PwC ReportingInBrief. Ind AS Transition Facilitation Group (ITFG) Clarification Bulletin 15

Transcription

1 PwC ReportingInBrief Ind AS Transition Facilitation Group (ITFG) Clarification Bulletin 15

2 In brief The Ind AS Implementation Committee of the Institute of Chartered Accountants of India (ICAI) constituted the Ind AS Transition Facilitation Group (ITFG) to address issues faced by preparers, users and other stakeholders on applicability and implementation of Ind AS. ITFG issues clarifications in the form of periodic bulletins. This InBrief provides an overview of the clarifications issued by the ITFG in its bulletin 15 and our insights on these clarifications, including related interpretative issues. Let's talk In determining the fair value of the liability component of a compound financial instrument with an equity conversion option, all the contractually determined future cash flows under the instrument shall be discounted at the market rate of interest prevailing at the time of issue. The discount rate shall be comparable to the instrument with respect to currency, time period, credit status and cash flows, but without the equity conversion option. Non-cumulative mandatorily redeemable preference share where payment of dividend is at the discretion of the issuer is a compound financial instrument. On initial recognition, fair value of the liability component is determined by discounting the eventual redemption amount using a market rate of interest. The residual amount represents the equity component. Furthermore, discretionary dividends will be recognised when they are declared and paid and are attributable to the equity component. Incentives receivable under a government scheme is a financial asset to be recognised in accordance with Ind AS 109 Financial Instruments, provided an entity has complied with the conditions attached to the scheme. An understanding between the government and the entity that on complying with the stipulated conditions under the scheme, the entity will be granted incentives constitutes a contract in accordance with Ind AS 32 Financial Instruments, Presentation. Applicability of Ind AS to an entity having net worth less than 250 crores INR as on 31 March 2017 in the following scenarios: (i) The entity began the process of listing at the beginning of financial year and gets listed as at the end of the year: It shall be required to prepare its financial statements in accordance with Ind AS from (ii) The entity is de-listed during the financial year : It shall prepare its financial statements in accordance with Ind AS since it was listed as at the beginning of the year. (iii) The entity began the process of listing during the financial year and may or may not get listed by the year end: It shall comply with Ind AS from that financial year, irrespective of whether the listing is completed by the year end. (iv) The entity issues debentures which were listed during financial year These debentures were delisted during the same financial year. Entity would not be required to comply with Ind AS since the entity did not have the status of a listed entity both at the beginning and at the end of the year. From the time a Non-Banking Finance Company (NBFC) ceases to carry on the activities of a NBFC, it shall determine the applicability of Ind AS following the roadmap as applicable to a Non-NBFC company. Roadmap applicable to a Non-NBFC company shall be followed even if the entity s application for termination of membership is in the process with the Securities and Exchange Board of India (SEBI). If an entity has not taken exemption under Ind AS 101 First time of Indian Accounting Standards of not restating past business combinations, the entity will be required to retrospectively apply the requirements of Ind AS 103 Business Combinations. The requirements of Appendix C to Ind AS 103 shall also be applied retrospectively to past business combinations under common control. Interest free refundable security deposits shall be discounted and measured at their present value on initial recognition. Rate of interest to be used for the purpose of discounting shall be determined considering the prevailing market rate of interest for a similar instrument with a similar credit rating. Lessor shall recognise land held under finance lease in the balance sheet and present them as a receivable at an amount equal to the net investment in the lease. If the entire lease rentals are received upfront there will be no receivable. Amounts outstanding towards retired partners capital in a partnership firm are in the nature of financial liabilities repayable on demand. Such amounts outstanding are not required to be discounted both on initial recognition and subsequent measurement. Investors (other than the parent) and fellow subsidiaries of an entity would not be required to mandatorily adopt Ind AS for their statutory reporting, merely because the entity meets the net worth or the listing criteria in the Ind AS roadmap and is therefore required to prepare its financial statements in accordance with Ind AS.

3 In detail 1. Determining the rate of interest to be considered in measuring the liability component of a Foreign Currency Convertible Bonds (FCCB) FCCB is a compound financial instrument containing two components namely, issuer s liability to pay contractually determined future cash flows at specified intervals and a conversion at maturity into fixed number of equity shares of the issuer. The conversion is at the option of the holder. On initial recognition, fair value of the liability component is determined by discounting the contractually scheduled future cash payments at the market rate of interest prevailing at the time of issue of the FCCB. The discount rate to be used for this should be comparable to instruments for aspects such as currency, time period, credit status and cash flows, but without the conversion option. Equity component is the residual amount after deducting the fair value of the liability component from the transaction value of the compound financial instrument. 2. Accounting for non-cumulative redeemable preference shares and discretionary dividends thereon Consider an example of a non-cumulative preference share which is mandatorily redeemable in cash after 5 years. The instrument carries a coupon rate of 6% p.a. and market rate of interest on the date of issue is 4% p.a. Such non-cumulative mandatorily redeemable preference share is a compound financial instrument. Liability component being the present value of the eventual redemption amount which is discounted at the market rate of return. The unwinding of discount on the liability component is recognised in the statement of profit or loss as interest expense. Residual amount is the equity component i.e. difference between the transaction value and the fair value of the liability component. Discretionary dividends on such preference shares will be recognised when they are actually declared and paid. Such discretionary dividends relate to the equity component and are accordingly recognised as a distribution of profit. Let s understand the accounting for a compound financial instrument i.e. a mandatorily redeemable preference share with discretionary dividend payments, with help of a mathematical example. An entity issues 600,000 mandatorily redeemable preference shares at the start of Year 1. The preference shares have a 3 year term and are issued at par value of Rs. 100 per share amounting to 60 million INR. Preference shares carry a coupon of 10% p.a. Dividends on preference shares are payable only if the entity declares dividends to the equity shareholders. When the shares are issued, the prevailing market interest rate for similar debt instrument but without discretionary coupon payments is 7%. Fair value of the liability component shall be determined first by discounting the contractual scheduled cash flows at the market rate of interest (i.e. rate of interest on an instrument with similar credit standing, currency, period and cash flows but without the discretionary dividend payments). Accordingly, the eventual redemption amount on the preference shares shall be discounted at the market rate of interest of 7% p.a, as shown below: INR Fair value of preference shares 60,000,000 Liability component - PV of redemption amount payable at the end of year 3 48,977, million INR / (1.07) ₃ Equity component (residual) (*) 11,022,127 (*) The difference between the fair value of the redeemable preference share and fair value of the liability component is assigned to equity. The amount credited to equity of 11,022,127 INR is not subsequently remeasured. The liability component of 48,977,873 INR is subsequently carried at amortised cost using an effective interest rate of 7% p.a. Discretionary dividend declared subsequently is allocted to the equity component and recognised as distribution of profit.

4 3. Accounting for incentives receivable under government schemes In accordance with Ind AS 109, an entity shall recognise a financial asset or a financial liability in its balance sheet when the entity becomes party to the contractual provisions of the instrument. A financial instrument arises from contractual obligations between the parties. Paragraph 13 to Ind AS 32 defines a contract as an agreement between two or more parties that has clear economic consequences that the parties have little, if any, discretion to avoid, usually because the agreement is enforceable by law. Contracts, and thus financial instruments, may take a variety of forms and need not be in writing. Government gives various incentives to promote industry or for other reasons. There may not be an agreement between the entity and government as to the rights and obligations. There is however an understanding between the government and the entity that on complying with the stipulated conditions attached to the Scheme, it will be granted benefits of the Scheme. An entity upon complying with all the stipulated conditions under the scheme becomes entitled to the incentives attached to the scheme. Although there may not be a one-on-one agreement between the entity and the government, an understanding that the entity will be entitled to incentives upon complying with the stipulated conditions meets the definition of a contract in accordance with Ind AS 32. Accordingly such incentives receivable shall be recognised as a financial asset in accordance with Ind AS 109. Basis above guidance provided by ITFG, where it is concluded that incentive receivable under government schemes is a financial asset, the entities may also need to consider the recognition, measurement and presentation requirements of Ind AS 109, example time value of money. 4. Applicability of Indian Accounting Standards Consider an example of an entity having net worth less than 250 crores INR as on 31 March Applicability of Ind AS to the entity from financial year under the following scenarios have been discussed below: a) The entity has initiated the process for listing its securities at the beginning of the year (i.e. 1 April 2017) and the entity gets listed as at the year-end. In accordance with Rule 4(1)(iii)(a) of the Companies (Indian Accounting Standards) Rules 2015, entities whose equity or debt securities are listed or are in the process of being listed on any stock exchange and having a net worth of less than rupees five hundred crores shall adopt Ind AS from financial year Accordingly, since the entity has initiated the process of listing as at the beginning of the year, it shall be required to comply with Ind AS from financial year b) The entity is listed at the beginning of the year and gets de-listed by the year end. In accordance with Rule 4(1)(iii)(a) of the Companies (Indian Accounting Standards) Rules 2015, an entity that is either listed or in the process of listing shall be required comply with Ind AS. Accordingly, the entity shall prepare its financial statements in accordance with Ind AS from the financial year irrespective of the fact that the entity is delisted by the year-end. c) The entity is unlisted at the beginning of the year, initiates the process of listing during the financial year and gets listed by the year-end. In accordance with Rule 4(1)(iii)(a) above it shall be required to prepare its financial statements in accordance with Ind AS for the year ending 31 March Furthermore, if the entity got listed during November 2017, it shall be required to comply with Ind AS from the quarter ended 31 December Considering the same facts above, the entity would be required to comply with Ind AS, even if the process of listing is not complete by the end of the year. d) The entity issued debentures which are listed during the financial year These debentures were de-listed during the same financial year. The Company was neither listed nor was in the process of listing both at the beginning and at the end of the year. Accordingly, the entity shall not be required to comply with Ind AS. Rule 4(9) of the Companies (Indian Accounting Standards) Rules 2015 provides that once a Company starts following Ind AS either voluntarily or mandatorily it shall be required to follow Ind AS for all the subsequent financial statements even if the criteria specified for mandatory adoption does not apply. For example, a listed entity which is required to adopt Ind AS from the financial year would continue to apply Ind AS in the subsequent years, even if the securities are delisted.

5 5. Applicability of Ind AS roadmap to a stock broker which has applied for termination of its membership Consider a registered stock broker entity, which has made an application for termination of its membership with the SEBI. In accordance with the Companies (Indian Accounting Standard) Rules, the entity falls under the definition of an NBFC. Let s assume that the entity has ceased to carry on the activities of an NBFC from the time of its application for termination with SEBI. ITFG has clarified that NBFC Ind AS road map shall not be applicable to the entity since it has ceased to carry on the activities of a NBFC. Roadmap applicable to Non-NBFC entities shall be followed by the entity to determine applicability of Ind AS, even though the entity s application for termination of membership as an NBFC is in process with the SEBI. The clarification issued by the ITFG is consistent with the clarification issued in ITFG bulletin No.13 (Issue No.4). ITFG had clarified that the Ind AS roadmap for NBFCs also applies to an entity which performs the activities of a NBFC, although it may not be registered with the Reserve Bank of India. Entities need to consider the nature of their activities in determining the applicability of Ind AS. Application for approval or termination of membership which is in process with the regulatory authorities is not the only determinative factor. 6. Accounting for business combinations under common control in the context of first-time adoption of Ind AS In accordance with paragraph C1 to Ind AS 101, a first time adopter may elect not to apply Ind AS 103 retrospectively to business combinations that have occurred before the date of transition to Ind AS. However, if a first time adopter chooses to restate any past business combination in accordance with Ind AS 103, it shall restate all business combinations from that date till the date of transition. Requirements of Ind AS 110 Consolidated Financial Statements shall also be applicable from that date. ITFG has clarified that if a first time adopter has not taken the business combination exemption, then it shall also apply Appendix C to Ind AS 103 to restate business combinations under common control which have occurred before the date of transition. Before applying the requirements of Appendix C to Ind AS 103, the entity shall also evaluate if the combining entities were under common control. In practice, where there is a Court approved scheme of amalgamation which specifies the accounting treatment to be followed in effecting the amalgamation in the financial statements of a transferee company, then that company would need to follow the accounting treatment prescribed in the approved scheme. This would be consistent with issue 8 of ITFG 12 wherein it was clarified that if the NCLT approves a scheme with a different appointed date as compared to the acquisition date as per Ind AS 103, the appointed date approved under the scheme will be the acquisition date. However, the transferee company shall disclose in its Ind AS financial statements the impact of deviating from Ind AS including: A description of the accounting treatment made along with the reason that the same has been adopted because of the Court Order/ Scheme. Description of the difference between the accounting treatment prescribed in the Accounting Standard and that followed by the Company. The financial impact, if any, arising due to such a difference. 7. Discounting of interest free security deposits Refundable interest free security deposits (for example rental deposits paid to lessors) meet the definition of a financial asset under Ind AS 32. In accordance with Ind AS 109, all financial instruments shall be initially measured at fair value. Fair value of a long term loan or a receivable with no interest can be measured at the present value of all future cash receipts discounted using the prevailing market rate of interest of a similar instrument (similar as to currency, term, type of interest rate and other factors) with a similar credit rating. If the entity determines that fair value (other than level 1) at initial recognition differs from the transaction price, the difference shall be deferred and recognised as a gain or loss only to the extent it arises from a change in factor (including time) that market participants would take into account when pricing the asset or liability.

6 In accordance with the above, where the effect of time value of money on refundable interest free security deposits is material, the deposits shall be recognised at their present value upon initial recognition. Discount rate to be used is determined based on an entity s individual facts and circumstance. If the interest free deposit is paid to a lessor in respect of a non-cancellable operating lease arrangement, the difference between the transaction value and fair value shall be deferred as prepaid rent. Prepaid rent shall be recognised as an expense over the lease term determined in accordance with Ind AS 17 Leases. Deposits which are repayable on demand shall be recognised at transaction price. Let s understand the accounting for interest-free rental deposits with the help of a mathematical example. Entity A has paid a rental deposit of 10 million INR on 1 April 20X1 in respect of an operating lease of its office premises. The lease term is 3 years. Rental deposit is interest-free and is repayable at the end of the lease term. Annual lease rentals amount to 2 million INR. Rent deposit is refundable at the end of the lease term and therefore it meets the definition of a financial asset. Rental deposit shall be intially recognised at fair value. For the purpose of determing the fair value, entity shall discount the future cash receipts using the market rate of interest. Let s assume that the market rate of interest on a deposit denominated in INR, with a counter party having a credit standing comparable to the lessor and having a term of 3 years is 10% p.a. Present value of 10 million INR receivable at the end of the lease term of 3 years is 7.51 million INR (10 million INR/ 1.10 ₃ ). Difference between the transction value and present value of the lease deposit of 2.49 million INR shall be recognised as pre-paid rental asset. Such amount shall be subsequently amortised in the profit or loss on a straight line basis over the lease term of 3 years. 8. Accounting for upfront lease premium received by a lessor Consider an example of a government entity which has received an upfront lease premium as consideration for allotment of land to a customer for 99 years. Lease premium is equal to the market value of land and only a nominal rent is subsequently payable over the lease term. The principles of Ind AS 18 Revenue are not applicable for recognition of revenue arising from lease agreements. Accordingly, recognition of lease premium depends on whether the lease of land is classified as an operating or a finance lease. If it is concluded that the lease of land qualifies as an operating lease then the upfront lease premium shall be recognised as operating lease rental income on a straight-line basis over the lease term. Long term nature of the lease is an indication that the lease satisfies the criteria to be classified as a finance lease. Lessor shall recognise land held under finance lease in the balance sheet and present them as a receivable at an amount equal to the net investment in the lease. Since the lease premium is received in advance, there will be no receivable. 9. Accounting for retired partners capital balances repayable by a partnership firm Requirements of Companies (Indian Accounting Standards) Rules 2015 are not applicable to a partnership firm and accordingly a partnership firm is not required to prepare its financial statements in accordance with Ind AS. However, consider an entity which is required to prepare its financial statements under Ind AS has evaluated and concluded that it has control over a partnership firm in accordance with the principles of Ind AS 110. Though Ind AS would not be applicable to the partnership firm, its financial information to be consolidated by the entity should be in compliance with Ind AS. In this context, a question has arisen on accounting for retired partners capital outstanding in the partnership firm that can be demanded at any time. In this regard, retired partners capital meets the definition of a financial liability under Ind AS 32. A financial liability shall be initially recognised at fair value in accordance with Ind AS 109. Considering these amounts can be demanded at any time they are not required to be discounted both on initial recognition and subsequent measurement. 10. Applicability of Ind AS to group companies which do not meet the net worth or listing criteria As per the roadmap for applicability of Ind AS, holding company, subsidiaries, joint ventures or associates of entities which meet the net worth or listing criteria specified in the roadmap, are also required to comply with Ind AS.

7 Consider an example of an entity which is covered under phase II of the Ind AS roadmap. Holding company, subsidiaries, associates and joint ventures of such entity will also be mandatorily required to adopt Ind AS. This requirement however does not extend to a fellow subsidiary of the entity. A holding company will be required to mandatorily prepare its separate and consolidated financial statements in accordance with Ind AS, if one of its subsidiaries meet the specified criteria in the roadmap. Therefore, a fellow subsidiary may be required by the holding company to prepare its financial statements in accordance with Ind AS for the purpose of preparing consolidated financial statements of the holding company. Such a fellow subsidiary may adopt Ind AS voluntarily for its statutory reporting. The requirement to comply with Ind AS will also not extend to an investor who has a significant influence over an entity which meets either the net worth or listing criteria specified in the roadmap. Assuming the investor is required to prepare its financial statements in accordance with Company (Accounting Standards) Rules, 2006 (Indian GAAP), the entity may also be required to provide financial information prepared in accordance with Indian GAAP for the purpose of preparation of consolidated financial statements of the investor. The takeaway Clarifications by ITFG is useful for the companies and other stakeholders as they navigate their journey through Ind AS. The current bulletin provides clarity on some of the key issues commonly faced by the stakeholders such as accounting of compound financial instruments, applicability of Ind AS to entities under various scenarios, accouting and measurement of interest free security deposits and application of Appendix C to Ind AS 103 to amalgamations effected before the transition date. The clarifications will promote consistency in interpretation and implementation of Ind AS. Entities should however exercise judgement and carefully evaluate the ITFG clarifications whilst applying them to their specific facts and circumstances.

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