Ind AS 17 -Leases. Ind AS 17 Leases. Included. Excluded. Definition of lease. Scope. Hire purchase contracts. Conditional sale agreements

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1 Ind AS 17 -Leases Ind AS 17 Leases Definition of lease Lease is an agreement whereby the o lessor conveys to the lessee o in return for a payment or series of payments o the right to use an asset o for an agreed period of time Scope Included Excluded Hire purchase contracts Lease agreements to explore for or use minerals, oil, natural gas Conditional sale agreements Licensing agreements for such items as motion picture films, video recordings, plays, manuscripts, patents and copyrights. 1

2 Ind AS 17 -Leases Asset plus services agreement Ind AS 17 also applies to agreements that transfer the right to use assets that also contain substantial service elements Example Entity A may enter into an agreement to rent photocopiers from entity B. As part of that agreement, entity B agrees to provide maintenance services in respect of the copiers. The fact that entity B has agreed to provide maintenance services does not change the fact that the part of the agreement that deals with the provision of the copiers should be treated as a lease Finance Lease and Operating Lease Finance Lease A lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred Operating lease A lease other than a finance lease in effect it is a lease where substantially all the risks and rewards incidental to ownership of an asset are not transferred Risk and Reward Risk Reward Possibilities of losses from idle capacity Expectation of profitable operation over the asset's life Technological obsolescence Gain from the appreciation in value of the asset's residual value Variations in return because of changing economic conditions 2

3 Ind AS 17 -Leases Lease term Non-cancellable period Period for which the lessee has contracted to lease the asset together with any further terms for which the lessee has the option to continue to lease the asset, with or without further payment, when at the inception of the lease it is reasonably certain that the lessee will exercise the option Non-cancellable lease A non-cancellable lease is defined by the standard as a lease that is cancellable only: o upon the occurrence of some remote contingency o with the permission of the lessor o if the lessee enters into a new lease for the same or an equivalent asset with the same lessor Break and exit clause If a lease contains a clean break clause, that is, where the lessee is free to walk away from the lease agreement after a certain time without penalty, then the lease term for accounting purposes will normally be the period between the commencement of the lease and the earliest point at which the break option is exercisable by the lessee Beginning of the lease End period of lease as per agreement Break clause ( Lessee is free to walk) 3

4 Ind AS 17 -Leases Renewal clauses and lease term Where the terms of renewal are significantly below a fair market rental then it is reasonable to assume that the lessee will extend the lease Then the lease term would include both the minimum period and the renewal period Where the rentals in the secondary period are based on a fair market basis, then the lease term will normally exclude the secondary period Finance lease - indicators Transfer of ownership to the lessee Option to purchase asset at a price that is expected to be sufficiently lower than the fair value Lease term equals to major part of the economic life of the asset Present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset Note: No hard line defined for substantial can be taken to be at least 90% Specialised nature such that lessee can use only Inception and commencement of the lease Lease classification (whether operating or finance) is made at the inception of the lease The inception of the lease is the earlier of o the date of lease agreement o parties' commitment to the lease's principal provisions The commencement of the lease term is the date from which the lessee is entitled to exercise its right to use the leased asset 4

5 Ind AS 17 -Leases Inception and commencement of the lease - example A lessee may sign an agreement to lease a car on 31 March, but does not take delivery of the car until 30 June The classification of the lease and the measurement of the related assets and liabilities will take place on 31 March, But the recognition in the financial statements of the lease assets and liabilities will not take place until 30 June Changes in lease classification Changes in estimates or changes in circumstances should not result in a change in classification Lease renegotiation results in reclassification of operating lease as a finance lease Changes in lease classification Entity A leases a building. The original term of the lease was for 30 years and the estimated useful and economic life of the building at the start of the lease was 45 years At inception the lease was classified as an operating lease. Now, nearing the end of the 30 years, the lease has been renegotiated The new lease term is 20 years, which is equal to the revised expected remaining economic life of the building Should the classification of the lease be re-assessed? 5

6 Ind AS 17 -Leases Lease involving land & buildings For classifying a lease involving land and buildings, land and buildings elements are required to be separated The minimum lease payments are allocated between the land and buildings elements in proportion to their relative fair values The land element of lease is normally classified as an operating lease however, when the title of land passes to the lessee at the end of the lease term it is classified as finance lease Lease involving land & buildings A long term lease of land should be classified on the basis of its substance and not only based on its legal form In the case of long term land agreements, the risks and rewards would be automatically transferred to the lessee, even though the title is not transferred In such a case, the lease for the land should be treated as a finance lease The buildings element is classified as an operating or finance lease by applying the classification criteria specified in the standard Accounting for finance leases - by lessees Accounted in lessee's balance sheet both as an asset and as an obligation to pay future rentals Amount to recognize = Lower of fair value of the leased asset the present value of the minimum lease payments Initial direct costs of the lessee are added to the amount recognised as an asset Discount factor is the interest rate implicit in the lease 6

7 Ind AS 17 -Leases Interest rate implicit in lease It is the discount rate that, at the inception of the lease that causes the present value of a) the minimum lease payments b) the unguaranteed residual value + = c) fair value of the leased asset + initial direct costs of the lessor Contingent rents Contingent rent is that portion of the lease payments that is not fixed in amount but is based on the future amount of a factor that changes other than with the passage of time Example: o Percentage of future sales, amount of future use, future price indices, future market rates of interest Charged to P&L as expense when incurred Example 1 Contingent rental payments A car is leased under a three year contract. The lease rentals during the three years are fixed provided the mileage does not exceed a maximum amount during that period Any mileage incurred above the maximum is subject to an additional charge How should the minimum lease rentals be calculated? 7

8 Ind AS 17 -Leases Example 2 Contingent rental payments Entity T is a telecom company and has entered into a lease contract with entity S for exclusive use of a submarine cable for overseas communication The contract is for 10 years, which corresponds to the economic life of the cable Ownership transfers at the end of the arrangement for no additional consideration The lease payments are dependent on the usage of the cable Example 2 Contingent rental payments The ceiling amount is Rs.10 lakhs per year at 100% usage and the minimum amount (floor) is Rs.6 lakhs per year, which corresponds to a usage of 60% or lower Management of entity T estimates that the average usage of the cable will be approximately 85% and the average annual lease payments are expected to be Rs.8,50,000 How should the minimum lease payments be calculated? Accounting for finance leases by lessors Recognised in the lessor's balance sheet as a receivable at an amount equal to the Lessor s net investment in the lease Over the lease term, rentals are apportioned between a reduction in the net investment in the lease and finance income 8

9 Ind AS 17 -Leases Gross and net investment Net Investment = Gross investment discounted at the interest rate implicit in the lease Gross investment = Minimum lease payments plus any unguaranteed residual accruing to the lessor Accounting for operating leases by lessees Operating leases should not be capitalised Lease payments recognised an expense on a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern of the user's benefit Straight-line basis applies even if the payments are not made on such a basis Operating lease incentives Examples Contributions to relocation or start-up costs Assumption of liabilities such as the rentals under an old lease which would otherwise fall to be a vacant property Giving rent-free period Reduced rental periods for an initial period of the lease Accounting treatment: Reduction of the rental expense over the lease term on a straight-line basis 9

10 Ind AS 17 -Leases Operating lease incentives - example A retailer may lease a new store for a five-year period with a six month rent-free period Although the retailer may not open the store for the first six months due to a fit-out period, the retailer still has the benefit of the use and enjoyment of the leased property during that initial period, as well as for the rest of the lease Hence, the incentive should be spread over the five years of the lease period from the commencement of the lease term on a straight-line basis Minimum lease payment Lessor Lessee Payments over the lease term Payments over the lease term Residual value Guaranteed by: Leasee, party related to the lessee, independent third party Residual value Guaranteed by: Leasee, party related to the lessee Accounting for operating leases - by lessors Lessor should present assets subject to operating leases in their balance sheets according to the nature of the asset The asset will be recorded as property plant and equipment or investment property 10

11 Ind AS 21 The Effects of Changes in Foreign Exchange Rates Globalization of markets Globalization has resulted in expansion of international trade Increasingly entities buy and sell goods and services from overseas parties/customers Also they extend their international reach through overseas branches in the form of subsidiaries or associates Application of Ind AS 21 An entity may carry on foreign activities in two ways 1. It may have transactions in foreign currencies 2. It may have foreign operations In addition, an entity may present its financial statements in a foreign currency 1

12 Need for this standard International transactions are often expressed and denominated in foreign currencies Such transactions should be converted into the functional currency of the entity The question remains at what rates should such transactions be converted into the functional currency historical or closing rate How should the difference in foreign exchange rate be treated Need for this standard Also the foreign operation of the entity in the form of a branch or a subsidiary may maintain the books in such foreign currency These transactions cannot be summed up with the transactions of the parent entity without converting the same into the functional currency of the entity How and when should such conversion be made and at what rate for foreign operations Need for this standard The financial statements may also be required to be presented in another currency other than the functional currency of the entity to the investors or prospective investors of the entity While presenting the financial statements in another currency what exchange rates should be used historical or closing or average How should the exchange difference be accounted for while presenting in another currency 2

13 Objectives 1. How to include foreign currency transactions and foreign operations in the financial statements of an entity and 2. Which exchange rates to use 3. How to report the effects of such changes in exchange rates in the financial statements 4. How to translate financial statements into a presentation currency Scope of Ind AS 21 Accounting for transactions and balances in foreign currencies Translating the results and financial position of foreign operations, included in the financial statements of the entity by consolidation, proportionate consolidation or the equity method Translating an entity s results and financial position into a presentation currency Benefits of Ind AS 21 Reduces the risk of foreign activities being incorrectly accounted for and the functional currency being determined incorrectly This could have a major impact on the financial statements Improves efficiency when dealing with foreign activities 3

14 Outside the scope of Ind AS 21 Derivative transactions in foreign currencies and balances that are within the scope of Ind AS109 Hedge accounting including the hedging of a net investment in a foreign Presentation of cash flows arising from transactions in a foreign currency, or with the translation of cash flows of a foreign operation Outside the scope of Ind AS 21 This Standard does not also apply to long-term foreign currency monetary items for which an entity has opted for the exemption given in paragraph D13AA of Appendix D to Ind AS 101 Such an entity may continue to apply the accounting policy so opted for such long-term foreign currency monetary items Functional Currency The functional currency of an entity is the currency of the primary economic environment in which that entity operates The primary economic environment in which an entity operates is normally the one in which it primarily generates and expends cash 4

15 How to determine Functional Currency The functional currency is determined separately for individual entities There is no such thing as a "group functional currency" Ind AS 21 gives the factors, primary and additional, that to determine the functional currency of an entity Apply factors in Ind AS 21 The functional currency is determined by applying the factors in Ind AS 21 It cannot be chosen freely by an entity Once determined, it is not changed unless there is a change in those underlying circumstances Primary Factors 1. The currency that mainly influences sales prices for goods /services i.e., sales prices are denominated/ settled 2. The currency of the country whose competitive forces and regulations mainly influence the pricing policy 3. The currency that mainly influences labour, material and other costs of providing goods or services 4. The currency in which finance is generated (i.e., issuing debt and equity instruments) 5. The currency in which receipts from customers are retained by the entity 5

16 Importance of Functional Currency Incorrectly determining the functional currency can have a major impact on the financial statements If it is determined incorrectly, transactions in the correct functional currency will be recorded as if they were foreign currency transactions Exchange differences will be recognised on transactions for which no foreign exchange difference should have arisen Importance of Functional Currency Similarly, transactions that should have led to recognition of foreign exchange differences, will not be provided for This may have a significant impact on both the statement of comprehensive income and the statement of financial position What is Foreign operation? Foreign operation is an entity that is a subsidiary, associate, joint venture or branch of a reporting entity, the activities of which are based or conducted in a country or currency other than those of the reporting entity 6

17 ADDITIONAL FACTORS FOR FOREIGN OPERATIONS Foreign operation Functional CCY 1. Degree of autonomy If its activities are carried out as an extension of the reporting entity without significant autonomy then the currency of the reporting entity would be the functional currency of such foreign operation If the foreign operation accumulates cash and incurs expenses, generates income all in local currency then the local currency would be the functional currency of such foreign operation Foreign operation Functional CCY Degree of autonomy Case Study Arvind Limited is an Indian company making mobile phones. It has a subsidiary in Singapore Arvind Pte Ltd. to which it sells some of the mobile phones. Arvind Pte Ltd. is the authorised dealer of Arvind Ltd. for the whole of South-East Asia and has no other activity other than selling these mobile phones. Determine the functional currency of Arvind Pte Ltd. 7

18 Foreign operation Functional CCY 2. Percentage and frequency of transactions with reporting entity If the transactions with the reporting entity are a high proportion of its activities then the currency of the reporting entity would be the functional currency of such foreign operation Few inter-company transactions would mean the local currency would be the functional currency of such foreign operation Foreign operation Functional CCY Percentage of transactions with reporting entity Case study ABCD Ltd. has a subsidiary ABCD Lanka Ltd. at Sri Lanka manufacturing cement. The subsidiary sells all of its output to its parent company. What is the functional currency of ABVD Lanka Ltd? Foreign operation Functional CCY 3. Effect of cash flows on the reporting entity If the cash flows of the foreign operation directly affect the cash flows of the reporting entity and are available for remittance to it then the currency of the reporting entity would be the functional currency of such foreign operation If the cash flows are mainly in local currency and do not impact the reporting entity s cash flows the local currency would be the functional currency of such foreign operation 8

19 Foreign operation Functional CCY Effect of cash flows on the reporting entity Case study Facelift Ltd. is an Indian entity having INR as it functional currency. It sells 95% of its production through its subsidiary situated in Dubai. Facelift Ltd. depends upon the remittances from Dubai to fund its normal business activities. The subsidiary at Dubai is able to remit the cash to India readily. Determine the functional currency of the subsidiary at Dubai. Foreign operation Functional CCY 4. Financing & debt servicing If the cash flows of the foreign operation are sufficient to service debt obligations without assistance from the reporting entity then the currency of the reporting entity would be the functional currency of such foreign operation If the financing and servicing of debt is out of local currency surpluses then the local currency would be the functional currency of such foreign operation Foreign operation Functional CCY Financing & debt servicing Case study PreSuppose Ltd. is an Indian company and recently started a subsidiary in London. The subsidiary borrowed 100,000 from Bank of England and yet to commence its operations. The subsidiary depends on it parent for repayment of the loan. What should be the functional currency of the subsidiary? 9

20 Where indicators are mixed Management uses its judgement to determine the functional currency that most faithfully represents the economic effects of the underlying transactions, events and conditions Priority is given to the primary indicators before considering the additional indicators which are designed to provide additional supporting evidence to determine an entity s functional currency Change of Functional Currency An entity s functional currency reflects the underlying transactions, events and conditions that are relevant to it Accordingly, once determined, the functional currency is not changed unless there is a change in those underlying transactions, events and conditions PRESENTATION CURRENCY 10

21 Presentation Currency The currency in which the financial statements are presented is defined as the presentation currency Unlike the functional currency, the presentation currency can be any currency of choice Differences Functional Currency Application of the factors in IndAS 21 to a set of facts and circumstances Presentation Currency Flexible choice. The presentation currency can be any currency of choice. Selected currency may have a big impact on net profit for the period Selected currency has no impact on net profit for the period MONETARY & NON-MONETARY ITEMS 11

22 Monetary Items The essential feature of a monetary item is a right to receive (or an obligation to deliver) a fixed or determinable number of units of currency Examples: o pensions and other employee benefits to be paid in cash o provisions that are to be settled in cash o cash dividends that are recognised as a liability o Investment in debt instruments held with the objective of collecting contractual cash flows Non monetary Items The essential feature of a non-monetary item is the absence of a right to receive (or an obligation to deliver) a fixed or determinable number of units of currency Non monetary Items Examples: amounts prepaid for goods and services (e.g. prepaid rent) goodwill & inventories intangible assets property plant and equipment provisions that are to be settled by the delivery of a nonmonetary asset Investment in equity instruments 12

23 FOREIGN CURRENCY TRANSACTIONS A foreign currency transaction A foreign currency transaction is one that is denominated or requires settlement in a foreign currency For example an entity may: o buy or sell goods or services in a foreign currency o borrow or lend funds when the amounts payable or receivable are in a foreign currency o acquire or dispose of assets, or incur or settle liabilities, in a foreign currency Foreign currency transactions An entity must convert foreign currency items into its functional currency for recording in its books of account A foreign currency transaction is entered into directly by an entity They often occur on a day-to-day basis They involve cash flows, and increase or decrease the net assets of the entity 13

24 Initial recognition A foreign currency transaction is one denominated or requiring settlement in a foreign currency These transactions are recorded in the functional currency by applying to the foreign currency amount the spot exchange rate between: o the functional currency, and o the foreign currency at the date of the transaction Initial recognition (Contd.) For practical reasons, a rate that approximates the actual rate at the date of the transaction is often used, for example, an average rate for a week or a month might be used for all transactions in each foreign currency occurring during that period However, if exchange rates fluctuate significantly, the use of the average rate for a period is inappropriate SUBSEQUENT MEASUREMENT 14

25 Subsequent reporting periods The treatment of foreign currency items at the end of the reporting period depends on whether the item is: o monetary or non-monetary, and o carried at historical cost or fair value Measurement at subsequent periods Items Measurement Basis Monetary Items NA Closing Rate Non-monetary Items Exchange Rate Historical cost Exchange rate at the date of transaction Non-monetary Items Fair value Exchange rate at the date at which fair value was determined The carrying amount of an item The carrying amount of an item is determined in conjunction with other relevant Standards Example: Property, plant and equipment may be measured in terms of fair value or historical cost in accordance with Ind AS 16 Property, Plant and Equipment Whether the carrying amount is determined on the basis of historical cost or on the basis of fair value, if the amount is determined in a foreign currency it is then translated into the functional currency in accordance with Ind AS 21 only 15

26 Comparison of two amounts The carrying amount of some items is determined by comparing two or more amounts Examples: The carrying amount of inventories is the lower of cost and net realisable value in accordance with Ind AS 2 Inventories Similarly, as per Ind AS 36 Impairment of Assets, the carrying amount of an asset for which there is an indication of impairment is the lower of its carrying amount before considering possible impairment losses and its recoverable amount Carrying amount - non-monetary assets When an asset is non-monetary and is measured in a foreign currency, the carrying amount is determined by comparing: the cost or carrying amount, as appropriate, translated at the exchange rate at the date when that amount was determined (i.e., the rate at the date of the transaction for an item measured in terms of historical cost); and the net realisable value or recoverable amount, as appropriate, translated at the exchange rate at the date when that value was determined (e.g. the closing rate at the end of the reporting period) Carrying amount - non-monetary assets Important note: The effect of this comparison may be that an impairment loss is recognised in the foreign currency but would not be recognised in the functional currency, or vice versa 16

27 Several exchange rates When several exchange rates are available, the rate used is that at which the future cash flows represented by the transaction or balance could have been settled if those cash flows had occurred at the measurement date If exchangeability between two currencies is temporarily lacking, the rate used is the first subsequent rate at which exchanges could be made EXAMPLES OF SUBSEQUENT MEASUREMENT Foreign Currency Monetary item Example 1: An entity (functional currency Euro) has an outstanding trade payable for A$1,500 which arose from a transaction when the spot exchange rate was Euro1 = A$1.2 and hence was initially recorded at Euro1,250. The closing rate is Euro1 = A$1.5 At what amount should the payable be recorded at the end of the reporting period? 17

28 Non Monetary item historical cost Example 2: An entity (functional currency Euro) purchased a machine for A$12,000 when the spot exchange rate was Euro1 = A$1.2. The closing rate is Euro1 = A$1.5. At what amount should the machine be recorded at the end of the reporting period? Non Monetary item Fair value Example 3: An entity (functional currency Euro) owns a building. The entity carries buildings at their revalued amounts. The valuation of the building was done at the end of the reporting period and the fair value was US $150,000. The building was purchased for US $100,000 when the spot rate was Euro1 = US $1.2. The closing rate is Euro1 = US $1.5. At what amount should the building be recorded at the end of the reporting period? Exchange differences on monetary items Exchange differences arise from: the settlement of monetary items at a subsequent date to initial recognition, and remeasuring an entity s monetary items at rates different from those at which they were initially recorded (either during the reporting period or at the previous reporting periods) Such exchange differences must be recognised as income or expenses in the period in which they arise 18

29 Exchange differences on monetary items If the transaction is settled in a different accounting period to that of the initial recognition of the transaction, the exchange difference to be recognised in each period is determined by the change in exchange rates during that period Exception to the rule There is one exception to this rule given by paragraph 32 of Ind AS 21 Exchange differences are recognised directly in other comprehensive income in the consolidated financial statements, if they arise on a monetary item that forms part of a reporting entity s net investment in a foreign operation denominated in the functional currency of either the parent or the foreign operation Exception to the rule In the financial statements that include the foreign operation and the reporting entity (e.g. consolidated financial statements when the foreign operation is a subsidiary), such exchange differences shall be recognised initially in other comprehensive income and reclassified from equity to profit or loss on disposal of the net investment 19

30 Exception to the rule - Example An example of this may be a long-term loan to the foreign operation without a repayment term, where management confirms that repayment is neither planned nor likely in the future Non-monetary items When a gain or loss on a non-monetary item is recognised in profit or loss, any exchange component of that gain or loss is also recognised in profit or loss When a gain or loss on a non-monetary item is recognised directly in other comprehensive income, any exchange component of that gain or loss is recognised directly in other comprehensive income (For example gain or loss on equity securities measured at FVOCI) Other comprehensive income Other Ind Ass require some gains and losses to be recognised in other comprehensive income For example, Ind AS 16 requires some gains and losses arising on a revaluation of property, plant and equipment to be recognised in other comprehensive income When such an asset is measured in a foreign currency, the revalued amount to be translated using the rate at the date the value is determined, resulting in an exchange difference that is also recognised in other comprehensive income 20

31 PRESENTATION CURRENCY Translation to presentation currency Statement presented Items Basis for FX rate Statement of financial position Statement of comprehensive income (Profit & Loss Account) Assets & Liabilities At the closing rate at the date of that statement of financial position Income & Expenses At the exchange rate at the transaction dates (an average rate for a period may be used unless rates fluctuate significantly) All resulting exchange differences are recognized in other comprehensive income Exchange differences - Presentation CCY Exchange differences are recognised in other comprehensive income These exchange differences are not recognised as income or expenses for the period because the changes in exchange rates have little or no direct effect on the present and future cash flows from the entity's operations 21

32 Exchange differences - Presentation CCY The cumulative amount of the exchange differences is presented in a separate component of equity until disposal of the foreign operation When the exchange differences relate to a foreign operation that is consolidated but not wholly-owned, accumulated exchange differences arising from translation and attributable to non-controlling interests are allocated to, and recognised as part of, non-controlling interests in the consolidated statement of financial position Comparison of AS 11 with Ind AS 21 Topic AS 11 Ind AS 21 Functional Currency No concept of functional currency. Foreign currency is a currency other than the reporting currency. Presentation No concept of currency presentation currency Functional currency is the currency of the primary economic environment in which the entity operates. Foreign currency is a currency other than the functional currency Presentation currency is the currency in which the financial statements are presented Comparison of AS 11 with Ind AS 21 Topic AS 11 Ind AS 21 Treatment of exchange differences A limited period irrevocable option for corporate entities to capitalise exchange differences on long term foreign currency monetary items incurred for acquisition of depreciable capital assets and to amortise exchange differences on other long-term foreign currency monetary items over the life of such items till a specified period. For long term foreign currency monetary items recognized in the financial statements for the period ending immediately before the beginning of the first Ind AS financial reporting period as per previous GAAP, the entity may continue the policy adopted for treatment of exchange difference. 22

33 Comparison of AS 11 with Ind AS 21 Topic AS 11 Ind AS 21 Exchange differences on monetary Net items forming part of net investment investment in a non-integral foreign operation are in a nonintegral recognized in 'Foreign Currency Same as above Translation Reserve'. This is foreign recognized as income or expense at operation the time of disposal of that operation. Comparison of AS 11 with Ind AS 21 Topic AS 11 Ind AS 21 Monetary assets are translated at Monetary assets are translated at closing rate. Non-monetary items closing rate. Non-monetary items are translated at historical rate if are translated at historical rate if Treatment in they are valued at cost. Nonmonetary items carried at fair monetary items carried at fair value they are valued at cost. Non- consolidated financial value are reported using are reported using exchange rates statements - that existed when the values were Integral foreign operations exchange rates that existed when the values were determined. Income and expense items are translated at historical/average rates. Exchange differences are shown in income statement. determined. Income and expense items are translated at historical/average rates. Exchange differences are shown in income statement. Comparison of AS 11 with Ind AS 21 Topic AS 11 Ind AS 21 Treatment in consolidate d financial statements - Nonintegral foreign operations Closing rate method is followed - all assets and liabilities are to be translated at closing rate while P&L items are translated at historical/average rates. The resulting exchange difference is taken to reserve and is recycled to P&L on the disposal of the nonintegral foreign operation. Assets and liabilities should be translated from functional currency to presentation currency at the closing rate; income and expenses at historical/averages rates for the period; exchange differences are recognized in other comprehensive income and accumulated in a separate component of equity. These are reclassified from equity to profit or loss when the gain or loss on disposal is recognized. 23

34 Comparison of AS 11 with Ind AS 21 Topic AS 11 Ind AS 21 Disposal of foreign operations Disposal does not depend on whether control over a foreign operation is lost or not. Even if control is lost, only proportionate amount of the reserve is recycled to P&L. Disposal depends on whether control is lost or not. If control is lost, the exchange difference attributable to the parent is reclassified to P&L from Foreign Currency Translation Reserve in other comprehensive income. Comparison of AS 11 with Ind AS 21 Topic AS 11 Ind AS 21 Treatment of derivatives AS 11 is applicable to exchange differences on all forward exchange contracts that are hedging instruments for existing assets and liailties. Not applicable for those contracts that hedge firm commitments or highly probable forecast transactions. Foreign currency derivatives not within the scope of Ind AS 109 (some derivatives embedded in other contracts) are within the scope of Ind AS 21. Ind AS 21 is also applicable when an entity translates from functional currency to presentation currency. Comparison of AS 11 with Ind AS 21 Topic AS 11 Ind AS 21 Foreign exchange contracts: Trading or speculative in nature The premium or discount on the contract is ignored and at each balance sheet date the value of the contract is marked to market and the gain or loss on the contract is recognized. Accounted for as derivative and valued at fair value 24

35 Comparison of AS 11 with Ind AS 21 Topic AS 11 Ind AS 21 Foreign exchange contracts: Not for trading or speculative in nature Change in functional currency The premium or discount on the contract is amortized as expense or income over the life of the contract. Exchange differences recognized in P&L in the reporting period in which the exchange rates change. Change in reporting currency is not covered by AS 11. Disclosure required for any change. Accounted for as derivative and valued at fair value Change in functional currency is exceptional and applied prospectively. Disclosures needed. Thank you R. Venkata Subramani 25

36 Ind AS 37 - Provisions, Contingent Liabilities and Contingent Assets Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets Objective Ensures that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets Sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount Provisions Before Ind AS 37, no accounting standard dealing with provisions Companies used to make large provisions when large profits are generated Such provisions were then used in future years when the underlying profits were not as good Effectively provisions were used for profit smoothing and not for the real purpose for which it is intended 1

37 Ind AS 37 - Provisions, Contingent Liabilities and Contingent Assets Provision is a liability Ind AS 37 views a provision as a liability A provision is a liability of uncertain timing or amount A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits Provision vs. liability The standard distinguishes provisions from other liabilities such as trade creditors and accruals This is on the basis that for a provision there is uncertainty about the timing or amount of the future expenditure Uncertainly is also present in the case of certain accruals but the uncertainty is generally much less for liabilities than for provisions Recognition A provision should be recognised as a liability in the financial statements when: o An entity has a present obligation (legal or constructive) as a result of a past event o It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation o A reliable estimate can be made of the amount of the obligation 2

38 Ind AS 37 - Provisions, Contingent Liabilities and Contingent Assets Legal obligation A legal obligation is an obligation is an obligation that derives from A contract (through its explicit or implicit terms) Legislation or Other operation of law Constructive obligation Ind AS 37 defines a constructive obligation as An obligation that derives from an entity s actions where: By an established pattern of past practice, published policies or a sufficiently specific current statement the entity has indicated to other parties that it will accept certain responsibilities; and As result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities Constructive obligation - example An oil company may have a established practice of always making good any environmental damage caused by drilling, even though it is not legally obliged to do so. In this way, it has created a valid expectation that it will do this and it will have to recognise the constructive obligation and make a corresponding provision each time it drills a new well 3

39 Ind AS 37 - Provisions, Contingent Liabilities and Contingent Assets Constructive obligation - example X Ltd is engaged in the manufacture of fertilisers. Effluents from the plant have polluted a river near the plant. Residents of the locality agitated against the pollution. X Ltd agreed to their demands and to reduce pollutions discharge and to install an Effluent treatment plant. After 1 year, not ETP has been installed and there is no legislation mandating such an installation. X Ltd has created a valid expectation on the part of the public that it will discharge its responsibilities Probable transfer of resources A transfer of resources embodying economic benefits is regarded as probable if the event is more likely that not to occur This appears to indicate a probability of more than 50%. However, the standard makes it clear that where there is a number of similar obligations the probability should be based on considering the population as a whole, rather than one single item Example: Transfer of resources If a company has entered into a warranty obligation then the probability of transfer of resources embodying economic benefits may well be extremely small in respect of one specific item However, when considering the population as a whole the probability of some transfer of resources is quite likely to be much higher If there is a greater than 50% probability of some transfer of economic benefits then a provision should be made for the expected amount 4

40 Ind AS 37 - Provisions, Contingent Liabilities and Contingent Assets Measurement of provisions The amount recognised as provision should be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period Estimates determined by the judgement of the management supplemented by the experience of similar transactions Allowance is made for uncertainty Where provision involves a large population of items, obligation is estimated by weighting all possible outcomes by their associated probabilities, ie expected value Where provision involves a single item, such as the outcome of a legal case, provision is made in full for the most likely outcome Time value of money Where the effect of the time value of money is material, the amount of a provision should be the present value of the expenditure required to settle the obligation An appropriate discount rate should be used The discount rate should be a pre-tax rate that reflects current market assessments of the time value of money The discount rates(s) should not reflect risks for which future cash flow estimates have been adjusted Future events / disposal of assets Future events: Future events which are reasonably expected to occur (e.g. new legislation, changes in technology) may affect the amount required to settle the entity s obligation and should be considered Expected disposal of assets: Gains from the expected disposal of assets should not be considered in measuring a provision 5

41 Ind AS 37 - Provisions, Contingent Liabilities and Contingent Assets Reimbursements Some or all of the expenditure needed to settle a provision may be expected to be recovered from a third party Then reimbursement should be recognised only when it is virtually certain that reimbursement will be received if the entity settles the obligation Reimbursement should be treated as a separate asset, and the amount recognised should not be greater than the provision itself The provision and the amount recognised for reimbursement may be netted off in profit or loss Changes in provisions Provisions should be reviewed at the end of each reporting period and adjusted to reflect the current best estimate If it is no longer probable that a transfer of resources will be required to settle the obligation, the provision should be reversed Onerous contracts An onerous contract is a contract entered into with another party under which the unavoidable costs of fulfilling the terms of the contract exceed any revenues expected to be received from contract and where the entity would have to compensate the party if it did not fulfil the terms of the contract For onerous contracts, the present obligation under the contract should be recognised and measured as a provision An example might be vacant leasehold property. The entity holding the lease is under an obligation to maintain the property but receives no income or benefit from it 6

42 Ind AS 37 - Provisions, Contingent Liabilities and Contingent Assets Examples of provisions Warranties: These are argued to be genuine provisions as on past experience it is probable, i.e., more likely than not, that some claims will emerge The provision must be estimated, however, on the basis of the class as a whole and not on individual claims In this case there is a clear legal obligation Examples of provisions Major repairs: Companies usually provide for expenditure on a major overhaul to be accrued gradually over the intervening years between overhauls. Now this is no longer possible as this may be a mere intention to carry out repairs, not an obligation The entity may also sell the asset in the meantime Examples of provisions Self insurance: Some entities create a provision for self insurance based on the expected cost of making good fire damage etc., instead of paying premiums to an insurance company. As per Ind AS 37 this provision is no longer justifiable as the entity has no obligation until a fire or accident occurs No obligation exists until that time 7

43 Ind AS 37 - Provisions, Contingent Liabilities and Contingent Assets Examples of provisions Environmental contamination: If the entity has an environmental policy such that other parties would expect the entity to clean up any contamination or If the entity has violated existing environmental legislation then a provision for environmental damage must be made Examples of provisions Decommissioning or abandonment costs: Some initial purchases may require a legal obligation to decommission the site at the end of its life. Prior to Ind AS 37 most entities set up the provision gradually over the life of the asset so that no one year would be unduly burdened with the cost Ind AS 37, however, insists that a legal obligation exists on the initial expenditure and therefore a liability exists immediately Examples of provisions Decommissioning or abandonment costs: This would appear to result in a large charge to profit and loss in the first year of operation However, the standard takes the view that the cost of purchasing the asset in the first place includes the costs of putting it right again Thus all the costs of decommissioning should be capitalised 8

44 Ind AS 37 - Provisions, Contingent Liabilities and Contingent Assets Provisions for restructuring Ind AS 37 defines a restructuring as: A program that is planned and is controlled by management and materially changes one of two things The scope of a business undertaken by an entity The manner in which that business is conducted Provisions for restructuring The following examples of events may fall under the definition of restructuring The sale or termination of a line of business The closure of business locations in a country or region or the relocation of business activities from one country region of another Changes in management structure, for example, the elimination of a layer of management Fundamental reorganisations that have a material effect on the nature and focus of the entity s operations Provisions for restructuring The question is whether or not an entity has an obligation legal or constructive at the end of the reporting period. An entity must have a detailed formal plan for the restructuring It must have raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it 9

45 Ind AS 37 - Provisions, Contingent Liabilities and Contingent Assets Provisions for restructuring A mere management decision is not normally sufficient. Management decisions may sometimes trigger recognition, but only if earlier events such as negotiations with employee representatives and other interested parties have been concluded subject only to management approval Where the restructuring involves the sale of an operation then Ind AS 37 states that no obligation arises until the entity has entered into a binding sale agreement This is because until this has occurred the entity will be able to change its mind and withdraw from the sale even if its intentions have been announced publicity Costs included in restructuring provision Restructuring provision should include only the direct expenditures arising from the restructuring, which are those that are both: Necessarily entailed by the restructuring; and Not associated with the ongoing activities of the entity The following costs should specifically not be included within a restructuring provision Retraining or relocating continuing staff Marketing Investment in new systems and distribution networks Start Present obligation as a result of an obligating event? No Possible obligation? No Yes Yes Probable outflow? No Remote Yes Yes No Reliable estimate? No (rare) Yes Provide Disclose contingent liability Do nothing 10

46 Ind AS 37 - Provisions, Contingent Liabilities and Contingent Assets Contingent liability - definition A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly within the control of the entity; or A present obligation that arises from past events but is not recognised because: It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or The amount of the obligation cannot be measured with sufficient reliability Treatment of contingent liability Contingent liabilities should not be recognised in financial statements but they should be disclosed The required disclosures are: A brief description of the nature of the contingent liability An estimate of its financial effect An indication of the uncertainties that exist The possibility of any reimbursement Contingent assets - definition A possible asset that arises from past events and whose existence will be confirmed by the occurrence or nonoccurrence of one or more uncertain future events not wholly within control of the entity A contingent asset must not be recognised Only when the realisation of the related economic benefits is virtually certain should recognition take place At the point, the asset is no longer a contingent asset 11