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Pharmaceutical Industry – An Accountants View
The requisite for biotech and pharmaceutical
companies has been innovation. In this industry
accounting and tax processes are a central part
of managing business. As the industry is purely
research driven, expenses are galore initiating
revenue recognition and business combinations.
Impairment of non financial assets
The study in the form of questions and answers
identifies the floating practical difficulties of the
complex rules within the framework and the
freedom of interpretation provided by IAS 36.
Statement of cash flows – A
discussion overview
As the success of any business depends on a
well managed cash flow predicting the probable
risks and forecasting an approach on the impact
of the changing business factors. The ED has
brought about limited changes to the current
standard though it’s a step towards convergence
to IFRS.
Regulatory Updates
The section covers the Amendment to equity
listing agreement of SEBI, a synopsis of RBI
Guidelines, a clear path for corporate governance
and NBFC and finally the EAC opinions.
It is with great pleasure we bring forth the July edition of the Accounting and Auditing update.
Pharmaceutical industry, which is often referred to as the hot bed of innovation, introduces unique
financial reporting challenges. The accounting dilemmas include: (1) upfront revenue recognition
versus deferral of revenues over the performance period; (2) aggregation versus separation of the
individual elements within a multiple element arrangement; (3) charging off versus capitalisation of
research and development costs; (4) assessment of triggers for recognition of impairments, etc.
We have attempted to provide our perspective on these financial reporting challenges in this
publication.
In this turbulent global economic environment, the carrying values of long lived assets are
constantly challenged by their recoverable amounts. Assessment of impairment also gets
influenced by the Generally Accepted Accounting Principles (GAAP) framework a company
operates under. A classical difference between US GAAP and International Financial Reporting
Standards (IFRS) is that, under US GAAP, impairment on a “held for use basis” is required to be
recognised only in situations where the undiscounted cash flows derived from the asset falls short
of the carrying amount, while, under IFRS, there is no such concept of undiscounted cash flow
comparison. We have attempted to highlight our perspective on the specific implementation
challenges in a Question & Answer format.
Cash flows from operations are synonymous to “net income” and material misclassification of cash
flows between operating, financing and investing categories could even result in a financial
statement restatement. The Institute of Chartered Accountants of India has issued an Exposure
Draft on the presentation of cash flow statements in line with the corresponding IFRS standard.
We have summarised the key provisions of that Exposure Draft and also discussed certain cash
flow specific implementation issues.
There seems to be all round efforts by various regulators in bringing forth improvements in financial
statement presentation and corporate governance. To name a few: (1) financial statements
prepared under IFRS as issued by the International Accounting Standards Board (IASB) is being
accepted by Securities and Exchange Board of India (SEBI) under certain specific circumstances; (2)
the Reserve Bank of India (RBI) has enhanced disclosure requirements in the accounting standards
for Non Banking Finance Companies (NBFCs) and Banks; (3) the RBI has issued specific corporate
governance norms such as partner rotation, constitution of audit committees for NBFCs meeting
certain specified criteria.
We hope you enjoy reading these articles. We look forward to receiving your valuable feedback on
what you would like us to cover in our future publications at aaupdate@in.kpmg.com
contentseditorial
1
10
19
24
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Pharmaceutical Industry – An Accountants View
The requisite for biotech and pharmaceutical
companies has been innovation. In this industry
accounting and tax processes are a central part
of managing business. As the industry is purely
research driven, expenses are galore initiating
revenue recognition and business combinations.
Impairment of non financial assets
The study in the form of questions and answers
identifies the floating practical difficulties of the
complex rules within the framework and the
freedom of interpretation provided by IAS 36.
Statement of cash flows – A
discussion overview
As the success of any business depends on a
well managed cash flow predicting the probable
risks and forecasting an approach on the impact
of the changing business factors. The ED has
brought about limited changes to the current
standard though it’s a step towards convergence
to IFRS.
Regulatory Updates
The section covers the Amendment to equity
listing agreement of SEBI, a synopsis of RBI
Guidelines, a clear path for corporate governance
and NBFC and finally the EAC opinions.
It is with great pleasure we bring forth the July edition of the Accounting and Auditing update.
Pharmaceutical industry, which is often referred to as the hot bed of innovation, introduces unique
financial reporting challenges. The accounting dilemmas include: (1) upfront revenue recognition
versus deferral of revenues over the performance period; (2) aggregation versus separation of the
individual elements within a multiple element arrangement; (3) charging off versus capitalisation of
research and development costs; (4) assessment of triggers for recognition of impairments, etc.
We have attempted to provide our perspective on these financial reporting challenges in this
publication.
In this turbulent global economic environment, the carrying values of long lived assets are
constantly challenged by their recoverable amounts. Assessment of impairment also gets
influenced by the Generally Accepted Accounting Principles (GAAP) framework a company
operates under. A classical difference between US GAAP and International Financial Reporting
Standards (IFRS) is that, under US GAAP, impairment on a “held for use basis” is required to be
recognised only in situations where the undiscounted cash flows derived from the asset falls short
of the carrying amount, while, under IFRS, there is no such concept of undiscounted cash flow
comparison. We have attempted to highlight our perspective on the specific implementation
challenges in a Question & Answer format.
Cash flows from operations are synonymous to “net income” and material misclassification of cash
flows between operating, financing and investing categories could even result in a financial
statement restatement. The Institute of Chartered Accountants of India has issued an Exposure
Draft on the presentation of cash flow statements in line with the corresponding IFRS standard.
We have summarised the key provisions of that Exposure Draft and also discussed certain cash
flow specific implementation issues.
There seems to be all round efforts by various regulators in bringing forth improvements in financial
statement presentation and corporate governance. To name a few: (1) financial statements
prepared under IFRS as issued by the International Accounting Standards Board (IASB) is being
accepted by Securities and Exchange Board of India (SEBI) under certain specific circumstances; (2)
the Reserve Bank of India (RBI) has enhanced disclosure requirements in the accounting standards
for Non Banking Finance Companies (NBFCs) and Banks; (3) the RBI has issued specific corporate
governance norms such as partner rotation, constitution of audit committees for NBFCs meeting
certain specified criteria.
We hope you enjoy reading these articles. We look forward to receiving your valuable feedback on
what you would like us to cover in our future publications at aaupdate@in.kpmg.com
contentseditorial
1
10
19
24
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Biotech and pharmaceutical companies their business. The Pharmaceutical industry
have been hotbeds for innovation for the is charecterised by significant research and
past few decades. The pharmaceutical development spends, heavy regulations
industry has four major processes in its surrounding research, clinical trials, drug
value chain — discovery, development, manufacture and sales and marketing
manufacturing, and marketing and sales. practices and pricing.
Each of these processes is vital for the
success of a pharmaceutical company. In
some cases, a large, vertically-integrated
pharmaceutical firm carries out a lot of
these functions. Sometimes, however,
certain activities are contracted or
outsourced to other firms. The trend of
outsourcing has grown over the past
decade. Outsourcing of drug development
to contract research organisations (CROs),
or manufacturing to contract manufacturing
organisations (CMOs), is common and has
led to the development of a new industry
known as contract research and
manufacturing services (CRAMS). The
pharmaceutical industry environment is
complex, and requires pharmaceutical
companies to balance various aspects of
ABOUT THE PHARMACEUTICAL
INDUSTRY
In normal times and for most industries, Canada, China, India, Israel, Japan and
accounting, issues tend to hum along in South Korea having plans to adopt IFRS or
the background—a necessary but relatively converge national GAAP with IFRS by 2011.
quiet part of business management. But One notable exception to this list is the US,
for the pharma industry, and in these times where until recently, US Generally
of financial systems turmoil, accounting Accepted Accounting Principles (US GAAP)
and tax processes are a central part of appeared set to continue as the required
managing businesses. Rarely does a day framework for all US public companies.
go by without a regulatory agency Within the pharmaceutical industry, the
commencing dispute proceedings against major global players are predominantly
pharma companies, thereby triggering based either in the Western Europe or in
significant judgmental estimates which the US. Since the adoption of IFRS in
impact financial reporting.Europe, two distinct comparable groups
Following a 2002 mandate by the EU, have been established within the industry:
International Financial Reporting Standards European pharma companies , with
(IFRS) (as endorsed by the EU) became the financial statements prepared under IFRS,
common financial reporting language for and US pharmaceutical companies with 1 financial statements prepared under the European-listed companies from 2005 .
US GAAP. The table on the following page This represented the first major step
shows the current accounting basis of a towards the establishment of a single set
number of the global pharmaceutical of high quality, globally accepted
companies. The recent developments in accounting standards. Over 100 countries
the US indicate that in the future direct worldwide now either require or permit the
comparability between companies use of IFRS (or a national variant, based on 1 throughout the world on one accounting IFRS) for listed companies . Other
platform is a realistic proposition.countries are following suit with Brazil,
FINANCIAL REPORTING IN
THE PHARMACEUTICAL INDUSTRY
Pharmaceutical Industry – AN ACCOUNTANT’S VIEW
“Pharmaceutical industry is heavily
regulated and highly research intensive”
“Regulatory
proceedings against
pharmaceutical
companies are
frequent, and
therefore,
accountants would
need to exercise
dexterity and
diligence in
evaluating
contingencies”
1. www.ec.europa.eu/internal_market/accounting/news/index_en.htm
1 2
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Biotech and pharmaceutical companies their business. The Pharmaceutical industry
have been hotbeds for innovation for the is charecterised by significant research and
past few decades. The pharmaceutical development spends, heavy regulations
industry has four major processes in its surrounding research, clinical trials, drug
value chain — discovery, development, manufacture and sales and marketing
manufacturing, and marketing and sales. practices and pricing.
Each of these processes is vital for the
success of a pharmaceutical company. In
some cases, a large, vertically-integrated
pharmaceutical firm carries out a lot of
these functions. Sometimes, however,
certain activities are contracted or
outsourced to other firms. The trend of
outsourcing has grown over the past
decade. Outsourcing of drug development
to contract research organisations (CROs),
or manufacturing to contract manufacturing
organisations (CMOs), is common and has
led to the development of a new industry
known as contract research and
manufacturing services (CRAMS). The
pharmaceutical industry environment is
complex, and requires pharmaceutical
companies to balance various aspects of
ABOUT THE PHARMACEUTICAL
INDUSTRY
In normal times and for most industries, Canada, China, India, Israel, Japan and
accounting, issues tend to hum along in South Korea having plans to adopt IFRS or
the background—a necessary but relatively converge national GAAP with IFRS by 2011.
quiet part of business management. But One notable exception to this list is the US,
for the pharma industry, and in these times where until recently, US Generally
of financial systems turmoil, accounting Accepted Accounting Principles (US GAAP)
and tax processes are a central part of appeared set to continue as the required
managing businesses. Rarely does a day framework for all US public companies.
go by without a regulatory agency Within the pharmaceutical industry, the
commencing dispute proceedings against major global players are predominantly
pharma companies, thereby triggering based either in the Western Europe or in
significant judgmental estimates which the US. Since the adoption of IFRS in
impact financial reporting.Europe, two distinct comparable groups
Following a 2002 mandate by the EU, have been established within the industry:
International Financial Reporting Standards European pharma companies , with
(IFRS) (as endorsed by the EU) became the financial statements prepared under IFRS,
common financial reporting language for and US pharmaceutical companies with 1 financial statements prepared under the European-listed companies from 2005 .
US GAAP. The table on the following page This represented the first major step
shows the current accounting basis of a towards the establishment of a single set
number of the global pharmaceutical of high quality, globally accepted
companies. The recent developments in accounting standards. Over 100 countries
the US indicate that in the future direct worldwide now either require or permit the
comparability between companies use of IFRS (or a national variant, based on 1 throughout the world on one accounting IFRS) for listed companies . Other
platform is a realistic proposition.countries are following suit with Brazil,
FINANCIAL REPORTING IN
THE PHARMACEUTICAL INDUSTRY
Pharmaceutical Industry – AN ACCOUNTANT’S VIEW
“Pharmaceutical industry is heavily
regulated and highly research intensive”
“Regulatory
proceedings against
pharmaceutical
companies are
frequent, and
therefore,
accountants would
need to exercise
dexterity and
diligence in
evaluating
contingencies”
1. www.ec.europa.eu/internal_market/accounting/news/index_en.htm
1 2
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Some of the key challenges relate to: element where (1) the delivered element
has a stand-alone value to the customer; In the
and (2) the fair value of the deliverable can case of multiple element arrangements it
be measured reliably. This guidance is may be necessary to evaluate whether a
largely consistent with the guidance under multiple element arrangement can be
US GAAP which necessitates standalone segmented into components, with different
value of the delivered element and the revenue allocations for each of the
ability to demonstrate the fair value of the component. Often the challenges relate to
undelivered elements in a multiple element situations where one element of the
arrangement as pre-conditions, to upfront arrangement has been delivered while the
revenue recognition of the delivered other elements are still undelivered. The
element.accounting question is usually whether it is
possible to recognise the revenue for the
delivered elements after deferring the fair
values of the undelivered elements. Or
should the entire arrangement be treated
as a single element and revenue
recognition take place on a systematic
method?
Under Indian GAAP, specific guidance in
this regard is not available, and as a result,
diversity in practice is observed. Generally,
the revenue recognition follows themes
such as the terms of the contract, passage
of risks/rewards and probability of collection
at the point of revenue recognition. Under
IFRS, if more than one separately
identifiable service is identified, paragraph
13 of IAS 18, Revenue requires the fair
value of the total consideration for the
agreement to be allocated to each service
and the recognition criteria of IAS 18 are
then applied to each service. In a contract
where there are both delivered and
undelivered elements, IFRIC 18 Transfers of
Assets from Customers permits upfront
revenue recognition for the delivered
Multiple element arrangements -
When US based pharmaceutical companies make comparisons of financial results with
eventually move to the IFRS regime, they those of their foreign counterparts easier,
can have the benefit of the implementation ease the access to foreign capital markets,
experience of major European-based and eventually reduce the compliance
pharmaceutical firms that are already costs.
reporting under IFRS since 2005. While As noted above there are many things to
some believe that the lack of detailed consider with respect to IFRS beyond a
guidance in IFRS is a shortcoming, others new accounting basis. In this document,
say that the US GAAP’s complex detail has we have sought to analyse the specific
resulted in arrangements structured to accounting application issues that surround
comply with accounting rules. Since a transactions generally entered into by a
number of multinationals then be under a pharmaceutical company, affecting revenue
single set of global accounting policies, the recognition and developmental activities.
move by the US-based pharmaceutical
companies to IFRS, as and when SEC
decides to permit IFRS adoption, should
Company Accounting Basis Company Accounting Basis
Actelion US GAAP Genetech, Inc. US GAAP
Amgen US GAAP GlaxoSmithKline IFRS
AstraZeneca IFRS Roche IFRS
Allergan US GAAP Johnson & Johnson US GAAP
Bristol Myers Squibb US GAAP Merck & Co., Inc. US GAAP
Celgene US GAAP Novartis IFRS
Elan Corp. IFRS Pfizer US GAAP
Eli Lilly US GAAP Sanofi-Aventis IFRS
Current accounting basis of a sample of global pharmaceutical companies
Source: OneSource Information Services Inc.
REVENUE RECOGNITION
Revenue recognition as always will
continue to be a point of contention
especially in the pharmaceutical industry,
both within company management as
well as between company management
and their auditors. Because of the variety
and complexity of business transactions,
revenue recognition is always among the
most important accounting policies, and
when coupled with the latest trend of
novel and incentivised structure of
arrangements, recognition of revenue
remains challenging and the level of
complexity associated /or the lack of
transaction specific guidance with certain
accounting rules may be overwhelming
sometimes.
Multiple-element arrangements are
commonplace in the pharmaceutical
industry with varying licensing
agreements, where companies will
license compounds or products, provide
for clinical support agreements, and
provide for a royalty stream once
approved for commercialisation. Such
arrangements give rise to unique revenue
recognition issues that companies must
address in order to properly recognise of
revenue. In the pharmaceutical industry,
once delivery of goods has occurred or
when a price is fixed and determinable,
it's not so black and white for revenue to
be recognised. Accounting rules continue
to evolve, but the challenges for
pharmaceuticals companies remain.
“It is clear that global convergence of
accounting standards will enable a
comparison between the financial statements
of the US multinationals with those of the
rest of the world”
“Often the challenge
in multiple element
arrangements is
whether it is
possible to and in
what manner to
separate the
delivered elements
from the undelivered
elements”
3 4
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Some of the key challenges relate to: element where (1) the delivered element
has a stand-alone value to the customer; In the
and (2) the fair value of the deliverable can case of multiple element arrangements it
be measured reliably. This guidance is may be necessary to evaluate whether a
largely consistent with the guidance under multiple element arrangement can be
US GAAP which necessitates standalone segmented into components, with different
value of the delivered element and the revenue allocations for each of the
ability to demonstrate the fair value of the component. Often the challenges relate to
undelivered elements in a multiple element situations where one element of the
arrangement as pre-conditions, to upfront arrangement has been delivered while the
revenue recognition of the delivered other elements are still undelivered. The
element.accounting question is usually whether it is
possible to recognise the revenue for the
delivered elements after deferring the fair
values of the undelivered elements. Or
should the entire arrangement be treated
as a single element and revenue
recognition take place on a systematic
method?
Under Indian GAAP, specific guidance in
this regard is not available, and as a result,
diversity in practice is observed. Generally,
the revenue recognition follows themes
such as the terms of the contract, passage
of risks/rewards and probability of collection
at the point of revenue recognition. Under
IFRS, if more than one separately
identifiable service is identified, paragraph
13 of IAS 18, Revenue requires the fair
value of the total consideration for the
agreement to be allocated to each service
and the recognition criteria of IAS 18 are
then applied to each service. In a contract
where there are both delivered and
undelivered elements, IFRIC 18 Transfers of
Assets from Customers permits upfront
revenue recognition for the delivered
Multiple element arrangements -
When US based pharmaceutical companies make comparisons of financial results with
eventually move to the IFRS regime, they those of their foreign counterparts easier,
can have the benefit of the implementation ease the access to foreign capital markets,
experience of major European-based and eventually reduce the compliance
pharmaceutical firms that are already costs.
reporting under IFRS since 2005. While As noted above there are many things to
some believe that the lack of detailed consider with respect to IFRS beyond a
guidance in IFRS is a shortcoming, others new accounting basis. In this document,
say that the US GAAP’s complex detail has we have sought to analyse the specific
resulted in arrangements structured to accounting application issues that surround
comply with accounting rules. Since a transactions generally entered into by a
number of multinationals then be under a pharmaceutical company, affecting revenue
single set of global accounting policies, the recognition and developmental activities.
move by the US-based pharmaceutical
companies to IFRS, as and when SEC
decides to permit IFRS adoption, should
Company Accounting Basis Company Accounting Basis
Actelion US GAAP Genetech, Inc. US GAAP
Amgen US GAAP GlaxoSmithKline IFRS
AstraZeneca IFRS Roche IFRS
Allergan US GAAP Johnson & Johnson US GAAP
Bristol Myers Squibb US GAAP Merck & Co., Inc. US GAAP
Celgene US GAAP Novartis IFRS
Elan Corp. IFRS Pfizer US GAAP
Eli Lilly US GAAP Sanofi-Aventis IFRS
Current accounting basis of a sample of global pharmaceutical companies
Source: OneSource Information Services Inc.
REVENUE RECOGNITION
Revenue recognition as always will
continue to be a point of contention
especially in the pharmaceutical industry,
both within company management as
well as between company management
and their auditors. Because of the variety
and complexity of business transactions,
revenue recognition is always among the
most important accounting policies, and
when coupled with the latest trend of
novel and incentivised structure of
arrangements, recognition of revenue
remains challenging and the level of
complexity associated /or the lack of
transaction specific guidance with certain
accounting rules may be overwhelming
sometimes.
Multiple-element arrangements are
commonplace in the pharmaceutical
industry with varying licensing
agreements, where companies will
license compounds or products, provide
for clinical support agreements, and
provide for a royalty stream once
approved for commercialisation. Such
arrangements give rise to unique revenue
recognition issues that companies must
address in order to properly recognise of
revenue. In the pharmaceutical industry,
once delivery of goods has occurred or
when a price is fixed and determinable,
it's not so black and white for revenue to
be recognised. Accounting rules continue
to evolve, but the challenges for
pharmaceuticals companies remain.
“It is clear that global convergence of
accounting standards will enable a
comparison between the financial statements
of the US multinationals with those of the
rest of the world”
“Often the challenge
in multiple element
arrangements is
whether it is
possible to and in
what manner to
separate the
delivered elements
from the undelivered
elements”
3 4
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Likely changes arising from the Exposure draft on revenue recognition
Under the proposed model outlined in the recent exposure draft on revenue
recognition, unlike the existing provisions of EITF 00-21, Revenue Arrangements with
Multiple Deliverables, an entity will no longer be required to defer all revenue under a
multiple-element arrangement due to a lack of fair value on undelivered items. It is
presumed the entity will be able to estimate the selling price. An entity would need to
use the relative selling price method when allocating consideration to each of the
performance obligations and the currently permissible residual method will not be
acceptable.
Company A licenses, manufactures, and found non-competitive. In such situations, have any standalone value in the hands of
sells pharmaceutical products. Company company B can source from alternative the customer as (1) re-sale, sub-license or
B agrees to pay a non-refundable up-front vendors after obtaining regulatory transfer of the rights is not possible; and
fee to company A for providing access to approvals which by no means can be (2) the move to alternative vendors would
proprietary product information required categorised as perfunctory. Company B not be an automatic process, would
by the regulatory agencies in certain only has access to proprietary involve time and need the regulatory
specified territories. Concurrently, information, but cannot sell, sublease or approval. Accordingly, the upfront
company B also enters into an agreement transfer the rights to proprietary product consideration does not represent a
to purchase products for a four year to any third party. The key accounting separable service and would be required
period at certain prices which provide question is whether or not it is possible to to be deferred and systematically
certain assured recoveries of costs and recognise the non-refundable recognised over the period of company A’s
reasonable margins. The supply consideration for provision of access to supply commitment.
agreement can be terminated only for proprietary products upfront. Provision of
quality issues or where the supplier is access to proprietary products does not
Multiple element arrangement,
an example:
Milestone payments, an example:Milestone payments - Contracts in which
milestone payments are received in return
for performing a service should be
accounted using the percentage of
completion method. Where fees are payable
only after a clinical trial, generally there is a
presumption that the outcome of the trial
cannot be estimated with certainty and
therefore it would be possible to assert that
“collectibility is probable” only once the
milestone event has occurred. Therefore, no
revenue in respect of these milestones
would be recognised until they are
successfully completed and costs would be
expensed as incurred.
Company X has developed a molecule for The upfront payment received should be
the treatment of a specific disease and is in recognised over the term of the
the process of conducting clinical trials. arrangement primarily due to the fact that
Company X has signed a licensing and there is a fair level of continuing
marketing agreement with Company Y, a involvement. Milestone payments, being
large pharmaceutical company, to fund the substantive events, would be recognised
product development and subsequent only when the milestones are met. At the
phases of clinical trials. Company Y has also outset of the agreement, Company X is
acquired a license to sell, market and only guaranteed to receive $3 million of the
distribute the product in a particular total cost of the trial of $5 million. Currently,
geography. The commercial terms in this there exists diversity in practice under
arrangement would involve company Y Indian GAAP for a transaction of the above
paying company X (1) an up-front non- nature.
refundable fee of USD 3 mn, and (2) a
milestone payment of USD 5 mn upon
receipt of approval from the regulators.
Milestone payments coupled with
royalty streams -
Incentives to customers/dealers -
payments will be recognised in customer incentives include cash
Where milestone accordance with the achievement of incentives, delivery of goods and services
payments are coupled with royalty milestones. However, where the royalty without charge, and gifts in the form of
streams, it would be important to payments are subsidised, the allocation products or services from an unrelated
evaluate the arrangement as a multiple of the entire consideration would be entity. Consistent with US GAAP, under
element arrangement and then assess required to be recomputed and re- IFRS, sales incentives offered to
whether it is possible to separate the allocated between the milestone customers including incentives given for
milestone payments from the royalty payments and the royalty streams based early payments are reduced from
streams. If it is possible to assert that on fair values. revenue. However, under Indian GAAP,
milestones have standalone value and early payments are not reduced from
also possible to establish that the revenue. This impacts the revenue Pharmaceutical companies may introduce
milestones and the royalty streams are recognised by companies, who currently incentives for their dealerships for the
set at fair values, royalty streams will be consider cash discount and other sales purchase of products. The incentives and
recognisable on an accrual basis as and incentives as a separate expenditure in the arrangements provided by different
when the underlying sales take place and the income statement.companies vary significantly. Examples of
collection is probable. The milestone
RESEARCH is an original and planned
investigation undertaken with the prospect of
gaining new knowledge and understanding.
DEVELOPMENT is an application of research findings or other knowledge to a plan
or design for the production of new or substantially improved materials, products, processes
etc., before the start of commercial production or use.
RESEARCH AND DEVELOPMENT EXPENSES
Internal research and development
(R&D) costs -
Under IFRS, costs incurred during a
The pharmaceutical sector 'research phase' should be recognised as
is one of the most research-driven an expense through profit and loss
industries. Pharmaceutical companies account, whereas costs incurred during
need to generate new discoveries to be the 'development phase' can be
able to sustain their product pipeline and capitalised as an intangible asset, so long
secure future revenues. As research and as the entity can demonstrate technical
development activities require a skilled feasibility of completing the intangible
workforce, state-of-the-art laboratories as asset, the ability to sell and use it, the
well as need to comply with many future economic benefits arising out of
regulations, R&D costs are one of the the asset under the development,
most significant items in the income intention and availability of adequate
statements of the pharmaceutical technical and financial resources to
companies. R&D costs are among the complete the intangible asset under
largest expenditures incurred by development and measure; the
companies in the pharmaceutical industry expenditure incurred on the development
and are incurred at various stage of a on the asset.
product development cycle.
“Non-refundable upfront payments received for future performance
or for continuing involvement is not recognised immediately and
instead deferred and recognised progressively as the performance
milestones are achieved”
“In multiple element arrangements, it is important to look beyond
the contractual provisions to assess whether there is cross
subsidisation of the pricing for the delivered elements and those of
the undelivered elements. If pricing is not set at fair values, the
consideration should be allocated based on fair values”
“Capitalisation is
permissible only for
development costs
which have reached
the stage of technical
feasibility”
5 6
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Likely changes arising from the Exposure draft on revenue recognition
Under the proposed model outlined in the recent exposure draft on revenue
recognition, unlike the existing provisions of EITF 00-21, Revenue Arrangements with
Multiple Deliverables, an entity will no longer be required to defer all revenue under a
multiple-element arrangement due to a lack of fair value on undelivered items. It is
presumed the entity will be able to estimate the selling price. An entity would need to
use the relative selling price method when allocating consideration to each of the
performance obligations and the currently permissible residual method will not be
acceptable.
Company A licenses, manufactures, and found non-competitive. In such situations, have any standalone value in the hands of
sells pharmaceutical products. Company company B can source from alternative the customer as (1) re-sale, sub-license or
B agrees to pay a non-refundable up-front vendors after obtaining regulatory transfer of the rights is not possible; and
fee to company A for providing access to approvals which by no means can be (2) the move to alternative vendors would
proprietary product information required categorised as perfunctory. Company B not be an automatic process, would
by the regulatory agencies in certain only has access to proprietary involve time and need the regulatory
specified territories. Concurrently, information, but cannot sell, sublease or approval. Accordingly, the upfront
company B also enters into an agreement transfer the rights to proprietary product consideration does not represent a
to purchase products for a four year to any third party. The key accounting separable service and would be required
period at certain prices which provide question is whether or not it is possible to to be deferred and systematically
certain assured recoveries of costs and recognise the non-refundable recognised over the period of company A’s
reasonable margins. The supply consideration for provision of access to supply commitment.
agreement can be terminated only for proprietary products upfront. Provision of
quality issues or where the supplier is access to proprietary products does not
Multiple element arrangement,
an example:
Milestone payments, an example:Milestone payments - Contracts in which
milestone payments are received in return
for performing a service should be
accounted using the percentage of
completion method. Where fees are payable
only after a clinical trial, generally there is a
presumption that the outcome of the trial
cannot be estimated with certainty and
therefore it would be possible to assert that
“collectibility is probable” only once the
milestone event has occurred. Therefore, no
revenue in respect of these milestones
would be recognised until they are
successfully completed and costs would be
expensed as incurred.
Company X has developed a molecule for The upfront payment received should be
the treatment of a specific disease and is in recognised over the term of the
the process of conducting clinical trials. arrangement primarily due to the fact that
Company X has signed a licensing and there is a fair level of continuing
marketing agreement with Company Y, a involvement. Milestone payments, being
large pharmaceutical company, to fund the substantive events, would be recognised
product development and subsequent only when the milestones are met. At the
phases of clinical trials. Company Y has also outset of the agreement, Company X is
acquired a license to sell, market and only guaranteed to receive $3 million of the
distribute the product in a particular total cost of the trial of $5 million. Currently,
geography. The commercial terms in this there exists diversity in practice under
arrangement would involve company Y Indian GAAP for a transaction of the above
paying company X (1) an up-front non- nature.
refundable fee of USD 3 mn, and (2) a
milestone payment of USD 5 mn upon
receipt of approval from the regulators.
Milestone payments coupled with
royalty streams -
Incentives to customers/dealers -
payments will be recognised in customer incentives include cash
Where milestone accordance with the achievement of incentives, delivery of goods and services
payments are coupled with royalty milestones. However, where the royalty without charge, and gifts in the form of
streams, it would be important to payments are subsidised, the allocation products or services from an unrelated
evaluate the arrangement as a multiple of the entire consideration would be entity. Consistent with US GAAP, under
element arrangement and then assess required to be recomputed and re- IFRS, sales incentives offered to
whether it is possible to separate the allocated between the milestone customers including incentives given for
milestone payments from the royalty payments and the royalty streams based early payments are reduced from
streams. If it is possible to assert that on fair values. revenue. However, under Indian GAAP,
milestones have standalone value and early payments are not reduced from
also possible to establish that the revenue. This impacts the revenue Pharmaceutical companies may introduce
milestones and the royalty streams are recognised by companies, who currently incentives for their dealerships for the
set at fair values, royalty streams will be consider cash discount and other sales purchase of products. The incentives and
recognisable on an accrual basis as and incentives as a separate expenditure in the arrangements provided by different
when the underlying sales take place and the income statement.companies vary significantly. Examples of
collection is probable. The milestone
RESEARCH is an original and planned
investigation undertaken with the prospect of
gaining new knowledge and understanding.
DEVELOPMENT is an application of research findings or other knowledge to a plan
or design for the production of new or substantially improved materials, products, processes
etc., before the start of commercial production or use.
RESEARCH AND DEVELOPMENT EXPENSES
Internal research and development
(R&D) costs -
Under IFRS, costs incurred during a
The pharmaceutical sector 'research phase' should be recognised as
is one of the most research-driven an expense through profit and loss
industries. Pharmaceutical companies account, whereas costs incurred during
need to generate new discoveries to be the 'development phase' can be
able to sustain their product pipeline and capitalised as an intangible asset, so long
secure future revenues. As research and as the entity can demonstrate technical
development activities require a skilled feasibility of completing the intangible
workforce, state-of-the-art laboratories as asset, the ability to sell and use it, the
well as need to comply with many future economic benefits arising out of
regulations, R&D costs are one of the the asset under the development,
most significant items in the income intention and availability of adequate
statements of the pharmaceutical technical and financial resources to
companies. R&D costs are among the complete the intangible asset under
largest expenditures incurred by development and measure; the
companies in the pharmaceutical industry expenditure incurred on the development
and are incurred at various stage of a on the asset.
product development cycle.
“Non-refundable upfront payments received for future performance
or for continuing involvement is not recognised immediately and
instead deferred and recognised progressively as the performance
milestones are achieved”
“In multiple element arrangements, it is important to look beyond
the contractual provisions to assess whether there is cross
subsidisation of the pricing for the delivered elements and those of
the undelivered elements. If pricing is not set at fair values, the
consideration should be allocated based on fair values”
“Capitalisation is
permissible only for
development costs
which have reached
the stage of technical
feasibility”
5 6
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
The major challenge faced by the Costs of trial batches for available for use (date of receipt of
pharmaceutical industry is to demonstrate drugs under development which have no regulatory and marketing approval) over the
the technical and commercial feasibility of alternative future use and where the estimated useful life. In a way, paragraph
the drug under development and from technical feasibility is not established 25 of IAS 38 attempts to draw some
what point can a company commence should be reflected as development distinction between cost of in-licensed
capitalisation of the costs incurred on the expenses in the income statement. know-how vis-à-vis the cost of self
development. There is no definitive starting However, trial batches are necessary to developed know-how. In the former, the
point for capitalisation. Management obtain regulatory approval to validate the probability of economic benefits flowing in
should use their judgment, based on the use of machinery (unrelated to the approval is assumed while in the latter it is required
facts and circumstances of each for new drugs), the related costs (other to be demonstrated after careful
development project to evaluation the point than abnormal costs) should be capitalised consideration of facts and circumstances.
where the technical feasibility of the project together with the cost of machinery as
can be established and demonstrate the those that are related to bringing the Pharmaceutical companies pay CROs an
criteria’s set down under IAS 38, Intangible machinery to its working condition.upfront consideration to perform research
Assets been met. and have full rights of access to the
When an entity files its submission to the Pharmaceutical companies research findings for a finite period of time.
regulatory authority for final approval, a frequently in-license (i.e., obtain the right to In such situations, the upfront payment
strong indication exists that an entity has use) know-how to manufacture specific should be deferred as a pre-payment and
met all the criteria for capitalisation of the drugs. These arrangements usually involve should be recognised in the income
development costs. Securing regulatory the payment of an up-front non-refundable statement over the life of the research, in
approval is generally viewed by the consideration. Frequently, it is not possible accordance with the underlying assumption
pharmaceutical entities all over the world to conclude whether or not regulatory of accrual basis of accounting. If the
as the best evidence (e.g., receipt of US approvals will be received for the drugs research terminates early, the remainder of
FDA approval) that all the criteria for under development. Paragraph 25 of IAS 38 the pre-payment should be written off as
capitalisation have been met. Apart from suggests that the price of an entity pays to research and development costs in the
very few companies that capitalise acquire an intangible asset, reflects the income statement.
development costs based on the “probable expectations about the probability that the
future economic benefits criteria” prior to expected future economic benefits from Innovators frequently have issues where
the receipt of regulatory approvals, an the asset will flow to the entity. The effect generic companies copy their drugs and
overwhelming number of pharmaceutical of probability is, therefore, reflected in the threaten their patents. Costs incurred by
multinationals do not capitalise their cost of the asset. The probability innovators to defend their patents are in
development costs incurred prior to the recognition criterion is always considered the nature of maintenance expenses, do
receipt of regulatory approval. to be satisfied for separately acquired not increase the expected future economic
intangible assets. Accordingly, the benefits, and accordingly, do not qualify for
purchased know-how is capitalised and capitalisation.
amortised from the date the know-how is
Trial run costs -
Upfront payments to conduct research -
Upfront payments to in-license know-
how -
Costs incurred to defend patents -
LEGAL CONTINGENCIES
Contingent liabilities are recognised with it infringement contingencies require a
is more likely than not that an obligation careful evaluation, review of facts and
exists. If a range of loss exists and no one consultation with both external and internal
amount is more likely than under IFRS, an legal counsel. Some of the law-suits could
entity would accrue a liability at the best threaten the very existence of the company
estimate after considering all possible and therefore, could also have a going
outcomes weighted based on their concern implication.
probabilities. IFRS also requires disclosing a
roll forward of the loss accrual balance. For
losses that are not more likely than not of
occurring, but a loss is greater than remote,
disclosure is required under IFRS. In
pharmaceutical industries, the assessment
of whether an accrual is required to be
established with respect to patent
INVENTORIES
LIFO method of inventory valuation is of a similar nature throughout the entity. Any
prohibited under IFRS. This further impacts inventory write-downs are required to be
the tax accounting basis, since tax requires reversed in subsequent periods if the value
use of the cost basis used under an entity’s recovers. Further, pharmaceutical companies
generally accepted accounting principles. If need to establish policies for inventory
the IRS does not adjust for this, there will be obsolescence taking into account the dates
a significant tax impact for entities using of expiry, shelf life, etc.
LIFO. Under IFRS, an entity is required to
use the same cost method for all inventories
BUSINESS COMBINATIONS
Consolidation and inorganic growth have book values on a designated date as
become the main stay in the Indian approved by the courts in the case of
pharmaceutical sector with several amalgamations.
acquisitions being made over the last few Several acquisitions also include earn-out
years. Similar to US GAAP, IFRS would payments linked to future performance.
require that irrespective of the legal form of IFRS and US GAAP now require that such
the transaction, such acquisitions must be cash earn-out arrangements should also be
recognised on a fair value basis. Under this fair valued on the acquisition date. Any
approach, all assets and liabilities of the subsequent changes in the fair value of
acquired company would be fair valued on such earn-out arrangements are not
the acquisition date. Similarly, unrecognised capitalised, but recognised through the
intangible assets such as in-process R&D income statement. Under the Indian GAAP,
projects, brand /trademark (including those earn-out payments are generally capitalised
with indefinite useful lives), product-related at the time of the payment.
intangibles (dossiers, marketing
authorisations), customer relationships Further, IFRS and the US GAAP require that would also be recognised during the transaction costs incurred for the acquisition. Only the balance consideration acquisition (finder’s fees, due diligence would be recognised as goodwill. Further, costs, etc) are charged to the income IFRS would require that the results of the statement. This is different from the Indian acquired company be included in the GAAP under which capitalisation of direct financial statements of the acquirer only costs of acquisition is permissible.from the date when control is transferred–
and not from a designated effective date.
Under Indian GAAP, companies consolidate
assets, liabilities and goodwill based on
INTANGIBLE ASSETS
Pharmaceutical companies generally have
significant amounts of intangibles and
goodwill on their balance sheets. The
inherent uncertainties in the business result
in a risk of impairment of these assets. IFRS
allows the use of discounted cash flows to
determine if impairment exists. This is unlike
US GAAP which requires the use of an
undiscounted cash flow method.
Impairment analysis under IFRS is similar to
Indian GAAP, with IFRS containing certain
additional guidance with respect to
impairment testing for a Cash Generaitng
Unit (CGU) which contains minority interest.
Also, under IFRS, goodwill must be
allocated to a CGU or a group of CGU’s.
IFRS does not allow reversal of impairment
charge for goodwill, which is permissible
under Indian GAAP if certain specific criteria
are met.
“Fair valuing the earn outs
on the date of business
combinations would
require significant
judgements and estimates”
7 8
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
The major challenge faced by the Costs of trial batches for available for use (date of receipt of
pharmaceutical industry is to demonstrate drugs under development which have no regulatory and marketing approval) over the
the technical and commercial feasibility of alternative future use and where the estimated useful life. In a way, paragraph
the drug under development and from technical feasibility is not established 25 of IAS 38 attempts to draw some
what point can a company commence should be reflected as development distinction between cost of in-licensed
capitalisation of the costs incurred on the expenses in the income statement. know-how vis-à-vis the cost of self
development. There is no definitive starting However, trial batches are necessary to developed know-how. In the former, the
point for capitalisation. Management obtain regulatory approval to validate the probability of economic benefits flowing in
should use their judgment, based on the use of machinery (unrelated to the approval is assumed while in the latter it is required
facts and circumstances of each for new drugs), the related costs (other to be demonstrated after careful
development project to evaluation the point than abnormal costs) should be capitalised consideration of facts and circumstances.
where the technical feasibility of the project together with the cost of machinery as
can be established and demonstrate the those that are related to bringing the Pharmaceutical companies pay CROs an
criteria’s set down under IAS 38, Intangible machinery to its working condition.upfront consideration to perform research
Assets been met. and have full rights of access to the
When an entity files its submission to the Pharmaceutical companies research findings for a finite period of time.
regulatory authority for final approval, a frequently in-license (i.e., obtain the right to In such situations, the upfront payment
strong indication exists that an entity has use) know-how to manufacture specific should be deferred as a pre-payment and
met all the criteria for capitalisation of the drugs. These arrangements usually involve should be recognised in the income
development costs. Securing regulatory the payment of an up-front non-refundable statement over the life of the research, in
approval is generally viewed by the consideration. Frequently, it is not possible accordance with the underlying assumption
pharmaceutical entities all over the world to conclude whether or not regulatory of accrual basis of accounting. If the
as the best evidence (e.g., receipt of US approvals will be received for the drugs research terminates early, the remainder of
FDA approval) that all the criteria for under development. Paragraph 25 of IAS 38 the pre-payment should be written off as
capitalisation have been met. Apart from suggests that the price of an entity pays to research and development costs in the
very few companies that capitalise acquire an intangible asset, reflects the income statement.
development costs based on the “probable expectations about the probability that the
future economic benefits criteria” prior to expected future economic benefits from Innovators frequently have issues where
the receipt of regulatory approvals, an the asset will flow to the entity. The effect generic companies copy their drugs and
overwhelming number of pharmaceutical of probability is, therefore, reflected in the threaten their patents. Costs incurred by
multinationals do not capitalise their cost of the asset. The probability innovators to defend their patents are in
development costs incurred prior to the recognition criterion is always considered the nature of maintenance expenses, do
receipt of regulatory approval. to be satisfied for separately acquired not increase the expected future economic
intangible assets. Accordingly, the benefits, and accordingly, do not qualify for
purchased know-how is capitalised and capitalisation.
amortised from the date the know-how is
Trial run costs -
Upfront payments to conduct research -
Upfront payments to in-license know-
how -
Costs incurred to defend patents -
LEGAL CONTINGENCIES
Contingent liabilities are recognised with it infringement contingencies require a
is more likely than not that an obligation careful evaluation, review of facts and
exists. If a range of loss exists and no one consultation with both external and internal
amount is more likely than under IFRS, an legal counsel. Some of the law-suits could
entity would accrue a liability at the best threaten the very existence of the company
estimate after considering all possible and therefore, could also have a going
outcomes weighted based on their concern implication.
probabilities. IFRS also requires disclosing a
roll forward of the loss accrual balance. For
losses that are not more likely than not of
occurring, but a loss is greater than remote,
disclosure is required under IFRS. In
pharmaceutical industries, the assessment
of whether an accrual is required to be
established with respect to patent
INVENTORIES
LIFO method of inventory valuation is of a similar nature throughout the entity. Any
prohibited under IFRS. This further impacts inventory write-downs are required to be
the tax accounting basis, since tax requires reversed in subsequent periods if the value
use of the cost basis used under an entity’s recovers. Further, pharmaceutical companies
generally accepted accounting principles. If need to establish policies for inventory
the IRS does not adjust for this, there will be obsolescence taking into account the dates
a significant tax impact for entities using of expiry, shelf life, etc.
LIFO. Under IFRS, an entity is required to
use the same cost method for all inventories
BUSINESS COMBINATIONS
Consolidation and inorganic growth have book values on a designated date as
become the main stay in the Indian approved by the courts in the case of
pharmaceutical sector with several amalgamations.
acquisitions being made over the last few Several acquisitions also include earn-out
years. Similar to US GAAP, IFRS would payments linked to future performance.
require that irrespective of the legal form of IFRS and US GAAP now require that such
the transaction, such acquisitions must be cash earn-out arrangements should also be
recognised on a fair value basis. Under this fair valued on the acquisition date. Any
approach, all assets and liabilities of the subsequent changes in the fair value of
acquired company would be fair valued on such earn-out arrangements are not
the acquisition date. Similarly, unrecognised capitalised, but recognised through the
intangible assets such as in-process R&D income statement. Under the Indian GAAP,
projects, brand /trademark (including those earn-out payments are generally capitalised
with indefinite useful lives), product-related at the time of the payment.
intangibles (dossiers, marketing
authorisations), customer relationships Further, IFRS and the US GAAP require that would also be recognised during the transaction costs incurred for the acquisition. Only the balance consideration acquisition (finder’s fees, due diligence would be recognised as goodwill. Further, costs, etc) are charged to the income IFRS would require that the results of the statement. This is different from the Indian acquired company be included in the GAAP under which capitalisation of direct financial statements of the acquirer only costs of acquisition is permissible.from the date when control is transferred–
and not from a designated effective date.
Under Indian GAAP, companies consolidate
assets, liabilities and goodwill based on
INTANGIBLE ASSETS
Pharmaceutical companies generally have
significant amounts of intangibles and
goodwill on their balance sheets. The
inherent uncertainties in the business result
in a risk of impairment of these assets. IFRS
allows the use of discounted cash flows to
determine if impairment exists. This is unlike
US GAAP which requires the use of an
undiscounted cash flow method.
Impairment analysis under IFRS is similar to
Indian GAAP, with IFRS containing certain
additional guidance with respect to
impairment testing for a Cash Generaitng
Unit (CGU) which contains minority interest.
Also, under IFRS, goodwill must be
allocated to a CGU or a group of CGU’s.
IFRS does not allow reversal of impairment
charge for goodwill, which is permissible
under Indian GAAP if certain specific criteria
are met.
“Fair valuing the earn outs
on the date of business
combinations would
require significant
judgements and estimates”
7 8
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Useful life -
Reversal of impairment -
Impairment -
Under IFRS, the depreciable (1) expiry of patents or changes in
amount of an intangible asset should be legislation covering patents; (2)
amortised on a systematic basis over the consolidation of purchasing power in the
best estimate of its useful life. Useful life is hands of large insurance companies
defined as the period of time over which an resulting in a move to a tender based
asset is expected to be used by the entity. regime (as in the case of Germany); (3)
Companies should assess the useful lives development of a drug by a competitor
initially and on an annual basis. Some of with a superior potential; (4) general
the pharmaceutical industry specific factors advances in the manner of treating
which should be considered include: (1) particular diseases; (4) national health care
Duration of the patent right or license and reforms impacting reimbursement policies
any recent regulatory decisions impacting of insurance companies, etc.
patent rights; (2) expected sales and any Impairment
anticipated fall in the sales beyond a period losses recognised may also be reversed
of time; (3) development of new drugs with where there has been a change in the
superior efficacy; (3) move to a tender estimates used to determined the asset’s
based regime with concentration of recoverable amount since the last
purchasing power in the hands of state run impairment loss was recognised. The
insurance agencies, etc.carrying amount of the asset is increased
Pharmaceutical companies to its recoverable amount, but shall not
generally have significant amounts of exceed its carrying amount adjusted for
intangibles and goodwill on their balance amortisation or depreciation had no
sheets. The inherent uncertainties in the impairment loss been recognised for the
business result in a risk of impairment of asset in the prior years. These situations
these assets. Under IFRS, an entity should could occur in a pharmaceutical industry
assess whether there are any triggers where an impairment loss was initially
which indicate that an asset is impaired at recognised and subsequently, there is a
each reporting date. While IFRS provides significant anticipated increase in the
certain general indicators of impairment, income arising from a favourable court
some of the pharmaceutical industry decision which was not considered
specific impairment indicators include: probable or a competitor’s product being
removed from the market.
In summary, the accounting challenges in a pharmaceutical industry continue
to be centered around revenue recognition (upfront vs. deferral), accounting
for research and development (capitalise vs. expense) and intangible assets
(amortise and carry forward vs. impair). Adoption of IFRS around the world
is expected to introduce homogeneity in accounting practices and permit
international comparability and thereby accelerate cross border transactions.
CONCLUSION
Impairment of non-financial assets
Paradigm shift in accounting convention from
‘Historical cost’ to ‘Fair value’
“All that glitters is not gold”,
uttered The Prince of Morocco
as he read the message revealed
when he lifted the lid of a gold
casket, as required of him to win
the hand of a princess. The
message was a lesson taught
from beyond the grave by the
father of the princess Portia in
Shakespeare’s, The Merchant of
Venice. The same sentiment can
be applied to balance sheets in
the midst of the current global
economic crisis. In this case, the
glittering substances are the
carrying values of non-current
assets, particularly goodwill and
intangible assets.
CONTRACT MANUFACTURING/
TOLL MANUFACTURING
A common practice amongst
Pharmaceutical companies, particularly
those with highly diversified product
portfolios, is to enter into exclusive ‘contract
manufacturing’ arrangements, whereby an
identified manufacturing company would
procure assets (tangible/intangible) that
should be exclusively used by them to
produce an identified set of products for and
on behalf of the contracting pharmaceutical
company. Companies entering into such
arrangements should be mindful of the
requirements in IFRIC 4, Determining
whether an Arrangement contains a Lease,
that provides for identification of any
embedded lease component included as
part of the underlying product supply
transaction, in cases where a ‘right to use’
on identified assets is conveyed amongst
the parties thereby.
9 10
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Useful life -
Reversal of impairment -
Impairment -
Under IFRS, the depreciable (1) expiry of patents or changes in
amount of an intangible asset should be legislation covering patents; (2)
amortised on a systematic basis over the consolidation of purchasing power in the
best estimate of its useful life. Useful life is hands of large insurance companies
defined as the period of time over which an resulting in a move to a tender based
asset is expected to be used by the entity. regime (as in the case of Germany); (3)
Companies should assess the useful lives development of a drug by a competitor
initially and on an annual basis. Some of with a superior potential; (4) general
the pharmaceutical industry specific factors advances in the manner of treating
which should be considered include: (1) particular diseases; (4) national health care
Duration of the patent right or license and reforms impacting reimbursement policies
any recent regulatory decisions impacting of insurance companies, etc.
patent rights; (2) expected sales and any Impairment
anticipated fall in the sales beyond a period losses recognised may also be reversed
of time; (3) development of new drugs with where there has been a change in the
superior efficacy; (3) move to a tender estimates used to determined the asset’s
based regime with concentration of recoverable amount since the last
purchasing power in the hands of state run impairment loss was recognised. The
insurance agencies, etc.carrying amount of the asset is increased
Pharmaceutical companies to its recoverable amount, but shall not
generally have significant amounts of exceed its carrying amount adjusted for
intangibles and goodwill on their balance amortisation or depreciation had no
sheets. The inherent uncertainties in the impairment loss been recognised for the
business result in a risk of impairment of asset in the prior years. These situations
these assets. Under IFRS, an entity should could occur in a pharmaceutical industry
assess whether there are any triggers where an impairment loss was initially
which indicate that an asset is impaired at recognised and subsequently, there is a
each reporting date. While IFRS provides significant anticipated increase in the
certain general indicators of impairment, income arising from a favourable court
some of the pharmaceutical industry decision which was not considered
specific impairment indicators include: probable or a competitor’s product being
removed from the market.
In summary, the accounting challenges in a pharmaceutical industry continue
to be centered around revenue recognition (upfront vs. deferral), accounting
for research and development (capitalise vs. expense) and intangible assets
(amortise and carry forward vs. impair). Adoption of IFRS around the world
is expected to introduce homogeneity in accounting practices and permit
international comparability and thereby accelerate cross border transactions.
CONCLUSION
Impairment of non-financial assets
Paradigm shift in accounting convention from
‘Historical cost’ to ‘Fair value’
“All that glitters is not gold”,
uttered The Prince of Morocco
as he read the message revealed
when he lifted the lid of a gold
casket, as required of him to win
the hand of a princess. The
message was a lesson taught
from beyond the grave by the
father of the princess Portia in
Shakespeare’s, The Merchant of
Venice. The same sentiment can
be applied to balance sheets in
the midst of the current global
economic crisis. In this case, the
glittering substances are the
carrying values of non-current
assets, particularly goodwill and
intangible assets.
CONTRACT MANUFACTURING/
TOLL MANUFACTURING
A common practice amongst
Pharmaceutical companies, particularly
those with highly diversified product
portfolios, is to enter into exclusive ‘contract
manufacturing’ arrangements, whereby an
identified manufacturing company would
procure assets (tangible/intangible) that
should be exclusively used by them to
produce an identified set of products for and
on behalf of the contracting pharmaceutical
company. Companies entering into such
arrangements should be mindful of the
requirements in IFRIC 4, Determining
whether an Arrangement contains a Lease,
that provides for identification of any
embedded lease component included as
part of the underlying product supply
transaction, in cases where a ‘right to use’
on identified assets is conveyed amongst
the parties thereby.
9 10
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
At its most basic, the standards that govern other companies in the same industry.
impairment testing for both IFRS and US During this period of macroeconomic
GAAP require companies to assess if their upheaval, it is going to be more difficult to
future cash flows support the carrying justify projections that have not worsened
values of their assets. While there are some since the prior reporting date, which,
differences in the standards, both sets of presumably, would be predicated on
rules require a company to consider the company-specific factors. Of course auditors
impact of ‘triggers’ – indicators of and regulators will also be looking for
impairment – on the carrying value of its companies that want to take a ‘Big Bath.’
assets. Financial crisis is definitely a trigger This is the practice of company
in both sets of standards. Recent earnings management being ‘extremely conservative’
releases indicate that the impairments are and taking excessive write-downs.
making their way into the bottom lines of Companies may do this to improve
companies. Advanced Micro Devices profitability on later years, as well as
reported in January 2009 that it reflected increase the return on assets when the
USD 714 million in impairment charges for economy improves. They may merely be
goodwill and intangibles. Now may be a trying to match the returns that their peers
good time to help ensure that accounting will now get in the light of large impairment
folks familiarise themselves with impairment charges.
triggers. While AS 28, Impairment of Assets, Further massive write-offs may reveal that
IAS 36, Impairment of Assets, SFAS 142, many acquisitions were not as profitable as
Goodwill and Other Intangible Assets, and once thought. Like Portia’s late father, those
SFAS 144, Accounting for the Disposal and with investments in equities and bonds will
Impairment of Long-lived Assets (in addition learn the hard way – all that glitters is not
to several EITF’s and other literature) cite gold. Shiny things can just as well be a fool’s
numerous examples, they all have thread of gold. Impairment test is a complex process
the same basic guidance: adverse changes described in detail in the standards, but
in the company’s earnings prospects are a which nonetheless raises many questions.
trigger to test assets for impairment. What Although there is a lot of common ground in
is notable about these recent impairment the concepts underpinning impairment for
events is that they are not in the banking or assets, cash generating unit (CGU) and
construction industries, those that are at the goodwill, more differences arise when
epicenter of the current economic and looking at their application. The central issue
financial crisis. This lack of connection to the guiding all the analysis is therefore towards
progenitors of the downturn is what makes how the rules are actually implemented in
impairment suddenly very relevant to most the impairment test given the fact that
companies.sometimes formulations are unclear and
With the crisis at hand and in the light of detailed interpretation is frequently needed.
recent accounting scandals (e.g., Satyam’s This article seeks to portray in the form of
chairman’s admission that he perpetrated a question and answers, some of the practical
multi-year, billion dollar fraud), a natural difficulties in application of the intricate
reaction is to wonder if your auditor principles within the framework, which
/regulator will be approaching impairment result from the room for interpretation
differently than in the past. While technically provided by IAS 36.
no, the practical outcome is yes, they will.
These difficulties are increased by the lack
of visibility on business plans in a very
uncertain economic and financial
environment. What this means to
accounting staffs is that the assumptions
used in calculating the fair value of assets
will be heavily scrutinised and would be
subjected to an increased level of
skepticism than ever done before. Another
aspect to the process that was not such a
factor in good times is the overall
comparison of impairment testing results to
How should a company
consider ‘corporate assets’ that
are a part of more than one
CGU in the impairment
assessment process?
The distinctive characteristics of corporate
assets are that they do not generate cash
inflows independently of other assets or
groups of assets and their carrying amount
cannot be fully attributed to one specific
CGU under review (head office building,
computer centre, research centre, etc.). As a
consequence, allocation of corporate assets
to various CGUs, on a reasonable and
consistent basis, is required. This allocation
helps ensure that the impairment review
checks whether the CGU’s net cash flows
will recover not only the carrying values of
the CGU, but also the allocated portion of
the corporate assets.
Under IFRS, when it is not possible to
allocate the entire corporate assets to CGUs
on a reasonable and consistent basis, a two
stage approach is followed:
STAGE 1:
STAGE 2:
To the extent Corporate assets
can be allocated to CGUs, the recoverable
amounts should be compared with the
carrying values of the CGU including the
allocated portion of the corporate assets and
the resultant impairment loss is recognised,
Perform an impairment test at
an overall level by grouping the carrying
values of the CGUs and also the corporate
assets which cannot be allocated on a
reasonable basis and compare them with
the recoverable amount of the larger group.
Any further impairment loss arising from
this comparison is recognised. Assuming
that there are two CGUs A and B with
carrying values of 100 and 200
respectively, and there are two corporate
assets building and research centre carrying
values of 120 and 60 respectively.
Assuming further that the building can be
allocated while the research centre cannot
be allocated on a reasonable basis and that
the recoverable amounts of CGUs A and B
are 180 and 220 respectively, the results of
the two stage impairment test is
summarised below. The impairment losses
arising from these tests should be allocated
pro rata to the assets of the CGU and the
corporate assets.
CGU-A CGU-B
Carrying value of assets 100 200
Allocation of Building 40 80
Total carrying value 140 280
Recoverable amount 180 220
First stage impairment loss - 60
Stage 1 impairment test
CGU-A CGU-B Total
Adjusted carrying values post Stage 1 impairment
140 220360
Research centre - - 60
Total carrying value 140 220 420
Recoverable amount 180 220 400
Stage 2 impairment loss - - 20
Stage 2 impairment test
11 12
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
At its most basic, the standards that govern other companies in the same industry.
impairment testing for both IFRS and US During this period of macroeconomic
GAAP require companies to assess if their upheaval, it is going to be more difficult to
future cash flows support the carrying justify projections that have not worsened
values of their assets. While there are some since the prior reporting date, which,
differences in the standards, both sets of presumably, would be predicated on
rules require a company to consider the company-specific factors. Of course auditors
impact of ‘triggers’ – indicators of and regulators will also be looking for
impairment – on the carrying value of its companies that want to take a ‘Big Bath.’
assets. Financial crisis is definitely a trigger This is the practice of company
in both sets of standards. Recent earnings management being ‘extremely conservative’
releases indicate that the impairments are and taking excessive write-downs.
making their way into the bottom lines of Companies may do this to improve
companies. Advanced Micro Devices profitability on later years, as well as
reported in January 2009 that it reflected increase the return on assets when the
USD 714 million in impairment charges for economy improves. They may merely be
goodwill and intangibles. Now may be a trying to match the returns that their peers
good time to help ensure that accounting will now get in the light of large impairment
folks familiarise themselves with impairment charges.
triggers. While AS 28, Impairment of Assets, Further massive write-offs may reveal that
IAS 36, Impairment of Assets, SFAS 142, many acquisitions were not as profitable as
Goodwill and Other Intangible Assets, and once thought. Like Portia’s late father, those
SFAS 144, Accounting for the Disposal and with investments in equities and bonds will
Impairment of Long-lived Assets (in addition learn the hard way – all that glitters is not
to several EITF’s and other literature) cite gold. Shiny things can just as well be a fool’s
numerous examples, they all have thread of gold. Impairment test is a complex process
the same basic guidance: adverse changes described in detail in the standards, but
in the company’s earnings prospects are a which nonetheless raises many questions.
trigger to test assets for impairment. What Although there is a lot of common ground in
is notable about these recent impairment the concepts underpinning impairment for
events is that they are not in the banking or assets, cash generating unit (CGU) and
construction industries, those that are at the goodwill, more differences arise when
epicenter of the current economic and looking at their application. The central issue
financial crisis. This lack of connection to the guiding all the analysis is therefore towards
progenitors of the downturn is what makes how the rules are actually implemented in
impairment suddenly very relevant to most the impairment test given the fact that
companies.sometimes formulations are unclear and
With the crisis at hand and in the light of detailed interpretation is frequently needed.
recent accounting scandals (e.g., Satyam’s This article seeks to portray in the form of
chairman’s admission that he perpetrated a question and answers, some of the practical
multi-year, billion dollar fraud), a natural difficulties in application of the intricate
reaction is to wonder if your auditor principles within the framework, which
/regulator will be approaching impairment result from the room for interpretation
differently than in the past. While technically provided by IAS 36.
no, the practical outcome is yes, they will.
These difficulties are increased by the lack
of visibility on business plans in a very
uncertain economic and financial
environment. What this means to
accounting staffs is that the assumptions
used in calculating the fair value of assets
will be heavily scrutinised and would be
subjected to an increased level of
skepticism than ever done before. Another
aspect to the process that was not such a
factor in good times is the overall
comparison of impairment testing results to
How should a company
consider ‘corporate assets’ that
are a part of more than one
CGU in the impairment
assessment process?
The distinctive characteristics of corporate
assets are that they do not generate cash
inflows independently of other assets or
groups of assets and their carrying amount
cannot be fully attributed to one specific
CGU under review (head office building,
computer centre, research centre, etc.). As a
consequence, allocation of corporate assets
to various CGUs, on a reasonable and
consistent basis, is required. This allocation
helps ensure that the impairment review
checks whether the CGU’s net cash flows
will recover not only the carrying values of
the CGU, but also the allocated portion of
the corporate assets.
Under IFRS, when it is not possible to
allocate the entire corporate assets to CGUs
on a reasonable and consistent basis, a two
stage approach is followed:
STAGE 1:
STAGE 2:
To the extent Corporate assets
can be allocated to CGUs, the recoverable
amounts should be compared with the
carrying values of the CGU including the
allocated portion of the corporate assets and
the resultant impairment loss is recognised,
Perform an impairment test at
an overall level by grouping the carrying
values of the CGUs and also the corporate
assets which cannot be allocated on a
reasonable basis and compare them with
the recoverable amount of the larger group.
Any further impairment loss arising from
this comparison is recognised. Assuming
that there are two CGUs A and B with
carrying values of 100 and 200
respectively, and there are two corporate
assets building and research centre carrying
values of 120 and 60 respectively.
Assuming further that the building can be
allocated while the research centre cannot
be allocated on a reasonable basis and that
the recoverable amounts of CGUs A and B
are 180 and 220 respectively, the results of
the two stage impairment test is
summarised below. The impairment losses
arising from these tests should be allocated
pro rata to the assets of the CGU and the
corporate assets.
CGU-A CGU-B
Carrying value of assets 100 200
Allocation of Building 40 80
Total carrying value 140 280
Recoverable amount 180 220
First stage impairment loss - 60
Stage 1 impairment test
CGU-A CGU-B Total
Adjusted carrying values post Stage 1 impairment
140 220360
Research centre - - 60
Total carrying value 140 220 420
Recoverable amount 180 220 400
Stage 2 impairment loss - - 20
Stage 2 impairment test
11 12
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
When does a group of assets
held for disposal qualify for
being considered as a
discontinued operation?
As per IFRS 5, Non-current Assets Held for
Sale and Discontinued Operations, the
presentation of operation as a discontinued
operation is limited to a component of
entity that either has been disposed of , or is
classified as held for sale, and: (1)
represents a separate major line of business
or geographical area of operation, (2) is
part of a co-ordinated single plan to dispose
a separate major line of business or
geographical area of operation, or (3) is a
subsidiary acquired exclusively with a view
to resale. The group of assets held for sale
should meet the definition as prescribed in
IFRS 5 /ED of AS 24 ‘component’ of the
entity to be able to be considered for
discontinued operations presentation. A
component of an entity comprises
operations and cash flows that can be
distinguished clearly, both operationally
and for financial reporting purposes, from
the rest of the entity. In other words, a
component of an entity would have been a
cash-generating unit or a group of cash-
generating units while being held for use.
When long-lived assets are
impaired and relate to a foreign
operation, is there a requirement
to reclassify the entire or an
appropriate portion of the
foreign currency translation
reserve to the profit or loss?
Can an entity reuse the calculation
of the recoverable amount of a
CGU that was estimated in the
previous reporting period?
What are the rules governing the allocation of goodwill to
CGUs and annual impairment under IFRS?
Only on the actual disposal of a foreign
operation, the cumulative amount of the
exchange differences relating to that
foreign operation, recognised in other
comprehensive income and accumulated in
the separate component of equity, is
required to be reclassified from equity to
profit or loss. In any other partial disposal
of a foreign operation, the entity shall
reclassify to profit or loss and only the
proportionate share of the cumulative
amount of the exchange differences
recognised in other comprehensive income.
However, a write-down of the carrying
amount of a foreign operation, either
because of its own losses or because of an
impairment recognised by the investor,
does not constitute a partial disposal.
Accordingly, no part of the foreign
exchange gain or loss recognised in other
comprehensive income is reclassified to
profit or loss at the time of recognition of
an impairment loss.
The most recent computation of the
recoverable amount of a CGU may be re-
used in the current year provided the
following criteria are met:
• the assets and liabilities making up the
unit have not changed significantly
since the most recent recoverable
amount calculation
• the most recent recoverable amount
calculation resulted in an amount that
substantially exceeded the carrying
amount of the unit
based on an analysis of events that have
occurred since the previous impairment
analysis, the likelihood that the recoverable
amount would be less than the current
carrying amount of the unit is remote.
The goodwill acquired in a business generating unit to which goodwill has
combination may or may not be directly been allocated, there may be an indication
attributable to a specific CGU. Where of an impairment of an asset within the
goodwill is identified with a CGU, the unit containing the goodwill. In such
impairment test would involve the circumstances, the entity tests the asset for
comparison of the carrying value of the impairment first, and recognises any
CGU with the recoverable amount and the impairment loss for that asset before
usual steps follow. There is limited testing for impairment of the cash-
guidance on how to allocate goodwill to generating unit containing the goodwill.
individual CGUs and this allocation Similarly, there may be an indication of an
should be done on a reasonable basis after impairment of a cash-generating unit
taking into account how the individual within a group of units containing the
CGUs are benefited from the synergies of goodwill. In such circumstances, the entity
the acquisition. Often goodwill is tests the cash-generating unit for
managed on a broader basis and allocated impairment first, and recognises any
to multiple CGUs as it cannot be allocated impairment loss for that unit, before
to a single CGU on a reasonable basis. At testing for impairment the group of units
the time of impairment testing a cash- to which the goodwill is allocated.
13 14
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
When does a group of assets
held for disposal qualify for
being considered as a
discontinued operation?
As per IFRS 5, Non-current Assets Held for
Sale and Discontinued Operations, the
presentation of operation as a discontinued
operation is limited to a component of
entity that either has been disposed of , or is
classified as held for sale, and: (1)
represents a separate major line of business
or geographical area of operation, (2) is
part of a co-ordinated single plan to dispose
a separate major line of business or
geographical area of operation, or (3) is a
subsidiary acquired exclusively with a view
to resale. The group of assets held for sale
should meet the definition as prescribed in
IFRS 5 /ED of AS 24 ‘component’ of the
entity to be able to be considered for
discontinued operations presentation. A
component of an entity comprises
operations and cash flows that can be
distinguished clearly, both operationally
and for financial reporting purposes, from
the rest of the entity. In other words, a
component of an entity would have been a
cash-generating unit or a group of cash-
generating units while being held for use.
When long-lived assets are
impaired and relate to a foreign
operation, is there a requirement
to reclassify the entire or an
appropriate portion of the
foreign currency translation
reserve to the profit or loss?
Can an entity reuse the calculation
of the recoverable amount of a
CGU that was estimated in the
previous reporting period?
What are the rules governing the allocation of goodwill to
CGUs and annual impairment under IFRS?
Only on the actual disposal of a foreign
operation, the cumulative amount of the
exchange differences relating to that
foreign operation, recognised in other
comprehensive income and accumulated in
the separate component of equity, is
required to be reclassified from equity to
profit or loss. In any other partial disposal
of a foreign operation, the entity shall
reclassify to profit or loss and only the
proportionate share of the cumulative
amount of the exchange differences
recognised in other comprehensive income.
However, a write-down of the carrying
amount of a foreign operation, either
because of its own losses or because of an
impairment recognised by the investor,
does not constitute a partial disposal.
Accordingly, no part of the foreign
exchange gain or loss recognised in other
comprehensive income is reclassified to
profit or loss at the time of recognition of
an impairment loss.
The most recent computation of the
recoverable amount of a CGU may be re-
used in the current year provided the
following criteria are met:
• the assets and liabilities making up the
unit have not changed significantly
since the most recent recoverable
amount calculation
• the most recent recoverable amount
calculation resulted in an amount that
substantially exceeded the carrying
amount of the unit
based on an analysis of events that have
occurred since the previous impairment
analysis, the likelihood that the recoverable
amount would be less than the current
carrying amount of the unit is remote.
The goodwill acquired in a business generating unit to which goodwill has
combination may or may not be directly been allocated, there may be an indication
attributable to a specific CGU. Where of an impairment of an asset within the
goodwill is identified with a CGU, the unit containing the goodwill. In such
impairment test would involve the circumstances, the entity tests the asset for
comparison of the carrying value of the impairment first, and recognises any
CGU with the recoverable amount and the impairment loss for that asset before
usual steps follow. There is limited testing for impairment of the cash-
guidance on how to allocate goodwill to generating unit containing the goodwill.
individual CGUs and this allocation Similarly, there may be an indication of an
should be done on a reasonable basis after impairment of a cash-generating unit
taking into account how the individual within a group of units containing the
CGUs are benefited from the synergies of goodwill. In such circumstances, the entity
the acquisition. Often goodwill is tests the cash-generating unit for
managed on a broader basis and allocated impairment first, and recognises any
to multiple CGUs as it cannot be allocated impairment loss for that unit, before
to a single CGU on a reasonable basis. At testing for impairment the group of units
the time of impairment testing a cash- to which the goodwill is allocated.
13 14
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
How should goodwill be tested for the
impairment in the event of existence of a non-
controlling interest in a subsidiary? Is there a
requirement to allocate the impairment loss to
non-controlling interest?
If there are indefinite lived intangibles like say
brand, goodwill and other long lived assets within
a single CGU being evaluated for impairment, on
what order should the impairment loss be
recognised? Within other long lived assets, how
should the impairment loss get allocated?
What are the instances that allow management to
change the allocation of goodwill amongst
various CGUs? is that an acceptable practice?
In the case of a partial acquisition, IFRS 3 (revised), Business
Combinations provides an accounting policy choice on a
transaction-by-transaction basis of whether to measure non-
controlling interest assets at fair value or at the non-controlling
interest’s proportionate share of the acquiree’s identifiable net
assets on the date of acquisition. If an entity measures non-
controlling interests at their proportionate share of the acquiree's
identifiable net assets on the date of acquisition, it can lead to the
recognition of goodwill calculated on the acquirer’s proportionate
share in the acquiree (as opposed to the “full goodwill” method).
The non-controlling interest's share in the goodwill is not
recognised in the acquirer's consolidated financial statements.
However, IAS 36 states that, by convention, the goodwill must be
tested for impairment based on the full goodwill including the
non-controlling interest's share. As a consequence, the goodwill
attributable to the non-controlling interest must be added to the
carrying amount of goodwill (“gross-up”). This adjusted carrying
amount is then compared to the recoverable amount.
However, if an entity measures non-controlling interests at fair
value at the date of acquisition, then the entity will not gross up
the carrying amount of goodwill allocated to a cash-generating
unit since it already includes a portion attributable to the non-
controlling interests. Example: acquisition of 80 percent of a
subsidiary (“partial goodwill” method):
- acquisition price: EUR110 mn;
- fair value of the identifiable net assets of the acquiree:
EUR100mn;
- goodwill recognised: EUR110mn - 80%* EUR100mn =
EUR30mn;
- calculation of “full goodwill” (gross-up):
EUR30mn / 80 % = EUR37.5mn, or
EUR110mn * 100 % / 80 % - EUR100mn = EUR37.5mn
Where impairment losses are estimated at the CGU level and not
at an individual asset level, an important challenge to contend is to
which asset the impairment loss is required to be allocated. If a
CGU comprises goodwill, indefinite lived intangible assets such
as a brand and other long lived assets and if it is determined that
the overall recoverable amount is lower than the aggregate
carrying value, intuitively companies tend to conclude that the
impairment loss should be first allocated to the brand and
thereafter to the remaining assets. However, IAS 36 mandates that
impairment loss should be first allocated to goodwill and
thereafter to the other assets on a pro rata basis based on the
carrying amount of each asset in the CGU. However, no asset is
written down to below its known recoverable amount or zero;
therefore an entity should determine the recoverable amount of
any of the individual assets or lower level CGU in the CGU being
tested, if possible. Any excess impairment loss in respect of an
asset is allocated pro rata to the other assets in the CGU to the
extent possible. A liability should be recognised for any
unallocated impairment loss only if it is required by another
standard.
If an entity reorganises its reporting structure in a way that
changes the composition of one or more cash-generating units to
which goodwill has been allocated, the goodwill shall be
reallocated to the units affected. This reallocation shall be
performed using a relative value approach similar to that used
when an entity disposes of an operation within a cash-generating
unit, unless the entity can demonstrate that some other method
better reflects the goodwill associated with the reorganised units.
Example
Goodwill had previously been allocated to cash-generating unit A.
The goodwill allocated to A cannot be identified or associated
with an asset group at a level lower than A, except arbitrarily. A is
to be divided and integrated into three other cash-generating
units, B, C and D. Because the goodwill allocated to A cannot be
non-arbitrarily identified or associated with an asset group at a
level lower than A, it is reallocated to units B, C and D on the
basis of the relative values of the three portions of A before those
portions are integrated with B, C and D.
What should be done in the
event of disposal of all or part of
a CGU to which goodwill has
been assigned? What would
happen if the CGU is merged
with another CGU within the
consolidated group?
In the event of disposal of all or part of a
CGU to which goodwill has been allocated,
the goodwill must be taken into account
when determining the gain or loss on
disposal. If the disposal only relates to a
part of a CGU to which the goodwill has
been allocated, the proportion of the
goodwill to be derecognised is measured on
the basis of the relative values of the
operation disposed of and the portion of the
CGU retained unless the entity can
demonstrate that some other method is
more appropriate. Merging of the CGU into
another unit within the consolidated group
would be treated as reorganising the
reporting structure which requires
reallocation of goodwill using a relative
value approach. Considering goodwill
when determining the gain or loss on
disposal of a CGU depicts a strong
indication that goodwill is monitored
internally at the organisational level of the
CGU which has been disposed of.
Consistency with the level of goodwill
allocation should then be checked.
Is it always required to
determine both the fair value
less cost to sell (FVLCS) and
value in use (VIU) when
conducting an impairment test,
or will one suffice?
impossibility to take into account capacity
investments, explicit forecast period
generally not exceeding five years, limited
perpetuity growth rate, etc. It may thus, be
that a CGU with strong growth outlook will
have a VIU lower than its carrying amount,
while the FVLCS, as determined based on
market data, is greater than its carrying
amount. Market participants and the entity's
management may assess differently the
assets use, growth and business
profitability. Generally, market cash flows
may not take into account a growth in sales
revenue or a level of profitability greater
than those prevailing in the sector, unless
these levels are anticipated and shared by
market participants. The fact that the entity
must calculate FVLCS on the basis of cash
flows anticipated by the market raises the
problem in periods of economic crisis. IAS
36 provides a hierarchy of methods of
determining fair value: (first level
hierarchy) based on an arms length binding
sale agreement; or (second level hierarchy)
based on the value at which the asset is
traded in the active market; or (third level
hierarchy) based on best information
available to reflect the amount an entity
could obtain from the disposal of the asset
at an arm’s length transaction. Best
available information could be derived
from multiples from recent transactions or
even discounted cash flows method taking
account of the market data at the date of
impairment testing. If discounted cash
flows from a market participant perspective
are used for determining fair values, those
would take into account the effects of
implementation of strategic plans and
anticipated future restructuring initiatives
and thus differ from cash flow projections
used for the calculation of VIU.
Under Indian GAAP, a 'net selling price' is
to be determined in the place of a FVLCS.
The amount thus calculated under Indian
GAAP would be that obtainable from sale
of an asset in an arm's length transaction
and is not akin to a discounted cash flow
derived based on a 'market participant'
approach. Due to the fact that certain forms
of fair value less cost to sell would not be
acceptable alternatives under Indian GAAP
as clarified by an Expert Advisory
Committee consensus, in theory and in
practice, there could be differences in the
recoverable amounts between the two
GAAPs and further the impairment losses
recognised could be different.
It is not always necessary to determine both
an asset’s FVLCS and its VIU. If either of
these amounts exceeds the asset’s carrying
amount, the asset is not impaired and it is
not necessary to estimate the other amount.
Thus, it is possible to use the FVLCS as the
recoverable amount even if the entity has no
intention to dispose of the asset. According
to IAS 36.21, the value in use of an asset
does not need to be determined if there is no
reason to believe that its value in use
materially exceeds its fair value less costs to
sell. In this instance, the recoverable amount
corresponds to the FVLCS.
Yes. Recoverable amount is defined as the
higher of an asset’s FVLCS and its VIU. In
the event that VIU < Net carrying amount
< FVLCS, it is actually forbidden to use
value in use as the recoverable amount and
thus to recognise an impairment loss. This
approach may seem paradoxical when the
entity has no intention to dispose of the
CGU. The paradox may partly be explained
by the fact that the calculation of value in
use under IAS 36 is very restricted:
Is the use of FVLCS permitted
when there is no intention to
dispose of the CGU? Should fair
value be always determined
based on the evidence of a recent
transaction or is it possible to
estimate the cash flows from a
market participant perspective?
Are there any circumstances for
cash flow projections to be based
on market assumptions that differ
from cash flows determined
based on entity’s assumptions?
Would there be a potential GAAP
difference in this regard between
Indian GAAP and IFRS?
“Reallocation of goodwill
occurs when there is a change
in composition of cash
generating units to which it is
previously allocated”
15 16
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
How should goodwill be tested for the
impairment in the event of existence of a non-
controlling interest in a subsidiary? Is there a
requirement to allocate the impairment loss to
non-controlling interest?
If there are indefinite lived intangibles like say
brand, goodwill and other long lived assets within
a single CGU being evaluated for impairment, on
what order should the impairment loss be
recognised? Within other long lived assets, how
should the impairment loss get allocated?
What are the instances that allow management to
change the allocation of goodwill amongst
various CGUs? is that an acceptable practice?
In the case of a partial acquisition, IFRS 3 (revised), Business
Combinations provides an accounting policy choice on a
transaction-by-transaction basis of whether to measure non-
controlling interest assets at fair value or at the non-controlling
interest’s proportionate share of the acquiree’s identifiable net
assets on the date of acquisition. If an entity measures non-
controlling interests at their proportionate share of the acquiree's
identifiable net assets on the date of acquisition, it can lead to the
recognition of goodwill calculated on the acquirer’s proportionate
share in the acquiree (as opposed to the “full goodwill” method).
The non-controlling interest's share in the goodwill is not
recognised in the acquirer's consolidated financial statements.
However, IAS 36 states that, by convention, the goodwill must be
tested for impairment based on the full goodwill including the
non-controlling interest's share. As a consequence, the goodwill
attributable to the non-controlling interest must be added to the
carrying amount of goodwill (“gross-up”). This adjusted carrying
amount is then compared to the recoverable amount.
However, if an entity measures non-controlling interests at fair
value at the date of acquisition, then the entity will not gross up
the carrying amount of goodwill allocated to a cash-generating
unit since it already includes a portion attributable to the non-
controlling interests. Example: acquisition of 80 percent of a
subsidiary (“partial goodwill” method):
- acquisition price: EUR110 mn;
- fair value of the identifiable net assets of the acquiree:
EUR100mn;
- goodwill recognised: EUR110mn - 80%* EUR100mn =
EUR30mn;
- calculation of “full goodwill” (gross-up):
EUR30mn / 80 % = EUR37.5mn, or
EUR110mn * 100 % / 80 % - EUR100mn = EUR37.5mn
Where impairment losses are estimated at the CGU level and not
at an individual asset level, an important challenge to contend is to
which asset the impairment loss is required to be allocated. If a
CGU comprises goodwill, indefinite lived intangible assets such
as a brand and other long lived assets and if it is determined that
the overall recoverable amount is lower than the aggregate
carrying value, intuitively companies tend to conclude that the
impairment loss should be first allocated to the brand and
thereafter to the remaining assets. However, IAS 36 mandates that
impairment loss should be first allocated to goodwill and
thereafter to the other assets on a pro rata basis based on the
carrying amount of each asset in the CGU. However, no asset is
written down to below its known recoverable amount or zero;
therefore an entity should determine the recoverable amount of
any of the individual assets or lower level CGU in the CGU being
tested, if possible. Any excess impairment loss in respect of an
asset is allocated pro rata to the other assets in the CGU to the
extent possible. A liability should be recognised for any
unallocated impairment loss only if it is required by another
standard.
If an entity reorganises its reporting structure in a way that
changes the composition of one or more cash-generating units to
which goodwill has been allocated, the goodwill shall be
reallocated to the units affected. This reallocation shall be
performed using a relative value approach similar to that used
when an entity disposes of an operation within a cash-generating
unit, unless the entity can demonstrate that some other method
better reflects the goodwill associated with the reorganised units.
Example
Goodwill had previously been allocated to cash-generating unit A.
The goodwill allocated to A cannot be identified or associated
with an asset group at a level lower than A, except arbitrarily. A is
to be divided and integrated into three other cash-generating
units, B, C and D. Because the goodwill allocated to A cannot be
non-arbitrarily identified or associated with an asset group at a
level lower than A, it is reallocated to units B, C and D on the
basis of the relative values of the three portions of A before those
portions are integrated with B, C and D.
What should be done in the
event of disposal of all or part of
a CGU to which goodwill has
been assigned? What would
happen if the CGU is merged
with another CGU within the
consolidated group?
In the event of disposal of all or part of a
CGU to which goodwill has been allocated,
the goodwill must be taken into account
when determining the gain or loss on
disposal. If the disposal only relates to a
part of a CGU to which the goodwill has
been allocated, the proportion of the
goodwill to be derecognised is measured on
the basis of the relative values of the
operation disposed of and the portion of the
CGU retained unless the entity can
demonstrate that some other method is
more appropriate. Merging of the CGU into
another unit within the consolidated group
would be treated as reorganising the
reporting structure which requires
reallocation of goodwill using a relative
value approach. Considering goodwill
when determining the gain or loss on
disposal of a CGU depicts a strong
indication that goodwill is monitored
internally at the organisational level of the
CGU which has been disposed of.
Consistency with the level of goodwill
allocation should then be checked.
Is it always required to
determine both the fair value
less cost to sell (FVLCS) and
value in use (VIU) when
conducting an impairment test,
or will one suffice?
impossibility to take into account capacity
investments, explicit forecast period
generally not exceeding five years, limited
perpetuity growth rate, etc. It may thus, be
that a CGU with strong growth outlook will
have a VIU lower than its carrying amount,
while the FVLCS, as determined based on
market data, is greater than its carrying
amount. Market participants and the entity's
management may assess differently the
assets use, growth and business
profitability. Generally, market cash flows
may not take into account a growth in sales
revenue or a level of profitability greater
than those prevailing in the sector, unless
these levels are anticipated and shared by
market participants. The fact that the entity
must calculate FVLCS on the basis of cash
flows anticipated by the market raises the
problem in periods of economic crisis. IAS
36 provides a hierarchy of methods of
determining fair value: (first level
hierarchy) based on an arms length binding
sale agreement; or (second level hierarchy)
based on the value at which the asset is
traded in the active market; or (third level
hierarchy) based on best information
available to reflect the amount an entity
could obtain from the disposal of the asset
at an arm’s length transaction. Best
available information could be derived
from multiples from recent transactions or
even discounted cash flows method taking
account of the market data at the date of
impairment testing. If discounted cash
flows from a market participant perspective
are used for determining fair values, those
would take into account the effects of
implementation of strategic plans and
anticipated future restructuring initiatives
and thus differ from cash flow projections
used for the calculation of VIU.
Under Indian GAAP, a 'net selling price' is
to be determined in the place of a FVLCS.
The amount thus calculated under Indian
GAAP would be that obtainable from sale
of an asset in an arm's length transaction
and is not akin to a discounted cash flow
derived based on a 'market participant'
approach. Due to the fact that certain forms
of fair value less cost to sell would not be
acceptable alternatives under Indian GAAP
as clarified by an Expert Advisory
Committee consensus, in theory and in
practice, there could be differences in the
recoverable amounts between the two
GAAPs and further the impairment losses
recognised could be different.
It is not always necessary to determine both
an asset’s FVLCS and its VIU. If either of
these amounts exceeds the asset’s carrying
amount, the asset is not impaired and it is
not necessary to estimate the other amount.
Thus, it is possible to use the FVLCS as the
recoverable amount even if the entity has no
intention to dispose of the asset. According
to IAS 36.21, the value in use of an asset
does not need to be determined if there is no
reason to believe that its value in use
materially exceeds its fair value less costs to
sell. In this instance, the recoverable amount
corresponds to the FVLCS.
Yes. Recoverable amount is defined as the
higher of an asset’s FVLCS and its VIU. In
the event that VIU < Net carrying amount
< FVLCS, it is actually forbidden to use
value in use as the recoverable amount and
thus to recognise an impairment loss. This
approach may seem paradoxical when the
entity has no intention to dispose of the
CGU. The paradox may partly be explained
by the fact that the calculation of value in
use under IAS 36 is very restricted:
Is the use of FVLCS permitted
when there is no intention to
dispose of the CGU? Should fair
value be always determined
based on the evidence of a recent
transaction or is it possible to
estimate the cash flows from a
market participant perspective?
Are there any circumstances for
cash flow projections to be based
on market assumptions that differ
from cash flows determined
based on entity’s assumptions?
Would there be a potential GAAP
difference in this regard between
Indian GAAP and IFRS?
“Reallocation of goodwill
occurs when there is a change
in composition of cash
generating units to which it is
previously allocated”
15 16
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
In the determination of the
expected future cash flows, can
a future restructuring, planned
future capital expenditure
/expansion be factored in to
arriving at the VIU or FVLCS?
For the purpose of discounting
the expected cash flows, is the
use of pre-tax /post-tax rate
appropriate? How is the pre-tax
discount rate determined?
What are the various ‘cross-
checks’ that are applied in
determining the reasonableness
of the VIU when a substantial
portion of the entity is tested for
impairment?
The recoverable amount must be estimated
based on the asset or group of assets’
current condition at the end of the reporting
period. For the purpose of calculating the
VIU, the entity must base cash the flow
projections on the most recent financial
forecasts approved by the management,
excluding any elements such as:
- external growth investments;
- capacity and performance investments;
however, cash flows include renewal
investments whose objective is to
maintain assets in their current
condition, net of disposals;
- the impact of a future restructuring to
which an enterprise is not yet
committed (neutralisation of future cash
outflows, related to cost savings and
expected advantages).
However, for the purpose of valuing
FVLCS when there is no binding sale
agreement and no active market, fair value
should be determined based on the best
information available to reflect the amount
that an entity could obtain at the reporting
date from the disposal of the asset in an
arm's length transaction between
knowledgeable, willing parties. The fair
value also reflects the market assessment of
expected net benefits to be derived from
restructuring the unit or from future capital
expenditure. Accordingly, the FVLCS
would generally consider including the cost
and the associated benefit on future
restructuring /planned capital expansions.
However, it is to be noted that Indian
GAAP as interpreted by an Expert Advisory
Committee does not support a market
participant based discounted cash flow
approach to determine FVLCS and
therefore, the effects of future restructuring
initiatives cannot be anticipated.
Future cash flows estimates should not
include inflows and outflows associated
with income tax. Consequently, IAS 36
requires that the entity uses a pre-tax
discount rate. When only the post-tax
discount rate is available, it must be
adjusted. Determination of a pre-tax
discount rate is generally not as simple as
grossing up the post-tax discount rate by a
standard tax rate, even in a situation where
the effective tax rate is identical to the
statutory tax rate. This can be linked to
factors such as a variable effective cash tax
rate over the forecast period because of, for
example, the utilisation of future tax losses
or taxable temporary differences relating to
the asset or CGU concerned. Therefore, the
standard indicates that, if the calculation is
carried out after tax, it is necessary to
determine, by an iterative process, the
inferred pre-tax rate. In practice, the
determination of a pre-tax rate is generally
difficult, and the rate used is a post-tax rate
which is permitted as long as this method
gives the same results as with a pre-tax rate.
In most cases, entities use a post-tax rate
applied to post-tax cash flows. The iterative
process, would involve first identifying the
discounted cash flow calculations using
post-tax cash flows and a post-tax discount
rate, and then by iteration determining what
the pre-tax discount rate would need to be
to cause the VIU determined using the pre-
tax cash flows and a pre-tax discount rate to
equal the VIU determined by the post-tax
discounted cash flow calculation.
In addition to performing sensitivity
analysis on key cash flow assumptions,
terminal value growth rates and the
discount rate generally, there are additional
cross-checks that are performed in testing
the reasonableness of a VIU calculation,
especially when a substantial portion of the
entity is tested for impairment, some of
these checks include:
- Comparison to market capitalisation
- Consideration of any recent offers made
to acquire the CGU or an asset
- Comparison to other recent valuations
performed for other purposes (i.e., for
tax reasons)
- Consideration on what analysts are
saying in their articles, reports and
briefings
- Comparison of the overall movement in
value in use and discount rates since the
last impairment test, to identify if it
makes sense
- Consideration as to how comparable a
company’s share prices have moved?
For example, if the CGU was acquired
close to the high points in equity
markets and there has been a large fall
in comparable companies’ share prices,
one might expect that the value in use
would show a lower value than the
acquisition price
- Reconciliation of the total fair value of
CGUs to total market capitalisation,
particularly if the market comparables
are used to value CGUs.
What are the circumstances for
reversal of a previously
recognised impairment loss?
Can impairment loss also be
reversed under the Indian and
US GAAP?
The standard (i.e., IAS 36) requires that at increase in carrying the value of assets
each reporting date an entity should assess shall not exceed the carrying amount that
whether there is an indication that a would have been determined (net of
previously recognised impairment loss has amortisation and depreciation) had no
reversed. If there is such an indication and impairment loss been recognised in prior
the recoverable amount of the impaired years.
asset or CGU subsequently increases, then The below approach is also contemplated
the impairment loss generally is reversed, under Indian GAAP. The difference relates
except those caused only by the unwinding to a reversal of impairment loss on
of the discount used in calculating the goodwill, which is permitted under limited
value in use. Reversal of the impairment circumstances, such as impairment loss
loss for goodwill is prohibited. Therefore, that arose because of a specific event of an
impairment loss shall be reversed if, and exceptional nature which is not expected
only if, there has been a change in the to recur and subsequent external events
estimates used to determine the assets have occurred that reverse the effect of
recoverable amounts since the last that event. Under US GAAP, reversal of all
impairment loss that was recognised. The impairment losses is prohibited.
Reversal of impairment
Individual asset – is recognised in the
income statement unless the asset is carried
at a revalued amount
CGU – is allocated to assets of CGU, follows
the same principles as for the allocation of an
impairment loss
Goodwill – No reversal of previous impairment
Internal Indicators
External Indicators
• Changes in the way the asset is used or expected
to be used
• Evidence from internal reporting indicates that
the economic performance of the asset will be
better than expected
• Significant increase in the market value
• Changes in technological, market, economic or
legal environment
• Changes in the interest rates
Given the economic turmoil and lack of concrete predictability on future business
prospects, more companies would re-evaluate goodwill and long-lived assets and
recognise that impairment losses are a very real prospect. While on the surface, it would
appear that there is a degree of similarity between US GAAP and IFRS in impairment
testing, the practical application of the underlying rules and substance coupled with
possibilities for a vast array of interpretations make this topic sensitive and challenging.
Testing for impairment is not to be considered as an ‘eye wash’ and should result in
depiction of the true business potential, in order to fairly reflect the operational reality
that underpin the commerce.
CONCLUSION
17 18
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
In the determination of the
expected future cash flows, can
a future restructuring, planned
future capital expenditure
/expansion be factored in to
arriving at the VIU or FVLCS?
For the purpose of discounting
the expected cash flows, is the
use of pre-tax /post-tax rate
appropriate? How is the pre-tax
discount rate determined?
What are the various ‘cross-
checks’ that are applied in
determining the reasonableness
of the VIU when a substantial
portion of the entity is tested for
impairment?
The recoverable amount must be estimated
based on the asset or group of assets’
current condition at the end of the reporting
period. For the purpose of calculating the
VIU, the entity must base cash the flow
projections on the most recent financial
forecasts approved by the management,
excluding any elements such as:
- external growth investments;
- capacity and performance investments;
however, cash flows include renewal
investments whose objective is to
maintain assets in their current
condition, net of disposals;
- the impact of a future restructuring to
which an enterprise is not yet
committed (neutralisation of future cash
outflows, related to cost savings and
expected advantages).
However, for the purpose of valuing
FVLCS when there is no binding sale
agreement and no active market, fair value
should be determined based on the best
information available to reflect the amount
that an entity could obtain at the reporting
date from the disposal of the asset in an
arm's length transaction between
knowledgeable, willing parties. The fair
value also reflects the market assessment of
expected net benefits to be derived from
restructuring the unit or from future capital
expenditure. Accordingly, the FVLCS
would generally consider including the cost
and the associated benefit on future
restructuring /planned capital expansions.
However, it is to be noted that Indian
GAAP as interpreted by an Expert Advisory
Committee does not support a market
participant based discounted cash flow
approach to determine FVLCS and
therefore, the effects of future restructuring
initiatives cannot be anticipated.
Future cash flows estimates should not
include inflows and outflows associated
with income tax. Consequently, IAS 36
requires that the entity uses a pre-tax
discount rate. When only the post-tax
discount rate is available, it must be
adjusted. Determination of a pre-tax
discount rate is generally not as simple as
grossing up the post-tax discount rate by a
standard tax rate, even in a situation where
the effective tax rate is identical to the
statutory tax rate. This can be linked to
factors such as a variable effective cash tax
rate over the forecast period because of, for
example, the utilisation of future tax losses
or taxable temporary differences relating to
the asset or CGU concerned. Therefore, the
standard indicates that, if the calculation is
carried out after tax, it is necessary to
determine, by an iterative process, the
inferred pre-tax rate. In practice, the
determination of a pre-tax rate is generally
difficult, and the rate used is a post-tax rate
which is permitted as long as this method
gives the same results as with a pre-tax rate.
In most cases, entities use a post-tax rate
applied to post-tax cash flows. The iterative
process, would involve first identifying the
discounted cash flow calculations using
post-tax cash flows and a post-tax discount
rate, and then by iteration determining what
the pre-tax discount rate would need to be
to cause the VIU determined using the pre-
tax cash flows and a pre-tax discount rate to
equal the VIU determined by the post-tax
discounted cash flow calculation.
In addition to performing sensitivity
analysis on key cash flow assumptions,
terminal value growth rates and the
discount rate generally, there are additional
cross-checks that are performed in testing
the reasonableness of a VIU calculation,
especially when a substantial portion of the
entity is tested for impairment, some of
these checks include:
- Comparison to market capitalisation
- Consideration of any recent offers made
to acquire the CGU or an asset
- Comparison to other recent valuations
performed for other purposes (i.e., for
tax reasons)
- Consideration on what analysts are
saying in their articles, reports and
briefings
- Comparison of the overall movement in
value in use and discount rates since the
last impairment test, to identify if it
makes sense
- Consideration as to how comparable a
company’s share prices have moved?
For example, if the CGU was acquired
close to the high points in equity
markets and there has been a large fall
in comparable companies’ share prices,
one might expect that the value in use
would show a lower value than the
acquisition price
- Reconciliation of the total fair value of
CGUs to total market capitalisation,
particularly if the market comparables
are used to value CGUs.
What are the circumstances for
reversal of a previously
recognised impairment loss?
Can impairment loss also be
reversed under the Indian and
US GAAP?
The standard (i.e., IAS 36) requires that at increase in carrying the value of assets
each reporting date an entity should assess shall not exceed the carrying amount that
whether there is an indication that a would have been determined (net of
previously recognised impairment loss has amortisation and depreciation) had no
reversed. If there is such an indication and impairment loss been recognised in prior
the recoverable amount of the impaired years.
asset or CGU subsequently increases, then The below approach is also contemplated
the impairment loss generally is reversed, under Indian GAAP. The difference relates
except those caused only by the unwinding to a reversal of impairment loss on
of the discount used in calculating the goodwill, which is permitted under limited
value in use. Reversal of the impairment circumstances, such as impairment loss
loss for goodwill is prohibited. Therefore, that arose because of a specific event of an
impairment loss shall be reversed if, and exceptional nature which is not expected
only if, there has been a change in the to recur and subsequent external events
estimates used to determine the assets have occurred that reverse the effect of
recoverable amounts since the last that event. Under US GAAP, reversal of all
impairment loss that was recognised. The impairment losses is prohibited.
Reversal of impairment
Individual asset – is recognised in the
income statement unless the asset is carried
at a revalued amount
CGU – is allocated to assets of CGU, follows
the same principles as for the allocation of an
impairment loss
Goodwill – No reversal of previous impairment
Internal Indicators
External Indicators
• Changes in the way the asset is used or expected
to be used
• Evidence from internal reporting indicates that
the economic performance of the asset will be
better than expected
• Significant increase in the market value
• Changes in technological, market, economic or
legal environment
• Changes in the interest rates
Given the economic turmoil and lack of concrete predictability on future business
prospects, more companies would re-evaluate goodwill and long-lived assets and
recognise that impairment losses are a very real prospect. While on the surface, it would
appear that there is a degree of similarity between US GAAP and IFRS in impairment
testing, the practical application of the underlying rules and substance coupled with
possibilities for a vast array of interpretations make this topic sensitive and challenging.
Testing for impairment is not to be considered as an ‘eye wash’ and should result in
depiction of the true business potential, in order to fairly reflect the operational reality
that underpin the commerce.
CONCLUSION
17 18
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Exposure Draft on AccountingStandard (AS) 3 (revised)
A discussion overview
Statement of cash flows
Managing the cash flow is indispensable for a successful
running and survival of any business. Every business is exposed
to a certain inherent risks. These risks typically include, but are
not limited to: credit risk, liquidity risk, market risk and
operational risk. All risks ultimately affect the profitability,
liquidity and cash flow position of the company.
Forecasting of cash flows thus becomes exceptionally essential
for assessing and sustaining the solvency of any company. It
enables the companies to understand and investigate the impact
of the changing business factors. It summarises expected
inflows and outflows of cash during a given period and it
counters the risk that the company is likely to face difficulty in
meeting the obligations associated with its financial liabilities
that are to be settled by delivering cash.
Statement of cash flows is a tool which To achieve convergence with International Flows as issued by the International
explains the actual year on year Financial Reporting Standards (IFRS), the Accounting Standards Board (IASB). We
performance of the Company, in terms of Institute of Chartered Accountants of India will also brief upon challenges faced by the
availability of cash at the beginning and at (ICAI) has issued Exposure Draft (ED) on companies who currently present
the end of each year. It helps in evaluating AS 3 (revised), Statement of Cash Flows. In information, say, for group reporting, etc.
the movement of cash within the this article, we aim to present an overview as per the US GAAP principles, as issued
organisation during a given period. It of the ED and to bring out the finer points by the Financial Accounting Standards
classifies the cash flows into operating, of difference between the current AS 3, Board (FASB), and wish to converge to
investing and financing activities. Cash Flow Statements, the ED as issued IFRS.
by the ICAI, and IAS 7, Statement of Cash
The position on the applicability of the ED on AS 3 should be clarified by
the regulatory authorities taking into consideration the roadmap and the
definition of SMC.
OUR COMMENTS
ScopeThe Central Government of India had vide The ED, however does not mention any for achieving convergence with IFRS by
notification no. G.S.R. 739(E) dated 7 such exemption from the applicability of companies on 22 January 2010. The
December 2006, issued the Companies the Standard. Para 3 of the ED specifically roadmap to convergence lays down a
(Accounting Standards) Rules, 2006 (‘the mentions that this Standard requires all phased approach to convergence by
Rules’) notifying the accounting standards entities to present a statement of cash companies, based on the listing and net
which became effective for accounting flows. IAS 7 also does not give any worth criteria. It further mentions, inter-alia,
periods commencing on or after 7 exemption to any company based on their that the existing Indian Accounting
December 2006. The current AS 3 as turnover, borrowing or net worth. This Standards would be applicable to
notified by the NACAS states that it is not raises a doubt whether, the ED will be companies, which do not get covered in
mandatory for Small and Medium Sized applicable to all companies including SMC either of the phases to convergence and to
Companies (SMC) as defined in the as defined. Small and Medium Companies. The
notification. notification has ,however, not revisited the In this regard, the Ministry of Corporate
definition of SMC.Affairs (MCA) has announced the roadmap
A statement of cash flows is presented by the cash receipts and payments with
classifying the cash flows into operating, attributes of more than one class of cash
investing and financing activities. As per IAS flows are classified based on the activity
7 the separate components of a single that is likely to be the predominant source
transaction are classified as operating, of the cash flows.
investing or financing. This is also the same
under the existing AS 3 and also the ED on
AS 3. However, the US GAAP provides that
Presentation of a statement of cash flow
“Cash flows are important key performance indicators and are
tracked by investors and creditors for making important decisions”
19 20
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Exposure Draft on AccountingStandard (AS) 3 (revised)
A discussion overview
Statement of cash flows
Managing the cash flow is indispensable for a successful
running and survival of any business. Every business is exposed
to a certain inherent risks. These risks typically include, but are
not limited to: credit risk, liquidity risk, market risk and
operational risk. All risks ultimately affect the profitability,
liquidity and cash flow position of the company.
Forecasting of cash flows thus becomes exceptionally essential
for assessing and sustaining the solvency of any company. It
enables the companies to understand and investigate the impact
of the changing business factors. It summarises expected
inflows and outflows of cash during a given period and it
counters the risk that the company is likely to face difficulty in
meeting the obligations associated with its financial liabilities
that are to be settled by delivering cash.
Statement of cash flows is a tool which To achieve convergence with International Flows as issued by the International
explains the actual year on year Financial Reporting Standards (IFRS), the Accounting Standards Board (IASB). We
performance of the Company, in terms of Institute of Chartered Accountants of India will also brief upon challenges faced by the
availability of cash at the beginning and at (ICAI) has issued Exposure Draft (ED) on companies who currently present
the end of each year. It helps in evaluating AS 3 (revised), Statement of Cash Flows. In information, say, for group reporting, etc.
the movement of cash within the this article, we aim to present an overview as per the US GAAP principles, as issued
organisation during a given period. It of the ED and to bring out the finer points by the Financial Accounting Standards
classifies the cash flows into operating, of difference between the current AS 3, Board (FASB), and wish to converge to
investing and financing activities. Cash Flow Statements, the ED as issued IFRS.
by the ICAI, and IAS 7, Statement of Cash
The position on the applicability of the ED on AS 3 should be clarified by
the regulatory authorities taking into consideration the roadmap and the
definition of SMC.
OUR COMMENTS
ScopeThe Central Government of India had vide The ED, however does not mention any for achieving convergence with IFRS by
notification no. G.S.R. 739(E) dated 7 such exemption from the applicability of companies on 22 January 2010. The
December 2006, issued the Companies the Standard. Para 3 of the ED specifically roadmap to convergence lays down a
(Accounting Standards) Rules, 2006 (‘the mentions that this Standard requires all phased approach to convergence by
Rules’) notifying the accounting standards entities to present a statement of cash companies, based on the listing and net
which became effective for accounting flows. IAS 7 also does not give any worth criteria. It further mentions, inter-alia,
periods commencing on or after 7 exemption to any company based on their that the existing Indian Accounting
December 2006. The current AS 3 as turnover, borrowing or net worth. This Standards would be applicable to
notified by the NACAS states that it is not raises a doubt whether, the ED will be companies, which do not get covered in
mandatory for Small and Medium Sized applicable to all companies including SMC either of the phases to convergence and to
Companies (SMC) as defined in the as defined. Small and Medium Companies. The
notification. notification has ,however, not revisited the In this regard, the Ministry of Corporate
definition of SMC.Affairs (MCA) has announced the roadmap
A statement of cash flows is presented by the cash receipts and payments with
classifying the cash flows into operating, attributes of more than one class of cash
investing and financing activities. As per IAS flows are classified based on the activity
7 the separate components of a single that is likely to be the predominant source
transaction are classified as operating, of the cash flows.
investing or financing. This is also the same
under the existing AS 3 and also the ED on
AS 3. However, the US GAAP provides that
Presentation of a statement of cash flow
“Cash flows are important key performance indicators and are
tracked by investors and creditors for making important decisions”
19 20
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Cash flows from operating
activities
financing. Typical examples of cash flows from operating activities may be presented
from the operating activities include: cash either by the direct or by the indirect
receipts from sale of goods or rendering of method, although the entities are
services, cash payments to suppliers of encouraged to follow a direct method.Cash flows from the operating activities are
material and services, cash receipts from primarily derived from the principal revenue Further, as per IAS 7 when using the
commission, etc. generating activities of the company. It also indirect method, the reconciliation begins
includes any activities which are not Like the existing AS 3, and the ED gives a with profit or loss, although practice varies
investing or financing. These signify the choice to the entities to report cash flows as to whether this is net profit or loss or,
extent to which the operations of the from operating activities using either the for example, profit or loss (i.e., before tax).
company have generated sufficient cash direct method or the indirect method. However, under the US GAAP, unlike IFRSs,
flows to repay loans, maintain the However, the ED specifically encourages when using the indirect method. It is
operating capability of the company, pay entities to use the direct method. This is in required that the reconciliation begin with
dividends and make new investments line with principles stated in IAS 7. Similarly, net income (net profit or loss).
without recourse to external sources of as per the US GAAP, like IFRSs, cash flows
Under IFRS, net cash flow information interest paid (net of capitalised interest)
attributable to operating, investing and from undistributed earnings, must be Interest and dividend received
financing activities of discontinued classified as operating activities.In this regard, there arises a question that operations also is required to be disclosed, whether interest and dividend received
Capitalised interesteither on the face of the statement of cash should be classified as operating or Another significant difference, in this regard flows or in the notes to the financial investing activities. The ED on AS 3 is the treatment of capitalised interest. statements. Whatever method of (revised) states that a financial institution IFRS do not contain specific guidance on presentation is chosen, the total cash flows should classify these as operating cash the classification of capitalised interest. In from each of operating, investing and flows. But for a non-financial company, our view, to the extent that borrowing financing activities, including both interest and dividends received should be costs are capitalised in respect of qualifying continuing and discontinued operations, classified as cash flows from investing assets, the costs of acquiring those assets must be disclosed on the face of the activities. IAS 7, however, does not make should be split in the statement of cash statement of cash flows. any such distinction and the entities can flows. Depending on the entity's
make an accounting policy choice of Unlike IFRSs, cash flow information for accounting policy on presenting the classifying interest and the dividend discontinued operations is not required to interest paid on the statement of cash received as cash flows from operating or be disclosed. Unlike IFRSs, when cash flow flows, the capitalised interest should be investing activities. US GAAP, however, information is reported for discontinued classified as operating or financing specifically states that interest and the operations, for the SEC registrants there activities. However, unlike IFRS, the US dividend received must be classified as are three alternatives: GAAP provides that the capitalised interest operating activities. must be classified as investing activities. • combine cash flows from discontinued
operations with cash flows from Bank overdrafts
continuing operations within each of IAS 7 and the ED has specifically
the operating, investing and financing mentioned, that bank overdrafts which are
categories;repayable on demand and which form an
• separately identify cash flows from integral part of an company’s cash The ED defines financing activities as, discontinued operations as a line item management, are included as part of cash activities that result in changes in the size within each category; or and cash equivalents. The existing AS 3 and composition of the contributed equity
was silent on this issue. Thus, till now by • present cash flows from discontinued and borrowings of the company. Cash
implication, bank overdrafts are in most operations separately with disclosure of flows from the financing activities typically
cases a part of the cash flows attributable operating, investing and financing include any additional funds raised by the
to financing activities since in India bank activities.company, say through issue of shares or
overdrafts are similar to cash-The existing Indian Accounting Standard borrowing from banks. It also includes cash
credits/advances against inventories/books 24, Discontinuing Operations, there does outflow in the form of repayment of debt,
debts. Unlike IAS 7 bank overdrafts under not deal with the concept of discontinued cash payments to owners to acquire or
the US GAAP are always included in operations. Rather, it defines discontinuing redeem the company’s shares, etc.
financing activities.operation as a major line of business or
geographical area of operations and can be
distinguished operationally and for financial
reporting purposes. However, the Exposure Interest and dividend paidDraft on AS 24 (revised), is in line with IFRS Similar to interest and dividend received as 5. mentioned above, IAS 7 allows an entity to
classify interest and dividend paid as
operating or financing activities by any
company, whether financial institution or
not. However, ED on AS 3 (revised)
mentions that a financial institution should
classify these as operating cash flows. But Investing activities relate to the acquisition for a non-financial company, interest and and disposal of long-term assets and other dividends paid should be classified as cash investments not included in cash flows from financing activities. The ED equivalents. Analysis of cash flows from explains that this is so because the interest investing activities is essential for and dividend paid are the costs of obtaining understanding the use of cash for capital financial resources. Similar to the ED, expenditure. This disclosure helps ensure under the US GAAP, the dividends paid proper maintenance of and additions to, a must be classified as financing activities. company’s physical assets to support its However, the US GAAP provides that the efficient operation and competitiveness.
Cash flows from financing
activities
Cash flows from investing
activities
Specific classification issues
Specific classification issues
Specific classification issues on the classification of tax benefits of cash flows associated with extraordinary
associated with share-based payments, items. This is in line with the issuance of Cash payments for assets held for rental and practice varies. However, unlike IFRS, ED on AS 5 (revised), Accounting Policies, to others the US GAAP provides that all income Changes in Accounting Estimates and The ED has explained that although the taxes, with the exception of excess tax Errors, and ED on AS 1, Presentation of cash proceeds from one sale of items like benefits recognised in paid-in capital Financial Statements, which prohibit property, plant and equipment and cash related to share-based payments, should presentation of extraordinary items of payment for acquisition of items of plant be classified as operating activities. Cash income or expense in the statement of are classified as investing activities, all cash flows related to the excess tax benefits comprehensive income. Under the US payments to manufacture or acquire assets recognised in the paid-in capital for share- GAAP though, unlike IFRS, the are held for rental to others and based payments are classified as financing presentation of certain items as subsequently held for sale in the ordinary activities, which may differ from practice "extraordinary items" is required. An course of business are cash flows from under IFRS. extraordinary item is one that is both operating activities. Similarly, the cash unusual in nature and infrequent in
Extraordinary itemsreceipts from rents and subsequent sales occurrence.Further, the existing AS 3 deals with the of such assets are also cash flows from
presentation of extraordinary items and Discontinued operationsoperating activities. The existing AS 3 does
states that the cash flows associated with As per IFRS 5, Non-current assets held for not deliberate this issue. The US GAAP
extraordinary items should be classified as sale and discontinued operations, a provides, that unlike IAS 7 only cash flows
arising from operating, investing or discontinued operation is limited to those from the sale or disposal of equipment that
financing activities as appropriate and operations that are a separate major line of was rented to others for a short period of
separately disclosed. The existing AS 5, Net business or geographical area, and time prior to the sale or disposal are
Profit or Loss for the Period, Prior Period subsidiaries acquired exclusively with a classified as operating activities, as are the
Items and Changes in Accounting Policies, view to resale. The results of discontinued cash flows related to the manufacture or
defines extraordinary items as income or operations are presented separately in the acquisition of such assets.
expenses that arise from events or statement of comprehensive income, and Income taxes transactions that are clearly distinct from cash flow information is disclosed. The Under IFRS, income taxes are classified as the ordinary activities of the enterprise and, comparative statement of comprehensive operating activities, unless it is practicable therefore, are not expected to recur income and cash flow information is re-to identify with them, and therefore, frequently or regularly. The ED on AS 3 presented for discontinued operations.classify them as, financing or investing (revised), however, prohibits presentation activities. IFRS does not contain guidance
In India, the listed companies are required by the Securities and Exchange Board of India (SEBI) guidelines to present
the statement of cash flows only under an indirect method. As required by the Insurance Regulatory and Development
Authority (IRDA) guidelines, insurance companies are required to use the direct method. Thus, to this extent there is a
requirement to align the various statutes governing a company.
OUR COMMENTS
21 22
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Cash flows from operating
activities
financing. Typical examples of cash flows from operating activities may be presented
from the operating activities include: cash either by the direct or by the indirect
receipts from sale of goods or rendering of method, although the entities are
services, cash payments to suppliers of encouraged to follow a direct method.Cash flows from the operating activities are
material and services, cash receipts from primarily derived from the principal revenue Further, as per IAS 7 when using the
commission, etc. generating activities of the company. It also indirect method, the reconciliation begins
includes any activities which are not Like the existing AS 3, and the ED gives a with profit or loss, although practice varies
investing or financing. These signify the choice to the entities to report cash flows as to whether this is net profit or loss or,
extent to which the operations of the from operating activities using either the for example, profit or loss (i.e., before tax).
company have generated sufficient cash direct method or the indirect method. However, under the US GAAP, unlike IFRSs,
flows to repay loans, maintain the However, the ED specifically encourages when using the indirect method. It is
operating capability of the company, pay entities to use the direct method. This is in required that the reconciliation begin with
dividends and make new investments line with principles stated in IAS 7. Similarly, net income (net profit or loss).
without recourse to external sources of as per the US GAAP, like IFRSs, cash flows
Under IFRS, net cash flow information interest paid (net of capitalised interest)
attributable to operating, investing and from undistributed earnings, must be Interest and dividend received
financing activities of discontinued classified as operating activities.In this regard, there arises a question that operations also is required to be disclosed, whether interest and dividend received
Capitalised interesteither on the face of the statement of cash should be classified as operating or Another significant difference, in this regard flows or in the notes to the financial investing activities. The ED on AS 3 is the treatment of capitalised interest. statements. Whatever method of (revised) states that a financial institution IFRS do not contain specific guidance on presentation is chosen, the total cash flows should classify these as operating cash the classification of capitalised interest. In from each of operating, investing and flows. But for a non-financial company, our view, to the extent that borrowing financing activities, including both interest and dividends received should be costs are capitalised in respect of qualifying continuing and discontinued operations, classified as cash flows from investing assets, the costs of acquiring those assets must be disclosed on the face of the activities. IAS 7, however, does not make should be split in the statement of cash statement of cash flows. any such distinction and the entities can flows. Depending on the entity's
make an accounting policy choice of Unlike IFRSs, cash flow information for accounting policy on presenting the classifying interest and the dividend discontinued operations is not required to interest paid on the statement of cash received as cash flows from operating or be disclosed. Unlike IFRSs, when cash flow flows, the capitalised interest should be investing activities. US GAAP, however, information is reported for discontinued classified as operating or financing specifically states that interest and the operations, for the SEC registrants there activities. However, unlike IFRS, the US dividend received must be classified as are three alternatives: GAAP provides that the capitalised interest operating activities. must be classified as investing activities. • combine cash flows from discontinued
operations with cash flows from Bank overdrafts
continuing operations within each of IAS 7 and the ED has specifically
the operating, investing and financing mentioned, that bank overdrafts which are
categories;repayable on demand and which form an
• separately identify cash flows from integral part of an company’s cash The ED defines financing activities as, discontinued operations as a line item management, are included as part of cash activities that result in changes in the size within each category; or and cash equivalents. The existing AS 3 and composition of the contributed equity
was silent on this issue. Thus, till now by • present cash flows from discontinued and borrowings of the company. Cash
implication, bank overdrafts are in most operations separately with disclosure of flows from the financing activities typically
cases a part of the cash flows attributable operating, investing and financing include any additional funds raised by the
to financing activities since in India bank activities.company, say through issue of shares or
overdrafts are similar to cash-The existing Indian Accounting Standard borrowing from banks. It also includes cash
credits/advances against inventories/books 24, Discontinuing Operations, there does outflow in the form of repayment of debt,
debts. Unlike IAS 7 bank overdrafts under not deal with the concept of discontinued cash payments to owners to acquire or
the US GAAP are always included in operations. Rather, it defines discontinuing redeem the company’s shares, etc.
financing activities.operation as a major line of business or
geographical area of operations and can be
distinguished operationally and for financial
reporting purposes. However, the Exposure Interest and dividend paidDraft on AS 24 (revised), is in line with IFRS Similar to interest and dividend received as 5. mentioned above, IAS 7 allows an entity to
classify interest and dividend paid as
operating or financing activities by any
company, whether financial institution or
not. However, ED on AS 3 (revised)
mentions that a financial institution should
classify these as operating cash flows. But Investing activities relate to the acquisition for a non-financial company, interest and and disposal of long-term assets and other dividends paid should be classified as cash investments not included in cash flows from financing activities. The ED equivalents. Analysis of cash flows from explains that this is so because the interest investing activities is essential for and dividend paid are the costs of obtaining understanding the use of cash for capital financial resources. Similar to the ED, expenditure. This disclosure helps ensure under the US GAAP, the dividends paid proper maintenance of and additions to, a must be classified as financing activities. company’s physical assets to support its However, the US GAAP provides that the efficient operation and competitiveness.
Cash flows from financing
activities
Cash flows from investing
activities
Specific classification issues
Specific classification issues
Specific classification issues on the classification of tax benefits of cash flows associated with extraordinary
associated with share-based payments, items. This is in line with the issuance of Cash payments for assets held for rental and practice varies. However, unlike IFRS, ED on AS 5 (revised), Accounting Policies, to others the US GAAP provides that all income Changes in Accounting Estimates and The ED has explained that although the taxes, with the exception of excess tax Errors, and ED on AS 1, Presentation of cash proceeds from one sale of items like benefits recognised in paid-in capital Financial Statements, which prohibit property, plant and equipment and cash related to share-based payments, should presentation of extraordinary items of payment for acquisition of items of plant be classified as operating activities. Cash income or expense in the statement of are classified as investing activities, all cash flows related to the excess tax benefits comprehensive income. Under the US payments to manufacture or acquire assets recognised in the paid-in capital for share- GAAP though, unlike IFRS, the are held for rental to others and based payments are classified as financing presentation of certain items as subsequently held for sale in the ordinary activities, which may differ from practice "extraordinary items" is required. An course of business are cash flows from under IFRS. extraordinary item is one that is both operating activities. Similarly, the cash unusual in nature and infrequent in
Extraordinary itemsreceipts from rents and subsequent sales occurrence.Further, the existing AS 3 deals with the of such assets are also cash flows from
presentation of extraordinary items and Discontinued operationsoperating activities. The existing AS 3 does
states that the cash flows associated with As per IFRS 5, Non-current assets held for not deliberate this issue. The US GAAP
extraordinary items should be classified as sale and discontinued operations, a provides, that unlike IAS 7 only cash flows
arising from operating, investing or discontinued operation is limited to those from the sale or disposal of equipment that
financing activities as appropriate and operations that are a separate major line of was rented to others for a short period of
separately disclosed. The existing AS 5, Net business or geographical area, and time prior to the sale or disposal are
Profit or Loss for the Period, Prior Period subsidiaries acquired exclusively with a classified as operating activities, as are the
Items and Changes in Accounting Policies, view to resale. The results of discontinued cash flows related to the manufacture or
defines extraordinary items as income or operations are presented separately in the acquisition of such assets.
expenses that arise from events or statement of comprehensive income, and Income taxes transactions that are clearly distinct from cash flow information is disclosed. The Under IFRS, income taxes are classified as the ordinary activities of the enterprise and, comparative statement of comprehensive operating activities, unless it is practicable therefore, are not expected to recur income and cash flow information is re-to identify with them, and therefore, frequently or regularly. The ED on AS 3 presented for discontinued operations.classify them as, financing or investing (revised), however, prohibits presentation activities. IFRS does not contain guidance
In India, the listed companies are required by the Securities and Exchange Board of India (SEBI) guidelines to present
the statement of cash flows only under an indirect method. As required by the Insurance Regulatory and Development
Authority (IRDA) guidelines, insurance companies are required to use the direct method. Thus, to this extent there is a
requirement to align the various statutes governing a company.
OUR COMMENTS
21 22
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Summary
The ED is a step towards convergence to IFRS and there
are limited changes brought about by the ED to the
current standard.
The ED has also brought certain changes to align the ED
with exposure drafts on other standards. For example, it
has included additional guidance on classification of cash
flows from changes in ownership interest in subsidiaries,
use of exchange rate between functional currency and
foreign currency at the date of cash flow for translation of
cash flows of a foreign subsidiary.
Also, the ED has certain additional disclosure
requirements. In respect of both obtaining and losing
control of subsidiaries or other businesses during the
period, a company shall also disclose, inter-alia, in
aggregate, the amount of cash and cash equivalents in the
subsidiaries or other businesses over which control is
obtained or lost; and the amount of the assets and
liabilities other than cash or cash equivalents in the
subsidiaries or other businesses over which control is
obtained or lost, summarised by each major category.
Apart from the mandatory disclosures, the ED encourages
the disclosure of certain additional information along with
management commentary. The ED has added disclosure
of amount of the cash flow arising from operating,
investing and financing activities of each reportable
segment in this category. Further the aggregate amounts
of cash flows from each of the operating, investing and
financing activities related to interests in joint ventures
reported using proportionate consolidation is encouraged.
Regulatory Updates
Amendment to Equity Listing Agreement of SEBI-
(An amendment to Clause 41)
Synopsis of the RBI Guidelines on the matters to be
disclosed in the Notes to Accounts – for financial
statements prepared by the Bank
Corporate governance and NBFC (Non-Banking
Financial Companies) – road to a greater
transparency
e. NBFCs shall frame their internal guidelines on corporate
governance, enhancing the scope of the guidelines without
sacrificing the spirit underlying the above guidelines and it shall
As per the Amendment to Equity Listing Agreement the Company be published on the company’s web-site, if any, for the
has the following options with respect to submitting of financials to information of various stakeholders.
the stock exchange:The partner/s of the Chartered Accountant firm conducting the
• Submit audited financial results (standalone and consolidated audit of NBFCs with deposits /public deposits of INR 50 crore and
financials) for the entire financial year within 60 days of the end above should be rotated every three years so that the same partner
of the financial year and intimate the stock exchange in writing does not conduct audit of the company continuously for more than
within 45 days of end of the financial year, the exercise of this a period of three years. However, the partner so rotated will be
option or eligible for conducting the audit of the NBFC after an interval of
three years, if the NBFC, so decides. Companies may incorporate • The company can submit unaudited financial results (standalone
appropriate terms in the letter of appointment of the firm of and consolidated financials) for the last quarter and year within
auditors and ensure its compliance.45 days of end of the financial year. Such un-audited financial
results for the last quarter and year is subject to limited review
by the statutory auditors of the company and a copy of the
limited review report should be furnished to the stock exchange
within 45 days from the end of the year. However, the company
is also required to submit audited financial results for the entire
financial year, as soon as they are approved by the Board.
The guidelines under Section 35A of the Banking Regulation Act,
1949 states that 'Summary of Significant Accounting Policies' and
'Notes to Accounts' may be included under Schedule 17 and
Schedule 18, respectively to maintain uniformity. It also requires
disclosures to be furnished in the “Notes to Accounts” which are
summarised below:
CapitalListed NBFCs which are required to adhere to listing agreement
• Capital – provide details on CRAR (%), CRAR – Tier I Capital (%), and rules framed by the SEBI on Corporate Governance are
CRAR – Tier II Capital (%), Percentage of the shareholding of required to comply with the SEBI prescriptions on Corporate
the Government of India in nationalised banks, amount raised by Governance.
issue of IPDI, amount raised by issue of upper tier II In order to adopt best practices and greater transparency in their instruments.operations, the Board of Directors of all Deposit taking NBFCs with
Investmentsdeposit size of INR 20 crore and above and all non-deposit taking
NBFCs with an asset size of INR 100 crore and above (NBFC-ND-• Disclose the value of investments in India and outside India on
SI), on the date of the last audited balance sheet are proposed to gross value of investments, provision for depreciation and net
considervalue of investments. Also provide a movement of provisions
a. Constitution of audit committee; held towards depreciation on investments
• Repo Transactions (in face value terms) - disclose minimum b. Constitution of nomination committee for appointment of
outstanding during the year, maximum outstanding during the directors;
year, daily average outstanding during the year and outstanding c. Constitution of Risk Management Committee;
as on 31 March for securities sold under repo and securities d. Disclosure and transparency – NBFC must brief to its Board of purchased under reverse repo (disclose separately for
Directors at a regular interval about progress made in putting in government securities and corporate debt securities)place a progressive risk management system and risk
• Non-SLR Investment Portfolio – issuer composition of Non-SLR management policy and strategy followed. Disclosure of
Investment with details of amount, extent of private placement, conformity with corporate governance standards viz. in
extent of ‘Below Investment Grade’ Securities, extent of composition of various committees, their role and functions,
‘Unrated Securities’, Extent of ‘Unlisted Securities’. Discloser for periodicity of the meetings and compliance with coverage and
Non performing Non-SLR investments.review functions, etc.
(Source: RBI Master Circular - RBI / 2010-11/27)
(Source: Circular dated 5 April 2010 issued by Securities and Exchange Board
of India (SEBI))
23 24
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Summary
The ED is a step towards convergence to IFRS and there
are limited changes brought about by the ED to the
current standard.
The ED has also brought certain changes to align the ED
with exposure drafts on other standards. For example, it
has included additional guidance on classification of cash
flows from changes in ownership interest in subsidiaries,
use of exchange rate between functional currency and
foreign currency at the date of cash flow for translation of
cash flows of a foreign subsidiary.
Also, the ED has certain additional disclosure
requirements. In respect of both obtaining and losing
control of subsidiaries or other businesses during the
period, a company shall also disclose, inter-alia, in
aggregate, the amount of cash and cash equivalents in the
subsidiaries or other businesses over which control is
obtained or lost; and the amount of the assets and
liabilities other than cash or cash equivalents in the
subsidiaries or other businesses over which control is
obtained or lost, summarised by each major category.
Apart from the mandatory disclosures, the ED encourages
the disclosure of certain additional information along with
management commentary. The ED has added disclosure
of amount of the cash flow arising from operating,
investing and financing activities of each reportable
segment in this category. Further the aggregate amounts
of cash flows from each of the operating, investing and
financing activities related to interests in joint ventures
reported using proportionate consolidation is encouraged.
Regulatory Updates
Amendment to Equity Listing Agreement of SEBI-
(An amendment to Clause 41)
Synopsis of the RBI Guidelines on the matters to be
disclosed in the Notes to Accounts – for financial
statements prepared by the Bank
Corporate governance and NBFC (Non-Banking
Financial Companies) – road to a greater
transparency
e. NBFCs shall frame their internal guidelines on corporate
governance, enhancing the scope of the guidelines without
sacrificing the spirit underlying the above guidelines and it shall
As per the Amendment to Equity Listing Agreement the Company be published on the company’s web-site, if any, for the
has the following options with respect to submitting of financials to information of various stakeholders.
the stock exchange:The partner/s of the Chartered Accountant firm conducting the
• Submit audited financial results (standalone and consolidated audit of NBFCs with deposits /public deposits of INR 50 crore and
financials) for the entire financial year within 60 days of the end above should be rotated every three years so that the same partner
of the financial year and intimate the stock exchange in writing does not conduct audit of the company continuously for more than
within 45 days of end of the financial year, the exercise of this a period of three years. However, the partner so rotated will be
option or eligible for conducting the audit of the NBFC after an interval of
three years, if the NBFC, so decides. Companies may incorporate • The company can submit unaudited financial results (standalone
appropriate terms in the letter of appointment of the firm of and consolidated financials) for the last quarter and year within
auditors and ensure its compliance.45 days of end of the financial year. Such un-audited financial
results for the last quarter and year is subject to limited review
by the statutory auditors of the company and a copy of the
limited review report should be furnished to the stock exchange
within 45 days from the end of the year. However, the company
is also required to submit audited financial results for the entire
financial year, as soon as they are approved by the Board.
The guidelines under Section 35A of the Banking Regulation Act,
1949 states that 'Summary of Significant Accounting Policies' and
'Notes to Accounts' may be included under Schedule 17 and
Schedule 18, respectively to maintain uniformity. It also requires
disclosures to be furnished in the “Notes to Accounts” which are
summarised below:
CapitalListed NBFCs which are required to adhere to listing agreement
• Capital – provide details on CRAR (%), CRAR – Tier I Capital (%), and rules framed by the SEBI on Corporate Governance are
CRAR – Tier II Capital (%), Percentage of the shareholding of required to comply with the SEBI prescriptions on Corporate
the Government of India in nationalised banks, amount raised by Governance.
issue of IPDI, amount raised by issue of upper tier II In order to adopt best practices and greater transparency in their instruments.operations, the Board of Directors of all Deposit taking NBFCs with
Investmentsdeposit size of INR 20 crore and above and all non-deposit taking
NBFCs with an asset size of INR 100 crore and above (NBFC-ND-• Disclose the value of investments in India and outside India on
SI), on the date of the last audited balance sheet are proposed to gross value of investments, provision for depreciation and net
considervalue of investments. Also provide a movement of provisions
a. Constitution of audit committee; held towards depreciation on investments
• Repo Transactions (in face value terms) - disclose minimum b. Constitution of nomination committee for appointment of
outstanding during the year, maximum outstanding during the directors;
year, daily average outstanding during the year and outstanding c. Constitution of Risk Management Committee;
as on 31 March for securities sold under repo and securities d. Disclosure and transparency – NBFC must brief to its Board of purchased under reverse repo (disclose separately for
Directors at a regular interval about progress made in putting in government securities and corporate debt securities)place a progressive risk management system and risk
• Non-SLR Investment Portfolio – issuer composition of Non-SLR management policy and strategy followed. Disclosure of
Investment with details of amount, extent of private placement, conformity with corporate governance standards viz. in
extent of ‘Below Investment Grade’ Securities, extent of composition of various committees, their role and functions,
‘Unrated Securities’, Extent of ‘Unlisted Securities’. Discloser for periodicity of the meetings and compliance with coverage and
Non performing Non-SLR investments.review functions, etc.
(Source: RBI Master Circular - RBI / 2010-11/27)
(Source: Circular dated 5 April 2010 issued by Securities and Exchange Board
of India (SEBI))
23 24
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Derivatives disclosures, wherever warranted, may be made in the ‘Notes to
Accounts’ to the balance sheet of banks.• Forward Rate Agreement/Interest Rate Swap – disclose the
notional principal of swap agreements, losses which would be Accounting Standard 9 – An enterprise should disclose the
incurred if the counterparties failed to fulfill their obligations circumstances in which revenue recognition have been postponed
under the agreement, collateral required by the bank upon pending the resolution of significant uncertainties.
entering into swaps, concentration of credit risk arising from the Accounting Standard 17 – While complying with the above swaps, the fair value of the swap book. Nature and terms of the Accounting Standard, banks are required to adopt the followingswaps including information on credit and market risk and the
accounting policies adopted for recording the swaps should also • The business segment should ordinarily be considered as the
be disclosed. primary reporting format and geographical segment would be
the secondary reporting format• Exchange Traded Interest Rate Derivatives – give instrument
wise details on notional principal amount undertaken during the • The business segments will be Treasury, Corporate/Wholesale
year, notional principal amount outstanding as on 31 March, Banking, Retail Banking and Other banking operations
notional principal amount outstanding and not ‘highly effective’, • Domestic and International segments will be the geographic mark-to-market value of outstanding and not ‘highly effective’. segments for disclosure.
• Disclosures on risk exposure in derivatives – provide qualitative Accounting Standard 18 – The illustrative disclosure format and quantitative details.recommended by the ICAI as a part of General Clarification (GC)
Asset quality 2/2002 has been suitably modified to suit banks. For illustrative
format refer to the master circular.• Non-Performing Assets – Disclose the opening balance, the
addition made during the year, reduction during the year and Accounting Standard 21 – A parent company, presenting the
closing balance for the movement of NPAs (Gross), movement Consolidated Financial Statements (CFS), should consolidate the
of net NPAs and movement of provisions for NPAs. Also financial statements of all subsidiaries - domestic as well as foreign,
disclose the ratio of net NPAs to Net Advances. except those specifically permitted to be excluded under the AS-21.
The reasons for not consolidating a subsidiary should be disclosed • Particulars of Accounts Restructured – Disclose the no. of in the CFS. The responsibility of determining whether a particular borrowers, amount outstanding and sacrifice (diminution in the entity should be included or not for consolidation would be that of fair value) on standard advance restructured, sub-standard the Management of the parent entity. In case, its Statutory Auditors advances restructured and doubtful advance restructured.are of the opinion that an entity, which ought to have been
• Details of financial assets sold to Securitisation/Reconstruction consolidated, has been omitted, they should incorporate their
Company for Asset Reconstructioncomments in this regard in the Auditors Report.
• Details of non-performing financial assets purchased/sold from Accounting Standard 22 – Deferred tax assets and liabilities may other banksbe created by banks based on the criteria met by banks mentioned
• Provision on Standard Assets - Provisions towards Standard in Master Circular.
Assets need not be netted from gross advances but shown
separately as 'Provisions against Standard Assets', under 'Other Accounting Standard 23 – A bank may acquire more than 20 Liabilities and Provisions - Others' in Schedule No. 5 of the percent of voting power in the borrower entity in satisfaction of its balance sheet. advances and it may be able to demonstrate that it does not have
the power to exercise significant influence since the rights Business ratios – On Interest Income as a percentage to Working
exercised by it are protective in nature and not participative. In such Fund, Non-interest income as a percentage to Working Funds,
a circumstance, such investment may not be treated as investment Operating Profit as a percentage to Working Funds, Return on
in associate under this Accounting Standard. Hence, the test should Assets, Business (Deposits plus advances) per employee, Profit per
not be merely the proportion of investment, but the intention to employee.
acquire the power to exercise significant influence.
Asset liability management – Maturity pattern of assets and Accounting Standard 24 – Merger/closure of branches of banks
liabilities – deposits, advances, investments, borrowings, foreign by transferring the assets/liabilities to the other branches of the
currency assets and foreign currency liabilities.same bank may not be deemed as a discontinuing operation and
hence, this Accounting Standard will not be applicable to Exposures – Provide disclosure on Exposure to Real Estate Sector, merger/closure of branches of banks by transferring the Exposure to Capital Market, Risk Category wise Country Exposure, assets/liabilities to the other branches of the same bank. Details of Single Borrower Limit (SGL)/Group Borrower Limit (GBL) Disclosures would be required under the Standard only when
exceeded by the bank, Unsecured Advances.discontinuing of the operation has resulted in shedding of liability
and realisation of the assets by the bank or the decision to Other disclosures – Amount of Provisions made for Income-tax
discontinue an operation which will have the above effect that has during the year and Disclosure of Penalties imposed by the RBI.
been finalised by the bank and the discontinued operation is The RBI requirements vis-à-vis disclosure Requirements as per substantial in its entirety.Accounting Standards issued by the ICAI
Accounting Standard 25 - The half yearly review prescribed by the Accounting Standard 5 – As per Banking Regulation Act 1949 RBI for public sector banks, in consultation with SEBI, is extended banks follow a format for the profit and loss account, which does to all banks. Banks may adopt the format prescribed by the RBI for not specifically provide for disclosure of the impact of prior period the purpose of half yearly review.
items on the current year’s profit and loss. However such (Source :RBI Master Circular - RBI / 2010-11/41)
EAC opinions project/asset could not be brought to its working condition, such as,
site preparation costs, installation costs, salaries of engineers
Virtual certainty in respect of deferred tax assets (ICAI Journal engaged in construction activities, etc. The Committee is of the May 2010) view that it should be seen that whether the expenses incurred on
Summarised below is the opinion given by the Expert Advisory the activities of the various departments are directly attributable to
Committee of the Institute in response to a query sent by a the construction. Accordingly, if the expenses incurred at the
member in relation to determining virtual certainty in respect of various departments are directly attributable to construction, these
deferred tax assets in situations where unabsorbed depreciation can be capitalised with the cost of the concerned fixed
and losses exist: asset(s)/project(s). As regards basis of allocation of the expenses of
these departments that can be allocated and capitalised to various The Committee is of the view that the orders secured by the
projects or assets under construction, the Committee is of the view company, may be considered while creating deferred tax asset
that the same should be allocated selecting an appropriate basis provided these are binding on the other party and it can be
that reflects the extent of usage of service rendered by the demonstrated that they will result in future taxable income.
department to the construction of the project.However, mere projections made by the company indicating the
earning of profits from future orders, or financial restructuring
proposal under consideration of the Government of India or the fact
that the books of account of the company are prepared on ‘going
concern’ basis, may not be considered as convincing evidence of
virtual certainty as contemplated in the ‘Explanation’ to paragraph
17 of AS 22 reproduced above Further, the mere fact that the items
covered under section 43B of the Income-tax Act, 1961, the
provision for liquidated damages, doubtful advances, guarantee
repairs and other contingencies, and unabsorbed depreciation can
be carried forward for an unlimited number of years, can also not
be a ground for recognising a deferred tax asset, since paragraph 17
of AS 22 read with its ‘Explanation’, requires virtual certainty
supported by convincing evidence at the date of the balance sheet.
The Committee also pointed out that a deferred tax asset can be
created to the extent that the future taxable income will be
available from future reversal of any deferred tax liability recognised
at the balance sheet date. To that extent, it would not be necessary
to consider the level of virtual certainty supported by convincing
evidence.
Capitalisation of expenditures in respect of projects under
construction (ICAI Journal June 2010)
With the withdrawal of “Guidance Note on Treatment of
Expenditure During Construction Period” by the ICAI, the
accounting is to be done as per AS 10, which stipulates that
administration and other general overhead expenses are usually
excluded from the cost of fixed assets since they do not relate to a
specific fixed asset. In some circumstances, such expenses as are
specifically attributable to construction of a project or to the
acquisition of a fixed asset or bringing it to its working condition,
may be included as part of the cost of the construction project or as
a part of the cost of the fixed asset. However, there was confusion
whether allocation of certain expenses which are incurred in
common or at corporate level is allowed under AS 10.
The Committee is of the view that the basic principle to be applied
while capitalising an item of cost to a fixed asset/project under
construction/expansion is that it should be directly attributable to
the construction of the project/fixed asset for bringing it to its
working condition for its intended use. The costs that are directly
attributable to the construction/acquisition of a fixed asset/project
for bringing it to its working condition are those costs that would
have been avoided if the construction/acquisition had not been
made. These are the expenditures without the incurrence of which,
the construction of project/asset could not have taken place and the
25 26
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Derivatives disclosures, wherever warranted, may be made in the ‘Notes to
Accounts’ to the balance sheet of banks.• Forward Rate Agreement/Interest Rate Swap – disclose the
notional principal of swap agreements, losses which would be Accounting Standard 9 – An enterprise should disclose the
incurred if the counterparties failed to fulfill their obligations circumstances in which revenue recognition have been postponed
under the agreement, collateral required by the bank upon pending the resolution of significant uncertainties.
entering into swaps, concentration of credit risk arising from the Accounting Standard 17 – While complying with the above swaps, the fair value of the swap book. Nature and terms of the Accounting Standard, banks are required to adopt the followingswaps including information on credit and market risk and the
accounting policies adopted for recording the swaps should also • The business segment should ordinarily be considered as the
be disclosed. primary reporting format and geographical segment would be
the secondary reporting format• Exchange Traded Interest Rate Derivatives – give instrument
wise details on notional principal amount undertaken during the • The business segments will be Treasury, Corporate/Wholesale
year, notional principal amount outstanding as on 31 March, Banking, Retail Banking and Other banking operations
notional principal amount outstanding and not ‘highly effective’, • Domestic and International segments will be the geographic mark-to-market value of outstanding and not ‘highly effective’. segments for disclosure.
• Disclosures on risk exposure in derivatives – provide qualitative Accounting Standard 18 – The illustrative disclosure format and quantitative details.recommended by the ICAI as a part of General Clarification (GC)
Asset quality 2/2002 has been suitably modified to suit banks. For illustrative
format refer to the master circular.• Non-Performing Assets – Disclose the opening balance, the
addition made during the year, reduction during the year and Accounting Standard 21 – A parent company, presenting the
closing balance for the movement of NPAs (Gross), movement Consolidated Financial Statements (CFS), should consolidate the
of net NPAs and movement of provisions for NPAs. Also financial statements of all subsidiaries - domestic as well as foreign,
disclose the ratio of net NPAs to Net Advances. except those specifically permitted to be excluded under the AS-21.
The reasons for not consolidating a subsidiary should be disclosed • Particulars of Accounts Restructured – Disclose the no. of in the CFS. The responsibility of determining whether a particular borrowers, amount outstanding and sacrifice (diminution in the entity should be included or not for consolidation would be that of fair value) on standard advance restructured, sub-standard the Management of the parent entity. In case, its Statutory Auditors advances restructured and doubtful advance restructured.are of the opinion that an entity, which ought to have been
• Details of financial assets sold to Securitisation/Reconstruction consolidated, has been omitted, they should incorporate their
Company for Asset Reconstructioncomments in this regard in the Auditors Report.
• Details of non-performing financial assets purchased/sold from Accounting Standard 22 – Deferred tax assets and liabilities may other banksbe created by banks based on the criteria met by banks mentioned
• Provision on Standard Assets - Provisions towards Standard in Master Circular.
Assets need not be netted from gross advances but shown
separately as 'Provisions against Standard Assets', under 'Other Accounting Standard 23 – A bank may acquire more than 20 Liabilities and Provisions - Others' in Schedule No. 5 of the percent of voting power in the borrower entity in satisfaction of its balance sheet. advances and it may be able to demonstrate that it does not have
the power to exercise significant influence since the rights Business ratios – On Interest Income as a percentage to Working
exercised by it are protective in nature and not participative. In such Fund, Non-interest income as a percentage to Working Funds,
a circumstance, such investment may not be treated as investment Operating Profit as a percentage to Working Funds, Return on
in associate under this Accounting Standard. Hence, the test should Assets, Business (Deposits plus advances) per employee, Profit per
not be merely the proportion of investment, but the intention to employee.
acquire the power to exercise significant influence.
Asset liability management – Maturity pattern of assets and Accounting Standard 24 – Merger/closure of branches of banks
liabilities – deposits, advances, investments, borrowings, foreign by transferring the assets/liabilities to the other branches of the
currency assets and foreign currency liabilities.same bank may not be deemed as a discontinuing operation and
hence, this Accounting Standard will not be applicable to Exposures – Provide disclosure on Exposure to Real Estate Sector, merger/closure of branches of banks by transferring the Exposure to Capital Market, Risk Category wise Country Exposure, assets/liabilities to the other branches of the same bank. Details of Single Borrower Limit (SGL)/Group Borrower Limit (GBL) Disclosures would be required under the Standard only when
exceeded by the bank, Unsecured Advances.discontinuing of the operation has resulted in shedding of liability
and realisation of the assets by the bank or the decision to Other disclosures – Amount of Provisions made for Income-tax
discontinue an operation which will have the above effect that has during the year and Disclosure of Penalties imposed by the RBI.
been finalised by the bank and the discontinued operation is The RBI requirements vis-à-vis disclosure Requirements as per substantial in its entirety.Accounting Standards issued by the ICAI
Accounting Standard 25 - The half yearly review prescribed by the Accounting Standard 5 – As per Banking Regulation Act 1949 RBI for public sector banks, in consultation with SEBI, is extended banks follow a format for the profit and loss account, which does to all banks. Banks may adopt the format prescribed by the RBI for not specifically provide for disclosure of the impact of prior period the purpose of half yearly review.
items on the current year’s profit and loss. However such (Source :RBI Master Circular - RBI / 2010-11/41)
EAC opinions project/asset could not be brought to its working condition, such as,
site preparation costs, installation costs, salaries of engineers
Virtual certainty in respect of deferred tax assets (ICAI Journal engaged in construction activities, etc. The Committee is of the May 2010) view that it should be seen that whether the expenses incurred on
Summarised below is the opinion given by the Expert Advisory the activities of the various departments are directly attributable to
Committee of the Institute in response to a query sent by a the construction. Accordingly, if the expenses incurred at the
member in relation to determining virtual certainty in respect of various departments are directly attributable to construction, these
deferred tax assets in situations where unabsorbed depreciation can be capitalised with the cost of the concerned fixed
and losses exist: asset(s)/project(s). As regards basis of allocation of the expenses of
these departments that can be allocated and capitalised to various The Committee is of the view that the orders secured by the
projects or assets under construction, the Committee is of the view company, may be considered while creating deferred tax asset
that the same should be allocated selecting an appropriate basis provided these are binding on the other party and it can be
that reflects the extent of usage of service rendered by the demonstrated that they will result in future taxable income.
department to the construction of the project.However, mere projections made by the company indicating the
earning of profits from future orders, or financial restructuring
proposal under consideration of the Government of India or the fact
that the books of account of the company are prepared on ‘going
concern’ basis, may not be considered as convincing evidence of
virtual certainty as contemplated in the ‘Explanation’ to paragraph
17 of AS 22 reproduced above Further, the mere fact that the items
covered under section 43B of the Income-tax Act, 1961, the
provision for liquidated damages, doubtful advances, guarantee
repairs and other contingencies, and unabsorbed depreciation can
be carried forward for an unlimited number of years, can also not
be a ground for recognising a deferred tax asset, since paragraph 17
of AS 22 read with its ‘Explanation’, requires virtual certainty
supported by convincing evidence at the date of the balance sheet.
The Committee also pointed out that a deferred tax asset can be
created to the extent that the future taxable income will be
available from future reversal of any deferred tax liability recognised
at the balance sheet date. To that extent, it would not be necessary
to consider the level of virtual certainty supported by convincing
evidence.
Capitalisation of expenditures in respect of projects under
construction (ICAI Journal June 2010)
With the withdrawal of “Guidance Note on Treatment of
Expenditure During Construction Period” by the ICAI, the
accounting is to be done as per AS 10, which stipulates that
administration and other general overhead expenses are usually
excluded from the cost of fixed assets since they do not relate to a
specific fixed asset. In some circumstances, such expenses as are
specifically attributable to construction of a project or to the
acquisition of a fixed asset or bringing it to its working condition,
may be included as part of the cost of the construction project or as
a part of the cost of the fixed asset. However, there was confusion
whether allocation of certain expenses which are incurred in
common or at corporate level is allowed under AS 10.
The Committee is of the view that the basic principle to be applied
while capitalising an item of cost to a fixed asset/project under
construction/expansion is that it should be directly attributable to
the construction of the project/fixed asset for bringing it to its
working condition for its intended use. The costs that are directly
attributable to the construction/acquisition of a fixed asset/project
for bringing it to its working condition are those costs that would
have been avoided if the construction/acquisition had not been
made. These are the expenditures without the incurrence of which,
the construction of project/asset could not have taken place and the
25 26
© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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The information contained herein is of a general nature and is not intended to address the circumstances of any particular
individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that
such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one
should act on such information without appropriate professional advice after a thorough examination of the particular
situation.
© 2010 KPMG, an Indian Partnership and a member
firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative
(“KPMG International”), a Swiss entity. All rights
reserved.
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of KPMG International Cooperative (“KPMG
International”), a Swiss entity.
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