Accounting and Auditing Update - March 2014

March 2014

ACCOUNTINGAND AUDITINGUPDATE

In this issue

Airport infrastructure p1

Carving-out: the financial reporting perspective p5

The Companies Act, 2013 Emphasis on investor protection p8

Simplified hedge accounting approach - Accounting for certain ‘receive-variable, pay-fixed’ interest rate swaps p13

Year-end reminders p15

Accounting for principal only currency swaps - recent EAC guidance p23

Regulatory updates p25

There have been few sectors in India that have got as much negative press and attention as the aviation sector in the recent past. Still, the level of interest both by local and overseas investors in this sector continues to be robust. Our lead sector article for this month focusses on some of the arrangements, the business models in vogue and their implications from an accounting and reporting perspective that are unique to this sector.

We also examine in this issue of the AAU, the complexity and challenges associated with carve-out financial statements. In the backdrop of an economic environment where many businesses are actively considering spin offs and value unlocking measures, carve-out financial information is increasingly used for diligence and by investors. Continuing with our ongoing series, we also highlight some of the changes in the Companies Act 2013 that focus on increased investor and stakeholder protection.

This month, as we approach the March financial year end for many companies, we are including a special round up feature that attempts to summarise in one place, key developments under Indian GAAP, U.S. GAAP and IFRS in the past year that may be relevant for preparers of financial statements.

Finally, in addition to our round of regulatory developments, we also cast our lens this month on recent developments in the area of hedge accounting affecting private companies under U.S. GAAP. The simplified hedge accounting proposals, on the face of it, appear to be an interesting and significant departure from the complexity that is often associated with this accounting area.

I hope you continue to find the Accounting and Auditing Update to be a good and informative read. In case you have any suggestions or inputs on topics we cover, we would be delighted to hear from you. Happy reading!

Editorial

© 2014 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.

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Airport infrastructureThe aviation sector is of national importance, contributing significantly to the process of economic development, enabling enhanced productivity and efficiency in the movement of goods and services. This sector usually generates employment directly and indirectly, and provides a number of feeder opportunities to an array of industries such as airports, airlines, cargo, ground handling, air navigation services, retail, real estate, tourism among others. While there have been a number of challenges faced by the sector recently, the Government’s decision to allow foreign carriers to invest in Indian airlines has given a ray of hope and could have sparked fresh interest in this sector.

In this article, we have highlighted some of the key aspects of the business model and significant regulatory changes faced by this sector and, in that context, salient accounting issues and challenges.

This article aims to

• Highlight some of the key aspects of the business model and significant regulatory changes faced by the sector

• Explain salient accounting issues and challenges.


Airport Infrastructure

Airport operations and regulatory changesThe revenues of an airport operator can be broadly classified into aeronautical and non-aeronautical revenues. The aeronautical revenues include ‘Passenger Service Fee’ (PSF), ‘User Development Fee’ (UDF), ‘Landing Charges’ and ‘Parking Charges’. The non-aeronautical revenues include cargo, fuel, retail, food and beverages, advertising, taxi, vehicle parking, among others.

PSF and UDF are collected as part of the passenger fare by the airline operators and are remitted to concerned airport operators. These charges are regulated charges and are approved by the Ministry of Civil Aviation.

a. PSF includes fees towards facilitation and security. The facilitation fee is levied to meet the expenditure on passenger facilities at the airports, and it is not utilised to fund new development/upgradation of airports whereas the security fees is towards the airport security which is collected by the airport operator on behalf of the Central Industrial Security Force (CISF).

b. UDF refers to the fee collected from embarking passengers for the provision of passenger amenities, services and facilities, and is intended to be used to defray expenses for the development, management, maintenance, operation and expansion of facilities at an airport.

Landing and parking charges are charged by the airport operator to various airlines who operate out of the concerned airports.

a. Landing charges refer to fees collected for the use of runways, taxiways and apron areas, including associated lighting, as well as for the provision of approach and aerodrome control. The charges are levied to all airline operators who have landed at the airport during the period, at a fixed rate, depending on the weight of the aircraft (per metric tonne).

b. Parking charges refer to charges collected from airline operators for the parking of aircraft and for their housing at an airport owned hangers at a fixed rate, depending on the weight of the aircraft (per metric tonne).

The earning potential of non-aeronautical activities is one of the key factors that makes airports an attractive business proposition for private investors. Indeed, the performance of the retail, car parking and real estate revenue streams underscore the resilience of the airport business model and help to protect the bottom line of many airports in a difficult year. Quiet often, non-aeronautical can determine the financial viability of an airport, although what they are allowed to do with the proceeds is dictated by the ‘till system’ they operate under. The till system is used to arrive at the rates for the various regulatory charges at the airport.

In order to formulate a systematic rate card for the regulatory charges for each airport operator across India and to bring about regulation, the Government of India (GOI) has set up a statutory body in December 2008 called Airports Economic Regulatory Authority (AERA or Authority). The objective of AERA is to regulate the tariff of aeronautical services at airports across India.

The Authority determines tariff for the aeronautical services taking into consideration ‘the concession offered by the GOI in any agreement or memorandum of understanding or otherwise’ with the airport operators. Accordingly, the Authority undertakes an ongoing process at various airports in a phased manner to analyse and assess the implications of the principles and mechanics, relating to tariff fixation, contained in the concession agreements in consultation with the respective airport operators.

The airport operators submit a multi-year tariff proposal to the Authority for determination of the tariff in advance for a period of time. The Authority analyses the proposal after which an ‘Annual Tariff Order’ is issued. The process is an ongoing process wherein these charges will be revised by the Authority from time to time.

The rates for PSF, UDF, landing and parking to be charged by an airport operator would depend on the outcome of the consultations and the views of the Authority. The primary method of computing these rates would depend on the regulatory ‘till’. The principle governing the till systems is that airlines’ business is not just air-ticket and in-flight revenue, but they also should be able to participate in commercial revenues that result from

such traffic; then it stands to logic that airports can also participate in the ticket and in-flight revenues of the airlines.

At the outset and specifically in the Indian context, to the extent passengers are required to pay UDF (or for that matter PSF), bringing in the entire contribution of non-aeronautical charges in aeronautical tariff determination could directly reduce (perhaps proportionately) these charges that are directly borne by passengers. The three types of tills are single till, dual till or hybrid till.

Under the single till principle, non-aeronautical revenues are used to subsidise aeronautical charges, and under this system, the airport operator will be allowed to earn a fixed percentage of profit on the total revenues earned by an airport operator based on which aeronautical charges to be levied are finalised. In contrast, under the dual till principle, only aeronautical revenues are considered for calculation of regulatory charges by the Authority, whereas under the hybrid till only some streams of the revenues (aeronautical and non-aeronautical) collected are considered during the calculation of the regulatory charges by the airport regulator.

Hence, single till helps ensure that the burden on the passengers of such charges is reduced, as the benefit of the high profits of the airport operator from the non-aeronautical revenues helps in subsidising the regulatory charges. Single till systems can sometimes not incentivise development of non-aeronautical revenues as the airport operator does not gain. Alternatively, the single till may lead an airport to maximise non-aeronautical revenues aggressively upto a maximum extent taking non-aeronautical investment at the expense of aeronautical investment and service quality.

Under a dual or hybrid till, an airport operator is incentivised to identify improvements in non-aeronautical operating and investment costs often brings down the aeronautical cost base as well as in this case, the airport operator will likely stand to gain.

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Accounting issues and challenges in the airport sectorService concession arrangementsThe arrangement between the Government and the private sector that formalises the private sector participation in this sector, is referred to as ‘service concession arrangement’ (SCA). SCAs are common in the Indian infrastructure scenario, and especially in the ‘greenfield’ airport sector. The private operators enter into a SCA whereby the Government grants the company exclusive right and privilege to carry out the development, design, financing, construction, commissioning, maintenance, operation and management of an airport.

Indian GAAP does not provide any guidance on the accounting for SCA by the operator or grantor; thus, varying accounting policies have been adopted by different operators. The Institute of Chartered Accountants of India (ICAI) proposed an Exposure Draft (ED) on Guidance on Accounting for Service Concession Arrangements in 2008. The ED replicates the principles which are set out in IFRIC 12, Service Concession Arrangements under IFRS.

The current accounting practices under Indian GAAP which are followed by various Indian companies are as below:

• The cost incurred on the infrastructure, which is the subject matter of the SCA, is normally capitalised as fixed assets by various Indian airports. The useful lives for the purpose of depreciating the asset does not exceed the concession term.

• The revenue from airport operations are recognised on an accrual basis, net of service tax, applicable discounts and collection charges, when services are rendered and it is probable that an economic benefit will be received, which can be quantified reliably.

• Concession fee payable to the GOI is usually a percentage of the total revenue earned by an airport operator and is accounted for as an expense in the case of airports.

The accounting for service concession arrangements as per IFRIC 12 depends on whether the airport operator is exposed to demand risk which leads towards following an intangible asset model as against a financial asset model. The key highlights of both the models are as below:

Airport charges derived using the single till approach are, therefore, likely to be lower than charges derived under a dual till because of the sharing of profits generated by non-aeronautical activities. Airports and their investors, particularly with privatisations, are increasingly becoming aware that their commercial revenue profits could be significantly enhanced through application of the dual till system.

Financial asset model

• Recognises the concession activity as a financial asset as the grantor bears the demand risk and the operator has an unconditional right to receive cash irrespective of the use of the infrastructure

• No fixed asset/property plant and equipment is recognised in the books

• Initial phase will involve construction contract like accounting (recognition of revenue and expense)

• A financial asset (receivable) is recognised as proceeds from the construction activity

• Interest income is recognised on an effective interest rate basis.

Intangible asset model

• Recognises the concession activity as an intangible asset to the extent that it has a right to charge for use of the infrastructure

• No fixed asset/property plant and equipment is recognised in the books

• Initial phase will involve construction contract like accounting (recognition of revenue and expense)

• An intangible asset is recognised as proceeds from the construction activity

• Collections in relation to the concession are treated as revenue and intangible asset will be amortised.

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TaxationAirport operators may be eligible for deduction under section 80-IA of the Income-tax Act, 1961 (IT Act), subject to the conditions specified therein. The benefit under section 80-IA is available to the operator developing/developing and maintaining/developing, operating and maintaining an infrastructure facility. The term ‘infrastructure facility’ for this purpose includes airport. Section 80-IA specifies the period for which the deduction is available. For the purpose of claiming the benefit, the company should, inter alia, be in a position to demonstrate that the relevant income in respect of which the benefit is claimed is ‘derived’ from the specified business. This can lead to a lot of accounting challenges in relation to the adequacy of tax provisions.

Even though an airport operator may be eligible to claim benefit under section 80-IA of the IT Act, the provisions of Minimum Alternate Tax (MAT) would apply. The IT Act allows for a carry forward of the MAT credit (representing the difference between the MAT paid and the tax liability under the normal provision of the IT Act) for a ten year period. Such credit can be set-off in the manner as prescribed under the IT Act. The above could have an impact on the accounting for taxes in relation to creation and carry forward of the MAT credit asset in the books.

Basically, MAT credit will need to be tested for recoverability and utilisation since 10 years may not be sufficient for an airport operator to break even or earn taxable income.

ConclusionThe world seems to be focussed on Indian aviation – from manufacturers, tourism boards, airlines, global businesses to individual travellers, shippers and businessmen. The airport operators operate in a potentially lucrative industry but are exposed to a number of variations in terms of demand and significant investment outlays, but also quite significantly, the impact of changing regulation that can fundamentally affect their enterprise values.

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Carving-out the financial reporting perspective

In the current business environment, a number of companies are either divesting or acquiring businesses that are part of existing companies/businesses. These acquisitions/disposals of parts of existing enterprises are referred to as carve-outs. A carve-out is often a strategic option for companies to not only survive but also create wealth for the investors. Carve-outs may consist of disposal of subsidiaries, segments, components, or any product line (carved-out entity/business) as a part of the overall strategic plan. This article discusses some of the key challenges from the financial reporting perspective in relation to sale/purchase of business undertakings on a going concern basis.

Carve-out financial informationCarve-out financial information refers to financial statements prepared by aggregating historical financial information relating to business activities (components) that had previously been reported as part of a larger reporting entity. The carve-out financial statements includes all relevant activities that have been a part of the history of the business and which can be expected to be repeated as the business continues in future. The

carve-out financial information should, also, ideally reflect the relevant activities/operations of the carve-out entity on a stand-alone basis. These activities/operations may have never been reported in the general purpose financial statements separately.

Carve-out financial information is key for valuation of businesses carved-out. Such information provides a basis for assessing the business model and understanding the nature of the business by the investors. The endeavor is to have the business running on a standalone basis and separated operationally, for smooth transition to a new entity created in the transaction.

It is worthwhile to note that no specific technical guidance, including definition of a carve-out, exists currently under the Indian GAAP (IGAAP). The periods for which the comparatives are provided in the carve-out financial statements will depend on the sale arrangement and the buyer’s/investor’s requirements. Special considerations need to be given for transactions between the carved-out business and other businesses in the entity. Such transactions may not have been captured separately as they are not inter-segment transactions if the carve

out business is a part of a single segment. This situation can be further complicated if the carved out business is represented in more than one segment in general purpose financial reporting.

An entity should assess whether it would be practicable to prepare the carve-out financial statements using a set of criteria determined to be appropriate. It is important to assess the extent to which the entity is able to separate each component’s financial performance and assets/liabilities from the rest of the entity without making significant assumptions related to amounts/items shared with the rest of the entity.


• Highlight the practical issues faced while preparing carve out financial statements.


Financial reporting challengesCarving out of business has several financial reporting challenges. Since most of the business transfers are designed as ‘slump sales’ for tax benefits, this article discusses the accounting issues for such transactions from an acquirer and acquiree’s perspective.

While a dedicated standard is not available under the IGAAP, references are made to existing standards, the most relevant being AS 10, Accounting for Fixed Assets from which analogies can be drawn. In the absence of more specific accounting guidance under IGAAP, it is not uncommon for companies to draw an analogy from other bodies of accounting literature such as U.S. GAAP. Further, at transaction level, compilation of the financial data for the carved out entity can prove to be practically onerous due to the widespread use of integrated accounting and ERP packages. The major challenges on compiling financial data for the carve-out entity is broadly segregated into three major aspects that are discussed in this article.

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Acquirer’s challenges‘Slump sale’ as a concept has been discussed under the Income Tax Act, 1961 (the IT Act) along with detailed provisions on the tax implications. It describes a slump sale as a transaction that involves transfer of one or more ‘undertakings’ as a going concern in return for a lump sum consideration without values being assigned to the individual assets and liabilities. An undertaking could be a division, business unit, product line or a business activity taken as a whole. However, it does not include individual assets or liabilities or a combination there of, not constituting a business activity.

Under AS 10, where several assets are purchased for a consolidated price, the consideration is apportioned to the various assets on a fair basis as determined by competent valuers. Hence, the acquirer will account for all the assets and liabilities at values determined post a valuation process. This may require recognition of assets not recognised by the seller, on account of these not meeting the separate recognition criteria for the seller. Common examples of the same are brands, patents, technical know-how. However, the recognition of such assets is subject to the definition of assets as enunciated under the relevant standards under IGAAP. For instance, under AS 26, Intangible assets, an intangible asset e.g., portfolio of customers is not recognised in absence of legal rights to protect or control the economic benefits expected to accrue from the underlying asset. In such instances, the amount attributable to these assets is accounted as goodwill.

Further, under AS 10, goodwill is generally accounted in the books only when some consideration in money or money’s worth is paid for it. Whenever the consideration paid for the acquisition exceeds the net assets of the seller, the excess is termed as ‘goodwill’. Goodwill arises from business connections, trade name or reputation of an enterprise or from other intangible benefits enjoyed by an enterprise.

As a matter of financial prudence, certain entities write off goodwill acquired over a period of three to five years. However, AS 10 does not require the goodwill, accounted on a slump sale, to be amortised mandatorily. AS 26 requires goodwill to be amortised systematically over the best estimate of the useful life (subject to the rebuttable presumption of the useful life of an intangible asset not exceeding 10 years). On account of lack of clarity in the accounting literature, there are mixed industry practices. Some companies amortise based on the AS 26 guidance, while the others opt for impairment testing rather than amortisation.

Further, a deferred tax asset (DTA) may be recognised by the carved out entity/acquirer on the carried forward losses and/or unabsorbed depreciation if virtual certainty (of the existence of future taxable income to absorb those losses) can be demonstrated. The acquired company may not have recognised the DTA due to the virtual certainty test not being met. The value of such DTA can impact the value of goodwill recognised. This could be subject to a consideration of whether the tax losses and unabsorbed depreciation will be allowed to be carried forward for the carved out entity which may or may not have been a separate entity for the purposes of tax assessments previously.


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Seller’s challengesThe announcement of the seller’s decision to carve out an entity calls for various disclosures from the accounting view point. AS 24, Discontinuing Operations (AS 24) provides detailed guidance for ‘discontinuing operation’.

AS 24 defines a discontinuing operation as a component of an enterprise that is being disposed off pursuant to a single plan substantially, in its entirety or in a piecemeal way, by selling off the assets and settling liabilities individually or terminating through an abandonment. A discontinuing operation represents a separate major line of business or geographical area of operations, that can be distinguished operationally and for financial reporting purposes. The accounting treatment for the respective assets and/or liabilities should ideally be in line with the respective accounting standards as prescribed under IGAAP

The disclosures required by AS 24 include description of the operation, date of the initial disclosure event, date of expected completion of the transaction, amount of

revenue and expenses attributable to the operation, carrying amounts of assets and liabilities of the operation, pre-tax profit or loss from ordinary activities attributable to the operation and net cash flows attributable to the operation in the current reporting period. These are required till the plan is substantially completed or abandoned, though full payments may not have been received.

A discontinuing operation may not be a segment as defined under AS 17, Segment Reporting. A part of a segment may also qualify as a discontinuing operation. However, this determination would likely require judgement since AS 24 does not prescribe a specific threshold for this assessment.

Disposal of a business unit, division, segment or line of business does not call into question the ability of the seller to continue as a going concern. However, if the discontinuing operation forms a substantial part of its operations and if the carve-out or sale could result in no other operations for the seller, then the

going concern assumption would need to be assessed appropriately and this is in an area that would require significant judgement.

For a sale of fixed assets that do not meet the definition of a discontinuing operation under AS 24, the disclosures would be governed by AS 10 that requires the assets retired from active use and held for disposal to be stated at lower of the net book value and net realisable value (NRV), separately in the financial statements. Expected losses are recognised in the income statement immediately.

Other key considerations for carve–out financial informationAllocation of expenses, to reflect the history of the relevant activities of the carved out entity, too deserves a mention. Absence of a systematic basis for internal allocations of the common costs, add to complexity. On account of absence of guidance under IGAAP, it is important to determine that allocations should be verifiable and can be measured reliably. For example, a carve-out of a division in which common assets and common personnel are used for other components that will not be included in the carve-out financial statements will require more complex allocations versus a component that is a separate legal entity and maintains separate accounting records. As the complexity in the computation of allocations increases, so does the level of judgement required to assess whether the resulting financial statements are consistent with their intended use. Allocations should not be arbitrary, and

should be based on expenses/income actually incurred and that are clearly identifiable. Allocations should be based on a systematic and rational basis appropriate for each item being allocated. Allocations by size (e.g., total revenue or total assets) are likely to be inappropriate unless a direct correlation can be drawn between size and the expense incurred. Examples of reasonable bases for determining allocations include specific identification, headcount, usage/utilisation, payroll, time, square footage, and/or time spent.

In case the carved out entity is a segment, division or a product line, the inter segment, division or product line, transactions eliminated for the purposes of compilation of the consolidated financial information, would need to be identified. It would further need to be evaluated if these were transacted at an arm’s length price.

Identification of assets and/or liabilities out of the pool of the common assets and/or liabilities, for example corporate office space, loans borrowed/advanced, derivatives and employee benefits can also pose to be difficult. Further, identification of open and on-going commitments like purchase orders and sales orders would also need to be considered.

ConclusionTo summarise, the preparation of carve-out financial statements is far from straightforward and encompasses a number of special considerations need to be taken into account. Companies preparing carve-out financial statements may find that a significant investment in time and resources are necessary to meet these challenges. Also, guidance in GAAP is currently limited in this area and most stakeholders would welcome any future measures to standardise the carve-out procedures to ensure consistency in reporting of such information.


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Emphasis on Investor ProtectionThe Companies Act, 2013

While institutional investors, corporates and promoters are often able to safeguard their interests through the knowledge and resources that they possess; it is the individual and minority investors whose interests sometimes remain vulnerable to decisions and actions taken by the companies and those charged with governance.

The Report of the Expert Committee on Company Law (the Report) constituted by the Ministry of Company Affairs vide Order dated 2 December, 2004 under the Chairmanship of Dr. Jamshed J. Irani examined the question as to whether a separate Act is required for investor protection. The Committee noted that a framework exists in India to deal with criminal offences; the requirement is to provide a suitable orientation to corporate law so that the investor, irrespective of size, is recognised as a stakeholder in the corporate processes, as a separate Act would require special enforcement mechanism with attendant coordination

issues. It was identified that in order to have clearly laid down rules leading to corporate governance, transparency, accountability and a mechanism to enforce non-compliance should be built in the Company Law itself. Therefore, the Companies Act, 2013 (2013 Act) incorporates a number of provisions that are directed towards investor protection. This article provides an overview of the investor protection measures included in the Act.


• Highlight the requirements of the 2013 Act regarding investor protection

• Explain our observations regarding these changes.


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Oppression and mismanagement and classification suitsAs per section 399 of the Companies Act, 1956:

• in case of a company having share capital, not less than 100 members of the company or not less than one-tenth of the total number of its members, whichever is less, or any member or members holding not less than one-tenth of the issued share capital of the company, provided that the applicant or applicants have paid all calls and other sums due on their shares

• in the case of a company not having a share capital, not less than one-fifth of the total number of its members have a right to apply to the Company Law Board for considering the case and pass an appropriate order so as to address the concern of oppression or mismanagement.

While similar provisions also exist in the 2013 Act, it also introduces the concept of class action suits. As per section 245 of the 2013 Act, if any class of investors are of the opinion that the management or conduct of the affairs of the company are being conducted in a manner prejudicial to the interests of the company or its members or depositors, then these investors or a class of them can, as a class, file an application before the Tribunal on behalf of the members or depositors, seeking passage of appropriate orders.

The following are the classes of investors who can apply to the Tribunal:

i. in the case of a company having a share capital, not less than 100 members of the company or not less than 10 per cent of the total number of its members, whichever is less, or any member or members singly or jointly holding not less 10 per cent of the issued share capital of the company, subject to the condition that the applicant or applicants have paid all calls and other sums due on his or their shares

ii. in the case of a company not having a share capital, not less than one-fifth of the total number of its members or

iii. not be less than one hundred depositors or not less than 10 per cent of the total number of depositors , whichever is less, or any depositor or depositors singly or jointly holding not less than 10 per cent of total deposits of the company.

The Tribunal, under section 245, has the powers to pass one or more of the following orders:

i. restraining the company from committing an act which is ultra vires the articles or memorandum of the company or leads to breach of any provision of the company’s memorandum or articles

ii. declaring a resolution altering the memorandum or articles of the company as void if the resolution was passed by suppression of material facts or obtained by mis-statement to the members or depositors

iii. restraining the company and its directors from acting on such resolution

iv. restraining the company from doing an act which is contrary to the provisions of this 2013 Act or any other law for the time being in force

v. restraining the company from taking action contrary to any resolution passed by the members.

Apart from the above, the Tribunal can also pass order to claim damages, compensation or demand any other suitable action from or against:

i. the company or its directors for any fraudulent, unlawful or wrongful act or omission or conduct or any likely act or omission or conduct on its or their part

ii. the auditor, including the audit firm of the company for any improper or misleading statement of particulars made in his audit report or for any fraudulent, unlawful or wrongful act or conduct, or

iii. any expert, advisor, consultant or any other person for any incorrect or misleading statement made to the company or for any fraudulent, unlawful, wrongful act or conduct or any likely act or conduct on his part.

The provisions of the 2013 Act are different from those in the Companies Act, 1956 in two aspects. Firstly, unlike the Companies Act, 1956, not only the equity shareholders or members, but also depositors can apply to Tribunal. Secondly, the right to seek compensation from the company, its directors, auditors, any expert or advisor has also been added. The section provides protection to the investors from those in control of the company. It is clear that the intent of the legislation is that apart from the company and its directors, the auditor, an expert, an advisor or consultant can also be asked to pay for damages/compensation if it is found that these parties acted in a fraudulent, unlawful or wrongful manner.

Class action suits can have their own advantages. The first advantage is reduction in cost of litigation which an investor has to bear. While the companies can withstand long-legal battles, it is often commented that, individual depositors and shareholders are not able to bear the legal costs over a long-term. A class of investors coming together and applying for the same cause could reduce the cost of litigation for the investors. The second advantage is a potential change in behaviour. The new law applies significant pressure on the directors, auditors, advisors and/or consultants to act professionally, with due care and without any bias. It is also expected that as the law would get settled and as the cases would get decided, what is acceptable and what is not would get clearly defined. While the advantages of a class action suit would likely benefit the investors; the companies, directors, auditors, advisors and consultants would potentially have to deal with increased litigation and associated costs including dealing with frivolous or illegitimate claims by unscrupulous stakeholders.


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Addressing grievances of investorsCompanies having more than 1,000 shareholders, debenture holders, deposit-holders or other security holders at any time, during the financial year are required to constitute a ‘Stakeholders Relationship Committee’ to resolve the grievances of security holders. It is envisaged that an investor grievance redressal mechanism with a non-executive chairman would help ensure protection of the interest of investors through timely intervention.

Related party transactions1

Related party transactions has been an area of focus for auditors, regulators and the shareholders. There have been concern that related party transactions could be used for siphoning of funds and defrauding investors. Due to this reason, the Companies Act, 1956 contained provisions like section 297 and section 299.

Perhaps, it was felt that the extant sections 297 and 299 of the Companies Act, 1956 do not comprehensively cover the relationships where a director or the Board could be seen to have compromised in their fiduciary duties towards the company and its investors. Therefore, the term ‘related parties’ has been defined in the 2013 Act (the Companies Act, 1956 did not define related party). The definition of ‘related party’ with respect to a company is a wider definition and includes holding company, subsidiary company, sister subsidiary, associate company, directors, key management personnel (including relatives), firms/companies where directors/relatives are interested and senior management i.e., members of core management team one level below executive directors including functional heads. Senior management/functional heads have been included in the draft rules even though they may not be in a position to control or take key decisions of the company. Further, ‘relatives’ in relation to an individual covers specified elder and younger generations without distinguishing between financially dependent and independent relatives.

Nature of Transaction Limits Specified

• Sale/purchase or supply of any goods or materials

• Availing or rendering of any services• Buying/selling/leasing of property• Appointment of agent for purchase or sale of

goods, materials, services or property

Aggregate with previous transactions during a financial year/individual transactions > five per cent of annual turnover or 20 per cent net worth, per last audited accounts (whichever is higher)

• Appointment to any office or place of profit in company, subsidiary or associate

Monthly remuneration exceeding INR 0.1 million

• Remuneration for underwriting subscription of any securities or derivatives

Remuneration exceeding INR 1 million

It may also be noted that the director’s report under section 134 of the 2013 Act is also required to include the details of related party transactions requiring consent of the Board/special resolution of members along with the justification for entering into them.

In January 2013, the Securities and Exchange Board of India (SEBI) had released its ‘Consultative Paper on Review of Corporate Governance Norms in India’ to align the existing corporate governance norms in India with the then existing Companies Bill, 2012 and other international practices. Consequent to the enactment of the 2013 Act, the SEBI Board has on 13 February 2014, approved the proposals to amend the corporate governance norms for listed companies in India. The amendments shall be applicable to all listed companies with effect from 1 October 2014. The SEBI norms require approval of all material related party transactions by shareholders through special resolution and seem to be more onerous than the related section under the 2013 Act.

The related party transactions are defined to include the following transactions:

i. Sale, purchase or supply of any goods or materials

ii. Selling or otherwise disposing of, or buying, property of any kind

iii. Leasing of property of any kind

iv. Availing or rendering of any services

v. Appointment of any agents for purchase or sale of goods, materials, services or property

vi. Related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company

vii. Underwriting the subscription of any securities or derivatives of the company.

The 2013 Act has made significant amendments vis-à-vis related party transactions regarding the approval process of related party transactions.

The transactions of the above mentioned nature of a company with its related parties, which are not in the ordinary course of business and which are not arm’s length would require the consent of the Board of Directors of the Company. It is expected that the Board of Directors, while approving such transactions, would keep the investors’ interest above their personal interest and discharge their fiduciary duties effectively. In case it is proved otherwise, the Act provides for serious consequences like fine and imprisonment, including class actions suit against the directors.

Under the 2013 Act, prior shareholders approval by special resolution would be required in respect of related party transactions exceeding the following prescribed limits:

i. Paid up share capital of the Company equals or exceeds INR 10 million; or

ii. Related party transactions exceeding following threshold limits:

1 KPMG publication: Companies Act 213 – New Rules of the Game October 2013


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Investments/loansSection 372A of the Companies Act, 1956, inter alia, contains provisions relating to (i) giving of loans by a company to any other body corporate and (ii) giving of guarantee/security, in connection with a loan made by any other person to, or to any other person by, any other body corporate. It provides a limit beyond which the aforesaid loan/guarantee/security requires previous approval of shareholders by a special resolution passed at a general meeting and approval of public financial institutions in relevant cases. The section also lays down other conditions for aforesaid loan/guarantee/security, including a stipulation of rate of interest on loan being not lower than prevailing bank rate. On the other hand, section 185 of the 2013 Act provides that no company shall, directly or indirectly, advance any loan, including any loan represented by a book debt, to any of its directors or to any other person in whom the director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person. The major change is that section 185 applies to private companies also (unlike section 295 of the Companies Act, 1956 which applies only to those private companies which were subsidiaries of public companies). Further, the explicit exemption to giving of loans by a holding company to its subsidiary and to provision of security/guarantee by a holding company for loans taken by its subsidiary

has also not been retained. While this is going to cause a significant difficulty to wholly owned subsidiaries who work on the finances provided by the holding companies, it would provide alienation to the investors’ money from being exposed to risk other than those risks which were perceived by the investors while making the investment. Recently, the MCA has clarified that till the time section 372A of the Companies Act, 1956 is repealed and section 186 of the 2013 Act is notified, a holding company is allowed to give guarantee or provide security in respect of loans made by banks or financial institutions, to its wholly owned subsidiary company provided such loans are exclusively used by the subsidiary for its principal business activities. The scope of the exemption is limited as it covers only guarantees and security provided and does not extend to loans given by a holding company to its wholly owned subsidiary company.

Whistle blowing mechanismApart from the corporate governance and transparency, the 2013 Act also requires all listed companies, companies which accept deposits from the public and companies which have borrowed money from banks and public financial institutions in excess of INR 500 million, to establish a vigil mechanism for directors and employees to report genuine concerns in such manner as may be prescribed. The 2013 Act also requires that the vigil mechanism, to be put in place should provide for adequate safeguards against victimisation of persons who use such mechanism and make provision for direct access to the chairperson of the Audit Committee in appropriate or exceptional cases. This provision in the 2013 Act could help ensure that the Audit Committee gets the information of cases/situations which could jeopardise the interest of the investors and others interested in the working and operation of the company.


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Serious Fraud Investigation OfficeThe entire gamut of corporate governance and transparency oriented measures in the 2013 Act would work only if there is a mechanism to monitor compliance. An investigation into the affairs of a company can be initiated by the Central Government in the following circumstances:

i. on receipt of report from the Registrar of Companies or inspector

ii. on intimation of a special resolution passed by the company that its affairs are required to be investigated

iii. in public interest

iv. on request of any department of central government or state government.

The investigation into the affairs of the company can be in the hands of inspectors as appointed by the Central Government or by assignment of the case to Serious Fraud Investigation Office (SFIO).

The 2013 Act gives statutory status to the SFIO. SFIO will comprise experts from various relevant disciplines including law, banking, corporate affairs, taxation, capital market, information technology and forensic audit.

Investigation report of SFIO filed with the Court for framing of charges shall be treated as a report filed by a Police Officer. SFIO shall have power to arrest in respect of certain offences which attract the punishment for fraud. Recognition of SFIO would strengthen and expedite the investigation process. The legal and statutory powers vested with the SFIO and its broad-based composition with experts drawn from various relevant disciplines would help make the process more effective.

ConclusionThe 2013 Act contains many of the necessary ingredients to boost and safeguard the interest of a wider range of stakeholders. It will be interesting to see if 2013 Act will achieve the objectives with which these provisions were inserted into the law.


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Simplified hedge accounting approach Accounting for certain ‘receive-variable, pay-fixed’ interest rate swaps

Companies often find it difficult to borrow fixed rate debt and rely on variable-rate debt and then enter into a receive-variable, pay-fixed interest rate swap to economically convert their variable-rate borrowing into a fixed-rate borrowing. Under U.S. Generally Accepted Accounting Principles (U.S. GAAP), a swap is a derivative instrument. Topic 815, Derivatives and Hedging, requires that an entity recognise all interest rate swaps on its balance sheet as either assets or liabilities and measure them at fair value. Topic 815 permits an entity to elect accounting method known as ‘cash flow hedge accounting’ to mitigate the income statement volatility of recording a swap’s changes in fair value, if certain requirements under that Topic are met. This hedge accounting results in presenting interest expense in the income statement as if the entity had fixed rate debt. But, many private companies contend that, due to lack of resources and difficult to understand and apply complex hedge accounting, they lack the expertise to comply with the requirements to qualify for hedge accounting. This requirement includes contemporaneous documentation at the inception of the hedge and the hedging effectiveness testing, both at the inception of the hedge

and on an ongoing basis. In addition, some stakeholders also questioned the relevance and cost associated with determining and presenting the fair value of a swap that is entered into for the purpose of economically converting a variable rate borrowing to a fixed-rate borrowing. Because of the practical difficulties, many private companies do not elect to apply hedge accounting, which results in income statement volatility.

The FASB1 has recently issued guidance that provides hedge accounting alternatives (i.e., the simplified hedge accounting approach) with a practical expedient to apply cash flow hedge accounting for ‘receive-variable, pay-fixed’ interest rate swaps, that are entered into for the purpose of economically converting a variable-rate borrowing into a fixed-rate borrowing to reduce income statement volatility, and address the concerns about the difficulty in understanding and applying the hedge accounting model.

ScopeThe simplified hedge accounting apply to all entities, except for public business entities, not-for-profit entities as defined in the Master Glossary of the FASB Accounting Standards Codification, financial institutions as described in paragraph 942-320-50-1 (e.g., banks, savings and loan associations, savings banks, credit unions, finance companies, and insurance entities) and employee benefit plans within the scope of Topics 960 through 965.

Requirement of simplified hedge accounting approachUnder this approach, an entity may assume no ineffectiveness for ‘receive-variable, pay-fixed’ interest rate swap designated in a hedging relationship under Topic 815.


• Summarise the recently issued FASB guidance that provides hedge accounting alternatives

• Explain the transition requirements.

1 Financial Accounting Standards Board


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This approach can be applied provided all of the following criteria are met:3

a. Both the variable rate on the swap and the borrowing are based on the same index and reset period (for example, both the swap and borrowing are based on one-month London Interbank Offered Rate [LIBOR] or both the swap and borrowing are based on three-month LIBOR). In complying with this condition, an entity is not limited to benchmark interest rates described in paragraph 815-20-25-6A.

b. The terms of the swap are typical (in other words, the swap is what is generally considered to be a ‘plain-vanilla’ swap), and there is no floor or cap on the variable interest rate of the swap unless the borrowing has a comparable floor or cap.

c. The repricing and settlement dates for the swap and the borrowing match or differ by no more than a few days.

d. The swap’s fair value at inception (that is, at the time the derivative was executed to hedge the interest rate risk of the borrowing) is at or near zero.

e. The notional amount of the swap matches the principal amount of the borrowing being hedged. In complying with this condition, the amount of the borrowing being hedged may be less than the total principal amount of the borrowing.

f. All interest payments occurring on the borrowing during the term of the swap (or the effective term of the swap underlying the forward starting swap) are designated as hedged whether in total or in proportion to the principal amount of the borrowing being hedged.

Application of simplified hedge accounting approachUnder the simplified hedge accounting approach, a private company has the option to measure the designated swap at settlement value instead of fair value.

The primary difference between settlement value and fair value is that counter-party non-performance risk is not considered in determining settlement value. One method of estimating settlement value is to perform a present value calculation of the swap’s remaining estimated cash flows using a valuation

technique that is not adjusted for nonperformance risk.

Companies may apply simplified hedge accounting on a swap-by-swap basis.

If any of the conditions, for applying the simplified hedge accounting approach subsequently cease to be met or the relationship otherwise ceases to qualify for hedge accounting, the gain or loss on the swap in accumulated other comprehensive income will be reclassified to earnings in accordance with paragraphs 815-30-40-1 through 40-6, with the swap measured at fair value on the date of change, and subsequent changes in fair value reported in earnings in accordance with paragraph 815-10-35-2. For example, if the related variable-rate borrowing is prepaid without terminating the ‘receive-variable, pay-fixed’ interest rate swap, the gain or loss on the swap in accumulated other comprehensive income shall be reclassified to earnings. Similarly, if the ‘receive-variable, pay-fixed’ interest rate swap is terminated early without the related variable-rate borrowing being prepaid, the gain or loss on the swap in accumulated other comprehensive income shall be reclassified to earnings. Under the simplified hedge accounting approach, documentation required to qualify for hedge accounting must be completed by the date on which the first annual financial statements are available to be issued after hedge inception rather than concurrently at hedge inception.

DisclosureThe current disclosure requirements in Topic 815 and Topic 820 on fair value measurement continue to apply for a swap accounted for under the simplified hedge accounting approach. In order to comply with those disclosures, amounts recorded at settlement value should be used in place of fair value wherever applicable with amounts disclosed at settlement value subject to all of the same disclosure requirements as amounts disclosed at fair value.

As per guidance in ASU 2014-03, a swap which has been covered under this simplified hedge accounting approach is not considered a derivative instrument under Topic 815, for the purpose of applying disclosure requirement in Topic 825, about the fair value of financial instruments.

TransitionThe simplified hedge accounting approach is effective for annual periods beginning after 15 December 2014, and interim periods within annual periods beginning after 15 December 2015. Early adoption is permitted to existing swaps, that meet the qualifying criteria on a swap-by-swap basis, during the year the new guidance is initially applied. In determining whether an existing swap meets all of the criteria in paragraph 815-20-25-131D to qualify for applying the simplified hedge accounting approach, the criteria that the swap’s fair value at the time of application of this approach is at or near zero does not need be considered. Instead, the swap’s fair value at the time the swap was entered into (or acquired) by the company should have been at or near zero.

A private company can apply either a modified retrospective approach or full retrospective approach for adopting the simplified hedge accounting approach.

Under modified retrospective approach, adjustments should be made to the assets, liabilities, and opening balance of accumulated other comprehensive income and retained earnings (or other appropriate components of equity) of the current period presented to reflect application of hedge accounting from the date the ‘receive-variable pay-fixed’ interest rate swap was entered into (or acquired) by the entity.

Under full retrospective approach, financial statements should be adjusted to reflect the period-specific effects of applying hedge accounting from the date the receive-variable, pay-fixed interest rate swap was entered into (or acquired) by the entity and corresponding adjustments should be made to the assets, liabilities, and opening balance of accumulated other comprehensive income and retained earnings (or other appropriate components of equity) of the earliest period presented to reflect application of hedge accounting from the date the ‘receive-variable, pay-fixed’ interest rate swap was entered into (or acquired) by the entity.

Companies need to provide the disclosures in paragraphs 250-10-50-1 through 50-3, Accounting Changes and Error Corrections, in the period that the entity adopts guidance in ASU 2014-03.

2 FASB Accounting Standards Update No. 2014-03 January 2014


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Year-end review

The year- end review highlights major developments in accounting, disclosure and regulatory matters in India along with the new accounting and disclosure matters in International Financial Reporting Standards and United States Generally Accepted Accounting Principles. The year-end review is intended to be a reminder to our readers of developments that may affect financial statements for companies during the year ending 31 March 2014 or in future periods. We would recommend the readers refer to the official standards or other information for complete descriptions of the new requirements and their respective provisions.


• Provides a reminder of the recently issued financial reporting and regulatory developments that may affect financial statements as at 31 March 2014.


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Indian Generally Accepted Accounting Principles

Revised Guidance Note on accounting for oil and gas producing activities Revision to the Guidance Note deals with areas where there are developments in recent times including in the nature of operations like sidetracking, farm-in farm-out, accounting matter related to impairment, greater refinement in definitions of terms specific to the industry particularly, reserves, and presentation and disclosure requirements.

This revised Guidance Note comes into effect in respect of accounting periods commencing on or after 1 April 2013.

Restatement of accounts due to audit qualifications Securities Exchange Board of India (SEBI) vide its circular dated 13 August 2012 mandated listed companies to submit either Form A (unqualified/matter of emphasis report) or Form B (qualified/subject to/except for audit report) along with the Annual Report to the stock exchanges. It is also envisaged that the qualified audit reports will be scrutinised by Qualified Audit Review Committee (QARC) and if necessary, the company will be required to restate its books of accounts to provide true and fair view of its financial position.

SEBI vide its circular dated 5 June 2013 has clarified that the restatement of books of accounts shall mean that the company is required to disclose the effect of revised financial accounts by way of revised pro-forma financial results immediately to the shareholders through Stock Exchange(s). The financial effects of the revision may be carried out in the annual accounts of the subsequent financial year as a prior period item so that the tax impacts, if any, can be taken care of.

Revised requirements for the stock exchanges and listed companies in a scheme of arrangement under the Companies Act, 1956

Vide circular dated 21 May 2013, SEBI has provided clarification/modifications to its circular dated 4 February 2013 on revision to clause 24(f) of the equity listing agreement. As per the revised clause of the listing agreement, listed companies are required to file draft scheme of amalgamation/merger/reconstruction/ reduction of capital with the stock

exchanges before submitting to High Court for approval.

SEBI has now provided for clarification/modifications which are related to requirement of valuation report, time limit available with SEBI to submit its comments to stock exchange on the draft scheme, applicability and matters related to voting by public shareholders through postal ballot and e-voting in specified cases.

SEBI notifies SEBI (Issue and Listing of Non-Convertible Redeemable Preference Shares) Regulations, 2013SEBI notifies regulations for issue and listing of redeemable preference shares vide notification dated 12 June 2013. The regulations provide for comprehensive regulatory framework for public issue and listing of non-convertible redeemable preference shares and issue and listing of perpetual non-cumulative preference shares and perpetual debt instrument, issued by banks on private placement basis in compliance with Guidelines issued by RBI.

Amendments to SEBI (Buy Back of Securities) Regulations, 1998Vide press release dated 25 June 2013, SEBI brought significant amendments to buyback of shares or other specified securities from the open market through stock exchange mechanism. Amendments relate to matters such as minimum buy-back limit, maximum buy-back period, creation of escrow limit, restriction on further raising of capital, time period for another buy-back offer, etc.

Commencement of 98 Sections of Companies Act, 2013 and commencement of Section 135, Corporate Social responsibility along with Schedule VII of the ActMinistry of Corporate Affairs (MCA) issued a notification dated 12 September 2013 for commencement of 98 sections of the Companies Act, 2013.

MCA also issued a notification dated 18 September 2013 which clarifies that the relevant provisions of the Companies Act, 1956 which correspond to the provisions of 98 sections of the Companies Act, 2013 cease to have effect from 12 September 2013.

On 27 February 2014, MCA has notified commencement of section 135, Corporate Social responsibility along with Schedule VII of the Act, Companies (Corporate Social Responsibility Policy) Rules, 2014 and amendment to Schedule VII (Activities which may be included by companies in their Corporate Social Responsibility Policies) of the Act. As per the notifications, the aforesaid provisions will come into force with effect from 1 April 2014.

Clarification on applicability of provision of Section 372A of the Companies Act, 1956MCA vide circular dated 19 November 2013 has clarified that Section 372A of the Companies Act, 1956 dealing with inter-corporate loans continues to remain in force till Section 186 of the Companies Act, 2013 is notified.

Clarification on applicability of Section 182(3) of the Companies Act, 2013MCA vide circular dated 10 December 2013 has issued clarifications on disclosures to be made under Section 182 of the Companies Act, 2013 pursuant to the scheme relating to ‘Electoral Trust Companies’ in terms of Section (24AA) of the Income-tax Act, 1961 coming into force.

MCA issues clarification on Section 185 of the Companies Act, 2013MCA vide general circular no. 03/2014 dated 14 February 2014 has clarified that till the time section 372A of the Companies Act, 1956 is repealed and section 186 of the Companies Act, 2013 is notified, a holding company is allowed to give guarantee or provide security in respect of loans made by banks or financial institutions, to its wholly owned subsidiary company provided such loans are exclusively used by the subsidiary for its principal business activities.

The scope of the exemption is limited as it covers only guarantees and security provided and does not extend to loans given by a holding company to its wholly owned subsidiary company.


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Deferred Tax Liability (DTL) on special reserve created under Section 36(1)(viii) of the Income-tax Act, 1961RBI vide notification dated 20 December 2013 has advised that, as a matter of prudence, banks should recognise deferred tax liability (DTL) on special reserve created under section 36(1)(viii) of the Income-tax Act, 1961. In case the expenditure due to creation of DTL on special reserve as at 31 March 2013 has not been fully charged to the Profit and Loss account, banks may adjust it directly from reserves. The amount so adjusted may be appropriately disclosed in the notes to accounts of the financial statements for the financial year 2013-14. From the year ending 31 March 2014 onwards, DTL on amounts transferred to special reserve should be charged to the Profit and Loss Account of that year.

Clarification on holding-subsidiary relationship under Section 2(87) of the Companies Act, 2013 MCA vide its circular dated 27 December 2013 has clarified that the shares held by a company or power exercisable by it in another company in a ‘fiduciary capacity’ shall not be considered for the purpose of determining holding-subsidiary relationship in terms of the provision of section 2(87) of the Companies Act, 2013.

Compliance with the Equity Listing Agreement: scrutiny by stock exchangesThe SEBI vide CIR/CFD POLICYCELL/13/2013 dated 18 November 2013 has directed stock exchanges to design appropriate framework in order to strengthen the supervision approach including improvement of mechanisms, to ensure compliance by the issuers with the reporting requirements under the Equity Listing Agreement. In this regard, SEBI has suggested various improvements such as (a) comparison of current filings made by the listed companies with that of the previous quarter (b) filings under clauses 41 and 49 of the Equity Listing Agreeement should be monitored for quality and substantive compliance, etc.

In order to ensure compliance, SEBI has directed the stock exchanges to carry out a review of disclosures made by the top 500 listed companies (by market capitalisation as on 31 March 2013) for the quarter ending 31 December 2013 with respect to clauses 35, 36, 41 and 49 of the Equity Listing Agreement.

Extension of timeline for alignment of existing employee benefit schemes with SEBI (ESOS and ESPS) Guidelines, 1999

The SEBI (ESOS and ESPS) Guidelines, 1999 were amended on 17 January 2013 vide notification CIR/CFD/DIL/3/2013, to prohibit listed companies from setting up any Employee Stock Option Scheme (ESOS) or Employee Stock Purchase Scheme (ESPS) that involve acquisition of shares from secondary market. Accordingly, the companies that had rolled out such schemes which allowed acquisition of own securities from secondary market were required to align those schemes as per the amended guidelines by 30 June 2013. The 30 June 2013 deadline was later extended up to 31 December 2013 by SEBI circular no. CIC/CFD/DIL/7/2013 dated 13 May 2013.

However, in November 2013, the SEBI issued a discussion paper to review the guidelines governing employee benefit schemes. According to the discussion paper, companies may be allowed to purchase its shares from the secondary market subject to shareholders’ approval. Considering review of proposals enunciated by the discussion paper, the SEBI has further extended the timeline for alignment of existing employee benefit schemes with the SEBI (ESOS and ESPS) Guidelines, 1999 up to 30 June 2014 (CIR/CFD/POLICYCELL/14/2013 dated 29 November 2013 and PR No. 109/2013 dated 20 November 2013).

Reports by regional director under section 394A of the Companies Act, 1956 MCA vide general circular dated 15 January 2014 has decided that while responding to a notice from a court, on behalf of the Central Government under section 394A with respect to arrangement/compromise/reconstruction/amalgamation (under section 391/394), the concerned regional director (RD) shall invite specific comments from Income-tax department within 15 days of receipt of notice before filing his response to the court. The RDs are also required to see whether, in a particular case, feedback from any other sectoral regulator is to be obtained and if it appears necessary, it will also be dealt with in a like manner. It is also emphasised that it is not for the RD to decide correctness or otherwise of the objections/views of the Income-tax department or other regulators.

Expert Advisory Committee Opinions ICAI has recently issued opinions on:

• Treatment of expenditure on stabilisation of expanded plant declared commercial (ICAI Journal The Chartered Accountant April 2013)

• Capitalisation of borrowing costs (ICAI Journal The Chartered Accountant May 2013)

• Recognition of expenditure incurred on branding and advertisement (ICAI Journal The Chartered Accountant June 2013)

• Accounting for unspent expenditure towards corporate social responsibility (ICAI Journal The Chartered Accountant July 2013)

• Adjustment of losses on sale of fixed assets, writing-off inventory and doubtful receivables against capital reserves arising out of acquisition of business, capital redemption reserves and revaluation reserves (ICAI Journal The Chartered Accountant August 2013)

• Amortisation of land right of way (ICAI Journal The Chartered Accountant September 2013)

• Treatment of disputed elements of cost in valuation of inventory of raw material (ICAI Journal The Chartered Accountant October 2013)

• Accounting treatment of share application money pending for allotment invested by holding company in subsidiaries (ICAI Journal The Chartered Accountant November 2013)

• Recognition of free of cost equipment provided by a contractee to the contractor (ICAI Journal The Chartered Accountant December 2013)

• Recognition of distribution network acquired in a business acquisition as an intangible asset (ICAI Journal The Chartered Accountant January2014)

• Treatment of mark to market losses on principal only currency swap (ICAI Journal The Chartered Accountant February 2014)

• Consolidation of ESOP Trust in the standalone financial statements, treatment of investment in own shares for EPS calculation in the standalone financial statements and treatment of ESOP trust in the financial statements for tax audit purposes (ICAI Journal The Chartered Accountant March 2014).


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International Financial Reporting Standards

IAS 19 Employee BenefitsIAS 19 removes option to apply the corridor method for actuarial gains and losses. Actuarial gains and losses are now recognised immediately in other comprehensive income (OCI) when they occur. The corridor approach, or another systematic method resulting in faster recognition in profit or loss, is no longer permitted. Under IAS 19, since net interest is now calculated as the net defined benefit liability (asset) multiplied by the discount rate that is used to measure the defined benefit obligation, the nature of plan assets held will have no impact on the net finance charge or credit. Further, the definition of short-term and other long-term employee benefits incorporates when it is ‘expected’ to be settled criteria.

IAS 19 generally is applied retrospectively in accordance with IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors and is effective for annual periods beginning on or after 1 January 2013.

IFRS 10 Consolidated Financial StatementsIFRS 10 introduces a single control model for all entities. Areas of change in the control model include the analysis of structured entities (e.g., securitisation vehicles), potential voting rights that are substantive rather than currently exercisable, and voting holdings just short of a majority. Under IFRS 10, previously unconsolidated entities that have significant relationships with the entity may now require consolidation and investees previously accounted for using equity accounting or as financial instruments may require consolidation.

There are a number of specific transitional requirements that apply on the adoption of IFRS 10, which provide relief from full retrospective adoption. The mandatory restatement of comparatives is limited to one year; this relief benefits entities that present more than one year of comparatives.

IFRS 10 is effective for annual periods beginning on or after 1 January 2013.

IFRS 11 Joint ArrangementsIFRS 11 divides joint arrangements into two types i.e., joint ventures and joint operations. Joint ventures must be accounted for using equity method and proportionate consolidation is prohibited. All jointly controlled entities under IAS 31, Interests in Joint Ventures, may not qualify as joint ventures under IFRS 11. Transitioning from proportionate consolidation to equity method and vice versa can affect all financial statements line items.


IFRS 12 Disclosure of Interests in Other Entities IFRS 12 is required to be applied by an entity that has interest in subsidiaries, joint arrangements, associates and unconsolidated structured entities.

The disclosures in respect of unconsolidated structured entities may be made on a prospective basis from the date of initial application. For other IFRS 12 disclosures, the mandatory restatement of comparatives is limited to the immediately preceding period.; this relief benefits entities that present more than one year of comparatives.


IFRS 13 Fair Value Measurement IFRS 13 does not establish new requirements for when fair value is required but provides a single source of guidance on how fair value is measured. The guidance should be applied when fair value is required or permitted under other IFRSs. IFRS 13 also includes new requirements regarding when it is appropriate to make an adjustment, such as a control premium, marketability, liquidity discount or a non-controlling interest discount, to a fair value measurement.

IFRS 13 contain extensive disclosure framework that combines the fair value measurement disclosures previously required by other IFRSs and adds additional disclosures.


Disclosures – Offsetting financial assets and financial liabilities Amendments to IFRS 7 include minimum disclosure requirements related to financial assets and financial liabilities that offset in the statement of financial position or are subject to enforceable master netting arrangements or similar agreements.

Amendments are effective for annual periods beginning on or after 1 January 2013, and are to be applied retrospectively.

Annual Improvements 2009-11 Cycle:The annual improvements 2009-2011 amendments are effective for annual periods beginning on or after 1 January 2013.

• Amendment to IFRS 1 First-time Adoption of International Financial Reporting Standards Repeated application of IFRS 1 The amendment clarifies that if an entity has applied IFRS in a previous reporting period, but whose most recent previous annual financial statements did not contain an explicit and unreserved statement of compliance with IFRS, then such an entity has an option either to apply IFRS 1 or else apply IFRS retrospectively in accordance with IAS 8, Accounting Policies, Changes in Estimates and Errors as if the entity had never stopped applying IFRS. In the latter case, such an entity should also disclose the reason for electing to apply IFRS on a continuous basis.

Irrespective of an entity choosing to apply IFRS 1 or otherwise, an entity shall disclose: (a) the reason it stopped applying IFRS and (b) the reason it is resuming the application of IFRS.

Borrowing cost exemption According to the amendment if a first time adopter of IFRS chooses borrowing cost exemption then it should not restate the borrowing cost component that was capitalised under previous GAAP. Also it should account for borrowing cost incurred on or after the date of transition (or an earlier date, as permitted by IAS 23) in accordance with IAS 23, Borrowing Costs. This includes those borrowing costs that have been incurred on qualifying assets already under construction at that date.


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• Amendment to IAS 1 Presentation of Financial Statements Comparative information beyond minimum requirements IAS 1 is amended to clarify that only one comparative period which is the preceding period is required for a complete set of financial statements. If an entity presents additional comparative information, then that additional information need not be in the form of a complete set of financial statements. However, such information should be accompanied with related notes and should be in accordance with IFRS.

Presentation of the opening statement of financial position and related notes IAS 1 is also amended to clarify that the opening statement of financial position is required only if there is a change in accounting policy, a retrospective restatement or a reclassification that has a material effect upon the information in that statement of financial position. Except for the disclosures required under IAS 8, notes related to the opening statement of financial position are no longer required and the appropriate date for the opening statement of financial position is the beginning of the preceding period, rather than the beginning of the earliest comparative period presented. This is regardless of whether an entity provides additional comparative information beyond the minimum comparative information requirements.

• IAS 16 Property, Plant and Equipment –classification of servicing equipment IAS 16 is amended to clarify that accounting of spare parts, stand-by equipment and servicing equipment. The definition of property, plant and equipment in IAS 16 is now considered in determining whether these items should be accounted for under the standard. If these items do not meet the definition of property, plant and equipment, then they are accounted for using IAS 2 Inventories.

• IAS 32 Financial Instruments: Presentation – income tax consequences of distribution IAS 32 is amended to clarify that income tax relating to distributions to holders of an equity instrument and to transaction costs of an equity

transaction shall be accounted for in accordance with IAS 12 Income Taxes.

The amendment removes a perceived inconsistency between IAS 32 and IAS 12. Before the amendment, IAS 32 indicated that distributions to holders of an equity instrument are recognised directly in equity, net of any related income tax. However, IAS 12 generally requires the tax consequences of dividends to be recognised in profit or loss in certain cases.

• IAS 34 Interim Financial Reporting – Segment assets and liabilities IAS 34 is amended to align the disclosure requirements for segment assets and segment liabilities in interim financial reports with those in IFRS 8, Operating Segments. IAS 34 now requires the disclosure of a measure of total assets and liabilities for a particular reportable segment if such amounts are regularly provided to the chief operating decision maker and for which there has been a material change from the amount disclosed in the last annual financial statements for that reportable segment.

IFRIC 20 Stripping Costs in the Production Phase of a Surface MineThis Interpretation applies to waste removal costs that are incurred in surface mining activity during the production phase of the mine (production stripping costs).

The IFRS Interpretations Committee clarified that when the stripping costs incurred relate to current period production, these need to be accounted for in accordance with IAS 2, Inventories. However, when the stripping costs improve access to ore, the entity shall recognise these costs as a non-current asset (stripping activity asset), if all the following criteria are met:

• it is probable that the future economic benefit (improved access to the ore body) associated with the stripping activity will flow to the entity

• the entity can identify the component of the ore body for which access has been improved

• the costs relating to the stripping activity associated with that component can be measured reliably.

If all the three criteria are not met, then the stripping costs are expensed as incurred.

Cases when the cost of stripping activity assets and the inventory produced are not separately identifiable, stripping costs are allocated based on relevant production measure.

An entity shall apply IFRIC 20 for annual periods beginning on or after 1 January 2013. Earlier application is permitted. An entity shall apply IFRIC 20 to production stripping costs incurred on or after the beginning of the earliest period presented.

Government loans (amendment to IFRS 1)This amendment adds a new exception to retrospective application of IFRS. A first time adopter of IFRS now applies the measurement requirements of the financial instrument standard to a government loan with a below market rate of interest prospectively from the date of transition to IFRS. Alternatively, a first time adopter may elect to apply the measurement requirements retrospectively to a government loan, if the information needed was obtained when it first accounted for that loan. This election is available on a loan by loan basis.

The amendment is effective for annual periods beginning on or after 1 January 2013, with earlier application permitted.

Presentation of items of Other comprehensive income (OCI) (Amendments to IAS 1)• The amendment requires an entity

to present separately the items of OCI that may be reclassified to profit or loss in the future from those that would never be reclassified to profit or loss. Consequently an entity that presents items of OCI before related tax effects will also have to allocate the aggregated tax amount between these sections.

• The amendment also changes the title of the Statement of Comprehensive Income to Statement of Profit or Loss and Other Comprehensive Income. However, an entity would be allowed to use other titles as well.

These amendments to IAS 1 are effective for financial years beginning on or after 1 July 2012. Earlier application is permitted. The amendments are applied retrospectively, in accordance with IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors.


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United States Generally Accepted Accounting Principles

Presentation of comprehensive income ASU 2011-05, Presentation of comprehensive Iincome, increases the prominence of other comprehensive income in financial statements. Entity will have the option to present the components of net income and comprehensive income in either one or two consecutive financial statements. The ASU eliminates the option in U.S. GAAP to present other comprehensive income in the statement of changes in equity. An entity should apply the ASU retrospectively.

The ASU is already effective for public entity. For a non-public entity, the ASU is effective for fiscal years ending after 15 December 2012 and interim and annual periods thereafter. Early adoption is permitted.

Reporting of amounts reclassified out of accumulated other comprehensive incomeASU 2013-02, Reporting of amounts reclassified out of accumulated other comprehensive income requires entities to disclose

• items reclassified out of accumulated other comprehensive income (AOCI) and into net income in their entirety, the effect of the reclassification on each affected net income line item and

• AOCI reclassification items that are not reclassified in their entirety into net income, a cross reference to other required U.S. GAAP disclosures.

The ASU applies to both public and non-public entities and will be applied prospectively. For public entities, the guidance is effective for annual reporting periods beginning after 15 December 2012 and interim periods within those years. For non-public entities, the new requirements are effective for annual reporting periods beginning after 15 December 2013 and interim and annual periods thereafter. Early adoption is permitted.

Derecognition of in-substance Real EstateASU 2011-10, Derecognition of in-substance real estate - a scope clarification (a consensus of the FASB’s Emerging Issues Task Force), resolves diversity in practice and clarifies that when

a parent (reporting entity) ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt, the reporting entity should apply the guidance in Subtopic 360-20, Property, Plant, and Equipment—Real Estate Sales, to determine whether it should derecognise the in substance real estate. ASU will be applied on prospective basis to deconsolidation events occurring after the effective date. Prior periods should not be adjusted even if the reporting entity has continuing involvement with previously derecognised in substance real estate entities.

For public entities, the guidance is effective for fiscal years beginning on or after 15 June 2012 and interim periods within those years. For non-public entities, the ASU is effective for fiscal years ending after 15 December 2013 and interim and annual periods thereafter. Early adoption is permitted.

Accounting for fair value information that arises after the measurement date and Its inclusion in the impairment analysis of unamortised film costsASU 2012-07, eliminate the rebuttable presumption that the conditions leading to the write off of unamortised film costs after the balance sheet date existed as of the balance sheet date. ASU also eliminates the requirement that an entity incorporate into fair value measurements used in the impairment tests the effects of any changes in estimates resulting from the consideration of subsequent evidence if the information would not have been considered by market participants at the measurement date.

The ASU is already effective for SEC filers. For all other entities, the amendments are effective for impairment assessments performed on or after 15 December 2013. The amendments resulting from this ASU should be applied prospectively. Earlier application is permitted, including for impairment assessments performed as of a date before 24 October 2012, if, for SEC filers, the entity’s financial statements for the most recent annual or interim period have not yet been issued or, for all other entities, have not yet been made available for issuance.

Presentation of an unrecognised tax benefit when a net operating loss carry forward or tax credit carry forward exists ASU 2013-11 requires an entity to present the unrecognised tax benefit as a reduction of the deferred tax asset for a net operating loss (NOL), similar tax loss, or tax credit carry forward rather than as a liability when the uncertain tax position would reduce the NOL or other carry forward under the tax law and the entity intends to use the deferred tax asset for that purpose.

Early adoption and retrospective application are permitted. ASU will be effective for public companies for annual and interim periods beginning after 15 December 2013, and will be effective for non-public companies for annual and interim periods beginning after 15 December 2014. Early adoption is permitted.

Clarifying the scope of disclosures about offsetting assets and liabilities ASU 2011-11 requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position.

ASU 13-01 clarifies that the scope of ASU 2011-11 applies to derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with Section 210-20-45 or Section 815-10-45 or subject to an enforceable master netting arrangement or similar agreement.

An entity is required to apply the ASU for fiscal years beginning on or after 1 January 2013, and interim periods within those annual periods. An entity should provide the required disclosures retrospectively for all comparative periods presented. The effective date is the same as the effective date of ASU 2011-11.


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Accounting for the release of a cumulative translation adjustment (CTA) upon certain derecognition events

ASU 2013-05 clarifies that when a reporting entity (parent) ceases to have a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business (other than a sale of in substance real estate or conveyance of oil and gas mineral rights) within a foreign entity, the parent is required to apply the guidance in Subtopic 830-30, Foreign Currency Matters—Translation of Financial Statements, to release any related cumulative translation adjustment into net income. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided.

The ASU also clarifies the accounting for the release of a CTA upon loss of a controlling interest in a foreign entity, partial sale of a foreign entity, and the acquisition in stages of a controlling interest in a foreign entity (step acquisition).

The guidance applies prospectively and is effective for public entities for fiscal years beginning on or after 15 December 2013, and for non-public entities for the first annual period beginning on or after 15 December 2014. Early adoption is permitted.

Testing Indefinite-Lived Intangible Assets for Impairment ASU 2012-02 gives an option to an entity to first assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Subtopic 350-30, Intangibles—Goodwill and Other.

The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after 15 September 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before 27 July 2012, if a public entity’s financial statements for the most recent annual or interim period have not yet been issued or, for non-public entities, have not yet been made available for issuance.

Liquidation Basis of Accounting ASU 2013-07 clarifies when an entity should apply the liquidation basis of accounting. In addition, the ASU provides principles for the recognition and measurement of assets and liabilities and requirements for financial statements prepared using the liquidation basis of accounting.

The amendments apply to all entities that issue financial statements that are presented in conformity with U.S. GAAP except investment companies that are regulated under the Investment Company Act of 1940 (the 1940 Act).

Effective for entities that determine liquidation is imminent during annual reporting periods beginning on or after 15 December 2013 and interim reporting periods therein. Entities should apply the requirements prospectively from the day that liquidation becomes imminent. Early adoption is permitted.

AICPA Issues Practice Aid on Goodwill Impairment Testing AICPA recently issued an accounting and valuation practice aid on goodwill impairment testing for preparers, auditors and valuation professionals. The practice aid is non-authoritative but expected to identify best practices in areas of impairment testing and a useful tool for management when engaging a third-party specialist to assist in conducting goodwill impairment testing. AICPA Issues Practice Aid on Acquired In-Process Research and Development Assets

AICPA recently issued an accounting and valuation practice aid about assets acquired to be used in research & development activities. The Practice Aid is intended for preparers, auditors, and valuation professionals and

includes detailed discussion about initial recognition of in-process R&D at the time of a business combination or asset acquisition, subsequent accounting, and valuation methodologies, and includes a comprehensive example.

Service Concession ArrangementsASU 2014-05 requires that an operating entity should not account for a service concession arrangement that is within the scope of the ASU as a lease in accordance with Topic 840, Leases. An operating entity should refer to other topics as applicable to account for various aspects of a service concession arrangement. The amendments also specify that the infrastructure used in a service concession arrangement should not be recognised as property, plant, and equipment of the operating entity.

The amendments are effective for a public entity for annual periods, and interim periods within those annual periods, beginning on or after 15 December 2014. For an entity other than a public business entity, the amendments are effective for annual periods beginning on or after 15 December 2014, and interim periods within annual periods beginning after 15 December 2015. Early adoption is permitted.


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Accounting for goodwill- a consensus of the Private Company Council

The amendments brought by ASU 14-02, apply to all entities except for public business entities and not-for-profit entities as defined in the Master Glossary of the Accounting Standards Codification (ASC) and employee benefit plans within the scope of Topics 960 through 965 on plan accounting.

The amendments allow an accounting alternative for the subsequent measurement of goodwill. Thus, an entity within the scope of the amendments that elects the accounting alternative should amortise goodwill on a straight-line basis over 10 years, or less than 10 years if the entity demonstrates that another useful life is more appropriate. An entity that elects the accounting alternative is further required to make an accounting policy election to test goodwill for impairment at either the entity level or the reporting unit level.

The accounting alternative, if elected, should be applied prospectively to goodwill existing as of the beginning of the period of adoption and new goodwill recognised in annual periods beginning after 15 December 2014, and interim periods within annual periods beginning after 15 December 2015. Early application is permitted, including application to any period for which the entity’s annual or interim financial statements have not yet been made available for issuance.

Accounting for certain receive-variable, pay-fixed interest rate swaps - simplified hedge Accounting approach - a consensus of the Private Company CouncilThe amendments brought by ASU 14-03 apply to all entities, except for public business entities and not-for-profit entities as defined in the Master Glossary of the FASB ASC, employee benefit plans within the scope of Topics 960 through 965 on plan accounting, and financial institutions.

The amendments allow the use of the simplified hedge accounting approach to account for swaps that are entered into for the purpose of economically converting a variable-rate borrowing into a fixed-rate borrowing. Under this approach, the income statement charge for interest expense will be similar to the amount that would result if the entity had directly entered into a fixed-rate borrowing instead of a variable-rate borrowing and a receive-variable, pay-fixed interest rate swap. Alternatively, that entity may continue to follow the current guidance in Topic 815. The simplified hedge accounting approach provides entities with a practical expedient to qualify for cash flow hedge accounting under Topic 815.

The simplified hedge accounting approach will be effective for annual periods beginning after 15 December 2014, and interim periods within annual periods beginning after 15 December 2015, with early adoption permitted. Private companies have the option to apply these amendments using either a modified retrospective approach or a full retrospective approach.

Refer to page no.13 of this publication for detailed discussion on this topic.


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Accounting for principal only currency swaps recent EAC guidance


• Explain the accounting of certain principal only currency swaps based on recent EAC guidance

A Principal Only Currency Swap (POS) is in economic terms similar to a foreign currency forward contract instrument. The only key difference is that a POS typically requires a periodic payment of swap cost (or forward premium) as opposed to a foreign currency forward contract that typically requires a payment/receipt of forward premium only at the settlement of the contract.

Accounting treatment of foreign currency contracts and derivative contracts is a complex area of accounting under Indian GAAP. In this article, we highlight and examine a recent opinion1 of the Expert Advisory Committee (EAC) of the Institute of Chartered Accountants of India (ICAI) that discusses whether a ‘principal only currency swap’ of an Indian company would be within the scope of AS 11, The Effects of Changes in Foreign Exchange Rates and consequently if paragraphs 46 and 46 A of AS 11 would be applicable to this contract under Indian GAAP. We are also assuming, for this analysis, that such contracts are not entered into for trading or speculation purposes.

The instrument that is subject of analysis is a POS entered into by an Indian entity that synthetically converted an underlying INR denominated borrowing into a foreign currency borrowing by requiring the entity to pay a foreign currency amount at the end of the contract. The Indian entity would be in receipt of a periodic swap (forward premium) payment over the life of the POS.

1 ICAI Journal – The Chartered Accountant, February 2014


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Accounting alternatives

Such POS could be accounted under AS 1 i.e., a company with such contract would be required to provide for losses in respect of all outstanding derivative contracts at the balance sheet date by marking them to market and recognising these losses in the statement of profit and loss. Any mark to market gain would not be recognised in the financial statements.

A company could also explore whether AS 30 is applied without applying hedge accounting to such POS e.g., if a company is able to designate the POS as a hedge of highly probable forecasted sales transaction assuming other conditions required by the standard are met. If AS 30 could be applied, then both mark to market gains and losses would be recognised in the statement of profit and loss.

Accounting literature available under Indian GAAP for foreign currency transactionsUnder Indian GAAP, on foreign currency transactions following sources of guidance are available:

• AS 11 – this standard is notified under the Companies (Accounting Standard) Rules, 2006 which deals with foreign currency transactions.

• AS 1, Disclosure of Accounting Policies - In March 2008, the Institute of Chartered Accountants of India (ICAI) issued an announcement that in case of derivatives if an entity does not follow AS 30, Financial Instruments – Recognition and Measurement, keeping in view the principle of prudence as enunciated in AS 1 an entity is required to provide for losses in respect of all outstanding derivative contracts at the balance sheet by marking them to market. In case of forward contracts to which AS 11 applies, the entity needed to fully comply with the requirements of AS 11.

In October 2007, ICAI had introduced AS 30 and AS 31, Financial Instruments: Presentation, which were to come into effect in respect to accounting periods commencing on or after 1 April 2009 and were to be recommendatory in nature for an initial period of two years and become mandatory in respect of accounting periods commencing on or after 1 April 2011. AS 30 would have required mark to market accounting for all derivatives depending on whether they qualified or not as a hedge, with immediate recognition in the statement of profit and loss. However, AS0 and AS 31 were not notified accounting standards under the Companies Act, and therefore, currently are not mandatory accounting standards for companies in India.

Scope of AS 11The scope of AS 11 covers accounting for the following:

a. transactions in foreign currencies

b. translating the financial statements of foreign operations

c. foreign currency transactions in the nature of forward exchange contracts.

POS – is this a forward contract within the scope of AS 11AS 11 applies to forward exchange contracts, including those that are entered into to hedge the foreign currency risk of existing assets and liabilities and is not applicable to the exchange difference arising on forward exchange contracts entered into to hedge the foreign currency risks of future transactions in respect of which firm commitments are made or which are highly probable forecast transactions.

POS could be argued to be a forward exchange contract. However, we need to analyse whether the POS transaction be considered to be a foreign currency transaction within para 36-39 of AS 11.

Para 36 of the standard clarifies that only those forward exchange contracts are covered under AS 11 which are entered into for hedging foreign currency risk where the underlying transaction is denominated in a foreign currency. In the case discussed at the EAC, the underlying transaction is an INR loan that does not give rise to any foreign currency risk. Rather, POS transaction would expose an Indian company to foreign currency risk. Further, the EAC was of the view that the INR loan and POS can not be treated as a single transaction to enable the treatment of INR loan as a foreign currency loan. This is due to the fact that AS 11 does not recognise such ‘synthetic accounting’. Moreover, in substance, the INR loan and POS (which is cancellable) would be treated as two separate transactions.

Para 38 of AS11 provides accounting treatment for those forward contracts which have been entered into for either trading or speculative purposes. In this case, we have assumed that POS has not been entered into for trading or speculative purposes. Therefore, the POS would not be covered under para 38 of AS 11.

Hence, such POS would not be considered as a forward contract covered under AS 11 and therefore, is not a foreign currency transaction within the scope of AS 11. Accordingly, paragraphs 46 and 46A of AS 11 would not be applicable in this situation.


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Regulatory updatesRBI circular on utilisation of floating provisionsThe Reserve Bank of India (RBI) has permitted banks to utilise up to 33 per cent of countercyclical provisioning buffer/floating provisions held by them as on 31 March 2013, for making specific provisions for non-performing assets, as per the policy approved by their Board of Directors.

Further, RBI has clarified that such utilisation may be over and above the utilisation of countercyclical provisioning buffer/floating provisions for the purpose of making accelerated/additional provisions as proposed in the Reserve Bank’s Press release dated 30 January 2014, on ‘Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders: Framework for Revitalising Distressed Assets in the Economy’.

Also refer to ‘KPMG in India’s First Notes’ dated 10 February 2014 for a discussion on the regulation.

[Source: RBI/2013-14/485; DBOD.

No.BP.95/21.04.048/2013-14: dated 7 February 2014]

SEBI announces new corporate governance normsThe Securities and Exchange Board of India (SEBI) approved the proposals to amend the corporate governance norms for listed companies in India. The amendments shall be applicable to all listed companies with effect from 1 October 2014. In January 2013, SEBI had released its ‘Consultative Paper on Review of Corporate Governance Norms in India’ to align the existing corporate governance norms in India with the then existing Companies Bill, 2012 and other international practices. Consequent to the enactment of the Companies Act, 2013 (2013 Act).

Whilst some norms are in line with the requirements of the 2013 Act, other norms are more stringent than those prescribed in the 2013 Act.

Norms such as prohibition of stock options to independent directors, compulsory whistle blower mechanism, exclusion of nominee director from the definition of independent director, performance evaluation of independent directors and the board of directors are some of the norms notified, which are in line with the requirements of the 2013 Act.

However, norms requiring approval of all material related party transactions by shareholders through special resolution seems more onerous than the related section under the 2013 Act. The 2013 Act, in this regard requires pre-approval of only those related party transactions specified in Section 188 of the 2013 Act, which are not in the ordinary course of business and those which are not on an arm’s length basis, by the shareholders.

Similarly, SEBI as per the revised norms restricts the total tenure of an Independent Director to two terms of five years. It specifically mentions that if a person who has already served as an Independent Director for five years or more in a listed company as on the date on which the amendment to listing agreement becomes effective, he shall be eligible for appointment for one more term of five years only. This requirement seems onerous as the related 2013 Act requirement are applied prospectively.

We believe the additional requirements as notified by the SEBI would strengthen the corporate governance framework for listed companies in India.

Also refer to ‘KPMG in India’s First Notes’, dated 14 February 2014 for a detailed clause by clause discussion.

[Source: PR No. 12/2014 dated 13 February 2014]


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MCA issues clarification on section 185 of the Companies Act, 2013The Ministry of Corporate Affairs (MCA) has clarified that till the time section 372A of the Companies Act, 1956 is repealed and section 186 of the 2013 Act is notified, a holding company is allowed to give guarantee or provide security in respect of loans made by banks or financial institutions, to its wholly owned subsidiary company provided such loans are exclusively used by the subsidiary for its principal business activities.

The scope of the exemption is limited as it covers only guarantees and security provided and does not extend to loans given by a holding company to its wholly owned subsidiary company.

Also refer to ‘KPMG in India’s First Notes’, dated 17 February 2014 for a discussion on the clarification.

[Source: General Circular No. 03/2014 dated 14 February 2014]

Tax audit limit increased from 45 to 60 The Institute of Chartered Accountants of India (ICAI) has increased the number of tax audit assignments that a practicing chartered accountant can undertake either as an individual or as a partner in the firm. The number stands increased from 45 assignments to 60 assignments. The new limit is applicable for audits conducted during the financial year 2014-15 and onwards.

[Source: ICAI’s announcement dated 11 February 2014 - http://www.icai.org/post.html?post_id=10354 ]

Insertion of paragraph 46 in AS 11 issued by ICAIThe MCA had amended (in 2009 and 2011) paragraph 46 and inserted paragraph 46A of the AS 11, The Effects of Changes in Foreign Exchange Rates under the Companies Accounting Standards Rules, 2006 (MCA notified standard). The Companies Accounting Standards Rules, 2006 are applicable to the entities to which the Companies Act applies. Recently, the ICAI has inserted paragraph 46 in AS 11, The Effects of Changes in Foreign Exchange Rates notified by it (ICAI notified standard). The insertion by the ICAI to AS 11 (ICAI notified standard) extends the options of the ‘MCA notified AS 11’ to the entities that are not covered by the Companies Act.

As per paragraph 46 and 46A of ‘MCA notified AS 11’ (and now also as per paragraph 46 of the ‘ICAI notified AS 11’) exchange differences arising on reporting of long-term foreign currency monetary items, based on option availed by an entity, can be:

a. adjusted to the cost of the asset, where the long-term foreign currency monetary items relate to the acquisition of a depreciable capital asset (whether purchased within or outside India), and consequently depreciated over such asset’s balance life

b. accumulated in ‘Foreign Currency Monetary Item Translation Difference Account’ (FCMITDA) and amortised over the balance period of long-term monetary asset/liability, in cases other than those falling under (a) above.

It is clarified by the ICAI that the newly introduced paragraph 46 in the ‘ICAI notified AS 11’ will be applicable for same periods as under section 46 and 46A of the ‘MCA notified AS 11’.

[Source: http://www.icai.org/new_category.html?c_id=219 - ICAI’s announcement dated 13 February 2014]

Manner of disclosure in auditor’s report about unaudited components or audited by another auditorAn entity’s stand-alone financial statements incorporates financial information of components such as branches/divisions, etc. Similarly, an entity’s consolidated financial statements incorporates the financial statements of components such as subsidiaries/joint ventures/associates, etc. For incorporating such financial information/financial statements, the principal auditor needs to rely on the work of a component auditor. There may also be situations where such components are not audited.

Based on representations from its members, the ICAI has issued guidance on the manner of disclosure in auditor’s report about unaudited components or audited by a component auditor. The summary of the guidance is as under:

Immaterial components whether remaining unaudited or audited by an auditor other than the principal auditor

The ICAI has clarified the principal auditor may or may not disclose the fact of such component/s in its report.

In case the principal auditor decides to make such disclosure, the same would be done under the ‘Other Matters’ paragraph, pursuant to SA 706, Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report.

Material components remaining unaudited

The principal auditor needs to consider the impact and assess whether the auditor’s opinion on the financial statements of the entity/consolidated financial statements of the group needs to be modified, in terms of the principles laid down in SA 705, Modifications to the Opinion in the Independent Auditor’s Report.

Material components audited by other auditors

The principal auditor would need to disclose the fact of such component/s in its auditor’s report. Such disclosure would be done under the ‘Other Matters’ paragraph, pursuant to SA 706, Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report.

The ICAI has clarified for audit reports of banks the format as prescribed under ‘Guidance note on audit of banks’ in relation to audited/unaudited components shall continue to apply.

[Source: http://www.icai.org/new_post.html?post_id=10362 – ICAI’s website- announcement dated 13 February 2014]


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ICAI announces amendments to audit/review report formatsThe ICAI has announced following changes:

1. Section 227(3)(bb) of the Companies Act, 1956 requires an auditor of a company to specifically report whether the report on accounts of any branch office audited by a person other than him, has been forwarded to him, and how has he dealt with it in preparation of the company’s auditor report. The ICAI has clarified that this fact should be included in the ‘Report on Other Legal and Regulatory Requirements’ paragraph of the auditor’s report. An illustrative format has also been suggested by the ICAI.

2. Currently, the illustrative format of the auditor’s report contain references to ‘Profit and Loss Account’ at various places. However, the revised Schedule VI which also corresponds to Schedule III of the Companies Act, 2013 uses the words ‘Statement of Profit and Loss’. In order to bring consistency the ICAI has suggested using the word ‘Statement of Profit and Loss’ instead of ‘Profit and Loss Account’ in the auditor’s report.

3. Amendment of the Companies (Auditor’s Report) Order, 2003 to allow an auditor to either report on the non-applicability of a particular clause/s individually or to report in aggregate the fact of non-applicability of different clauses under one statement. Illustrative format has also been prescribed by the ICAI in its announcement. The reason for the change is that certain clauses may not be applicable to a company and would not impact an auditor’s opinion on the financial statements.

4. Amendment to the ‘auditor’s responsibility’ paragraph of the auditor’s report to include the fact that the auditor’s assessment of internal control systems are only to design audit procedures and that such assessment is not for the purpose of expressing an opinion on the effectiveness of such internal controls. Illustrative format of the amended ‘auditor’s responsibility’ paragraph has also been prescribed by the ICAI.

5. The Companies Act, 2013 has notified Section 133 which empowers the Central Government to prescribe the standards of accounting. However, the Ministry of Corporate Affairs has clarified that till the time such standards are prescribed, the existing Accounting Standards notified under the Companies Act, 1956 shall continue to apply. In view of this the ICAI has provided guidance on the manner of reference to the Accounting Standards applicable to the company in the statutory auditor’s report as well as in limited review’s report:

Alternative 1: Make a reference to section 211(3C) of the Companies Act, 1956 (both in the ‘Management’s Responsibility for Financial Statements’ and ‘Report on Legal and Other Regulatory Matters’ paragraphs (as currently given in the illustrative format of independent auditor’s report for accompany given in Appendix to SA 700).

Alternative 2: Make a reference to only Companies Act, 1956 along with the reference to the relevant notifications of the MCA which clarify that the Accounting Standards prescribed under the Companies Act, 1956 would continue to apply in respect of section 133 of the Companies Act, 2013. Further the ‘Management Responsibility for Financial Statements’ paragraph and the ‘Report on Legal and Other Regulatory Matters’ paragraph in the independent auditor’s report would need to suitably reworded. Illustrative format has also been prescribed by the ICAI.

[Source- ICAI’s website- http://www.icai.org/post.html?post_id=10344 – announcements dated 7 February 2014]

Reports by Regional Director under section 394A of the Companies Act, 1956The Ministry of Corporate Affairs (MCA) has recently issued a circular clarifying that the Regional Directors (RD) are not responsible for ensuring correctness or otherwise of the objections/ views of the Income-tax department/regulators. But, if there are compelling reasons for doubting the correctness of the views, the RD should make a reference to the MCA for taking up the matter with concerned Ministry before filing the representation under Section 394A. This circular is effective from 15 January 2014.

Also refer to page no.17 of this publication for further details on this circular.

[Source: General Circular No. 1/2014 dated 15 January 2014]

RBI’s committee to review governance of bank boardsThe Reserve Bank of India (RBI) has formed a committee to review the governance of boards of banks in India.

The committee will review compliance with the regulatory requirements. The committee will also judge areas where such requirements can be rationalised and where the requirements need to be enhanced.

The committee will further review the working mechanism of the boards to ensure adequate allocation of time to issues like strategy, growth, risk management, etc.

The review will also include evaluation of the compensation guidelines, constitution of bank’s ownership and bank’s boards to ensure a mix of capabilities and independence.

The Committee is expected to submit its report within three months from the date of its first meeting.

[Source: General Circular No. 03/2014 dated 14 February 2014]


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RBI restricts intra-group transactions and exposures (ITEs) of banks In order to mitigate the risks arising from intra-group exposures and concentration of credit risk, the RBI has released the ‘guidelines on management of intra-group transactions and exposures (guidelines)’.

The guidelines are also aimed at ensuring an arm’s length transaction between the group entities and adherence to the risk management policies and prudential limits on the intra-group exposures.

As per the guidelines, banks should adhere to the following intra-group exposure limits:

• Single group entity exposure

– Five per cent of paid-up capital and reserves in case of non-financial companies and unregulated financial services companies

– 10 per cent of paid-up capital and reserves in case of regulated financial services companies.

• Aggregate group exposure

– 10 per cent of paid-up capital and reserves in case of all non-financial companies and unregulated financial services companies taken together

– 20 per cent of paid-up capital and reserves in case of the group i.e., all group (financial and non-financial) taken together.

The guidelines, inter-alia, require constant monitoring of the ITEs through board approved comprehensive policies, effective systems and processes laid in this regard. It is also mentioned that the banks must also ensure that the transactions in low-quality assets with group entities, whether regulated or unregulated, are not done for the purpose of hiding losses or window dressing of balance sheets.

The banks should submit the information about its group entities, intra-group support arrangements and intra group exposures on a regular basis to the RBI (the frequency and format will be prescribed by the RBI separately). However, it is stressed that in case the intra group exposure exceeds the prudential limits, the same needs to be reported at the earliest explaining the reasons for such breach of limits. Further, the exposure beyond the permissible limits would be deducted from the ‘common equity tier 1 capital’ of the bank and may lead to imposition of penalties by the RBI. In addition to reporting to the RBI, banks are also required to make specified disclosures in their financial statements.

The guidelines will be effective from 1 October 2014. Thus, the banks will be required to submit the data on intra-group exposures from the quarter ending 31 December 2014. However, in case the banks’ current intra-group exposure is more than the limits prescribed, it should bring down such excess limits latest by 31 March 2016. But as mentioned above, the exposure beyond the permissible limits would be deducted from the common equity tier 1 capital of the bank

[Source: RBI/2013-14/487; DBOD.No.BP.BC.96/21.06.102/2013-14 dated 11 February 2014]

RBI releases guidelines relating to framework on stressed asset resolutionThe RBI had on 30 January 2014, released a ‘Framework for Revitalising Distressed Assets in the Economy’ effective from 1 April 2014, which laid down guidelines for early recognition of financial distress, taking prompt steps for resolution and thereby ensuring fair recovery for lending institutions. For operationalising this framework, the RBI has through two notifications issued on 26 February 2014, released detailed guidelines on refinancing of project loans, sale of non-performing assets (NPAs) by banks and other regulatory measures and on formation of joint lenders’ forum and adoption of corrective action plan.

Also refer to KPMG in India’s First Notes dated 28 February 2014 which provides an overview of these guidelines, the potential implications and areas for action.

[Source: RBI/2013-14/502; DBOD.BP.BC.No.98 / 21.04.132 / 2013-14 dated 26 February 2014 and RBI/2013-14/503; DBOD.BP.BC.No.97/ 21.04.132 / 2013-14 dated 26 February 2014]

Notification of provisions relating to ‘Corporate Social Responsibility’ (CSR) under the Companies Act, 2013The MCA has notified 1 April 2014 as the date on which the provisions of section 135 (relating to CSR) and Schedule VII (covering suggested CSR activities) of the Companies Act, 2013 shall come into force. The notification has also made amendments to pre-notified schedule VII to elaborate/add/delete/few activities based on representations received by the industry.

Further the MCA has notified the Companies (Corporate Social Responsibility Policy) Rules, 2014 (the Rules) which will also be effective from 1 April 2014. The rules, inter-alia, include the definition of net profit, applicability of CSR provisions to private companies, foreign companies and their Indian branches, disclosure of CSR policy and activities on the company’s website, provisions relating to group CSR projects, etc.

Also refer to KPMG in India’s First Notes dated 28 February 2014 which provides an overview of this notification.

[Source: MCA notification dated 27 February 2014]


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MumbaiLodha Excelus, Apollo MillsN. M. Joshi MargMahalaxmi, Mumbai 400 011Tel: +91 22 3989 6000Fax: +91 22 3983 6000

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Introducing Voices on Reporting

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

In our first call, we covered the recently enacted sections of the Companies Act, 2013, and its implications on financial statements preparation for March 2014.

We also covered briefly SEBI corporate governance norms.

Missed an issue of Accountingand Auditing Update or First Notes?

The February 2014 edition of the Accounting and Auditing Update leads with our article on the e-commerce sector and provides insights into accounting issues relating to companies operating in this space. We also continue with our series of articles on the Companies Act, 2013, by including in this issue an article highlighting the increases and changes in reporting responsibilities arising out of the Act. The issue also highlights some of the key observations of the FRRB with regard to ongoing reporting practices of companies in India. Finally, we also cover key matters discussed in and arising out the 2013 AICPA conference relating to SEC and PCAOB matters and an overview of the key regulatory developments during the recent past.

Notification of provisions relating to corporate social responsibility under the Companies Act, 2013

The Ministry of Corporate Affairs (MCA) has vide its notification dated 27 February 2014, notified 1 April 2014 as the date on which the provisions of section 135 and Schedule VII of the Companies Act, 2013 shall come into force.

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Back issues are available to download from: www.kpmg.com/in

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Accounting and Auditing Update - March 2014