Accounting and Auditing Update - KPMG · SA 705 (Revised), Modifications to the : Opinion in the Independent Auditor’s Report: Clarification of how the new reporting elements are

Accounting and Auditing Update

www.kpmg.com/in

Issue no. 01/2016

Editorial

© 2016 KPMG, an Indian Registered 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.

Jamil Khatri

Partner and Head Assurance KPMG in India

Sai Venkateshwaran

Partner and HeadAccounting Advisory Services KPMG in India

As companies look to implement Ind AS, they are facing multiple Ind AS implementation challenges and they need to keep their stakeholders informed regarding the key judgements and estimation areas they are encountering.

Therefore, in this backdrop we are pleased to introduce a new series of the Accounting and Auditing Update (AAU) that will focus on the emerging Ind AS implementation challenges that companies are experiencing in India. Additionally, we will endeavour to highlight the new trends and approaches in the field of auditing.

In this edition of AAU, we discuss the changes that the Standards of Auditing bring to the auditor’s report. For listed companies, these changes require inclusion of description of key audit matters in the auditor’s report. Our article highlights the approach to be taken to identify key audit matters, its interaction with modified and disclaimed opinion, going concern, emphasis of matter and other matter paragraphs. We also carry an illustrative auditor’s report under the new format that would be applicable from April 2017.

Ind AS 101, First-time Adoption of Indian Accounting Standards is the standard that provides a starting point for preparation of Ind AS financial statements. Our article on Ind AS 101, takes a deep dive into some of the implementation issues arising from business combinations accounting while applying exemptions available in the standard.

Additionally, in another article we discuss the recognition of deferred taxes in relation to freehold land.

Financial instruments accounting can be complex depending on the specifics of contractual arrangements. We analyse the accounting of optionally convertible preference shares and financial guarantee contracts with the help of illustrative examples and detailed flowcharts.

The International Accounting Standards Board has been issuing amendments and exposure drafts to update existing standards. In this edition, we provide an update on the developments in relation to the share-based payments, business combinations and joint arrangements.

As is the case each month, we also cover a regular round-up of the recent regulatory updates in India.

As always, we would be delighted to receive any kind of feedback/suggestions from you on the topics that we should cover.


Table ofcontents


Auditor’s report augmented: More qualitative and transparent

01

09

13

19

23

29

33

Ind AS 101, First-time Adoption of Ind AS – accounting for business combinations

Classification of convertible preference shares

Freehold land – Impact of deferred taxes under Ind AS

Accounting for financial guarantee contracts

Recent updates from the International Accounting Standards Board

Regulatory updates


Introduction On 15 January 2015, the International Auditing and Assurance Standards Board (IAASB) released its new requirements for auditor reporting. The topic of auditor reporting had been on the IAASB’s agenda for some time.

In line with the international requirements, the Institute of Chartered Accountants of India (ICAI) revised its Standards on Auditing relating to auditor reporting on 17 May 2016. The new requirements aim at enhancing the informational value of the auditor’s report.

This article aims to provide:

– An overview of the recent revisions made to the auditor’s report that are applicable from 1 April 2017

– An insight into the reporting requirements prevalent internationally.

Auditor’s report augmented: More qualitative and transparent

1


Scope and applicability

Following table provides the suite of Standards on Auditing (SAs) that are new/revised:

New and revised SAs Description of changes

SA 700 (Revised), Forming an Opinion and Reporting on Financial Statements

Revisions to establish new required reporting elements, and to illustrate these new elements through an example in the auditor’s report.

SA 701, Communicating Key Audit Matters in the Independent Auditor’s Report

New standard to establish requirements and guidance for the auditor’s determination and communication of Key Audit Matters (KAMs). KAMs, which are selected from matters communicated to those charged with governance, are required to be communicated in the auditor’s reports for audits of financial statements of listed entities.

SA 705 (Revised), Modifications to the Opinion in the Independent Auditor’s Report

Clarification of how the new reporting elements are affected when expressing a modified opinion.

SA 706 (Revised), Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report

Clarification of the relationship between the emphasis of matter and other matter paragraphs and the KAM section of the auditor’s report.

SA 260 (Revised), Communication with Those Charged with Governance

Required auditor communication with those charged with governance will now include the significant risks identified by the auditor and circumstances that required significant modification of the auditor’s planned approach to the audit.

SA 570 (Revised), Going Concern. Amendments to the auditor reporting requirements relating to going concern, and new requirements to evaluate the adequacy of disclosure if events or conditions cast doubt on going concern.

The above Standards on Auditing are applicable for audits of financial statements for periods beginning on or after 1 April 2017. Specifically, SA 701 applies to audits of complete sets of general purpose financial statements of listed entities and circumstances when the auditor otherwise decides to communicate key audit matters in the auditor’s report. This SA also applies when the auditor is required by law or regulation to communicate KAM in the auditor’s report.

Scope of an auditThe new requirements do not intend to change the scope of a financial statement audit, and therefore, should not affect underlying audit work.

Changes in the auditor’s reportThe following changes will be made to the auditor’s reports issued on complete sets of general purpose financial statements:

• The report will be reordered, with an audit opinion required to be placed first

• Descriptions of the responsibilities of management and the auditor will be revised

• The auditor will provide a statement with respect to work performed over ‘other information’.

Following are additional changes for listed companies:• Introduction of KAM• Disclosure of other information not

received before report date and of related auditor responsibilities.

KAM - an overviewFor listed entities, the most significant change introduced in the auditor’s report is the inclusion of description of KAM.

KAM is defined by SA 701 to mean those matters that, in the auditor’s professional judgement, were of most significance in the audit of the financial statements of the current period. KAMs are selected from matters communicated with those charged with governance.

Inclusion of KAM in the auditor’s report is expected to provide following benefits:

• Users will be able to better understand the conclusions of the audit as reflected in the opinion. Itwill help enhance the auditor’s report by providing greater transparency about the audit that was performed.

• Provide information to users that may assist them in understanding the entity and financial statementareas involving significantmanagement judgement.

SA 701 provides principles-based approach to determine KAM. These principles help achieve an appropriate balance between prescription in the standard to promote consistency in which matters are determined and communicated as KAM, with the need to allow for auditor judgement to ensure that the KAM communicated in the auditor’s report are as entity-specific and relevant as possible.

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Stage 1: KAMs are identified from the matters communicated with those charged with governance.

Stage 2: From the matters communicated to those charged with governance, the auditor identifies matters that required significant auditor attention in performing the audit. While determining such matters, an auditor is required to consider the following:• Areas of higher assessed risk of

material misstatement, or significantrisks identified.

• Significant auditor judgementsrelating to areas in the financialstatements that involved significantmanagement judgement, including accounting estimates that have been identified as having high estimationuncertainty.

• The effect on the audit of significantevents or transactions that occurred during the period.

Stage 3: The auditor determines which of the matters identified in Stage 2 were of most significance in the audit of the financial statements. The application of the concept of ‘most significance’

involves making a judgement about the importance of each matter relative to others in the specific audit. Guidance that will assist in making that judgment is provided in the standard.

The requirements in SA 701 articulate the thought process an auditor should go through to consider the drivers of areas of significant auditor attention during the audit, it prominently states that KAM are always selected from matters communicated with those charged with governance.

The stage 3 requirement serves as a second filter or step in the decision-making framework to highlight that KAM selection of the ‘most significant matters’ from the ‘matters that were determined to have required significant auditor attention’ in stage 2.

SA 230, Audit Documentation (Revised) requires that an auditor should document the matters that will be communicated as KAM, and the significant professional judgements made in reaching this determination.

The number of KAMs to be included in the auditor’s report may be affected by the size and complexity of an entity, the nature of its business and environment, and the facts and circumstances of the engagement.

Manner of communicating KAMThe description of each key audit matter in the KAM section of the auditor’s report should include a reference to the related disclosures in the financial statements, and address:• why the matter was considered to be

one of most significance in the audit,and was therefore determined to be a key audit matter, and

• how the matter was addressed in the audit.

The new requirements do not require the description to include a detailed description of specific procedures performed with respect to the key audit matter or the outcome of audit work undertaken.

Matters not to be communicatedIn order to deal with concerns regarding communicating sensitive information, a matter identified as a key audit matter is not disclosed in the auditor’s report if:• law or regulation precludes public

disclosure about the matter, or• in extremely rare circumstances, the

auditor determines that the matter should not be communicated in the auditor’s report, because the adverse consequences of doing so would

3


Approach to identify KAMSteps to be followed while identification of KAM are as follows:

KAM (matters of most significance)

Matters that required significant auditor attention in performing the audit

Matters to be communicated to those charged with governance1

2

3

Source: KPMG IFRG Limited’s publication: Enhancing auditor reporting published in July 2015

reasonably be expected to outweigh the public interest benefits of such communication.

However, rationale for conclusion that a KAM should not be communicated in the auditor’s report and is required to be documented by the auditor.

Going concern as a KAMSA 701 highlights that a material uncertainty related to going concern is, by its nature, a KAM. However, reporting on the material uncertainty is not included in the KAM section but is done in accordance with SA 570.

Accordingly, SA 570 has also been amended which now specifically requires the auditor to consider whether, in the context of the applicable financial reporting framework the financial statements provide adequate disclosures when:• events or conditions that may cast

significant doubt on the entity’sability to continue as a going concern have been identified, but

• based on the audit evidence obtained, the auditor concludes that no material uncertainty exists.

Close call situationsSituations where there were events or conditions identified that may cast significant doubt on the entity’s ability to continue as a going concern, but after considering the management’s plans to deal with these events or conditions, the management and the auditor concludes that no material uncertainty exists. Such situations are often referred to as ‘close call’ situations.

SA 701 mentions that a close call would be included in the KAM section of the auditor’s report for a listed entity only if such matters were determined to be of most significance in the audit that was performed.

No KAM identifiedIn some very rare cases, the auditor may determine that there are no key audit matters. When this is the case, the auditor is required to:• communicate this assessment to

those charged with governance• document the rationale for the

assessment, and• disclose the conclusion in the

auditor’s report.

Interaction with a disclaimed or modified opinionAn auditor is prohibited from disclosing KAMs if the auditor disclaims the opinion to avoid giving credibility to specific items in the financial statements.

When the auditor modifies the opinion, the auditor is still required to provide a description of KAMs in the auditor’s report, provided that such matters are not relevant to the reasons for modifying the opinion. When KAMs are relevant to the reasons for modifying the opinion, they should be described in the ‘basis for modification’ section of the report. Additionally, the Standards on Auditing acknowledge explicitly that KAM is not a substitute for a modified opinion.

Interaction with Emphasis of Matter (EOM) and Other Matters (OM) paragraphsThe standard setters have appropriately differentiated between the concepts of EOM, OM and KAM. In many cases, the matters determined to be KAM are expected to relate to matters presented or disclosed in the financial statements. The revised Standards on Auditing • Prohibit the auditor from using an

EOM paragraph or OM paragraph when the matter has been determined to be a KAM and explain that, when SA 701 applies, the use ofEOM paragraphs is not a substitute for a description of individual KAM.

• Provide further guidance on the definition and purpose of KAMand the relationship with EOM paragraphs noting that, when KAM are communicated, there may be a matter not determined to be a KAM for which an EOM paragraph may be considered necessary, or a matter determined to be a KAM that is also fundamental to users’ understanding of the financial statements.

• Provide illustrative examples that clearly distinguish the concepts in circumstances in which KAM, an EOM paragraph and an OM paragraph are included in the same auditor’s report, with guidance on the possible placement of the respective elements in such cases.

• Require the use of the term ‘Emphasis of Matter’ in the heading when an EOM paragraph is included in the auditor’s report, with flexibilityfor the auditor to provide greater specificity in the heading tailored tothe matter.

International practiceLong-form audit reports were introduced in the United Kingdom (the U.K.) in 2013 for entities that apply the UK Corporate Governance Code (the Code). However, the reporting requirement under the Code differs from the ISAs on the following grounds:

• Different requirements with respect to identifying and describing the key audit matters.

• An additional requirement to include an explanation of materiality and the scope of the audit.

The new European Union (EU) legislation (effective June 2016) introduces additional reporting requirements for the statutory auditor of EU Public Interest Entities (PIEs) covering the statutory audit report, audit committee reporting and reporting to supervisory bodies of PIEs. These requirements were aimed at enhancing investor’s understanding of the audit process, including the critical judgements made during the audit.

For PIEs, the auditor’s report would need to provide, in support of the audit opinion:

• a description of the most significantassessed risks of material misstatement, including assessed risks of material misstatement due to fraud

• a summary of the auditor’s response to those risks, and

• where relevant, key observations arising with respect to those risks.

For all statutory audits in the EU (not just statutory audits of PIEs), the auditor’s report would need to:

• provide a statement on any material uncertainty relating to events or conditions that may cast significantdoubt about the entity’s ability to continue as a going concern.

ConclusionAn auditor’s report constitutes as an important document for the users while evaluating the effectiveness of an entity’s performance. The ICAI’s step to include the KAM in the auditor’s report is in line with international practices. The inclusion of KAM in the auditor’s report would no doubt help in better decision-making of the investors along with giving regulatory bodies a bird’s eye view of a company’s performance.

4


Auditor’s report on Consolidated Financial Statements of a listed company (incorporated under the Companies Act, 2013) prepared in accordance with a Fair Presentation Framework1

Report on the audit of the Consolidated Financial Statements2

Illustrative auditor’s report

Opinion - New Opinion firstWe have audited the accompanying consolidated financial statements of ABC Company Limited (hereinafter referred to as the ‘Holding Company’) and its subsidiaries (Holding Company and its subsidiaries together referred to as ’the Group’), its associates and jointly controlled entities, which comprise the consolidated Balance Sheet as at 31 March 20XX, and the consolidated statement of Profit and Loss, (the consolidated statement of changes in equity)3 and the consolidated cash flows statement for the year then ended, and notes to the consolidated financial statements, including a summary of significant accounting policies (hereinafter referred to as ‘the consolidated financial statements’)3.

In our opinion and to the best of our information and according to the explanations given to us, the aforesaid consolidated financial statements give the information required by the Act in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India, of their consolidated state of affairs of the Company as at 31 March 20XX, of consolidated profit/loss, (consolidated changes in equity)4 and its consolidated cash flows for the year then ended.

Basis for opinion - New Basis for opinionWe conducted our audit in accordance with the Standards on Auditing (SAs) specified under Section 143(10) of the Companies Act, 2013. Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Consolidated Financial Statements section of our report. We are independent of the Group in accordance with the Code of Ethics issued by ICAI, and we have fulfilled our other ethical responsibilities in accordance with the provisions of the Companies Act, 2013. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Key Audit Matters - New Key audit matters for listed companies Key audit matters are those matters that, in our professional judgement, were of most significance in our audit of the consolidated financial statements of the current period. These matters were addressed in the context of our audit of the consolidated financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters.

[Description of each key audit matter in accordance with SA 701.]

Responsibilities of the management and those charged with governance for Consolidated Financial Statements - Revised description of the management’s and those charged with governance responsibilities including a description of responsibilities for going concern. The Holding Company’s Board of Directors is responsible for the preparation and presentation of these consolidated financial statements in terms of the requirements of the Companies Act, 2013 that give a true and fair view of the consolidated financial position, consolidated financial performance and consolidated cash flows of the Group including its associates and jointly controlled entities in accordance with the accounting principles generally accepted in India, including the Accounting Standards specified under Section 133 of the Act. The respective Board of Directors of the companies included in the Group and of its associates and jointly controlled entities are responsible for maintenance of adequate accounting records in accordance with the provisions of the Act for safeguarding the assets of the Group and for preventing and detecting frauds and other irregularities; the selection and application of appropriate accounting policies; making judgements and estimates that are reasonable and prudent; and the design, implementation and maintenance of adequate internal financial controls, that were operating effectively for ensuring accuracy and completeness of the accounting records, relevant to the preparation and presentation of the financial statements that give a true and fair view and are free from material misstatement, whether due to fraud or error, which have been used for the purpose of preparation of the consolidated financial statements by the directors of the Holding Company, as aforesaid.

In preparing the consolidated financial statements, the respective Board of Directors of the companies included in the Group and of its associates and jointly controlled entities are responsible for assessing the ability of the Group and of its associates and jointly controlled entities to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Group or to cease operations, or has no realistic alternative but to do so.

The respective Board of Directors of the companies included in the Group and of its associates and jointly controlled entities are responsible for overseeing the financial reporting process of the Group and of its associates and jointly controlled entities.

1. SA 700 Illustration 22. The sub-title “Report on the Audit of the Consolidated Financial Statements” is

unnecessary in circumstances when the second sub-title “Report on Other Legal and Regulatory Requirements” is not applicable.

3. Where applicable4. Where applicable

5


Auditor’s responsibilities for the audit of the Consolidated Financial Statements - Revised description of the auditor’s responsibilities. Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with SAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements.

6


Other matters

(a) We did not audit the financial statements/financial information of ______ subsidiaries, and ______ jointly controlled entities,whose financial statements/financial information reflect total assets of INR______ as at 31 March 20XX, total revenues ofINR_______ and net cash flows amounting to INR______ for the year ended on that date, as considered in the consolidatedfinancial statements. The consolidated financial statements also include the Group’s share of net profit/loss of INR _____ forthe year ended 31 March 20XX, as considered in the consolidated financial statements, in respect of ____associates, whosefinancial statements/financial information have not been audited by us. These financial statements/financial informationhave been audited by other auditors whose reports have been furnished to us by the management and our opinion on the consolidated financial statements, in so far as it relates to the amounts and disclosures included in respect of thesesubsidiaries, jointly controlled entities and associates, and our report in terms of sub-sections (3) and (11) of Section 143 of the Act, in so far as it relates to the aforesaid subsidiaries, jointly controlled entities and associates, is based solely on the reports of the other auditors.

(b) We did not audit the financial statements/financial information of ______ subsidiaries and ______ jointly controlled entities,whose financial statements/financial information reflect total assets of INR______ as at 31 March 20XX, total revenues ofINR_______ and net cash flows amounting to INR______ for the year ended on that date, as considered in the consolidatedfinancial statements. The consolidated financial statements also include the Group’s share of net profit/loss of INR _____ forthe year ended 31 March 20XX, as considered in the consolidated financial statements, in respect of ____associates, whosefinancial statements/financial information have not been audited by us. These financial statements/financial information areunaudited and have been furnished to us by the management and our opinion on the consolidated financial statements, inso far as it relates to the amounts and disclosures included in respect of these subsidiaries, jointly controlled entities and associates, and our report in terms of sub-sections (3) and (11) of Section 143 of the Act in so far as it relates to the aforesaid subsidiaries, jointly controlled entities and associates, is based solely on such unaudited financial statements/financialinformation. In our opinion and according to the information and explanations given to us by the management, these financialstatements/financial information are not material to the Group.

Our opinion on the consolidated financial statements, and our report on Other Legal and Regulatory Requirements below, is not modified in respect of the above matters with respect to our reliance on the work done and the reports of the other auditors and the financial statements/financial information certified by the management.

Report on Other Legal and Regulatory Requirements

As required by Section 143(3) of the Act, we report, to the extent applicable, that:

(a) We have sought and obtained all the information and explanations which to the best of our knowledge and belief were necessary for the purposes of our audit of the aforesaid consolidated financial statements.

(b) In our opinion, proper books of account as required by law relating to preparation of the aforesaid consolidated financialstatements have been kept so far as it appears from our examination of those books and the reports of the other auditors.

(c) The Consolidated Balance Sheet, the Consolidated Statement of Profit and Loss, and the Consolidated Cash Flow Statement dealt with by this report are in agreement with the relevant books of account maintained for the purpose of preparation of the consolidated financial statements.

(d) In our opinion, the aforesaid consolidated financial statements comply with the Accounting Standards specified under Section 133 of the Act.

(e) On the basis of the written representations received from the directors of the Holding Company as on 31 March 20XX taken on record by the Board of Directors of the Holding Company and the reports of the statutory auditors of its subsidiary companies, associate companies and jointly controlled companies incorporated in India, none of the directors of the Group companies, its associate companies and jointly controlled companies incorporated in India is disqualified as on 31 March 20XX from being appointed as a director in terms of Section 164 (2) of the Act.

(f) With respect to the adequacy of internal financial controls over financial reporting of the Group and the operatingeffectiveness of such controls, refer to our separate report in Annexure.

(g) With respect to the other matters to be included in the Auditor’s Report in accordance with Rule 11 of the Companies (Audit and Auditor’s) Rules, 2014, in our opinion and to the best of our information and according to the explanations given to us:

i. The consolidated financial statements disclose the impact of pending litigations on the consolidated financial position ofthe Group, its associates and jointly controlled entities– Refer Note XX to the consolidated financial statements.

Or

There were no pending litigations which would impact the consolidated financial position of the Group, its associates and jointly controlled entities.5

ii. Provision has been made in the consolidated financial statements, as required under the applicable law or accountingstandards,for material foreseeable losses, if any, on long-term contracts including derivative contracts – Refer (a) Note XX for the consolidated financial statements in respect of such items as it relates to the Group, its associates and jointly controlledentities and (b) the Group’s share of net profit/loss in respect of its associates.

Or

The Group, its associates and jointly controlled entities did not have any material foreseeable losses on long-term contracts including derivative contracts.6

iii. There has been no delay in transferring amounts, required to be transferred, to the Investor Education and Protection Fund by the Holding Company and its subsidiary companies, associate companies and jointly controlled companies incorporated in India.

Or

Following are the instances of delay in transferring amounts, required to be transferred, to the Investor Education and Protection Fund by the Holding Company, and its subsidiary companies, associate companies and jointly controlled companies incorporated in India7.

Or

There were no amounts which were required to be transferred to the Investor Education and Protection Fund by the Holding Company, and its subsidiary companies, associate companies and jointly controlled companies incorporated in India8.

For XYZ & Co

Chartered Accountants

(Firm’s Registration No.)

Signature

(Name of the Member Signing the Audit Report)

(Designation9)

(Membership No. XXXX)

Place of Signature:

Date:

7


5. Where applicable6. Where applicable7. Where applicable

8. Where applicable9. Partner or Proprietor

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The Indian Accounting Standard (Ind AS) largely converged with International Financial Reporting Standards (IFRS) were notified by the Ministry of Corporate Affairs (MCA) in February 2015 under Section 133 of the Companies Act, 2013 (2013 Act). The new standards are expected to bring major accounting changes for the Indian corporate sector. These standards are applicable to corporates under two phases: companies covered under Phase I are required to apply Ind AS from the financial year beginning 1 April 2016 with the requirement to provide comparatives for the previous financial year 2015-16.

The new standards which are converged with IFRS, aim to reduce the significant gap between the current Indian GAAP and international standards. These standards are expected to also help India Inc. companies to present their financial statements, comparable with the leading global standards. Since the new standards are converged with IFRS and not IFRS adopted, there are certain carve-outs and carve-ins in Ind AS from IFRS.

This article aims to:

– Highlight the first-time adoption implementation issues while applying business combination exemption.

Ind AS 101, First-time Adoption of Ind AS - accounting for business combination

9


Ind AS conversion The corporates in India covered under Phase I of the road map have started complying with Ind AS beginning 1 April 2016 and listed companies have started presenting their Ind AS compliant interim financial results for the quarter ended 30 June 2016. The Ind AS conversion from the current Indian GAAP could be a stressful job.

The objective of Ind AS 101, First-time Adoption of Indian Accounting Standards, is to provide a suitable starting point for accounting in accordance with Ind AS and set out the procedures to be followed by entities for adoption of Ind AS.

Background of Ind AS 101Ind AS 101 provides certain exemptions and exceptions to facilitate smooth transition from Indian GAAP to Ind AS. These exceptions/exemptions are classified under mandatory exceptions and optional exemptions. Ind AS 101 provides certain key options for accounting under different heads such as business combination exemption, deemed cost exemptions, consolidation, etc.

In the following section we will highlight the options provided for business combinations and key implementation areas that could be challenging.

Under the current Indian GAAP, there is no comprehensive standard that deals with business combinations. Indian GAAP provides different standards that deal with amalgamation, consolidation and assets acquisition. Ind AS 103, Business Combinations applies to all business combinations, including amalgamations and all assets and liabilities acquired will be recognised at fair value.

Exemptions for business combinations under Ind AS 101Ind AS 101 allows a first-time adopter to choose to not to apply Ind AS 103 retrospectively to past business combinations i.e. those transactions which occurred before the date of transition to Ind AS. Additionally, it has been provided that if an entity opts to restate any business combination to comply with Ind AS 103, then such an entity should restate all business combinations later than the date of such business combination.

Therefore, Ind AS 101 provides following options for business combinations that occurred before the date of transition:

• restate all business combinations,• restate all business combinations

that occurred after a particular date of the first-time adopter’s choice butbefore the date of transition, or

• do not restate any business combinations prior to the date of transition.

The exemption for past business combinations also applies to past acquisitions of investments in associates, interests in joint ventures and interests in joint operations in which the activity of the joint operation constitutes a business. Furthermore, the date selected to restate previous business combinations applies equally for all such acquisitions.

Following is an example to explain business combination exemption:

Company A is transitioning to Ind AS from financial year beginning 1 April 2016 with the date of transition being 1 April 2015. Company A had following transactions in the previous periods:

a. Acquired control over company B on 30 September 2010

b. Acquired significant influence overcompany C on 31 December 2012

c. Acquired control over company D on 30 July 2015

i. If company A opts to apply the exemption to not to restate previous business combination, then A is not required to restate acquisition of B and C in its opening balance sheet on 1 April 2015. However, it will be required to restate the acquisition of D because the company entered into the transaction post the date of Ind AS transition.

ii. If a company opts to restate the acquisition of B, then A will be required to additionally restate the acquisition of C, since such transaction is post the date selected for applying business combination accounting under Ind AS 101.

Implementation challenges while applying business combination exemption

Accounting for restated and unrestated business combinations

Ind AS 101 provides an option to an entity to not restate its past business combinations while transitioning to Ind AS. If the entity opts not to restate business combinations, then significant adjustments would be required which are as follows:• Maintain current Indian GAAP

classification of the acquisition• Determine whether any additional

assets or liabilities should be recognised

• Determine whether any recognised assets or liabilities should be derecognised

• Remeasure the assets and liabilities subsequent to the business combination, if appropriate

• Adjust the measurement of goodwill/capital reserve, if appropriate.

Significant implications of restating past business combinations

Ind AS 101 permits a first-time adopter to restate past business combinations retrospectively in accordance with Ind ASs. However, retrospective restatement may be a difficult exercise in certain circumstances. This is primarily due to the requirement that the information available to restate the past business combinations must have been available at the time of the acquisition, the use of hindsight is prohibited. This may cause a practical difficulty for a first-time adopter, because it may not have been aware of all of the information to be collected at the date of acquisition in order to record the business combination on a basis that would be consistent with Ind ASs.

In case the past business combinations are restated:• Mandatory exceptions relating

to non-controlling interests as contained in Ind AS 101 continue to apply in relation to those transactions that occurred prior to the date after which all past business combination transactions are restated,

• Optional exemptions need to be evaluated specifically on a caseto case basis (e.g. deemed cost exemption relating to property, plant and equipment),

• Normal consolidation procedures apply from the date of restated past business combinations.

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Some of the general issues that may be encountered are:• Calculating the consideration

transferred in the business combination in accordance with Ind ASs and assessing whether any contingent consideration should be recognised without the use of hindsight

• Assessing whether to recognise contingent liabilities at the acquisition date, without the use of hindsight

• Measuring the fair value of assets acquired and liabilities assumed at the acquisition date on a basis consistent with Ind ASs

• Testing goodwill for impairment in a restated business combination.

There is no specific requirement in Ind AS 101 that goodwill acquired in a restated business combination be tested for impairment at the date of transition, however, it is preferable that an entity should test all goodwill for impairment at the date of transition.

Contingent consideration not recognised under previous GAAP

As per Ind AS 103, the consideration transferred in a business combination shall be measured at fair value. However, if the consideration transferred in the business combination includes any asset or liability resulting from a contingent consideration arrangement i.e. an arrangement where a percentage of consideration is dependent on the future event or an entity’s performance, then such consideration shall be recognised at its fair value at the acquisition date. The obligation to pay contingent consideration is classified either as a liability or as equity based on the definitions of an equity instrument and a financial liability in Ind AS 32, Financial Instruments: Presentation.

Under the current practice, contingent consideration is generally recorded as an additional goodwill, when the contingency is resolved. Whereas, Ind AS requires the fair value of the contingent consideration to be recorded upfront as a component of the total consideration. Any subsequent changes to the value of liability-settled contingent consideration are recorded in the statement of profit and loss. Since, the actual amount of contingent consideration can rarely be estimated with accuracy initially, the statement of

profit and loss is likely to be adjusted for the differences between the initial estimates and final payments.

Ind AS do not specifically provide the treatment in the opening Ind AS balance sheet for the contingent consideration that was not recognised under current Indian GAAP in an unrestated business combination and which remains outstanding at the date of transition. Therefore, such contingent consideration that was not recognised in an unrestated business combination and is determined to be liability-classified at the date of transition in accordance with Ind AS, should be recognised in the opening Ind AS balance sheet with a corresponding adjustment to retained earnings. The measurement of the liability-classified contingent consideration at the date of transition, and subsequently, should be based on the relevant Ind AS, i.e., Ind AS 109, Financial Instruments or Ind AS 37, Provision, Contingent Liabilities and Contingent Assets. Any changes in measurement of the liability-classified contingent consideration after the date of transition generally would be recognised in the statement of profit and loss.

Example: On 1 May 2014, company ABC acquires company XYZ. The agreement to purchase involves two conditions:

a. An immediate payment of INR100 million

b. Under a contingent arrangement that if after five years net profit ofthe newly formed company exceeds 20 per cent of current profits, thencompany ABC will pay INR10 million to the former shareholders of XYZ which is payable in cash.

The above mentioned example includes an arrangement where company ABC is required to pay cash to former shareholders of company XYZ after five years. Had the company ABC applied Ind AS at the acquisition date, i.e. 1 May 2014, then it should determine the fair value of the contingent consideration payable after five years and recognise it as a liability in its books on 1 May 2014. Therefore, the company would discount the INR10 million using the present value calculation and recognise the total of INR100 million and present value of INR10 million as on 1 May 2014.

Further, in the subsequent year if there are changes to the fair value of the amount payable to XYZ shareholders then that change will be recognised in company ABC’s statement of profit and loss till the time final payments are made.

However, ABC is transitioning to Ind AS from 1 April 2015 and applied current Indian GAAP on the date of transaction i.e. 1 May 2014 and did not recognise the contingent consideration in its books of accounts. While applying Ind AS at the date of transition the company ABC would recognise its liability classified contingent consideration inthe opening Ind AS balance sheet with a corresponding adjustment to retained earnings.

Goodwill/capital reserve adjustment and intangibles separation

Ind AS 101 provides that in cases, where entity opts to not to restate past business combinations, the carrying value of goodwill or capital reserve in its opening Ind AS balance sheet should be the carrying value for the goodwill/capital reserve as per current Indian GAAP and should be adjusted only in respect for following adjustments:

i. The first-time adopter shouldderecognise an intangible asset recognised under the previous GAAP which does not meet the recognition criteria of intangible assets as prescribed under Ind AS 38, Intangible Assets and increase goodwill/decrease capital reserve, as the case may be, to the extent of carrying value of previously recognised intangible asset.

ii. The first-time adopter shall recognisean additional intangible asset that was not recognised earlier in accordance with the previous GAAP, in its opening Ind AS balance sheet with a corresponding decrease in goodwill/increase in capital reserve.

iii. Regardless of whether there is any indication that the goodwill may be impaired, the first-time adoptershall apply Ind AS 36, Impairment of Assets, in testing the goodwill for impairment at the date of transition to Ind ASs and in recognising any resulting impairment loss in retained earnings. The impairment test should be based on conditions at the date of transition to Ind ASs.

iv. Correction of any errors discovered on transition to Ind AS


12

Examplesi. Recognition of an intangible asset

Suppose Company A is preparing its first Ind AS financial statements forthe financial year beginning 1 April2016, with a date of transition being 1 April 2015. A acquired subsidiary B in 2010 in a transaction that would be a business combination under Ind AS. A elects not to restate the acquisition of B. As part of the purchase accounting applied under current Indian GAAP, A did not recognise a separate intangible asset related to customer relationships of B at the date of acquisition. These customer relationships were internally generated by B.

Additionally, A did not recognise a separate intangible asset related to B’s research and development expenditure at the date of acquisition. The expenditure was related to internal projects carried out by B.

Although under Ind AS the customer relationship would have been recognised as a separate asset in accounting for the business combination, it is not recognised in A’s opening Ind AS balance sheet. This is because the customer relationship is internally generated and therefore would not be recognised in B’s own balance sheet if prepared in accordance with Ind AS. Similarly, no intangible asset is recognised in respect of research expenditure because, in accordance with Ind AS 38, it would not be recognised in B’s own balance sheet if prepared in accordance with Ind AS.

However, a separate intangible asset in respect of development expenditure is recognised in A’s opening balance sheet because it would be recognised in B’s own balance sheet if prepared in accordance with Ind AS. This example assumes that the recognition criteria in Ind AS 38 would have been met when the expenditure was incurred by B.

ii. Derecognition of an intangible asset Company N will prepare its firstInd AS financial statements for thefinancial year beginning 1 April 2016,with a date of transition being 1 April 2015. N acquired subsidiary

Q in 2012 in a transaction that would be a business combination under Ind AS. N elects not to restate the acquisition of Q.

As part of the purchase accounting applied under previous GAAP, N recognised a separate intangible asset related to Q’s market share. This asset was recognised in addition to assets such as customer relationships and backlog orders.

Market share is not recognised as a separate asset under Ind AS. Therefore, the intangible asset is eliminated, as an adjustment to goodwill, from N’s opening Ind AS balance sheet.

Deferred tax adjustment

Deferred tax is recognised for the estimated future tax effects of temporary differences and tax loss carry-forwards.

The recognition of deferred taxes at the date of transition involves the following steps:

• Identify the temporary differences at the date of transition.

• Measure the amount of deferred tax to be recognised.

• Recognise any adjustments in retained earnings in equity.

However, in certain cases adjustments to the balance of deferred tax at the date of transition are not recognised in equity in the following circumstances:

• If a business combination is restated, then the balance of deferred tax at the date of acquisition is determined as part of the reconstruction of the acquisition accounting. The corresponding entry is against goodwill at the date of acquisition.

• If a business combination is not restated but an intangible asset related to the acquisition is either subsumed within goodwill/capital reserve or is recognised separately from goodwill/capital reserve at the date of transition, then any related adjustment to the deferred tax also is recognised against goodwill/capital reserve as the case may be.

Example: Company S prepares its first Ind AS financial statements for the financial year ending 31 March 2016 with the date of transition being 1 April 2015. Company S acquired control

over company P by acquiring 90 per cent shares of company P and that transaction satisfies the conditions for business combination accounting. The tax rate applicable to S is 30 per cent.

S acquired intangible asset of P, which is related to internal projects of P, the fair value of such project is INR250. Had P applied business combination accounting as per Ind AS in its financial statements it would have recognised development expenditure as an asset at INR200. Under current Indian GAAP the asset was subsumed within goodwill and no deferred tax was recognised.

S opts to restate the acquisition of Pa. It will record intangible assets at its

fair value on the date of acquisition i.e. INR250. 90 per cent of the value will be reduced from goodwill i.e. INR225 and balance through Non-controlling Interest (NCI).

b. To recognise deferred tax at the date of transition, deferred tax liability will be recorded amounting to 30 per cent of acquisition value i.e. INR75and corresponding debit will be made to goodwill and NCI (i.e. INR 68 and INR 7 respectively).

S opts not to restate the acquisition of P

If S elects to not restate business combination, then a separate intangible asset will be recognised in S’s opening Ind AS balance sheet amounting to acquisition cost of the expenditure i.e. INR200. 90 per cent of the value will be reduced from goodwill i.e INR 180 and balance will through NCI i.e. INR 20. Please note the intangible asset will be recognised in the cases where the asset satisfies the recognition criteria inaccordance with Ind AS 38.

Further deferred tax liability will be recorded at 30 per cent of the value of the intangible asset i.e. INR60 and corresponding debit will be made to goodwill and NCI (i.e. INR 54 and INR 6 respectively).

References taken from

ICAI: Educational Material on Ind AS 101, First-time Adoption of Indian Accounting Standards published in June 2015.

KPMG IFRG Limted’s IFRS Handbook published in 2014.


Conclusion

The above issues highlight some of the implementation challenges while applying Ind AS 101 to the previous business combinations. Entities should consider specific facts and circumstances and guidance given in Ind AS 101 carefully, while arriving at the transition adjustments.

Indian Accounting Standards (Ind AS) 32, Financial Instruments: Presentation establishes principles for the classification of financial instruments, from the perspective of the issuer, into financial assets, financial liabilities and equity instruments.

Ind AS 32 requires the issuer of a financial instrument to classify the instrument, or its component parts, on initial recognition in accordance with the substance of the contractual arrangement and the definitions provided in the standard.

In this article, we analyse the key terms of an Optionally Convertible Preference Share (OCPS) to determine its classification and accounting treatment.


– Analyse the key terms of an Optionally Convertible Preference Share (OCPS) to determine its classification and accounting treatment

Classification of convertible preference shares

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Key terms of the financial instrument

Company X issues 2,000 OCPS on 1 April 2016 with the following key features:

Contractual features Details

Term 5 years

Face value INR1,000 each, issued at par

Redemption Redeemable at the end of the term on 31 March 2021

Dividend Discretionary, non-cumulative dividend of 6 per cent per annum

Conversion option Optionally convertible by the holder into ordinary shares at any time until maturity (American-style option)

Conversion ratio Each preference share is convertible into 5 ordinary shares

Company X has determined that the market interest rate for instruments of comparable credit status and providing substantially the same cash flows, on the same terms, but with mandatory distributions and without the conversion option, as 9 per cent.

Accounting issueThe OCPS are financial instruments that are required to be classified by company X in accordance with the guidance in Ind AS 32. The subsequent accounting treatment for the OCPS is based on such classification.

Ind AS 32 requires an issuer of a financial instrument to evaluate its terms to determine whether it contains both a liability and an equity component. Such components are analysed and classified separately as either a financial liability, financial asset or an equity instrument.

The OCPS is redeemable at the end of its five year term, indicating that it contains a liability component. However, the dividend payable on the OCPS is discretionary and non-cumulative in nature. Further, the holder may also convert the OCPS into a pre-

determined number of ordinary shares at any time until maturity. This indicates that the OCPS may also contain an equity component and is in the nature of a ‘compound’ financial instrument. Company X should therefore analyse each of these components separately to determine their classification.


Source: KPMG in India’s analysis, 2016

As illustrated above, each component is analysed separately to determine its classification. The analysis, based on the guidance in Ind AS 32, indicates that:

• The redeemable principal amount of the OCPS is in the nature of a financial liability component as company X has a contractual obligation to redeem this amount to the holders at the end of the five year term,

• The discretionary, non-cumulative dividend component is an equity component since the company has no contractual obligation to pay this dividend to the holders, and

• The conversion option into a fixed number of ordinary shares is also in the nature of an equity component, since the company could be required to settle this component by issuing a fixed number of its own equity instruments.

Accounting guidance and analysis

Classification of the OCPS

The following is an illustration of the relevant guidance in Ind AS 32 for classification of the OCPS and our analysis.

Guidance Analysis of the OCPS

No

No

No

No

Yes

Yes

Yes

Yes

Identify the components of the OCPS

Redeemable principal amount

Yes

Financial liability Equity Equity

Discretionary, non-cumulative

distribution

No

No Yes

Yes

Yes

Holder’s option to convert into ordinary shares

NoIs there a contractual

obligation to deliver cash/ another financial asset?

May the component be settled in the issuer’s

own equity instruments?

Is the component a derivative that meets the ‘fixed for fixed’ criterion?

Do all settlement alternatives result in equity classification?

Financial liability Equity

Figure 1: Analysis to classify the OCPS based on relevant guidance

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Initial recognition amounts

Ind AS 32 requires the issuer to first determine the carrying amount of the liability (redeemable principal component) by measuring the fair value of a similar liability (including any embedded non-equity derivative features) that does not have an associated equity component.

The carrying amount of the equity instrument represented by the discretionary dividend stream and

the option to convert the OCPS into ordinary shares should be determined by deducting the fair value of the financial liability from the fair value of the compound financial instrument as a whole.

Figure 2 illustrates the process for allocation of the initial carrying amount of the OCPS into its liability and equity components.

Accounting treatment

The following are the illustrative accounting entries on initial recognition and for subsequent measurement of the OCPS, assuming conversion occurs at the end of the first year.

Fair value of the entire OCPS (INR1,000)

Fair value of liability component (INR650)

(INR1,000 discounted at 9 per cent over 5 years)

Residual equity component (INR350)

(INR1,000 - INR650)

Figure 2: Allocation of initial carrying amount of OCPS

Date Accounting entry Amount

1 Apr 2016 On initial recognition of the OCPS

BankOCPS liabilityEquity

Dr 2,000,000Cr 1,300,000Cr 700,000

31 Mar 2017 Accrual of interest for year 1

Interest expenseOCPS liability

Dr 117,000

Cr 117,000

31 Mar 2017 Assuming that the OCPS is converted into equity at the end of year 1

OCPS liabilityEquity

Dr 1,417,000Cr 1,417,000

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Consider this….

• An instrument that is redeemable in cash may alsoinclude an equity component based on its otherterms. In the illustration above, a holder’s option toconvert the OCPS into a fixed number of ordinaryshares is classified as an equity component. Theamount attributable to this equity component oninitial recognition shall remain in equity and willnot be reclassified even if the OCPS are ultimatelyredeemed in cash by the issuer.

• The OCPS include a discretionary dividendcomponent, which is also classified as equity.If the issuer declares and pays a distribution onthe OCPS, this is considered to be an equitydistribution/dividend payment and not an interestexpense.

• The interest expense recognised by the issuer onthe liability component represents the unwinding ofthe discount applied in determining the fair value ofthis financial liability at the time of initial recognition.


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The accounting of deferred taxes under Ind AS on freehold land is likely to throw distinct challenges for the entities. This is due to differences in the approach to recognise deferred taxes under Ind AS in comparison to current Indian GAAP. Further, the complexity increases due to different tax treatments available under the Income-tax Act, 1961 (IT Act) for the freehold land when sold as part of a slump-sale arrangement or as a stand-alone asset.

Freehold land – Impact of deferred taxes under Ind AS

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– Highlight the impact of accounting for deferred taxes on freehold land under Ind AS.

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Why the debate?The IT Act does not permit an entity to claim depreciation on land.

A freehold land may qualify as a long-term capital asset under the IT Act and an entity could take the benefit of indexation on the cost of acquisition of freehold land while computing long-term capital gains tax.

Additionally, an entity may sell its freehold land on a slump-sale basis where the benefit of indexation would not be available to the entity while computing capital gains.

Current practiceThe practice under current Indian GAAP is to not recognise deferred taxes on freehold land. The argument seems to stem from AS 22, Accounting for Taxes on Income where accounting of deferred taxes is based on timing differences (also known as the income statement approach).

Transition to Ind ASUnder Ind AS 12, Income Taxes, deferred taxes are recognised on temporary differences (based on what is known as the balance sheet approach). Temporary difference is the difference between the tax base of an asset or liability and its carrying amount in the financial statements. The concept of timing differences followed under Indian GAAP is narrower than temporary differences approach.

For determining deferred taxes under Ind AS on the freehold land (temporary differences approach) a comparison is made between the carrying amount of freehold land in the accounting books with the tax base. The tax base of the freehold land is the amount attributed to freehold land for tax purposes. Generally, the tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. An entity is likely to recover the carrying amount of an asset either through use or sale. In the case of

freehold land, generally, an entity does not depreciate its freehold land and therefore, carrying amount of freehold land is expected to be recovered through sale.

When the guidance of Ind AS is applied, it appears that an entity would be required to follow the guidance of Ind AS 12 on the freehold land and recognise deferred taxes. However, in practice an entity may not have any intention of selling its freehold land as it could be vital for running its operations and business. Additionally, it may not be possible to forecast when or if the freehold land would eventually be disposed of. Therefore, timing of reversal of temporary difference is not certain and an entity may not be in a position to ascertain whether the freehold land would be sold as part of the slump-sale or as a separate asset.

Therefore, in India, two situations are likely to arise:

Situation 1: Sale of freehold land as a part of slump-sale

If the freehold land is kept at the cost model in the accounting books, then there would not be any temporary difference as the tax base would also be equal to the carrying amount in the accounting books.

Situation 2: Sale of freehold land as a separate asset (capital asset)

If freehold land is treated as a long-term capital asset on which yearly indexation is allowed as per the IT Act, then it is likely that temporary difference would arise on which Ind AS 12 guidance on deferred taxes would be required to be applied.

Next stepsAccounting of deferred taxes on freehold land could be a highly judgemental area for entities under Ind AS as it involves considerable estimation. Therefore, companies should consider all facts and circumstances while accounting for deferred taxes and disclose the judgement taken in respect to deferred taxes on the freehold land. To address

such uncertainty, following steps could be helpful:

• Consider all factors concerning its expected profitability, bothfavourable and unfavourable, when assessing whether a deferred tax asset should be recognised on the basis of availability of future taxable profits. A deferred tax asset shouldbe recognised if:

– An entity has stable earnings history

– There is no evidence to suggest that current earnings level will not continue into the future, and

– There is no evidence to suggest that the tax benefits will not be realised for some other reason.

• Assess if the fair value of freehold land is higher than its tax base (due to indexation), then this is a factor taken into account in assessing the probability of whether taxable profits will be available to offset thedeductible temporary difference in future.

• While assessing an entity should also take into account the appropriate scheduling of the reversal of such temporary differences. If the assessment is favourable, then a deferred tax asset should be recognised for the deductible temporary differences

• Assess the situation where an entity does not have an intention to sell freehold land separately, for example, it has constructed a factory on that land and the factory is vital for its operations. The entity should also assess its past experience of slump-sale of such assets.

The difficulty of estimating the timing of the reversal of the temporary difference is not in itself a reason for not recognising a deferred tax asset. However, it is a relevant factor in assessing the probability of the availability of future tax profits.

21

Consider this….

• Application of Ind AS 101, First-time Adoptionof Indian Accounting Standards: When an entitytransitions to Ind AS it would also have to recognisedeferred tax assets and liabilities to reflect anyadjustments to book value recognised as a result ofadopting Ind AS.

In the case of freehold land, the entity would haveto consider the Ind AS 101 implications includingdeemed cost exemptions taken for transitioning toInd AS while accounting for deferred taxes.

If there is a temporary difference in the opening IndAS balance sheet, then deferred taxes would berecognised in that opening Ind AS balance sheet.Adjustments to the balance of deferred tax at thedate of transition are recognised in equity, generally,in retained earnings.

• Freehold land measured at revaluation policy:If an entity exercises the option of following therevaluation policy for its freehold land under Ind AS16, Property, Plant and Equipment then it shouldalso consider the implications on accounting ofdeferred taxes under Ind AS.


22


Indian Accounting Standard (Ind AS) 109, Financial Instruments includes within its scope, an issuer’s rights and obligations arising under an insurance contract that meets the definition of a financial guarantee contract. A scope exemption is available for such contracts only when an issuer had previously asserted explicitly that it regards such financial guarantees as insurance contracts and has used accounting that is applicable to insurance contracts under Ind AS 104, Insurance Contracts.

In this article, we analyse how to identify a financial guarantee contract (as defined in Ind AS 109) and the appropriate accounting treatment to be followed by the issuer and the holder.

Accounting for financial guarantee contracts

23



– Highlight the accounting treatment of a financial guarantee contract.

24

Key terms of the contract

Subsidiary company S enters into a term loan arrangement with bank B on 1 April 2016 on the following terms:

Contractual features Details

Term 5 years

Loan amount INR100 million

Interest 11 per cent per annum, payable quarterly

Principal repayment 20 quarterly instalments

Guarantee Parent company P provides a guarantee to bank B – to make payment of the amount due if company S fails to make a payment within 30 days after it falls due. (Any subsequent recoveries are utilised to reimburse company P for amounts paid under the guarantee).

Guarantee fee/premium Nil

Company P has made no assertion in its business documentation or its previous financial statements that it regards financial guarantee contracts as insurance contracts.

Company S has estimated the fair value of the guarantee (using the principles of Ind AS 113, Fair Value Measurement) as INR5 million based on the premium/fee that it would be required to pay to a market participant (e.g., a bank) to provide a similar guarantee at 1 April 2016.

Accounting issue

Company P

The parent company P is required to analyse whether the guarantee provided to bank B meets the definition of a financial guarantee contract and should be recognised at its fair value under Ind AS 109.

Company S

Company S is the beneficiary of the guarantee. While Ind AS 109 does not specifically apply, company S may reflect the financial guarantee contract appropriately in its financial statements on the same principles as those applied by P.

Bank B

The holder of the financial guarantee is required to assess whether this guarantee is within the scope of Ind AS 109 or should be accounted for separately.



Accounting guidance and analysis

Scope and definition

Ind AS 109 defines a financial guarantee contract as ‘a contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due in accordance with the original or modified terms of a debt instrument.’ Based on this definition, the contract between company P and bank B qualifies as a financial guarantee contract only if it meets all the conditions illustrated in Figure 1 below.


25

Based on the analysis above, the contract between company P and bank B meets the definition of a financial guarantee contract and will fall within the scope of Ind AS 109.

Recognition and measurement

Guarantor – Company P

Ind AS 109 requires the guarantor to recognise the financial guarantee

contract initially at its fair value. Since company P is the parent entity of the beneficiary, company S, there will be no impact at a consolidated level. However, P will be required to recognise a liability in its separate financial statements for the fair value of the financial guarantee. As no payment is made by S to P, this may be considered as a capital contribution by company P to its subsidiary, since the

guarantee has been provided by P in its capacity as a shareholder.

Subsequently, this guarantee is to be measured at the higher of an amount determined based on the expected loss method (as per guidance in Ind AS 109) or the amount originally recognised less, the cumulative amount recognised as income on a straight-line basis in accordance with Ind AS 18, Revenue.


Guidance Analysis of the OCPS

Yes

Yes

Yes

No

No

No

Is the reference obligation a debt

instrument

Yes - the contract guarantees the term loan (a debt instrument) provided by

bank B to company S

Yes - company P will compensate bank B only in the event that company S fails to

make a payment within 30 days after it falls due

Yes - company P will compensate bank B only for losses incurred (any subsequent recoveries from company S are repaid to

company P)

The contract qualifies as a financial guarantee contract

If the guarantee contract does not meet one of the three conditions, it may be a credit derivative contract

Is the holder compensated only for a

loss that it incurs?

Is the holder not compensated for more

than the actual loss incurred?

Figure 1: Analysis for qualifying as a financial guarantee contract

The following is the accounting treatment in the separate financial statements of company P.


1 April 2016 On initial recognition of the financial guarantee

Investment in SFinancial guarantee liability

Dr 5,000,000Cr 5,000,000

31 March 2017 Subsequent recognition of income on a straight line basis (assuming expected loss is less than the unamortised liability amount)

Financial guarantee liabilityGuarantee income

Dr 1,000,000Cr 1,000,000


1 April 2016 On initial recognition of the financial guarantee

Prepaid expense (guarantee premium)Equity

Dr 5,000,000Cr 5,000,000

31 March 2017 Subsequent recognition of income on a straight line basis (assuming expected loss is less than the unamortised liability amount)

Guarantee expensePrepaid expense (guarantee premium)

Dr 1,000,000Cr 1,000,000

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Beneficiary – Company S

Ind AS 109 does not apply to the beneficiary of a financial guarantee contract. In an arm’s length transaction between unrelated parties, the beneficiary would recognise the guarantee fee or premium paid as an expense. However, in the illustration above, company S does not pay

a premium to its parent entity for providing this financial guarantee.

Therefore, company S would be required to develop and consistently apply an accounting policy to recognise the impact of this financial guarantee contract in its separate financial statements.

One view is that the subsidiary should mirror the accounting treatment in the separate financial statements of the parent entity. Therefore, company S should recognise the fair value of the guarantee as an equity infusion by the parent as follows.

On consolidation, the transactions recognised in the separate financial statements of the parent and subsidiary companies will be eliminated.

An alternative view may be that the guarantee is an integral part of the borrowing and the subsidiary company merely recognises the guaranteed borrowing from the bank at its fair value, being the nominal amount of proceeds received. The financial guarantee from the parent is not recognised separately. On consolidation, the parent entity should reverse the accounting entries

relating to the financial guarantee that were recognised in its separate financial statements.

Holder – Bank B

Ind AS 109 does not provide any specific guidance on accounting by the holder of a financial guarantee. A holder may develop and consistently apply an accounting policy for such contracts under Ind AS.

A financial guarantee contract held by an entity that is not an integral part of another financial instrument

is not within the scope of Ind AS 109. If a financial guarantee is an integral element of a debt instrument held by the entity, it should not be accounted for separately. The effect of the protection offered by such guarantee should be considered by the holder when measuring the fair value of the debt instrument, estimating expected cash flows and assessing impairment of the debt instrument.




27

Consider this….

• A guarantee contract that requires the guarantor (company P inthe illustration above) to make a payment to the holder (bankB) when a loss has not been incurred, for example, based onchanges in the credit rating of company S, does not meet thedefinition of a financial guarantee contract. Similarly, guaranteecontracts that fail any one of the three conditions in Figure 1above are not financial guarantee contracts as defined in Ind AS109. Such contracts may be considered credit derivatives andare measured at fair value with changes in fair value recognisedin the statement of profit and loss (fair value through profit orloss).

• Other features that may result in guarantee contracts beingconsidered credit derivatives include those that require theguarantor to make payments in response to changes in aspecified variable (e.g., credit index, interest rates, etc.) orwhen the debtor fails to make payment within a specified creditperiod. However, in the latter case, if subsequent recoveriesfrom the debtor are used to repay the guarantor such contractsmay still qualify as financial guarantee contracts.

• In the example above, if the subsidiary company S pays theparent company P a guarantee commission/premium, companyP is required to determine if this premium represents thefair value of the financial guarantee contract. If the premiumis equivalent to an amount that company S would have paidto obtain a similar guarantee in a stand-alone arm’s lengthtransaction, then the fair value of the financial guaranteecontract at inception is likely to equal the premium received.Company P should recognise a liability for the amount ofpremium received and subsequently measure the financialguarantee contract at the higher of the amount of lossallowance determined in accordance with Ind AS 109 andthe amount initially recognised, less cumulative amount ofincome recognised (based on amortisation of the premium) inaccordance with Ind AS 18.


28


Amendments to IFRS 2 to clarify the accounting for certain types of arrangements

Background

The International Accounting Standards Board (IASB) received comments from many stakeholders that there is an ambiguity over how an entity should account for the following issues:

• The effects of vesting conditions on the measurement of a cash-settled share-based payment

• The classification of share-based payment transactionswith net settlement features, and

• The accounting for a modification to the terms andconditions of a share-based payment that changes the classification of the transaction from cash-settled toequity-settled.

Accordingly, in November 2014, IASB published an Exposure Draft (ED) Classification and Measurement of Share-based Payment Transactions proposing amendments to IFRS 2. Based on the comment letters received, IASB on 20 June 2016 issued narrow-scope amendments to IFRS.

Entities are required to apply the amendments for annual periods beginning on or after 1 January 2018. Earlier application is permitted.

Below is an overview of these narrow-scope amendments issued by IASB.

Measurement of a cash-settled awards

Issue

IFRS 2 requires an entity to measure the liability for a cash-settled share-based payment initially and at the end of each reporting period until settled, at the fair value of the cash-settled share-based payment, taking into account the terms and conditions on which the cash-settled share-based payment was granted and the extent to which the employees have rendered service to date.

Currently, there is no guidance in IFRS 2 on how to measure the fair value of the liability incurred in a cash-settled share-based payment. As a result, diversity in practice exists between measuring the liability using the same approach as for equity-settled awards and using full fair value.

Recent updates from the International Accounting Standards Board

29


This article aims to highlight:

– Amendments to IFRS 2, Share-based Payment to clarify the accounting for certain types of arrangements

– Proposed amendment to the definition of business in the IFRS 3, Business Combinations and

– Proposed amendment to IFRS 11, Joint Arrangements relating to accounting for previously held interests.

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Amendment

The amendments clarify that a cash-settled share-based payment is measured using the same approach as for equity-settled share-based payments i.e. the modified grant date method. Therefore, in measuring the liability:

• Market and non-vesting conditions are taken into account in measuring its fair value, and

• The number of awards to receive cash is adjusted to reflect the bestestimate of those expected to vest as a result of satisfying service and any non-market performance conditions.

The new requirements do not change the cumulative amount of expense that is ultimately recognised, because the total consideration for a cash-settled share-based payment is still equal to the cash paid on settlement.

Classification of awards settled net of tax withholdings

Issue

In some countries, an entity may be obligated to collect or withhold tax related to a share-based payment, even though the tax obligation is often a liability of the employee and not the entity. Some share-based payment arrangements permit or require the entity to withhold a portion of the shares that would otherwise be issued to the employee, and to pay the tax authorities on the employee’s behalf.

Currently, it is unclear whether the portion of the share-based payment that is withheld in these instances should be accounted for as equity-settled or cash-settled.

Amendment

The amendment provides an exception to the requirement of IFRS 2. The amendment states that for classification purposes, a share-basedpayment transaction with employees is accounted for as equity-settled if:

• The terms of the arrangement permit or require an entity to settle the transaction net by withholding a specified portion of the equityinstruments to meet the statutory tax withholding requirement (the net settlement feature), and

• The entire share-based payment transaction would otherwise be classified as equity-settled if therewere no net settlement features.

The exception does not apply to equity instruments that the company withholds in excess of the employee’s tax obligation associated with the share-based payment.

Modification of awards from cash-settled to equity-settled

Issue

A cash-settled share-based payment may change to an equity-settled share-based payment because of modifications to the terms and conditions of the arrangement. In addition, there are transactions in which a cash-settled share-based payment is settled and replaced by a new equity-settled share-based payment. IFRS 2 does not specifically address such situations.

Amendment

The amendments clarify that entities should apply the following approach.

• At the modification date: – the liability for the original cash-

settled share-based payment is derecognised, and

– the equity-settled share-based payment is measured at its fair value as at the modification date, and recognised to the extent that the goods or services have been received up to that date.

• The difference between the carrying amount of the liability derecognised as at the modification date, andthe amount recognised in equity as at that date, is recognised in the statement of profit and lossimmediately.

Next steps

The amendments are expected to help in resolving some long-standing ambiguities in share-based payment accounting and help in bringing consistency of practice. In India, the Institute of Chartered Accountants of India (ICAI) has issued an ED in August 2016 for proposed amendments to Ind AS 102, Share-based Payments which are on the lines as the amendments to IFRS 2 issued by the IASB.

Last date for comments end on 5 September 2016. Companies should carefully study these amendments and provide their comments to the ICAI.

Clarifying the definition of business

Defining a business is important from the perspective of application of IFRS 3. This is because the financial reporting requirements for acquisition of a business are different from the requirements for a purchase of a group of assets that does not constitute a business. For example, in a business combination, contrary to an asset acquisition, an entity considers following aspects (as described in the table below):

Business acquisition Asset acquisition

Goodwill (not amortised) P x

Additional intangibles P x

Bargain purchase gain P x

Day - 1 deferred tax P x

Capitalised transaction costs x P

Source: Definition of business, slideshare published by KPMG IFRG Ltd dated 4 July 2016


No

Yes

No

Yes

Is substantially all of the fair value of the gross assets acquired concentrated in a single identifiable

asset or group of similar assets?

The acquired set of activities and assets is not a business

The acquired set of activities and assets is not a business

Does the acquired set of activities and assets include an input and a substantive process that

together contribute to the ability to create outputs?

The acquired set of activities and assets is a business

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Test 1: Asset concentration test

Is substantially all the fair value concentrated in one or more similar assets?

The proposal includes a quantitative threshold test. In order to assess whether a transaction is the acquisition of a business, an entity first assesses whether substantially all of the fair value of the gross assets acquired are concentrated in a single asset or group of similar assets. If the fair value is concentrated in this way then the transaction is not the acquisition of a business but an asset acquisition. In all other cases, the transaction could be a business combination if the additional tests are fulfilled. A single identifiable

asset for this test, is any asset or group of assets that would be recognised and measured as a single identifiable asset in a business combination.

In addition, for this assessment tangible assets that are attached to each other, and cannot be physically removed and used separately from, other tangible assets without incurring significant cost, or significant diminution in utility or fair value to either asset, shall be considered as single identifiable asset.

Under the proposals, the following assets would not be combined into a single identifiable asset or considered a group of similar identifiable assets:

• Separately identifiable tangible and intangible assets,

• Different classes of tangible assets (for example, inventory and manufacturing equipment) Unless they meet the criterion to be considered a single identifiable asset

• Identifiable intangible assets in different intangible asset classes (for example, customer-related intangibles, trade marks, and in-process research and development),

• Financial assets and non-financial assets, and

• Different classes of financial assets (for example, cash, accounts receivable and marketable securities).

Currently, IFRS 3, provides a broad definition of business. With a broad business definition, determining whether a transaction is an asset acquisition or a business acquisition has long been a challenging but an important area of judgement.

The IASB (Board) carried out a post implementation review of IFRS 3 in 2014 and 2015. That review identified that stakeholders faced difficulties to apply the definition of a business in IFRS 3. Because IFRS 3 is the result of a joint project between the Board and the US Financial Accounting Standards Board (FASB), the business combinations requirements in IFRS and US Generally Accepted Accounting

Principles (US GAAP) are substantially converged. It was observed that the FASB received similar feedback regarding difficulties in applying the definition of a business. Consequently, the FASB and the Board have worked together to respond to this feedback and the proposed amendments to IFRS 3 and the Proposed Accounting Standards Update Clarifying the Definition of a Business, issued by the FASB in November 2015, are based on substantially converged tentative conclusions.

The Board in June 2016 issued an Exposure Draft (ED) ED/2016/1 which proposes to amend IFRS 3 and IFRS 11.

The amendments propose to clarify:

a. The definition of a business, and

b. The accounting for previously held interests when an entity obtains control of a business that is a joint operation and when it obtains joint control of a business that is a joint operation.

The proposals - at a glance

The proposals aim to narrow the business definition and facilitate more robust decision-making when assessing whether a set of acquired assets and activities constitutes a business. The ED provides the following flowchart to explain the new concepts.

Source: IASB’s ED on Definition of a Business and Accounting for Previously Held Interests issued in June 2016


The diagram below summarises the assessment process set out in the ED:

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Test 2: Acquired process is substantive test

When evaluating whether a set of activities and assets include a substantive process, the presence of more than an insignificant amount of goodwill may be an indicator that an acquired process is substantive and the set of activities and assets is a business. However, a business need not have goodwill. The proposals provide a framework to assist an entity in evaluating whether the set of activities and assets includes a substantive process. The proposals include two different sets of criteria to consider depending on whether the set of activities and assets has outputs i.e.

• when the set of activities and assets do not have outputs

• when the set of activities and assets have outputs.

If a set of activities and assets do not, at the acquisition date, have outputs (for example, it is an early-stage entity that has not started generating revenues), the set is a business only if it includes an organised workforce (which is an input) with the necessary skills, knowledge, or experience to perform an acquired substantive process (or group of processes).

In addition, that acquired substantive process (or group of processes) shall be critical to the ability to develop or convert another acquired input or inputs into outputs. Inputs that the organised workforce could develop (or is developing) or convert into outputs include the following:

a. intellectual property that could be used to develop a good or service

b. other economic resources that could be developed to create outputs, or

c. rights to access necessary materials or rights that enable the creation of future outputs.

Examples of the inputs include technology, in-process research and development projects, real estate and mineral interests.

A process (or group of processes) is not critical if, for example, it is ancillary or minor within the context of all the processes required to create outputs.

If a set of activities and assets have outputs at the acquisition date (for example, if it generates revenue before the acquisition), the set is a business if either: a. The acquired set of activities and

assets includes a process (or group of processes) that, when applied to an acquired input or inputs, contributes to the ability to continue producing outputs, even without the acquisition of an organised workforce, and that process (or group of processes) is considered distinct or scarce, or cannot be replaced without significant cost,effort, or delay in the ability to continue producing outputs; or

b. The acquired set of activities and assets include an organised workforce with the necessary skills, knowledge, or experience to perform an acquired process (or group of processes) that when applied to an acquired input or inputs, is critical to the ability to continue producing outputs.

An acquired contract is not a substantive process. However, an acquired contract may give access to an organised workforce, for example a contract for outsourced property management or outsourced asset management. An entity shall assess whether an organised workforce accessed through such a contractual arrangement performs a substantive process that the entity controls, and thus has acquired (for example, considering the duration and the renewal terms of the contract).

This assessment may involve considerable judgement in some cases. The proposals do not provide additional guidance for making that judgement.

Accounting for previously held interests under IFRS 11

There is diversity in practice in accounting for previously held interests in the assets and liabilities of a joint operation in two types of transactions:

• Those in which an entity obtains control of a business that is a joint operation, and

• Those in which it obtains joint control of a business that is a joint operation.

In particular, differing views exist about whether an entity applies the principles on accounting for a business combination achieved in stages to those previously held interests when the investor obtains joint control.

Whether to fair value previously held interest

The Board observed that the joint operator may retain joint control, or the party that participates in, but does not have joint control of, the joint operation may obtain joint control, of the joint operation.

The Board observed that, although such transactions change the nature of any interests in the assets and liabilities of the joint operation, the transaction does not result in a change in the group boundaries or the method of accounting for the previously held interests in the joint operation. In this respect, the transaction is analogous to a transaction that results in an investment in an associate becoming an investment in a joint venture and vice versa.

For both of these transactions, as stated in IAS 28 Investment in Associates and Joint Ventures, an investor does not apply the principles on accounting for a business combination achieved in stages to those previously held interests. The Board also observed that remeasuring previously held interests would conflict with the requirements of IFRS 11 for an entity to account for the assets and liabilities relating to its interest in the joint operation in accordance with the applicable IFRS.

Consequently, the Board proposes that, when an investor obtains joint control of a business that is a joint operation, the entity should not remeasure previously held interests in the assets and liabilities of the joint operation.


Revisions to the Framework proposed by the MAT-Ind AS Committee

The Central Board of Direct Taxes (CBDT) issued a press release on 5 August 2016, announcing certain modified recommendations/suggestions on select matters submitted by the Minimum Alternate Tax (MAT) – Indian Accounting Standards (Ind AS) Committee (the Committee) in its report dated 23 July 2016 (the report).

Background

On 18 March 2016, the Committee issued a report proposing a framework for computation of book profits for Ind AS compliant companies (the Framework) for the computation of book profit for the purpose of levy of MAT under Section 115JB of the Income-tax Act, 1961 (the IT Act).

In this report (issued on 18 March 2016) the Committee had made the following key recommendations:

• No further adjustments should be made to the net profits of Ind AS compliant companies, other thanthose specified in Section 115JB of the IT Act,

• Certain items included in net Other Comprehensive Income (OCI), that are permanently recorded in reserves and never reclassified into the statement ofprofit and loss, be included in book profits for MAT atan appropriate point of time, and

• Certain adjustments recorded in retained earnings on first-time adoption of Ind AS, that would neversubsequently be reclassified into the statement ofprofit and loss should be included in book profits (forthe purpose of levy of MAT) in the year of first-timeadoption of Ind AS.

Regulatory updates

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Overview of the recommendations in the report (issued on 5 August 2016)

The Committee received several responses from stakeholders, specifically on its recommendations relating to first-time adoption of Ind AS. These were examined and the recommendations of the Committee on the issues raised are as follows.

Property, plant and equipment – adjustments to retained earnings

Requirements of Ind AS 101, First-Time Adoption of Ind AS

Ind AS 101 permits an entity to measure items of Property, Plant and Equipment (PPE) at the date of transition at their recomputed values, measured in accordance with Ind AS 16, Property, Plant and Equipment, from inception. Alternatively, a first-time adopter of Ind AS can opt to apply the ‘deemed cost’ exemption and measure items of PPE either at their fair value or at carrying value as per the previous GAAP, on the date of transition. At the date of transition the resulting adjustments in the carrying value of existing PPE are recorded in retained earnings.

Recommendation

The initial recommendation of the Committee (in the report issued on 18 March 2016) was to include the amount of this adjustment in the book profit of the year of first-time adoption of Ind AS, since these amounts would never be reclassified to the statement of profit and loss. However, based on responses received from stakeholders, the Committee has now recommended the following:

• Following the principles in Sections 115JB of the IT Act thatare applicable for revaluation of assets, the adjustments in retained earnings relating to PPE, on first-time adoption of Ind AS, should be ignored for computation of book profits

• Depreciation as well as gains or losses on disposal of such assets (for computation of book profits)should be computed by ignoring the retained earnings adjustment on first-time adoption, and

• Other adjustments to PPE such as decommissioning liability, foreign exchange capitalisation, borrowing costs, etc., on the date of transition should also be ignored in a similar manner.

The Committee has also stated that the same principle be applied to items of intangible assets on the date of transition to Ind AS.

Leases – straight-lining of lease rentals

Requirements of AS 19, Leases and Ind AS 17, Leases

Under Indian GAAP, AS 19 requires straight-lining of operating lease rentals even if payments to the lessor are structured to increase in line with expected general inflation. A corresponding lease equalisation liability/asset is recognised under AS 19. However, Ind AS 17 states thatoperating lease payments shall not be recognised on a straight-line basis in this scenario. Accordingly, any existing lease equalisation liability/asset shall be adjusted to retained earnings on the date of transition.

Recommendation

After consideration of several options, the Committee has recommended that this retained earnings adjustment should be included in the book profits for levy of MAT, over a period of three years starting from the year of first-time adoption of Ind AS, i.e., over three financial years.

Companies should include the applicable portion of the retained earnings adjustment relating to first-time adoption of Ind AS when computing their book profits for MAT purposes in these three years.

Investments – fair value adjustments through profit and loss account

Requirements of Ind AS 109, Financial Instruments

Ind AS 109 requires or permits measurement of certain financial assets or financial liabilities at fair value through profit or loss in specific circumstances. Examples include:

• Investments in equity instruments or mutual fund units

• Investments in subsidiaries/associates/joint ventures where the entity has opted to measure these at fair value through profit or loss intheir separate financial statements

• Investment in debt instruments that do not meet the criteria for amortised cost measurement

• Derivative assets or liabilities, or• Any other financial asset or liability

designated at fair value through profitor loss under Ind AS 109.

Adjustments arising from recognition of such items at fair value on the date of transition to Ind AS are recognised in retained earnings.

Recommendation

On examining several options and considering the dual aspects of taxation of unrealised gains/losses and maintenance of records, the Committee has recommended that the retained earnings adjustment should be included in book profit over a period of three years starting from the year of first-time adoption of Ind AS.

Other issues - recommendation

The Committee also considered issues relating to all other adjustments relating to first-time adoption of Ind AS recorded in retained earnings, which would never subsequently be reclassified to the statement of profit and loss. It recommended that these should be included in the book profit over a period of three years starting from the year of first time adoption of Ind AS.

Also refer to KPMG in India’s IFRS Notes dated 10 August 2016 that provides an overview of the recommendations in the report.

(Source: CBDT press release dated 5 August 2016)


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SEBI provides certain relaxations for Ind AS compliant half yearly and annual financial results for debt securities and/or non-cumulative redeemable preference shares

The Securities and Exchange Board of India (SEBI), on 10 August 2016, issued a circular (the SEBI Circular) (CIR/IMD/DF1/69/2016) prescribing formats for the disclosure of half-yearly and financial results by entities that have listed their debt securities and/or non-cumulative redeemable preference shares (listed companies).

Further, in continuation of its efforts to facilitate smooth transition to Indian Accounting Standards (Ind AS), SEBI has also provided certain relaxations for the first half-year of adoption of Ind AS. The SEBI Circular is applicable from its date of publication, i.e. 10 August 2016.

Overview of the circular

The circular issued by SEBI provides followinga. Formats for disclosure of financial

results – The circular prescribes the formats for submission of Ind AS compliant half yearly and annual results.

b. Relaxations for first half year of the adoption of Ind AS - The SEBI circular provides certain relaxations, for the first year of adoption of Ind AS, to listed companies while reporting their Ind AS compliant half yearly and annual financial results.

c. The SEBI circular provided significant clarifications on issues relating to implementation of Ind AS.

Also refer KPMG in India IFRS Notes dated 19 August 2016 that provides an overview of the circular issued by SEBI.

The MCA issues amendments for consolidated financial statements of wholly-owned and partially-owned subsidiaries

Background

The Ministry of Corporate Affairs (MCA) has been issuing various amendments and clarifications to the Companies Act, 2013 (2013 Act) and its corresponding Rules to ease the implementation of the 2013 Act.

The 2013 Act through Section 129(3) of the 2013 Act prescribes the requirements for preparation of the Consolidated Financial Statements (CFS).

On 14 October 2014, the MCA provided an exemption from the preparation of CFS to wholly-owned intermediate companies incorporated in India under certain circumstances.

New development

Recently, the MCA through a notification dated 27 July 2016 issued the Companies (Accounts) Amendment Rules, 2016 (the Rules) that provide following amendments to following rules:

• Rule 6 on manner of consolidation of accounts

A new proviso to Rule 6 has been inserted which provides that a company is not required to prepare CFS, if it meets the following conditions:

i. It is a wholly-owned subsidiary, or is a partially-owned subsidiary of another company and all its other members (including those not otherwise entitled to vote) having been intimated in writing and for which the proof of delivery of such an intimation is available with the company, do not object to the company not presenting CFS

ii. It is a company whose securities are not listed or are not in the process of listing on any stock exchange, whether in India or outside India, and

iii. Its ultimate or any intermediate holding company files CFS with the Registrar of Companies (ROC) which are in compliance with the applicable accounting standards.

The amendment grants relief to wholly-owned and partially-owned companies if their ultimate or any intermediate holding company prepares a CFS. However, such ultimate or intermediate parent companies would have to file CFS with the ROC in compliance with the Accounting Standards under the 2013 Act.

• Rule 8 on matters to be included in the Board’s report

The amended Rules provide that the Board should report on the highlights of the performance of its subsidiaries, associates and joint venture companies and their contribution to the overall performance of the company during the period under report.

• Rule 13 on companies required to appoint internal auditor.

The following two amendments have been made in the said Rule:

1. An internal auditor may either be an individual, a partnership firm or a body corporate and

2. A cost accountant could also be an internal auditor.

(This amendment has been made in line with the requirements of Section 138 of the 2013 Act which states that an internal auditor could be a Chartered Accountant (CA) or a cost accountant or such other professional as may be decided by the board to conduct internal audit of the functions and activities of the company).

Additionally, MCA has extended the last date of filing of annual returns and financial statements forms. The MCA has revised form AOC-4 and other forms such as AOC-4 (XBRL) and AOC-4 (CFS) are under revision. These forms are expected to be available by the end of August 2016. Therefore, MCA has extended the last date of filing these forms (AOC-4, AOC-4 (XBRL), AOC-4 (CFS) and MGT-7) until 29 October 2016 (where the due date for holding an Annual General Meeting (AGM) is on or after 1 April 2016) without the payment of additional fees.

Please refer to KPMG in India’s First Notes dated 16 August 2016 that provides an overview of the amendments issued by MCA.


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The MCA notifies NCLT and NCLAT Rules, 2016

On 1 June 2016 the MCA constituted the National Company Law Tribunal (NCLT) and National Company Law Appellate Tribunal (NCLAT) to exercise and discharge the powers and functions as conferred on it under the 2013 Act. The MCA also notified certain related Sections of the 2013 Act to enable the NCLT/NCLAT exercise their powers.

Recently, on 21 July 2016, MCA has notified the rules corresponding to the sections relating to NCLT/NCLAT (The Rules). They are as follows:

1. National Company Law Tribunal Rules, 2016 (NCLT Rules) and

2. National Company Law Appellate Tribunal Rules, 2016 (NCLAT Rules).

The Rules came into force from 21 July 2016 i.e. the date they have been published in the official gazette of India and provide the procedures that companies would be required to follow while making an application to the NCLT/NCLAT along with the manner in which the cases would be disposed of by the NCLT/NCLAT.

Important topics dealt in the Rules

The notification of the much awaited Rules on NCLT/NCLAT signify the MCA’s continuing efforts towards a smooth transition to the 2013 Act. Amongst others, these Rules provide for the following notable provisions:

Transfer of cases of CLB to NCLT: The NCLT Rules clarify that matters earlier dealt by CLB would be transferred to the respective benches of the NCLT (Tribunal) as if such cases had been originally filed in the Tribunal or its bench (to which it is transferred) on the date upon which they were actually filed with the CLB or its bench.

However, the Tribunal is allowed to consider the actions of the CLB as deemed to have been taken or done under the corresponding provisions of these Rules and the provisions of the 2013 Act, and could thereupon continue with the proceedings. Where the order is reserved by the CLB or its bench then in such a case, the Tribunal should reopen the matter and rehear the case as if the hearing had not taken place.

Conducting a class action suit (Section 245): The 2013 Act has introduced the concept of class action to be instituted against the company through which shareholders and depositors can seek to restrain the company from committing an act which is ultra vires the articles or memorandum. The NCLT Rules provide that while considering the admissibility of an application made under this provision, the Tribunal can take into account additional grounds such as:

• Whether the class has so many members that joining them individually would be impractical, making a class action desirable

• Whether there are questions of law or fact common to the class

• Whether the claims or defences of the representative parties are typical of the claims or defences of the class

• Whether the representative parties will fairly and adequately protect the interests of the class.

Application under Section 131 - Voluntary revision of financialstatements or Board’s report: The NCLT Rules provide that where directors of a company feel that the financialstatements of the company are not in compliance with the provisions of Section 129 or Section 134 of the 2013 Act, an application in the prescribed format can be made to the Tribunal for obtaining approval for preparing revised financial statements or a revised report.Such an application should be filedwithin 14 days of the decision taken by the Board.

Application under Section 140 - Removal, resignation of auditors and giving special notice: The NCLT Rules deal with three situations:

• An application can be filed by adirector on behalf of the company or the aggrieved auditor to the Tribunal in the manner prescribed in the Rules

• Where Tribunal is satisfied on anapplication of the company or the aggrieved person that the rights conferred by the provisions of Section 140 are being abused by the auditor, then the copy of the representation of the auditor need

not be sent to every member of the company and the representation need not be read out at the meeting

• If the application is made by the central government and the Tribunal is satisfied that any change of theauditor is required, it shall within 15 days of receipt of such an application make an order that the auditor shall not function as an auditor and the central government may appoint another auditor in his place.

Application for calling or obtaining a direction to call annual general meeting (Section 97): Any member of the company can make an application under Section 97 of the 2013 Act for calling or obtaining a direction to call the annual general meeting of the company in the manner prescribed in the NCLT Rules.

Amicus Curiae: The Tribunal may seek views of professionals/professional bodies to provide their views on any points or legal issues.

Filling through electronic media: The NCLAT (Appellate Tribunal) may allow filing of appeal or proceedings through electronic modes such as online filing and provide for rectification of defects by e-mail or internet and in such filing, these Rules shall be adopted as nearly as possible on and from a date to be notified separately and the central government may issue instructions in this behalf from time to time.


37

Detailed rules, forms and procedures have been prescribed in relation to certain specific matters including but not limited to the following:

• Petition for the conversion of a public company into a private company

• Appeals against the refusal for registration of transfer or transmission of securities or for the rectification of the register ofmembers

• Application for consolidation and division of all or any of the share capital resulting in a change in the voting percentage of shareholders

• Application where a company fails to redeem the debentures or repay the deposits or any part thereof or any interest thereon.

(Source: MCA notification dated 21 July 2016 and KPMG in India First Notes dated 8 August 2016)

Exposure drafts issued by ICAI

The Institute of Chartered Accountants of India (ICAI) has issued the following exposure drafts to facilitate Ind AS implementation and address accounting issues.

• Ind AS 102, Share Based Payments(Comments to be sent by 5 September 2016)

• Guidance Note on Combined Financial Statements (Comments to be sent by 5 September 2016)

• Guidance Note on Accounting for Oil and Gas Producing Activities (Comments to be sent by 31 August 2016)

(Source: ICAI exposure drafts issued by ICAI in August 2016)

Implementation of Ind AS by select All India Term Lending and Refinancing Institutions (AIFIs)

The Reserve Bank of India (RBI), through its notification dated 4 August 2016, has inter-alia advised that selected AIFIs (i.e. Exim Bank, NABARD, NHB and SIDBI), will follow Ind AS as notified under the Companies (Indian Accounting Standards) Rules, 2015, subject to any guideline or direction issued by RBI, in the following manner:

• AIFIs will comply with Ind AS for accounting periods beginning from 1 April 2018 onwards, with comparatives for the periods ending 31 March 2018 or thereafter. Ind AS will be applicable to both stand-alone and consolidated financial statements. It is alsoprescribed that comparatives will mean comparative figures for thepreceding accounting period

• AIFIs will apply Ind AS only as per the above timelines and are not permitted to adopt Ind AS earlier

• Each AIFI is advised to set up a Steering Committee headed by an official of the rank of an ExecutiveDirector and comprising members from cross-functional areas of the AIFI to immediately initiate the implementation process. The name and details of the designated officialand the team may be forwarded by email to RBI

• The Audit Committee of the board should oversee the progress of the Ind AS implementation process and report to the board on a quarterly intervals

• AIFIs should disclose in their Annual Report, the strategy for Ind

AS implementation, including the progress made in this regard. These disclosures should be made from the financial year 2016-17 until full implementation

• AIFIs also need to be in preparedness to submit pro forma Ind AS financial statements as perthe prescribed formats and the associated guidance to RBI from the half year ended 30 September 2016 onwards. The pro forma statements for the half year ended 30 September 2016 will be submitted latest by 30 November 2016. Considering that the financial year of NHB is from Julyto June, it may prepare pro formaInd AS financial statements for thehalf year ended 31 December 2016 which will be submitted latest by 28 February 2017.

(Source: RBI circular RBI/2016-17/34 dated 4 August 2016)


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KPMG in India’s IFRS institute Visit KPMG in India’s IFRS institute - a web-based platform, which seeks to act as a wide-ranging site for information and updates on IFRS implementation in India.The website provides information and resources to help board and audit committee members, executives, management, stakeholders and government representatives gain insight and access to thought leadership publications that are based on the evolving global financial reporting framework.

The MCA issues amendments for consolidated financial statements of wholly-owned and partially-owned subsidiaries

16 August 2016

Background

The Ministry of Corporate Affairs (MCA) has been issuing various amendments and clarifications to the

Companies Act, 2013 (2013 Act) and its corresponding Rules to ease the implementation of the 2013 Act.

The 2013 Act through Section 129(3) of the 2013 Act prescribes the requirements for preparation of the Consolidated Financial Statements (CFS).

On 14 October 2014, the MCA provided an exemption from the preparation of CFS to wholly-owned intermediate companies incorporated in India under certain circumstances.

New developments

Recently, the MCA through a notification dated 27 July 2016 issued the Companies (Accounts) Amendment Rules, 2016 (the Rules) that provide following amendments to following rules:

• Rule 6 on manner of consolidation of accounts

• Rule 8 on matters to be included in the Board’sreport

• Rule 13 on companies required to appoint internalauditor.

Additionally, MCA has extended the last date of filing of annual returns and financial statements forms.

This issue of First Notes provide an overview of the above MCA amendments.

KPMG in India is pleased to present Voices on Reporting – a monthly series of knowledge sharing calls to discuss current and emerging issues relating to financial reporting.

In our recent call, on 11 August 2016, we provided an overview of the proposals issued by the MAT – Ind AS Committee on 5 August 2016.

Missed an issue of Accounting and Auditing Update or First Notes?

IFRS NotesInd AS Transition Facilitation Group (ITFG) issues clarifications Bulletin 4

26 August 2016

Background

With Indian Accounting Standards (Ind AS) being applicable to large corporates from 1 April 2016, the Institute of Chartered Accountants of India (ICAI) on 11 January 2016 announced the formation of the Ind AS Transition Facilitation

Group (ITFG) in order to provide clarifications on issues arising due to applicability and/or implementation of Ind AS under the Companies (Indian Accounting Standards) Rules, 2015 (Rules 2015).

Earlier this year, the ITFG issued three bulletins to provide guidance on issues relating to the application of Ind AS.

New developments

The ITFG held its fourth meeting on 19 August 2016, and issued its bulletin (Bulletin 4) to provide clarifications on four issues relating to the application of Ind AS, as considered in its meeting.

This issue of IFRS Notes provides an overview of the issues considered in Bulletin 4.

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 endeavour 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.


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Documents

Accounting and Auditing Update - KPMG · SA 705 (Revised), Modifications to the : Opinion in the Independent Auditor’s Report: Clarification of how the new reporting elements are