Category: IND AS/IGAAP - Interpretation & Practical Application

Companies frequently provide guarantees on the obligations of other entities, for example bank loan of a joint venture (JV), performance under a contract of a subsidiary, or payment obligations of an associate. These guarantees can take many forms such as financial guarantees, performance guarantees, credit guarantees, and there has been significant diversity in how these are accounted for. Some entities treated guarantees as mere contingent liabilities with disclosure only, while others recognized liabilities at fair value under Ind AS 109, Financial Instruments. This divergence arose due to ambiguity over which Indian Accounting Standard (Ind AS) applies to a given guarantee.

A recent agenda decision by the IFRS Interpretations Committee (IFRIC) in April 2025 dealing with analogous IFRS standards has provided much needed clarity on the accounting treatment for issued guarantees. Although issued under IFRS, this guidance is relevant for interpreting Ind AS. In this article, the authors discuss the types of guarantees commonly seen, the diversity in practice, the clarifying guidance, and the conclusion reached.

TYPES OF GUARANTEES AND COMMON SCENARIOS

Guarantees can be issued in many forms and for various purposes, such as:

(i) Financial Guarantees: These involve an entity guaranteeing payments of debt obligations of another entity. For example, a parent company may guarantee repayment of a bank loan taken
by its subsidiary or joint venture. If the debtor fails to pay, the guarantor must reimburse the holder of the debt.

(ii) Performance Guarantees: These ensure the performance of contractual obligations. For instance, a company may guarantee that its associate or JV will fulfil the terms of an EPC (engineering, procurement, construction) contract covering completion of a project or meeting certain performance standards. If the obligor fails to perform, the guarantor compensates the affected party which could involve monetary compensation or stepping in to perform the work.

(iii) Other Contractual Guarantees: Variations include guarantees of payment obligations under non-debt contracts (e.g. guaranteeing a minimum revenue or profit to a third party), warranty and service guarantees provided in customer contracts (assuring quality or uptime), and guarantees in partnership agreements (e.g., one partner guaranteeing certain returns to another).

These guarantees may be issued on behalf of different related parties such as a joint venture, an associate, a subsidiary, or even an unrelated third party. The terms and conditions can vary widely, some guarantees cover specific loans or bonds, others cover broader obligations or future losses. The rights and obligations of the guarantor also differ. Some guarantees give the guarantor recourse against the primary obligor, for example, an indemnity from the subsidiary to the parent, while others do not. Some are provided for a fee, others are free of charge often when given to benefit a related party. This variety means that no single Ind AS governs all guarantees, and careful analysis is required for each contract.

THE ACCOUNTING DILEMMA AND DIVERGENCE IN PRACTICE

The core question which arise is which Ind AS applies to a given guarantee? In the absence of explicit guidance, companies interpreted standards differently.

Many companies defaulted to Ind AS 109 for guarantees, especially for explicit financial guarantees of debt. Ind AS 109 contains the definition of a financial guarantee contract (FGC) and specific accounting requirements. According to Ind AS 109, a financial guarantee contract is “a contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due in accordance with the original or modified terms of a debt instrument”. If a guarantee met this definition (essentially a credit guarantee on a debt obligation), it would clearly fall under Ind AS 109 as a financial instrument. In such cases, Ind AS 109 requires the guarantor to recognize a liability at fair value at inception of the guarantee, and subsequently measure it as per financial instrument guidance (typically at the higher of the initially recognized amount amortized, and the expected credit loss allowance). Many companies did follow this for bank loan guarantees and similar credit guarantees, recording a liability with the offset often treated as an investment in the subsidiary or an expense, depending on the context.

However, when the guarantee related to non-debt obligations or performance risks, practice varied. Some viewed these as not meeting the narrow Ind AS 109 definition, since the trigger was not strictly a ‘debt instrument’ default. For example, a parent guaranteeing to compensate a customer if its JV fails to complete a project on time (a performance guarantee). This type of guarantee does not meet the Ind AS 109 definition of a financial guarantee contract, because it is not a guarantee of payment on a debt instrument. Lacking a clear Ind AS analogy for such insurance-like guarantees, some companies resorted to Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets treating the guarantee as a contingent liability to be disclosed, and only recognized as a provision if payment became probable. Under Ind AS 37, unless an outflow is probable and estimable, only a disclosure is required. This meant many performance guarantees remained off-balance-sheet except perhaps a provision at the tail end if a default was imminent. Other companies, attempting to be conservative, recognized a provision upfront at some estimate of potential loss, citing general prudence. The lack of uniformity was evident, as IFRIC also observed diversity in practice globally with such guarantees.

A few entities, noting the insurance-like nature of performance guarantees, drew analogy to Ind AS 104/Ind AS 117 Insurance Contracts. Ind AS 104 which is based on IFRS 4 was the interim standard for insurance and Ind AS 117 based on IFRS 17 is the new comprehensive insurance standard effective from financial year 2024-25 in India. Under insurance accounting, a performance guarantee (which involves accepting significant risk of a non-financial loss) could be seen as an insurance contract. However, historically this treatment was rare unless the company was itself an insurer. Ind AS 104/117 were typically outside the scope for non-insurance companies, and many firms were unaware that they could consider a guarantee as an insurance contract. In fact, IFRS/Ind AS allowed an option: if an issuer explicitly treated certain guarantees as insurance contracts in the past, it could continue to do so. In Ind AS terms, an issuer who had asserted that its guarantees are insurance could elect to apply Ind AS 117 instead of Ind AS 109 for those contracts.

Guarantees as part of customer contracts: Another grey area was when guarantees were provided to customers as part of a sales or service contract. For example, a construction company might guarantee the performance of a facility for a period (beyond a normal warranty), or a parent entity might guarantee the obligations of its subsidiary to a customer. Some aspects of such guarantees could be viewed as extended warranties or performance bonuses/penalties, possibly falling under Ind AS 115 Revenue from Contracts with Customers as part of the revenue arrangement. Many companies do not segregate these, or they treated any such guarantees as either Ind AS 37 contingencies or simply include any payouts as reductions of revenue when incurred with no liability upfront.

The net result is a lack of comparability. Some companies carry significant guarantee liabilities on their balance sheets under Ind AS 109 while others with similar exposures show nothing but contingent liability disclosures.

IFRIC AGENDA DECISION (APRIL 2025): CLARIFYING GUIDANCE AND ITS IND AS INTERPRETATION

In April 2025, the IFRS Interpretations Committee published an agenda decision titled “Guarantees Issued on Obligations of Other Entities.” This decision, while not introducing new rules, clarified how existing standards should be applied to guarantee contracts. The authors interpret the essence of this guidance in the Ind AS context below, as the underlying principles apply equally to Ind AS 109, 117, 115, and 37 given their alignment with corresponding IFRSs.

No single standard for all guarantees: The IFRIC emphasized that accounting for a guarantee should not be based on the nature of the issuer i.e., whether the company is an insurer, a bank, or a non-financial entity, but on the terms of the contract and the scope definitions in the standards. There is no definition of ‘guarantee’ in the standards and no one Ind AS applies to every type of guarantee. Instead, one must analyze the guarantee’s features and determine which standard’s scope it falls under. In other words, the substance of the guarantee determines the accounting a principle that guides the step-by-step framework described below.

Step 1: Is it a financial guarantee contract under Ind AS 109?

The first assessment is whether the guarantee meets the definition of a financial guarantee contract as per Ind AS 109 (Financial Instruments). As noted earlier, Ind AS 109 defines a financial guarantee contract (FGC) as an obligation to reimburse the holder for loss due to a debtor’s failure to pay a debt when due. Classic examples that do meet this definition include a parent guaranteeing a bank loan of its subsidiary or a corporate guarantee on a bond, in both cases, there is a specified debtor, a debt instrument (loan/bond), and the guarantor pays only if the debtor fails to pay covering the lender’s loss.

If the guarantee does meet this definition, then Ind AS 109 applies unless the company has a prior insurance accounting election. Under Ind AS 109, such guarantees are treated as financial liabilities. The issuer must recognize a liability at fair value when the guarantee is issued even if no fee is charged). This typically results in an immediate debit to an appropriate account (investment in subsidiary if the guarantee benefits a subsidiary, or to P&L expense if it’s for an unrelated party).

Subsequently, the guarantee liability is typically measured at the higher of (a) the amount initially recognized (less any income recognized if a fee was received) and (b) the loss allowance determined as per expected credit loss (ECL) methodology. In practice, for intra-group financial guarantees given for no fee, the initial fair value of the guarantee is often credited to a liability and debited as an increase in the investment in the subsidiary (in separate financial statements), reflecting a capital contribution. Any difference if a fee is charged would be recognized as income over the guarantee period. Importantly, Ind AS 37 would not apply in this case indeed, Ind AS 37 explicitly scopes out provisions for matters covered by Ind AS 109’s financial instruments. Some entities treated financial guarantees as contingencies, but this is incorrect given the Ind AS 109 requirements (a ‘common misconception’ that Ind AS 37 could be used for financial guarantees has been debunked by the guidance).

One nuance: the term ‘debt instrument’ in the definition has been a point of debate. Does it strictly mean a loan or bond, or could it include other payables like a fixed payment obligation under a contract? The IFRIC noted diversity in interpreting debt instrument, and the IASB plans to further examine this definition. Until clarified, companies must apply reasonable judgment with disclosure in determining whether an obligation is a debt instrument under Ind AS 109. If in doubt and the guarantee primarily covers a payment default risk, it’s safer to lean towards treating it as a financial guarantee contract, given that what is being guaranteed is a credit loss.

Exception of insurance accounting election: Ind AS 109 (similar to IFRS 9) provides an option that if an issuer had previously asserted explicitly that certain guarantees are insurance contracts and accounted for them as such, it can continue to do so (on a per contract election basis). This means if a company historically treated its financial guarantees under Ind AS 104/117, it may elect to continue using Ind AS 117 for those contracts, despite them meeting the financial guarantee definition. This is a narrow exception aimed at insurers or special cases and must have been established in prior practice. The election is irrevocable for each contract once made. Few non-insurer Indian companies are likely to have this history. Going forward, new issuers of financial guarantees will apply Ind AS 109 if the contract meets the FGC definition unless they meet any regulatory criteria for not doing so. Such guarantees also need financial instrument disclosures such as credit risk exposure, and other related disclosures as per Ind AS 107.

Lets discuss it with an example:

On 1 April 20X1, Parent ‘P Ltd.’ signs a guarantee in favour of Bank for a credit limit of ₹1,000 crore sanctioned to its joint venture ‘JV’. The facility works like an overdraft. The JV can draw any amount within the limit over three years and repay as it earns cash from the project. No guarantee commission is charged by P Ltd.

Since the JV has not utilised the entire limit on day one, does P Ltd. still recognise a liability?

Analysis under Ind AS:

A financial guarantee contract exists when P Ltd. becomes obligated, not when the JV draws the money. If the JV does not pay when an instalment becomes due, P Ltd. must reimburse the bank. The guarantee protects the bank against credit loss arising from non-payment of a debt.

This meets the definition of a Financial Guarantee Contract under Ind AS 109, because the guarantee is linked to repayment of a debt.

Accounting by P Ltd. (separate financial statements):

(i) On the date the guarantee is issued, P Ltd. recognises a liability at fair value, even if the loan is undrawn or partially drawn.

(ii)   After initial recognition, the liability is measured at the higher of:

– the unamortised portion of the initial fair value, and

– the expected credit loss (ECL) on the guarantee.

In other words, P Ltd. recognises a present obligation because the guarantee exposes it to the JV’s credit risk from the moment the guarantee is signed and not from when the JV draws the loan.

Step 2: If not a financial guarantee under 109, is it an insurance contract under Ind AS 117?

If the guarantee does not squarely fall under financial guarantee scope under Ind AS 109 (for instance, it does not involve reimbursing a loss on a debt instrument), the next question is whether it meets the definition of an insurance contract per Ind AS 117. Ind AS 117 defines an insurance contract as an arrangement under which one party (issuer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event adversely affects them. ‘Insurance risk’ is essentially any risk other than financial risk (financial risk relates to changes in financial variables like credit risk, market prices, etc.). In the context of guarantees, a pure performance guarantee often entails insurance risk, the uncertain future event could be the failure of the underlying entity to perform some service or deliver a product, which is not a financial variable but an outcome risk. If that failure adversely affects the counterparty (e.g. the customer of the JV or subsidiary), and the guarantor will compensate for that loss, the contract is transferring significant non-financial risk to the guarantor, essentially an insurance arrangement.

Ind AS 117 is applicable to insurance contracts issued regardless of the issuer’s typical business. So even a construction or manufacturing company can issue an ‘insurance contract’ in substance. For example, a parent company’s guarantee to complete a project or pay damages if its JV fails is very much like a performance bond, which economically is an insurance contract (the parent takes on the project completion risk). If such risk is significant and the compensation is linked to an adverse event (project failure), the guarantee meets the insurance contract definition.

If a guarantee qualifies as an insurance contract under Ind AS 117, the issuer has two possibilities:

(a) Mandatory application of Ind AS 117 in general, insurance contracts should be accounted under Ind AS 117, which involves recognition of a liability for remaining coverage and incurred claims, measured using either the general model (fulfilment cash flows plus a contractual service margin) or the simplified premium allocation approach, along with disclosure of risk assumptions, etc. Ind AS 117 is a complex standard and will result in a very different measurement than Ind AS 109. For non-insurers, applying Ind AS 117 could be challenging operationally, but it might better reflect the nature of the obligation (especially if there are many guarantees issued or which extends over multiple periods and the risk is significant).

(b) Elect to apply Ind AS 115 (for service contracts) or Ind AS 109 (for certain credit limits). Ind AS 117 itself provides some scope choices. In particular, if a contract’s primary purpose is the provision of services for a fixed fee (often called the “fixed-fee service contract” scope exception, e.g. certain extended warranty contracts), an entity may choose to account for it under Ind AS 115 instead. Also, as noted earlier, if the contract is essentially a financial guarantee (compensation capped at the amount of the debtor’s obligation), the issuer can choose Ind AS 109 or Ind AS 117. These choices are to be made carefully and consistently for similar contracts, and once made for a portfolio, the choice is irrevocable.

In summary, a guarantee that transfers significant non-financial risk (and is not a financial guarantee of debt) will generally fall under Ind AS 117. The guarantor would account for it much like an insurance company would by recognizing an insurance contract liability, measuring the best estimate of fulfilment cash outflows plus a risk adjustment, and recognizing income as it is released from risk over time (if consideration is received, unearned premium or a similar liability is recognized). If no consideration is received (e.g., a parent gives a free performance guarantee for its JV), under Ind AS 117 the initial recognition would still record a liability for the stand-ready obligation and a corresponding deemed contribution (much as under Ind AS 109 , the entity would record a contribution). The recent guidance essentially reminds companies that not all guarantees are financial instruments, some are insurance contracts in nature and should be accounted for using insurance principles, even by non-insurers. Importantly, this is not an elective treatment as per step 1, this is not a per contract election, and would apply to all contracts of this nature.

Step 3: If neither financial guarantee nor insurance contract, then consider other standards (Ind AS 109, 115, or 37).

If after the above analysis the guarantee doesn’t neatly fit Ind AS 109 or Ind AS 117, then one needs to look at other accounting standards that might capture the substance of the guarantee. In Ind AS context, the remaining possibilities are:

(i) Ind AS 109 (other scopes): Just because a guarantee is not a ‘financial guarantee contract’ by definition, it might still be within Ind AS 109 if it meets another category. For example, loan commitments. Paragraph 2.3 of Ind AS 109 brings some loan commitments (to provide a loan at below-market rates) into its scope. A standby liquidity facility or guarantee to lend money if needed might fall here. In such cases, recognition and measurement principles for financial liabilities of Ind AS 109 would apply.

(ii) Ind AS 115: If the guarantee is issued to a counterparty that is also a customer in a revenue contract, and none of the above standards captures it, Ind AS 115 might come into play. Ind AS 115 excludes financial instruments and insurance contracts from its scope, but if the guarantee doesn’t qualify as those, and it is part of the sales deal, the arrangement could be treated as a performance obligation or a guarantee obligation under the revenue standard. For example, consider a technology vendor that guarantees a certain performance of a product for three years. If that guarantee is beyond a standard warranty (which itself is accounted either as assurance warranty, a cost accrual under Ind AS 37 or service warranty which is a separate performance obligation under Ind AS 115), it may effectively be a separate service that the customer receives (a form of insurance service). Ind AS 115 would then require identifying that performance guarantee as a distinct obligation and allocating some of the transaction price to it (or if free, perhaps recognizing a liability for the obligation to stand ready, akin to an onerous performance obligation). In a parent-subsidiary-customer scenario, like a parent guaranteeing the performance of its subsidiary to the customer, Ind AS 115 could be relevant in the consolidated financial statements of the parent (because from the group’s perspective, the customer contract includes a guarantee feature). In such consolidated accounts, any payout under the guarantee might be treated as a contract cost or a reduction of revenue rather than a separate financial expense. The entities should thus examine if a guarantee given to a customer (directly or implicitly) is actually an element of a revenue arrangement. If so, ensure compliance with Ind AS 115, e.g. recognize a liability for future penalty/compensation obligations as an offset to revenue, if material.

(iii) Ind AS 37: Finally, if none of the above standards governs the guarantee, Ind AS 37 serves as the fallback. Ind AS 37 applies to contingent obligations that are not within the scope of another standard. So, only when a guarantee does not qualify as a financial instrument or insurance contract, the entity account for it under Ind AS 37. In practice, very few guarantees should land here after the above analysis. Under Ind AS 37, if a provision is recognized, it would be measured as the best estimate of the obligation (similar concept to fulfilment cost but without the insurance contract framework of risk adjustment and service margin). If the likelihood of payout is low, it may only be disclosed as a contingent liability. However, entities must be cautious, if a guarantee is a contract that could potentially require payment, usually it does create a present obligation (even if conditional) and if not covered by other standards, Ind AS 37 would demand a provision if the obligation is probable and estimable.

CONCLUSION

The accounting for guarantees on obligations of other entities has evolved from a divergent practice to a more principled approach under Ind AS, made easy by the IFRIC agenda decision of April 2025 which provides clarification. The key is to identify the nature of risk a guarantee covers and apply the appropriate Ind AS, i.e., financial instrument standards for pure credit risk guarantees, insurance standard for performance and other non-financial risk guarantees, revenue standard for customer-related guarantees, and provisions standard only as a last resort. This multi-standard framework may appear complex, but it aligns each type of guarantee with the accounting model that best captures its economics under Ind AS.

In essence, the clarifying guidance (when translated to Ind AS) is that companies must use judgment to determine which Ind AS applies, based on the substance and terms of the guarantee contract, and apply that standard’s recognition and measurement requirements.

BCAJ Admin

Recently the IFRS Interpretations Committee (IFRIC) clarified on a few issues relating to segment disclosures required under Ind AS 108 Operating Segments.

An entity is required to report a measure of total assets and liabilities for each reportable segment, if such amounts are regularly provided to the chief operating decision maker (CODM). Further specific disclosures are required, of certain items, for each reportable segment, if those amounts are included in the measurement of the segment profit or loss, reviewed by the CODM or if those items are regularly provided to the CODM, even if those items were not included in measuring the segment profit or loss.

Paragraph 23 of Ind AS 108 which sets out the above requirement is reproduced below:

An entity shall report a measure of profit or loss for each reportable segment. An entity shall report a measure of total assets and liabilities for each reportable segment if such amounts are regularly provided to the chief operating decision maker. An entity shall also disclose the following about each reportable segment if the specified amounts are included in the measure of segment profit or loss reviewed by the chief operating decision maker, or are otherwise regularly provided to the chief operating decision maker, even if not included in that measure of segment profit or loss:

a) revenues from external customers;

b) revenues from transactions with other operating
segments of the same entity;

c) interest revenue;

d) interest expense;

e) depreciation and amortisation;

f) material items of income and expense disclosed in accordance with paragraph 97 of Ind AS 1, Presentation of Financial Statements;

g) the entity’s interest in the profit or loss of associates and joint ventures accounted for by the equity method;

h) income tax expense or income; and

i) material non-cash items other than depreciation and amortisation.

An entity shall report interest revenue separately from interest expense for each reportable segment unless a majority of the segment’s revenues are from interest and the chief operating decision maker relies primarily on net interest revenue to assess the performance of the segment and make decisions about resources to be allocated to the segment. In that situation, an entity may report that segment’s interest revenue net of its interest expense and disclose that it has done so.

IFRIC reiterated that paragraph 23 of Ind AS 108 requires an entity to disclose the specified amounts for each reportable segment when those amounts are:

• included in the measure of segment profit or loss reviewed by the CODM, even if they are not separately provided to or reviewed by the CODM, or
• regularly provided to the CODM, even if they are not included in the measure of segment profit or loss.

The other clarification provided was with respect to materiality in the context of segment disclosures.

Before we jump to the issue, let us first quote certain important paragraphs under Ind AS 1 Presentation of Financial Statements:

PARAGRAPH 7: MATERIALITY

Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity.

Materiality depends on the nature or magnitude of information, or both. An entity assesses whether information, either individually or in combination with other information, is material in the context of its financial statements taken as a whole.

Information is obscured if it is communicated in a way that would have a similar effect for primary users of financial statements to omitting or misstating that information. The following are examples of circumstances that may result in material information being obscured: (a) information regarding a material item, transaction or other event is disclosed in the financial statements but the language used is vague or unclear; (b) information regarding a material item, transaction or other event is scattered throughout the financial statements; (c) dissimilar items, transactions or other events are inappropriately aggregated;(d) similar items, transactions or other events are inappropriately disaggregated; and (e) the understandability of the financial statements is reduced as a result of material information being hidden by immaterial information to the extent that a primary user is unable to determine what information is material.

Assessing whether information could reasonably be expected to influence decisions made by the primary users of a specific reporting entity’s general purpose financial statements requires an entity to consider the characteristics of those users while also considering the entity’s own circumstances.

PARAGRAPHS 30–31: AGGREGATION

30. Financial statements result from processing large numbers of transactions or other events that are aggregated into classes according to their nature or function. The final stage in the process of aggregation and classification is the presentation of condensed and classified data, which form line items in the financial statements. If a line item is not individually material, it is aggregated with other items either in those statements or in the notes. An item that is not sufficiently material to warrant separate presentation in those statements may warrant separate presentation in the notes.

30A When applying this and other Ind ASs an entity shall decide, taking into consideration all relevant facts and circumstances, how it aggregates information in the financial statements, which include the notes. An entity shall not reduce the understandability of its financial statements by obscuring material information with immaterial information or by aggregating material items that have different natures or functions.

31 Some Ind ASs specify information that is required to be included in the financial statements, which include the notes. An entity need not provide a specific disclosure required by an Ind AS if the information resulting from that disclosure is not material except when required by law. This is the case even if the Ind AS contains a list of specific requirements or describes them as minimum requirements. An entity shall also consider whether to provide additional disclosures when compliance with the specific requirements in Ind AS is insufficient to enable users of financial statements to understand the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance.

PARAGRAPH 97: DISCLOSURE REQUIREMENTS

97 When items of income or expense are material, an entity shall disclose their nature and amount separately.

A question arises as to the meaning of ‘material items of income and expense’ in the context of paragraph 97 of Ind AS 1 as referenced in paragraph 23(f) of Ind AS 108.

MATERIAL ITEMS OF INCOME AND EXPENSE

Paragraph 23(f) of Ind AS 108 sets out one of the required ‘specified amounts’, namely, ‘material items of income and expense disclosed in accordance with paragraph 97 of Ind AS 1’. Paragraph 97 of Ind AS 1 states that ‘when items of income or expense are material, an entity shall disclose their nature and amount separately’.

Definition of ‘Material’

Paragraph 7 of Ind AS 1 defines ‘material’ and states ‘information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial reports make on the basis of those financial statements, which provide financial information about a specific reporting entity’.

Paragraph 7 of Ind AS 1 also states that ‘materiality depends on the nature or magnitude of information, or both. An entity assesses whether information, either individually or in combination with other information, is material in the context of its financial statements taken as a whole’.

Aggregation of information

Paragraphs 30–31 of Ind AS 1 provide requirements about how an entity aggregates information in the financial statements, which include the notes. Paragraph 30A of Ind AS 1 states that ‘an entity shall not reduce the understandability of its financial statements by obscuring material information with immaterial information or by aggregating material items that have different natures or functions’.

Applying paragraph 23(f) of Ind AS 108 – material items of income and expense

IFRIC clarified that, when Ind AS 1 refers to materiality, it is in the context of ‘information’ being material. An entity applies judgement in considering whether disclosing, or not disclosing, information in the financial statements could reasonably be expected to influence decisions users of financial statements make on the basis of those financial statements.

IFRIC clarified, in applying paragraph 23(f) of Ind AS 108 by disclosing, for each reportable segment, material items of income and expense disclosed in accordance with paragraph 97 of Ind AS 1, an entity:

a) applies paragraph 7 of Ind AS 1 and assesses whether information about an item of income and expense is material in the context of its financial statements taken as a whole;

b) applies the requirements in paragraphs 30–31 of Ind AS 1 in considering how to aggregate information in its financial statements

c) considers the nature or magnitude of information—in other words, qualitative or quantitative factors — or both, in assessing whether information about an item of income and expense is material; and

d) considers circumstances including, but not limited to, those in paragraph 98 of Ind AS 1.

Furthermore, paragraph 23(f) of Ind AS 108 does not require an entity to disclose by reportable segment each item of income and expense presented in its statement of profit or loss or disclosed in the notes. In determining information to disclose for each reportable segment, an entity applies judgement and considers the core principle of Ind AS 108 — which requires an entity to disclose information 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.

BCAJ Admin

When a subsidiary merges
with its parent company, the profit element in the inter-company transactions
and the consequential tax effects need to be eliminated from the earliest
comparative period. This article explains why and how this is done.

FACTS

A parent has several
subsidiaries and is listed on Indian exchanges. One of the subsidiaries merges
with the parent. The merger order is passed by the NCLT on 30^th
November, 2020 with the appointed date of 1^st April, 2019. The
appointed date is relevant for tax and regulatory purposes.

Prior to 1^st
April, 2019 the subsidiary had sold inventory to the parent for onward sale by
the parent. The cost of inventory was INR 80 and the subsidiary had sold it to
the parent at INR 100. At 1^st April, 2019 the inventory was lying
with the parent company. The tax rate applicable for the parent and the
subsidiary is 20%.

The parent sells the
inventory to third parties at a profit in May, 2019. In June, 2019, the
subsidiary sells inventory to the parent. The cost of inventory was INR 160 and
the subsidiary had sold it to the parent at INR 200. At 30^th June,
2019 the inventory remains unsold in the books of the parent company.

After the merger, the
subsidiary becomes a division of the parent company and the inventory transfer
between the division and the parent is made at cost.

In preparing the merged
financial statements, whether adjustments are made for the unrealised profits
and the consequential tax effects? If yes, how are these adjustments carried
out?

RESPONSE

Paragraph 2 of Appendix C
of Ind AS 103 Business Combinations of Entities Under Common Control
defines a common control transaction as

‘Common
control business combination means a business combination involving entities or
businesses in which all the combining entities or businesses are ultimately
controlled by the same party or parties both before and after the business
combination, and that control is not transitory.’

Paragraph 8 states as
follows

‘Business
combinations involving entities or businesses under common control shall be
accounted for using the pooling of interests method.’

Paragraph 9 states as
under:

‘The pooling of interest
method is considered to involve the following:

(i)  The assets and liabilities of the combining
entities are reflected at their carrying amounts.

(ii)  No adjustments are made to reflect fair values
or recognise any new assets or liabilities. The only adjustments that are made
are to harmonise accounting policies.

(iii) The financial information in the financial
statements in respect of prior periods should be restated as if the business
combination had occurred from the beginning of the preceding period in the
financial statements, irrespective of the actual date of the combination.
However, if business combination had occurred after that date, the prior period
information shall be restated only from that date.’

The following conclusions
can be drawn:

1. The transaction is a common control transaction
and is accounted for using the pooling of interests method.

2. The financial statements for prior periods are
restated from the earliest comparative period, i.e., from 1^st April,
2019.

3. Adjustments are made to the financial
statements to harmonise accounting policies. Therefore, in the merged accounts
unrealised profits arising from the transaction between the parent and the
merged subsidiary should be eliminated.

4. As this is a listed entity and information
relating to comparative quarters is provided in the financial results, the
adjustments for unrealised profits are made for all comparative and current
year quarters, up to the date the merger takes place.

In the merged accounts, the
following adjustments are made with respect to the unrealised profits:

At 1^st April,
2019, the following adjustment will be required to the merged numbers:

Inventory
credit                                                 20

Deferred
tax asset debit (20% on 20)                  4

Retained
earnings debit                                     16

The adjustment is made to
reflect the fact that when the inventory is sold to external parties, the
merged entity will not be subject to tax again on INR 20.

As the inventory is sold in
the first quarter, the following entry will be passed with respect to tax:

P&L (deferred tax line)
debit                  4

Deferred tax asset credit                       4

At 30^th June,
2019 the following adjustment will be required:

Inventory
credit                                    40

Current
tax asset debit (20% on 40)       8

P&L
debit                                            32

Since the parent will file
a revised return for the previous financial year, the tax paid on INR 40 will
be shown as recoverable from the tax authorities, rather than as a deferred tax
asset.

The above adjustments are carried out
for all the quarterly results from 1^st April 2019 up to the date of
the NCLT order, i.e. 30^th November, 2020.

BCAJ Admin