Category: Article

Apart from
changes in the accounting, there are several other areas where there
would be an impact, some of which are highlighted hereunder:

Impact of transition on the profit/loss, financial position and net worth of the entity.

Communication with the Board and/or Audit Committee.

Increased volatility in the results.

Increased
disclosure requirements, both quantitative and qualitative which would
result in greater transparency. There would be significantly detailed
disclosures about management judgements and estimates.

Changes in existing information systems requirements.

Impact on reporting on Internal Financial Controls.

Need for increased availability of and enhanced capability of resources.

Greater
alignment with business operations due to increased focus on substance
rather than legal form. There would be greater emphasis on the
underlying business rationale and true economics of various transaction.

Tax implications of and the cost associated with the transition

Loan covenants

Dividend distribution

Investor relations.

An
attempt has been made in the foregoing paragraphs to briefly examine
the various practical considerations in the transition to and adoption
of Ind AS by corporates.

PREPARA TION OF IND-AS OPENING BALANCE SHEET
The
first and foremost consideration in the transition to Ind-AS is the
preparation of the opening Balance sheet. Whilst preparing the Opening
Ind-AS Balance Sheet, subject to the mandatory exceptions and
exemptions, an entity would normally require to ascertain the
adjustments under the following broad headings:

Not to recognise items as assets and liabilities, if Ind-AS does not permit their recognition.

Recognise all assets and liabilities whose recognition is required by Ind-AS.

Reclassify assets, liabilities, and items of equity as per Ind-As requirements.

Measure all assets and liabilities in accordance with Ind-AS.

Let us now examine some of the common adjustments which may be required under each of the above heads.

Not to recognise items as assets and liabilities if Ind- AS does not permit their recognition:

Some of the common adjustments which may be required in this respect are briefly discussed hereunder:

Ind-AS-10 Events after the Reporting Period does not permit recognition of proposed dividends as
an adjusting event and hence the same is not to be presented as a
liability as is the case with AS-4. The proposed dividend is only
required to be disclosed as a note.

Any deferred income or expenditure
such as premium/discount on issue/redemption of debentures / bonds or
expenses on issue of debentures or bonds recognised in terms of the
special dispensation under AS-26, and which are an integral part of the
amortised cost of financial assets and liabilities should be factored in
to determine the effective interest rate and reversed in the opening
balance sheet.

The carried forward balance of any share issue expenses
which are amortised in terms of the special dispensation under AS-26
are required to be eliminated whilst preparing the opening balance
sheet. (The treatment to be adopted if already adjusted against Securities premium Account is not clear).

Any contingent assets or reimbursements like insurance or other claims which are not virtually certain and do not meet the recognition criteria under Ind-AS-37 should be reversed in the opening balance sheet.

In the opening consolidated financial statements, assets and liabilities of joint ventures which are included under the Proportionate Consolidated method should be reversed since the same is no longer permissible

Any held for sale subsidiary, associate or joint venture should be eliminated from consolidation and disclosed as a separate disposal group.

Recognise all assets and liabilities whose recognition is required by Ind-AS.

Some of the common adjustments which may be required in this respect are briefly discussed hereunder:

All derivative financial assets and liabilities and embedded derivatives shall be recognised if not done earlier.

Certain
provisions in the nature of restructuring obligations, onerous
contracts, decommissioning liabilities, site restoration, warranties,
litigation etc. need to be recognised based on constructive obligations, which may not have been recognised earlier or were disclosed as contingent liabilities.

Various intangible assets
like brands, customer lists etc. acquired in a business combination,
which earlier were part of goodwill need to be recognised if
retrospective application of Ind-AS 103 is opted for.

Recognition of certain new investment properties
in view of the differences in the recognition criteria e.g land held
for long term capital appreciation, building that is vacant but is held
to be leased under one or more operating leases etc.

Deferred tax assets and liabilities would need to be recognised based on the Balance sheet approach.

In the consolidated financial statements investments in joint ventures need to be recognised based on the equity method.

Assets
and liabilities of any held for sale subsidiary, associate or joint
venture would need to be recognised and presented as a disposal group.

Reclassify assets, liabilities, and items of equity as per Ind-As requirements.

Some of the common adjustments which may be required in this respect are briefly discussed hereunder:

Classification of financial liabilities and equity should be based on the substance
rather than legal form e.g. redeemable preference shares would need to
be reclassified as debt, fully convertible debentures would need to be
reclassified as equity etc.

Compound financial instruments need to be split into debt and equity components e.g. partly / optionally convertible bonds.

Financial assets, notably investments, need to be reclassified into amortised cost, fair value through profit and loss, fair value through other comprehensive income etc.

Certain intangible assets acquired as part of earlier business combinations may not meet the definition of intangible assets and hence need to be included as part of goodwill e.g. certain acquisition cost, promotional cost etc.

An entity preparing consolidated financial statements
for the first time or which has not consolidated any subsidiary under
AS-21 e.g. where the control is exercised through the power to govern
the operating policies and business decisions rather than through
shareholding alone would need to incorporate the relevant assets and
liabilities.

Measure all assets and liabilities in accordance with Ind-AS.

Some of the common adjustments which may be required in this respect are briefly discussed hereunder:

In case of purchase of inventories, fixed assets and intangible assets on deferred settlement terms, the interest element would need to be segregated.

In case of fixed assets, if the fair value model is opted for, it would necessitate a remeasurement.

Government grants in the form of non-monetary assets or concessional loans are to be measured at the fair value.

Borrowing cost are to be calculated using the effective interest rate method.

Where the time value of money is material, provisions should be on a discounted basis.

Share based payment transactions need to be recognised on a fair value basis.

Assets and liabilities acquired in a business combination need to be measured at fair value.

Non-current assets held for sale and Discontinued Operations need to be measured at fair value less costs to sell.

All
Financial assets and liabilities to be initially recognised at fair
value and subsequently measured based on their classification as above.

As
part of the transition to Ind-AS entities are also required to evaluate
the various exemptions, both mandatory and voluntary, which are
provided for under Ind-AS-101, the important ones of which are briefly
discussed hereunder:

MANDATORY EXEMPTIONS TO RETRO – SPECTIVE APPLICATION OF IND-AS
A first time adopter is provided with the following key mandatory exemptions to retrospective application of certain Ind-AS:

Derecognition of Financial Assets and Liabilities

There
is no need to recognise any financial asset or liability which is
already derocognised under local GAAP. Alternatively, the entity may
apply derecognition criteria retrospectively by choosing a cut off date.


Hedge Accounting

Any transactions entered into before the date of transition are not to be retrospectively designated as hedges.

Classification and Measurement of Financial Assets and Liabilities

The
determination of cash flows for time value measurement of financial
assets on the date of transition is not required when it is
impracticable to assess the same retrospectively, subject to adequate
disclosures being made till their derecognition.

For measurement
of existing financial assets and liabilities on the date of transition,
if it is impracticable to determine effective interest rate
retrospectively, the fair value on the date of transition shall be the
new gross carrying amount or the new amortised cost for applying the
effective interest method.

Embedded Derivatives

A
first time adopter shall assess whether an embedded derivative is
required to be separated from the host contract on the basis of
conditions that existed at the later of the date it first became a party
to the contract and the date of reassessment.

Government Loans

The
benefit of a government loan at below market rate of interest is not
required to be recognised as a government grant on the date of
transition.

VOLUNTARY EXEMPTIONS TO RETRO – SPECTIVE APPLICATION OF IND-AS
A
first time adopter is provided with the following key voluntary
exemptions to retrospective application of certain Ind-AS. Understanding
the same is of critical importance since it could impact comparability
of results of entities in the same sector.

Share based Payment Transactions

Voluntary
retrospective application of fair valuation in respect of equity
instruments granted, vested and not settled or any modification made
before the date of transition is available. Similar considerations apply
to any liabilities arising out of such transactions which are settled
before the date of transition. However, an entity may adopt earlier
application if fair value disclosures have been publicly made.

Deemed Cost of Property, Plant and Equipment and Intangible Assets

The
entity can opt for the previous GAAP carrying amount as deemed cost.
Alternatively, the fair value on the date of transition can also be
considered as the deemed cost provided it is comparable with what is
required under Ind-AS. In certain cases, an event driven fair value used
during a privatisation, IPO etc. can also be considered as a deemed
cost. In case fair value is taken as deemed cost, the same should be
allocated component wise and depreciation shall be calculated
accordingly.

Deemed Cost of Investment Property

These
may be identified on the date of transition based on Ind-AS criteria of
these being used to earn rentals or for capital appreciation as against
the AS-13 criteria of it not being intended to be used or occupied
substantially in the operations of the enterprise.

Leases

Separate
classification where lease includes both land and building into the
finance (normally for land) and operating lease, as applicable on the
date of transition is permissible where there is a composite lease of
land and building.

Determining whether an arrangement contains a lease on the date of transition based on the specific assets test – fulfilment of the arrangement is dependent on the use of a specific asset or right to use of an asset.

Cumulative Translation Differences

Cumulative
translation differences for all foreign operations (Ind-AS does not
distinguish between integral and non-integral operations) on the date of
translation shall be zero; and

Gains and losses on subsequent
disposal of foreign operations shall exclude translation differences
prior to the date of transition.

Long Term Foreign Currency Monetary Items

If these are reflected under FCMDTA account, similar treatment can continue on the date of transition.

In
case these are adjusted against the carrying value of the fixed assets,
similar treatment can continue only if the entity adopts the deemed
cost model as discussed above.

Investments in Subsidiaries, Associates and Joint Ventures

Deemed
cost as per previous GAAP (i.e. fair value in the separate financial
statements on date of transition or previous GAAP carrying amount) on
the date of transition can be used.

Assets and Liabilities of Subsidiaries, Associates and Joint Ventures

If
an entity adopts Ind-AS before or simultaneously with the
parent/investor, no adjustments required. However, if the entity adopts
Ind-AS later than the parent/investor, respective carrying amounts on
the date of the investor’s/ parent’s transition can be considered.

Compound Financial Instruments

An
entity is required to split into liability and equity components
retrospectively unless liability component is no longer outstanding on
date of transition.

Designation of Previously Recognised Financial Instruments

All Financial assets are required to be classified into three types, as under:

Fair value through Profit and Loss in
cases where the holding of the financial asset helps to eliminate or
significantly reduce measurement or recognition uncertainty or holding
period is less than 12 months. It can be used irrespective of the
business model discussed below.

Fair value through other comprehensive income in
cases where the business model involves collection of contractual cash
flows either through selling the asset or through principal and interest
payments.

Amortised cost, in cases where the business model involves collection of contractual cash flows of interest and principal.

All Financial liabilities are required to be classified into two types, as under:

1. Fair value through Profit and Loss (very selectively)
2. A mortised cost.

The above designations can be either at initial recognition or on the date of transition.

The
amortised cost of financial assets and liabilities shall be determined
on the basis of the benchmark interest rate on the date of transition,
if it is impractical to determine the same retrospectively.

All
Equity instruments always to be classified at fair value – either
through Profit & Loss or through Other Comprehensive Income and no
recycling permissible if option of classifying through OCI is selected –
No specific impairment analysis required

Fair Value Measurement of Financial Assets and Liabilities on Initial Recognition

This may be applied prospectively to transactions entered into on or after the date of transition.

Decommissioning Liabilities included in Cost of Fixed Assets

Where exemption from retrospective application is sought, following needs to be done:

Measure the liability on the date of transition as per Ind-AS 37.

To
the extent it is to be included in the cost of the asset, the amount
should be estimated based on the assumption that it would be included
when the liability first arose and then discounted accordingly, using
historical risk adjusted discount rates (based on average annual
inflation, and incremental borrowing rates).

Calculate accumulated depreciation on the above amount using current estimated useful life.

Service Concession Arrangements

Recognise financial assets and intangible assets on the date of transition.

Use the previous GAAP carrying amounts.

Test for impairment at the date of transition unless impractical to do so.

Joint Venture Accounting – Transition from Proportionate Consolidation to Equity Method

Business Combinations

An entity may choose not to apply Ind-AS-3 to business combinations that occurred before the date of transition.

However, if it decides to restate any past business combinations, it should restate all business combinations after that date.

Apart from the various exemptions, certain other key considerations under various Ind-AS are discussed hereunder:

OTHER KEY CONSIDERATIONS IN TRANSITION Ind-AS-2 Inventories

In
respect of inventories acquired on deferred settlement basis, the
interest element thereon shall be excluded. This needs to be adjusted on
the date of transition.

Sale of inventories after the reporting
period would be an adjusting event under Ind-AS 10 discussed below
which would need to be adjusted on the date of transition.

Ind-AS10 Events After Reporting Period

Any
provision for proposed dividend and related dividend distribution tax
after the reporting period shall be reversed and added back to retained
earnings.

Settlement of a court case after reporting period
confirms the existence of a present obligation and accordingly the
previously created provision needs to be adjusted or fresh provision
need to be created in terms of Ind-AS-37.

An entity shall adjust
cost of assets purchased based on information available after reporting
period if it opts for carrying value as the deemed cost.

On the
date of transition any legal and/or constructive obligations after the
reporting period shall be taken into account if not considered under
previous GAAP. (see discussion on Ind-AS 19 on Employee Benefits below)

Ind-AS 19 on Employee Benefits

Actuarial
gains and losses arising on defined benefit plans and other long term
employee benefits should be recognised in the Statement of Other
Comprehensive Income and cannot be recycled to the Profit and Loss
Account.

All past service costs need to be immediately expensed off.

Instead
of recognising interest cost in the Profit and Loss Account, Ind- AS-19
requires recognition of net interest cost based on the net defined
benefit asset or liability and the discount rate at the beginning of the
year.

Other miscellaneous adjustments in the actuarial assumptions.

Revised actuarial valuation would be required.

More
specific guidance on accounting for constructive obligations i.e. as a
result of informal practices. These would need to be henceforth
recognised in the financial statements

Ind-AS 23 on Borrowing Costs

Inventories
which are manufactured or otherwise produced in large quantities on a
repetitive basis are not considered as qualifying assets even if they
take a substantial period of time to get ready for their intended use or
sale. e.g wines, cheese etc.

Borrowing costs shall be measured
applying effective interest rate method from the date transition date.
Accordingly, ancillary borrowing cost written off earlier need to be
amortised. Earlier period borrowing costs should not be restated.

Dividend payable in respect of compulsorily redeemable preference shares
would also need to be considered as borrowing costs eligible for
capitalisation depending on the specific circumstances.

Ind-AS 12 Income
Taxes

Balance Sheet method to be adopted for computation of deferred
tax asset or liability by which the tax base is compared with accounting
base. Primary impact would be in respect of business combinations and
consolidation adjustments.

Tax base of an asset is the amount
deductible for tax purposes against any taxable economic benefits that
would flow to the entity when it recovers the carrying amount of the
asset. e.g depreciable assets, uncollected income taxed on a cash basis,
assets measured at fair value where the fair value gain is not taxed or
fair value loss is disallowed.

Tax base of a liability is its
carrying amount, less any amount deductible for tax purposes. E.g.
income received in advance taxed at a later date, loan payable having an
amortised cost.

A first time adopter would have to establish the
history of items that give rise to temporary differences and adopt
retrospective application.

Implications vis-à-vis ICDS needs to be
considered?

Ind-AS 38 Intangible Assets

Unamortised share issue
expenses need to be charged off. Amounts in the nature of transaction
cost need to be reduced from equity.

Any unamortised borrowing costs
need to be analysed. Initial transaction cost need to be reduced from
the borrowings and any ancillary cost needs to be considered in the
calculating the effective interest rate.

Revenue based amortisation
of toll roads would not be permitted for toll roads arising after the
transition date.

Amortisation of intangible assets with indefinite
useful life not permitted. E.g., Right of Way, Stock Exchange broking
card etc. These would however need to be tested for impairment.

Implications vis-à-vis adjustment against Securities Premium Account to be considered.

Ind-AS 21 Effects of Changes in Foreign Exchange Rates

The concept of functional currency introduced for the first time. No first time exemption provided. It is the currency of the primary economic environment
in which the entity operates. It is normally the currency which
influences the income and expenses the most. e. g. shipping company.

Ind-AS 37 Provisions, Contingent Liabilities and Contingent Assets

Specific
requirement to recognise provisions in respect of constructive
obligations. AS-29 does not specifically refer to the same. It only
refers to creation of provisions arising out of normal business customs
and practices, to maintain business relations etc.

Restructuring provisions need to be made based on constructive obligations as against legal obligations in terms of AS-29.

Discounting of provisions where effect of time value of money is material.

OTHER AREAS HAVING SIGNIFICANT IMPACT

FINANCIAL INSTRUMENTS

Recognition and Measurement

Greater use of fair value – use of judgement and valuation tools in many cases.

Impairment to be calculated on the Expected Credit Loss Model.

–
Assessment of whether there is a significant increase in the credit
risk since initial inception or there is a low credit risk; in which case
12 months expected credit losses are recognised.

– Where
significant increase in credit risk since initial inception and no
objective evidence of impairment, in which case life time expected
credit losses to be recognised on a PD basis

– Where there is
objective evidence of impairment, life time expected credit losses are
recognised and interest income is computed on the net basis (i.e. net of
credit allowances)

– The above will have a big impact on financial institutions and NBFCs which are covered at a later date. However, in the interim any loans granted by non- financial entities would still need to be evaluated since currently they are not even covered by the prudential guidelines. Financing of group entities would need closer scrutiny.

Derivative Instruments- Currently, there are diverse practices adopted. Whilst some entities were adopting AS-30 (which is recommendatory in nature), other entities are following the ICAI announcement which requires only losses to be recognised. Post adoption of Ind-AS, consistency would creep in and recognition of both gains and losses either through Profit and Loss or OCI (where hedge accounting is adopted) would be required. The impact would be greater for entities who were hitherto following the ICAI announcement and recognising only losses.

Transaction Costs
– In respect of long term borrowings, these will be recognised over the tenor of the borrowing using the effective interest rate method as against the current practice of charging off.

– In respect of financial assets, these would need to be charged off as against the current practice of capitalising the same, unless these are in respect of financial assets recorded on amortised cost basis, in which case they would need to be adjusted against the carrying value.

BUSINESS COMBINATIONS

Recognition and Measurement

Acquisition Value
– Assets and liabilities to be recognised at fair value.
– Contingent Liabilities and Intangible Assets not recognised in the acquiree’s financial statements would also need to be recognised at fair value.

– Non controlling interests to be measured at fair value.

– Significant changes in the value of goodwill reflecting a more accurate depiction of the premium paid on acquisition even though the legal form of the acquisition has not changed.

– Recording of assets at fair value will normally result in higher depreciation and amortisation – In case of intangibles with indefinite useful life or with higher useful life lower or no amortisation.

– Goodwill will not have to be amortised but tested for impairment.

– In case of a business combination in stages, the previously held equity interest to be measured at acquisition date fair value, with resultant gain or loss recognised in the Profit and Loss resulting in greater volatility in the Income Statement.

Accounting for Transaction Costs
– These need to be charged off as against the current practice of generally capitalising them.

Accounting vis-à-vis High Court Orders
– Under the Companies Act, 2013, certificate from the auditors required whether scheme is in accordance with the Accounting Standards thereby doing away with the leeway provided under the Companies Act, 1956.

– Position in the intervening period till the notification of the relevant sections under the Companies Act, 2013, especially for non-listed companies not clear.

CONSOLIDATED/GROUP ACCOUNTS

Recognition and Measurement

Preparation of Consolidated Financial statements – Many additional SPEs would get consolidated and there could be deconsolidation of certain subsidiaries since two companies cannot consolidate the same subsidiary since control can be exercised only by one entity. Investment entities are also not required to be consolidated.

– Consolidation mandated under the Companies Act, 2013 of associates and joint ventures even if there are no subsidiaries.

– Proportionate consolidation method no longer permissible.

– Definition of control is different. An investor is deemed to control an enterprise only when he has the power over the entity or when he has exposure or rights to variable returns from its involvement with the investee and has the ability/power the affect these returns. Such powers can be exercise even when there is no majority ownership. Even potential voting rights are relevant.

– Changes in ownership interest that do not result in loss of control should be adjusted against equity. No guidance under current GAAP and hence differing practices were adopted.

– Losses incurred by the subsidiary to be allocated between the controlling and non-controlling interest as against the practice under Indian GAAP of adjusting these against the majority, unless there is a binding obligation to make good the losses.

Uniform Accounting Policies
– Not very rigid and strictly enforceable under current GAAP. – Challenges could be encountered especially in case of associates over which control is not exercised.

– Many group entities would be required to change their policies, the individual impact of which would need to be evaluated.

Uniform Financial Year
– Maximum gap reduced to three months as against six months. – On adoption many entities would be compelled to change their year ends.

INCOME TAXES

Recognition and Measurement

Recognition based on Balance Sheet method for taxable temporary differences as against timing differences under the current GAAP.

Recognition of deferred tax on business combinations.

Recognition of deferred tax assets on losses is not very stringent.

Deferred tax liability required to be recognised in consolidated financial statements for all taxable temporary differences in connection with group investments unless the investor is able to control the timing of the reversal in the foreseeable future.

Significantly detailed disclosures and reconciliations.

EMPLOYEE BENEFITS AND SHARE BASED PAYMENTS

Recognition and Measurement

Actuarial gains and losses to be taken to Other Comprehensive Income which will reduce volatility.

Employee benefits are required to be recognised based on constructive obligation as against the current practice of generally recognising the same based on legal obligation.

ESOPS to be mandatorily recorded on a fair value basis which would result in increased charges and hence have a significant impact on key performance indicators like EPS.

Share based payments to non-employees like vendors against supply of goods and services would need to be recorded on a fair value basis in all cases, which is currently missing. Only fixed assets so acquired are accounted for at fair value in terms of AS-10. This could have a negative impact on the financial results and other performance indices, dividend servicing abilities and loans covenants, amongst others.

PROPERTY, PLANT AND EQUIPMENT

Recognition and Measurement

Mandatory Component Accounting

– Any cost which is significant in relation to the total cost and has a separately defined useful life need to be separately identified and depreciated accordingly.
– Residual value calculations and estimates need to be evaluated afresh.
– Even companies not adopting Ind-AS need to adopt the same in terms of the Companies Act, 2013.
– Expected to a have a material and significant impact on highly capitalised manufacturing entities and IT technology companies.
– Could have a significant impact on insurance, asset backed financing, amongst other matters.

Revaluation of Assets
– No selective revaluation permitted.
– Updation of revaluation on a regular basis.

– Depreciation charge to be charged off to Income Statement. Even companies not adopting Ind- AS need to follow the same in terms of the Companies Act, 2013

– Since it is an option it can affect comparability of results of the same class of companies and hence uniformity in terms of loan covenants including security cover etc. would be an issue.

–For companies adopting the revaluation route whilst the asset base would be higher, there would also be a higher corresponding depreciation charge

Repairs and Overhaul expenditure
– Needs to be capitalised if it satisfies the recognition criteria.

– Corresponding decapitalisation of the replaced parts.

– Closer scrutiny of the renewal and asset maintenance policies of companies, especially those which are asset heavy.

Unrealised Exchange Differences
– These are required to be charged off in all cases prospectively.
– Companies who have opted for the transitional relief for continuing treatment of capitalisation in terms of para 46A of AS-11 till the tenor of the loans or till FY 2020. This would impact comparability of results.
– Greater volatility in the results of companies who have large overseas borrowings.

INTANGIBLE ASSETS

Recognition and Measurement

Intangible assets can have indefinite useful lives, identification of which should be adequately and appropriately demonstrated and justified. Such assets need to be subjected to an annual impairment assessment.

Fair valuation is now permissible especially if an active market exists.

CONCLUSION
The above assessment is just the tip of the ice-berg and in actual practice there could be many other issues, challenges and implications which would merit a detailed assessment.

The purpose of this article is to identify the professional responsibilities of the auditors in dealing with the legal and regulatory framework, various components of the legal and regulatory framework which need to be considered by the auditors and evaluating their impact during an audit of the financial statements, duly supplemented by certain practical scenarios.

Relevant auditing pronouncements:

• SA-250 on Consideration of Laws and Regulations in an Audit of Financial Statements

• SA-260 on Communication to those charged with Governance ?

• SA-265 on Communicating Deficiencies in Internal Control

• SA-315 on Identifying and Assessing the Risks of Material Misstatements Through Understanding the Entity.

Professional responsibilities of auditors: The various professional responsibilities of auditors under each of the above SAs to the extent they deal with the impact of and consideration of laws and regulations in an audit of the financial statements are briefly discussed below.

SA-250 on Consideration of Laws and Regulations in an Audit of Financial Statements:

SA-250 is the primary Auditing Standard which deals with the auditor’s responsibilities to consider laws and responsibilities which are relevant to an entity in an audit of its financial statements. It envisages the following two situations:

• Laws and regulations which have a direct effect on the financial statements and issuance of audit reports and other certificates in respect of the reporting entity.

• Laws and regulations which have an indirect effect on the financial statements of the reporting entity, but compliance with which may have a fundamental effect on the operating aspects of a business, non-compliance with which may result in material penalties being levied by the concerned regulatory authorities.

Accordingly, the laws and regulations which are most likely to materially affect the financial statements and with which an auditor is primarily concerned can be broadly categorised as under:

• Form and content of the financial statements, including amounts to be reflected and disclosures to be made. These include the following:

(1) Specific format of the financial statements and the related disclosure requirements under Schedule VI to the Companies Act, 1956 (‘the Act’) and other disclosure requirements under the Act, such as transfer to Capital Redemption Reserve on buy-back of shares u/s.77A of the Act, amounts contributed to any political party or for any political purpose u/s.293A of the Act, amounts contributed to the National Defence Fund u/s.293B of the Act.

(2) Reporting requirements under the Companies (Auditor’s Report) Order, 1988 (CARO).

(3) Specific format of the financial statements and related disclosure requirements under the Third Schedule to the Banking Regulation Act, 1949 for banking companies and disclosures in the financial statements in terms of various Circulars issued by the Reserve Bank of India (RBI) from time to time.

(4) Issue of Long Form Audit Report in the case of banks.

(5) Certificate for Capital Adequacy, net worth, etc. in case of certain entities like banks, stockbrokers, etc.

(6) Specific format of the financial statements and the related disclosure requirements issued by the Insurance Regulatory and Development Authority (IRDA) for insurance companies and disclosures in the financial statements in terms of the various Circulars issued by the IRDA from time to time.

(7) Specific format of the financial statements and the related disclosure requirements issued by the Securities and Exchange Board of India (SEBI) for mutual funds and disclosures in the financial statements in terms of the various Circulars issued by SEBI from time to time.

(8) Disclosures under Clause 32 of the Listing Agreement mandated by SEBI.

(9) Disclosures under the Micro Small and Medium Enterprises Act, 2006.

• Conducting the business of the entity including licensing, registration and health and safety requirements for entities like banks, NBFCs, mutual funds, pharmaceutical companies, hotels, etc., non-compliance of which could lead to Going Concern issues as well as financial consequences like penalties, fines, etc.

• Operating aspects of the business like provisioning for banks and NBFCs, valuation of investments for banks and mutual funds, contributions to employee retirement benefit funds, taxation issues, etc. which could have a direct impact on the financial statements.

Responsibilities of management and those charged with governance:

SA-250 also clearly articulates that the primary responsibility for ensuring that an entity complies with laws and regulations rests with the management and those charged with governance.

The responsibilities of the management and those charged with governance in this regard can cover the following broad aspects:

• Laying down appropriate operating procedures and systems, including internal controls in general for all business areas and operating cycles and specifically with regard to the various legal and regulatory aspects like capturing the data for provisioning requirements for banks and NBFCs, calculating various taxes and other statutory dues, valuation of investments, determination of subsidies for fertiliser companies, etc.

• Developing an appropriate code of conduct for employees and other stakeholders for dealing with various aspects like insider trading, conflict of interest, etc.

• Maintaining a log/register of the various laws and regulations applicable together with a compliance check-list for the same and laying down systems and procedures for monitoring and reporting compliance therewith with the ultimate objective of periodically preparing a Compliance Certificate for submission to the Board of Directors or other equivalent authority.

• Establishing a legal department depending upon the complexity, size and nature of business of the entity and hiring/availing the services of legal advisors and consultants.

•     Ensuring that various statutory committees as required in terms of various statutes and regulations have been duly constituted with the appropriate constitution and terms of reference e.g., audit committee, asset-liability management committee, investment committee, risk management committee, etc. In this case, care should be taken to ensure that the conflicting requirements under different statutes/regulations are appropriately married e.g., the requirements for constitution of an audit committee for a listed NBFC would have to comply with the requirements of section 292A of the Act, Clause 49 of the Listing Agreement and the RBI guidelines. In this case, since the requirements under Clause 49 of the Listing Agreement are more stringent, especially with regard to the composition of and the matters to be disclosed to/discussed at the Audit Committee, the same should be adhered to.

Responsibilities of auditors:

SA-250 recognises that it is not the primary responsibility of the auditor to detect non-compliance with laws and regulations since these are matters for the courts to decide. SA-250 requires the auditor to gather sufficient appropriate evidence to obtain reasonable assurance that the entity is complying with the laws and regulations applicable to it. For this purpose, he should perform the following audit procedures to help identify any acts of non-compliance with the relevant laws and regulations:

•     Making inquiries of the management and those charged with governance to identify whether the entity is complying with the laws and regulations.

•     Inspecting correspondence with the relevant licensing and regulatory authorities.

These procedures can be performed both at the planning and the execution stage.

The procedures which could be performed at the planning stage are outlined below:

•     Obtaining a general understanding of the applicable legal and regulatory framework, including identification of those laws and regulations which would have a fundamental effect on the operations or the entity or affect its going concern status. For this purpose, the auditor should use his knowledge of the business and industry in which the entity is operating.

•     Reading of the minutes of various meetings.

•     Making inquiries with the management and those charged with governance regarding policies and procedures for compliance with the applicable legal and regulatory framework keeping in mind the matters discussed earlier as well as identifying, evaluating, disclosing and accounting for litigations and claims in terms of the applicable financial re-porting framework.

•     Identifying whether any specific reporting is required under certain laws and regulations e.g., PF, ESIC, income-tax, etc. under CARO, compliance with various RBI/SEBI requirements, etc.

The procedures which could be performed at the execution stage are outlined below:

•     Following up on the inquiries made with the management and those charged with governance during the planning stage.

•     Inspecting correspondence with and inspection reports of the relevant regulatory authorities.

•    Reviewing the nature of payments made to various legal consultants to identify any hidden claims and possible non-compliances.

•     Performing appropriate control and substantive procedures to take care of any business/industry-specific requirements like provisioning, valuation, accrual of employee and retirement benefit expenses, duties, subsidies, incentives, etc.

Based on the above procedures, the following are certain types of non-compliances the auditor could encounter, the impact of which would need to be dealt with in terms of the relevant legal, regulatory and financial reporting framework:

•     Non-payment or delayed payment of statutory dues necessitating reporting under CARO.

•     Non-compliance with certain statutory and procedural requirements under various laws and regulations in respect of specific types of transactions e.g., non-compliance with the provisions of section 372A of the Act, in respect of loans and investments, granting of loans by banks to directors in violation of the provisions of the Banking Regulation Act, 1949, inadequate provisioning for advances under the RBI guidelines, incorrect computation of royalty payable to the government in respect of mining and oil exploration activities, etc.

•     Non-compliance with the relevant licensing/regulatory requirements or transactions which are ultra vires.

•     Payments/transactions undertaken in violation of exchange control guidelines.

The above and any other possible non-compliances would need to be carefully evaluated by the auditor to understand the nature and circumstances thereof and obtain sufficient other information to evaluate its impact on the financial statements as under:

•     Whether there would be any financial consequences in the form of fines, penalties, damages, etc.?

•    Whether the entity would be embroiled in litigation and the consequential disclosure towards contingent liabilities, if any?

•     Whether the entity would be forced to discontinue operations and whether there are any going concern issues?

•     Whether the financial consequences are serious enough to impact the true and fair view?

The auditor should discuss the above aspects with the management and those charged with governance and where he is not satisfied with the outcome, he may seek independent legal advice.

Other Standards:

The requirements of other SAs which deal with the audit considerations pertaining to the implications arising from the impact of laws and regulations are summarised below:

•     SA-260 which deals with the auditor’s responsibility to communicate audit-related matters to those charged with governance recognises the fact that in certain situations there are obligations imposed by statutory and legal requirements to communicate certain matters to those charged with governance. This would include certain matters which are mandatorily required to be communicated to/discussed by the Audit Committee in terms of section 292A of the Act and Clause 49 of the Listing Agreement with the Stock Exchanges, mandatory communication to the Chief Executive Officers of banks and NBFCs, as mandated by the RBI, of any serious irregularities and frauds which are noted during the course of the audit.

•     Similarly, SA-265 which deals with the auditor’s responsibility to communicate deficiencies in internal control recognises the fact that in certain situations there are obligations imposed by legal and regulatory requirements to communicate deficiencies in internal control to regulatory authorities. Examples thereof include the direct communication to the RBI of any non-compliance with the RBI guidelines in respect of NBFCs and reporting any serious irregularities and frauds in respect of banks directly to the RBI.

•     SA-315 which requires the auditor to obtain an understanding of the entity and its environment includes an understanding of the entity’s legal and regulatory framework and how the entity is complying with that framework.

Components/Elements of the legal and regulatory framework:

The various components/elements of the legal and regulatory framework which need to be considered by the auditor can be broadly classified as follows:

•    Principal acts and legislations which regulate the financial reporting and operating aspects of the entity.

•     Regulations, notifications and guidelines issued pursuant to the above.

•     Sector/industry specific policies notified by the government or other regulators.

•     Legal and judicial pronouncements issued by the Supreme Court, High Courts and other judicial authorities.

Each of these elements is briefly discussed hereunder:

Principal Acts and legislations:

It is imperative that the auditor identifies the principal Acts and legislations governing the entity which deal with the incorporation of the entity as well as lay down its financial reporting, taxation, tariff fixation and operating framework amongst others. The primary legislation which deals with the incorporation of most entities is the Companies Act, 1956 which lays down the financial reporting framework as well as other operating requirements for certain types of transactions like borrowings, investments, advances, managerial remuneration and donations, compliance with which is essential or else the transactions could be illegal or ultra vires thereby exposing the entity to penalties, fines or other forms of prosecution. There are other legislations which lay down the registration/licensing requirements for certain specific types of entities like banks, insurance companies, broking companies, etc. The continued compliance with the minimum capitalisation and other requirements for licensing and registration of such entities is of utmost importance and any failure to comply with the same could lead to penalties and fines as well as going-concern issues.

Apart from the above, there are various legislations which deal with various operating aspects of the business like cess and levies, taxation, labour and employment, environmental protection, health and safety, etc. which need to be continuously monitored and assessed since any failure to adhere to the same could either result in material misstatements (in the form of non-accrual or under accrual of cess, duties, taxes or employee/retirement benefits, environmental remediation and legal costs) or expose the entity to potential litigation and penalties/ fines which could be sizeable and also impact the going concern assumption.

With the ever increasing globalisation, many entities are setting up branches and subsidiaries/joint ventures abroad, thereby exposing them to international laws and regulations. A case in point is the UK Bribery Act, 2010 which applies to all entities which are registered in the UK or who have some connection with entities registered in the UK. Accordingly, if an entity in India is a holding company, subsidiary or associate of an entity which is registered in the UK, it would have to comply with the provisions laid down therein.

Regulations, Notifications, Guidelines and Circulars:

In many cases, the principal Acts governing the entity provide enabling powers to various statutory authorities to issue regulations, Notifications, Guidelines and Circulars which would lay down the financial reporting, taxation, tariff fixation, licensing, registration and operating framework amongst others for an entity. Examples of such statutory authorities include RBI, SEBI, IRDA, Central Electricity Regulatory Authority, Telecom Regulatory Authority. As is the case with the principal Acts and legislations, it is imperative that the auditor identifies these so as to determine their impact on the financial statements and reporting requirements.

Sector/Industry-specific policies:
The auditor should also keep in mind any sector/ industry-specific requirements since any deviations from the same could result in the entity not being able to undertake its activities and also expose it to litigation. Examples include the Tourism Policy, Exchange Control Policy, Telecom Policy, Oil exploration and Licensing Policy, Foreign Direct Investment policy.

Legal and judicial pronouncements:
Whilst the Legislature may frame various laws and the statutory authorities may issue various guidelines, notifications, etc., it is the judiciary which ultimately interprets certain contentious issues. Accordingly, it is imperative that the auditor is aware of the various judicial pronouncements which could have an impact on the financial condi-tions and operating results of an entity. These mainly include judicial pronouncements relating to tax matters and other statutory payments. However, in certain situations, the impact of certain judicial pronouncements can even lead to the discontinuance of the business or going concern issues like the recent order by the Supreme Court in the matter pertaining to the allocation of telecom licences.

•     Recently, the High Courts of Judicature at Madras and Madhya Pradesh had passed an order dealing with the issue of whether various employee allowances paid by employers would get covered within the definition of ‘Basic Wages’ under the Employees’ Provident Fund and Miscellaneous Provisions Act, 1952 (the Provident Fund Act). Pursuant to the same, the Employees Provident Fund Organisation has issued a clarification to various Officers/Commissioners asking them to take note of these judgments and utilise the same as per merits of the case as and when similar situation arises in the field offices. In both the above judgments, it has been held that allowances like conveyance/transportation/special allowance/education/food concession/medical/city compensatory, etc. are to be treated as part of ‘Basic Wages’ under the Provident Fund Act for the purpose of determination of the Provident Fund (PF) liabilities if the same are being uniformly, necessarily and ordinarily paid to all employees. This could result in additional liabilities, if any demands are raised by the authorities.

•     The recent judgment of the Supreme Court banning mining activities in the State of Karnataka could have an impact on the operations of the affected entities.

Practical scenarios:

Before concluding, let us briefly evaluate the impact which the following recent changes in regulations will have on the financial and reporting aspects of a significant number of entities so as to gain a better perspective.

Service tax and Cenvat credit:

With effect from 1st July, 2011 service tax is payable on accrual basis based on ‘Point of Taxation Rules’ (POTR) as compared to receipt basis for most of the taxable services. This would have an impact on CARO Reporting as the due date of payment of service tax would consequently change.

In respect of CENVAT credit, the fol-lowing are some of the important changes which are relevant to the audit of financial statements:

(1)    With effect from 1st July, 2011, banking companies and financial institutions including NBFCs will be required to pay 50% of the CENVAT credit availed on inputs and input services every month. Accordingly, the balance 50% should be immediately charged off under the respective expenses.

(2)    With effect from 1st July, 2011, providers of life insurance services and management of investment in ULIPs will be required to pay 20% of the CENVAT credit availed on inputs and input services every month.

(3)    With effect from 1st July, 2011, input credit in case of a pure service provider will be allowed in proportion of the taxable and exempt services rendered during the year. Input credit in case of an entity involved in trading as well as providing other services will be allowed in proportion of the gross profit on trading activity (which is exempt) and the taxable service rendered during the year. Accordingly, the balance should be immediately charged off under the respective expenses. It is imperative that the ratio of nature of trading activities and services provided by the client are identified at an early stage.

The Companies (Cost Accounting Records) Rules, 2011: The Ministry of Corporate Affairs has issued a Notification dated 3rd June, 2011 prescribing the Companies (Cost Accounting) Rules, 2011 (‘Rules’). Hitherto, the prevailing practice was for the Central Government to prescribe the Cost Accounting Rules applicable to specific products or industries and reference to such products or industry was being made by the auditors in their report under CARO. However, under the Rules now prescribed, the same would apply to the entity as a whole if it engaged in manufacturing, processing and mining activities and not to specific products, except those which are prescribed under the Rules like bulk drugs, sugar, fertilisers, etc. This would necessitate a change in the manner of our reporting under CARO as well as reviewing the prescribed records and their reconciliation with the financial records, which is specifically prescribed in the Rules.

Conclusion:

An auditor needs to continuously evaluate the impact of laws and regulations in respect of each entity. For this purpose, he needs to make inquiries with the management and those charged with governance, who are primary responsible to ensure such compliance, to identify that there is a proper framework to monitor any such non-compliances.

Reference material:

•     Indian Auditing Standards

•     Wiley’s Interpretation and Application of International Standards on Auditing by Steven Collings

•     Various Research Reports on Audit Process available for general public.

As mentioned in the Foreword of the ICAI Guidance Note on Revised Schedule VI to the Companies Act, 1956 (ICAI GN), “to make Indian business and companies competitive and globally recognisable, a need was felt that format of Financial Statements of Indian corporates should be comparable with international format. Since most of the Indian Accounting Standards are being made at par with the international Accounting Standards, the changes to format of Financial Statements to align with the Accounting Standards will make Indian companies competitive on the global financial world. Taking cognisance of imperative situation and need, the Ministry of Corporate Affairs revised the existing Schedule VI to the Companies Act, 1956”.

The Ministry of Company Affairs (MCA) vide Notification dated 28th February 2011 notified the format of Revised Schedule VI. Further vide Notification dated 30th March 2011, it was clarified that the “The new format shall come into force for the Balance Sheet and Profit and Loss Account to be prepared for the financial year commencing on or after 1st April 2011”.

The ICAI GN issued in December 2011 gives detailed guidance on the Revised Schedule VI and the manner in which the various instructions contained in Revised Schedule VI are to be interpreted.

The structure of Revised Schedule VI is as under:

(a) General Instructions
(b) Part I — Form of Balance Sheet
(c) General Instructions for preparation of Balance Sheet
(d) Part II — Form of Statement of Profit and Loss
(e) General Instructions for preparation of Statement of Profit and Loss

It should be noted that besides the format for preparation of Balance Sheet and Profit and Loss statement as notified by the Revised Schedule VI, there are other disclosure requirements also. These disclosures are:

(a) Disclosures as per the notified Accounting Standards i.e., as per the Companies (Accounting Standards) Rules, 2006;

(b) Disclosures under the Companies Act, 1956 (e.g., on buyback of shares — section 77, political contributions — section 293, etc.);

(c) Disclosures under Statutes (e.g., as per the Micro, Small and Medium Enterprises Development Act, 2006);

(d) Disclosures as per other ICAI pronouncements (e.g., disclosure on MTM exposure for derivatives);

(e) In case of listed companies, disclosures under Clause 32 of the Listing Agreement (e.g., Loans to associate companies, etc.)

Applicability of the Revised Schedule

A company having its financial year ending on, say, 30th June 2011, 30th September 2011 or 31st December 2011 cannot adopt the new format since their financial years have not commenced on or after 1st April 2011. Since the format of Revised Schedule VI is a statutory format, a company cannot decide to follow the same even on a voluntary basis. However, if a company decides to prepare its financial statements from 1st April 2011 to 31st December 2011 (i.e., for a period of 9 months), it will have to prepare the same using the format of Revised Schedule VI.

All companies registered under the Companies Act, 1956 have to prepare their financial statements using Revised Schedule VI. However, proviso to section 211 exempts banking companies, insurance companies and companies engaged in generation or supply of electricity from following the said format since these are governed by their respective statutes. However, since the Electricity Act 2003 and the Rules thereunder do not prescribe any format for preparing financial statements, such companies will have to follow the format laid down by the Revised Schedule VI till a separate format is prescribed.

Listed companies require to publish information on quarterly and annual basis in the prescribed format in terms of clauses 41(l)(ea) and 41(l)(eaa) of the Listing Agreement. These formats are inconsistent with formats under the Revised Schedule VI. However, since the formats are statutory formats as per the Listing Agreement, the same will have to be followed till the time a new format is prescribed under Clause 41 of the Listing Agreement.

Companies which are in the process of making an issue of shares (IPO/FPO) have to file ‘offer documents’ containing among other details, financial information of the last 5 years. The formats of Balance Sheet and Statement of Profit and Loss prescribed under the SEBI (Issue of Capital & Disclosure Requirements) Regulations, 2009 (‘ICDR Regulations’) are inconsistent with the format of the Balance Sheet/Statement of Profit and Loss in the Revised Schedule VI. However, since the formats of Balance Sheet and Statement of Profit and Loss under ICDR Regulations are only illustrative, to make the data comparable and meaningful for users, companies will be required to use the Revised Schedule VI format to present the restated financial information for inclusion in the offer document. It may also be noted that the MCA had vide General Circular No. 62/2011, dated 5th September 2011 has clarified that ‘the presentation of Financial Statements for the limited purpose of IPO/FPO during the financial year 2011-12 may be made in the format of the pre-revised Schedule VI under the Companies Act, 1956. However, for period beyond 31st March 2012, they would prepare only in the new format as prescribed by the present Schedule VI of the Companies Act, 1956’.

Revised Schedule VI requires that except in the case of the first financial statements (i.e., for the first year after incorporation), the corresponding amounts for the immediately preceding period are to be disclosed in the Financial Statements including the Notes to Accounts. Accordingly, corresponding information will have to be presented starting from the first year of application of the Revised Schedule VI. Thus, for the Financial Statements for the financial year 2011-12 corresponding amounts need to be given for the financial year 2010-11. This will require all companies to take an extra effort to compile the corresponding amounts for 2010-11 for disclosing in Revised Schedule VI prepared for the financial year 2011-12.

All companies whether private or public, whether listed or unlisted, and irrespective of their size in terms of turnover, assets, etc. (other than those mentioned in para 9 above) will have to adhere to the new format of financial statements from 2011-12 onwards. Many small or family-owned companies which are run as an extension of partnerships will have difficulties in adopting the new formats since they may not have the necessary trained manpower or infrastructure for such changeover.

Major principles as per Revised Schedule VI

As per general instructions contained in the Revised Schedule VI, the terms used shall carry the meanings as per the applicable Accounting Standards (AS). As per the ICAI GN, the applicable AS for this purpose shall mean the AS notified by the Companies (Accounting Standards) Rules, 2006.

Revised Schedule VI requires that if compliance with the requirements of the Companies Act, 1956 (Act) and/or AS requires a change in the treat-ment or disclosure in the financial statements, the requirements of the Act and/or AS will prevail over Revised Schedule VI.

As per preface to the AS issued by ICAI, if a par-ticular AS is not in conformity with law, the provi-sions of the said law or statute will prevail. Using this principle, disclosure requirements of existing Schedule VI were considered to prevail over AS. However, since the Revised Schedule VI gives specific overriding status to the requirements of AS notified by the Companies (Accounting Stan-dards) Rules, 2006, the same would prevail over the Revised Schedule VI.

There are several instances of conflict between provisions of the Revised Schedule VI and the notified AS e.g., definition of Current Investments as per the Revised Schedule VI and AS -11, definition of Cash and Cash Equivalents as per the Revised Schedule VI and AS-3, treatment of proposed dividend as per the Revised Schedule VI and AS- 4, etc. In all such cases, provisions of the AS will prevail over the Revised Schedule VI.

The nomenclature for the Profit and Loss account is now changed to ‘Statement of Profit and Loss’. Also, only the vertical format is prescribed for both Balance Sheet and the Statement of Profit and Loss.

The format of the Statement of Profit and Loss as per the Revised Schedule VI does not contain disclosure of appropriations like transfer to reserves, proposed dividend, etc. These are now to be disclosed in the Balance Sheet as part of adjustments in ‘Surplus in Statement of Profit and Loss’ contained in ‘Reserves and Surplus’. Further, debit balance of ‘profit and loss account’, if any, is to be disclosed as a reduction from ‘Reserves and Surplus’ (even if the final figure of Reserves and Surplus becomes negative).

It is clarified by the Revised Schedule VI that the requirements mentioned therein are minimum requirements. Thus, additional line items, sub-line items and sub-totals can be presented as an addition or substitution on

the face of the financial statements if the company finds them necessary or relevant for understanding of the company’s financial position. Also, in preparing the financial statements, a balance will have to be maintained between providing excessive detail that may not assist users of the financial statements and not providing important information as a result of too much aggregation.

Revised Schedule VI requires use of the same unit of measurement uniformly throughout the financial statements and ‘Notes to Accounts’. Rounding off requirements, if opted, are to be followed uniformly throughout the financial statements and ‘Notes to Accounts’. The rounding off requirements as per pre-revised Schedule VI and as per the Revised Schedule VI are summarised in the following table:

The disclosure requirements as per the Revised Schedule VI do not contain several disclosures which were required by pre-revised Schedule VI. Some of these are:

(a)    Disclosures relating to managerial remuneration and computation of net profits for calculation of commission;
(b)    Information relating to licensed capacity, installed capacity and production;
(c)    Information on investments purchased and sold during the year;
(d)    Investments, sundry debtors and loans & advances pertaining to companies under the same management;
(e)    Maximum amounts due on account of loans and advances from directors or officers of the company;
(f)    Commission, brokerage and non-trade discounts; and
(g)    Information as required under Part IV of pre-revised Schedule VI.

Major changes in the format of Balance Sheet
Equity and Liabilities

A new disclosure requirement regarding details of number of shares held by each shareholder holding more than 5% shares in the company is inserted by the Revised Schedule VI. The ICAI GN has clarified that in the absence of any specific indication of the date of holding, such information should be based on shares held as on the Balance Sheet date. For this disclosure, the names of the shareholders would be normally available from the Register of Members required to be maintained by every company.

Details pertaining to number of shares issued as bonus shares, shares bought back and those allot-ted for consideration other than cash needs to be disclosed only for a period of five years immediately preceding the Balance Sheet date including the current year. Under the pre-revised Schedule VI requirement is to disclose such items at all times.

In case of listed companies, share warrants are issued to promoters and others in terms of SEBI guidelines. Since such warrants are effectively and ultimately intended to become part of capital, Revised Schedule VI requires that the same be disclosed as part of the Shareholders’ funds as a separate line-item — ‘Money received against share warrants.’ In case the said warrants are forfeited, the amount already paid up would be transferred to ‘Capital Reserve’ and disclosed as part of ‘Reserves and Surplus’.

There are specific disclosures required by the Re-vised Schedule VI for ‘Share Application money pending allotment’. It has been also stated that share application money not exceeding the issued capital and only to the extent not refundable is to be included under ‘Equity’ and share application money to the extent refundable is to be separately shown under ‘Other current liabilities’. Disclosures required regarding share application, whether included under ‘Equity’ or under ‘Other current li-abilities’ are as under:

(a)    terms and conditions;
(b)    number of shares proposed to be issued;
(c)    the amount of premium, if any;
(d)    the period before which shares are to be allotted;
(e)    whether the company has sufficient authorised share capital to cover the share capital amount on allotment of shares out of share application money;
(f)    Interest accrued on amount due for refund;
(g)    The period for which the share application money has been pending beyond the period for allotment as mentioned in the share application form along with the reasons for such share application money being pending.

A major change in the format of balance sheet as per the Revised Schedule VI is the classification of all items of liabilities and assets into Current and Non-Current. The terms ‘Current’ and ‘Non-Current’ are defined by Revised Schedule VI as under:

(a)    A liability is classified as Current if it satisfies any of the following criteria:
(i)    it is expected to be settled in the company’s normal operating cycle;
(ii)    it is held primarily for the purpose of being traded;
(iii)    it is due to be settled within 12 months after the reporting date; or
(iv)    The company does not have an unconditional right to defer settlement of the liability for at least 12 months after the reporting date.

All other liabilities shall be classified as non-current.

  (b)  An asset shall be classified as current when it satisfies any of the following criteria:
  (i)  It is expected to be realised in, or is intended for sale or consumption in the company’s normal operating cycle;
  (ii)  It is held primarily for the purpose of being traded;
  (iii)  It is expected to be realised within 12 months after the reporting date; or
  (iv)  It is cash or cash equivalent unless it is restricted from being exchanged or used to settle a liability for at least 12 months after reporting period date.

All other assets shall be classified as non-current.

  (c)  ‘Operating Cycle’ is defined by Revised Schedule VI as “An operating cycle is the time between the acquisition of assets for processing and their realisation in cash or cash equivalents. Where the normal operating cycle cannot be identified, it is assumed to have duration of twelve months”.

  (d)  Thus, all companies will need to bifurcate balances in respect of all liabilities and assets into ‘current’ and ‘non-current’. The definitions contain four conditions out of which even if one is satisfied, the said liability or asset would be classified as ‘current’. If none of the conditions are satisfied the said liability or asset will be classified as ‘non-current’. The four conditions are quite subjective since they use phrases like ‘expected’, ‘held primarily’, ‘due to be settled’, etc.

  (e)  As per the definition, current liabilities would include items such as trade payables, employee salaries and other operating costs that are expected to be settled in the company’s normal operating cycle or due to be settled within twelve months from the reporting date. Thus, liabilities that are normally payable within the normal operating cycle of a company, are classified as current even if they are due to be settled more than twelve months after the end of the balance sheet date.

  (f)  Similarly, as per the definition, current assets would include assets like raw materials, stores, consumable tools, etc. which are intended for consumption or sale in the course of the company’s normal operating cycle. Such items of inventory are to be classified as current even if the same are not actually consumed or realised within twelve months after the balance sheet date. Current assets would also include inventory of finished goods since they are held primarily for the purpose of being traded. They would also include trade receivables which are expected to be realised within twelve months from the balance sheet date.

  (g)  A company can have multiple operating cycles in case they are manufacturing/dealing in different products. In such cases, the bifurcation into ‘current’ and ‘non-current’ can become difficult.

  (h)  Companies will also need to bifurcate all their borrowings into ‘current’ and ‘non-current’. It is possible that the same borrowing will be classified into two components depending on the portion repayable within/after twelve months from the balance sheet date. Other detai ls in respect of borrowings such as  whether secured (with terms of security) or unsecured, whether guaranteed or not, details of repayment of loans, details of redemption in case of debentures, etc. are also required to be disclosed.

  (i)  Since the format of the balance sheet mentions Deferred Tax Liability (DTL)/Deferred Tax Asset (DTA) as a non-current liability/asset, the same is to be always classified as non-current and cannot be classified as ‘current’ even if the deferred tax liability/asset would become payable or receivable within twelve months of the balance sheet date. It should be also noted that such DTL/DTA is always disclosed on a net basis as required by AS-22.

(j)    For several items of liabilities/assets, the aforesaid classification exercise can become quite cumbersome and time-consuming for companies especially since the same is also required to be done for 2010-11.

In case of loans taken by a company, Revised Schedule VI requires specific disclosure of period and amount of continuing default as on the balance sheet date in repayment of loans and interest to be specified separately in each case.

Revised Schedule VI requires disclosure of loans and advances taken from related parties. ‘Related Parties’ for this purpose would mean those parties as defined by AS-18.

Revised Schedule VI requires disclosure of ‘Trade Payables’ as part of ‘other non-current liabilities’ or ‘current liabilities’. A payable can be classified as ‘trade payable’ if it is in respect of amount due on account of goods purchased or services received in the normal course of business. As per the pre-revised Schedule VI, the term used was ‘Sundry Creditors’ which included amounts due in respect of goods purchased or services received as well as in respect of other contractual obligations. Since amounts due under contractual obligations can no longer be included within ‘trade payables’, items like dues payables in respect of statutory obligations like contribution to provident fund, purchase of fixed assets, contractu-ally reimbursable expenses, interest accrued on trade payables, etc. will need to be classified as ‘others’.

Assets

As per Revised Schedule VI, the disclosure for fixed assets is to be segregated into:

(a)    Tangible assets;
(b)    Intangible assets;
(c)    Capital work-in-progress; and
(d)    Intangible assets under development

The classification of tangible assets is similar to the one under pre-revised Schedule VI, but has a separate item for ‘Office Equipment’. Besides, ‘Plant and Machinery’ is now renamed as ‘Plant and Equipment’.

Classification of intangible assets as a separate item of Fixed Assets is introduced by Revised Schedule VI. It is also required to classify ‘Computer Software’ separately within ‘Intangible Assets’.

It is also necessary to separately disclose, a reconciliation of the gross and net carrying amounts of each class of assets at the beginning and end of the reporting period showing additions, disposals, acquisitions through business combinations (i.e., on account of amalgamations/demergers, etc.) and other adjustments (like capitalisation of borrowing costs as per AS-16) and the related depreciation/ amortisation and impairment losses/reversals.

Since Revised Schedule VI specifically requires capital advances to be included under long-term loans and advances, the same cannot be included under capital work-in-progress. The same also cannot be therefore included within current assets.

There is also a specific requirement to include ‘assets given/taken on lease’, both tangible and intangible under each of the items of fixed assets.

As per Revised Schedule VI, all Investments are to be bifurcated into ‘current’ and ‘non-current’. They also further need to be classified (as in the pre-revised Schedule VI) into trade/non-trade and
quoted/unquoted.

The classification of investments is to be done as under:

(a)    Investment property;
(b)    Investments in Equity Instruments;
(c)    Investments in preference shares;
(d)    Investments in Government or trust securities;
(e)    Investments in debentures or bonds;
(f)    Investments in Mutual Funds;
(g)    Investments in partnership firms; and
(h)    Other investments (specifying nature thereof).

Revised Schedule VI also requires that under each classification, details need to be given of names of bodies corporate indicating separately whether they are:
(a)    subsidiaries,
(b)    associates,
(c)    joint ventures, or
(d)    controlled special purpose entities.

In regard to investments in the capital of partnership firms, the names of the firms (with the names of all their partners, total capital and the shares of each partner) need to be given. It is possible that the partnership firm maintains both ‘capital’ and ‘current’ accounts of its partners. In that case, the bal-ance in ‘capital’ account will be clas-sified as a ‘non-current’ investment in the balance sheet of the company, whereas the balance in ‘current’ account is classified as ‘current’ investment.

In case the company has an investment in a ‘Limited Liability Partnership’ (LLP), the disclosure norms of ‘partnership firm’ (as discussed in para 41 above) will not apply since an LLP is considered as a ‘body corporate’.

As per Revised Schedule VI, all loans and deposits, deposits, etc. given by a company
are to be classified into ‘current’ and ‘non-current’.

Revised Schedule VI requires disclosure of loans and advances given to related parties. ‘Related Parties’ for this purpose would mean those parties as defined by AS-18.

Revised Schedule VI requires disclosure of ‘Trade Receivables’ as part of ‘other non-current assets’ or ‘current assets’. A receivable shall be classified as ‘trade receivable’ if it is in respect of the amount due on account of goods sold or services rendered in the normal course of business. As per the pre-revised Schedule VI, the term ‘sundry debtors’ included amounts due in respect of goods sold or services rendered or in respect of other contractual obligations as well. Since, amounts due under contractual obligations cannot be included within ‘Trade Receivables’, items like dues in respect of insurance claims, sale of fixed assets, contractually reimbursable expenses, interest accrued on trade receivables, etc. will need to be classified within ‘others’.

The pre-revised Schedule VI required separate presentation of debtors for those outstanding for a period exceeding six months (based on billing date) and ‘other debtors’. However, for the ‘current’ portion of ‘Trade Receivables’, the Revised Schedule VI requires separate disclosure of ‘Trade Receivables outstanding for a period exceeding six months from the date they became due for payment’. This requirement can result in a lot of work for companies since it would mean modifying their accounting systems to compile the amounts exceeding six months based on the due date. Giving corresponding data for 2010-11 would also result in added work for most companies.

The requirement for classifying ‘loans and advances’ and ‘trade receivables’ into secured/unsecured and good/doubtful also continues in Revised Schedule VI.

The Revised Schedule VI does not contain any specific disclosure requirement for the unamortised portion of expense items such as share issue expenses, ancillary borrowing costs and discount or premium relating to borrowings. These items were included under the head ‘Miscellaneous Expenditure’ as per the pre-revised Schedule VI. Though, Revised Schedule VI does not mention disclosure of any such item, since additional line items can be added on the face or in the notes, unamortised portion of such items can be disclosed (both ‘current’ as well as ‘non-current’ portion), under the head ‘other current/non-current assets’ depending on whether the amount will be amortised in the next 12 months or thereafter.

The term ‘cash and bank balances’ existing in the pre-revised Schedule VI is replaced under Revised Schedule VI by ‘Cash and Cash Equivalents’. These are to be classified into:

(a)    Balances with banks;
(b)    Cheques, drafts on hand;
(c)    Cash on hand; and
(d)    Others (specify nature).

For ‘Cash and Cash Equivalents’, disclosure is also separately required as per Revised Schedule VI for:

(a)    Earmarked balances with banks (for example, for unpaid dividend);
(b)    Balances with banks to the extent held as margin money or security against the borrowings, guarantees, other commitments;
(c)    Repatriation restrictions, if any, in respect of cash and bank balances shall be separately stated;
(d)    Bank deposits with more than twelve months maturity shall be disclosed separately.

Major changes in the format of Statement of Profit and Loss

Revised Schedule VI requires disclosure of ‘Revenue from Operations’ on the face of the statement of profit and loss. In the case of a company other than a finance company, such ‘Revenue from Operations’ is to be disclosed as:

(a)    Sale of products
(b)    Sale of services
(c)    Other operating revenues
(d)    Less: Excise duty

Though Revised Schedule VI specifically requires disclosure of Sale of Products on ‘gross of excise’ basis, there is no mention of whether Sales Tax/VAT and Service Tax is also to be included or not in sale of products or sale of services, respectively. Though not entirely free of doubt, the ICAI GN has stated that “Whether revenue should be presented gross or net of taxes should depend on whether the company is acting as a principal and hence responsible for paying tax on its own account or, whether it is acting as an agent i.e., simply collecting and paying tax on behalf of government authorities. In the former case, revenue should also be grossed up for the tax billed to the customer and the tax payable should be shown as an expense. However, in cases, where a company collects tax only as an intermediary, revenue should be presented net of taxes.” (Also refer BCAJ February 2012 ‘Gaps in GAAP’ for a discussion on whether taxes should be disclosed gross or net).

In addition to Revenue from Op-erations, Revised Schedule VI also requires disclosure of ‘Other Operating Revenue’ as well as ‘Other Income’. The term ‘Other Operating Revenue’ is not defined by Revised Schedule VI. The ICAI GN has how-ever clarified that “this would include revenue arising from a company’s operating activities, i.e., either its principal or ancillary revenue-generating activities, but which is not revenue arising from the sale of products or rendering of services. Whether a particular income constitutes ‘other operating revenue’ or ‘other income’ is to be decided based on the facts of each case and detailed understanding of the company’s activities. The classification of income would also depend on the purpose for which the particular asset is acquired or held”.

In respect of a finance company, Revised Schedule VI requires ‘Revenue from Operations’ to include revenue from:
(a)    Interest and
(b)    Other financial services.

Though the term ‘finance company’ is not defined by Revised Schedule VI, the ICAI GN states that “the same should be taken to include all companies carrying on activities which are in the nature of ‘business of non-banking financial institution’ as defined in section 45I(f) of the Reserve Bank of India Act, 1935”.

In    case    of    all    companies, Revised Schedule VI requires ‘Other income’ to be disclosed on the face of the statement of profit and loss. For this purpose ‘Other Income’ is to be classified as:

(a)    Interest Income (in case of a company other than a finance company);
(b)    Dividend Income;
(c)    Net gain/loss on sale of Investments;
(d)    Other non-operating income (net of expenses directly attributable to such income).

As can be seen from the above, in the case of all company (including a finance company) Dividend income and Net gain/loss on sale on investments will be always classified as ‘Other Income’.

‘Other Income’ will also include share of profits/ losses in a partnership firm. Though there is no specific requirement mentioned for the same in the Revised Schedule VI, the ICAI GN mentions that the same should be separately disclosed. The ICAI GN also requires that in case the financial statements of the partnership firm are not drawn up to the same date as that of the company, adjustments should be made for effects of significant transactions and events that occur between the two dates and in any case, the difference between the two reporting dates should not be more than six months.

Revised Schedule VI requires the aggregate of the following expenses to be disclosed on the face of the Statement of Profit and Loss:

(a)    Cost of materials consumed
(b)    Purchases of stock-in-trade
(c)    Changes in inventories of finished goods, work in progress and stock in trade
(d)    Employee benefits expense
(e)    Finance costs
(f)    Depreciation and amortisation expense
(g)    Other expenses.

The ICAI GN mentions that for the purpose of disclosure, ‘Cost of materials consumed’, should be based on ‘actual consumption’ rather than ‘derived consumption’. In such a case, excesses/shortages should be separately disclosed rather than included in the amount of ‘cost of materials consumed’. This requirement was also contained in the ICAI pronouncements on the pre-revised Schedule VI.

As per Revised Schedule VI separate disclosure is also required for the following items which are classified under ‘Other Expenses’:

(a)    Consumption of stores and spare parts;
(b)    Power and fuel;
(c)    Rent;
(d)    Repairs to buildings;
(e)    Repairs to machinery;
(f)    Insurance;
(g)    Rates and taxes, excluding taxes on income;
(h)    Miscellaneous expenses.

The threshold for disclosure of ‘Miscellaneous Expenses’ is changed to those that exceed ‘1% of revenue from operations or Rs.100,000 whichever is higher’ as against the requirement of pre-revised Schedule VI of ‘1% of total revenue or Rs.5,000 whichever is higher’.

The format of Statement of Profit and Loss in Revised Schedule VI also requires specific disclosures of ‘Exceptional’, ‘Extraordinary’, items and ‘Discontinuing Operations’. These terms are defined by AS -4, AS-5 and AS-24, respectively and disclosures should be done in accordance with these definitions.

Disclosures by way of Notes

Besides the above disclosures, Revised Schedule VI also requires disclosures by way of Notes attached to the financial statements. Some of the major requirements are as under:

(a)    For manufacturing companies: raw materials consumed and goods purchased under broad heads;
(b)    For trading companies: purchases of goods traded under broad heads;
(c)    For companies rendering services: gross income derived from services rendered under broad heads.

Revised Schedule VI does not require disclosure of quantitative details for any of the above categories of companies. The same is also clearly mentioned in para 10.7 of the ICAI GN.

The ICAI GN also mentions that ‘broad heads’ for the purpose of the disclosure in para 62 above are to be decided taking into account the concept of materiality and presentation of ‘True and Fair’ view of financial statements. The said GN also mentions that normally 10% of the total value of sales/services, purchases of trading goods and consumption of raw materials is considered as an acceptable threshold for determination of broad heads.

Revised Schedule VI requires disclosures of ‘Contingent liabilities and commitments’. For this purpose, besides others, ‘other commitments’ are also to be disclosed. Such disclosure of ‘other commitments’ was not required as per pre-revised Schedule VI.

There is no explanation of what would be covered as part of ‘other commitments’ in Revised Schedule VI. The ICAI GN has however clarified that disclosures required to be made for ‘other commitments’ should include ‘only those non-cancellable contractual commitments (cancellation of which will result in a penalty disproportionate to the benefits involved) based on the professional judgment of the management which are material and relevant in understanding the financial statements of the company and impact the decision making of the users of financial statements. Examples may include commitments in the nature of buyback arrangements, commitments to fund subsidiaries and associates, non-disposal of investments in subsidiaries and undertakings, derivative related commitments, etc.’ Most of the other disclosure requirements as per Revised Schedule VI in Notes are similar to the requirements of pre-revised Schedule VI.

Implementation of Revised Schedule VI
As can be seen from the above, disclosure requirements of Revised Schedule VI are quite different from those existing in the pre-revised Schedule VI. Many of these disclosures and concepts (like ‘current’, non-current’) are similar to terms and concepts used in IFRS. Unless, companies gear up well in time to adhere to these new requirements for 2011-12 (and corresponding figures for 2010-11), it will be difficult for them to meet the reporting deadlines of the Companies Act, 1956.