Accounting and Auditing Update

Transcription

1 Accounting and Auditing Update Issue no. 21/2018 April

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3 Editorial The new revenue standard, Ind AS 115, Revenue Contracts with Customers provides guidance that applies to contracts with customers in all sectors. Accordingly, the standard may change the way pharmaceutical companies account for sales transactions. In this issue of the Accounting and Auditing Update (AAU), we focus on the impact of Ind AS 115 on the pharmaceutical sector. The article highlights that while transitioning to Ind AS 115, pharmaceutical entities would need to take critical decisions while identifying performance obligations, accounting for licences of intellectual property, variable consideration, financing element, etc. Banks are required to meet certain capital adequacy norms that require regulatory capital to be classified as Tier 1 and Tier 2 capital. While banks prepare for the transition to Ind AS, one important aspect to consider is which components of the regulatory capital meet the definition of equity as per Ind AS. Our article on this topic explains the Ind AS requirements with the help of an illustrative. Auditor reporting and responsibility has changed in response to significant developments in corporate reporting e.g. in relation to the details included in companies annual reports. Users attribute a lot of importance to the information in annual reports. Therefore, a new Standard on Auditing (SA) 720, The Auditor s Responsibilities Relating to Other Information, increases the auditor s responsibilities with respect to other information. The article explains the concept of other information and enhanced reporting responsibility of the auditors with regard to other information. This SA is applicable for audits of financial statements beginning on or after 1 April The Institute of Chartered Accountant of India (ICAI) published an educational material in the form of frequently asked questions on Ind AS 103, Business Combinations. We have summarised key examples in the education material and highlighted the accounting principles of the business combinations standard. As is the case each month, we also cover a regular round-up of some recent regulatory updates in India and internationally. We would be delighted to receive feedback/suggestions from you on the topics we should cover in the forthcoming edition of AAU. Sai Venkateshwaran Partner and Head Accounting Advisory Services KPMG in India Ruchi Rastogi Partner Assurance KPMG in India

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5 Table of contents Ind AS 115 Impact on the pharmaceutical sector Accounting for instruments held as regulatory capital by banks Enhanced focus on other information in auditor reporting Frequently asked questions on business combinations Regulatory updates

6 01 Ind AS Impact on the pharmaceutical sector This article aims to: Highlight the key impacts of Ind AS 115 on the entities engaged in the pharmaceutical sector Summary Determination of separate performance obligations in an arrangement with multiple promises is a key step. While applying the distinct test, evaluate whether a pharmaceutical licence is distinct from the other goods and services in a contract. Evaluate the criteria for assessing licence of an Intellectual Property (IP) as a predominant item in a contract to determine eligibility of royalty exception and ensure consistent application. When multiple goods and services are considered as a single performance obligation, determining whether the over-time criteria are met would involve judgement.

7 02 The much awaited standard on revenue recognition for Ind AS compliant companies i.e. Ind AS 115, Revenue from Contracts with Customers (which is based on IFRS 15, Revenue from Contracts with Customers) has been notified by the Ministry of Corporate Affairs (MCA) on 28 March The new standard is effective for accounting periods beginning on or after 1 April 2018 (in line with the IFRS applicability date i.e. 1 January 2018) Ind AS 115 replaces existing revenue recognition standards Ind AS 11, Construction Contracts and Ind AS 18, Revenue and revised guidance note of the Institute of Chartered Accountants of India (ICAI) on Accounting for Real Estate Transactions for Ind AS entities issued in The core principle of Ind AS 115 is that revenue should be recognised when (or as) an entity transfers control of goods or services to a customer at the amount to which an entity expects to be entitled. To achieve the core principle, the new standard establishes a five-step model that entities would need to apply to determine when to recognise revenue, and at what amount. Therefore, a single model applies to contracts with customers across all industries. Ind AS 115 will change the way in which pharmaceutical entities have been accounting for their sales transactions. In this article, we cast our lens on the key implementation issues of Ind AS 115 to be considered by entities in the pharmaceutical sector. 1. Performance obligations Entities in the pharmaceutical sector generally enter into arrangements which comprise multiple promises such as licences, Research and Development (R&D) services, manufacturing and distribution arrangements, etc. The new standard introduces detailed guidance on identifying separate components, which applies to all types of revenue generation transactions. This could result in goods or services being unbundled more frequently than under the current guidance. Additionally, arrangements may also include terms related to goods and services that the customer has not yet committed to, such as option to renew or extend agreements and optional purchases of products. Therefore, determining which of the options in the contract give rise to a material right to customers to be considered as a separate performance obligation under the new standard would be crucial. An entity would need to evaluate at the contract inception, the promised goods or services to determine which goods or services (or bundle of goods or services) are distinct and therefore, constitute a performance obligation.

8 03 A good or service that is promised to a customer, is distinct if both the following criteria are met: Criterion 1: Capable of being distinct Can the customer benefit from the good or service either on its own or together with other readily available resources? Criterion 2: Distinct within the context of contract Is the entity s promise to transfer the good or service separately identifiable from other promises in the contract? Yes No Distinct performance obligation Not distinct combine with other goods and services. (Source: Revenue Issues In-Depth, KPMG IFRG Limited s publication, May 2016) If the above mentioned criteria are not met, then the good or service would be combined with other promised goods or services in the contract until the entity identifies a bundle of goods or services that is distinct. Example A pharmaceutical entity A entered into an arrangement with a customer under which the customer gets a licence for exclusive rights of a compound Z. Entity A undertakes to perform the R&D service to get the compound Z approved for commercial sale which primarily relate to testing and validating its efficacy. The R&D services required to develop compound Z further could be performed by another pharmaceutical company. Entity A would need to consider whether the licence and the R&D services are distinct. Accordingly, in this case, entity A determines that following factors are present: a. R&D services required to commercialise compound Z are not unique or specialised i.e. other entities could also perform them b. R&D services do not have a transformative effect on the licence and c. Entity A s services do not change the nature of the compound. Therefore, the licence and the R&D services would be considered as distinct and therefore, the contract would include two performance obligations (licence and R&D services). However, if in the given case, R&D services provided were different such that no other entity would have been able to provide it or the R&D service significantly modify the compound Z, then the licence and R&D service would not be considered as distinct and would be treated as a single performance obligation.

9 04 2. Licences of an Intellectual Property (IP) Unlike current accounting standards, Ind AS 115 provides specific guidance with respect to the licences of an IP. A contract to transfer a licence to a customer may include promises to deliver other goods or services in addition to the promised licence. These promises may be specified in the contract or implied by an entity s customary business practices. An entity would need to apply step 2 of the revenue model to identify each of the performance obligations in a contract that includes a promise to grant a licence in addition to other promised goods or services. A licence of IP that is distinct from other goods and services in the contract is a separate performance obligation. To determine whether the performance obligation is satisfied at a point in time or over-time, it requires an entity to consider the nature of the promise and ascertain whether the promise provides the customer with the right to: a. Access the entity s IP throughout the licence period. b. Use the entity s IP as it exists at the point in time at which the licence is granted. Yes Use licence guidance Does the customer have a right to use the entity s IP? Is the licence distinct? Yes No No Apply general guidance Point in time recognition Over-time recognition (Source: Pharmaceuticals slide share IFRS 15 Revenue Are you good to go?, published by KPMG IFRG Limited, 2017) The new standard includes the following criteria (as explained in the flowchart below) to consider the nature of the licence: Are all the following criteria met? No Right to use the entity s IP Criterion 1: Entity expects to undertake activities that significantly affect the IP Criterion 2: Rights directly expose the customer to positive or negative effects of the entity s activities Criterion 3: Activities do not result in the transfer of a good or service to the customer entity s activities Yes Right to access the entity s IP (Source: Revenue Issues In-Depth, KPMG IFRG Limited s publication, May 2016)

10 05 For pharmaceutical entities, determining whether the licence is distinct from the other goods and services in the contract is expected to be a more challenging step. If the licence is not distinct, then the entity should apply the general guidance of Ind AS 115 to determine the timing of revenue recognition. However, it may use the licence criteria (as given above) to evaluate the combined performance obligation. Example Licences of biological compounds and drug formulae are examples of right to use licences (i.e. point in time recognition) under Ind AS 115. In respect to to such licences, it is generally being considered that the entity is not likely to undertake future activities that will significantly affect the underlying IP i.e. the underlying IP is complete. Assessment of future activities includes only those activities that do not transfer a separate good or service to the customer. For example, R&D services provided to a customer as a separate performance obligation under the contract does not consider these activities in making an assessment for the underlying IP. An example of a licence that is not considered as distinct would be a drug compound that requires proprietary R&D services from the entity. 3. Estimation of constraint in a variable consideration In the pharmaceutical sector, development of new products and obtaining approvals required for commercialisation involves significant risks and accordingly, a large portion of the consideration could be variable in many arrangements. For instance, arrangements may include payments contingent on development milestones being met, approvals being received or future production or sales levels. Similarly, distribution and manufacturing arrangements for approved drugs may include other forms of variable consideration such as volume rebates and rights of return. As per Ind AS 115, these variable considerations would be included in the transaction price only to the extent that it is highly probable that significant revenue reversal will not subsequently occur (the constraint). Application of constraint is expected to be an area of key judgement for many pharmaceutical entities when their contracts include large amounts of consideration that are dependent on highly uncertain future events. An entity may need to constraint the estimate of variable consideration to zero at the start of the contract for inherent uncertainty of events such as regulatory approval for a drug. Therefore, such entities should consider all the facts and circumstances which could increase the likelihood or magnitude of a revenue reversal. This includes the risk of both under and over-statement of revenue based on all information available to management for each reporting period. 4. Sales and usage - based royalties Ind AS 115 provides an exception from the general requirements of estimation of variable consideration in case of sale or usage-based royalties that are attributable to a licence of an IP (royalty exception). Accordingly, these are to be recognised at the later of the following: When the subsequent sale or usage occurs and Satisfaction or partial satisfaction of the performance obligation to which some or all of the sales or usagebased royalty has been allocated. In the pharmaceutical sector, biotechnology and pharmaceutical licences are often sold with R&D services and/or a promise to manufacture the drug for the customer with all the consideration in the form of a sales-based royalty. In such cases, the royalty exception would be applied if an entity considers the licence to be the predominant item in the arrangement i.e. it ascribes significantly more value to the licence than to other goods or services to which the royalty relates. However, assessment of predominant would be critical in the absence of any clear definition as different entities may ascribe different criteria for its assessment. For one entity, the licence which represents the major part of the value could be predominant, while for another, licence of IP comprising the largest item in a bundle of goods or services could be predominant and would be eligible for royalty exception.

11 06 5. Revenue recognition - point in time or over-time Ind AS 115 provides a control-based approach to be applied to all transactions i.e. at the contract inception, an entity need to evaluate whether it transfers control of the good or service over-time or at a point in time. Revenue is recognised At the point in time when the customer obtains control Revenue is recognised over-time when any of the following criteria are met: or Over-time if specific criteria are met (Source: Pharmaceuticals slide share IFRS 15 Revenue Are you good to go?, published by KPMG IFRG Limited, 2017) Sr. no. 1. Criteria Customer simultaneously receives and consumes the benefits provided by the entity s performance as the entity performs Example Routine or recurring services e.g. R&D services an arrangement.arrangement. Therefore, determining the appropriate measure of progress of these types of arrangements could be another challenge. An entity would need to select an output or input method for measuring the progress of each performance obligation (satisfied over-time) that is consistent with the nature of the performance obligation or apply a method consistently to similar performance obligations in similar circumstances. Similarly, pharmaceutical entities which undertake contract manufacturing and have been using the units delivered or produced method to recognise revenue would need to reconsider the applicability of such methods as these methods have been specifically excluded under Ind AS 115 when there are material amounts of work in progress that are controlled by the customer. Additionally, an entity needs to reconsider the conclusions reached for special arrangements such as repurchase agreements (forward, call and put options), consignment arrangements, bill-and-hold arrangements and customer acceptance in light of the change in the principle of revenue recognition from risks and rewards based approach (under current Ind AS i.e. Ind AS 18) to transfer of control under Ind AS Entity s performance creates or enhances an asset that the customer controls as the asset is created or enhanced Entity s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date Modifying a customer s drug compound Developing a compound to a customer s specifications If none of the above criteria are met, then control of the good or service transfers at a point in time. In case of pharmaceutical entities, the challenge lies in determining whether the over-time criteria is met when multiple goods and services are considered as a single performance obligation, for example, a licence and R&D service or a licence and manufacturing service in

12 07 6. Allocating the transaction price Current Ind AS does not provide specific guidance on allocation of consideration to components of a transaction. Certain interpretations include guidance on allocation for service concession arrangements, and customer loyalty programmes and agreements for sale of real estate. However, Ind AS 115 requires an entity to allocate the transaction price at the contract inception to each performance obligation on the basis of relative standalone selling prices. The best evidence of such a price is the observable price from stand-alone sales of the goods or services to similarly - situated customers. If observable price is not available, then price needs to be estimated by using: Adjusted market assessment approach: Evaluate the market in which goods or services are being sold and estimate the price that a customer would be willing to pay For example, if a contract includes a licence and R&D service that are distinct, then an entity needs to determine the stand-alone selling prices of both licence and R&D. Determination of the stand-alone selling price of a licence for a drug which is not yet approved could be challenging. However, in case any variable consideration or a discount could be allocated to one or more of the performance obligations, then it would be less challenging. This is possible only if the entity has evidence that supports the allocation of any discount or variable consideration to the specific performance obligations. Expected cost plus a margin approach: Forecast expected costs of satisfying a performance obligation and add an appropriate margin for that good or service Residual approach (only in limited circumstances): Estimate the stand-alone selling price by reference to the total transaction price less the sum of observable stand-alone selling prices of other goods or services promised in the contract. Is the price directly observable? No Yes Estimate Use observable price Estimation methods include Adjusted market assessment Cost plus margin Residual value (Source: Pharmaceuticals slide share IFRS 15 Revenue Are you good to go?, published by KPMG IFRG Limited, 2017)

13 08 7. Significant financing component Currently, Ind AS 18 requires an entity to discount consideration to present value if payment is being deferred and the arrangement effectively constitutes a finance transaction. For instance, an entity sells a product and allows the customer to pay the agreed price after two years when it takes ownership of the product. However, it does not provide any guidance with respect to adjustments to consideration in case payment is received in advance. Ind AS 115 applies to both deferred and advance payments as well as both point in time and over-time contracts. Therefore, significant financing components are expected to be identified more frequently under it with more complex calculations in case of contract with over-time performance obligations. Interest expense Advance payment Performance date Interest income Deferred payment Practical expedient No need to recognise if period between payment and performance is < 1 year 8. Transition approach Ind AS 115 provides the following transition options: a. Retrospective method: Under this method, entities recognise the cumulative effect of applying Ind AS 115 at the start of the earliest comparative period presented. As part of this method, an entity could use certain practical expedients for smooth transition. b. Cumulative effect method: Under this method, an entity recognise the cumulative effect of applying Ind AS 115 at the date of initial application, with no restatement of the comparative periods presented i.e. the comparative periods are presented in accordance with current GAAP. Entities using this method are required to disclose the quantitative effect of Ind AS 115 and an explanation of the significant changes between the reported results under Ind AS 115 and those that would have been reported under current GAAP. Both these approaches have their pros and cons and hence, would require a careful evaluation. It is important to note that, under either approach, an entity can choose to apply Ind AS 115 only to those contracts that are not complete at the date of transition (i.e. contract for which the entity has transferred to the customer all of the goods or services identified under Ind AS 11, Ind AS 18 and related interpretations). Accordingly, contracts relating to licences of drugs that are approved are likely to be assessed as complete as the entity has transferred the licence to the customer. However, for contracts that are not complete at the date of initial application, for instance in the given case, if the entity also provides the R&D services under contract, then an entity would need to consider whether all of the identified services have been provided. (Source: Pharmaceuticals slide share IFRS 15 Revenue Are you good to go?, published by KPMG IFRG Limited, 2017) The main considerations in determining significant financing component are the period between performance and payment for that performance and the discount rate that applies. However, a contract may not include significant financing component if a substantial portion of the consideration is variable and based on occurrence or non-occurrence of events outside the entity s control. For instance, a contract with consideration that comprises a fixed payment payable only on obtaining regulatory approval and a sales-based royalty would not include a significant financing component. However, a contract which involves a significant up-front payment would require further analysis, including consideration of when the performance obligations in the contract are satisfied.

14 09 9. Disclosures There are minimal specific disclosures with respect to revenue under the current standards. However, Ind AS 115 has specific disclosure requirements in the following areas: Costs to obtain or fulfil a contract Contract balances Understand nature, amount, timing and uncertainty of revenue and cash flows Disaggregation of revenue Performance obligations Significant judgements (Source: Revenue Issues In-Depth, KPMG IFRG Limited s publication, May 2016) Entities need to assess whether their current systems and processes are capable of capturing, aggregating and reporting information to meet the new disclosure requirements. This may require significant changes to the existing data-gathering processes, IT systems and internal controls. Additionally, ensure that the information used to comply with disclosure requirements is reliable. Sources: Ind AS 115, Revenue Contracts with Customers Revenue Issues In-Depth, KPMG IFRG Limited s publication, May 2016 Pharmaceuticals slide share IFRS 15 Revenue Are you good to go?, published by KPMG IFRG Limited, 2017

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16 11 Accounting for instruments held as regulatory capital by banks This article aims to: Explain how regulatory capital of the banks would be classified and accounted under Ind AS Summary Banks in India are subject to capital adequacy norms stipulated by the Reserve Bank of India s (RBI s) guidelines on Basel III. The regulatory capital of banks generally comprises the following financial instruments: Tier 1 capital: This includes common equity (CET1), certain Perpetual Non-cumulative Preference Shares (PNCPS) and certain Perpetual Debt Instruments (PDI); and Tier 2 capital: This includes other subordinated debt instruments with predetermined maturity. Currently, as per a RBI circular dated 30 March 2010, CET1 and PNCPS are classified as equity, and other instruments are classified as liabilities. On transition to Indian Accounting Standards (Ind AS), banks will be required to classify the financial instruments issued by it in accordance with the substance of the contractual arrangement and the definitions of financial liability and equity specified in Ind AS 32, Financial Instruments: Presentation, and measure them in accordance with the requirements of Ind AS 109, Financial Instruments. This article demonstrates key considerations when determining the classification of regulatory capital held by banks as equity or financial liability and their measurement.

17 12 Example: Classification of regulatory capital of bank A Bank A is a Scheduled Commercial Bank incorporated in India. In order to comply with the capital adequacy norms as per the RBI guidelines on Basel III, bank A holds the following capital instruments as on 31 March 2018 in its financial statements: Instrument/ characteristics Common equity Perpetual debt instrument Redeemable Non-Cumulative Preference Shares (RNCPS) Tier II bonds Classification as per Basel III rules CET1 Additional Tier I capital Tier II capital Tier II capital Amount recognised in regulatory capital (INR in million) Accounting classification (IGAAP) 8,765 2,000 3,000 2,200 Shareholders equity Liability Liability Liability Perpetual or dated Perpetual Perpetual Dated Dated Original maturity date Not applicable Not applicable 31 March September 2023 Optional call date and redemption amounts Not applicable 30 September 2024 (subject to RBI approval), redemption at par 1 No call option, redemption at par No call option, redemption at par Coupon/dividends Dividend Coupon Dividend Coupon Fixed/floating Not applicable Fixed Fixed Fixed Coupon rate Not applicable 10.65% 10.25% 10.20% Coupon dividend is discretionary or mandatory Fully discretionary Fully discretionary Fully discretionary Mandatory Write down feature No Yes Yes Yes Conversion option No No No No Write down/conversion triggers Not applicable Point of Non- Viability (PONV) trigger, as determined by RBI PONV trigger as determined by RBI PONV trigger as determined by RBI 1. However, the bank does not do anything which creates an expectation that the call will be exercised.

18 13 Accounting issue As per Ind AS 32, on initial recognition of financial instruments, the issuers of those instruments are required to classify them or their component parts as a financial liability, financial asset or equity, in accordance with the substance of the contractual arrangement and the definitions provided in the said standard. Accordingly, on the date of transition to Ind AS, i.e. 1 April , bank A is required to determine the classification of the instruments held as regulatory capital, as per the requirements of Ind AS 32 and determine their measurement in accordance with Ind AS 109. Accounting guidance and analysis The debt instruments issued by bank A are subject to the capital adequacy guidelines, prescribed by RBI, and will be written down, when RBI determines that such an action is required (generally when the bank becomes insolvent- at the point of non-viability ). These instruments are commonly referred to as statutory bailin instruments. Statutory bail-in requirements do not impact the issuer s classification as financial liabilities or equity on initial recognition. However, the bail-in features that are contractual terms of the instruments would be considered in the classification. Figure 1 below shows the assessment required to be made by bank A when determining the classification of the instruments considering their bail-in features. Figure 1: Analysis for classification of capital instruments held by bank A Guidance RNCPS Identify the components of the capital instruments Perpetual debt instruments Redeemable principal amount Discretionary, non-cumulative distribution Tier II Bonds Yes Is there a contractual obligation to deliver cash/another financial asset No Yes No Yes No Can the component be settled in the issuer's own equity instruments? No No No Yes No Is the component a derivative that meets the 'fixed for fixed' criterion? Yes Do all settlement alternatives result in equity classification? No Yes Financial liability Equtiy Equtiy Financial liability Equtiy Financial liability Source: KPMG in India s analysis 2018, read with Ind AS The RBI, through its press release dated 5 April 2018, deferred the implementation of Ind AS by one year for scheduled commercial banks and regional rural banks. Accordingly, these banks would prepare their first Ind AS financial statements for financial year beginning 1 April 2019, and the transition date would be 1 April 2018.

19 14 Common equity Classification: These are common shares issued by bank A, and represent the most subordinated claim in liquidation of the bank. The holders of these instruments are entitled to a claim on the residual assets, which is proportionate to their share of paid up capital, after all senior claims have been repaid in liquidation. These instruments fall within the definition of an equity instrument under Ind AS 32. Measurement: The entire amount (INR8,765 million) will be classified under equity. Perpetual debt instruments Classification: Bank A does not have a contractual obligation to deliver cash or another financial asset in order to pay the coupon on the instrument (which is discretionary) or the principal amount. Accordingly, the bank has full discretion to cancel distributions/payments on the perpetual debt instrument, and such cancellation would not be considered as a default. Further, the call option available with the bank, is not a contractual obligation on the bank to buy back the instruments. Hence, the instruments do not satisfy the definition of a financial liability, accordingly they fall within the definition of an equity instrument. Measurement: the entire amount (INR2,000 million) will be classified under equity. cent). In that case, the carrying amount of the liability on initial recognition is INR2,956 million. This liability is required to be measured at amortised cost, in accordance with Ind AS 109. Discretionary dividend feature Classification: The discretionary, non-cumulative dividend component is an equity component since the company has no contractual obligation to pay this dividend to the holders of the instrument. Measurement: The equity component of the compound financial instrument will be assigned the residual amount of the compound financial instrument, after deducting the fair value of the liability from the fair value of the compound financial instrument. In this case, the equity component will be measured at INR44 million (INR3,000 million INR2,956 million). Tier II bond Classification: Bank A has a contractual obligation to pay the mandatory coupon of per cent on the principal amount, and to redeem the principal on 15 September Thus, it is in the nature of a financial liability, and is required to be classified accordingly. Measurement: The liability will be measured at fair value on initial recognition, and subsequently, will be measured at amortised cost, in accordance with Ind AS 109. Redeemable Non-Cumulative Preference Shares (RNCPS) The RNCPS is a compound financial instrument, where the obligation to redeem the principal amount of the preference shares and the discretionary dividends feature of the same are treated as two separate components, and are recognised separately in the balance sheet. These components are assessed as below: Redemption of preference shares Classification: This component represents a contractual obligation of bank A to redeem the principal amount of the preference shares to its holders on 31 March Therefore, the component is in the nature of a financial liability, and will be classified accordingly. Measurement: The initial carrying amount of a compound financial instrument is allocated to its equity and liability components. The carrying amount of the liability component is computed by measuring the present value of future cash flows of the instrument, using a discount rate, equivalent to the rate of interest applied by the market to a similar instrument, without the equity feature (say nine per

20 15 Consider this If in the above example, the preference shares were non-redeemable, then the appropriate classification of the preference shares would depend on the other terms and conditions associated with such shares in particular, the attached dividend rights. If dividends are discretionary, then this fact supports the classification of the preference shares as equity instruments. If dividends are not discretionary, then they represent a contractual obligation, and the instrument is classified as a financial liability. A preference dividend in which payment is contingent on the availability of future distributable profits differs from a discretionary dividend. With a discretionary dividend, the issuer is able to avoid the payment of dividends indefinitely. However, the payment of a contingent dividend cannot be avoided indefinitely. The fact that the issuer might currently be unable to pay the dividend has no bearing on its classification. Consequently, contingent dividends are classified as a liability. With the implementation of Ind AS 109, RBI will be required to reassess the classification of the regulatory capital instruments, and to make the appropriate amendments in its circulars.

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22 17 Enhanced focus on other information in auditor reporting This article aims to: Provide an overview of the reporting requirements under SA 720 (Revised). Introduction In April 2015, the International Auditing and Assurance Standards Board (IAASB) issued revised International Auditing Standard (ISA) 720, The Auditor s Responsibilities Relating to Other Information, in order to ensure that it continues to be capable of enhancing the credibility of financial statements. The revised standard became effective for audits of financial statements for periods ending on or after 15 December In line with international requirements, the Institute of Chartered Accountants of India (ICAI) revised its Standards on Auditing (SAs) 720 SA 720 (Revised), The auditor s responsibilities relating to other information. This SA deals with the auditor s responsibilities relating to other information, whether financial or non-financial information (other than financial statements and the auditor s report thereon), included in an entity s annual report. The following section aims to provide an overview of the auditors responsibilities under SA 720 (Revised) to report on other information included in an entity s annual report.

23 18 Meaning of other information under SA 720 (Revised) SA 720 (Revised) defines other information as financial or non-financial information (other than financial statements and the auditor s report thereon) included in an entity s annual report. Annual reports include a lot of qualitative and quantitative information. The information provided by annual reports is used by users of the financial statements to analyse the risk associated with business and in decision making. Depending on the applicable law, regulation or custom, one or more of the following documents may form part of the annual report: Management report, management commentary, or operating and financial review or similar reports by those charged with governance (for example, a directors report) Chairman s statement Corporate governance statement/reports. Following are not other information within the scope of this SA: Separate industry or regulatory reports (for example, capital adequacy reports), may be prepared in the banking, insurance, and pension industries Corporate social responsibility reports Sustainability reports Diversity and equal opportunity reports Product responsibility reports Labour practices and working conditions reports Human rights reports Other regulatory filings with the government agencies such as the Registrar of Companies. Objective of SA 720 (Revised) The SA 720 (Revised) increases the responsibility of the auditor relating to other information in enhancing the reliability of financial statements. The auditor s responsibilities relating to other information (other than applicable reporting responsibilities) apply regardless of whether the other information is obtained by the auditor prior to, or after, the date of the auditor s report. Scope of SA 720 (Revised) The SA 720 (Revised) is written in the context of an audit of financial statements by an independent auditor. The auditor s opinion on the financial statements does not cover the other information, nor does this SA require the auditor to obtain audit evidence beyond that required to form an opinion on the financial statements. The SA 720 (Revised) requires an auditor to read and consider the other information to ascertain the cases where: There is a material inconsistency between the other information and the financial statements There is a material inconsistency between the other information and the auditor s knowledge obtained in the audit. The material inconsistency identified by the auditor may indicate that there is a material misstatement of the financial statements or of the other information, either of which may undermine the credibility of the financial statements and the auditor s report thereon. Such material misstatements may also inappropriately influence the economic decisions of the users for whom the auditor s report is prepared. The SA 720 (Revised) would also assist the auditor in complying with relevant ethical requirements and to avoid association with information that the auditor believes contains a materially false or misleading statement. In some cases, the applicable financial reporting framework may require specific disclosures but permit them to be located outside of the financial statements. As such disclosures are required by the applicable financial reporting framework, they form part of the financial statements. Accordingly, they do not constitute other information for the purpose of this SA. For example, certain disclosures required by Ind AS 107, Financial Instruments: Disclosures. The SA 720 (Revised) also does not apply to preliminary announcements of financial information or securities offering documents, including prospectuses. Applicability The revised standard on auditing is effective for audits of financial statements for periods beginning on or after 1 April 2018.

24 19 Main changes in scope of the auditor s work The main changes brought by revised SA 720 (Revised) are: The revised SA 720 (Revised) broadened the scope of other information by linking it to the concept of an annual report 1 Enhanced the auditor s work effort with respect to other information and Provided transparency by requiring reporting on the auditor s work relating to other information. It is pertinent to note that the revised SA 720 (Revised) has retained the concept in extant SA 720 that other information is not required to be audited (i.e., that auditors do not obtain assurance on the other information). When the other information is obtained after the date of the auditor s report, the auditor is not required to update the procedures performed in accordance with requirement of SA 560, Subsequent Event (paragraphs 6 and 7). However, the auditor would communicate with management or those charged with governance about the possible implications when the other information is obtained after the date of the auditor s report. Auditor s role in respect to other information The auditor would make appropriate arrangements with the management of a company to obtain other information in a timely manner and if possible prior to the date of the auditor s report. The auditor should read the other information and Consider whether there is a material inconsistency between the other information and the financial statements, and Consider whether there is a material inconsistency between the other information and the auditor s knowledge obtained in the audit, in the context of audit evidence obtained and conclusions reached in the audit. The auditor should remain alert for indications that the other information not related to the financial statements or the auditor s knowledge obtained in the audit appears to be materially misstated. The auditor should include in his/her audit documentation the procedures performed and final version of the other information on which auditor has performed his/her procedures. 1. As per SA 720 (Revised), an annual report is a document, or combination of documents, prepared typically on an annual basis by management or those charged with governance in accordance with law, regulation or custom, the purpose of which is to provide owners (or similar stakeholders) with information on the entity s operations and the entity s financial results and financial position as set out in the financial statements.

25 20 Reporting by auditors under SA 720 (Revised) The auditor s report would include a separate section with a heading Other Information, or other appropriate heading, when, at the date of the auditor s report: For an audit of financial statements of a listed entity, the auditor has obtained, or expects to obtain, the other information, or For an audit of financial statements of an unlisted corporate entity, the auditor has obtained some or all of the other information. In case of an audit of financial statements of an unlisted corporate entity, the auditor may consider that the identification in the auditor s report of other information that the auditor expects to obtain after the date of the auditor s report would be appropriate in order to provide additional transparency about the other information that is subject to the auditor s responsibilities under SA 720 (Revised). The auditor may consider it appropriate to do so, for example, when management is able to represent to the auditor that such other information would be issued after the date of the auditor s report. Using the heading other information or other appropriate heading, the auditor s report will include: A statement that management is responsible for the other information. Identification of the other information obtained prior to the date of the auditor s report. In the case of audit of a listed entity, the auditor is also required to identify any other information expected to be obtained after the date of the auditor s report. A statement that the auditor s opinion does not cover the other information and, accordingly, that the auditor does not express (or will not express) an audit opinion or any form of assurance conclusion thereon. A description of the auditor s responsibilities relating to reading, considering and reporting on other information as required by SA 720 (Revised). When other information has been obtained prior to the date of the auditor s report, either: A statement that the auditor has nothing to report; or If the auditor has concluded that there is an uncorrected material misstatement of the other information, a statement that describes the uncorrected material misstatement of the other information. Extract of the auditor s report The following is an example 2 of reporting when the auditor has obtained all of the other information prior to the date of the auditor s report and has not identified a material misstatement of the other information. Other Information [or another title if appropriate, such as Information Other than the Financial Statements and Auditor s Report Thereon ] The company s Board of Directors is responsible for the other information. The other information comprises the [information included in the X report, but does not include the financial statements and our auditor s report thereon.] Our opinion on financial statements does not cover the other information and we do not express any form of assurance conclusion thereon. In connection with our audit of the financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard. 2. Illustration 1 provided in Appendix 1 of SA 720 (Revised)

26 21 Auditor s response in case if material misstatement of the other information exists In case the auditor after reviewing the other information concludes that material misstatement of the other information exists, then the auditor should request the management to correct the other information and if required communicate the matter to those charged with governance. Guidance has been provided in the following situations: Situation 1: If the auditor concludes that a material misstatement exists in other information obtained prior to the date of the auditor s report, and the other information is not corrected after communicating with those charged with governance, the auditor should take appropriate action, including: Reporting implications: The auditor should consider implications for the auditor s report and communicating with those charge with governance to consider the ways to address the material misstatement in the auditor s report such as a disclaimer of opinion on the financial statements. Withdrawal from the engagement: The auditor may consider withdrawing from the engagement, where withdrawal is possible under applicable law or regulation. In cases where withdrawal is not possible, the auditor may issue a report to the legislature providing details of the matter or may take other appropriate actions. Situation 2: If the auditor concludes that a material misstatement exists in other information obtained after the date of the auditor s report: If the material misstatement has been corrected: The auditor should perform the additional procedures ensure correction has been made and review the steps taken by the management to communicate with those in receipt of the other information. If the other information is not corrected: The auditor should take appropriate action considering the auditor s legal rights and obligations, to seek to have the uncorrected material misstatement appropriately brought to the attention of users for whom the auditor s report is prepared. If, as a result of performing the procedures mentioned above, the auditor is of the opinion that a material misstatement in the financial statements exists or the auditor s understanding of the entity and its environment needs to be updated, the auditor would respond appropriately in accordance with the other SAs.

27 22 Consider this The revision of SA 720 aims to clarify and increase the auditor s involvement with other information whether financial or non-financial information other than audited financial statements that is included in the entity s annual report. The auditors are not required to obtain assurance about the other information. The auditor s report will include a separate section on other information when the auditor has obtained some or all of the other information as of the date of the auditor s report. For audits of financial statements of listed entities, other information section will also be included if the auditor expects to obtain other information after the date of the auditor s report. Sources: SA 720 (Revised), The Auditor s Responsibilities Relating to Other Information, issued by ICAI. IAASB s publication, At a Glance, The International Standard on Auditing (ISA) 720 (Revised), The Auditor s Responsibilities Relating to Other Information, published in April 2015.

28 23 Frequently asked questions on business combinations This article aims to: Highlight some of the key examples discussed in the education material on Ind AS 103. Background Ind AS 103, Business Combinations provides guidance on accounting for business combinations by applying the acquisition method. Though, internationally, there is limited authoritative guidance on accounting for legal mergers or common control business combinations, Ind AS 103 provides guidance on common control transactions also. In addition, Ind AS 103 has one more notable difference with its global counterpart, International Financial Reporting Standard (IFRS) 3, Business Combinations. IFRS 3 requires bargain purchase gain arising on business combination to be recognised in the statement of profit and loss. Ind AS 103 requires that the bargain purchase gain should be recognised in equity as capital reserve. The Institute of Chartered Accountants of India (ICAI) has published an Education Material on Ind AS 103, which contains summary of the standard in form of key requirements and Frequently Asked Questions (FAQs) covering certain issues expected to be encountered frequently while implementing this standard in the Indian scenario.

29 24 Identification of business A business is an integrated set of activities and assets that are capable of being conducted and managed to provide a return to investors by way of dividends, lower costs or other economic benefits. Thus, it consists of inputs and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not required to qualify as a business as long as there is the ability to create outputs. What constitutes a business, is a matter of professional judgement which may require careful assessment of facts and circumstances. Some of the examples discussed in the education material that help to distinguish between the group of assets and business are as follows: Development stage entity: In case an entity has a licence to develop a new drug (input), but lacks processes to apply to licence to create an output. It does not have any employees, nor pursuing a plan to produce outputs since no research and development is being performed. If such an entity is acquired by another entity then such an acquisition would not be construed as a business but instead be accounted as an asset acquisition. On the other hand, where an entity is performing final clinical trials and is pursuing a plan to produce outputs (i.e. a commercially developed drug to be sold or licensed), acquisition of shares in such an entity results in the acquirer acquiring inputs (licence for drug and employees) and processes (operational and management processes associated with the performance and supervision of the clinical trials), therefore, represents an acquisition of business. Investment property: An entity may purchase few investment properties, rented to tenants. It also takes over a contract with the property management entity (which has unique knowledge related to investment properties in the area and makes all decisions, both of strategic nature and related to the daily operations of the property). Additionally, ancillary activities necessary to fulfil the obligations arising from these lease contracts are also in place, specifically activities related to maintaining the building and administering the tenants. In this case, the acquired set of investment properties would be construed to be a business because it contains all of the inputs and processes necessary for it to be capable of creating outputs to provide an acquirer. In contrast, if the property management contract was not taken over, then the group of assets might not meet the definition of a business because the key element of the infrastructure of the business, i.e. property management, was not taken over. In such a case, the acquirer entity would be required to account for the transaction as the purchase of individual investment properties, and not as the purchase of a business. Acquisition date For each business combination, one of the combining entities would be identified as the acquirer. The acquisition date is the date on which the acquirer obtains control of the acquiree. In addition, Ind AS 103 clarifies that the date on which the acquirer obtains control of the acquiree is generally the date on which the acquirer legally transfers the consideration, acquires the assets and assumes the liabilities of the acquiree - the closing date. In practical cases, it may happen that the acquirer might obtain control on a date that is either earlier or later than the closing date. For example, the acquisition date precedes the closing date if a written agreement provides that the acquirer obtains control of the acquiree on a date before the closing date. An acquirer is required to consider all pertinent facts and circumstances in identifying the acquisition date. Few examples discussed in the education material (for business combinations that do not involve a court approved scheme) help understand the issues involved while identifying the acquisition date. Regulatory approval: A regulatory approval (e.g. Competition Commission of India) is considered substantive for an entity to acquire control of another s operations, in such a case, the acquisition is considered to be completed only on receipt of such regulatory approval. Therefore, the date of acquisition cannot be earlier than the date on which regulatory approval is obtained. Acquirer consulted on major decisions: In a case where an entity makes an offer for all the shares of an entity and the parties concerned agree that the acquirer would be consulted on any major decisions pending transfer of shares, the date of acquisition will be the date on which the acquirer obtains control of the acquiree. The activity of mere consultation would not ensure that acquirer can impose its decisions on the acquiree and has power to direct the relevant activities of the acquiree. Thus, in this case, the offer date should not be construed as the date of acquisition.

30 25 Contingent consideration The standard defines contingent consideration as, an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. However, contingent consideration may also give the acquirer the right for return of previously transferred consideration, if specified conditions are met. Few examples discussed in the education material that help apply the guidance on contingent consideration are as follows: Consideration relating to protective clause: An entity on acquisition of another entity paid a consideration of INR5 crore of which INR4 crore is paid at the acquisition date while balance INR1 crore is placed in an escrow account. INR1 crore relates to a protective clause to protect the acquirer from any false representations and warranties, if any, made by the acquiree. In case there is no violation of the representations and warranties (reported or noticed) within one year of the acquisition date, the amount in the escrow account would be released to the sellers. In the given case, the nature of escrow amount is protective, funds would be released to the sellers based on the validity of conditions that existed at the acquisition date and are not dependent on the future performance of the entity acquired. Thus, INR1 crore is not treated as contingent consideration and instead be treated as part of purchase consideration and taken into account for computation of goodwill/bargain purchase, if any. Forfeiture on termination of employment: An acquirer may enter into an arrangement for payments to employees or selling shareholders of the acquiree that are contingent on a post-acquisition event. The accounting for such arrangements depends on whether the payments represent contingent consideration issued in the business combination (which are included in the acquisition accounting), or are separate transactions (which are accounted for in accordance with other relevant Ind AS). Certain indicators are provided in the standard that would help to evaluate whether an arrangement for payments to employees or selling shareholders is part of the exchange for the acquiree or is a transaction separate from the business combination. Generally, arrangements in which the contingent payments are not affected by employment termination may indicate that the contingent payments are additional consideration rather than remuneration. However, judgement would be required to be applied while evaluating such arrangements. Further, the standard clarifies that when in certain arrangements contingent consideration payments are automatically forfeited if employment terminates, then such payments would be considered as remuneration for post-combination services. Thus, such consideration should be treated as remuneration for the post-combination services and would not form part of purchase consideration. Subsequent measurement and accounting of contingent consideration: Ind AS 103 provides that the acquirer is required to account for changes in the fair value of contingent consideration that are not measurement period adjustments as follows: a. Contingent consideration classified as equity would not be remeasured and its subsequent settlement would be accounted for within equity. b. Other contingent consideration that: is within the scope of Ind AS 109, Financial Instruments, is required to be measured at fair value at each reporting date and changes in fair value would be recognised in profit or loss in accordance with Ind AS 109 is not within the scope of Ind AS 109 is required to be measured at fair value at each reporting date and changes in fair value would be recognised in the statement of profit and loss. In a situation, where an entity (the acquirer) acquires another entity (the acquiree) in the month of September 2017 for cash and the acquirer agrees to pay the selling shareholder an amount equivalent to 10 per cent of profits in excess of INR10 crore generated over the next two years in cash in lump sum at the end of the three years. The acquirer determines the fair value of the contingent consideration liability to be INR1 crore at the date of acquisition and this is taken into account for computation of purchase consideration. Going forward, a year after the acquisition, if the acquiree has performed better than initially projected and a higher payment is expected to be made at the end of year two and the fair value of this financial liability is INR2.5 crore at the end of the first year. In accordance with the requirement of the standard stated above, the contingent consideration should be re-measured at the end of the year i.e. 31 March 2018 by debiting the statement of profit and loss by the amount of difference in fair values of contingent liability (which in this case is INR1.5 crore) while recognising a corresponding liability for contingent consideration at the same amount (i.e. INR1.5 crore).

31 26 Acquisition related costs Acquisition related costs are costs which an acquirer incurs to effect a business combination and are excluded from the consideration transferred and expensed when incurred except costs to issue debt or equity securities which are to be recognised in accordance with Ind AS 32 and Ind AS 109. The acquisition-related costs include finder s fees; advisory, legal, accounting, valuation and other professional or consulting fees; general administrative costs, including the costs of maintaining an internal acquisitions department; and costs of registering and issuing debt and equity securities. The examples of such costs given in the standard are indicative and do not preclude any other cost to be considered as acquisitionrelated cost. The acquirer should account for acquisitionrelated costs as expenses in the periods in which the costs are incurred and the services are received. However, the costs to issue debt or equity securities, as already mentioned above, is required to be recognised in accordance with Ind AS 32 and Ind AS 109. The education material has examples on stamp duty and regulatory fees payable on acquisition which are as follows: Stamp duty: Any stamp duty payable for transfer of assets in connection with a business combination is an acquisition-related cost and would not be considered as a part of the fair value exchange between the buyer and seller for the business i.e. the stamp duty is incurred to acquire the ownership rights in land in order to complete the process of transfer of assets. While this cost has been incurred in connection with a business combination, it does not increase the future economic benefits from the net assets comprising the business (which would be recognised at fair value) and hence, cannot be capitalised. It is important to note that the accounting treatment of stamp duty incurred for separate acquisition of an item of property, plant and equipment (i.e. not as part of business combination) differs under Ind AS 16, Property, Plant and Equipment. Regulatory fees: Where assets acquired in a business combination include an intangible asset that comprise a wireless spectrum licence. If an entity has to pay an additional one-time payment to the regulator in the acquiree s jurisdiction in order for the rights to be transferred for the use of acquirer, then the payment to the regulator represents a transaction cost and hence, will be regarded as acquisition-related cost incurred to effect the business combination. Such costs cannot be construed to be separate from the business combination because the transfer of the rights to the acquirer is an integral part of the business combination itself. Hence, such costs would be expensed as incurred. However, had the right been acquired separately (i.e. not as part of business combination), the transaction costs would be capitalised as part of the intangible asset in accordance with requirements of Ind AS 38, Intangible Assets.

32 27 Accounting for common control transactions Appendix C to Ind AS 103 provides that common control business combination means a business combination involving entities or businesses in which all the combining entities or businesses are ultimately controlled by the same party or parties both before and after the business combination, and that control is not transitory. In addition, common control business combinations are required to be accounted for using the pooling of interests method. In practice, issues may arise regarding recognition of differences, arising in case of a common control business combination, if the consideration paid is in excess of the share capital of the transferor and the transferee company does not have any reserves. Appendix C to Ind AS 103 provides that the identity of the reserves is required to be preserved and to appear in the financial statements of the transferee in the same form in which they appeared in the financial statements of the transferor. The education material deals with following issues: Transferee company as no or inadequate reserves: In cases where the transferee company does not have any reserves (including capital reserve), a literal reading of the above guidance in Appendix C might suggest that the adjustment should be made to capital reserve. However, where the consideration is in excess of the carrying value of the net assets (including the reserves), the difference could be adjusted to either revenue reserve(s) or capital reserve (subject to the approvals required, if any, e.g. for capital reduction). If the transferee company has no reserves or has inadequate reserves, the debit should be to an account appropriately titled (e.g., amalgamation adjustment deficit account). The nature of such a reserve is akin to debit balance in the statement of profit and loss. The balance in the account should be presented as part of reserves. Additionally, a disclosure note explaining the nature of this account should be given in the financial statements. Asset acquisition under common control: In another practical situation, where an entity A Ltd.(the transferee) acquired 80 per cent of the share capital of another entity B Ltd. (the transferor) which held a single asset, or a group of assets not constituting a business. Further, the balance 20 per cent of the share capital was held by another unrelated third entity. The fair value of the asset is INR20,000. A Ltd controls B Ltd. as defined in Ind AS 110, Consolidated Financial Statements. Cash paid for the acquisition is INR16,000 and fair value of NCI is INR4,000. In this case, an issue arises regarding accounting of an acquisition of a controlling interest in another entity that is not a business. In accordance with Ind AS 110, an entity is required to consolidate all investees that it controls, not just those that are businesses and recognise any NCI in non-wholly owned subsidiaries. In addition, when the acquisition of an entity is not a business combination, the requirements of acquisition accounting of Ind AS 103 relating to the allocation of the consideration transferred to the identifiable assets and liabilities and the recognition of goodwill are not applicable. Requirements of Ind AS 103 stated that upon the acquisition of an asset or a group of assets that do not constitute a business, the acquirer is required to identify and recognise the individual identifiable assets acquired (including those assets that meet the definition of, and recognition criteria for, intangible assets in Ind AS 38) and liabilities assumed. The cost of the group would be allocated to the individual identifiable assets and liabilities on the basis of their relative fair values at the date of purchase. Such a transaction or event does not give rise to goodwill. Thus, it may be inferred that Ind AS 103 acknowledges that the cost paid for the assets may differ from the sum of their fair values and hence, may need to be allocated to the assets and liabilities acquired. Ind AS 16 and Ind AS 38, both provide that cost is the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction or, where applicable, the amount attributed to that asset when initially recognised in accordance with the specific requirements of other Ind AS, e.g. Ind AS 102, Sharebased Payments. Therefore, when an asset is acquired, its cost is the amount of consideration paid, plus the amount of NCI recorded related to that asset- as this represents a claim relating to that asset. Additionally, Ind AS 103 provides that for each business combination, the acquirer is required to measure at the acquisition date components of NCI in the acquiree that are present ownership interests and entitle their holders to a proportionate share of the entity s net assets in the event of liquidation at either: a. fair value; or b. the present ownership instruments proportionate share in the recognised amounts of the acquiree s identifiable net assets.

33 28 All other components of NCI are required to be measured at their acquisition-date fair values, unless another measurement basis is required by Ind AS. Thus, in the given situation A Ltd. is required to recognise assets at cost, which is the sum of consideration given and any NCI recognised. If the NCI has a present ownership interest and is entitled to a proportionate share of net assets upon liquidation, then the acquirer has a choice to recognise the NCI at its proportionate share of net assets or its fair value (measured in accordance with Ind AS 113 Fair Value Measurement); in all other cases, NCI is recognised at fair value (measured in accordance with Ind AS 113), unless another measurement basis is required in accordance with Ind AS. Additionally, A Ltd. may also evaluate the implications of Ind AS 36, Impairment of Assets, for the asset recognised in its books.

34 29 Regulatory updates

35 30 RBI defers the effective date for implementation of Ind AS for banks to 1 April 2019 On 5 April 2018, the Reserve Bank of India (RBI) through its press release deferred the implementation of Indian Accounting Standards (Ind AS) by one year for scheduled commercial banks i.e would be the first year of Ind AS with as the comparative year. The implementation of Ind AS by banks requires certain legislative changes in the format of financial statements to comply with disclosures required by Ind AS. The change in format requires an amendment to the third schedule of the Banking Regulation Act, 1949 to make it compatible with accounts under Ind AS. Considering the pending amendments to the Banking Regulation Act, 1949, as well as the level of preparedness of several banks, RBI has taken a decision to defer the applicability of Ind AS. Also, RBI is yet to issue prudential norms and operational guidelines to facilitate the implementation of the new accounting standards. (Source: RBI s Statement on Developmental and Regulatory Policies dated 5 April 2018 and KPMG in India s IFRS Notes dated 6 April 2018) MCA notifies Ind AS 115 and amendments to other Ind AS The Ministry of Corporate Affairs (MCA), on 28 March 2018, notified Ind AS 115, Revenue from Contracts with Customers (which is based on IFRS 15, Revenue from Contracts with Customers) as part of the Companies (Indian Accounting Standards) Amendment Rules, The new standard is effective for accounting periods beginning on or after 1 April 2018, thus aligning the Ind AS 115 applicability date with the IFRS 15 applicability date i.e. 1 January Ind AS 115 replaces existing revenue recognition standards Ind AS 11, Construction Contracts and Ind AS 18, Revenue and revised guidance note of the Institute of Chartered Accountants of India (ICAI) on Accounting for Real Estate Transactions for Ind AS entities issued in The new standard also modifies other Ind AS for example Ind AS 16, Property, Plant and Equipment for determining the date of sale of Property, Plant and Equipment (PPE) i.e. date of disposal of an item of PPE is the date the recipient obtains control of that item in accordance with Ind AS 115. The corresponding changes to other Ind AS have also been notified. Further, with Ind AS being converged with IFRS, there is a need to keep Ind AS updated with revisions made to IFRS in order to maintain convergence. Accordingly, MCA issued certain amendments to other Ind AS along with notifying Ind AS 115. These amendments maintain convergence with IFRS by incorporating amendments issued by International Accounting Standards Board (IASB) into Ind AS. Additionally, the IASB along with the IFRS Interpretations Committee, issues amendments to IFRS either as part of its annual improvement process or as specific amendments to IFRS, to resolve inconsistencies in the standards or to provide further clarifications. The amendments relate to the following standards: Ind AS 40, Investment Property Ind AS 21, The Effects of Changes in Foreign Exchange Rates Ind AS 12, Income Taxes Ind AS 112, Disclosure of Interests in Other Entities Ind AS 28, Investments in Associates and Joint Ventures Please refer to KPMG in India IFRS Notes dated 10 April 2018 and 11 April 2018 for detailed overview of amendments to Ind AS and Ind AS 115 notified by MCA. (Source: MCA notification G.S.R. 310(E). dated 28 March 2018) The MCA amends Companies (Filing of Documents and Forms in XBRL) Rules and extended last date for filing of financial statements Rule 12(1) of the Companies (Accounts) Rules, 2014 requires that every company should file the financial statements with the Registrar of Companies (ROC) together with Form AOC-4 and the consolidated financial statements, if any, with Form AOC-4 CFS. Section 137 of the Companies Act, 2013 (2013 Act) requires that every company should file such a form with the ROC within 30 days of the date of the Annual General Meeting (AGM). Further, Rule 3 of Companies (Filing of Documents and Forms in Extensible Business Reporting Language (XBRL)) Rules, 2015, prescribed that the following class of companies are required to file their financial statements in XBRL format: a. Companies listed with stock exchanges in India and their Indian subsidiaries b. Companies with paid-up capital of INR5 crore or above c. Companies with turnover of INR100 crore or above d. All companies which are required to prepare their financial statements in accordance with Companies (Ind AS) Rules, 2015 Recently, MCA through its notification dated 8 March 2018 issued the Companies (Filing of Documents and

36 31 Forms in XBRL) Amendment Rules, 2018 to clarify that the companies which have filed their financial statements as given above should continue to file their financial statements and other documents even if they do not fall under the class of companies specified therein in succeeding years. Therefore, companies which have filed their financial statements under the Companies (Filing of Documents and Forms in XBRL) Rules, 2011, should continue to file their financial statements and other documents as prescribed in those Rules even if they do not fall under the class of companies specified therein. Additionally, MCA through its notification dated 28 March 2018 has extended the last date for filing of AOC- 4 XBRL for Ind AS complaint companies for the financial year without additional fees till 30 April Earlier the last date was extended to 31 March (Source: MCA notification no. G.S.R. 213(E) dated 8 March 2018 and circular no. 1/2018 dated 28 March 2018) Exemption from provisions relating to deferred tax asset/liability for government companies The MCA through its notification dated 2 April 2018 provides that the provisions of Ind AS 12 or AS 22, Accounting for Taxes on Income relating to recognising Deferred Tax Asset (DTA)/Deferred Tax Liability (DTL) in the financial statements will not be applicable to a government company which meets the given criteria: It is a Public Financial Institution (PFI) as defined under Section 2(72)(iv) of the 2013 Act It is a Non-Banking Financial Company (NBFC) registered with RBI under Section 45-IA of the RBI Act, 1934 and It is engaged in the business of infrastructure finance leasing with not less than 75 per cent of its total revenue being generated from such business with government companies or other entities owned or controlled by the government. Earlier the exemption was available for seven years up to 31 March The MCA has amended the earlier notification and now this exemption is available indefinitely to government companies. (Source: MCA notification No. S.O. 529(E) dated 5 February 2018 and MCA notification S.O. 1465(E) dated 2 April 2018)

37 32 SEBI decisions regarding the Report of the Committee on Corporate Governance Background The SEBI constituted a Kotak Committee on Corporate Governance (the committee) in June 2017 under the Chairmanship of Mr. Uday Kotak. The objective of this committee was to suggest measures for enhancing the standards of corporate governance of listed entities in India. On 5 October 2017, the committee submitted the report on corporate governance to SEBI. On 28 March 2018, SEBI considered the recommendations of the committee and the public comments thereon. Accordingly, they accepted certain recommendations without modifications, few with modifications and referred certain recommendations to various agencies (i.e. government, other regulators, professional bodies, etc.) since the matters involved those agencies. Overview of the circular The following section provides an overview of the decisions considered by SEBI and the decisions have been categorised on the basis of their applicability dates. The following table provides the decisions that are expected to be applicable from 1 April 2018 and have been accepted without modifications are as follows: Eligibility criteria for independent directors Eligibility criteria for a director to be an independent director has been revised and would be as follows: Specifically exclude persons who constitute the promoter group of a listed entity. Require an undertaking from an independent director that he/she is not aware of any circumstance or situation, which exists or may be reasonably anticipated, that could impair or impact his/her ability to discharge his/her duties with objective independent judgements and without any external influence. The board of the listed entity to take on record the above undertaking after due assessment of the veracity of such undertaking. Exclude board inter-locks arising due to common non-independent directors on boards of listed entities (i.e. a non-independent director of a company on the board of which any non-independent director of the listed entity is an independent director, cannot be an independent director on the board of the listed entity). For example, if Mr. A is an executive director on the board of entity A (being a listed entity) and is also an independent director on the board of entity B, then no non-independent director of entity B can be an independent director on the board of entity A. Additionally, board of directors as a part of the board evaluation process may be required to certify every year that each of its independent directors fulfils the conditions specified in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations) and is independent of the management. Role of an audit committee The audit committee members would need to also review the utilisation of loans and/ or advances from/investment by the holding company in the subsidiary exceeding INR100 crore or 10 per cent of the asset size of the subsidiary, whichever is lower. Role of nomination and remuneration committee Nomination and remuneration committee members are required to identify and recommend persons who can be appointed in senior management. Accordingly, the persons in senior management should include all members of management one level below the chief executive officer/managing director/whole-time director/manager (including chief executive officer/manager, in case chief executive officer/manager is not part of the board) and should specifically include the company secretary and the Chief Financial Officer (CFO). Administrative staff would not be included in senior management. Also the nomination and remuneration committee members would need to recommend the remuneration payable to the senior management to the board of the listed entity.

38 33 Role of risk management committee The board of directors would need to include cyber security and related risks while specifying the role and responsibility of risk management committee. Additionally, the requirement for constitution of a risk management committee should be applicable to top 500 listed entities determined on the basis of market capitalisation, as at the end of the immediate previous financial year. Auditor related disclosures The explanatory statement to the notice that is sent to shareholders for an AGM in relation to the item on appointment/re-appointment of auditor(s), would include the following disclosures (in addition to any other disclosures that the board of directors may deem fit): a. Basis of recommendation for appointment including the details in relation to and credentials of the auditor(s) proposed to be appointed and b. Proposed fees payable to the statutory auditor(s) along with the terms of appointment. In case of a new auditor, any material change in the fee payable to such an auditor from that paid to the outgoing auditor and the rationale for such change c. Detailed reasons for resignation of an auditor as given by the said auditor. Secretarial audit Secretarial audit has been made compulsory for all listed entities under the Listing Regulations in line with the provisions of the 2013 Act. Secretarial audit has also been extended to all material unlisted Indian subsidiaries. Related Party Transactions (RPTs) In order to strengthen transparency on RPTs, the listed entities would need to take action on the following requirements: A person or an entity belonging to the promoter or promoter group of the listed entity and holds 20 per cent or more of shareholding in the entity would be considered as a related party. Half yearly disclosure of RPTs on a consolidated basis, in the disclosure format required for RPT in the annual accounts as per the accounting standards, on the website of the listed entity within 30 days of publication of the half-yearly financial results. Copy of the same also has to be submitted to the stock exchanges. Disclosure of transactions with promoters/promoter group entities holding 10 per cent or more shareholding be made annually and on a half-yearly basis (even if not classified as related parties). Strict penalties may be imposed by SEBI for failing to make requisite disclosures of RPTs. The Listing Regulations would be amended to allow related parties to cast a negative vote as such voting cannot be considered to be in conflict of interest. Therefore, all material RPTs would require approval of the shareholders through resolution and no related party would vote to approve such a resolution whether the entity is a related party to the particular transaction or not. Utilisation of proceeds of preferential issue and Qualified Institutional Placement (QIP) A disclosure regarding utilisation of funds raised through preferential allotment and QIPs undertaken in the relevant financial year, until such funds are fully utilised would be required. This disclosure will be included in other disclosures section of the Corporate Governance Report.

39 34 Obligations on the board with respect to subsidiaries The board of listed companies would need to take actions regarding following: Definition of material subsidiary: The definition of a material subsidiary has been revised to mean a subsidiary whose income or net worth exceeds 10 per cent (from the current 20 per cent) of the consolidated income or net worth respectively, of the listed entity and its subsidiaries in the immediately preceding accounting year. For the requirement of appointment of independent directors on the board of material subsidiaries, the threshold of 20 per cent would continue. Appointment of an independent director: At least one independent director on the board of directors of the listed entity should be a director on the board of directors of an unlisted material subsidiary, including unlisted foreign material subsidiary. Significant transaction or arrangement: The management of the unlisted subsidiary should periodically bring to the notice of the board of directors of the listed entity, a statement of all significant transactions and arrangements entered into by the unlisted subsidiary (currently the disclosure is required for material subsidiary).

40 35 The decision that is expected to be applicable from 1 April 2018 but has been accepted with a modification is as follows: Royalty/brand payments to related parties: The payments made by listed entities with respect to brands usage/ royalty amounting to more than two per cent of consolidated turnover of the listed entity would require prior approval from the shareholders on a majority of minority basis. The decisions that are expected to be applicable from 1 April 2019 or 1 April 2020 Maximum number of directorships The maximum number of listed entity directorships held by a person has been brought down from 10 to eight (for an independent director it should not exceed seven) with effect from 1 April From 1 April 2020, the number of directorships would be reduced to seven listed entities. Any person who is serving as a whole-time director/managing director in any listed entity would serve as an independent director in not more than three listed entities. Disclosure of directors expertise The corporate governance report would disclose competencies of its board members against every identified competency/expertise without disclosing names in the annual report for financial year ending 31 March However, detailed disclosures of competencies of every board member, along with their names, would be required with effect from 31 March Quarterly financial disclosures The composition of board of directors of the listed entity would comprise of not less than six directors. This requirement is expected to be applicable to top 1,000 listed entities from 1 April 2019 and to top 2,000 listed entities from 1 April Minimum six directors on board of directors A disclosure regarding utilisation of funds raised through preferential allotment and QIPs undertaken in the relevant financial year, until such funds are fully utilised would be required. This disclosure will be included in other disclosures section of the Corporate Governance Report. One independent woman director The board of directors would be required to appoint at least one independent woman director. This requirement is expected to be applicable to top 500 listed entities from 1 April 2019 and to top 1,000 listed entities from 1 April Separation of chief executive officer/ managing director and chairperson Top 500 listed entities would be required to separate the roles of chairperson and chief executive officer/managing director from 1 April While the committee had recommended that all listed entities with more than 40 per cent of public shareholding should separate the roles of the chairperson and chief executive officer/managing director with effect from 1 April 2020, with the chairperson being a non-executive director, SEBI has decided to modify the recommendation to make it applicable to the top 500 listed entities. However, it is unclear if the modification is meant to restrict the applicability to the top 500 listed companies with public shareholding of more than 40 per cent or instead extend the applicability to all of the top 500 listed entities irrespective of the level of public shareholding. Quorum for board meetings The quorum for every meeting of the board of directors of the listed entity would be one-third of its total strength or three directors, whichever is higher, including at least one independent director. This requirement is subject to the requirements of the 2013 Act and the participation of the directors by video conferencing or by other audio visual means would also be counted for the purposes of such quorum. This requirement is expected to be applicable to top 1,000 listed entities from 1 April 2019 and to top 2,000 listed entities from 1 April 2020.

41 36 Timing of AGM and webcast of AGM The top 100 listed entities would need to hold AGMs within five months after the end of financial year i.e. by 31 August 2019 and also provide webcast of AGMs from financial year (Source: Report of the SEBI committee on corporate governance dated 5 October 2017, SEBI press release no. PR No. 09/2018 dated 28 March 2018 and KPMG in India First Notes dated 20 April 2018) Ind AS Transition Facilitation Group (ITFG) issues Clarifications Bulletin 15 The Ind AS Transition Facilitation Group (ITFG) in its meeting considered certain issues received from the members of the ICAI, and issued its Clarifications Bulletin 15 on 5 April 2018 to provide clarifications on following 10 application issues relating to Ind AS. The ITFG provided clarification on the following issues relating to the application of Ind AS: General applicability issues Ind AS applicability to an NBFCs Ind AS applicability to entities in a group Foreign Currency Convertible Bonds Compulsorily redeemable Non-Cumulative Preference Shares (RNCPS) Classification of incentives receivable from government entities as financial assets Application of Ind AS to past business combinations of entities under common control Accounting for interest free refundable security deposits Lease premium collected at the time of lease deed Accounting for outstanding retired partners capital balances by a partnership firm. (Source: ITFG 15 issued by ICAI and KPMG in India s IFRS Notes dated 18 April 2018) The objective of the standard is to: Lay down broad principles for the joint auditors in conducting the joint audit Provide a uniform approach to the process of joint audit Identify the distinct areas of work and coverage thereof by each joint auditor Identify individual responsibility and joint responsibility of the joint auditors in relation to audit. Effective date: The revised standard is effective for audits of financial statements for periods beginning on or after 1 April (Source: SA 299 issued by ICAI) ICAI issued SA 299, Joint audit of financial statements The ICAI on 28 March 2018, issued Standard on Auditing (SA) 299 (Revised), Joint audit of financial statements. A joint audit is an audit of financial statements of an entity by two or more auditors appointed with the objective of issuing the audit report. Such auditors are described as joint auditors. The revised standard lays down the principles for effective conduct of joint audit to achieve the overall objectives of the auditor. Further, the standard deals with the special considerations in carrying out audit by joint auditors.

42 37 The Payment of Gratuity (Amendment) Act, 2018 Background The Payment of Gratuity Act, 1972 requires for the payment of gratuity to employees in specified establishment or company, or shop which has employed 10 or more people. The gratuity is paid to employees if they have provided at least five years of continuous service at the time of termination. The Payment of Gratuity (Amendment) Bill, 2017 (the bill) was introduced in the Lok Sabha by the Minister for Labour and Employment in December 2017 to amend the Payment of Gratuity Act, The bill empowers central government to specify: a. The period of maternity leave eligible for qualifying as continuous service b. Maximum amount payable to an employee under the Payment of Gratuity Act, Under the Payment of Gratuity Act, 1972, the maximum maternity leave, for the purpose of calculating continuous service was based on the maternity leave provided under the Maternity Benefit Act, Similarly, the maximum amount of gratuity payable to an employee cannot exceed INR10 lakh under the Payment of Gratuity Act, New development The bill has been approved by both the houses in March 2018 and the Payment of Gratuity (Amendment) Act, 2018 has been published in the Official Gazette on 29 March Further, the central government through its notification dated 29 March 2018 has specified the following: Amount of gratuity payable to an employee under the Payment of Gratuity Act, 1972 should not exceed INR20 lakh. However, an employee continues to have the right to receive better terms of gratuity under any award, agreement or contract with the employer. The period of maternity leave in case of female employees should not exceed 26 weeks for the purpose of the Payment of Gratuity Act, (Source: Minister for Labour and Employment notification S.O. 1419(E) dated 29 March 2018) IASB revises the Conceptual Framework for Financial Reporting Background The Conceptual Framework for Financial Reporting (Conceptual Framework) is a set of concepts and accompanying guidance that provides a foundation for decisions that the International Accounting Standards Board (IASB) makes while developing a standard. It is not a standard in itself, and does not override any standard developed by IASB. The Conceptual Framework was initially developed in 1989 by IASB s predecessor body, the International Accounting Standards Committee as the Framework for the Preparation and Presentation of Financial Statements. In 2013, IASB issued a Discussion Paper reviewing the Conceptual Framework, and based on the comments received from the stakeholders, in 2015 it issued the Exposure Draft on revisions to the Conceptual Framework. New development On the basis of comments received from the stakeholders on the Exposure Draft of the Revised Conceptual Framework for Financial Reporting (Revised Framework), IASB issued the Revised Framework on 29 March The Revised Framework is more comprehensive than the existing Conceptual Framework, and provides IASB with a full set of tools that cover all aspects of standard setting from the objective of financial reporting, to presentation and disclosures. The Revised Framework fills the gap in the existing Conceptual Framework (for example, by providing guiding principles on selecting the method for measuring elements of financial statements, provides guidance on presentation and disclosure of financial statements), updates various aspects of the Conceptual Framework (for example, by revising the definitions of assets and liabilities), and provides clarification on various aspects (for example, by clarifying the role of measurement uncertainty). The major changes introduced by the Revised Framework are: It describes the reporting entity and its boundary It has updated the definitions of an asset, a liability, an income and an expense Provides the criteria for including assets and liabilities in financial statements (recognition) and guidance on when to remove them (derecognition) Describes the measurement bases and guidance on when to use them States the concepts and provides guidance on presentation and disclosures; and

43 38 Provides clarification on the role of prudence, stewardship, measurement uncertainty and substance over form. The Revised Framework is effective immediately for IASB and the IFRS Interpretations Committee to set better standards. Entities that use the Conceptual Framework to develop an accounting policy (where none of the existing standards cover a transaction), would be required to follow the Revised Framework for annual periods beginning on or after 1 January (Source: Conceptual Framework for Financial Reporting issued by IASB dated 28 March 2018) The IASB proposes changes to IAS 8 The IASB on 28 March 2018 released the Exposure Draft (ED) to propose narrow-scope amendments to IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors. IAS 8 provides the criteria for selecting and changing accounting policies. IAS requires entities to change accounting policy either as requirements in IFRS or when the change would provide more useful information to users of the financial statements. Further, the standard requires an entity to apply a voluntary change in accounting policy retrospectively (i.e. as if it had always applied the new accounting policy), unless this is not practicable. The IFRS Interpretation Committee considered the scenario that an entity may choose to change an accounting policy based on an agenda decision released by the IFRS Interpretations Committee. Applying a voluntary change in accounting policy that results from an agenda decision can be challenging in some situations. Even though, IFRS Interpretations Committee s agenda decisions are non-authoritative, they include explanations on application of IFRSs. Considering this issue, IASB has proposed that if an entity changes an accounting method as a result of an agenda decision by the IFRS Interpretations Committee, the entity should perform assessment of benefits and cost. If the entity s cost of determining the effect of the retrospective application exceeds the expected benefits to users of the financial statements, the new accounting policy would not be applied retrospectively. Additionally, IASB proposes application guidance for the assessment of benefit and cost in the standard. Effective date: The exposure draft does not contain a proposed effective date. (Source: Accounting Policy Changes, Proposed Amendments to IAS 8 issued by IASB) Discontinuance of letters of undertaking and letters of comfort for trade credits The RBI through its notification dated 13 March 2018, has decided to discontinue the practice of issuance of letter of undertakings and letter of credit for the purpose of trade credits for imports into India by AD Category I banks with immediate effect. Letters of credit and bank guarantees for trade credits for imports into India may continue to be issued subject to compliance with the Master Circular on Guarantees and Co-acceptances. (Source: RBI notification RBI/ /139 A.P. (DIR Series) Circular No. 20 sated 13 March 2018)

44 KPMG in India s IFRS institute Visit KPMG in India s IFRS institute - a web-based platform, which seeks to act as a wideranging site for information and updates on IFRS implementation in India. The website provides information and resources to help board and audit committee members, executives, management, stakeholders and government representatives gain insight and access to thought leadership publications that are based on the evolving global financial reporting framework. IFRS Notes Ind AS Transition Facilitation Group (ITFG) issues Clarifications Bulletin April 2018 The Ind AS Transition Facilitation Group (ITFG) in its meeting considered certain issues received from the members of the Institute of Chartered Accountants of India (ICAI), and issued its Clarifications Bulletin 15 on 5 April 2018 to provide clarifications on 10 application issues relating to Indian Accounting Standards (Ind AS). This issue of IFRS Notes provides an overview of the clarifications issued by ITFG through its Bulletin 15. First Notes SEBI decisions regarding the Report of the Committee on Corporate Governance 20 April 2018 On 28 March 2018, the Securities and Exchange Board of India (SEBI) considered the recommendations of the Kotak Committee on Corporate Governance (the Committee) and the public comments thereon. Accordingly, they accepted certain recommendations without modifications, few with modifications and referred certain recommendations to various agencies (i.e. government, other regulators, professional bodies, etc.) since the matters involved those agencies. In this issue of First Notes, we have provided an overview of the decisions considered by SEBI. Voices on Reporting Webinar KPMG in India is pleased to present Voices on Reporting a monthly series of knowledge sharing calls to discuss current and emerging issues relating to financial reporting. The new revenue standard Ind AS 115, Revenue from Contracts with Customers is applicable to Indian companies following the Ind AS road map framework from 1 April Revenue is a crucial financial performance indicator for companies and the new standard is expected to have pervasive impact due to the addition of significant new concepts on recognition, measurement and disclosure of revenue. In our recent session of Voices on Reporting webinar on 26 April 2018, we focussed on the impact of Ind AS 115 on the following sectors: Pharmaceuticals Media Contract manufacturing The audio recording and presentation can be accessed at KPMG in India website. Previous editions are available to download from: Feedback/queries can be sent to aaupdate@kpmg.com Follow us on: kpmg.com/in/socialmedia Introducing Ask a question write to us at aaupdate@kpmg.com The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation 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. The KPMG name and logo are registered trademarks or trademarks of KPMG International. This document is meant for e-communication only.