recognised in the Profit and Loss account, on a port-folio basis. Any gain arising on this valuation is not recognised by the Company in line with the principle of prudence as enunciated in Accounting Standard 1 – ‘Disclosure of Accounting Policies’. Any subsequent changes in fair values, occurring after the balance sheet date are accounted for in the period in which they arise.

Finolex  Cables  Ltd. –   (31-3-2008)

From Notes  to Accounts

10A. Quantitative information of derivative instruments outstanding as at the balance sheet date:

Not reproduced.

B. The Company has entered into derivative transactions with an objective to hedge the financial risks associated with its business viz. foreign exchange and interest rate.

C. The Company has not hedged the following foreign currency exposures:

i) Borrowings grouped under secured loans equivalent to Rs.999.250 Million (Previous year Rs.1,476.875 million) and under unsecured loans equivalent to Rs.739.657 million. (Previous year Rs.652.678 million).

ii) Creditors for imports equivalent to Rs.39.393 million (Previous year 45,961 million).

iii) Receivables equivalent to RS.171.991million. (Previous year Rs.195.630 million).

d) Loss on derivative/forex transactions in-cludes Rs.92.000 million loss on certain outstanding derivatives at the balance sheet date assessed by the management based on the principle of prudence. In respect of other contracts, since they are in the nature of ef-fective hedge, profit/loss, if any, has not been ascertained separately.

ITC Ltd. –   (31-3-2008)

From Notes  to Accounts:

Derivative    Instruments:

The company uses Forward Exchange Contracts and Currency Options to hedge its exposures in foreign currency related to firm commitments and highly probable forecasted transactions. The information on Derivative Instruments is as follows:

a) Derivative Instrument outstanding as at year end:

Not  reproduced.

b) Foreign exchange currency exposures that have not been hedged by a derivative instrument or otherwise as at year end:

Not reproduced.

c) Consequent to the announcement issued by the Institute of Chartered Accountants of India in March 2008 on Accounting for Derivatives, the Company has marked to market the outstanding derivative contracts as at 31st March, 2008 and accordingly, unrealised gains of Rs.9.05 crores (net of taxes) have been ignored. As a result, profit after tax for the year and reserves are lower by Rs.9.05 crores.

Housing Development Finance Corporation Ltd. – (31-3-2008)

From Notes to Accounts:

ii) As on March 31, 2008, the Corporation has foreign currency borrowings (excluding FCCB) of USD 1,079.58 million equivalent (Previous year USD 1,068048 million). The Corporation has undertaken principal-only swaps, currency options and forward contracts on a notional amount of USD 808 million equivalent (Previous year USD 777 million) to hedge the foreign currency risk. Further, interest rate swaps on a notional amount of USD 230 million equivalent (Previous year USD 391 million) are outstanding, which have been undertaken to hedge the interest rate risk on the foreign currency borrowings. As on March 31,2008, the Corporation’s net foreign currency exposure on borrowings net of risk management arrangements is USD 447.13 million (Previous year USD 100.17 million).

As a part of asset liability management and on account of the increasing response to the Corporation’s Adjustable Rate Home Loan product as well as to reduce the overall cost of borrowings, the Corporation has entered into interest rate swaps wherein it has converted its fixed-rate rupee liabilities of a notional amount of Rs.12,265 crores (Pre-vious year Rs.7,265 crores) as on March 31,2008 for varying maturities into floating rate liabilities linked to various benchmarks. In addition, the Corporation has entered into cross-currency swaps of a notional amount of USD 652 million equivalent (Previous year USD 643 million), wherein it has converted its rupee liabilities into foreign currency liabilities and the interest rate is linked to the benchmarks of respective currencies.

iii) Gains/losses arising out of foreign exchange fluctuations in respect of foreign currency borrowings, net of risk management arrangements, are to the account of the Corporation. Wherever the Corporation has entered into a forward contract or an instrument, that is in substance, a forward exchange contract, the difference between the forward rate and the exchange rate on the date of the transaction is recognised as income or expense over the life of the contract. The amount of exchange difference in respect of such contracts to be recognised as expense in the Profit and Loss account over subsequent accounting periods is Rs.97.78 crores (Previous year Rs. 45.54 crores).

Other monetary assets and liabilities in foreign currencies are revalued at the rates of exchange prevailing at the year end. The reduced liability, net of risk management arrangements, of Rs.8.67 crores (Previous year Rso4.31cores [net of loss on mark to market of derivatives Rs.103.04 crores]) arising upon revaluation at the year end (based on the prevailing exchange rate) has been credited to the Provision for Contingencies account.

iv) Cross-currency swaps and other derivatives have been marked to market at the year end. The net gain of Rs.293.59 crores on such mark to market of derivatives is included under Advance Payments (Schedule No.7) and not recognised in the Profit and Loss account in view of the recent announcement by the Institute of Chartered Accountants of India (ICAI), which requires the principle of prudence to be followed in accounting for mark-to-market gains/losses on derivatives.

SRF Ltd. –   (31-3-2008)

From Significant  Accounting Policies

a) Transactions in foreign currencies are recorded at the rate prevalent on the date of transactions.

b) All foreign currency liabilities and monetary assets are stated at the exchange rate prevailing as at the date of balance sheet and the difference taken to Profit and Loss account as exchange fluctuation loss or gain.

c) Pursuant to ICAI announcement for adoption of AS-30 Financial Instruments: Recognition and Measurement, the Company has accounted for the hedge accounting of all the hedging instruments including derivatives in accordance with paragraph 99 and 106 of the said standard, affecting either the Profit and Loss account or hedging reserve (equity segment) as the case may be. The debit balance, if any, in the hedging reserve is being shown as a deduction from free reserves.

d) The Company discloses the open and hedged foreign exchange exposure as note to the accounts.

From Notes  to Accounts:

SRF has entered into long-term contracts for the transfer / sale of Carbon Emission Reductions (CER) with reputable global buyers. The cash flow from these sales forms the mainstay of SRF’s multi-year capital expansion plan, and as such these cash flows need to be both stable and secure. To ensure stability of revenues in foreign currency from the transfer / sale of CERs, the Company has entered into forward contracts with the banks to part sell Euros to be earned out of future CER sales.

The details of the forex exposure of the Company as on 31 March, 2008 are as under:

Details not reproduced.

The Company has not entered into any hedging transactions in the nature of speculation in 2007-08 (Previous year Nil).

Tube Investments  of India  Ltd. (31-3-2008)
From Significant Accounting Policies:

The Company uses forward contracts to hedge its risks associated with foreign currency fluctuations relating to certain firm commitments and forecasted transactions. The Company designates these as cash flow hedges.

The use of forward contracts is governed by the Company’s policies on the use of such financial derivatives consistent with the Company’s risk management strategy. The Company does not use derivative financial instruments for speculative purposes.

Forward contract derivatives instruments are initially measured at fair value, and are remeasured at subsequent reporting dates. Changes in the fair value of these derivatives that are designated and effective as hedges of future cash flows are recognised directly in ‘Hedge Reserve Account’ under shareholders’ funds and the ineffective portion is recognised immediately in the Profit and Loss account.
 
Changes in the fair value of derivative financial instruments that do not qualify for hedge accounting are recognised in the Profit and Loss account as they arise.

Hedge accounting is discontinued when the hedging instrument expires or is sold, terminated, or ( exercised, or no longer qualifies for hedge account-ing. At that time, for forecasted transactions, any cumulative gain or loss on the hedging instrument recognised under shareholders’ funds is retained there until the forecasted transaction occurs. If a hedged transaction is no longer expected to occur, the net cumulative gain or loss recognised under shareholders’ funds is transferred to the Profit and Loss account for the year.

From Notes  to Accounts:

Pursuant to the announcement of the Institute of Chartered Accountants of India (ICAI) in respect of ‘Accounting for Derivatives’, the Company has opted to follow the recognition and measurement principles relating to derivatives as specified in AS-30 ‘Financial Instruments, Recognition and Measurement’, issued by the ICAI, from the year ended 31st March,2008.

Consequently, as of 31st March 2008, the Company has recognised mark-to-market (MTM) losses of Rs.3.03 cr. relating to forward contracts and other derivatives entered into to hedge the foreign currency risk of highly probable forecast transactions that are designated as.effective cash flow hedges, in the Hedge Reserve Account as part of the shareholders funds.

The MTM net loss on undesignated/ineffective forward contracts amounting to Rs.0.65 cr. has been recognised in the Profit & Loss account.

Manner of Disclosure of Accounting Policies

From Published Accounts

1 ITC
Limited — (31-3-2009)

Significant Accounting Policies

It is corporate policy :

Convention :

To prepare financial statements
in accordance with applicable Accounting Standards in India.

A summary of important
accounting policies is set out below. The financial statements have also been
prepared in accordance with relevant presentational requirements of the
Companies Act, 1956.

Basis of accounting :

To prepare financial statements
in accordance with the historical cost convention modified by revaluation of
certain Fixed Assets as and when undertaken as detailed below.

Fixed assets :

To state Fixed Assets at cost of
acquisition inclusive of inward freight, duties and taxes and incidental
expenses related to acquisition. In respect of major projects involving
construction, related pre-operational expenses form part of the value of assets
capitalised. Expenses capitalised also include applicable borrowing costs.

To capitalise software where it
is expected to provide future enduring economic benefits. Capitalisation costs
include licence fees and costs of implementation/system integration services.

The costs are capitalised in the
year in which the relevant software is implemented for use.

To charge off as a revenue
expenditure all upgradation/enhancements unless they bring similar significant
additional benefits.

Depreciation :

To calculate depreciation on
Fixed Assets and Intangible Assets in a manner that amortises the cost of the
assets after commissioning, over their estimated useful lives or, where
specified, lives based on the rates specified in Schedule XIV to the Companies
Act, 1956, whichever is lower, by equal annual instalments. Leasehold properties
are amortised over the period of the lease.

To amortise capitalised software
costs over a period of five years.

Revaluation of assets :

As and when Fixed Assets are
revalued, to adjust the provision for depreciation on such revalued Fixed
Assets, where applicable, in order to make allowance for consequent additional
diminution in value on considerations of age, condition and unexpired useful
life of such Fixed Assets; to transfer to Revaluation Reserve the difference
between the written-up value of the Fixed Assets revalued and depreciation
adjustment and to charge Revaluation Reserve Account with annual depreciation on
that portion of the value which is written up.

Investments :

To state Current Investments at
lower of cost and fair value; and Long-Term Investments, including in Joint
Ventures and Associates, at cost. Where applicable, provision is made where
there is a permanent fall in valuation of Long-Term Investments.

Inventories :

To state inventories including
work-in-progress at lower of cost and net realisable value. The cost is
calculated on weighted average method. Cost comprises expenditure incurred in
the normal course of business in bringing such inventories to its location and
includes, where applicable, appropriate overheads based on normal level of
activity. Obsolete, slow moving and defective inventories are identified at the
time of physical verification of inventories and, where necessary, provision is
made for such inventories.

Sales :

To state net sales after
deducting taxes and duties from invoiced value of goods and services rendered.

Investment income :

To account for Income from
Investments on an accrual basis, inclusive of related tax deducted at source.

Proposed dividend :

To provide for Dividends
(including income-tax thereon) in the books of account as proposed by the
Directors, pending approval at the Annual General Meeting.

Employee benefits :

To make regular monthly
contributions to various Provident Funds which are in the nature of defined
contribution scheme and such paid/payable amounts are charged against revenue.

To administer such Funds through
duly constituted and approved independent trusts with the exception of Provident
Fund and Family Pension contributions in respect of unionised staff which are
statutorily deposited with the Government.

To administer through duly constituted and approved independent trusts, various Gratuity and Pension Funds which are in the nature of defined benefit/contribution schemes. To determine the liabilities towards such schemes, as applicable, and towards employee leave encashment by an independent actuarial valuation as per the requirements of Accounting Standard-15 (revised 2005) on ‘Employee Benefits’. To determine actuarial gains or losses and to recognise such gains or losses immediately in Profit and Loss Account as income or expense.

To charge against revenue, actual disbursements made, when due, under the Workers’ Voluntary Retirement Scheme.

Lease rentals?:

To charge rentals in respect of leased equipment to the Profit and Loss Account.

Research and Development?:

To write off all expenditure other than capital expenditure on Research and Development in the year it is incurred. Capital expenditure on Research and Development is included under Fixed Assets.

Taxes on income?:

To provide current tax as the amount of tax payable in respect of taxable income for the period.

To provide deferred tax on timing differences between taxable income and accounting income-subject to consideration of prudence. Not to recognise deferred tax assets on unabsorbed depreciation and carry forward of losses unless there is virtual certainty that there will be sufficient future taxable income available to realise such assets.

Foreign currency translation?:

To account for transactions in foreign currency at the exchange rate prevailing on the date of transactions. Gains/Losses arising out of fluctuations in the exchange rates are recognised in the Profit and Loss Account in the period in which they arise. To account for differences between the forward exchange rates and the exchange rates at the date of transactions, as income or expense over the life of the contracts.

To account for profit/loss arising on cancellation or renewal of forward exchange contracts as income/ expense for the period.

To account for premium paid on currency options in the Profit and Loss Account at the inception of the option.

To account for profit/loss arising on settlement or cancellation of currency option as income/expense for the period.

To recognise the net mark-to-market loss in the Profit and Loss Account on the outstanding portfolio of options as at the Balance Sheet date, and to ignore the net gain, if any.

To account for gains/losses in the Profit and Loss Account on foreign exchange rate fluctuations relating to monetary items at the year end.

Caims?:

To disclose claims against the Company not acknowledged as debts after a careful evaluation of the facts and legal aspects of the matter involved.

Segment reporting?:

To identify segments based on the dominant source and nature of risks and returns and the internal organisation and management structure.

To account for inter-segment revenue on the basis of transactions which are primarily market-led.

To include under ‘Unallocated Corporate Expenses’ revenue and expenses which relate to the enterprise as a whole and are not attributable to segments.

Joint ventures for oil and gas fields

New Page 1VIDEOCON INDUSTRIES LTD.

7. Joint ventures for oil and gas fields :

In respect of joint ventures in the nature of Production
Sharing Contracts (PSC) entered into by the Company for oil and gas exploration
and production activities, the Company’s share in the assets and liabilities as
well as income and expenditure of joint venture operations are accounted for
according to the participating interest of the Company as per the PSC and the
joint-operating agreements on a line-by-line basis in the Company’s financial
statements.

Exploration, development and production costs :

The Company follows the ‘Successful Efforts Method’ of
accounting for oil and gas exploration, development and production activities as
explained below :

(a) Exploration and production costs are expensed in the
year/period in which these are incurred.

(b) Development costs are capitalised and reflected as
‘Producing Properties’. Costs include recharges to the joint venture by the
operator/affiliate in respect of the actual cost incurred and as set out in
the Production Sharing Contract (PSC). Producing properties are depleted using
the ‘Unit of Production Method’.


Abandonment costs :

Abandonment Costs relating to dismantling, abandoning and
restoring offshore well sites and allied facilities are provided for on the
basis of ‘Unit of Production Method’. Aggregate abandonment costs to be incurred
are estimated, based on technical evaluation by experts.

Revenue recognition :

(a) Revenue is recognised on transfer of significant risk and reward in respect of ownership.

(b) Sale of crude oil and natural gas are exclusive of sales tax. Other sales/turnover includes sales value of goods, services, excise duty, duty drawback and other recoveries such as insurance, transportation and packing charges, but excludes sale tax and recovery of financial and discounting charges.

levitra

Section A : Illustration of accounts and audit report of a company based in United States where the assumption of Going Concern is questioned

General Motors Corporation, USA — (31-12-2008)

From Notes to Consolidated Financial Statements :
Note 2 : Basis of Presentation :

Going Concern :

The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realisation of assets and the liquidation of liabilities in the normal course of business. We have incurred significant losses from 2005 through 2008, attributable to operations and to restructurings and other charges such as support for Delphi and past, present and future costcutting measures. We have managed our liquidity during this time through a series of cost reduction initiatives, capital markets transactions and sales of assets. However, the global credit market crisis has had a dramatic effect on our industry.

In the second half of 2008, the increased turmoil in the mortgage and overall credit markets (particularly the lack of financing to buyers or lessees of vehicles), the continued reductions in U.S. housing values, the volatility in the price of oil, the recession in the United States and Western Europe and the slowdown of economic growth in the rest of the world created a substantially more difficult business environment. The ability to execute capital markets transactions or sales of assets was extremely limited, and vehicle sales in North America and Western Europe contracted severely and the pace of vehicle sales in the rest of the world slowed. Our liquidity position, as well as our operating performance, were negatively affected by these economic and industry conditions and by other financial and business factors, many of which are beyond our control.

These conditions have not improved through January 2009, with sales of total vehicles for the U.S. industry falling to 657,000 vehicles, or a seasonally adjusted rate of 9.8 million vehicles, which was the lowest level for January since 1982. We do not believe it is likely that these adverse economic conditions, and their effect on the automotive industry, will improve significantly during 2009, notwithstanding the unprecedented intervention by governments in the United States and other countries in the global banking and financial systems.

Due to this sudden and rapid decline of our industry and sales, particularly in the three months ended December 31, 2008, we determined that, despite the far-reaching actions to restructure our U.S. business, we would be unable to pay our obligations in the normal course of business in 2009 or service our debt in a timely fashion, which required the development of a new plan that depended on financial assistance from the U.S. Government. On December 31, 2008, we entered into a Loan and Security Agreement (UST Loan Agreement) with the United States Department of the Treasury (UST), pursuant to which the UST agreed to provide us with a $ 13.4 billion secured term loan facility (UST Loan Facility). We borrowed $ 4.0 billion under the UST Loan Facility on December 31, 2008, an additional $ 5.4 billion on January 21, 2009 and $ 4.0 billion on February 17, 2009. As a condition to obtaining the UST Loan Facility, we agreed to achieve certain restructuring targets within designated time frames as more fully described in Note 15.

Pursuant to the terms of the UST Loan Facility and as described more fully in Note 15, we submitted to the UST on February 17, 2009 our plan to return to profitability and to operate as a going concern (Viability Plan). In order to execute the Viability Plan, we have requested additional U.S. Government funding of $ 22.5 billion to cover our baseline scenario liquidity requirements and $ 30.0 billion to cover our downside sensitivity liquidity requirements. We proposed that the funding could be met through a combination of a secured term loan of $ 6.0 billion and preferred equity of $ 16.5 billion under a Viability Plan baseline scenario, representing an increase of $ 4.5 billion over our December 2008 request, reflecting changes in various assumptions subsequent to the December 2, 2008 submission and $ 9.1 billion incremental to the $ 13.4 billion currently outstanding. We have suggested to the UST that the current amount outstanding as of February 28, 2009 of $ 13.4 billion under the UST Loan Facility plus an incremental $ 3.1 billion requested in 2009 could be provided in the form of preferred stock. We believe this structure would provide the necessary medium-term funding we need and provide a higher return to the UST, commensurate with the higher returns the UST receives on other preferred stock investments in financial institutions.

Under a Viability Plan downside sensitivity sce-nario, an additional $ 7.5 billion of funding would be required above the amounts described above, which we have requested in the form of a secured revolving credit facility. The collateral used to sup-port the current $ 13.4 billion UST Loan Facility would be used to support the proposed $ 7.5 billion secured revolving credit facility and the $ 6.0 billion term loan. Our Viability Plan also assumes $ 7.7 billion in loans under the provisions of the Energy Independence and Security Act of 2007 (Section 136 Loans) from the Department of Energy. Our 2009 baseline vehicle sales forecast is 10.5 million vehicles in the United States and 57.5 million vehicles globally. In 2009, our liquidity, under our Baseline plan, is dependent on obtaining $ 4.6 billion of funding from the UST in addition to the $ 13.4 billion received to date; a net $ 2.3 billion from other non-U.S. governmental entitles the receipt of $ 2.0 billion in Section 136 Loans; and the sale of certain assets for net proceeds of $ 1.5 billion. This funding and additional amounts described above are required to provide the necessary working capital to operate our business until the global economy recovers and consumers have an available credit and begin purchasing automobiles at more historical volume levels. In addition, the Viability Plan is dependent on our ability to execute the bond exchange and voluntary employee beneficiary association (VEBA) modifications contemplated in our submissions to the UST and our ability to achieve the revenue targets and execute the cost reduction and other restructuring plans. We currently have approximately $1 billion of outstanding Series D convertible debentures that mature on June 1, 2009. Our funding plan described -above does not include the payment at maturity of the principal amount of these debentures. If we are unable to restructure the Series D convertible debentures prior to June 1, 2009, or otherwise satisfactorily address the payment due on June I, 2009, a default would arise with respect to payment of these obligations, which could also trigger cross defaults in other outstanding debt, thereby potentially requiring us to seek relief under the U.S. Bankruptcy Code.

The following is a summary of significant cost reduction and restructuring actions contemplated by the Viability Plan:

(Not reproduced here)

Report of Independent Registered Public Accounting Firm :

We have audited the accompanying Consolidated Balance Sheets of General Motors Corporation and subsidiaries (the Corporation) as of December 31, 2008 and 2007, and the related Consolidated Statements of Operations, Cash Flows and Stockholders’ Equity (Deficit) for each of the three years in the period ended December 31, 2008. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Over-sight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of General Motors Corporation and subsidiaries at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

The accompanying consolidated financial statements for the year ended December 31,2008, have been prepared assuming that the Corporation will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Corporation’s recurring losses from operations, stockholders’ deficit, and inability to generate sufficient cash flow to meet its obligations and sustain its operations raise substantial doubt about its ability to continue as a going concern. Management’s plans concerning these matters are also discussed in Note 2 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

As discussed in Note 3 to the consolidated financial statements, the Corporation: (1) effective January 1, 2008, adopted Statement of Financial Accounting Standards No.157, Fair Value Measurements, (2) effective January 1, 2007, adopted the recognition and measurement provisions of FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109, (3) effective January 1, 2007, changed the measurement date for defined benefit plan assets and liabilities to coincide with its year end to conform to Statement of Financial Accounting Standards No. 158,Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132 (R) (SFAS No.158), and (4) effective December 31, 2006, began to recognise the funded status of its defined benefit plan in its consolidated balance sheets to conform to SFAS No. 158.

As discussed in Note 4 to the consolidated financial statements, on November 30,2006, the Corporation sold a 51% controlling interest in GMAC LLC, its former wholly-owned finance subsidiary. The Corporation’s remaining interest in GMAC LLC is accounted for as an equity method investment.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Corporation’s internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organisations of the Treadway Commission and our report dated 4-3-2009 expressed an adverse opinion on the Corporation’s internal control over financial reporting.

Oil and gas exploration and development costs

New Page 1ESSAR OIL LTD. — (31-3-2007)

6. Oil and gas exploration and development costs

The Company follows the ‘Full Cost Method’ of accounting for
its oil and gas exploration and development activities, whereby all costs
associated with acquisition, exploration and development of oil and gas
reserves, are capitalised under capital work-in-progress, irrespective of
success or failure of specific parts of the overall exploration activity within
or outside a cost centre (known as ‘cost pool’). Exploration and survey costs
incurred are held outside cost pools until the existence or otherwise of
commercial reserves are determined. These costs remain undepleted pending
determination, subject to there being no evidence of impairment. Costs are
released to its cost pool upon determination or otherwise of reserves. When any
field in a cost pool is ready to commence commercial production, the accumulated
costs in that cost pool are transferred from capital work-in-progress to the
gross block of assets under producing properties. Subsequent exploration
expenditure in that cost pool will be added to gross block of assets, either on
commencement of commercial production from a field discovery or failure. In case
a block is surrendered, the accumulated exploration expenditure pertaining to
such block is transferred to the gross block of assets. Expenditure carried
within each cost pool (including future development cost) will be depleted on a
unit-of-production basis with reference to quantities, with depletion computed
on the basis of the ratio that oil and gas production bears to the balance
proved and probable reserves at commencement of the year. The financial
statements of the Company reflect its share of assets, liabilities, income and
expenditure of the joint-venture operations, which are accounted on the basis of
available information on line-to-line basis, with similar items in the Company’s
financial statements to the extent of the participating interest of the Company
as per the various joint-venture agreement(s).

Revenue recognition :

Revenue on sale of goods is recognised when the property in
the goods is transferred to buyer for a price, or when all significant risks and
rewards of ownership have been transferred to the buyer and no effective control
is retained by the Company in respect of the goods transferred to a degree
usually associated with ownership and no significant uncertainty exists
regarding the amount of consideration that will be derived from the sale of
goods.

Revenue on transactions of rendering services is recognised,
either under the completed service contract method or under the proportionate
completion method, as appropriate. Performance is regarded as achieved when no
significant uncertainty exists regarding the amount of consideration that will
be derived from rendering the services.


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Oil and gas assets

New Page 1CAIRN INDIA LTD. — (31-12-2006)

4. Oil and gas assets :

Cairn India Group follows the ‘Successful Efforts Method’ for
accounting for oil and gas assets as set out by the Guidance Note issued by the
ICAI on ‘Accounting for Oil and Gas Producing Activities’.

Expenditure incurred on the acquisition of a licence interest
is initially capitalised on a licence-by-licence basis. Costs are held,
undepleted, within exploratory & development wells in progress until the
exploration phase relating to the licence area is complete or commercial oil and
gas reserves have been discovered.

Exploration expenditure incurred in the process of
determining exploration targets which cannot be directly related to individual
exploration wells is expensed in the period in which it is incurred.

Exploration/appraisal drilling costs are initially
capitalised within exploratory & development wells in progress on a well basis
until the success or otherwise of the well has been established. The success or
failure of each exploration/appraisal effort is judged on a well-by-well basis.
Drilling costs are written off on completion of a well, unless the results
indicate that oil and gas reserves exist and there is a reasonable prospect that
these reserves are commercial.

Where results of exploration drilling indicate the presence
of oil and gas reserves which are ultimately not considered commercially viable,
all related costs are written off to the Profit and Loss Account. Following
appraisal of successful exploration wells, when a well is ready for commencement
of commercial production, the related exploratory and development wells in
progress are transferred into a single-field cost centre within producing
properties, after testing for impairment.

Where costs are incurred after technical feasibility and
commercial viability of producing oil and gas is demonstrated and it has been
determined that the wells are ready for commencement of commercial production,
they are capitalised within producing properties for each cost centre.
Subsequent expenditure is capitalised when it enhances the economic benefits of
the producing properties or replaces part of the existing producing properties.
Any costs remaining associated with such part replaced are expensed in the
financial statements.

Net proceeds from any disposal of an exploration asset within
exploratory and development wells in progress are initially credited against the
previously capitalised costs and any surplus proceeds are credited to the Profit
and Loss Account. Net proceeds from any disposal of producing properties are
credited against the previously capitalised cost and any gain or loss on
disposal of producing properties is recognised in the Profit and Loss Account,
to the extent that the net proceeds exceed or are less than the appropriate
portion of the net capitalised costs of the asset.


(c) Depletion :



The expenditure on producing properties is depleted within
each cost centre. Depletion is charged on a unit-of-production basis, based on
proved reserves for acquisition costs and proved and developed reserves for
other costs.


(d) Site restoration costs :



At the end of the producing life of a field, costs are
incurred in removing and restoring the site of production facilities. Cairn
India Group recognises the full cost of site restoration as an asset and
liability when the obligation to rectify environmental damage arises. The site
restoration asset is included within producing properties of the related asset.
The amortisation of the asset, calculated on a unit-of-production basis on
proved and developed reserves, is included in the ‘depletion and site
restoration costs’ in the Profit and Loss Account.

Revenue from operating activities :

Revenue represents the Cairn India Group’s share of oil, gas
and condensate production, recognised on a direct-entitlement basis and tariff
income received for third-party use of operating facilities and pipelines in
accordance with agreements.


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Accounting for Oil and Gas Activity

New Page 1RELIANCE INDUSTRIES LTD. — (31-3-2007)

3. Accounting for Oil and Gas Activity :

The Company has adopted ‘Full Cost Method’ of accounting for
its oil and gas activity and all costs incurred in acquisition, exploration and
development are accumulated considering the country as a cost centre. Oil and
gas joint ventures are in the nature of jointly controlled assets. Accordingly,
assets and liabilities as well as income and expenditure are accounted on the
basis of available information, on line-by-line basis with similar items in the
Company’s financial statements, according to the participating interest of the
Company.

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Exploration, Development & Production Costs

New Page 1Oil and Natural Gas Corporation Ltd. — (31-3-2007)

1. Exploration, Development & Production Costs :

5.1 Acquisition cost :


Acquisition cost of an oil and gas property in
exploration/development stage is taken to acquisition cost under the respective
category. In case of overseas projects, the same is taken to capital work in
progress. Such costs are capitalised by transferring to producing property when
it is ready to commence commercial production. In case of abandonment, such
costs are expensed. Acquisition cost of a producing oil and gas property is
capitalised as producing property.

5.2 Survey costs :


Cost of surveys and prospecting activities conducted in the
search of oil and gas are expensed in the year in which these are incurred.

5.3 Exploratory/Development wells in progress :


5.3.1 All acquisition costs, exploration costs involved in
drilling and equipping exploratory and appraisal wells, cost of drilling
exploratory type stratigraphic test wells are initially capitalised as
exploratory wells in progress till the time these are either transferred to
producing properties on completion as per policy no. 5.4.1 or expensed in the
year when determined to be dry or of no further use, as the case may be.

5.3.2 All wells under as ‘exploratory wells in progress’
which are more than two years old from the date of completion of drilling are
charged to Profit and Loss Account except those wells which have proved reserves
and the development of the fields in which the wells are located has been
planned.

5.3.3 All costs relating to development wells are initially
capitalised as development wells in progress and transferred to producing
properties on completion as per policy no. 5.4.1.

5.4 Producing properties :


5.4.1 Producing properties are created in respect of an
area/field having proved developed oil and gas reserves, when the well in the
area/field is ready to commence commercial production.

5.4.2 Cost of temporary occupation of land, successful
exploratory wells, all development wells, depreciation on related equipment and
facilities, and estimated future abandonment costs are capitalised and reflected
as producing properties.

5.4.3 Depletion of producing properties :


Producing properties are depleted using the ‘Unit of
Production Method’. The rate of depletion is computed with reference to the area
covered by individual lease/licence/asset/amortisation base by considering the
proved developed reserves and related capital costs incurred including estimated
future abandonment costs. In case of acquisition, cost of producing properties
is depleted by considering the proved reserves. These reserves are estimated
annually by the Reserve Estimates Committee of the Company, which follows the
International Reservoir Engineering Procedures.

5.5 General administrative expenses :


General administrative expenses at assets, basins, services,
regions and headquarters are charged to Profit and Loss Account.

5.6 Production costs :


Production costs include pre-well head and post well head
expenses including depreciation and applicable operating costs of support
equipment and facilities.

Abandonment costs :

7.1 The full eventual estimated liability towards costs
relating to dismantling, abandoning and restoring offshore well sites and allied
facilities is recognised at the initial stage as cost of producing property and
liability for abandonment cost, based on the latest technical assessment
available at current costs with the Company. The same is reviewed annually.

7.2 Cost relating to dismantling, abandoning and restoring
onshore well sites and allied facilities are accounted for in the year in which
such costs are incurred, as the salvage value is expected to take care of the
abandonment costs.

Revenue recognition :

15.1 Revenue from sale of products is recognised on transfer
of custody to customers.

15.2 Sale of crude oil and gas produced from exploratory
wells in progress in exploratory areas is deducted from expenditure on such
wells.

15.3 Sales are inclusive of all statutory levies except Value
Added Tax (VAT). Any retrospective revision in prices is accounted for in the
year of such revision.

15.4 Revenue in respect of fixed price contracts is
recognised for the quantum of work done on the basis of percentage of completion
method. The quantum of work done is measured in proportion of cost incurred to
date to the estimated total cost of the contract or based on reports of physical
work done.

15.5 Finance income in respect of assets given on finance
lease is recognised based on a pattern reflecting a constant periodic rate of
return on the net investment outstanding in respect of the finance lease.

15.6 Revenue in respect of the following is recognised when
there is reasonable certainty regarding ultimate collection :

(a) Shortlifted quantity of gas.
(b) Gas pipeline transportation charges and statutory duties thereon.
(c) Reimbursable subsides and grants.
(d) Interest on delayed realisation from customers.
(e) Liquidated damages from contractors.

ACC LTD. — (31-12-2007)

New Page 1ACC LTD. — (31-12-2007)

From Notes to Accounts :

There are no Micro, Small and Medium Enterprises, as defined
in the Micro, Small and Medium Enterprises Development Act, 2006 to whom the
Company owes dues on account of principal amount together with interest and
accordingly no additional disclosures have been made.

The above information regarding Micro, Small and Medium
Enterprises has been determined to the extent such parties have been identified
on the basis of information available with the Company. This has been relied
upon by the auditors.


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FULFORD (INDIA) LTD. — (31-12-2007)

New Page 1FULFORD (INDIA) LTD. — (31-12-2007)

From Notes to Accounts :

The Company has not received any intimation from the
suppliers regarding status under the Micro, Small and Medium Enterprises
Development Act, 2006 (the act) and hence disclosure regarding :

(a) Amount due and outstanding to suppliers as at the end
of accounting year;

(b) Interest paid during the year;

(c) Interest payable at the end of the accounting year, and

(d) Interest accrued and unpaid at the end of the
accounting year, has not been provided.


The Company is making efforts to get the confirmations from
the suppliers as regards their status under the Act.


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Honeywell Automation India Ltd. — (31-12-2007)

New Page 1HONEYWELL AUTOMATION INDIA LTD. — (31-12-2007)

From Notes to Accounts :

Disclosure in accordance with Section 22 of the Micro, Small
and Medium Enterprises Development Act, 2006 :

Particulars

Amount (Rs.
‘000)

(a) Principal amount remaining unpaid and

206,945

Interest due
thereon

—

(b) Interest
paid in terms of Section 16

—

(c) Interest due and payable for the period of delay in
payment

—

(d) Interest accrued and remaining unpaid

—

(e) Interest due and payable even in succeeding years

—

The Company has compiled the above information based on
verbal confirmations from suppliers. As at the year end, no supplier has
intimated the Company about its status as a Micro or Small Enterprise or its
registration under the Micro, Small and Medium Enterprises Development Act,
2006.

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MRF LTD. — (30-9-2007)

New Page 1MRF LTD. — (30-9-2007)

From
Schedules :

A. Current
Liabilities :

Rs. crore

Rs. crore

Sundry Creditors :

Outstanding dues of Micro Enterprises & Small Enterprises
(Note 5)

3.30

1.50

Outstanding dues of creditors other than Micro
Enterprises & Small Enterprises

411.68

370.73


From Notes to Accounts :




8. There are no delays in the payment of dues to micro,
small and medium enterprises, to the extent such parties have been identified
on the basis of information available with the Group. Previous year’s figures
stated in Schedule 8 represent amounts due to small-scale industrial
undertakings.



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HINDUSTAN UNILEVER LTD.

New Page 1HINDUSTAN UNILEVER LTD.

— (31-12-2007)

From Schedule :

Sundry Creditors (Refer Note 21)

From Notes to Accounts :

There are no Micro and Small Enterprises, to whom the Company
owes dues, which are outstanding for more than 45 days as at 31st December,
2007. This information as required to be disclosed under the Micro, Small and
Medium Enterprises Development Act, 2006 has been determined to the extent such
parties have been identified on the basis of information available with the
Company.

&

HONEYWELL AUTOMATION INDIA LTD. — (31-12-2007)


From Notes to Accounts :

Disclosure in accordance with Section 22 of the Micro, Small
and Medium Enterprises Development Act, 2006 :

Particulars

Amount (Rs.
‘000)

(a) Principal amount remaining unpaid and

206,945

Interest due
thereon

—

(b) Interest
paid in terms of Section 16

—

(c) Interest due and payable for the period of delay in
payment

—

(d) Interest accrued and remaining unpaid

—

(e) Interest due and payable even in succeeding years

—

The Company has compiled the above information based on
verbal confirmations from suppliers. As at the year end, no supplier has
intimated the Company about its status as a Micro or Small Enterprise or its
registration under the Micro, Small and Medium Enterprises Development Act,
2006.

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S & S Power Switchgear Ltd.

New Page 1S & S POWER SWITCHGEAR LTD.

— (30-9-2007)

From Notes to Accounts :

7. The Company is in the process of identifying the
small-scale units and Micro, Small and Medium Enterprises and hence :

(a) Interest, if any, payable as per Interest on Delayed
Payment to Small Scale and Ancillary Industrial Undertakings Ordinance, 1993
and the Micro, Small and Medium Enterprises Development Act, 2006 is not
ascertainable, and

(b) Amount payable to small-scale units is not
ascertainable.


From Auditors’ Report :



(g) Subject to the foregoing, in our opinion and to the
best of our information and according to the explanations given to us, the
said financial statements read along with the notes thereon, subject to the
dues to the small-scale industry units (Refer Note 7 of Schedule 15), give
the information required by the Companies Act, 1956, in the manner so required
and give a true and fair view in conformity with the accounting principle
generally accepted in India.



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Abbott India Ltd. — (30-11-2007)

New Page 1ABBOTT INDIA LTD. — (30-11-2007)

From Schedules :

A. Current Liabilities :

 
Rupees in millions
As at 30-11-2006 Rupees in millions

Sundry Creditors :

Due to Micro & Small Enterprises (Refer Note B 27 —
Schedule 16)

—
 —

Others†
308.4
286.6

† Previous year includes an amount of Rs.36.7 million due to
small-scale industrial undertakings.



From Notes to Accounts :




(a) An amount of Rs.4.4 million and Nil was due and
outstanding to suppliers as at the end of the accounting year on account of
Principal and Interest, respectively.

(b) No interest was paid during the year.

(c) No interest is payable at the end of the year other
than interest under the Micro, Small and Medium Enterprises Development Act,
2006.

(d) No amount of interest was accrued and unpaid at the end
of the accounting year.

The above information and that given in Schedule 10 —
‘Current Liabilities and Provisions’ regarding Micro, Small and Medium
Enterprises has been determined to the extent such parties have been
identified on the basis of information available with the Company. This has
been relied upon by the auditors.



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Section A : Disclosures in Unaudited Quarterly Results regarding treatment of foreign exchange fluctuations for the period/quarter ended 31-12-2008

From Published AccountsTata Motors Ltd.

2. Net Loss after tax of Rs.26,326 lakhs for the quarter
ended December 31, 2008 includes notional exchange loss (net) of Rs.22,652 lakhs
on revaluation of foreign currency borrowings, deposits and loans given. Net
Profit after tax of Rs.40,984 lakhs for the nine months ended December 31, 2008
includes notional exchange loss (net) of Rs.63,255 lakhs on revaluation of
foreign currency borrowings, deposits and loans given.

4. Effective from April 1, 2008 the Company has applied hedge
accounting principles in respect of forward exchange contracts as set out in
Accountings Standards (AS) 30 — Financial Instruments : Recognition and
Measurement, issued by the Institute of Chartered Accountants of India.
Accordingly, all such contracts outstanding as on December 31, 2008 are marked
to market and a notional loss aggregating to Rs.16,481 lakhs (net of tax)
arising on contracts that were designated and effective as hedges of future cash
flows, has been directly recognised in the Hedging Reserve Account to be
ultimately recognised in the Profit and Loss Account depending on the exchange
rate fluctuation till and when the underlying forecasted transaction occurs.
Earlier such notional loss/gain was recognised in the Profit and Loss Account on
the basis of exchange rate on the reporting date.

&
GMR Infrastructure Ltd.


The foreign exchange loss (Net) of Rs.2,524 lakhs for the
quarter ended December 31, 2008 (2007 : Gain of Rs.96 lakhs) and Rs.12,986 lakhs
for the nine months period ended December 31, 2008 (2007 : Gain of Rs.1,829
lakhs), accounted pursuant to Accounting Standard 11 on the Effects of Changes
in Foreign Exchange Rates include the following :

(a) Vemagiri Power Generation Limited (VPGL), a notional
loss of Rs.477 lakhs for the quarter ended December 31, 2008 (2007 : Gain of
Rs.122 lakhs) and Rs.2,639 lakhs for the nine months period ended December 31,
2008 (2007 : Gain of Rs.1,392 lakhs)

(b) GMR Hyderabad International Airport Limited (GHIAL), a
notional loss of Rs.2,501 lakhs for the quarter ended December 31, 2008
(2007 : NIL) and Rs.11,012 lakhs for the nine months period ended December 31,
2008 (2007 : NIL)


The above notional foreign exchange losses of these two
subsidiaries have been accounted on the conversion of their project loans
denominated in foreign currency into Indian Rupees, using closing rates as at
the reporting date. However, both these subsidiaries have adequate foreign
currency revenues to provide hedge against any currency fluctuation risks that
may arise as and when the interest payments and principal repayments of these
loans are made and hence forex risks associated with these loans will not have
any bearing on the profitability of these two subsidiaries.

&
Reliance Industries Ltd.


The Company has continued to adjust the foreign currency
exchange differences on amounts borrowed for acquisition of fixed assets, to the
carrying cost of fixed assets in compliance with Schedule VI to the Companies
Act, 1956 as per legal advice received which is at variance to the treatment
prescribed in Accounting Standards (AS-11) on ‘Effects of Changes in Foreign
Exchange Rates’ notified in the Companies (Accounting Standards) Rules 2006. Had
the treatment as per the AS-11 been followed, the net profit after tax for the
nine months period ended 31st December 2008 would have been lower by Rs.1,177
crore (US $ 242 million).

&
The Great Eastern Shipping Co. Ltd.


1. Even though not yet mandatory, in accordance with the
recommendations of the Institute of the Chartered Accountants of India, the
Company has with effect from April 01, 2008 adopted the principles enunciated in
Accounting Standard (AS) 30, Financial Instruments : Recognition and Measurement
in respect of hedge accounting and recognition and measurement of derivatives.
Consequently, the revaluation gain/(loss) on designated hedging instruments that
qualify as effective hedges has been appropriately recorded in the hedging
reserve account. Designated hedging instruments include foreign currency loan
liabilities and currency, interest rate and bunker derivatives. Earlier, the
revaluation gain/(loss) on the foreign currency loan liabilities was recognised
in the profit and loss account, whereas the gain/(loss) on currency, interest
rate and bunker derivatives was recognised on settlement. Consequent to the
designation of foreign currency loan liabilities as hedging instruments, the
profit of the Company for the quarter and nine months ended December 31, 2008 is
higher by Rs.62.60 crores and Rs.252.18 crores, respectively. Gain/(loss) on
revaluation of ineffective hedge transactions and on settlement of hedge
transactions is recognised in the Profit and Loss Account.

2. Exceptional item includes :

(a) Net Compensation (paid)/received on cancellation of
vessel construction/sale contracts for the quarter and nine months ended
December 31, 2008 was Rs.(14.85) crores. (for the quarter and nine moths ended
December 31, 2007 the corresponding amount was Rs. ‘Nil’).

(b) Exchange gain/(loss) on revaluation of foreign currency
loan liabilities in accordance with As-11 for the quarter and nine months
ended December 31, 2008 were Rs. ‘Nil’ and Rs.(138.57) crores,
respectively. (For the quarter and nine months ended December 31, 2007 the
corresponding amounts were Rs.22.42 crores and Rs.186.49 crores,
respectively.)

Tata Steel Ltd.


Notional exchange loss during the period includes an unrealised translation loss of Rs.753.38 crores (Rs.153.56 crores for the quarter) on Convertible Alternate Reference Securities (CARS) issued in September 2007. The liability has been translated at the exchange rate as on 31st December 2008. CARS are convertible into equity shares only between 4th September 2011 and 6th August 2012 and are redeemable in foreign currency only in September 2012, if not converted into equity, and are neither convertible nor redeemable ti114th September 2011.

Bharti  Airtel  Ltd.

As reported in the last quarter, the Company has followed the accounting policy to adjust foreign exchange fluctuation on loan liability for fixed assets till June 30, 2008, as per requirement of Schedule VI of the Companies Act, 1956 based on legal advice. During the nine months period effective April I, 2008, the Company has adopted the treatment prescribed in Accounting Standard (AS-11) ‘Effect of Changes in Foreign exchange Rates’ notified in the Companies (Accounting Standard) Rules 2006 dated December 7, 2006. Instead of capitalising/ recapitalising such fluctuation as per policy hitherto followed, the Company has changed/ credited such fluctuations directly to the Profit & Loss Account.

Had the Company continued with the earlier policy net profit after tax would have been higher by Rs.245.09 crore and Rs.900.12 crore for the quarter and nine months ended December 31, 2008, respectively, for the Company and the net profit after tax would have been higher by RS.248.42 crore and Rs.929.94 crore for the quarter and nine months ended December 31, 2008, respectively, for the Group.

Reliance  Communications   Ltd.

The Company is pursuing aggressive capex plans which include significant expansion of nationwide wireless network. The Company has funded these initiatives primarily by long-term borrowings in foreign currency and Foreign Currency Convertible Bonds (‘FCCBs’). In compliance of Schedule VI of the Companies Act, 1956 and on the basis of legal advice received by the Company, short-term fluctuations in foreign exchange rates relate to such liabilities and borrowings related to acquisition of fixed assets are adjusted in the carrying cost of fixed assets. Had the accounting treatment as per Accounting Standard (AS) 11 been continued to be followed by the Company, the net profit after tax for the quarter and nine months ended 31st December 2008 would have been lower by Rs.59,566 lakh and Rs.84,837 lakh for realised and Rs.2,757 lakh and Rs.1,80,359 lakh for unrealised currency exchange fluctuation, respectively. This excludes an amount of Rs.21,048 lakh and Rs.1,14,674 lakh for the quarter and nine months ended on 31st December 2008 on FFCBs for which the Company will not be liable, if FCCBs are converted on or before the due date i.e., 1st May 2011 and 18th February 2012. This matter was referred to by the auditors of the Company in their limited review report.

 Jet Airways  Ltd.

The Company,  based  on legal advice has, from the first quarter of the current year, adjusted the foreign currency differences on amounts borrowed for acquisition of fixed assets acquired from outside India aggregating Rs.38,081 lac and Rs.188,454 lac for quarter and nine months ended 31st December 2008 to the carrying cost of the fixed assets, in compliance with Schedule VI of the Companies Act, 1956 which is in variance with the treatment prescribed in Accounting Standard (AS) 11 on ‘Effects of Changes in Foreign Exchange Rates’ notified in the Companies (Accounting Standards) Rules. Had the treatment as per AS-ll been followed, the net loss before tax for the quarter and nine months ended 31st December 2008 would have been higher by Rs.35,791 lac and Rs.185,227 lac, respectively.

Consequent to following this practice from the first quarter of the current year, the foreign currency difference (gain) previously credited to the profit and loss account aggregating Rs.20,727 lac has been reversed from the opening balance of profit and loss account and adjusted to the cost of fixed assets.

These are matters of reference in limited review report of statutory auditors.

Ranbaxy  Laboratories  Ltd.

3. Foreign exchange Loss/(Gain) on loans represents exchange differences arising during the period(s) on foreign currency borrowings including Foreign Currency Convertible Bonds.

4. (A) Pursuant to ICAI Announcement’ Accounting for Derivatives’ on the early adoption of Accounting Standard (AS) 30 – Financial Instruments: Recognition and Measurement, the Company has early adopted the said Standard with effect from October I, 2008, to the extent that the adoption does not conflict with existing mandatory accounting standards and other authoritative pronouncements, company law and other regulatory requirements. Pursuant to the adoption:

i) Transitional loss mainly representing the loss on fair valuation of foreign currency options, determined to be ineffective cash flow hedges on the date of adoption, amounting to Rs.ll,788 million (net of tax) has been adjusted against the opening balance of revenue reserves as of January I, 2008.

ii) Loss on fair valuation of forward covers, which qualify as effective cash flow hedges amounting to Rs.723 million (net of tax), on the date of adoption, has been recognised in the hedging reserve account.

B) For the quarter, foreign exchange loss arising on account of change in fair value of foreign currency options determined to be ineffective cash flow hedge, amounted to Rs.7,843 million before tax and has been recognised under ‘Exceptional items’. Net of tax the loss is Rs.5,177 million.

Essar Oil Ltd.

2. Exceptional items consist of (a) forex loss of Rs.679 crore on account of unprecedented depreciation in the value of rupee during the quarter, and (b) provision of Rs.524 crore on account of write down of inventory to net realisable value due to steep fall in crude/petroleum product prices during the quarter.

3. The Company has recognised exchange difference on all foreign currency monetary items as at the end of the period. There is no loss (net) on outstanding commodity derivative contracts at the end of the period.

Format and disclosures for financial statements prepared using IFRS

Revision of Financial Statements

Lok Housing and Constructions Ltd.


    — (31-3-2009)

    From Notes to Accounts :

    (2a) The global economy in general and the real estate industry in particular is passing through recession, which has resulted into financial meltdown of an un-precedental scale. During the previous financial years the Company had entered into various agreements for sale of its real estate, plots, properties, development rights and constructed premises, held by it as stock in trade. In accordance with the consistently followed accounting practice of the Company, sales revenue and profit thereon were recognised at the time of entering into such agreement to sell. Due to the above-mentioned financial meltdown some of the parties to whom sales had been effected have failed to meet their commitment. Considering the overall interest of the Company, the management decided to reacquire the properties by mutually terminating the agreements for sale entered into in the previous financial years. During the current financial year the Company has entered into 53 agreements resulting into cancellations of sale. These agreements for cancellation of sales pertain to sales and revenue/profits recognised during financial year 2006-07 and 2007-08. Though the cancellation of sales was effected during the current year and accordingly in normal course the sales return and reversal of profit thereon should be effected during the current financial year. However, the Company has been legally advised that on the doctrine of ‘Real Income’ and ‘Relation Back’, the cancellation effect should be effected in the year in which the sales and profits were originally recognised and not in the year in which the actual cancellation has taken place (that is the current financial year). Accordingly the Company has revised and re-casted its financial statements for financial years 2006-07 and 2007-08 on the above-mentioned principles. Accordingly, during the year under review, sales return and reversal of profit are not reflected, though the cancellations of sales have occurred during this financial year. The aggregate value of sales return and profit reversal as mentioned above are Rs.181.56 crores and Rs.91.23 crores, respectively for financial year 2006-07 and Rs.100.58 crores and Rs.77.78 crores, respectively for financial year 2007-08. The auditors do not concur with the above view of revising the financial statements of earlier years on the principle of ‘Relation Back’ and ‘Real Income’, instead are of the opinion that the sales return and its consequence on the profit and loss account should be reflected in the year in which such sales return takes place (cancellation of sales agreements), accordingly in the opinion of the auditors the sales return and reversal of profit thereon should be accounted/reflected during the current financial year and not in the earlier years as done by the Company.

    (2b) The Company has revised its financial statements for financial years 2006-07 and 2007-08, giving effect of cancellation of sales, in the respective years, in the manner stated in note 2(a) above. The revised financial statements are already approved by the Board of Directors at its meeting held on 30th March 2009, However the revised financial statements 2006-07 and 2007-08 are not yet adopted and approved by the shareholders. It is proposed to get the revised financial statements for financial years 2006-07 and 2007-08 at the forthcoming Annual General Meeting, along with the financial statements for 2008-09. The act of revision of the Financial Statements for F.Y. 2006-07 and 2007-08 is in accordance with the Circular No. 17/75/2002-CL.V, dated 13-1-2003 issued by the Ministry of Finance and Company Affairs permitting revision of financial statements under certain circumstances.

    From Auditors’ Report :

    (e) In our opinion and to the best of our knowledge and according to the explanation given to us and subject to the specific reference being drawn on :

    (i) note # 2(a) regarding non-accounting of sales returns of Rs.2,82,14.46 lacs effected during the year under review (instead of sales return being accounted in earlier years). The resulting impact being that sales/gross revenue for the year is over-stated by Rs.2,82,14.46 lacs and the net loss after tax is under-stated by Rs.1,69,01.50 lacs, however the reserves and surplus and inventories remaining the same; and

    (ii) note # 2(b) regarding the current financial statements for financial year 2008-09 are subject to the approval of the revised financial statements of financial year 2006-2007 and 2007-2008 by the shareholders at the forthcoming general meeting of the shareholders;

    (iii) . . . .

    (iv) . . . .

    (v) . . . .

    the said Balance Sheet, Profit and Loss Account and Cash Flow Statement read together . . . .

    From Directors’ Report :

    Review of Operations :

    . . . .

    In Financial Year 2008-09, number of agreements for sale have been cancelled, such agreements pertaining to Financial Years 2006-2007 and 2007-2008. The Company has been legally advised that since cancellation of sales pertains to sales recognised earlier, the financial statements of the period during which sales and profits were recognised need re-construction/amendment on the doctrine of ‘Relation-back’ to determine ‘Real-income’. Accordingly the Company has amended the financial statements of the relevant previous years i.e., 2006-2007 and 2007-2008 and shall submit them before the shareholders to adopt the same in this forthcoming Annual General Meeting. An elaborate explanation in this respect has been given in the Explanatory Statement of Notice convening this Annual General Meeting. (not reproduced here)

Lok Housing and Constructions Ltd.

— (31-3-2008 — revised)

    From Notes to Accounts :

During the year under review the Company had entered into several ,agreements in respect of sale of residential flats, commercial shops, properties and developments rights. Sales and revenue in respect of which is accounted in accordance with the consistently followed method of revenue recognition as mentioned in note no. 1 above. During the financial year 2008-09 the Company has entered into 48 agreements having aggregate sales value Rs.100,58.14Iacs, resulting into cancellation of sales recognised during the year under review. This cancellation of agreements have resulted into reduction in gross sales by Rs.100,58.14 lacs and corresponding reduction in net profit after tax by Rs.77,78.03 lacs. Though the cancellation of sales in respect of sales effected during the year under review has happened during the financial year 2008-2009, the Company has been legally advised that on the doctrine of ‘Real Income’ and ‘Relation Back’, the cancellation effect in respect of the above transaction should be effected in the year under review and not at the time when actual cancellation took place. Accordingly the Company has redrafted its financial statements on the above-mentioned principles as if the transaction for sales had not occurred at all. Consequently during the year under review, sales and net profit before tax is reduced compared to the original financial statements prepared for the year under review. In view of the amendment to the financial statements of the Company giving effect to the above-mentioned cancellation transactions, the Company is once against presenting the amended financial statements to the members for their approval.

The financial statements are revised in accordance with the Circular number 1/2003, dated 13th January 2003, issued by the Ministry of Finance and Company Affairs. The auditors have relied on the management’s interpretation of the said Circular that the proposed revision of the financial statements is in accordance with the letter and spirit of the said Circular, thereby the revision of financial statements is in accordance with the provisions of the Companies Act, 1956.

From Auditors’ Report:

As per our opinion, which opinion is also supported by the Institute of Chartered Accountants of India, a company cannot reopen and revise the accounts once adopted by the shareholders at an Annual General Meeting. Contrary to this opinion, the Board of Directors of the Company has reopened and revised the aforesaid accounts in terms of Circular of the Ministry of Finance and Company Affairs dated 13-1-2003 in compliance with the accounting standards.

We have considered the earlier Auditor’s Report dated 30th June 2008 on the original accounts and have examined the changes made therein, which are as under:

Cancellation of sale amounting to Rs.l00,58.14 lacs reversal of cost of sales thereto amounting to Rs.22,80.10 lacs and resulting reduction in profit after tax by Rs.77,78.03 lacs.

e) In our opinion and to the best of our knowledge and according to the explanation given to us and subject to the specific reference being drawn on note # 2(a) regarding the treatment for cancellation of sale agreements aggregating to Rs.100,58.14 lacs and resulting reduction in profit after tax by Rs.77,78.03 lacs and thereby revising the financial statements of the said year, the said Balance Sheet, Profit & Loss Account and Cash Flow Statement read together with the notes ….

From Directors’ Report:

Your Company had entered into several transactions for sale of various real estate products and properties during the year under review, when the market situations were at its pinnacle. As it is the practice in the real estate industries the payments are deferred and paid over a period of time. In accordance with the consistent accounting practice of the Company as mentioned in the notes to account the sale and profit in respect of these sale transactions were recorded. However, after the sub-prime crises, fall of giant financial institutions like Fannie Mai, Freddi Mac, Lehman Brothers, the world economy has gone into severe recession and financial meltdown, consequent of which the prices in all markets and real estate in particular have fallen by over 50-60%. The parties who had transacted in the past started defaulting on their payments. Considering the peculiarity of our business and the over-all interest of the Company, your management thought of mutually terminating some of the transactions for sale, so as to avoid the property from going into prolonged and unproductive litigation.

These cancellations of sales happened during November-December 2008, that is falling into the financial year 2008-09. In normal and regular course these sales would be shown as sales return during financial year 2008-09, however the Company has been legally advised that on the principle of ‘Real income’ and on the doctrine of ‘Relation back’, the Company should revise its financial statements for the year in which the original sales transaction hapened. Accordingly the financials statements of financial year 2007-08 are revised.
 
The Company has approached the shareholders to consider and adopt the Revised Annual Accounts and relevant Report there on for the financial Year 2007-2008.

Lok Housing and Constructions Ltd. – (31-3-2007 – revised)

From Notes to Accounts:

During the year under review the company had entered into several agreements in respect of sale of residential flats, commercial shops, properties and development rights. Sales and revenue in respect of which is accounted in accordance with the consistently followed method of revenue recognition as mentioned in note no. 1 above. During the financial year 2008-2009 the Company has entered into agreements having aggregate sales value Rs.1,81,5633 lacs resulting into cancellation of sales recognised during the year under review. This cancellation of agreements has resulted into reduction in gross sales by Rs.1,81,56331acs and corresponding reduction in net profit after tax by Rs.91,23.47 lacs. Though the cancellation of sales effected during the year under review has happened during the financial year 2008-2009, the Company has been legally advised that on the doctrine of ‘Real Income’ and ‘Relation Back’, the cancellation effect in respect of the above transactions should be effected in the year under review and not at the time when actual cancellation took place. Accordingly the Company has redrafted its financial statements on the above-mentioned principles as if the transaction for sales had not occurred at all. Consequently during the year under review, sales and net profit before tax is reduced compared to the original financial statements prepared for the year under review. In view of the amendment to the financial statements of the Company giving effect to the above-mentioned cancellation transactions, the Company is once again presenting the amended financial statements to the members for their approval.

The financial statements are revised in accordance with the Circular number 1/2003, dated 13th January 2003, issued by the Ministry of Finance and Company Affairs. The auditors have relied on the management’s interpretation of the said Circular, that the proposed revision of the financial statements is in accordance with the letter and spirit of the said Circular, thereby the revision of financial statements is in accordance with the provisions of the Companies Act, 1956.

From Auditors’ Report:

As per our opinion, which opinion is also supported by the Institute of Chartered Accountants of India, a company cannot reopen and revise the accounts once adopted by the shareholders at an Annual General Meeting. Contrary to this opinion, the Board of Directors of the Company. has reopened and revised the aforesaid accounts in terms of the Circular of the Ministry of Finance and Company Affairs dated 13-1-2003 in compliance with the accounting standards.

We have considered the earlier Auditor’s Report dated 28th June, 2007 on the original accounts and have examined the changes made therein which are as under:

Cancellation of sales amounting to Rs.l,81,56.333Iacs reversal of cost of sales thereto amounting to Rs.90,32.86 lacs and resulting in reduction in profit after tax by Rs.91,23.47 lacs.

These financials statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

e) In our opinion and to the best of our knowledge and according to the explanation given to us and subject to the specific reference being drawn on note # 2, regarding the treatment for cancellation of certain sale agreements aggregating to Rs.l,81,56.33 lacs and resulting into reduction in profit after tax by Rs.91,23.47 lacs and thereby revising the financial statements of said year, the said Balance Sheet, Profit & Loss Account and Cash Flow Statement read together with the notes …


From Directors’ Report:

Not reproduced since similar to disclosures in Directors’ Report for 31-3-2008 (revised).

Section A : Treatment of Foreign Exchange Fluctuations as per AS-11 — ‘The Effects of Changes in Foreign Exchange Rates’ issued under the Companies Acounting Standards) Rules, 2006

New Page 1Section A : Treatment of
Foreign Exchange Fluctuations as per AS-11 — ‘The Effects of Changes in Foreign
Exchange Rates’ issued under the Companies (Accounting Standards) Rules, 2006

  • Reliance Industries Ltd. — (31-3-2008)


From Notes to Accounts :

The Company has continued to adjust the foreign currency
exchange differences on amounts borrowed for acquisition of fixed assets to the
carrying cost of fixed assets in compliance with Schedule VI to the Companies
Act, 1956 as per legal advice received, which is at variance to the treatment
prescribed in Accounting Standard (AS-11) on ‘Effects of Changes in Foreign
Exchange Rates’ notified in the Companies (Accounting Standards) Rules 2006. Had
the treatment as per AS-11 been followed, the net profit after tax for the year
would have been higher by Rs.29.65 crore.

From Auditors’ Report :

In our opinion and read with Note No. 5 of Schedule ‘O’
regarding accounting for foreign currency exchange differences on amounts
borrowed for acquisition of fixed assets, the Balance Sheet, Profit and Loss
Account and Cash Flow Statement dealt with by this report are in compliance with
the Accounting Standards referred to in Ss.(3C) of S. 211 of the Companies Act,
1956.

  • ACC Ltd. — (31-12-2007)


From Accounting Policies on Foreign Currency Translation :

Exchange differences :

Exchange differences arising on the settlement of monetary
items or on reporting company’s monetary items at rates different from those at
which they were initially recorded during the year, or reported in previous
financial statements, are recognised as income or as expenses in the year in
which they arise, except those arising from investments in non-integral
operations. Exchange differences arising in respect of fixed assets acquired
from outside India on or before accounting period commencing after December 7,
2006 are capitalised as a part of fixed asset.

  • Chemplast Sanmar Ltd. — (31-3-2008)


From Notes to Accounts :

Consequent to the Notification of Companies (Accounting
Standards) Rules, 2006, the exchange differences relating to import of fixed
assets, which were hitherto being capitalised as part of the cost of fixed
assets, have been recognised in Profit and Loss Account. As a result of this
change, the profit for the year ended 31st March 2008 has decreased by Rs. 76.07
lacs.

  • Tata Elxsi Ltd. — (31-3-2008)


From Notes to Accounts :

Adoption of Revised Accounting Standard :

Treatment of Foreign Fluctuation :

The Company has adopted the Accounting Standard 11 ‘The
Effects of Changes in Foreign Exchange Rates’ (AS-11) issued under the Companies
(Accounting Standards) Rules, 2006, consequent to which exchange differences
arising on restatement/payment of foreign currency liabilities contracted for
purchase of fixed assets are charged to the Profit and Loss account.

Prior to the adoption of AS-11, the Company adjusted the
exchange differences arising on restatement/payment of such liabilities against
the cost of the related asset. Consequent to the change in accounting policy,
the profit before tax for the year and exchange gain is higher by Rs.1.90 lakhs.

  • Ramkrishna Forgings Ltd. — (31-3-2008)


From Notes to results submitted to BSE :

As per the legal advice received by the Company with regard
to treatment for the foreign currency exchange difference on amount borrowed for
acquisition of fixed assets from country outside India, the foreign currency
exchange difference has been adjusted to carrying cost of fixed assets in
compliance with Schedule VI of the Companies Act, 1956 which is at variance with
the treatment prescribed in Accounting Standard (AS-11) on ‘Effects of Change in
Foreign Currency Rates’ as notified in the Companies (Accounting Standard)
Rules, 2006. Had the treatment as per AS-11 been followed, the net profit after
tax, net block as well as reserves and surplus would be lower by Rs.2,33,92,121.

levitra

The issuance of IFRS standards in India

Accounting Standards

The International Financial Reporting Standards (IFRS)
roadmap issued by the Ministry of Corporate Affairs (MCA) stated that the IFRS
standards would be submitted to the MCA by 30 April 2010. It is widely believed
that The Institute of Chartered Accountants of India (ICAI) would facilitate the
notification of the IFRS standards in the Companies Accounting Standard Rules
through the National Advisory Committee on Accounting Standards (NACAS).

As per the roadmap issued by the MCA, there shall be two
separate sets of accounting standards u/s.211(3C) of the Companies Act, 1956.
The first set shall comprise the Indian Accounting Standards which are converged
with the IFRS and apply to the specified class of companies. The second set
shall comprise the existing Indian Accounting Standards and apply only to the
companies not covered in any of the phases of the roadmap or till the date of
applicability of IFRS for companies covered in
later phases.

Under IFRS, there are 29 International Accounting Standards (IAS)
and 9 IFRS, 11 Standing Interpretations Committee (SIC) interpretations and 16
International Financial Reporting Interpretations Committee (IFRIC)
interpretations, a total of 65. At the end of March, more than 40 of these
promulgations were not yet issued by the Institute of Chartered Accountants of
India.

Under the circumstances, corporate entities have raised
questions on how the commitment made in the roadmap can be achieved. More
importantly, entities do not know if they should start preparing for IFRS as
issued by the International Accounting Standards Board (IASB) or there will be
certain changes/exceptions to those standards. If there are changes, what will
those changes be ? Particularly, what is not clear is, whether Indian companies
will be able to use all the options allowed under IFRS or ICAI/MCA shall remove
certain options while adopting IFRS in India. For example, under IFRS, IAS-19
provides a number of alternatives to account for actuarial gains and losses,
such as the corridor approach, full recognition to income statement, full
recognition to reserves instead of the income statement. In India, it may be
possible that some of these alternatives may not be allowed.

The author is not in agreement that the alternative
accounting available under IFRS should be eliminated. This would not provide a
level playing field to Indian entities vis-à-vis international companies which
will have this benefit. It may be noted that Australia introduced IFRS
initially by eliminating multiple alternatives under IFRS. However, at a later
date they realised that this was not workable and reverted back to a full IFRS
providing all the options available under IFRS to Australian companies.

Considering the number of pending standards, there is a clear
need to significantly accelerate the process of issuing the IFRS standards. Any
time provided for public exposure will further delay the issuance of these
standards. Currently issuance and notification of standards happens on a
standard by standard basis. This process, if followed for IFRS, will take a long
time and there is no way that the 30 April deadline would be met. To smoothen
the process, the ICAI/NACAS should expose and notify all standards at one go.


For companies covered by the convergence roadmap, we may mention that it is
more of an operational issue and the ICAI/NACAS/MCA will resolve the  same
in due course. The Indian Government is committed to achieve convergence with
IFRS in  India. Thus, entities should not slow down their conversion
efforts.

levitra

Gaps in GAAP Amendment to AS-11

The Central Government, vide Notification dated 31 March 2009, has amended Accounting Standard (AS) 11 The Effects of Changes in Foreign Exchange Rates, notified under the Companies (Accounting Standard) Rules, 2006. Pursuant to the amendment, a new paragraph has been inserted in AS-11 to allow amortisation/capitalisation of foreign exchange differences arising on long-term monetary items. The amendment has far-reaching consequences, than is apparent on a plain reading.

The option permitted is not in accordance with IAS-21 Effect of Changes in Foreign Exchange Rates. The Institute of Chartered Accountants of India (ICAI) and The Ministry of Corporate Affairs (MCA) have committed to adopt IFRS with effect from April 1, 2011. Availability of the option only till March 31, 2011 clearly reinforces ICAI and MCA commitment towards adopting IFRS by 2011. Companies should take serious note of this, and start preparing for IFRS, given that the IFRS conversion process is a lengthy process.

In Annexure 1, through a simple example, the author has tried to explain the practical application of the amendment when a loan is taken for working capital purposes with regards to (a) retrospective application of the standard, (b) write-off of unamortised balance at 31 March 2011 and (c) the method of amortisation. In Annexure 2, the example remains the same, except that the loan is taken for acquiring fixed assets.

The key salient features are :

1. Exchange differences on monetary items under AS-11 are required to be recognised in the P&L Account. The amendment to AS-11 allows an alternative treatment of amortising/capitalising exchange differences on long-term monetary items.

2. If a company avails the option given in the Notification, it needs to be adopted for all long-term foreign currency monetary items. In other words, cherry picking of monetary items is not permitted.

3. The alternative treatment is optional and has to be exercised in the first reporting period after the date of the Notification. The option once exercised is irrevocable.

4. The alternative treatment applies to exchange differences, i.e., both exchange gains and losses.

5. The Notification is issued by The Ministry of Corporate Affairs (MCA) as per the authority granted under the Companies Act, 1956 which is applicable to companies. For non-corporate entities, such as partnership firms, trusts and HUFs, the ICAI has clarified that the AS-11 amendment would not apply.

6. The exchange differences to the extent falling within paragraph 4(e) of AS-16 would continue to be governed by the said requirements since these do not fall within the purview of AS-11. The option given in the Notification is available only in respect of exchange differences to the extent these are governed under AS-11.

7. If the long-term foreign currency monetary item relates to other than an acquisition of a depreciable capital asset, exchange differences should be accumulated in the ‘Foreign Currency Monetary Item Translation Difference Account’ and amortised over the life of the monetary item but not beyond 31 March 2011. If the monetary item is settled, then exchange differences cannot be carried forward and will need to be recognised immediately.

8. If the long-term foreign currency monetary item relates to acquisition of a depreciable capital asset, exchange differences arising on such monetary items should be added to or deducted from the cost of the asset.

9. Capitalisation of exchange differences as cost of depreciable asset and accumulation of exchange differences in the ‘Foreign Currency Monetary Item Translation Difference Account’ are not two separate options. Thus, if a company decides to capitalise exchange differences on foreign currency loan taken for acquisition of a depreciable capital asset, it would also need to defer the exchange differences to the ‘Foreign Currency Monetary Item Translation Difference Account’ on the foreign currency loan taken for working capital.

10. Schedule VI has been amended to remove the requirement with regard to capitalisation of exchange differences. Henceforth, the requirement with regard to capitalisation of exchange difference will be dealt with only under Accounting Standards notified in the Companies (Accounting Standards) Rules.

11. Unlike pre-revised Schedule VI, the amendment does not make any distinction in respect of fixed assets acquired from outside India or otherwise. Hence the optional treatment in the Notification would have to be applied in respect of all depreciable assets, whether acquired from within or outside India.

12. A company cannot apply this amendment with prospective effect or to accounting periods commencing before 7 December 2006. The Notification is applicable to all accounting periods commencing on or after 7 December 2006. If a company follows financial year, then the Notification would apply to all long-term monetary items that existed on 1 April, 2007 and thereafter. If a company follows calendar year, then the Notification would apply to all long-term monetary items that existed on 1 January, 2007 and thereafter.

13. To the extent the adjustment relates to earlier years (for example 1-4-2007 to 31-03-2008), the same has to be effected through the general reserve account.

14. Companies need to carefully evaluate the impact of current taxes, deferred taxes and impairment. With regards to the retrospective adjustment through the general reserve (effect of earlier years), deferred tax on that component will be adjusted to (a) in the case of a ‘Foreign Currency Monetary Item Translation Difference Account’ to a reserve account, (b) in the case of capitalisation to fixed asset it is less clear, whether the same should be adjusted to the P&L account, reserve account or ignore it as a permanent difference.

15. Networth of company will increase if exchange loss is capitalised in fixed assets and vice-versa. Exchange differences on long-term monetary assets and liabilities accumulated in ‘Foreign Currency Monetary Item Translation Difference Account’ will have no effect on networth of the company when compared to the existing AS-11 requirements.

It may be noted that AS-ll does not deal with derivatives in general, other than forward exchange contractswhich are entered into to hedge assets and liabilities on the balance sheet. AS-l1 also does not cover forward contracts that are entered into to hedge highly probable transactions and firm commitments. The AS-l1 amendment applies to monetary items.Derivatives are not monetary items within the definition of AS-l1. Therefore AS-11 amendment does not apply to derivative accounting; however, because the derivatives are entered into for hedging monetary items, the amendment has significant impact in the way such derivatives are accounted for.

The existing requirements relating to (a)A5-11with regards to forward exchange contracts, (b) Announcement of the ICAI with regards to derivatives in general, (c) AS-30 Financial Instruments: Recognition and Measurement (applicable from 1-4-2009 on recommendatory basis and 1-4-2011on mandatory basis), (d) the fact that AS-30 has not yet been notified in the Companies (Accounting Standards) Rules, and (e) the current amendment to AS-l1 creates a permutation and combination of numerous situations and complexities for which there may be no answer in current Indian GAAP literature other than by conjecture. It is possible that numerous practices would emerge. This was clearly visible in the implementation by companies of the Announcement on Derivatives issued by the ICAL This amendment will only further add to that confusion.

Consider the following situation. Company has entered into an option contract to hedge foreign currency loan liability of USD 100 taken for operations. As per the amendment, exchange difference on long-term loan liability for working capital purpose should be accumulated in Foreign Currency Monetary Item Difference Account. The following accounting treatments are theoretically possible for the option contract:

a) Account for mark-to-market losses on the option contract in the profit and loss account disregarding accounting for exchange differences on the underlying hedged item. Gains, if any, may be ignored.

b) Alternatively, gains on the option contracts may be recognised if the company can demonstrate that it is complying with AS-30 principles, to the extent possible.

c) If option is an effective hedge, adjust mark-to-market changes on option contract with exchange difference on underlying loan and account for net exchange difference on loans in Foreign Currency Monetary Item Difference Account. If there is net MTM gain, then it may be ignored.

d) The treatment in (c) above could also be used for an ineffective hedge, provided it is reasonably an economic hedge.

e) The same as scenario (c), but company may recognise net MTM gains on option contract in Reserve account if the company is following principles of AS-30 for derivative contracts.

Annexure  1

How are exchange differences accumulated in the ‘Foreign Currency Monetary Item Translation Difference Account’ amortised? Consider the following scenario:

i) FXLimited’s financial year ends on 31 March.

ii) On 1 April 2006,FXhas taken foreign currency loan amounting to Euro 300,000,for use in the working capital.

iii) The loan is repayable after 6 years, i.e., on 31 March 2012.

iv) Given in a table at the top of the next column, is the amount of exchange gain/ loss arising on the loan at each reporting date

v) FX has decided to amortise exchange differences as per the option given in the Notification.

Response

In respect of exchange differences arising on restatement of long-term monetary items not pertaining to acquisition of depreciable capital assets, the Notification provides that the same should be accumulated in the ‘Foreign Currency Monetary Item Translation DifferenceAccount’ and amortised over the remaining lifeof the loan but not beyond 31 March 2011.As per the Notification, the amendment is applicable retrospectively in respect of accounting periods commencing on or after 7 December 2006. Thus, the company would adopt the following treatment:

i) Exchange difference arising during the year ended 31 March 2007 continues to be recognised in the P&L. No retrospective adjustment is allowed for these differences.

ii) FXneeds to retrospectively adjust the amount of exchange loss recognised in the year ended 31 March 2008. The amount of retrospective’ adjustment is computed as below:

iii) FX would determine amount to be amortised in each of subsequent years as shown in the table appearing at top on the following page.

The amortisation is based on the remaining life of the loan and period to 31 March 2011, whichever is earlier. In this case,31March2011 is earlier; thus amortisation is one-third, one-half and one for years ending 31 March 2009, 31 March 2010 and 31 March 2011, respectively.

iv) No exchange differences can be carried beyond 31 March 2011 and exchange differences arising in the year ended 31 March 2012 need to be recognised immediately. In any case, FX should have adopted IFRS from 1 April 2011 and application of IAS-21 would also require exchange differences on monetary items to be recognised immediately.

An interesting observation is that since the amendment has a retrospective effect, previous exchange differences that were recognised in profit or loss would be transferred to the ‘Foreign Currency Monetary Item Translation Difference Account’ through general reserve. As this account is amortised to profit or loss of FX, there would be a double recording of the exchange difference in the profit or loss; once in previous years’ profit or loss and once going ahead by way of amortisation in future profit or loss.

Note 1

There can be various methods of determining amortisation. For example, one may argue on the following possible methods of amortisation:

i) The loan repayment is after 5 years from the date of retrospective application, i.e., 1 April 2007. Thus, amortisation for the year ended 31 March 200S is 1/ 5th of the exchange differences for the year. Since the Notification does not allow carry forward beyond 31 March 2011, any amount remaining at 31 March 2011 is written off at the said date.

ii) Year ended 31 March 200S is the 2nd year of the loan and the total period of the loan is 6 years. Thus, appropriate amortisation for the year is 2/ 6th of exchange differences for the year ended 31 March 200S.

iii) Year ended 31 March 200S is the 2nd year of the loan and the Notification allows carry forward only up to 31 March 2011. Thus, appropriate amortisation for the year is 2/5th of exchange differences for the year ended 31 March 200S.

iv) As per the Notification, FX can apply the amendment from 1 April 2007 and it is allowed to amortise exchange differences arising on the loan up to 31 March 2011. Thus, maximum deferral period for exchange differences arising and accumulated on the loan during the year ended 31 March 200S is 4 years. Accordingly, 1/4th of exchange differences is appropriate amortisation for the exchange differences.

The author is of the view that method (iv) is the most appropriate method for amortising exchange differences. Thus, the calculation is based on this method.

Annexure    2

Capitalisation of Exchange Difference

Consider the following scenario:

i) FX Limited’s  financial  year ends  on 31 March.

ii) On 1 April 2006, FX has taken foreign currency loan amounting to Euro 300,000, for acquiring plant. At the date of loan, exchange rate was Euro 1 = INR 60.

iii) FX purchased the plant amounting to INR lS,OOO,OOOusing loan amount.

iv) The useful life of the plant is 10 years and depreciation is based on the straight-line method. The loan is repayable after 6 years, i.e., on 31 March 2012.

v) Given at top on the next page in a table is the amount of exchange gain/ loss arising on the loan at each reporting date

vi) FX has decided to capitalise exchange differences as per the option given in the Notification.

Response
In respect of exchange differences arising on restatement of long-term monetary items pertaining to acquisition of depreciable capital assets, the Notification provides that the same should be adjusted to the cost of the asset and should be depreciated over the balance life of the asset (as against the life of the loan). As per the Notification, the amendment is applicable retrospectively in respect of accounting periods commencing on or after 7 December 2006. Thus, the company would adopt the following treatment:

(i) Exchange difference arising during the year ended 31 March 2007 continues to be recognised. No retrospective adjustment is required/ allowed for these differences.

(ii) FXneeds to retrospectively adjust the amount of exchange loss recognised in the year ended 31 March 2008. For exchange differences capitalised in a year, it is assumed that the same arises evenly during the year. Accordingly, the company charges 50% depreciation on such addition. On this basis, the amount to be capitalised for previous periods is determined as shown in the table alongside.

(iii) FX passes the following entry to apply the option retrospectively (at 1 April 2008)

Debit Plant INR…………….. 850,000
Credit General Reserve……………. INR 850,000

(iv) For subsequent years, FX determines capitalisation and depreciation as shown in the table below:

(v) Exchange differences arising in the year ended 31 March 2012 need to be recognised as income/ expense immediately and cannot be capitalised. In any case, FX should have adopted IFRS from 1 April 2011 and application of IAS-21 would also require exchange differences on monetary items to be recognised immediately. Also, carrying amount of plant would be determined based on IAS-16/ IFRS 1 principles.

Straight-lining of Lease

Business Combinations under IFRS

New Page 1As mergers and
acquisitions are fairly common nowadays and accounting implications significant,
there has been considerable focus and debate on how business combinations are
accounted for. Theoretically there are two methods, the pooling method and the
purchase method. The pooling method is applied when two business equals combine
into a new entity, with no acquirer being clearly identified. The purchase
method is applied when an acquirer is clearly identified in a business
combination. It may be noted that pooling is allowed only if certain conditions
indicating the merger of equals is fulfilled.

Under the pooling method the excess of consideration for
acquisition over the book value of the assets acquired is adjusted against
reserves, since the underlying transaction is a get-together of two enterprises
and consequently there is no goodwill to be recorded as an asset. Whereas under
the purchase method the consideration paid over and above the fair value of the
net assets acquired is captured as goodwill, which going forward is
tested for impairment. Under the purchase method, all identifiable assets
and liabilities are fair valued, irrespective of whether those
assets/liabilities were recorded or not in the books of the acquiree.

IFRS 3 — Business Combinations now prohibits pooling
method, since permitting two methods vitiated comparability and created
incentives for structuring business combinations to qualify for pooling, and
achieve the desired accounting objective, given that the two methods produced
quite different results. Besides in the real world it is improbable that there
would be combination of business equals with the acquirer not being
identifiable. Therefore, IFRS 3 now allows only the purchase method. With the
abolition of pooling method, there is no more incentive under IFRS to structure
deals, so as to qualify for the pooling method.


Fair value accounting under IFRS 3 reflects the true
value of an acquisition and the premium paid, i.e., goodwill. Going ahead
it would also result in an appropriate depreciation/amortisation of assets
acquired, since the fair value rather than book value of the assets would be
depreciated. It results in greater transparency and management responsibility
for the acquisition and the price paid to acquire the business. Any future
impairment of acquisition goodwill will put to question the appropriateness of
management’s decision to acquire the business.

Considerable judgment will be called for in applying IFRS 3,
including the identification and valuation of intangible assets and contingent
liabilities. Unfortunately, IFRS 3 provides limited guidance on determining fair
value of assets and liabilities acquired. There exists some guidance that
valuation report should be taken.

An interesting point to note is that IFRS 3
prohibits amortisation of goodwill and requires goodwill to be
tested only for impairment. Amortisation of goodwill results in an
even spread of charge to the income statement over several years; contrarily, a
huge one-off impairment charge on impairment of goodwill, as required by IFRS 3,
will bring in substantial volatility to the income statement.

Under Indian GAAP, there is no comprehensive standard dealing
with business combinations. In fact there are as many as six standards that deal
with various types of business combinations and accounting for goodwill. Many of
these requirements are disparate and inconsistent, for example, goodwill
resulting from an amalgamation has to be compulsorily amortised over not more
than 5 years, whereas there is no compulsion to amortise goodwill on acquisition
of a subsidiary. Another example is that acquisition accounting in the case of
acquisition of a subsidiary or an associate is based on book values, whereas
amalgamation other than which fulfil pooling conditions, can be accounted either
using book values or fair values of net assets acquired.

As stated above, acquisition accounting of sub-sidiaries,
associates and joint ventures under Indian GAAP is based on book values rather
than fair values. Unlike Indian GAAP, IFRS 3 requires assets and liabilities
acquired, including contingent liabilities, to be recorded at fair value.
Contingent liabilities are not recorded as liabilities under Indian GAAP.
Contingent liabilities are fair valued and recorded under IFRS in an
acquisition, since the consideration paid for a business by an acquirer is also
influenced by the nature and quantum of contingent liabilities of the acquiree.
For reasons mentioned above, goodwill determined under Indian GAAP is a plug-in
number, unrealistic and of little use in analysing the business combination.

IFRS 3 requires all Business Combinations (excludes common
control transactions) within its scope to be accounted as per purchase method
and prohibits pooling method. Indian GAAP permits both purchase method and
pooling of interest method, in the case of amalgamations. Pooling of interest
method is allowed only if the amalgamation satisfies certain specified
conditions.

In IFRS 3, acquisition accounting is based on substance.
Reverse acquisition under IFRS is accounted assuming the legal acquirer is the
acquiree. For example, a big private limited company to seek quick listing may
be legally acquired by a small listed company. Under IFRS, the private company
would be treated as an acquirer though legally it was acquired by the listed
company. In Indian GAAP, acquisition accounting is based on legal
form and in the above example the listed company would be treated as an
acquirer.

Business combination accounting under Indian GAAP is outdated
and does not reflect the underlying substance and the true premium paid for an
acquisition. Because of the inconsistent and disparate requirements across
various standards, it provides incentives for deal structuring. It is high time
that IFRS 3 is adopted in India without waiting for 2011.

levitra

GAPs in GAAP – Are We Really Converging to IFRS ?

Accounting standards

On a perusal of Ind-ASs, the Indian IFRS equivalent, it is
clear that they are not the same as IFRS as issued by IASB in many respects. The
differences are so numerous that people are questioning the need to change from
existing Indian GAAP to another form of Indian GAAP. Is the change and hard work
justifiable, if Indian entities are unable to proclaim that their financial
statements are IFRS-compliant and use them for cross-border fund raising or
other purposes ?

Certainly each country should have its own endorsement
process to notify accounting standards. However, that process should not be used
for ‘carve-outs’ unless they are absolutely necessary in the rarest of rare
circumstances and on sound technical grounds. The main concerns on Ind-AS are as
follows.

    (a) IFRS as issued by IASB are accepted globally on all major stock exchanges. As Ind-AS contain significant deviations from IFRS, the same may not be accepted for the purpose of raising funds from capital markets outside India. Adopting IFRS without carve-outs will make capital flows in and out of India seamless.

    (b) Global and local investors and the analyst community may not find Ind-AS financial statements very useful, as they will not be comparable with peer group companies across the globe.

    (c) In India, there are many entities with a presence in more than one part of the world, for example, they may have foreign parents/subsidiaries. Such companies look at conversion to IFRS as an opportunity to have one accounting language across all their units and eliminate the need for preparing financial statements under multiple GAAPs. The only way this can be achieved is if the entity complies with IFRS as issued by the IASB in entirety.

    (d) There is a threat that IASB may publicly disown Ind-AS as being IFRS-compliant, in which case India’s G-20 and commitments made to European Union may be put to question.

    (e) Adopting IFRS without deviations would help India’s young accounting work force to seek global opportunities and also significantly enhance its BPO potential.

Many of the differences between Ind-AS and IFRS do not
represent the economic substance of the transaction and hence may be a
disservice to all investors and providers of risk capital (and not just global
investors), for whom these financial statements are predominantly prepared. For

example:

  • The option to defer
    exchange differences on long-term monetary items is given with an intention to
    provide relief to companies who want to smoothen the impact of exchange
    differences on its statement of profit and loss. Notwithstanding the
    intention, amortisation will not result in smoothening in all cases. If
    exchange rates show an increasing trend, then exchange difference impact of
    earlier years will cause a major dent in subsequent years close to repayment
    of those long-term monetary items — for example — A company has taken a loan
    of USD 100 in year 1999-2000 repayable after three years when the exchange
    rate was 1 USD = Rs. 43. Exchange rates at the end of year 1999-2000,
    2000-2001 and 2001-2002 were 1 USD 43.63, Rs. 46.46 and Rs. 48.89,
    respectively. If the company does not avail the option, it will charge off
    exchange loss of Rs. 63, Rs. 283, Rs. 243 in each of the year respectively.
    With the use of option, charge to P&L in each of the year will be Rs. 21, Rs.
    163 and Rs. 406, respectively. It is clear that the use of option will lead to
    backloading charge of earlier years in certain situations.

  • Whilst
    smoothening may be preferred by some preparers of financial statements, what
    is relevant to investors and analyst is a full recognition policy, as that
    depicts the position of the company as at a particular date, which an
    amortisation policy distorts. Assuming all things remain the same, a company
    would be preferred by an investor if it did not have a carry forward exchange
    loss.

    Further, there are other related issues which are not addressed in Ind-AS —
    for example — whether deferment of gains/losses as per the option will impact
    the calculation of adjustment to interest cost as per Ind-AS 23 or how hedge
    accounting will work if a company has taken fair value hedge against the
    underlying foreign currency monetary item ?

  • Unlike IFRS, Ind-AS
    40 does not permit the use of fair value model, for measurement of investment
    property. Ind-AS 40, however, mandates the fair value disclosure for
    investment property. A big accounting firm recently conducted a survey on IFRS
    financial statements of 30 global real estate companies. Out of these 30
    companies, 27 have used the fair value model. Considering the global practice,
    Indian real estate companies should also be allowed to reflect true value of
    their assets in their balance sheet as that is the only relevant yardstick
    from an investor ‘s perspective. Whilst under Ind-AS 40 information on fair
    value will be required in the notes to financial statements these would not be
    prepared with the same level of rigidity as it would if those were recorded in
    the financial statements.

  • As per IAS 19,
    the rate used to discount post-employment benefit obligations is determined by
    reference to market yields on high quality corporate bonds. IAS 19 allows the
    use of market yields on government bonds as a fall-back if there is no deep
    market in corporate bonds. In contrast, Ind-AS mandates the use of market
    yields on government bonds for discounting, in all cases. Many Indian
    companies have operations all across the globe including regions where there
    are deep and liquid markets for high-quality corporate bond rates only. Ind AS
    should permit the use of high-quality corporate bond rates in such instances
    to avoid practical difficulty in re-computing defined benefit obligation of
    foreign operation who were determining their defined benefit liability using
    IAS 19 or equivalent principles. This will also result in the saving of time
    and cost for preparers of financial statements.

  • Ind-AS 101 does
    not mandate comparative information to be given as per Ind-AS. The comparative
    information will be under the Indian GAAP. It is difficult to understand how
    investors or analysts can understand these financial statements that do not
    contain comparable numbers prepared under the same framework.

In addition, it is likely that practice related differences are likely to emerge between IFRS and Ind-AS. For example, globally under IFRS, rate regulated assets are not recognised as they do not fulfil the definition of an asset under the IFRS framework. Under the current Indian GAAP practice is to recognise rate-regulated adjustments as assets. It is most likely that this practice under the Indian GAAP may be carried forward under Ind-AS. Another example is that of agricultural accounting. Under IFRS biological assets are fair valued under IAS 41. However, Ind-AS will not contain any standard on agricultural accounting for the time being and consequently the practice of measuring biological assets at cost under the Indian GAAP most likely would be carried forward under Ind-AS.

Regulatory hurdles may also widen the gap between Ind-AS and IFRS — for example — depreciation rates under Schedule XIV of the Companies Act may de facto become the norm though those may not reflect the useful life of an asset for a company and hence may not comply with IFRS. The Companies Act needs to be amended to disable certain sections which are not aligned to IFRS accounting, for example, section 391 and section 394 permit departure from accounting standards in an amalgamation or restructuring exercise. Even if these sections are amended, those probably can only have a prospective effect. Therefore it is not clear what happens to the accounting prescribed in court sanctioned schemes prior to amendment of section 391 and section 394 which may be in conflict with IFRS.

Further, more changes may emerge in the future between the two frameworks, as IFRS standards undergo a change, which may not be incorporated in Ind-AS. Given the existing date uncertainty on IFRS implementation, and the substantial dilution of IFRS, the global community would question India’s ability to push through major reforms. By adopting IFRS as it were, India could have played a leading role in the global arena; unfortunately, this is a missed opportunity, for a nation that aims to become the third largest economy in the next few decades. People will continue to question the need to move from one set of Indian GAAP to another set of Indian GAAP.

GAPs in GAAP – Accounting for Agriculture

Accounting Standards

IAS-41 prescribes the accounting treatment for agriculture,
which includes biological transformation of living animals or plants for sale,
into agricultural produce, or into additional biological assets. IAS-41 requires
measurement at fair value less estimated point-of-sale costs from initial
recognition of biological assets up to the point of harvest, except in rare
cases.

IAS-41 requires that a change in fair value less estimated
point-of-sale costs of a biological asset be included in profit or loss for the
period in which it arises. Under a historical cost accounting model, a
plantation forestry enterprise might report no income until first harvest and
sale, perhaps 30 years after planting. On the other hand, IASB believes an
accounting model that recognises and measures biological growth using current
fair values reports changes in fair value throughout the period between planting
and harvest.

Where market-determined prices or values are not available
for a biological asset in its present condition, IAS-41 requires use of the
present value of expected net cash flows from the asset discounted at a current
market-determined pre-tax rate in determining fair value.

When IAS-41 was issued it met with severe criticism because
many agricultural assets are simply not subject to reliable estimates of fair
value. Take for instance, a pony which is kept as a potential breeding stock,
grows into a fine stallion. The stallion starts winning race events. The
stallion earns substantial amount for its owner from breeding services. The
stallion gets older, his utility decreases. Eventually the stallion dies of old
age and the carcass used as pet food. At each stage in the life of the horse,
the fair values would change significantly, but estimating the fair values could
be extremely subjective and difficult. In many ways, the stallion reminds one of
fixed assets. Changes in fair value of fixed assets are not recognised in the
income statement, then why should the treatment be different in the case of
agricultural non-financial assets ?

Vineyards and coffee and tea plantations have similar
measurement issues. The relationship between the vines and coffee or tea plants
and the land that they occupy is unique and integrated. The vine or plant itself
has relatively little value. However, in conjunction with the land, they do have
value. Determining the fair value for a vineyard, coffee or tea plantation
involves estimating the production along with sales prices and costs for a
number of years in the future, together with estimating a terminal value and the
application of a discount rate to calculate the net present value — an
enormously complex and subjective task. The value of the vines and plants would
then have to be determined as a residual because it would be calculated by
deducting the value of the unimproved land and the value of the infrastructure
from the aggregate value. It is clear that the valuation, as a result of the
estimates and subjectivity, is open to substantial variability.

Because biological assets are subject to droughts, floods and
diseases, the unrealised gains arising from changes in fair value can give a
distorted picture of the financial results of the agricultural enterprise. It
could be misunderstood and may lead to inappropriate decision-making, such as
dividend declaration from unrealised profits. Another question about the
reliability of measurements relates to the homogeneity of the assets. During the
transformation process, it could be very difficult to determine the likely
quality. Even if the quality is known, estimating the price and the market where
the produce would be ultimately sold could become a challenge.

Although the recognition of unrealised gains and losses on
financial assets is achieving wider acceptance, the IASB has not yet put forward
any convincing arguments in favour of a fair value model for non-financial
assets.

IAS-38, Intangible Assets, allows intangible assets to be
carried at revalued amounts. However, for intangible assets to be carried at
revalued amounts, IAS-38 imposes strict criteria — an active market is
necessary, which requires items traded to be homogeneous, with willing buyers
and sellers normally being found at any time and prices being available to the
public. However, IAS-41 does not impose the same hurdles for agricultural assets
and requires them to be fair valued except in rare cases. The IAS-41 approach
therefore is inconsistent with other international standards.

In India, there is no accounting standard on biological
assets and agricultural produce. Accounting standard on agriculture is the need
of the hour as many Indian companies are venturing in these businesses in big
way due to thrust on retail, dairy, horticulture, etc. Given the criticisms on
fair valuation and the fact that commercial farming enterprises in India operate
as private companies and surely don’t need the additional cost burden that may
not produce reliable results, the ICAI should develop a standard based on the
historical cost model.

levitra

Fair Value or Fear Value?

Accounting Standards

Fair value accounting is an integral aspect of International
Financial Reporting Standards (IFRS). In good times, everyone likes fair value
accounting, however, in bad times they are complaining. With the adoption of
IFRS from 2011 by India, the debate on fair value accounting has exacerbated.
Some argue that fair value accounting is procyclical and caused the recent
credit crisis. However subsequent research done by SEC indicates that financial
institutions collapsed because of credit losses on doubtful mortgages, caused by
sub-prime lending, and not fair value accounting.

Those criticising fair value accounting do not seem to
provide any credible alternatives. Do we take a step back to historical cost
accounting, wherein financial assets are stated at outdated values and hence not
relevant or reliable? Is there any better way of accounting for
derivatives, other than using fair value accounting ? For example, in the
case of long-term foreign exchange forward contracts there may not be an active
market. For such contracts, entities obtain MTM quotes from banks. In practice,
significant differences have been observed between quotes from various banks.
Though fair value in this case is judgmental, is it still not a much better
alternative than not accounting or accounting at historical price ?

Some years ago an exercise was conducted by a global
accounting firm to determine employee stock option charge. By making changes to
the input variables, all within the allowable parameters of IFRS, option expense
as a percentage of reported income was found to vary as much as 40% to 155%.
However, since then the IASB has issued an Exposure Draft on fair value
measurement, and overtime subjectivity and valuation spread is expected to
reduce substantially.

The next question is what kind of assets and liabilities lend
themselves better to fair value accounting. Whilst many non-financial assets
under IFRS are accounted at historical cost, biological assets are accounted at
fair value. Unfortunately many biological assets are simply not subject to
reliable estimates of fair value. Take for instance, a colt which is kept as a
potential breeding stock, grows into a fine stallion. The stallion starts
winning race events and is also used in Bollywood films. The stallion earns
substantial amount for its owner from breeding and other services. The stallion
gets older, his utility decreases. Eventually the stallion dies of old age and
the carcass used as pet food. At each stage in the life of the horse, the fair
value would change significantly, but estimating the fair values could be
extremely subjective and difficult. In many ways, the stallion reminds one of
fixed assets. Changes in fair value of fixed assets are not recognised in the
income statement, then why should the treatment be different in the case of
biological non-financial assets ?

In India the debate on fair value has got confused because of
lack of understanding of IFRS. For example, a common misunderstanding is that
all assets and liabilities are stated at fair value. However, the truth is that
under IFRS many non-financial assets such as fixed assets or intangible
assets are stated at cost less depreciation. In the case of investment
properties, a company is allowed to choose either the cost option or fair value
option for accounting. The apprehension of using fair value accounting for
investment properties is driven by tax considerations. However, one may note
that IFRS financial statements are driven towards the needs of the investor and
not of any regulator. Therefore, the income-tax authorities should ensure that
IFRS is tax neutral.

Being an emerging economy, without deep markets in many
areas, India would have specific challenges. Many of the challenges in
determining fair valuation applicable to emerging economies may also apply to
any other developed economy. However, lack of expertise and experience in
emerging economies may amplify the problem. Additional education might be needed
on how to make estimates and judgments and the disclosure of fair value in
financial statements.

Many emerging economies do not have a deep and active market
for long-term maturities, and in the case of corporate bond there may not be an
active market at all. Valuation of such bonds would be difficult as there would
be no market to mark, and estimating discount rate for longer-term maturities
could be challenging. A country may have only one risk premium that covers all
maturities but not broken up for specific duration or industry sector — this can
compound the problem.


Any valuation that involves tax and foreign exchange as a
variable will add another dimension of complication in the case of emerging
economies. This is because tax rates and regulations are not stable and
change quite frequently. Also, experience indicates that foreign exchange
reference rates announced by the central bank or a regulatory body may be
significantly different from the market. In the case of foreign exchange forward
contract, there may not be an active market beyond one year. Significant
differences have been observed in the MTM quotes from various banks on long-term
forward contracts.

If one has to value a corporate bond that is not actively
traded, the discount rate would be the base rate plus a credit rating-based
credit spread. There are various discounting curves available such as the
zero-coupon interest rate, yield to maturity rate, MIBOR, Fixed Income Money
Market and Derivative Association (FIMMDA) rate, etc. FIMMDA issues credit
rating-based credit spread on a monthly basis. Reuters issues credit spread on a
daily basis but only for AAA rated instruments. The reliability of the valuation
of the bond would depend upon (a) the reliability of the base rate used (b) the
availability and reliability of the credit rating for the instrument, and (c)
the reliability of the credit spread. If a company uses a particular curve to
discount a corporate bond (say, YTM curve) which is different from the
acceptable practice in the market (say, FIMMDA), then the value would differ
from how the market determines it.

Similar issues would also arise in the case of valuation of
government bonds. Many of them may be very illiquid, particularly the state
government bonds. Quotes from different brokers often differ significantly. Also
it is difficult to know if the brokers are acting as principal or agents and
whether the broker will fulfil the deal at the committed price. Valuing them in
the absence of a market may yield different results, as risk premium for state
governments may not be available and would certainly not be the same as that of
the central government. As per RBI requirements state government securities are
valued applying the YTM method by marking it up by 25 basis point, above the
yields of the central government securities of equivalent maturity. However,
under IFRS this approximation may not work, as it is clear that
different states have different risk profiles, which impacts their valuation.

Under IFRS a company may have to fair value its foreign currency convertible bond listed on a foreign securities exchange. However, in many instances at the reporting period there may be no trade as it may not be actively traded. This could lend itself to potential abuse as insignificant trades at the reporting date may inaccurately determine the fair value of the bonds. The appropriate thing to do in such situations is to make an adjustment to the quoted price based on a detailed analysis so as to measure the bond at its fair value.

It is also common in an emerging economy that an entity is required to estimate fair value of an unquoted instrument, without the benefit of detailed cash flow forecasts, management budgets, or robust multiples. An entity may own an insignificant amount, say, 10% of another entity, and therefore may not be legally entitled to obtain that information from the investee. In many cases, local benchmark companies or their financial information may simply not be available on which to base the valuation. It may be noted that RBI requires unquoted equity instruments to be valued at break-up value from the company’s latest available balance sheet, and in its absence, at Re.1 per company. Such valuations would not be acceptable under IFRS.

When estimating fair value in an emerging economy, modelling a non-financial variable could be extremely difficult. For example, under IFRS, acquisition accounting requires fair valuation of contingent liabilities of the acquiree. If the contingent liabilities were with regard to tax, in many developed economies there is a settlement system and past experience on which an estimate can be based. However, in emerging economies the litigations tend to be very long-drawn and uncertain, eventually resulting in a full liability or no liability at all. The tax authorities that influence the variable may change their behavior rapidly, thereby making the historical behaviour an inaccurate basis on which to predict future behaviour.

Sometimes market dynamics work in a very complicated manner in emerging economies. It may be difficult to determine the principal or most advantageous market due to regulatory or political circumstances. For example, a commodity market may have been cornered by a few selected players, and though in legal terms, all market participants can trade in the market, in actual terms it may be restrictive. Whether such a market should be considered in determining the fair value, if the market participant is not entirely clear whether it will be allowed entry and trade without any restriction ? Such questions would be more common in emerging economies.

Highest and best use is a concept that underscores fair valuation. As people are supposed to act rationally, a fair value measurement considers a market participant’s ability to generate economic benefit by using the asset in its highest and best use. However, highest and best use is subject to the restrictions of what is physically, legally and financially feasible. This could be a difficult area particularly in emerging economies, in the absence of clear laws or the manner in which they are implemented. For example, a builder that owns a piece of land, may not be clear, whether he will be allowed to construct 10 floors or 20 floors and whether the property development is restricted by laws in terms of its usage, for example, only for residential or commercial purposes, etc. This could make the valuation of the land a difficult task.

The above are issues that emerging economies may face more prominently than developed economies. In any system or methodology, fair valuation cannot be expected to provide, the same results if different valuers were valuing it. This is because it is not a science but an art and no guidance or methodology can ever make it a science. However, some additional guidance from the IASB on the above issues will certainly be helpful in bringing about clarity and consistency on how these issues are handled and in collapsing the range within which the fair value should fall. Issuance of guidance that specifically deals with fair valuation issues in emerging economies, will also reduce the resistance in these economies towards fair valuation.

To sum up, fair value accounting does not create good or bad news; rather it is an impartial messenger of the news. However, IASB should look at improvements in terms of providing guidance on a regular basis to reduce judgment and subjectivity as well as restricting the use of fair value accounting only to those assets and liabilities that lend themselves better to fair value accounting. IASB should also focus on providing specific guidance on the fair value challenges that emerging economies such as India would face.

GAPs in GAAP – Discount rate for employee benefits (Proposed amendments to IAS 19)

Accounting Standards

IAS 19 Employee Benefits have required pension obligations to
be discounted at rates based on high quality corporate bond rates. However, in
countries with no deep market in such bonds the rate on government debt is to be
used.

One of the effects of the current financial crisis has been a
significant widening of the spread between yields on government bonds and those
on high quality corporate bonds. In particular, the current market results in
otherwise identical obligations being measured at very different rates due
solely to the presence or absence of a deep corporate bond market. In light of
this, the IASB published an exposure draft aiming to remove this lack of
comparability. The proposal will require the use of corporate bond rates in all
circumstances. The intention of the amendment of IAS 19 seems to be to require
use of a consistent reference in choosing the rate for discounting employee
benefit obligations regardless of whether there is a deep market in high quality
corporate bonds in the country concerned. The Board envisages that there will be
improved comparability between reporting entities due to a reduction in the
range of rates used.

Should the Board eliminate the requirement to use government
bond rates to determine the discount rate for employee benefit obligations when
there is no deep market in high quality corporate bonds ?

Since market interest rates differ considerably from country
to country or from currency zone to currency zone, consistency in application is
primarily important among plans operated in the same country or currency zone.
The financial crisis has not only widened the spread between government bond
rate and the rate on high quality corporate bonds, it has also widened the range
of corporate bond rates generally considered to be of high quality. In
particular, now that we see evidence of the spread between government bond rate
and corporate bond rate narrowing again, the range of applied corporate bond
rates within a jurisdiction is a significantly bigger concern than the spread
between government bond rate and corporate bond rate.

Generally, government bond rates are more reliably
determinable and show a significantly narrower range than high quality corporate
bond rates. In countries or currency zones where there is no or no deep market
for high quality corporate bonds the range of applied discount rates may be even
wider. The proposed change may actually decrease comparability among entities
within a jurisdiction (such as India) that would have previously applied a
discount rate determined by reference to government bond rates, as the range of
available rates for high quality corporate bonds tends to be much wider than
that of government bond rates.

This is aggravated by the fact that the current IAS 19, as
well as the proposed amendment, do not contain any further guidance regarding
the meaning of the phrase ‘high quality corporate bond rate’. So even if the
Board proceeds with this ED despite the concerns, more detailed guidance is
needed on what constitutes ‘high quality’. This would avoid the risk of
continued significant variability in discount rates selected, even within those
jurisdictions having a deep market for high quality corporate bonds.

The Board reminds its constituencies that it intends to
review the accounting for employee benefits more broadly in due course and notes
that these proposals are not meant to pre-empt that. Perhaps more ominously, the
Board notes that “The Board has not yet considered whether the measurement of
employee benefit obligations could be improved more generally and, in
particular, the Board has not yet considered whether the yield on high quality
corporate bonds is the most appropriate discount rate for postemployment benefit
obligations.”

Rather than proceeding with this ‘quick fix’, it is
recommended that the Board works expeditiously on its comprehensive review of
IAS 19, including the choice of discount rate. This will avoid a disruption of
financial information for those entities operating in jurisdictions that
currently use government bond rates to discount defined benefit obligations. In
those jurisdictions where entities currently use government bond rates due to
the absence of a deep market for high quality corporate bonds, users are
accustomed to this practice, the discount rate can be determined reliably and is
applied consistently by entities in that jurisdiction. The ED would lead to a
considerable widening of the range of discount rates applied and a move from a
‘level 1 fair value’ discount rate to a ‘level 3 fair value’ discount rate.

One would generally support proposals to improve
comparability and consistency. However, it appears inappropriate to have
consistency without having considered whether corporate bond rate or government
bond rate is appropriate to use. This quick fix proposed change only for
purposes of consistency does not match well with numerous accounting options
under IFRS — particularly one that needs mention is the manner in which
actuarial gains and losses are recognised in IFRS. Besides, for reasons
mentioned above, it is highly questionable if consistency would be achieved by
the proposed amendments.

The author would therefore recommend status quo and no haphazard changes to
IAS 19 discount rate at this stage.

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Impact of IFRS on Banks

Accountant Abroad

International accounting standards will make it harder for
banks to keep assets off their balance sheets, a UK regulator said on Monday,
while the United States continues to mull whether to broaden its use of foreign
rules.

Under current U.S. accounting rules, companies can keep
certain loans, such as those linked to risky mortgages and credit card debt, in
off-balance sheet vehicles known as ‘qualified special purpose entities’ (QSPEs).

The United Kingdom adheres to international financial
reporting standards (IFRS), which have more flexible accounting rules, but have
forced firms to include more assets on their books. It is said that having a
precise rule may be advantageous, but a precise rule also makes it possible to
design something that is precisely just outside the rule. Therefore the more
principles-based approach under IFRS adopted under UK (Generally Accepted
Accounting Principles) makes it much more difficult to design something in such
a way that it is off-balance sheet.

Few companies that have to adopt international accounting
standards have had to put about 200 off-balance sheet entities back on their
books. Many of the vehicles that were brought back on the balance sheet were
originally created using U.S. accounting rules and “a lot” were set up as QSPEs.
The SEC is examining whether to allow domestic companies to use international
standards instead of U.S. accounting rules.

Foreign-listed firms in the United States can already forego
U.S. standards for international rules and the SEC is expected to come up with a
“roadmap” to broaden use of IFRS. The treatment of off-balance sheet items is
one of many accounting methods that is being examined and debated.

The U.S. accounting rule maker, the Financial Accounting
Standards Board, will soon propose to eliminate the QSPEs. However, the board
has delayed the implementation of the rule change and said it should take effect
for reporting periods after November 15, 2009.

China pushes forward producing accounting, auditing and financing talents :

China’s three National Accounting Institutes are to teach
annually 100,000 people and help them become senior professionals in accounting,
auditing, and financing over the next five to ten years.

Meanwhile, another 1,000 will receive training and teaching
from the three institutes and reach an international level of competence each
year, according to the Chairman of the Institutes’ board of directors.

He raised these two ambitious goals after a board meeting
recently, which analysed the achievements and experiences of the institutes over
the past ten years.

Beijing National Accounting Institute was the first of the
three to be founded in 1998, and had taught more than 130,000 people over the
past decade, averaging 13,000 per year, according to figures from the
institute’s journal. The other two are in the eastern metropolis of Shanghai and
the coastal city of Xiamen, founded in 2000 and 2002, respectively.

Led and supported by multiple state departments, the
institutes are expected to produce talents in accounting, auditing and
financing, who will work as experts and professionals in the country’s
macro-economy management departments, large and medium-sized enterprises and
financial organisations.

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Governance – Rethinking Takeover Regulations in UK in the Wake of Kraft’s Conquest of Cadbury

Accountant Abroad

Workers at the Cadbury plant
in Keynsham, in the west of England, thought they had a sweet deal. In the
middle of a takeover bid for the British confectioner last year, the U.S. food
company Kraft pledged that the factory, earlier slated for closure by Cadbury,
would remain open if it won the company. When the deal wrapped, though, the
pledge soured. Too much of Keynsham’s production had apparently been shifted to
Poland to reverse its closure, Kraft lamented. The plant, after more than 75
years making chocolate, will shut next year, its staff of 400 among the early
casualties of the $ 18 billion deal.

Few hostile bids for a
British firm and a beloved brand have ruffled the country’s business and
political chiefs the way Kraft did. But the debate took a twist. Although the
Americans were excoriated for their U-turn, the pivotal role of short-term
Cadbury investors in handing the firm to Kraft sparked calls for a rethink of
the way takeovers are governed in the U.K.

And that’s exactly what the
Takeover Panel, the independent body that sets the rules for deals involving
U.K. firms, is doing — undertaking a review of the mergers and acquisitions
process with an eye on reform. The government is poised to unveil its own
recommendations for change, Business Secretary Vince Cable said to a
parliamentary committee on July 20.

Few would dispute any
British claim of being the takeover capital of Europe. According to Dealogic,
which tracks global M&A, the U.K. has seen more than twice as many of its
companies bought since 2005 as any of Europe’s other leading economies. Among
the conquests : airport operator BAA bought by Spain’s Ferrovial, British Energy
bought by France’s EDF and iconic car maker Jaguar and steel maker Corus taken
over by India’s Tata Group.

Chalk at least some of that
up to the Anglo-Saxon brand of capitalism, one that European continental
regulators have often resisted. France, for instance, has bluntly protected its
‘national champion’ companies from hostile offers. With boards and the
government less able to meddle in the takeover process in Britain, says Roger
Barker, head of corporate governance at the London- based Institute of
Directors, it is “very much an outlier in terms of the openness of our market
for corporate control.”

To make deals tougher for
acquirers to execute, the Takeover Panel is considering ways to grant
longer-term shareholders in a target firm more power to decide the fate of an
offer. One proposal being considered would see the threshold for an acquisition
increased from 50% plus one of the voting rights to 60% or higher. Another would
disenfranchise investors who buy a target’s shares after an offer has been made
by denying them the right to vote on the bid.

Both ideas have their flaws.
U.K. corporate law permits a shareholder to control a company with 50% plus one
by, for instance, issuing resolutions to dismiss the board and appoint a new
one. That such a stake would no longer grant ownership seems incongruous.
Depriving newer investors of the right to vote on a takeover, meanwhile, makes
presumptions about their motives and desirability that won’t always be fair.
After all, the reason there are short-term shareholders is that some long-term
shareholders sell out. They are voting with their feet. Disenfranchising on
those grounds, says Michael McKersie — an assistant director at the Association
of British Insurers, which represents major investors in U.K. stocks — “is just
a form of discrimination.”

Other proposals, though, are
less fraught. Giving shareholders in a bidding company a say in the process
seems sensible, since those left holding stock in the combined entity have far
more to lose from a poorly judged acquisition. Big deals involving a British
buyer sometimes require approval from the bidding company’s shareholders. For
instance if Kraft were a U.K. company, it would have needed shareholders to
approve the move for buying out Cadbury.

The City is not anticipating
revolutionary change within the Takeover Panel’s recommendations. Any radical
measures to ensure that deals are decided on the basis of long-term-shareholder
value rather than short-term speculation, would be more likely to come from the
government. The Institute of Directors’ Barker, for one, is betting on the
government to take some significant action. Officials are already mulling plans
to subject big deals to greater regulatory scrutiny before an offer has
officially been tabled. That’s far too late to help workers at the Cadbury plant
in Keynsham. But it just might make the deal’s aftertaste a touch less bitter !

(Source : Time, 16-8-2010)

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Practical Insights into Accounting for change in Ownership Interest in a Subsidiary under IND AS

The business combination and consolidation principles as discussed under Ind AS-103 (Business combinations) and Ind AS-27 (Consolidated and Separate Financial Statements) provide elaborate guidance on different arrangements between shareholders that lead to change in ownership interest. Such a change in ownership interest may alter the existing control conclusion (i.e., that lead to an investor obtaining or losing control over an investee) or that may not alter the existing control conclusion. In this article, we focus on the guidance provided under Ind AS on such transactions between shareholders, sharing our perspectives on the accounting for such arrangements.

There could be mainly four scenarios for change in ownership interest over an investee, where the change in ownership interest in the investee leads to:

(1)    dilution of ownership interest that leads to loss of control over a subsidiary;
(2)    dilution of ownership interest, but the control over a subsidiary is retained;
(3)    acquisition of additional ownership interest in an existing subsidiary; and
(4)    acquiring control over the investee that is not a subsidiary at the time of acquisition.

Scenario 2 and 3 as mentioned above relate to dilution of existing interest and acquisition of additional interest, respectively, that does not change the control conclusion i.e., the investee would be classified as a subsidiary before and after the change in ownership interest. As the accounting principles for such transactions are common, we shall combine the scenario 2 and scenario 3 for the purpose of this discussion.

The accounting for change in ownership interest in an investee that is not classified as a subsidiary, associate or joint venture in accordance with Ind AS shall be accounted based on guidance provided under the Ind AS-32 and Ind AS- 39 relating to financial instruments and is beyond the discussion under this article.

Let us consider each of the above scenarios.

Dilution leading to loss of control

Dilution and loss of control

The dilution of ownership interest in a subsidiary may be in the nature of absolute change or a relative change in ownership interest and takes various forms such as:

— the parent selling all or part of its ownership interest in its subsidiary;
— the subsidiary issues shares to third parties, thereby reducing the parent’s ownership interest in the subsidiary.

Such a dilution may lead to loss of control over the subsidiary. However, sometimes the loss of control may not involve change in ownership interest (absolute or relative), but may be effected

through contractual arrangements, such as:

— a contractual agreement that gave control of the subsidiary to the parent expires; or

— substantive participating rights are granted to other parties.

Accounting for loss of control

When a parent loses control of a subsidiary, broadly the following steps are involved in accounting for the loss of control over a subsidiary, whereby the parent:

—  de-recognises the assets (including any good-will) and liabilities of the subsidiary at their carrying amounts in the consolidated financial statements at the date when control is lost;

— de-recognises the carrying amount of any non-controlling interests (NCI) in the subsidiary in the consolidated financial statements at the date when control is lost (including any components of other comprehensive income attributable to them);

— recognises the fair value of the consideration received, if any, from the transaction, event or circumstances that resulted in the loss of control;

— recognises any investment retained in the former subsidiary at its fair value at the date when control is lost;

— reclassifies to profit or loss (or transfers directly to retained earnings if required in accordance with other Ind AS) gain or loss previously recognised in other comprehensive income (OCI); and

— recognises any resulting difference as a gain or loss in profit or loss attributable to the parent.

Based on the above broad steps, there is a two-fold impact for the loss of control in the profit or loss account (i) reclassification of amounts accumulated in the OCI; (ii) loss or gain due to loss of control over subsidiary.

Reclassification from OCI to profit or loss

The amounts accumulated in OCI are transferred to profit or loss account as on losing control, components of other comprehensive income related to the subsidiary’s assets and liabilities are accounted for on the same basis as would be required if the individual assets and liabilities had been disposed of directly.

Loss or gain due to loss of control

If the loss of control is pursuant to sale of all of the parent’s investment in the former subsidiary, then the loss or gain would only comprise of loss or gain on sale of subsidiary.

However, if the parent retains some or all of its investment in the former subsidiary after losing control (i.e., a non-controlling interest), then such investments would be measured at its fair value as at the date of losing control and the impact would be recognised as part of loss or gain in profit or loss account. In such a case, the loss or gain due to loss of control would comprise of two elements i.e.,

—  loss or profit on disposal of subsidiary; and

—  loss or gain on remeasurement of investments to the extent retained at the time of losing control.

Illustration
The above principles can be explained with the help of the following example:

— Company A owns 60% of the shares in Company B.

— On 1 April 2010 A disposes of a 20% interest in B for cash of Rs. 200 and loses control over B.

—  The fair value of the remaining 40% (i.e., 60 – 20) investment is determined to be Rs. 400.

— At the date that A disposes of a 20% interest in B, the carrying amount of the net assets of B is Rs. 875.

— Before allocation to NCI, the OCI included foreign currency translation reserve (FCTR) of Rs. 50 and available-for-sale revaluation reserve (AFS reserve) of Rs. 100 relating to the subsidiary.

— The amount of NCI in the consolidated financial statements of A on 1 April 2010 is Rs. 350. The carrying amount of NCI includes an amount of Rs. 20 and Rs. 40 relating to NCI’s share (i.e., 40%) in the FCTR and AFS reserve, respectively.

A shall record the following entry to reflect its loss of control over B at 1st April 2010:

The 165 recognised in profit or loss comprises:

— the increase in the fair value of the retained 40% investment of Rs. 50 [400 – (875 x 40%)];

— the gain on the disposal of the 20% interest of Rs. 25 [200 – (875 x 20%)],

— the reclassification adjustments for transfer from OCI of Rs. 90 (30 + 60).

The remaining interest of 40% represents the cost on initial recognition of that investment and the subsequent accounting for the said investment would be as per Ind AS-28 (Investment in Associates) or Ind AS-39 (Financial Instruments: Recognition and Measurement), depending upon whether the investee qualifies as an associate.

Change in ownership interest while retaining control

After a parent has obtained control of a subsidiary, it may change its ownership interest in that subsidiary without losing control. This can happen, for example, through the parent buying shares from, or selling shares to, the NCI or through the subsidiary issuing new shares or reacquiring its shares.

Transactions that result in changes in ownership interests while retaining control are accounted for as transactions with equity holders in their capacity as equity holders. As a result, no gain or loss on such changes is recognised in profit or loss; instead it is recognised in equity. Also, no change in the carrying amounts of assets (including goodwill) or liabilities is recognised as a result of such transactions. This approach is consistent with NCI being a component of equity.

The interests of the parent and NCI in the subsidiary are adjusted to reflect the relative change in their interests in the subsidiary’s equity. Any difference between the amount by which NCI are adjusted and the fair value of the consideration paid or received is recognised directly in equity. Similar principles also apply when a subsidiary issues new shares and the ownership interests change due to that issuance.

Broadly, the following steps are involved in accounting for such transactions:

— Calculate the amount of adjustment required in NCI

— Recognise the difference between the adjustment to NCI and consideration, in equity. Illustrations:

The above principles can be explained with the help of the following examples:

Illustration 1: Subsidiary issues fresh shares leading to change in relative interest

— Company B has 100 ordinary shares outstanding and the carrying amount of its equity (net assets) is Rs. 100. S has no other comprehensive income.

—  Company A owns 90% of B, i.e., 90 shares.

— B issues 20 new ordinary shares to a third party for Rs. 40 in cash, as a result of which B’s net assets increase to Rs. 140;

— A’s ownership interest in B reduces from 90% to 75% (A now owns 90 shares out of 120 issued); and

— NCI in B increase from Rs. 10 (100 x 10%) to Rs. 35 (140 x 25%).

Company A records the following entry in its consolidated financial statements to recognise the increase in NCI in B arising from the issue of shares as follows:

Illustration 2: Purchase of additional interest from NCI

— Company A acquired 80% of Company B in a business combination several years ago. A sub-sequently purchases an additional 10% interest in B from third parties for Rs. 300;

—  The carrying value of B’s net assets, NCI and parent’s share of equity was Rs. 1000, Rs. 200 and Rs. 800, respectively.

Consequent to the additional purchase of 10% interest in B, the NCI shall adjusted by Rs. 100 for the 10% interest and the difference between the consideration paid (i.e., Rs. 300) and the adjustment to NCI (i.e., Rs. 100) shall be recognised in equity.

Illustration 3: Sale of interest

— Company A acquired 80% of Company B in a business combination several years ago. A subsequently sells a 20% interest in S for Rs. 300, but retains control of B.

— The carrying value of B’s net assets, NCI and parent’s share of equity was Rs. 1000, Rs. 200 and Rs. 800, respectively.

Consequent to the sale of 20% interest in B, the NCI shall be adjusted (i.e., increase) by Rs. 200 for the 20% interest and the difference between the consideration received (i.e., Rs. 300) and the adjustment to NCI (i.e. difference of Rs. 100) shall be recognised in equity.

Acquisition control over the investee that is not a subsidiary at the time of acquisition

The fourth scenario discussed above is in relation to acquisition of shares in an investee resulting in the investor acquiring control over the investee. Such transactions are covered within Ind AS-103 (Business Combinations) to the extent the investee constitutes a business. If the investee does not constitute a business, then the accounting should be in line with the other applicable Ind ASs. We will cover these in subsequent articles.

Summary

Overall, the implementation of the above guidance would involve exercise of judgment as the accounting for change in ownership interest is dependent on whether the control conclusion has changed. In case the change in ownership interest leads to:

— gaining control over an investee that constitutes a business, then such arrangements are recognised as business combinations as per Ind AS-103;

—  losing of control over an existing subsidiary, then any profit or loss on change of ownership (including fair value movements of retained interest) is recognised as part of profit or loss; and

— any change in absolute or relative interest that does not change the control conclusion in case of a subsidiary, is recognised in equity.

IFRS implementation Û Auditors’ Training

Accountant Abroad

Earning your stripes as a certified public accountant is not
an easy job. This is about to get even more complicated as the United States
Securities and Exchange Commission is moving toward adoption of International
Financial Reporting Standards (IFRS).

There is going to be a scramble to train people who are in or
headed for financial accounting careers. Plus, there will be a host of issues
that arise for the profession: Training institutes and firms will be stretched
to prepare auditors for the switch. Accounting firms may face new legal
liability. And, investors will have a new breed of financial statements to
study. There’s work ahead for all involved.


Principle-based v. rule-based :


One thing most accountants have probably learned is this :
U.S. GAAP largely is considered a rules-based set of standards, while IFRS is
considered more principles-based and, therefore, subject to more interpretation.
This requires that accountants know business, the economics behind transactions
and the accountant’s responsibility to society to report things that reflect
economic reality. Without this knowledge, data could be presented in ways that
could be misunderstood or misleading. If rules are going to be less specific,
then intent needs to be understood.

Will professors focus more on principles and the conceptual
framework for the rules rather than on the rules themselves ? But will there be
time to teach anything but regulations and the how-to mechanics of accounting ?
These questions remain un- answered.

There is a need to graduate students who know more ‘canon’
than context since partners and managers can do the interpretive work. There is
a requirement for entry-level people who know enough rules to be effective when
sent out on a job. Most agree that principles will be of increasing importance
in training the next generation of accountants as there is more judgment needed
in applying IFRS.

However, this does not take away the fact that focus needs to
be on the conceptual framework, which is more heavily relied upon in IFRS.
Professors can round out this knowledge by comparing IFRS specifics to those of
U.S. GAAP.

This brings in the issue of litigation. One can take a legal
stand when it comes to rules by saying that ‘These are the rules. We made sure
the company conformed to them.’ This is not the same with principles. They can
be interpreted differently, and the interpretation that seemed like a good idea
during audit might not look as good in front of a jury. In light of legal
issues, the shift to fewer rules and more principles will prompt accountants to
hone skills in documenting interpretations and procedures clearly and concisely,
resulting in the entry-level person turning into a critical thinker and a good
writer.

The other point to ponder is discussions between auditors and
corporate management over disclosures and unqualified financial statements. IFRS
may give managers more power in negotiating with auditors over rules’
interpretation and adverse opinions in statements. Issuing an audit opinion is
the auditor’s discretion including the type of opinion to issue. However, there
is a school of thought which opines that this could result in additional
disclosures in the financial statements whether by way of a footnote or
otherwise. If this takes place, then investors will need to work harder to
understand the financial health of companies they’re researching.

World-class catch-up :

Since 2005, companies in the European Union have been
adhering to IFRS, a circumstance that some feel puts U.S. markets at a
disadvantage. “Banks are interested in IFRS because U.S. regulations place a
significant cost on firms.”

GAAP compliance makes U.S. markets more expensive places to
raise capital and less competitive than foreign markets. That was particularly
true for foreign firms, as they had to reconcile statements to U.S. GAAP prior
to this past January, when the SEC dropped the GAAP-reconciliation requirement.
The fact that the SEC said it’s OK to file under IFRS is tantamount to saying
those standards are acceptable.

IFRS may soon be acceptable for U.S. securities issuers, too.
The SEC voted on August 27, 2007 to publish for public comment a proposed
roadmap that could lead to the use of IFRS by U.S. issuers beginning in 2014.
The proposed multi-year plan sets out several milestones that, if achieved,
could lead to the use of IFRS by U.S. issuers in their filings with the
commission. With market globalisation as a driver, the push to bring U.S.
accounting in line with international standards is definitely on. This is going
to result in a requirement for much more robust IFRS education. Academics expect
IFRS questions to first appear on the CPA exam this year. Convergence between
the two standards — U.S. GAAP and IFRS — already is under way.

(Source : knowledge.Wpcarey.com)

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Investor Protection – Shareholder Nominees As Directors

Accountant Abroad

A new rule in the US makes
it easier for minority investors to remove
profligate and ineffective board
members


We have witnessed in recent
times how SEBI has been introducing measures to regulate market players in its
quest to protect small investors. There has been some speculation that the
regulator may introduce provisions to force companies to appoint directors
representing small investors and employees. In this context the following report
on the fallout of a new SEC ruling allowing investor nominees for board
positions makes interesting reading.

The Securities and Exchange
Commission, the US securities market regulator, recently voted in favour of a
proposal that requires companies to put candidates nominated by investors on the
proxy statements sent to stockholders before director elections. Such candidates
can be put up by investors or groups that will be eligible to offer nominees.
The new regulations will let investors owning 3% of a company nominate directors
on corporate ballots, a step that may help shareholders oust board members
accused of non-performance and a failure to boost shareholder value.

The SEC acted in response to
investor complaints that company-selected directors failed to rein in
compensation and risk-taking that led to more than $ 1.79 trillion of writedowns
in the financial sector during the credit crisis. Business groups, including the
US Chamber of Commerce, have fought the change, arguing that labour unions and
pension funds will misuse the threat of proxy fights to seek concessions that
would harm companies.

SEC chairperson Mary
Schapiro said before the vote : “These rules reflect compromise and weighing
competing interests; as with all compromises, they do not reflect all the views
of any one person or group. They are rational, balanced and necessary to enhance
investor confidence in the integrity of our system of corporate governance.” The
SEC has considered permitting so-called proxy access since 2003, only to back
away in the face of opposition from corporations and concern that the agency
would lose a law suit.

The Chamber of Commerce, the
nation’s biggest business lobby, is weighing the possibility of filing a
lawsuit. The organisation had worked with Washington-based lawyer Eugene Scalia
about a year ago to analyse the SEC’s rule-making process on the matter.

“Using the proxy process to
give labour unions, pension funds and others greater leverage to try to ram
through their agenda makes no sense,” David Hirschmann, chief executive officer
of the Chamber’s capital markets unit, said in a statement. The business lobby
“will continue to fight this flawed approach using every method available.” he
said. Scalia, a partner at Gibson Dunn & Crutchei; has won suits against the SEC
over rules for mutual funds and fixed-indexed annuities on the grounds that the
agency made procedural missteps in writing regulations.

Under the SEC’s proxy access
rule, shareholders will be able to nominate at least one director and as much as
25% of a company’s board. Investors will be required to hold the minimum amount
of stock at least through the date of the election, and couldn’t use the rule if
they hold the shares for the purpose of changing control of the company.

“Smaller reporting
companies” with less than $ 75 million in market capitalisation will be exempt
from the rule for three years, the SEC said. Nominating dissident directors
previously required that shareholders mail a separate ballot with the names of
competing candidates and persuade other investors to vote along with them.
Activist investors such as Carl Icahn and Nelson Peltz have waged proxy fights
to get their candidates elected to boards of companies they said were
under-performing.

Various institutional
investors and the bodies representing pension and labour funds have opined to
the effect that the process was time-consuming and too expensive for all but the
wealthiest shareholders. One of the lessons of this current economic downturn is
to be mindful that governance is a significant risk factor and the new
regulation that affords greater accountability will go a long way towards
mitigating that risk. However, the rule won’t necessarily cut costs for
investors because of filing requirements the SEC has mandated. The legal costs
for meeting the process may ultimately be as much as the printing costs sought
to be avoided.

As for possibilities of
litigation arising out of the new rule, one view is that the SEC is susceptible
to litigation, because the rule doesn’t allow shareholders to reject proxy
access if they don’t want it or set “different parameters for ownership
thresholds and holding periods”. There is room for a very serious legal
challenge on the grounds that the rule is internally inconsistent. It will be
interesting to see how investors respond to the new opportunity handed out to
them.

(Source :Bloomberg/Financial Express, 30-8-2010—
excerpted & edited report)

levitra

Auditors should try old-fashioned auditing

Getting back to basic checks may be the only way for accounting firms to avoid flawed audits — says Emile Woolf, forensic and litigation consultant.
    One of the defining features of the economic crisis is disclosure of high-level fraud on a breathtaking scale. Although the auditors’ traditional mantra —‘It is not the purpose of audits to detect fraud’ —is repeated at every opportunity, somehow those who rely on audits as a safeguard do not get the message.

    The battle against public expectation has been waged since the beginning of auditing. Various attempts have been made to ‘educate’ investors on what they should expect, but none has succeeded in persuading the public or the courts that the profession’s perception of audit scope is sustainable whenever a higher level of effectiveness is warranted. Routinely bland, mechanical expressions in audit reports carrying more hope than conviction, fill pages, but are read only by insomniacs seeking a cure. Much of that nonessential tidbit in the audit report is now being trimmed.

    It is true that by no means all expectations of audit effectiveness are justified. In the midst of the BCCI debacle Emile Woolf received a box of golf balls with the (then) PriceWaterhouse logo after Emile Woolf wrote an article highlighting the absurdity of seeking to pin the Bank of England’s supervisory failures on BCCI’s auditors. Similarly unwarranted expectations were voiced when Equitable Life’s auditors, Ernst & Young, were misguidedly sued for not anticipating potential consequences of a dispute on guaranteed annuities that was resolved only when it finished up in the House of Lords.

‘Auditability’ Pressures

    Informed opinion is sensitive to the distinction between baseless exploitation of auditors as deep-pocket scapegoats, and auditing that is indefensibly substandard. But with the expansion of global markets, the ‘auditability’ of major enterprises becomes inversely proportional to the scale of their operations, and short-circuiting basic procedures by auditors inevitably follows.

    Currently in the news is the fraud at Satyam, India’s outsourcing giant. Its founder and chairman has confessed publicly to orchestrating a scam over several years resulting in massive cash overstatements. How ironic that last September Satyam was given the Golden Peacock award by the World Council on Corporate Governance, and in 2007 its crooked chairman was named Ernst & Young Entrepreneur of the Year ! It is too early to comment on the Satyam audits, but following these admissions, PriceWaterhouse, the Indian arm of PwC, formally withdrew audit opinions previously issued. In a letter to Satyam, released by the Mumbai Stock Exchange, the auditors stated that they had ‘placed reliance on management controls over financial reporting’ when signing off the accounts. Whether or not this means they did not, independently, confirm bank balances inflated by some $1 bn (£0.7bn), is not known.

    Either way, history shows that no matter how plausibly firms re-invent technical justifications for relying on the work of others, their neglect to perform the most obvious procedures lands them in trouble — over and over again.

Missing the Obvious

    In one of many examples from my case-book, had the auditors merely opened the company’s ‘private cash-book’ they would have seen columns blatantly recording the finance director’s substantial personal expenditure and illicit ‘loans’ to finance department personnel (mainly the FD’s relatives). Instead they relied on ‘high-level IT systems reviews’ in which the FD obligingly collaborated.

    Executives of another cash-strapped company conspired to sit on millions of pounds of receipts from debtors instead of remitting them to the finance company that had discounted related invoices months earlier. The breach could have been discovered by comparing one of the balances listed on the finance company’s month-end reconciliation with the corresponding sales ledger balance. Instead, the auditors relied on analytical procedures framed on unchecked representations of one of the conspirators.

    There is a common thread that threatens to mire the reputations of some major firms if a systemic flaw, now embedded in their auditing culture, is not rooted out. Relying on high-level ‘management controls’, unsupported by basic transactional checks on company records, has never been justified. It is time to resurrect that thing called good, old-fashioned auditing.

    Source : Accountancy, March 2009.

Security alert

Accountant AbroadLately there
have been quite a few reported cases of lost customer data both in the
government or public sector domain as well as in private corporate sector. This
is forcing information security up the corporate agenda.

It seems as though with every new day comes a fresh
revelation of an organisation that has lost some customer data. First there was
the loss by Revenue & Customs Department of two discs containing details of 25
million child benefit recipients. Then the Ministry of Defence admitted that
details of 600,000 applicants to the armed forces were stolen from a laptop in
the boot of a naval officer’s car. Those were just the two largest such
revelations in the UK. There have been many others, such as the loss by the
vehicle registrar in Northern Ireland of the personal details of more than 6,000
car owners.

It is not only government bodies that are failing to protect
customer data. Private businesses are also struggling. To give just two examples
in insurance industry, Norwich Union has lost £3m of customer money through
identity fraud, and Nationwide lost a laptop containing 11m customers’ details.
There are signs that cases such as these are finally driving the issue of data
security up the corporate agenda, forcing senior executives to consider the many
ways in which sensitive data can go astray.

Perhaps the most obvious way to lose data is through the
physical loss of a storage device such as a laptop, a disc or an external hard
drive. According to recent research, business travellers in the UK lose a
staggering 8,500 laptops and other mobile devices in UK airports every year.
Stockport Primary Care Trust recently revealed that it lost the personal medical
records of 4,000 NHS patients on a USB stick.

Helen Hart, a senior associate at law firm Stevens & Bolton
LLP, says : “Data should only be able to be copied over to portable storage
devices with the consent of the company and with such data being passworded. As
passwords can be cracked quite easily by experienced hackers, data should be
encrypted if possible. Organisations that already encrypt information should use
the most up-to-date technology as older methods are easier to hack.”

According to Jim Fulton, vice-president of marketing at
Digital Persona, more and more companies are beginning to use fingerprint
biometric technology. He says : ‘The technology has evolved and is now more
reliable and durable, as well as more affordable and practical. Fingerprint
readers are being embedded into an increasing number of mobile devices like
phones, PDAs, laptops and even USB memory sticks.’

However, for most data it is not necessary to go this far.
Secure encryption is by and large very simple and affordable. In fact, as Jim
Selby, European product manager for Kingston Technology, points out : “The most
shocking aspect of the loss of 25m records by the Revenue, the data on the two
discs could easily have been stored on an inexpensive and easy to use encrypted
two gigabyte USB drive costing just about £ 65.”

Last year, US clothing retailer TJX, had 45m records stolen
in what is perhaps the largest corporate data theft on record. The thieves
managed this by simply parking outside one of the company’s shops and accessing
its wireless Internet system. As Mario Zini, business development director at
Claranet, says : ‘Companies are making ever greater use of the Internet, and
this is exposing their data to ever greater risk.’

Most corporates are now well used to fending off hackers.
Patrick Walsh, director of product management and marketing for eSoft, outlines
the extent of the attacks : “If you put a computer on the public Internet, it
will be scanned by hackers within minutes. If a service such as a Secure Shell
server is publicly available, it is likely to be a matter of minutes before
hackers attempt common username and password combinations at fast rates. An
unpatched Windows machine on the public Internet without a firewall will be
compromised in under 10 minutes.”

He goes on to outline the following steps that companies can
take to protect their systems : “Antivirus scanning must happen for all files
that come into an organisation, not just those that arrive as email attachments.
Websites known to host phishing attacks, malware, and exploits should be
blocked. This list must be updated in real time. Peer-to-peer and instant
messaging applications should be strictly controlled. Email with phishing
attacks should be blocked before it reaches the end user. All confidential data
between home offices, branch offices, and headquarters should be encrypted and
sent over a virtual private network.”

While those technical enhancements will go a long way towards
protecting a company’s customer data, on their own they are not sufficient.
Martha Bennett, research director at Datamonitor, says : “Information security
is much like physical security. Whatever sophisticated alarm systems a home
owner puts in place, burglars will always find a way in if they try hard
enough.” Any business that wants to protect its customer data needs to go beyond
a purely technical solution to implement proper processes and training.

David Cole, security consultant at risk management
specialists DNV IT Global Services, says : “One of the main areas where
organisations fall down in securing information is lack of employee training.
Many have focussed on installing the latest technology to protect their data
while not addressing the weakest link in any organisation — employees
themselves. Good training can bring the threat of data theft alive for
employees, to help them understand and advocate information security policy.”

Providing  this  training  is far  from  simple.  The threats  change  on an almost  daily basis, and few people are sufficiently enthused  by data security to maintain   a focus  on  it.  Joe  Fantuzi,   CEO  of Workshare, describes how one of his products  can help:  “The  key is continual  reinforcement.   Our Workshare Protect scans all documents  leaving the system  to check for any sensitive  data,  and  then asks the user if he or she actually wants  to send it out. Google recently sent out a Power Point presention that  contained  confidential  information  on projected financials in the speaker notes. If they’d used our system they would probably have been spared this embarrassment.”

Clearly, there is much to be done. William McKinney, marketing director of Sterling Commerce, stresses the importance of building a strategy. “Companies tend to be reactive,” he says “Don’t just leap on the latest threat in the media. – Take time to look at your business and work out where the threats lie. Where are your points of weakness? Which is the most sensitive data ?”

Devising and implementing this strategy is a long-term project that will require most businesses to invest significant quantities of time and money. However, a growing number of businesses are sufficiently concerned by the threats of not only fines from regulators, but also negative media coverage that they are starting to act. It is not before time.

Better  data  security  in seven  steps:

    1. Classify your data according to its sensitivity and confidentiality to ensure that the security measures are appropriate to the risk.

    2. Perform a formal risk assessment to identify security vulnerabilities and to ensure appropriate risk mitigation.

    3. Embed formal accountability for data security in job descriptions.

    4. Employ appropriate tools such as encryption and biometrics where sensitivity or confidentiality is a key issue.

    5. Ensure the corporate audit committee has information security as a key item on its agenda.

    6. Encourage the board to recognise its final accountability for security. It needs to ask the right questions and allocate appropriate resources.

    7. Provide all staff with repeated education and reminders about their responsibility for security.

(Source:    accountancymagazine.com/March2008)

Business Combinations

ICAI’s announcement on accounting for derivatives – Practical issues and challenges

Accounting Standards

Application of AS-30, Financial Instruments: Recognition and
Measurement is recommendatory from 1-4-2009 and mandatory from 1-4-2011.
However, in the meanwhile various regulatory authorities were concerned about
the manner in which derivative losses were being accounted for. To ensure that
losses on account of exposure to derivatives are duly provided in financial
statements, the ICAI has recently issued an Announcement on accounting of
derivatives. The Announcement is applicable to all derivatives except for
forward exchange contracts covered under AS-11, The Effects of Changes in
Foreign Exchange Rates. The Announcement applies to financial statements for the
period ending on or after 31 March, 2008. The Announcement prescribes following
accounting guidance for derivatives :


• Entities should do accounting for all derivatives in
accordance with AS-30. In case AS-30 is followed by the entity, a disclosure
of the amounts recognised in the financial statements should be made.

• In case an entity does not follow AS-30, the entity
should mark-to-market all the outstanding derivative contracts on the balance
sheet date. The resulting mark-to-market losses should be provided for keeping
in view the principle of prudence as enunciated in AS-1, Disclosure of
Accounting Policies.

• The entity should disclose the policy followed with
regard to accounting for derivatives in its financial statements.

• In case AS-30 is not followed, the losses provided for
should be separately disclosed by the entity.

• In case of derivatives covered under AS-11, that standard
would apply.

• The auditors should consider making appropriate
disclosures in their reports if the aforesaid accounting treatment and
disclosures are not made.

The objective of ICAI in providing clarification on
accounting for derivative is to ensure that financial statements reflect a true
and fair picture of the financial position. The Announcement comes at the fag
end of the financial year and leaves very little time for corporates to
implement it. Derivative deals are complex and companies will require time to
ensure proper fair valuation of such contracts.

Accounting Standards are required to be notified under the
Companies (Accounting Standard) Rules, 2006. In the absence of the Announcement
being notified under the Act, the question of its legal validity arises.
Companies may argue that they are not bound to comply with accounting treatment
prescribed in the Announcements. However, auditors are required to qualify the
accounts, if an ICAI Announcement is not followed. Companies wanting to avoid a
qualification from the auditor are indirectly forced to comply. The Announcement
therefore creates a surrogate rather than a legal requirement for companies to
follow. The author believes that due process of law has been by-passed.

The Announcement prescribes that accounting for derivatives
can be done in accordance with AS-30. Should AS-30 be early adopted in its
entirety or is the early adoption limited to accounting principles relating to
derivatives and hedge accounting ? AS-30 is not yet notified in the Companies
(Accounting Standard) Rules, 2006. If AS-30 has to be adopted in its entirety,
it will conflict with some existing accounting standards notified in the
Companies (Accounting Standards) Rules, 2006, such as accounting for investments
under AS-13 and accounting for forward contracts under AS-11. On the other hand,
AS-30 cannot be applied selectively for derivative and hedges, since it
contradicts the requirement of the Indian GAAP framework which prohibits
selective application of standards. This dichotomy is insoluble.

The Announcement is based on the framework of ‘Prudence’. If
prudence is all that it takes to make financial statements true and fair, then
it begs the question, why does one need any other accounting standards ? AS-30
requires recognition of unrealised gains on derivatives as well. So also, under
AS-11, speculative contracts are marked to market and both gains and losses are
recognised. Therefore as can be seen ‘Prudence’ has been overtaken by the
framework of ‘fair valuation’. If fair value is the framework that is the
cornerstone of future accounting standards, it is illogical to issue an
Announcement based on the concept of ‘Prudence’.

The Announcement is not applicable to forward exchange
contracts covered under AS-11. To determine whether a particular derivative
contract is covered under scope of AS-11 or the announcement, it is crucial to
decide whether such derivative contract is in substance a forward exchange
contract. AS-11 defines forward exchange contract as ‘an agreement to exchange
different currencies at a forward rate’. Forward rate is defined as ‘the
specified exchange rate for exchange of two currencies at a forward rate’.
Paragraph 36 of AS-11 also states “An enterprise may enter into a forward
exchange contract or another financial instrument that is in substance a forward
contract, which is not intended for trading or speculation purposes, to
establish the amount of the reporting currency required or available at the
settlement date of a transaction”. Considering the definition of forward
contracts, it would be easy to conclude in case of derivative instruments like
plain vanilla USD-INR forward contract undertaken to hedge USD receivable is
covered under AS-11. However, whether a purchase option, written option or
option with exotic features such as knock-in-knock-out, range options, etc.
would be within the scope of AS-11 is a question mark.

The Announcement states “In case an entity does not follow
AS-30, keeping in view the principle of prudence as enunciated in AS-1 the
entity is required to provide for losses in respect of all outstanding
derivative contracts at the balance sheet date by marking them to market”. There
is no guidance given in the Announcement regarding how such losses should be
computed. Theoretically, following options are possible : (a) losses can be
computed on each contract basis (b) losses can be computed based on portfolio
basis — net loss is determined for each category of derivatives such as option
contracts or commodity contracts (c) losses can be computed on global-company
basis — net loss on entire portfolio of derivatives taken together. Guidance is
also needed on whether losses should be calculated considering fair value
changes in the derivatives only or whether offsetting gain on the hedged item
can be considered for determining net losses.

The Announcement does not clarify whether losses on embedded derivatives need to be provided or not. A corporate may incorporate a stand-alone derivative in another host contract and try to avoid recognition of losses on the derivatives.

The Announcement requires provision for mark-to-market losses. Many of the derivative instruments are proprietary products of banks, which do not have any ready market. Therefore such derivatives are rather marked to a model, which is usually bank-specific, rather than marked-to-market. Fair valuation of derivatives, particularly long-term derivatives, is likely to be highly subjective, since it would involve considerable extrapolation. In many  cases such long-term judgments do not match with the actual situation that emerges later. Hence fair valuation of illiquid instruments tends to be very unreliable. In a survey done by Ernst & Young, it was found that stock option expense as a percentage of reported results could vary as much as 40% to 155% by just tinkering with the assumptions, but within the boundaries of the Standard.

The whole issue of whether these contracts are wagering contracts is something that will be eventually settled in the court of law. It is probably too early to say if the liability will eventually devolve on the corp orates or on the bank. Neither does the Announcement cover these uncertainties, nor does it clearly state if what is being dealt with are only foreign exchange derivatives or all types of derivatives.

From the above it is evident that there are various complex issues in the implementation of the Announcement, which ICAI needs to clarify. Unless clarity is provided on the above issues, various companies will follow different accounting policies to compute losses on derivative contracts. This will hamper comparability and result in subjectivity and inconsistency in accounting for derivatives. The ICAI should defer the applicability of the Announcement till the time clarity on the above-mentioned issues is provided to the Industry. In the meanwhile, the requirement should be restricted to disclosure of derivative losses only. ICAI may also consider advancing the 2011 mandatory date for AS-30 to 2009.

SA 330 – The Auditor’s Responses to Assessed Risks

While planning an audit of financial statements, the auditor identifies risks of material misstatement both at the financial statement level and at the assertion level. The objective of the auditor is to obtain sufficient and appropriate audit evidence to address this risk and he does so by designing and implementing appropriate responses to such risks. How the auditor designs these responses will be influenced by the auditor’s assessment of the risk of material misstatement at the assertion level for each class of transactions, account balances and disclosures including:

  • the likelihood of material misstatement due to the particular characteristics of the relevant class of transactions, account balances, or disclosures (i.e., inherent risk); and

  • the existence and operation of relevant controls (i.e., control risk), thereby requiring the auditor to obtain audit evidence to determine whether the controls are operating effectively and whether reliance can be placed on their operating effectiveness in determining the nature, timing and extent of substantive procedures.

Let us break the auditor’s responses to assessed risks into two parts and look at each one of them independently and in conjunction, bearing in mind the auditor’s objectives while performing an audit of financial statements:

1)    Overall response to the risks identified at financial statement level
2)    Audit procedures which are responsive to assessed risks of material misstatements at the assertion level.

Overall response to the risks identified at financial statement level

Guilelessly put, risk of material misstatements at the financial statement level is the risk that the financial statements as a whole may not reflect a true and fair view. Risk of material misstatement as we know is a function of inherent risk and control risk. To address this risk, the auditor may include the following responses while planning the audit of financial statement:

  • Incorporating additional elements of unpredictability in the selection of further audit procedures to be performed (like varying the timing of audit procedures, selecting items for testing that have lower amounts or are otherwise outside customary selection parameters, etc.)

  • Making generic changes to the nature, timing or extent of audit procedures, for example: performing substantive procedures at the period end instead of at an interim date; or modifying the nature of audit procedures to obtain more persuasive audit evidence.

  • Emphasising to the audit team the need to maintain professional skepticism.

  • Assigning more experienced staff or those with special skill sets or using experts and providing increased levels of supervision

The auditor’s assessment of the financial statement level risks, and thereby his overall responses, are affected by his understanding of the control environment. An effective control environment may allow him to have more confidence in internal controls and the reliability of audit evidence generated internally within the entity. The overall response by an auditor to the financial statement risks generally has a noteworthy bearing on the auditor’s general approach towards an audit. Hence it is important that these responses are evaluated and implemented by the auditor in the planning stage of an audit.

Audit procedures which are responsive to assessed risks of material misstatements at the assertion level

The nature, timing and extent of audit procedures are based on the assessment of risk of material misstatement at the assertion level of financial statement captions by the auditor and the auditors’ approach to address a specific risk may vary. For example:

  • He may choose to perform only test of operating effectiveness of controls if he feels that he may achieve an effective response to the risk of material misstatement for a particular assertion.

  • He may choose to perform only substantive procedures if he concludes that there are no effective controls relevant to that particular assertion.

  • He may choose to have a combined approach using both test of controls and substantive procedures.

The design of further audit procedures to be performed by the auditor is generally based on:

1)    The auditor’s assessment of inherent risk and control risk assigned to an assertion, and
2)    Persuasiveness of audit evidence required to address the degree of risk identified.

Let us consider a case study to understand the above concepts.

Case study

Addressing risks at the financial statement level

Background

KKM and Company (‘KKM’) is a financial institution operating in a highly regulated environment. Based on the following scenarios, let us examine the approach that the auditors of KKM, M/s. ALB and Associates would need to adopt to address the risk of material misstatement at financial statement level.

1.    Based on the experience obtained during the past audits, management inquiries conducted and the results obtained while evaluating the design and implementation of higher level controls, the auditors have assessed the control environment to be effective.

2.    The engagement team is comparatively new and is undertaking the audit of this company for the very first time.

3.    The management of the company is well aware of the audit procedures performed by the audit team on a year on year basis. They are ready with all the information required by the audit team at the commencement of the audit. All the information required to be given to the auditors is entirely reviewed by the management to identify any errors and changes and any identified changes are duly incorporated in the information sent to auditors for audit.

4.    As per the policy in place at ALB and Associates, based on the risk grading assigned to KKM while performing the engagement acceptance formalities, the audit team is required to have at least two managers reviewing the work done by the engagement team. However, the engagement partner is of the belief that one manager is sufficient to review the audit.

Evaluation

As per SA 330, the auditor is required to address the risk of material misstatement at financial statement level. He may do so by changing the nature, timing and extent of his audit procedures.

1.    In this scenario, the auditor has concluded that the control environment of the entity is effective. Based on the efficacy of the control environment and existence and operation of internal controls, the reliability of the audit evidence generated internally by the entity increases. This may help the auditor to reduce the nature, timing and extent of audit procedures to be performed by him. Such a reliance on internal controls may help him to place less emphasis on substantive procedures and elect to have a controls based approach towards audit. Such an approach would also help the auditor save time and resources.

2.    In such a scenario where the engagement team is relatively new to the client, the engagement manager/ partner need to ensure that the team is appropriately trained and guided to apply professional skepticism during the course of the audit. The audit team may also find it useful to engage the work of experts wherever required. The audit team should also be made to attend trainings on audit methodology and procedures so as to equip them with the requisite knowledge about the client and the industry. The audit team should familiarise themselves with the client and the industry in which it operates by perusing the previous year’s work papers to obtain an understanding of the issues which were identified in the prior year audit as well as to address any carried forward issues from the previous year’s audit.

3.    In the current scenario, the audit team has been performing identical audit procedures over a period of time due to which the client is well aware of these procedures. In such a scenario, the audit team should include surprise procedures so as to eliminate the consistency of audit procedures so as to incorporate an element of unpredictability in the procedures applied. This surprise element will also help the audit team to address the fraud risk, if any, for certain classes of transactions. For example the audit team may perform a surprise visit for one of the branches of the company for verification of cash balances, select certain low value debtors or debtors with credit balances for balance circularisation etc.

4.    The engagement partner is deviating from the policy followed by the firm while performing the audit of this entity. In the given scenario, based on the risk grade assigned to the entity, at least two managers are to be assigned to this engagement. Hence the engagement partner should increase the number of managers on the job to two. This would increase the supervision on engagement, thus also helping the auditors to address the risk of material misstatement at the financial statement level.

Closing Remarks

Assessing risk lies at the core of the audit process and this article has introduced and explained some of the terminology used by SA 330, giving guidance to auditors on how to respond to assessed risks. In general, tests of control are short, quick audit tests, whereas substantive procedures will require more detailed audit work. SA 330 requires that, irrespective of the assessed risks of material misstatement, the auditor would need to design and perform substantive procedures for each class of transactions, account balance and disclosures. We will discuss the concept of assessing risks at the assertion level in our next article.

GAPS in GAAP – Accounting Standards v. law of the land

Accounting Standards

As per our framework, Indian Accounting Standards can be
overridden by the laws of the land and court orders. SEBI was concerned that
companies were taking accounting and tax advantage of this by obtaining orders
u/s.391, u/s.394 and u/s.101 of the Companies Act that did not require
compliance with accounting standards. For example, companies used ‘securities
premium’ to write off current expenses such as doubtful debts, deferred tax
liability, impairment, etc. by filing a petition for capital reduction.

Consequently SEBI decided to put an end to this, by a
suitable amendment of the listing agreement as follows : “The company agrees
that, while filing for approval any draft scheme of
amalgamation/merger/reconstruction, etc. with the stock exchange, it shall also
file an auditor’s certificate to the effect that the accounting treatment
contained in the scheme is in compliance with all the Accounting Standards
u/s.211(3C) of the Companies Act, 1956.”

A question arose whether the amendment was also applicable to
the schemes of unlisted subsidiaries/associates/joint ventures of a listed
entity. It is clear that SEBI has jurisdiction only over listed entities and not
unlisted subsidiaries, associates and joint ventures of listed entities or
unlisted companies. For example, where the scheme involves an unlisted
subsidiary and a third party, the listed company is not required to file an
auditor’s certificate of compliance with accounting standards with the stock
exchange as it is not a party to the scheme. Thus, the unlisted subsidiary of
the listed entity can obtain the accounting arbitrage, which the listed entity
itself could not.

The other related question is what accounting treatment would
apply in the consolidated financial statements (CFS). Take for instance an
unlisted subsidiary of a listed entity which has got the court approval on a
scheme which is not in compliance with the accounting standards. Can the listed
entity use the treatment prescribed in the court scheme in its CFS ? The SEBI
Circular does not provide any specific guidance on the matter. The author
believes that the Circular is applicable only to a scheme filed by a listed
entity or where it is a party to the scheme. It does not apply to a scheme filed
by a non-listed subsidiary, associate or joint venture, even if it results in a
non-compliance with the accounting standards at CFS level of the listed entity.

This is because SEBI’s rights are more preemptive and apply
only to a listed entity. In other words, under the current listing agreement (as
modified by the amendment) SEBI can stop a listed company from filing a scheme
with the High Court that is not in compliance with the accounting standards.
However, it cannot stop a listed entity’s subsidiary from filing a scheme that
does not comply with accounting standards. Neither can it stop the listed entity
from applying the accounting treatment under the scheme sanctioned by the High
Court in the financial statements of the subsidiary or in its own CFS.

Consequently, there has been a raft of schemes filed by
subsidiaries of listed entities which are not in compliance with the accounting
standards. Let’s take a simple example. Listed entity (LCO) wants to amalgamate
another company into its own self. The amalgamation accounting results in
significant recognition of intangibles and goodwill. LCO is worried that in
subsequent years owing to impairment and amortisation, its future profits would
be adversely impacted. It therefore wants to use S. 391, S. 394 or S. 101 to
write off the intangibles and goodwill against securities premium or reserves.
Unfortunately, SEBI’s Circular preempts that, as LCO is not able to obtain a
certificate from the auditors that the accounting treatment is in compliance
with the accounting standards. To circumvent this problem, LCO floats a
subsidiary, and achieves the relevant objective in the financial statements of
the subsidiary and consequently in the CFS of LCO.

Whilst SEBI’s effort to prevent bad accounting practices is
laudable, because of jurisdictional issues, it may not have been able to achieve
its objective completely. The right medicine would be for the Ministry of
Corporate Affairs to amend S. 391, S. 394 and S. 101 of the Companies Act, to
prevent such accounting arbitrage. The author understands that these sections
will be amended along with the introduction of IFRS in India, since IFRS does
not allow a legal override of accounting standards.

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Gaps in GAAP – Consolidation of Foreign Subsidiaries

Accounting Standards

Consider the following query and response.


Query :

Parent Limited (P), India, has a subsidiary S Limited,
Singapore. During the year, S Limited acquires a subsidiary — SS Limited, UK.
The GAAP followed by each of these companies are :

P Indian GAAP

S Singapore GAAP

SS UK GAAP

SS Limited uses the corridor approach for accounting pension
plans in its financial statements and the same is used by S Limited for
consolidation without any adjustments. S Ltd. computes goodwill on consolidation
as per Singapore GAAP based on fair value of net assets of SS on the date of
acquisition. For the CFS — consolidated financial statements — of P under Indian
GAAP — can net assets of SS be recorded at fair value ? Also, can the financial
statements of SS Limited be incorporated without any adjustments to pension
obligation ?

Response :

Paragraph 3 of AS-21 states that “In the preparation of CFS,
other accounting standards also apply in the same manner as they apply to the
separate financial statements.” Thus it may be noted that in the CFS, though
AS-21 permits different accounting policies they nevertheless have to be those
that are acceptable under Indian GAAP. Indian GAAP does not allow corridor
approach under AS-15 (Revised), nor can goodwill be determined using fair value.
Therefore CFS will have to be redrawn as per Indian GAAP policies. In CFS of P,
acquisition of SS will be recorded at book value and goodwill determined
accordingly. Further, all actuarial gains and losses will be accounted for and
deferral using corridor approach will not be permitted.

Moral of the story :

Wide disparities in accounting standards across borders
create unnecessary burden on preparer’s besides creating confusion in the minds
of users of financial statements. Some of us are familiar with conservative
accounting under German GAAP. Despite that, in 1993, under German GAAP
Daimler-Benz reported a profit of 168 million Deutsche Marks, but under US GAAP
for the same period, the company reported a loss of almost a billion Deutsche
Marks, largely caused by pension blues. To the user of financial statements, a
company that makes profit under Indian GAAP and loss under IFRS or vice versa
is clearly not a comprehensible situation.

It may be noted that IFRS are already adopted in the UK and
Singapore. Had India been on IFRS, Indian CFOs will not have to struggle with
multiple reports. Elimination of multiple reports is just one of the advantages
of converging to a global standard like IFRS. The ICAI’s announcement to
converge to IFRS by 2011 (actually 2010, since comparatives under IFRS would be
required) is a step in the right direction. However, lot of work to converge to
IFRS is still pending including obtaining regulatory amendments for the same and
providing clarity on income-tax issues. These milestones need to be achieved on
a war footing; otherwise the whole convergence exercise could get trapped in a
hopeless tangle.

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GAPs in GAAP – Related-Party Transactions

Accounting Standards

Related-party transactions
occur in numerous areas, such as sales and purchases, loans, investments,
financial guarantees, cost sharing arrangements, share-based payments, etc.
When a related-party transaction takes place at arm’s length, the accounting is
the same as for a non-related party. However, the challenge arises in
situations where the related-party transactions are not at arm’s length. Under
Indian GAAP (IGAAP), AS-18 requires disclosure of related-party transactions.
However, either there is no guidance on the accounting of related-party
transactions or the IGAAP practice does not reflect the substance. This is one
of the fundamental difference between International Financial Reporting
Standards (IFRS) and IGAAP. Let us consider some examples.

A parent company extends INR
1000 interest-free loan to a subsidiary, which is repaid after two years by the
subsidiary. The applicable interest rate for a similar loan is 10% p.a. The loan
will be recorded by the parent company at INR 826, which is the fair value (INR
1000 discounted by 10% for 2 years). The balance INR 174 represents an
investment by the parent in the subsidiary. In subsequent years, interest would
be imputed, and recognised as income by the parent company and as expense by the
subsidiary company.


INR

INR


In the books of the Parent Company


Year 0

Loan to Subsidiary Dr

826


Investment in Subsidiary Dr

174


Cash Cr


1000

Year 1

Loan to Subsidiary Dr

83


Interest Income Cr


83

Year 2

Loan to Subsidiary Dr

91


Interest Income Cr


91


Cash Dr

1000


Loan to Subsidiary Cr


1000

In the subsidiary, the
accounting would be exactly the reverse. Investment would be replaced by equity
contribution from the parent, and instead of interest income there would be
interest expense. At the consolidated level, the entries would cross out, and
there would be no impact.

Similar accounting may apply in the case of financial guarantees (a financially strong company in the group provides a financial guarantee to a bank for loans extended to another group member) or cost sharing arrangements or purchases and sales between related parties. In the case of group settled share-based payments, the company whose employees receive stock options will have to bear the charge in accordance with the requirements of IFRS 2. In IGAAP the accounting practice with regards to group settled share-based payments is quite disparate. In many cases, the practice is not to account for such arrangements under IGAAP.

Under IGAAP, the accounting for related-party transactions is developed by conjecture and practice than any robust standard/guidance. Whilst some of these issues will be addressed in IFRS, IGAAP will continue to apply for some companies. Therefore there is a need to make suitable amendments to IGAAP and to keep it dynamic.

IFRS Conversion in India on Fast Track

Accounting Standards

Understanding the need for a well-coordinated approach, the
Ministry of Corporate Affairs (MCA) recently set up a high-powered group
comprising various stakeholders such as National Advisory Committee on
Accounting Standards (NACAS), SEBI, RBI, IRDA, ICAI, IBA and CFOs of industries.
The Core Group is supported by two sub-groups. The first sub-group would assist
the Core Group in identification of changes required in various laws,
regulations and accounting standards for convergence with IFRS. The second
sub-group would interact with various stakeholders in order to understand their
concerns on the issue of convergence with IFRS, identify problem areas and
ascertain the preparedness of the stakeholders for such convergence.

A joint meeting of the Core Group and the two sub-groups was
held on 6 August 2009. At the meeting, the ICAI presented the details of a
comprehensive capacity building programme which it is carrying on to prepare the
Chartered Accountancy (CA) profession for this transition and stated that a
large number of professionals have undergone training and the process is being
accelerated. The Chairman of the Accounting Standards Board of ICAI informed
that the convergence project is at an advanced stage of completion. CFOs present
in the meeting stated that industry was getting prepared. They also requested
amendments to the Companies Act and other Regulations and also the early
exposure of accounting standards which are IFRS compliant, to enable them to
prepare for meeting the deadline.

The main purpose of the Core Group is to issue a road map in
the near term for convergence to enable adherence to the targeted date of 2011.

The author strongly supports the formation of the Core Group
and the issuance of the proposed road map. We congratulate the Ministry of
Company Affairs for its unprecedented and historic action of bringing all the
concerned regulators on a common platform to achieve smooth convergence to IFRS
in India.

We believe that the proposed road map as a minimum should
contain the following :

(i) The date of transition to IFRS and the requirement of
comparable numbers

(ii) Whether IFRS would be applied as they are or there
would be certain carve-in or carve-out to those standards. This is important
so that the entities, which start preparing for conversion, are clear about
the standards that are applicable to them

(iii) Whether the first-time adoption rules under IFRS 1
First-time Adoption of IFRS would be applicable

(iv) The direct and indirect tax implications of transition
to IFRS, including implications under the new direct tax code

(v) Legal amendments needed to the key statutes to achieve
convergence. For example, Companies Act, 1956, Banking Regulation Act
(including its Third Schedule), SEBI Regulations/Guidelines and the Listing
Agreement, RBI Guidelines to Banks/NBFCs, IRDA Regulations, Electricity Act
tax laws especially Income-tax Act, etc. The road map should also cover
whether and how these amendments can be carried out prior to the transition
date

(vi) The ICAI has taken more than seven years to issue the
financial instruments standards from the date of the first issuance of IAS 39
Financial Instruments : Recognition and Measurement. These standards are still
to be notified under the Companies Accounting Standard Rules. If all the IFRS
are to be notified under the Companies Accounting Standard Rules, whether and
how it can be done at least one year prior to the transition date — for
example, would there be a fast tracking process.

Conversion to IFRS is a tedious task involving significant
time, cost and efforts. The experience indicates that for large groups,
convergence to IFRS may take even more than one year. Thus, entities need to
start preparing for transition to IFRS well in advance. To facilitate the same,
the road map should be absolutely clear on the above aspects.

We recommend the MCA should avoid any changes to IFRS. This
will enable Indian entities to be fully IFRS compliant and give an ‘unreserved
and explicit statement of compliance with IFRS’ in their financial statements.
Generally, the financial statements which are fully IFRS compliant have a higher
brand value globally as compared to the financial statements that are not fully
IFRS compliant. Also, most developed stock exchanges require financial
statements to be fully compliant with IFRS for listing purposes. If IFRS are not
adopted as they are, significant efforts involved in the conversion process may
not yield the desired benefits to converting companies and to the nation.

This article is dedicated to the loving memory of my friend
Rahul Roy, who became the President of the Institute of Chartered Accountants of
India at a young age of 33, a record impossible to break. Rahul was a great
professional, a great author and orator but more importantly a good human being.
I have penned 4 small lines in his memory . . . .

Tomorrow may or may not be

The next moment we may or may not see

But no time can wither your loving memories

Those I’ll cherish till the end of time.

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Revised Schedule VI – Is it a step in the right direction ?

Accounting Standards

Schedule VI of the Companies Act, 1956, prescribes the format
of financial statements and disclosure requirements for corporate entities in
India. Considering the economic and regulatory changes that have taken place
globally, and being as old as the Act itself (1956), Schedule VI had completely
outlived its utility. The Ministry of Corporate Affairs (MCA) has issued two
drafts of revised Schedule VI for comments, namely, Saral Schedule VI for Small
and Medium Companies (SMCs) and the other for Non-Small and Medium Companies
(Non-SMCs). The revised draft aims at eliminating numerous statistical and
statutory disclosure requirements which are not relevant from an investor
perspective. Accordingly, capacity details, expenditure/income in foreign
currency, details of debts/advances due from companies under the same
management, quantitative information on inventories are done away with.

In May 2008, MCA issued a press release in which it has
committed to convergence with International Financial Reporting Standards (IFRS)
by April 1, 2011. Recently, at the G20 Summit on Financial Markets and the World
Economy, the then Finance Minister also committed to have convergence with IFRS in India. One aim of revising Schedule VI was to
attain compatibility and convergence with IFRS as well as Indian Accounting
Standards. Accordingly, the draft does not require capitalisation of exchange
gain or loss relating to fixed assets acquired from outside India. More
importantly, assets and liabilities are required to be classified as current and
non-current, which would help stakeholders in analysing the liquidity and
solvency status of a company.

Though the revision of Schedule VI aims at convergence with
IFRS, it would be far better to notify IAS 1, Presentation of Financial
Statements (or an Indian equivalent that will be issued in the near term),
in the Companies Accounting Standards Rules, rather than rewriting Schedule VI.
This is because accounting standards and disclosure requirements are dynamic in
nature and need to be updated frequently to keep pace with changes in economic
and regulatory environment. If these formats are contained in
an accounting standard, it would be easier to amend, add or delete the
requirements. However, if it is con-tained
in an Act, the process of amending will become very excruciating and difficult,
if not impossible.

Draft revised Schedule has suggested specific format
for profit and loss account. For Non-SMCs functional classification is required
and for SMCs, classification based on nature of expense is required. Considering
industry-specific requirements, IAS 1 provides entities with a choice to either
adopt the function of expense method or the nature of expense method. The
functional classification required in the draft Schedule VI would involve a
tedious process of allocating various expenses to functional heads like cost of
sales, selling and marketing expenses and administrative expenses, which is not
hitherto required. As regards Cash Flow Statement, draft Schedule VI has
mandated the use of indirect method only. This is a deviation from IAS 7
Statement of Cash Flows as well as AS-3 Cash Flow Statements which
permit both the direct and indirect method. It is rather unfortunate that
choices available to global companies are not being provided to Indian
companies.

IAS 1 is very prescriptive and sets out elaborate
requirements on presentation of financial statements. Draft Schedule VI, even
though modelled on lines of IAS 1, does not set out such important
requirements. For example, disclosures required under IAS 1, such as critical
judgements made in application of accounting policies; assumptions made about
the future and other major sources of estimation uncertainty that have a
significant risk of resulting in a material adjustment to the carrying amounts
of assets and liabilities within the next financial year are not required under
draft Schedule VI.

As per IAS 1, Statement of Changes in Equity (SOCIE) and
Statement of Comprehensive Income (SOCI) also form part of complete set of
financial statements. SOCIE includes all changes in equity arising from
transactions with owners in their capacity as owners, whereas SOCI includes
profit or loss for the period and other non-owner changes in equity. Draft
revised Schedule VI does not incorporate the concept of SOCIE and SOCI in the
financial statements. This would make revised Schedule VI out of sync with IFRS
(or an Indian equivalent that will be issued in the near term) even before it is
issued. Interestingly, in the general instructions contained in the draft
Schedule VI, an override clause allows accounting standards to override any
conflicting requirement of Schedule VI. If that be so, the point really is, do
we really need Schedule VI ?

Globally, the task of drafting accounting standards including
the format of financial statements and the disclosure requirements is carried
out by a specialised professional body, for example, in the United States the
task is carried out by FASB (Financial Accounting Standard Board). Accounting
standards and disclosure requirements is a specialised job, and the role of
regulators in this area is very limited. In light of various arguments, the
author believes that abandoning rather than revising Schedule VI is a step in
the right direction. This will also bring us in line with the global trend.

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Substantive Analytical Procedures: Relevance and Efficacy in an Audit

During the course of an audit of financial statements, an auditor is required to obtain sufficient and appropriate audit evidence to ensure that the financial statements are not materially misstated. The procedures adopted for this purpose are enquiry, observation, testing and re-performance. The procedures around testing involve testing of controls as well as test of details. The test of details may comprise of substantive testing or use of substantive analytical procedures (SAPs) or a combination of both.

SAP procedures consist of evaluating financial information through analysis of plausible relationships among both financial and non-financial data. It also consists of investigation of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount. The basic presumption behind the use of SAP by an auditor is that correlation between data can be expected to exist in the absence of any condition either financial or non-financial disturbing such relationship. However it is to be noted that while performing any form of SAP, prior knowledge of the industry in which the entity operates is very crucial along with the understanding the efficiencies and limitations that are harbored in adapting such procedures. SAP are subject to auditor judgment including evaluation of the data to be used and understanding the conclusions reached.

SAP may be performed using various methods like statistical techniques and Computer Assisted Audit Techniques (“CAAT’s”). They can be performed at financial caption level or at a disaggregated detailed level of information. The auditor may choose to apply SAP on financial statements as a whole or on any specific component of the financial statements. The decision about which audit procedures to perform, including whether to use SAP, is based on the auditor’s experience about the expected effectiveness and efficiency of the available audit procedures to reduce audit risk at the assertion level to an acceptably lower level.

SAP are generally used by the auditor at the following stages of audit:

  •     Risk assessment procedures (termed as planning SAP) which assist the auditor in identifying and assessing the risks of material misstatement thus allowing them to provide a basis for designing and implementing the audit procedures. For instance – revenue trend analysis, gross margin analysis, effective tax rate reconciliation, etc.

  •     Substantive procedures (termed as SAP) to obtain corroborative audit evidence about relevant assertions and the risks attached to such assertions. For instance, payroll logic test, interest costs as a percentage of borrowings, etc.

  •     Final analytical procedures – to perform an overall review of the financial statements (termed as final SAP) to aid the auditor while forming an overall conclusion as to whether the financial statements are consistent with the auditor’s understanding of the entity and its business.

Suitability of a particular analytical procedure for a given assertion:

SAP are generally more applicable to large volumes of transactions that tend to be predictable over time. However, the suitability of a particular analytical procedure will depend upon the auditor’s assessment of how effective it will be in detecting a misstatement that, individually or when aggregated with other misstatements, may cause the financial statements to be materially misstated. Different types of SAP provide different levels of assurance.

For example building up an expectation of payroll cost (as demonstrated in the case study discussed later) can provide persuasive evidence and may eliminate the need for further verification by means of tests of details, provided the information used and the elements of the payroll cost is appropriately tested.

On the other hand, calculation and comparison of effective tax rate to profit before tax can be deemed as a means of confirming the completeness of tax provision, however this will provide less persuasive evidence, but may be reduce the detail of work that needs to be performed for other audit steps performed on the caption.

It is imperative that the auditor has adequate assurance over the efficacy of the internal controls around over financial reporting of an enterprise before he concludes to place reliance solely on analytical procedures to get comfort over any financial statement caption.

    Reliability of data

Before placing reliance on the assurance obtained from SAP the auditor needs to evaluate and confirm the data used to perform SAP. The reliability of data is influenced by its source and nature and is dependent on the circumstances under which it is obtained. Some of the parameters that may be considered by an auditor to evaluate the reliability of the data are:

    i. Source of the information available, for instance, information may be more reliable when it is obtained from independent sources outside the entity.

    ii. Comparability of the information available, for instance, information from the same industry may be more reliable than information of the entities operating in the cluster of industries.

    iii. Nature and relevance of the information available. For example, whether budgets have been established as results to be expected rather than as goals to be achieved; and

    iv. Controls over the preparation of the information that are designed to ensure its completeness, accuracy and validity. For example, controls over the preparation, review and maintenance of accounting information. The auditor may choose to test the operative effectiveness of controls over preparation of data giving him further assurance on the reliability of the data used to perform SAP.

While devising substantive analytical procedures, an auditor considers comparison of the entity’s financial information with:

  •     Comparable information of the prior period for the caption on which assurance is planned to be achieved through SAP.

  •     Anticipated results of the entity including budgets and forecasts made by the management.

  •     Expectations made by the auditor, for example – comparing actual with estimated lease rent or an estimation of depreciation.

  •     Information of the industry in which the entity operates – for instance, the comparison of the debtors’ turnover ratio of the enterprise with that of the industry to identify nuances in the entity’s operating cycle, industry growth with sales growth of the enterprise.

The auditor also considers relationships amongst the various elements of financial information to obtain assurance on the trend/variation in financial statement captions. An illustrative inventory of such relationships is as given below:

  • relationship between variation in turnover and debtors
  • variation in material cost consumption with variation in input prices, manufacturing yield, capitalization of new machinery, variation in cost of repairs of plant and machinery
  • correlation of variation in payroll costs with employee count, labor turnover

correlation between labor efficiency rates and production costs

  • variation in power and fuel consumption costs with variation in manufacturing output/power tariffs.

Let us understand SAP with the help of a practical example:

Background:

ABC India Private Limited (‘ABC’) is a service provider whose primary business is to act as customer care center for its clients. The business model involves setting up of a call center with relevant IT, telecommunication and other infrastructure facilities and hiring and training graduates with good communication skills who are required to attend to customer calls. As far as execution of services is concerned, the employee pyramid comprises of a large number of graduates, related proportion of supervisors/ team leaders and delivery heads. ABC also has a robust sales and marketing team. The company has signed agreements with various customers where its revenue is
based on an agreed charge-out rate and the number of executives requested for by the customer. the executives may be assigned on a 24×7 basis or otherwise depending on     the    customer     requirements.    The    major    expenses     for ABC comprise of payroll cost.  

Application of SAP on Payroll Cost


the auditor may use SaP to obtain evidence surrounding ‘C’ of salary costs. to start with the auditor would need to build up an expectation for the payroll cost. he may do so by using the average salary earned per employee and the average number of employees which were employed by the company during the year. he also needs to determine the amount of variance from the expectation so worked out with the actual cost which can be accepted without further investigation.     This     amount     is influenced by the materiality, the assurance that is desired by the auditor while performing this analytical procedure and the assessed     risk     for     the    financial    caption    assertion.    Let us assume that the auditor has set the amount of allowable difference as rs. 2 crore. he may arrive at his expectation of the salary cost as follows

Scenario 1:
The    salary    cost    of    the    company    as    per    the    draft    financials    
is rs. 32.10 crore which is different than the salary cost as arrived by the auditor in his expectation. however the difference between the expectation i.e. rs. 31.26 crore and the actual cost (rs. 32.10 crore) is rs. 84 lakh which is within the limit of allowable difference set by the auditor. In such a situation the audit may choose not to perform any further scrutiny on the difference and conclude to have obtained the desired level of assurance from this procedure that he initially set out to obtain.

Scenario 2:
The    salary    cost    of    the    company    as    per    the    draft    financials     is rs. 34.57 crore which is different than the salary cost as arrived by the auditor in his expectation. however the difference between the expectation  i.e.rs. 31.26 crore and the actual cost (rs. 34.57 crore) is rs. 3.31 crore which is greater than the allowable difference set by the auditor during the commencement of this exercise.

In such a case the auditor would investigate into the reasons for the variance arrived at by him so as to bring the variance to an acceptable level. he may also chose to do further audit procedures on this caption to get the required level of assurance.

Some reasons for variance may be:

  • Joining of senior personnel in a band with salary far higher than average

  • Large number of joiners at month end or vice versa

  • Increment during the period for certain bands of employees, including mid-term increment

  • Exceptional/discretionary bonus or other payouts, etc.

  • Revision is statutory obligations such as percentage of provident fund/superannuation contribution, minimum wages payable under labor laws, changes in retiral benefits    such    as    gratuity,    basis    of    leave    encashment

  • Revision in assumptions made for payroll liabilities which are actuarially valued such as pension, compensated benefits, gratuity, post medical retirement benefits etc.

After investigating the difference, the auditor may rebuild his expectation so as to take effect of the newly identified factors and modify his evaluation of the difference identified based on those factors.

In this case, the auditor may also be able to build up an expectation on the revenue for a reporting period for ABC as the revenue model is entirely based on the category of employees who have been assigned to customers. one could apply the agreed charge out rates on the average number of employees employed during a period and arrive at the expectation. a similar exercise of comparing and challenging the actual results against the actual results could provide insights on what further audit procedures need to be undertaken to obtain assurance on the revenue recognised during a given period.

Conclusion

Use of SAP during the planning, execution and completion stages of an audit enables an auditor to obtain sufficient and appropriate audit evidence to address the risk of material misstatement as also brings efficiencies in the audit process by way of reduced effort on substantive testing. Substantive analytical procedures provide the auditor with an overall perspective of the financial impact of significant events that have taken place in an enterprise during the reporting period. It could be said that SAP aids the auditor in setting the level of professional skepticism in terms of identifying areas where additional or detailed substantive testing may be required to be performed.

GAPS in GAAP – ED of Ind-AS 41 First-time Adoption of Indian Accounting Standards

Accounting standards

On 31 May 2010, the Institute of Chartered Accountants of
India (ICAI) issued Ind-AS 41, an exposure draft (ED) on the Indian equivalent
of IFRS 1 First-time Adoption of IFRS. There are some differences, which
apparently appear minor but have some significant consequences. Going ahead
there will be two sets of accounting standards in India, one is the Indian GAAP
and the other IFRS converged Standards which are likely to be known as ‘Indian
Accounting Standards (Ind-AS).’

Ind-AS will be issued by the ICAI and will have to be
notified in the Companies (Accounting Standards) Rules through NACAS. It will be
a separate body of accounting standards which may not always be the same as IFRS
issued by the International Accounting Standards Board (IASB) (hereinafter
referred to as ‘IFRS’). In other words there may be differences between the
converged standards notified in India and IFRS. This is clear from the EDs on
the converged standards issued by the ICAI so far. Other than Ind-AS 41, we see
differences in other standards, for example, the discount rate used for
long-term employee benefits and the recognition of actuarial gains/losses. Ind-AS
is likely to force a government bond rate for discounting and would require full
recognition of actuarial gains/losses. IFRS requires the use of a high-quality
corporate bond rate and the government bond rate is permitted as a fallback only
where there is no deep market for corporate bond. IFRS allows the corridor
approach, which permits not to recognise the actuarial gains/losses within the
corridor, and the deferral of actuarial gains/losses beyond the corridor amount.
Also under IFRS, full recognition in other comprehensive income or P&L is
permitted as other alternatives.

Many entities around the world are able to make a dual
statement of compliance on their financial statements, which is an unreserved
statement that the financial statements are in accordance with IFRS and the
standards notified in their local jurisdiction. This is only possible where
there are no differences between IFRS and the standards notified or else those
differences may be minimal and have either no impact on the entity or the impact
is immaterial. The advantage of making a dual statement of compliance is that
the financial statements can be used within India as well as in almost all major
capital markets in the world which accept IFRS financial statements. If Indian
companies fail to make dual statement of compliance, they may need to reconvert
again in accordance with IFRS, at the time of foreign listing.

Any Government would be challenged in making a decision as to
whether to adopt full IFRS or to make certain deviations which are deemed
necessary. As already stated, the advantage of adopting full IFRS is that it
would certainly help entities that are having or seeking foreign listing. Also
Indian entities that have several foreign subsidiaries which use IFRS, would
prefer to have the entire group on IFRS, rather than for different companies of
the group to be on different national versions of IFRS. However, such companies
as a percentage of total companies in India may be small and hence the
Government may not deem fit to impose full IFRS on all the companies in India.
This then brings us to the next point, what kind of changes from IFRS should the
Government consider when notifying Ind-AS. Certainly not the changes that are
being contemplated, with regards to the discount rate and the accounting for
actuarial gains and losses. Some countries have only a corporate bond market and
virtually no government bond market. An Indian entity that has a subsidiary in
such a country will not be able to use a government bond rate, as none exists.
In which case, a question on how to comply with Ind-AS may arise. With regards
to accounting for actuarial gains/losses, the author believes that if the
multiple options are available to entities in other countries, Indian entities
should not be deprived of that benefit. It is interesting to note that Australia
started off eliminating multiple options when it first notified the IFRS
standards. However, it later fell back to allowing the full range of options
under IFRS.

Other challenges under Ind-AS to making a dual statement of
compliance are :

  1. There are
    numerous differences between IFRS 1 and Ind-AS 41, which have been described
    elsewhere in this article. If these differences are relevant to a company,
    then dual statement of compliance may not be possible.

  2. Ind-AS 41 allows
    a company not to provide comparative numbers in accordance with Ind-AS. The
    companies that use this option will not be able to provide a dual statement of
    compliance as this will not be in accordance with IFRS.

  3. Another option
    for Indian companies is to present Ind-AS comparatives for 2010–11 in addition
    to the Indian GAAP comparatives. A company which intends to comply with both
    Ind-AS and IFRS in its first Ind-AS financial statements may consider this
    option to be more suitable. This option is, however, not without challenges.
    IFRS 1.22 covers the scenario where a company presents comparative information
    or a historical summary in accordance with both IFRS and Indian GAAP. It
    requires a company to label such comparative information prominently as the
    Indian GAAP information, as not being prepared in accordance with IFRS, and to
    disclose the nature of the main adjustments that would make the Indian GAAP
    comparatives comply with IFRS, although quantification is not required. If all
    the notes (including narratives) contain Indian GAAP comparative information,
    labelling of such information may be very challenging. Besides presentation of
    Indian GAAP comparative in the first Ind-AS financial statements is a huge
    challenge as the Ind-AS format for the income statement and balance sheet are
    significantly different from the Schedule VI formats. Furthermore, the Ind-AS
    disclosure requirements are more extensive than those of the Companies Act and
    Indian GAAP. It is therefore difficult to see how the Indian GAAP and Ind-AS
    financial statements could be presented in the same document, without amending
    the presentation/disclosure of Indian GAAP numbers significantly.

(4)        It
is a well-accepted position in India that if the requirement of an accounting
standard are not in conformity with law, the law will prevail over accounting
standards. This aspect is recognised in paragraph 4.1 of the Preface to the
Statements of Accounting Standards. The ED of Ind-AS 41 and other exposure
drafts issued by the ICAI contain a reference to the Preface. We understand
that as part of IFRS conversion exercise, the MCA will also modify the
Companies Act, 1956, to remove existing inconsistencies with Ind-AS. However,
there may be other laws prescribing treatments contrary to Ind-AS or such
inconsistencies may arise in future. We believe that any such inconsistency
with law if any will not allow Indian companies to make a dual statement of
compliance with IFRS.

 

(5)        The
Expert Advisory Committee (EAC) of the ICAI has been issuing opinions on
matters relating to application of accounting standards. If the
opinions/interpretations on Ind-AS are not in accordance with global
interpretations/ practice or the views of the IASB, then differences would
arise though the basic standards themselves may be the same or similar.

 

(6)        A
final set of converged standards have not yet been notified. It is expected
that there may be some differences between the notified standards and IFRS, as
discussed elsewhere in this article. We also understand that many corporate
entities are making strong representations on issues that are very significant
to them, such as the accounting of foreign exchange gains/losses on long-term
loans, or the prohibition on the percentage of completion method in the case of
real estate companies. At this point in time, it is a matter of conjecture as
to how these issues would be resolved.

 

(7)        There
is no clarity on the application of Schedule VI and Schedule XIV and what their
role would be under Ind-AS.

 

(8)        In
future, differences between notified standards and IFRS may arise, if the
Ind-AS do not keep pace with the changes in IFRS or where there are
disagreements. This feature is clearly visible in many jurisdictions that have
converged to IFRS in the past.

 

Differences with IFRS 1 :

 

Most of the first-time
exemptions/exceptions in Ind-AS 41 are in line with IFRS 1. However, the ICAI
has made few changes while adopting IFRS 1 in India. The changes broadly are :

 

(i)         IFRS
1 provides for various dates from which a standard could have been implemented.
For example, a company would have had to adopt the de-recognition requirements
for transactions entered after 1 January 2004. However, for Ind-AS 41 purposes,
all these dates have been changed to coincide with the transition date elected
by the company adopting Ind-AS;

 

(ii)        Deletion
of certain exemptions not relevant for India. For example, IFRS 1 provides an
exemption to a company that adopted the corridor approach for recording
actuarial gain and losses arising from accounting for employee obligations. In
India, since corridor approach is not elected, the resultant first-time
transition provision has been deleted;

 

(iii)       Adding
new exemptions in Ind-AS 41. For example, paragraph D 26 has been added to
provide for transitional relief while applying AS 24 (Revised 20XX) —
Non-current Assets Held for Sale and Discontinued Operations. Paragraph D 26
allows a company to use the transitional date circumstances to measure such
assets or operations at the lower of carrying value and fair value less cost to
sell; and

 

(iv)       Under
IFRS 1, equity and comprehensive income reconciliation to the previous GAAP is
required for the comparative year only. Under Ind-AS, such reconciliation is
required for the comparative (if presented) as well as the current year.

 

There are other interesting differences as
well. If a company becomes a first-time adopter later than its subsidiary,
associate or joint venture, it compulsorily needs to measure, in its
consolidated financial statements, the assets and liabilities of the subsidiary
(or associate or joint venture) at the same carrying amounts as in the
financial statements of the subsidiary (or associate or joint venture). The ED
of Ind-AS 41 also contains the same exemptions/ requirements. However, these
exemptions/requirements are based on Ind-AS financial statements; without any
reference/fallback to IFRS. This indicates that if a parent, subsidiary,
associate or joint venture of an Indian company is already using IFRS in its
separate/consolidated financial statements, the company will not be able to use
those financial statements in its transition to Ind-AS. This will create
considerable workload for Indian companies that have global operations.

 

Ind-AS 41 will be applicable to the first
set of annual Ind-AS financial statements prepared by a company. The first
Ind-AS financial statements are defined as the first annual financial
statements in which a company adopts Ind-AS by an ‘explicit and unreserved
statement of compliance with Ind-AS.’ The ED does not recognise or allow any
fallback on IFRS for this purpose. This indicates that companies, which are
already IFRS compliant, e.g., in accordance with the option given by the SEBI
or to comply with foreign listing requirements, will not be allowed to use
these financial statements to claim compliance with Ind-AS for the first time
and on an ongoing basis. Rather, they will need to prepare their opening
balance sheet in accordance with Ind-AS again. This will create additional
work-load for Indian companies listed on US and other foreign stock exchanges
or have used the voluntary option of SEBI and have already transitioned to
IFRS.

 

Conclusion :

 

Overall the author believes that Ind-AS
should not make any departures from the full IFRS standards unless they are
required in the rarest of rare cases. This will ensure that we receive the full
benefit of adopting full IFRS standards. So far it appears that the departures
that are expected to be made (discount rate on long-term employee benefits or
accounting of actuarial gains/losses) are unwarranted. As the standards are not
yet notified, and as companies make strong representations, it is not clear at
this stage, what exceptions would be made to the full IFRS standards. The
Government will have to exercise judgment on what departures to make; this
could be in the area of foreign exchange accounting, loan loss provisioning in
the case of banks, completed contract accounting in the case of real estate
companies, etc. There has to be a solid technical argument for making these
exceptions, and a balance achieved between interest of various stakeholders,
such as the company, investors, national interest, etc.

GAPs in GAAP – Accounting for rate-regulated entities

Many governments regulate the pricing of essential services such as natural gas, water and electricity. The objective is to provide price protection to consumers while providing a fair return to the supplier. These regulatory mechanisms have created significant accounting issues under IFRS, which does not have any elaborate guidance on the subject. The accounting for rate-regulated entities is now on the agenda of the International Accounting Standards Board (IASB) and a separate project has been set up to deal with it.

Accounting practices :

    Regulators often set prices in advance, based on estimated volumes, cost and a target rate of return. At the end of the period, the regulator and the entity determine the actual volumes, cost and return. This will give rise either to a surplus that needs to be refunded to the customer or a deficit that needs to be recovered from the customer. This is done by way of future price adjustments. The question to be addressed is whether these assets and liabilities can be recognised within the IFRS framework.

    In India, for example a power supply company recognised these assets/liabilities with the corresponding impact being adjusted against revenue. The following disclosure was made : “The Company determines surplus/deficit (i.e., excess/shortfall of/in aggregate gain over Return on Equity entitlement) for the year in respect of its licence area operations (i.e., generation, transmission and distribution) based on the principles laid down under the (Terms and Conditions of Tariff) Regulation, 2005 notified by MERC (Maharashtra Electricity Regulatory Commission) and the tariff order issued by it. In respect of such surplus/deficit, appropriate adjustments as stipulated under the regulations are made during the year. Further, any adjustments that may arise on annual performance review by MERC under the aforesaid tariff regulations are made after the completion of such review.” In the absence of similar disclosures by other companies, it is difficult to know the extent to which regulatory assets and liabilities are recognised on Indian balance sheet.

Are these assets and liabilities ?

    This will be addressed by the IASB in the ED. In 2005, the International Financial Reporting Interpretations Committee (IFRIC) was asked to provide guidance on the subject. The IFRIC concluded that regulatory assets and liabilities can only be recognised if they qualify under the IASB’s Framework.

    The main argument against recognising these rights and obligations as assets and liabilities under IFRS is that their recovery or payment is based only on future sales, over which the entity has no control or present obligation. Only in situations where there is a guarantee given to the entity by the regulator would an asset exist; however, that may not be the case in India.

    The IASB staff have put forward many arguments supporting the recognition of certain rate regulated assets and liabilities. The IASB and the FASB (US Financial Accounting Standards Board) have agreed to remove the misunderstood notion of control and to focus the definition of an asset on whether the entity has some rights or privileged access to the economic resource.

    With respect to liability recognition, the IASB and the FASB agreed, that their current respective definitions overemphasise the need to identify both the specific past events and the future outflow of economic benefits. Instead, the definition should focus on the economic obligation that presently exists.

    When considering recognition issues, the Board will also need to consider whether an asset or liability can be recognised where the regulatory approval for the specific matter is anticipated but has not been formally received, as formal approval is obtained after recognition of the asset or liability, and can sometimes take years.

    Whatever standard is finally issued, an assessment of the facts and circumstances of each regulatory mechanism will be required, as each jurisdiction is unique. As a result, regulators should pay close attention to this project to understand how their mechanisms affect the results of the rate-regulated enterprises in their jurisdiction.

    It has been estimated that the US electricity industry alone has reported regulatory assets and liabilities of $ 675 billion and $ 450 billion, respectively in 2007. In India, the corresponding numbers could be a fraction, but would nevertheless be staggering, to make accounting of rate-regulated entities a high-priority accounting issue. Also, in India, there is no guidance on rate-regulated entities. With India adopting IFRS in 2011, the accounting for rate-regulated entities in the country would be dictated by the final outcome of the IASB project. As an interim measure the ICAI should provide some guidance.

Gaps in GAAP – Accounting for MAT Credit

Accounting Standards

The Finance Act, 2000, w.e.f. 1-4-2001, introduced S. 115JB
according to which a company is liable to pay MAT under the provisions of the
said section in respect of any previous year relevant to the assessment year
commencing on or after the 1st day of April, 2001. The MAT under this Section is
payable where the normal income-tax payable by such company in the previous year
is less than 10% of its book profit which is deemed to be the total income of
the company. Such company is liable to pay income-tax at the rate of 10% of its
book profit. The Finance Act, 2005, inserted Ss.(1A) to S. 115JAA, to grant tax
credit in respect of MAT paid u/s.115JB of the Act with effect from A.Y.
2006-07.


The salient features of MAT credit u/s.115JAA as applicable,
in respect of tax paid u/s.115JB, are as below :

(a) A company, which has paid MAT, would be allowed credit
in respect thereof.

(b) The amount of MAT credit would be equal to the excess
of MAT over normal income-tax for the assessment year for which MAT is paid.

(c) No interest is allowable on such credit.

(d) The MAT credit so determined u/s.115JB can be carried
forward up to seven succeeding assessment years.

(e) The amount of MAT credit can be set off only in the
year in which the company is liable to pay tax as per the normal provisions of
the Act and such tax is in excess of MAT for that year.

(f) The amount of set-off would be to the extent of excess
of normal income-tax over the amount of MAT calculated as if S. 115JB had been
applied for that assessment year for which the set-off is being allowed.


Whether MAT credit can be considered as an asset ?

As per the “Guidance Note on Accounting for Credit
Available in Respect of Minimum Alternative Tax Under the Income-tax Act, 1961″,
issued by the Council of the Institute of Chartered Accountants of India,
although MAT credit is not a deferred tax asset under AS-22, yet it gives rise
to expected future economic benefit in the form of adjustment of future
income-tax liability arising within the specified period. A question, therefore,
arises whether the MAT credit can be considered as an ‘asset’ and in case it can
be considered as an asset, whether it should be so recognised in the financial
statements.

MAT paid in a year in respect of which credit is allowed
during the specified period under the Act is a resource controlled by the
company as a result of past event, namely, the payment of MAT. MAT credit has
expected future economic benefits in the form of its adjustment against the
discharge of the normal tax liability if the same arises during the specified
period. Accordingly, the Guidance Note concluded that MAT credit is an ‘asset’.
However, it is recognised in the balance sheet when it is probable that the
future economic benefits associated with it will flow to the enterprise and the
asset has a cost or value that can be measured reliably.

MAT credit should be recognised as an asset only when and to
the extent there is convincing evidence that the company will pay normal
income-tax during the specified period. Such evidence may exist, for example,
where a company has, in the current year, a deferred tax liability because its
depreciation for the income-tax purposes is higher than the depreciation for
accounting purposes, but from the next year onwards, the depreciation for
accounting purposes would be higher than the depreciation for income-tax
purposes, thereby resulting in the reversal of the deferred tax liability to an
extent that the company becomes liable to pay normal income-tax.

EAC Opinion :

The Expert Advisory Committee has addressed the MAT issue in
the Compendium of Opinions, Volume XXV, Query No. 24, titled ‘Creation of
deferred tax asset in respect of MAT credit under Ss.(1A) of S. 115JAA of the
Income-tax Act, 1961.’ The EAC noted that payment of MAT does not result in any
timing differences, since it does not give any rise to any difference between
accounting income and taxable income which are arrived at before adjusting the
tax expense; viz., MAT in this case. Accordingly, it would not be correct
to recognise any deferred tax asset in respect of MAT under AS-22. The author
agrees with this view.

However, unfortunately the EAC has remained silent on whether
MAT credit can be recognised as other asset if not as deferred tax asset. In the
opinion of the author, the answer is in the affirmative in light of the
recommendations of the Guidance Note discussed above. The author recommends that
in future in order to remove any scope for doubt or confusion, the EAC should
respond to queries comprehensively.

levitra

Gaps in GAAP – Compensated absences (such as annual leave) – Whether long-term or short-term under IAS 19s?

Accounting Standards

Fact pattern :


In India, employees are entitled to fixed annual leave, say
20 days, per completed year of service. The employees have a right to utilise
the leave at any time after entitlement or alternatively seek cash compensation
on resignation/retirement. Based on past experience, employees generally do not
utilise their leave entitlement immediately. Rather they carry forward a
substantial portion of the unutilised leaves (usually representing the maximum
ceiling imposed by the company — this could range from 180-300 days) up to
retirement/resignation. The carry forward leave is then encashed at the time of
retirement/resignation.

The value of leave liability if determined based on
short-term or long-term classification under IAS 19, may provide materially
different provision amounts. This is because long-term classification involves
discounting and use of the PUC actuarial valuation method.


Question:





  •  From IAS 19 perspective, whether compen sated absences
    are short-term or other long-term employee benefits ?


  •  How is the presentation of the liability done under IAS
    1 — whether current or non-current ?



Term


Definition pre-2007 amendment


Definition post-2007 amendment

Short-term
employee benefits


Short-term employee benefits are
employee benefits (other than termination benefits) which fall due
wholly within twelve months after the end of the period in which the
employees render the related service.


Short-term employee benefits are
employee benefits (other than termination benefits) that are due to be
settled within twelve months after the end of the period in which
the employees render the related service.

Other long-term employee benefits

Other long-term employee benefits
are employee benefits (other than post-employment benefits and termination
benefits) which do not fall due wholly within twelve months
after the end of the period in which the employees render the related
service.

Other long-term employee benefits
are employee benefits (other than post-employment benefits and termination
benefits) that are not due to be settled within twelve months
after the end of the period in which the employees render the related
service.

Paragraph 8

extracts


Short-term employee benefits include
items such as : short-term compensated absences (such as paid annual leave
and paid sick leave) where the absences are expected to occur within
twelve months after the end of the period in which the employees render the
related employee service.

Short-term employee benefits include
items such as : short-term compensated absences (such as paid annual leave
and paid sick leave) where the compensation for the
absences is due to be settled within twelve months after the end of
the period in which the employees render the related employee service.

Discussion:

Requirements of IAS 19:

Position before amendment of IAS 19 in 2007:

Before the 2007 annual improvements project, paragraph 7 of
IAS 19 stated that short-term benefits (which include compensated absences) fall
due within twelve months from the end of the reporting period when the employee
has rendered the service. Short-term compensated absences were described in
paragraph 8 as benefits ‘expected to occur’ within twelve months after the end
of the period. Other long-term employee benefits were defined as employee
benefits which are expected to ‘fall due’ more than twelve months from the end
of the period. Therefore, a compensated absence which is due to the employee but
is not expected to occur for more than twelve months, was not an ‘other
long-term employee benefit’ as defined in paragraph 7 of IAS 19, nor was it a
short-term compensated absence as described in paragraph 8 of IAS 19.

Amendment in annual improvement project 2007:

The IASB’s intention was to require measurement based on
expected time of settlement. With a view to resolve the above conflict, the IASB
amended the definition of short-term employee benefits and other long-term
employee benefits to replace the terms ‘fall due’ and ‘expected to occur’ with
‘due to be settled.’ It has made a similar amendment in paragraph 8 as well.

Basis for conclusion paragraphs BC4B and BC4C to the amendment provide as below?:

“BC4B?.?.?.?.?the IASB concluded that the critical factor in distinguishing between long-term and short-term benefits is the timing of the expected settlement. Therefore, the IASB clarified that other long-term benefits are those that are not due to be settled within twelve months after the end of the period in which the employees rendered the service.

BC4C?.?.?.?.?The IASB noted that this distinction between short-term and long-term benefits is consistent with the current/ non-current liability distinction in IAS 1 Presentation of Financial Statements. However, the fact that for presentation purposes a long-term benefit may be split into current and non-current portions does not change how the entire long-term benefit would be measured.”

While paragraph BC4B indicates that short-term/ long-term classification should be based on expected settlement, reference to IAS 1 in paragraph BC4C means that a leave may be treated as long-term only if the entity has an unconditional right to defer settlement of liability for at least twelve months after the reporting period.

In other words, whilst the IASB’s intention was to measure such liability based on expected time of settlement, the confusing wordings in IAS 19, both pre and post revision, lend itself to two views.

Position in India?:

In Indian GAAP, the requirements of accounting standard are in line with pre-revised IAS 19. The ICAI has taken a view to treat compensated absences as other long-term employee benefits. Consequently, the practice under Indian GAAP is to treat the leave liability as long-term. In the few IFRS accounts published by Indian companies, it appears that leave liability has been provided based on long-term classification. However, that may not necessarily be what other companies would do, as they start adopting IFRS in 2011.

Further points to consider?:

   i) The IASB has also recognised this issue and has tentatively approved a proposal to amend paragraph BC4C in the basis for conclusion to delete the reference to consistency with IAS 1 and add a sentence to paragraph BC4B to clarify that the definitions of short-term employee benefits and other long-term employee benefits are based on the timing of when the entity expects the benefit to become due to be settled. This indicates that IASB preference is to treat accumulated absences as long-term.

    ii) Globally there appears to be a mixed practice and a mixed view on this issue.

Authors view?:

Under IAS 19?:

The long-term classification for measurement of liability under IAS 19 seems more relevant to India given that this is how it has been accounted for so far, this is the intent of the IASB as well as this is based on ICAI guidance. However, given the confus-ing drafting and reference to IAS 1 in the BC, and the use of the words ‘due to be settled’, the short-term view is also sustainable.

Under IAS 1?:

With regards to presentation under IAS 1 as current or non-current, the same would be current liability because the entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period.

GAPs in GAAP – AS-7 – Percentage of completion accounting based on an output measure

In applying percentage of completion accounting based on an output measure (e.g., completion of physical proportion of contract work), how should incurred costs be accounted for ? The following example is used to illustrate the issue. Assume that all contract costs incurred in each period can be attributed to the output in that period.

View 1: Allocate costs in the same proportion as revenue

AS-7, paragraph 21 requires both contract revenue and contract costs to be recognised as revenue and expenses by reference to the stage of completion. Paragraph 24 also states that contract revenue is matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit that can be attributed to the proportion of work completed. Therefore when revenue is recognised based on an output measure, the actual incurred contract cost should be allocated pro rata between expenses and inventory. This view results in the same gross margin percentage throughout the contract period as can be seen below.


View 2:

Recognise  costs as incurred

Paragraph 25 indicates that contract costs usually are recognised as an expense in the accounting periods in which the work to which they relate is performed. Paragraph 26 requires incurred costs that related to future activity to be recognised as assets. Therefore incurred costs that can be attributed to activity in the current period should be expensed. This view results in a changing gross margin percentage throughout the contract period.


Conclusion:

As can be seen from a plain reading of the standard, two views are possible. The standard-setters should clarify this issue, so that there can be uniformity  in practice  on this issue.