ACCOUNTING AND AUDITING UPDATE

Transcription

1 ACCOUNTING AND AUDITING UPDATE August 2015 In this edition Impact of the new revenue standard on the real estate sector p1 Pushdown accounting: A new basis of accounting in separate financial statements under U.S. GAAP p5 Plugging gaps in financial reporting: FRRB s recent observations p11 The IASB issues an exposure draft on the Conceptual Framework for financial reporting p17 The IASB proposes clarifications to the new revenue standard p23 Regulatory updates p27

2 EDITORIAL

3 Jamil Khatri Partner KPMG in India Sai Venkateshwaran Partner and Head Accounting Advisory Services KPMG in India The new revenue standard is being actively discussed among stakeholders, International Accounting Standards Board (IASB), Financial Accounting Standards Board (FASB) and the Transition Resource Group globally and in India. After deferring the standard by one year, the IASB has issued an exposure draft proposing clarifications in few areas and providing practical expedients to help with the transition to the new standard. In this edition, we provide an overview of the IASB s proposals and also highlight the current thinking of the FASB on these proposals. Additionally, the new revenue standard is expected to affect different sectors of the economy. In this month s Accounting and Auditing Update, we cast our lens on the impact of the new revenue standard on the real estate sector in light of the guidance available in the current Indian GAAP. The Financial Reporting Review Board (FRRB) has recently issued its key observations with respect to reporting under the Revised Schedule VI to the Companies Act, The requirements relating to the preparation and presentation of the financial statements under the Schedule III to the Companies Act, 2013 are similar as that of Revised Schedule VI, and we have highlighted some of FRRB s significant observations in this issue of the Accounting and Auditing Update. We also provide an overview of the pushdown accounting approach which has gained momentum as a new basis of accounting in separate financial statements under the U.S. GAAP. Apart from our regular round up of regulatory updates, this edition of the Accounting and Auditing Update also provides an overview of the exposure draft on the Conceptual Framework for Financial Reporting issued by the IASB. As always, we would like to remind you that in case you have any suggestions or inputs on topics we cover, we would be delighted to hear from you.

4 1 Impact of the new revenue standard on the real estate sector This article aims to 1 : Highlight key impacts of Ind AS 115, Revenue from Contracts with Customers on real estate sector Provide the related guidance available in the Indian GAAP. In May 2014, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) published their new joint standard on revenue from contracts with customers. The new standard replaces IAS 11, Construction Contracts, IAS 18, Revenue, IFRIC 13, Customer Loyalty Programmes, IFRIC 15, Agreements for the Construction of Real Estate, IFRIC 18, Transfer of Assets from Customers and SIC-31, Revenue-Barter Transactions Involving Advertising Services. Under current Indian GAAP, Accounting Standard (AS) 7, Construction Contracts and AS 9, Revenue Recognition are the two standards that provide general guidance on revenue recognition. Guidance Note on Accounting for Real Estate Transactions (guidance note) provides accounting treatment for entities dealing in real estate as sellers or developers. The guidance note provides guidance on application of percentage of completion method on transactions and activities of real estate sector that have the same economic substance as construction contracts. The guidance note primarily provides guidance on application of percentage of completion method in respect of real estate contracts which have the same economic substance as construction contracts. As per the guidance note, project revenues and project costs associated with the project should be recognised as revenue and expenses respectively applying the percentage of completion method when the outcome of a project can be estimated reliably. Further, there is a rebuttable presumption that the outcome of a real estate project can be estimated reliably and that revenue should be recognised under the percentage of completion method only when the events in (a) to (d) below are completed. a. All critical approvals necessary for commencement of the project have been obtained. b. When the stage of completion of the project reaches a reasonable level of development. A reasonable level of development is not achieved if the expenditure incurred on construction and development costs is less than 25 per cent of the construction and development costs. 1. KPMG s publication Accounting for revenue is changing - Impact on housebuilders February 2015 c. At least 25 per cent of the saleable project area is secured by contracts or agreements with buyers.

5 2 d. At least 10 per cent of the total revenue as per the agreements of sale or any other legally enforceable documents are realised at the reporting date in respect of each of the contracts and it is reasonable to expect that the parties to such contracts will comply with the payment terms as defined in the contracts. In India, Ind AS 115, Revenue from Contracts with Customers is the standard on revenue recognition that is converged with IFRS 15, Revenue from Contracts with Customers. The new standard contains single model that will be applied while accounting for contracts with customers across all industries including real estate. It is expected to replace current guidance under Indian GAAP. Five-step model As per the new standard, entities will apply a five-step model to determine when to recognise revenue, and at what amount. The model specifies that revenue should be recognised when (or as) an entity transfers control of goods or services to a customer at the amount to which the entity expects to be entitled. To achieve the core principle, the new standard establishes a fivestep model: Step 1 - Identify the contract (One or multiple) Step 2 - Identify performance obligations (One obligation or multiple) Step 3 - Determine the transaction price (Total consideration for contract) Step 4 - Allocate the transaction price (Allocate to various performance obligations identified) Step 5 - Recognise revenue (At a point in time or over time) The entities that currently use percentage of completion method will need to reassess whether to recognise revenue over time or at a point in time. The impact of the new standard will vary by industry. Ind AS 115 is expected to have significant impact on the accounting of revenue by entities engaged in development and sale of real estate units, specifically with respect to detailed guidance under step 1, step 2 and step 5 of the new standard. This article highlights likely impact of new revenue standard on accounting for real estate contracts considering the current accounting guidance under the Indian GAAP. Sale of completed units Under Ind AS 115, revenue is recognised only when a contract is in the scope of the standard - i.e. when the contract is legally enforceable and certain other criteria are met. If a contract does not meet the specified criteria, then any consideration received from the buyer is recognised as a liability until the criteria are met. Revenue for the sale of units that are completed before the real estate developer enter into a contract with a buyer is likely to be recognised at a point in time; however, this timing will be determined based on the transfer of control rather than the transfer of the significant risks and rewards of ownership. Judgement may be required to determine the point in time at which control transfers as various indicators may be required to determine the point in time at which control transfers and also various indicators may be met at different points in time - e.g. a buyer can be exposed to the risks and rewards of ownership prior to obtaining physical possession of the house. Sale of incomplete units Contract performance obligations Ind AS 115 requires an entity to identify the performance obligations in a contract. A performance obligation is a promise in a contract to transfer to a customer a good or service (or a bundle of goods or services) that is distinct. A good or service is distinct from other goods or services, and so is a performance obligation if: The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer, and The entity s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. Ind AS 115 includes additional guidance to help determine whether the above mentioned criteria are met. Indicators that a performance obligation is separately identifiable include the following: The entity does not provide a significant service of integrating the good or service with other goods or services promised in the contract. The good or service does not significantly modify or customise another good or service promised in the contract. The good or service is not highly dependent on, or highly interrelated with, other goods or services promised in the contract. These indicators are expected to have an impact on the real estate industry due to the integrated nature of construction activities. For example, in a construction contract, a real estate developer may be required to sell/use bricks, windows, fitting and provide construction services under a contract to construct a building. All the items to be used in the construction of a building (i.e. bricks, windows, etc.) are distinct but the standard requires an entity to consider if they are distinct in the context of the contract before deciding they are performance obligations. In this example, the real estate developer provides significant integration service because it is putting all the materials (bricks, windows, etc.) together to construct the building. Therefore, there would be one performance obligation which is to provide construction services.

6 3 Generally, in a contract for the development and sale of a real estate unit, entities provide significant services to integrate the goods or services with other goods or services and goods or services individually purchased for construction activities are highly interrelated. Therefore, in most of the cases, development and sale of a real estate unit would be one performance obligation and would continue to be the unit of account for contract accounting in line with the current guidance under AS 7. How to recognise revenue: over time or at a point in time? Ind AS 115 provides that an entity shall recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (i.e. an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset. In respect of a real estate contract accounted for as a unit of account, a question to be analysed is whether revenue will be recognised at the time of completion of real estate unit and transfer of control to the customer. Ind AS 115 provides additional guidance to address the same. An entity recognises revenue over time i.e. control of the good or service transfers to the customer over time if one or more of the following criteria are met: S. No. Criteria Example The customer simultaneously receives and consumes the benefits provided by the entity s performance as the entity performs. The entity s performance creates or enhances an asset that the customer controls as the asset is created or enhanced. The 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. Routine or recurring services e.g. cleaning services. Building an asset on a customer s site. Building a specialised asset that only the customer can use, or building an asset to a customer order. Applying the criteria to real estate contracts may result in different conclusions on the pattern of transfer of control, depending on the relevant facts and circumstances of each contract. A real estate developer would need to determine if the buyer controls the asset as it is created or enhanced e.g., work in progress may transfer to the buyer as a new house is constructed. In some cases, it may not be clear if a buyer controls the property as it is constructed, and it will be necessary to evaluate whether: It has an enforceable right to payment for performance completed to date. If both of these conditions are met, revenue will be recognised over time, using a method that depicts performance. In practice, this criterion may be more difficult to meet as it means that at the time of cancellation of contract by a customer, the real estate developer should have a right to payment that approximates selling price of the real estate i.e. collect costs incurred plus a profit margin. The amount to which it is entitled does not need to be equal to the contract margin, but should be based on either a reasonable proportion of the entity s expected profit margin or a reasonable return on the entity s cost of capital. In the event of cancellation by buyer, if the real estate developer takes back the property and forfeits some part of the deposit paid by the buyer then the above criterion may not be satisfied resulting in revenue recognition at a point in time. As per the current guidance under AS 7, for all contracts that meet the definition of a construction contract, an entity recognises revenue and profits over time by reference to the percentage of completion of the contract activity. Therefore, under the current guidance, progressive revenue recognition is the automatic accounting treatment for all construction contracts. Unlike current accounting guidance, there is no automatic right to recognise revenue on a progressive basis for all construction contracts under Ind AS. For transactions currently accounted for using the percentage of completion method, it will be necessary for real estate developer to evaluate contracts against the new criteria to establish whether it is appropriate to recognise revenue over time or point in time. Next steps While progressive revenue recognition similar to percentage of completion accounting under the current accounting guidance is retained under Ind AS 115, the criteria to achieve this outcome have changed. Real estate developers will need to consider their contractual terms to assess whether they can continue to recognise revenue over time as failure to do so may lead to significant deferral of revenue. There are changes to the basis of measurement of revenue as well which may impact revenue recognition and timing. Adoption of new revenue standard is expected to have significant impact on revenue recognition by entities engaged in the development and sale of real estate units. The new standard could impact top line of real estate companies and companies need to assess how their financial reporting, information systems, processes and internal control will be effected. Entities will need to engage with their investors and other stakeholders to establish expectation of how their key performance indicators or business practices may change as a result of the new standard. Its performance creates an asset with no alternative use to it due to contractual or practical restrictions e.g., particular unit/location has been clearly identified and assigned specifically to the buyer, and

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8 5 Pushdown accounting: A new basis of accounting in separate financial statements under U.S. GAAP This article aims to 1 : Provide an overview of the pushdown accounting approach as envisaged in Topic 805, Business Combinations Highlight the related key implementation issues. The guidance in the pushdown accounting applies to separate financial statements of an acquiree and its subsidiaries under the U.S. GAAP. Pushdown accounting refers to establishing a new basis of accounting in the separate financial statements of the acquired entity (or acquiree) after it is acquired. On acquisition, the acquiree company values the assets and liabilities of the acquired company at their fair value. This results in establishing two set of values for the acquiree company, i.e. one based on historical cost and other based on fair value. However, under pushdown accounting, the fair value adjustments are considered in the separate financial statements of the acquiree company, replacing its historical cost. For example, company A acquired 100 per cent shareholding of company B on 1 April Company A applied the principles under the U.S. GAAP for business combination and fair valued all the assets and liabilities of company B. As part of fair valuation exercise, company A would generally recognise assets and liabilities at fair value including certain additional assets such as intangibles and goodwill on fair valuation and may also recognise certain additional liabilities. Company B while preparing its financial statements, generally does not consider the valuation of its assets and liabilities by company A. However, if the principles of pushdown accounting are applied, the financial statements of company B would consider the impact of the fair valuation exercise by company A. The objective of financial reporting is to provide information that is useful to present and help potential investors, creditors, donors, and other capital market participants in making rational investment, credit, and similar resource allocation decisions. Through pushdown accounting, the acquiree company will be able to present its balance sheet, the way its investors had valued it on the date of acquisition, giving a fair presentation of the balance sheet to its creditors/investors and other users of financial statements. As a result of pushdown accounting, a company may end up having additional assets in the balance sheet as a result of recognition of the intangibles and goodwill and this may have an impact on the profitability from operation as those recognised assets would need to be amortised/depreciated or can have an impairment charge. 1. KPMG s publication Issues In-Depth Pushdown accounting, February 2015

9 6 Applicability Until recently, it was only Staff Accounting Bulletin no. 115 issued by the Securities and Exchange Commission (SEC) which provided the guidance on pushdown accounting where it made it mandatory for all the public companies with 95 per cent of the acquiree company reporting under the U.S. GAAP. However, in November 2014, the Financial Accounting Standards Board (FASB) issued guidance on pushdown accounting where in pushdown accounting was made optional for the companies. Consequently, the SEC rescinded its existing guidance with the new guidance issued by the FASB. Accordingly, pushdown accounting is optional even for an SEC registrant. Requirements of the new standard under the U.S. GAAP An acquired entity reporting under the U.S. GAAP has an option to apply pushdown accounting in its separate financial statements upon occurrence of an event in which an acquirer obtains control of an acquired entity. An acquired entity should determine whether to elect to apply pushdown accounting for each individual change-in-control event in which an acquirer obtains control of an acquired entity. If the acquiree elects the option to apply pushdown accounting, it must apply the accounting as of the acquisition date. Once an entity elects to apply pushdown accounting to a specific change-in-control event, that decision is irrevocable. If pushdown accounting is not applied in the reporting period in which the change-in-control event occurs, an acquired entity will have the option to elect to apply pushdown accounting in a subsequent reporting period to the acquired entity s most recent change-in-control event. Such change in the accounting would be considered as a change in the accounting principle. Any consolidated subsidiary of an acquired parent also have the option to apply pushdown accounting in its separate financial statements irrespective of whether the acquired parent applies pushdown accounting in its consolidated financial statements. Example: Pushdown to subsidiaries of an acquired entity Entity A (Acquirer) Entity A (aquirer) acquires 80 per cent of entity B (acquired parent) and its wholly owned subsidiary entity C (acquired subsidiary). After considering the informational needs of its separate financial statement users, entity B chooses not to apply pushdown accounting. Entity B (Acquired Parent) Entity C (Acquired Subsidiary) Entity C performs a similar evaluation as entity B and elects to apply pushdown accounting. Its new basis is consistent with that established by entity A even though entity B did not apply pushdown accounting. For purposes of entity B s separate consolidated financial statements, entity C s financial information would be based on entity C s historical information (not pushdown information) even though entity C applies pushdown accounting in its separate financial statements. Source: Issues In-Depth-Pushdown Accounting issued by KPMG in February 2015 The Emerging Issues Task Force (EITF) considered that if an acquired parent elected pushdown accounting, whether the same election must be made for its consolidated subsidiaries. The EITF ultimately concluded that each entity in the acquired consolidated group could decide whether to apply pushdown accounting in its separate financial statements because different entities within the group may have different financial statement users with different information needs. Transactions including the formation of a joint venture, acquisitions of assets or groups of assets that do not constitute a business, combinations of entities under common control and certain other transactions that are identified in Accounting Standard Codification (ASC) paragraph are not within the scope of the standard because they do not fall under the scope of business combinations accounting.

10 7 Initial measurement An entity that elects to apply pushdown accounting in its separate financial statements upon a change-in-control event will reflect the new basis of accounting established by the acquirer for the individual assets and liabilities of the acquired entity. In applying pushdown accounting, the carrying amounts of the assets and liabilities in the financial statements of the acquired entity are adjusted to reflect the acquisition accounting adjustments recorded (or that would have been recorded) in the consolidated financial statements of the acquiring entity as of the date control was obtained. If pushdown accounting is applied, the separate financial statements of the acquired entity must reflect all of the acquisition adjustments; partial pushdown accounting is not permitted. If a company elects to follow pushdown accounting, then: If the fair valuation of assets and liabilities results in a goodwill in the books of an acquiree, the same shall be recognised in the books of the acquired company. In case the acquisition results in a bargain purchase, the income arising on bargain purchase is not recorded in the books of the acquired company. The acquiree recognises a bargain purchase gain as an adjustment to equity (or net assets of a not-for-profit acquiree) in its separate financial statements. Transaction costs are not pushed down to the separate financial statements of the acquired company. Acquisition-related liabilities, including debt incurred by an acquirer, is recognised in the separate financial statements of the acquired entity only if that entity is required to do so under other U.S. GAAP (e.g. obligations resulting from joint and several liability arrangement). Subsequent measurement of the assets and liabilities shall be in line with the requirements of other accounting standards as applicable. Presentation of pushdown accounting in financial statements The application of pushdown accounting represents termination of one basis of accounting and the creation of a new basis. Therefore, the acquiree should not combine the periods prior to and subsequent to the date that pushdown accounting is applied. To emphasise the change in accounting basis, a line generally separates the predecessor and successor financial statement periods if those periods are presented together. The financial statements also would clearly describe the basis of presentation as a result of applying pushdown accounting. Example of pushdown accounting Entity A acquired all of the outstanding common stock of entity B for INR1,000. Entity A accounts for the acquisition as a business combination under ASC Topic 805. Entity B elects to apply pushdown accounting in its separate financial statements. As of the date of the acquisition, the book value of entity B s net assets was INR650. Entity B s equity accounts reflected common stock of INR100, additional paid-in capital of INR200, and retained earnings of INR350. The fair value of entity B s identifiable net assets acquired is INR800. Therefore,INR200 was allocated to goodwill (INR1,000 purchase price less INR800 fair value of identifiable net assets). Entity B records the following entry to record the pushdown accounting adjustments. Identifiable net assets INR150 Goodwill 200 Retained earnings 350 Additional paid-in capital INR700 Entity B s financial statements before and after applying pushdown accounting as of the date of acquisition reflect the following: Before pushdown After pushdown Identifiable net assets INR650 INR800 Goodwill Total net assets INR650 INR1,000 Common stock INR Additional paid-in capital Retained earnings Total equity INR650 INR1,000 Source: Issues In-Depth-Pushdown Accounting issued by KPMG in February 2015 Other implementation issues Acquisition-related goodwill-segment reporting If pushdown accounting is applied, all goodwill related to the acquisition is pushed down to the acquiree and presented as goodwill in the acquiree s separate financial statements even if some of the goodwill is allocated to the other reporting units in the acquirer s consolidated financial statements. The guidance in ASC topic 350, Intangibles-Goodwill and Other requires that the parent assigns all goodwill acquired in a business combination to one or more reporting units on the date of acquisition. Acquisition-related goodwill should be assigned to the reporting units of the acquirer that are expected to benefit from the synergies of the combination. The ways in which goodwill is allocated to the acquired entity and the parent s other reporting units may create differences between the amount of goodwill pushed down to the acquiree s separate financial statements (i.e. all of the goodwill from the transaction) and the goodwill allocated to the acquiree at the parent level. Effectively, some of the acquiree s goodwill might be allocated to other reporting units in the acquirer s consolidated financial statements while all of the goodwill is pushed down to the acquired entity for its separate financial statements.

11 8 Goodwill amortisation/impairment If the acquiree is a public business entity, the goodwill is subject to an annual impairment test under ASC subtopic A private company that has been acquired by a public business entity may elect the alternative accounting available for goodwill i.e. to amortise goodwill on a straight-line basis over 10 years or less if another useful life is more appropriate. In such a case, the acquiree s subsequent accounting for goodwill will be different from the acquirer. Because the alternative may only be elected by a private company, the effect of this election would need to be reversed in the parent s consolidated financial statements, which may be complicated. Contingent consideration Consideration transferred in a business combination may include contingent consideration. Contingent consideration could arise from an obligation by the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control if specified future events occur or conditions are met. The standard does not provide guidance about whether the contingent consideration should be pushed down to the acquiree. We believe that a contingent consideration asset or liability should be pushed down to the acquiree only if the acquiree is legally obligated to pay or has the right to receive the contingent consideration. The contingent consideration would not be pushed down to the acquiree if it represents a legal right or obligation of the acquirer, not the acquiree. If that occurs and pushdown accounting is applied, the offset for the obligation that is not pushed down will be an increase to additional paid-in capital. If the contingent consideration is not a legal obligation of the acquiree, the acquiree would not report the fair value changes of the obligation in its separate financial statements. The treatment of contingent consideration being pushed down to an acquired entity would be similar to the treatment of acquisition-related debt of an acquirer that is pushed down to an acquired entity s separate financial statements. Acquisition of a foreign entity If a foreign entity is acquired, foreign currency guidance specifies that goodwill and other acquisition adjustments represent assets or liabilities of the acquired foreign entity, regardless of whether the acquisition accounting adjustments are pushed down to the foreign entity. Therefore, they must be measured in the functional currency of the acquired entity, and, if the local currency is the functional currency of the foreign entity, be translated at current exchange rates in the acquirer s consolidated financial statements. As a consequence, this translation will affect the cumulative translation adjustment in the acquirer s financial statements.

12 9 Presentation of contingent expenses of the acquiree In December 2014, the SEC staff addressed the presentation of expenses that are incurred by the acquiree contingent upon the closing of a business combination when financial statements reflecting the application of pushdown are presented. Examples include investment banking fees paid by the acquiree, which are contingent on the closing of the acquisition or share-based compensation award plans that accelerate awards if the issuer has a change-in-control event. The staff speech encouraged registrants to evaluate whether it is appropriate to record expenses that are related to the business combination in either the predecessor or successor periods as appropriate based on the specific facts and circumstances. Any cost that is a direct consequence of the consummation of the business combination should not be recognised until consummation occurs, and would not be recognised in the period preceding the business combination. The other view is that the contingent expense is recognised in the acquiree s predecessor period financial statements. The support for this view is that, because the financial statements present the acquiree s results for the period up to consummation of the business combination, there is no longer any risk that consummation of the business combination will not occur and, therefore, any cost should be recognised at the closing of the predecessor period. Whichever method is used, it should be applied consistently to all costs triggered by the consummation of a business combination. Additionally, disclosures of the facts and circumstances, the amounts and the policy elected should be provided. Income tax considerations Deferred income taxes generally should be recognised for temporary differences related to the assets and liabilities included in both the consolidated and stand-alone financial statements. The amounts of those temporary differences for the acquired entity s assets and liabilities may not be the same in the consolidated and separate financial statements because business combination accounting adjustments reflected in the consolidated financial statements may not have been pushed down to the acquired entity s separate financial statements.

13 10 When an acquisition is treated as a taxable transaction (resulting in a step-up in the basis of the assets and liabilities for tax purposes) and the acquired entity does not apply pushdown accounting in its separate financial statements, the step-up in basis of the financial statement carrying amount is not reflected in the acquired entity s financial statements. In this instance, the change in the temporary difference due to the change in tax basis is recognised as an adjustment to equity. Further, a valuation allowance recorded as of the acquisition date for the newly created deferred tax assets should also be recognised with an adjustment to equity. However, any subsequent change to the valuation allowance or change in the valuation allowance for existing deferred tax assets (including the write-off of existing deferred tax assets that the acquired entity can no longer realise as a result of the business combination) should be recognised as a component of income from continuing operations. Accounting under IFRS Pushdown accounting is not addressed by, and is not applicable under, IFRS. However, some fair value adjustments could be reflected in the acquiree as revaluations if permitted by the relevant standards, as long as the revaluations are kept up to date subsequently under IFRS. For example, on 31 March 2011, company E acquired all of the shares of company F and as part of the acquisition accounting, recognised land and buildings at INR500 (the previous cost-based carrying amount was INR300) and a trademark at INR150 (which was not recognised previously). F could recognise the fair value adjustment of INR200 in respect of land and buildings in its own financial statements for the period ended 31 December 2011 if it changes its accounting policy to one of revaluation and complied with all the revaluation requirements, including the need to keep revaluations up to date.

14 11 Plugging gaps in financial reporting: FRRB s recent observations This article aims to: Highlight significant observations made by the Financial Reporting Review Board (FRRB) with respect to reporting practices under the Revised Schedule VI. In order to enhance the financial reporting practices followed by various enterprises, the Institute of Chartered Accountants of India (ICAI) constituted the Financial Reporting Review Board (FRRB) in July The FRRB reviews general purpose financial statements of the companies and the auditor s report thereon with a view to determine: a. Compliance with the generally accepted accounting principles in the preparation and presentation of the financial statements b. Compliance with the disclosure requirements prescribed by the regulatory bodies, statutes and rules and regulations relevant to the enterprise, and c. Compliance with the reporting obligation of the auditors. Recently, the ICAI published certain observations specific to the Revised Schedule VI to the Companies Act, 1956 (1956 Act). It is pertinent to mention that the requirements relating to preparation and presentation of the financial statements under the Schedule III to the Companies Act, 2013 (2013 Act) are similar 1 as that of Revised Schedule VI to the 1956 Act. Accordingly, the observations of the FRRB made with respect to the Revised Schedule VI to the 1956 Act will also be relevant for preparation of financials statements as per the Schedule III to the 2013 Act. According to the ICAI, the observations of the FRRB are best practices that should be followed. This article summarises the significant observations and the views of the FRRB as published recently by the ICAI A Ramaiya Guide to the Companies Act Providing guidance on the Companies Act, th edition, volume 2, Section The ICAI Journal The Chartered Accountant May 2015

15 12 Equity and liabilities Reporting requirements under the Revised Schedule VI Companies are, inter alia, required to disclose certain matters with regard to share capital, e.g.: Reconciliation of the number of shares outstanding at the beginning and at the end of the reporting period The rights, preferences and restrictions attached to each class of shares Number of shares held by the shareholders holding more than five per cent shares, etc. Debit balance in the statement of profit and loss which arises in case of accumulated losses, is required to be presented as a negative figure under the head Surplus. The aggregate amount of the balance of reserves and surplus is to be shown after adjusting negative balance of surplus, if any. If the net result is negative, the negative figure is to be shown under the head reserves and surplus. Companies are required to disclose repayment terms of term loans as well as other loans including disclosure of period of maturity with respect to the balance sheet date, number and amount of instalments, the rate of interest and other significant relevant terms, if any. Other long-term liabilities are required to be classified into: Trade payables Others. Current liabilities are required to be classified into: Short-term borrowings Trade payables Other current liabilities Short-term provisions. FRRB observations Certain companies have omitted to report one or more of the disclosures prescribed for share capital in their balance sheet. According to the FRRB, omission of any such information is not in accordance with the Revised Schedule VI. Certain companies have continued to follow the practice as prescribed under the pre-revised Schedule VI i.e. presenting the debit balance of profit and loss on the assets side of the balance sheet. Such practice is not in compliance with the requirements of the Revised Schedule VI. In some cases, the rate of interest (at which such loans have been taken) has not been disclosed. In other cases, repayment terms of the loan, the period of maturity, number and amount of instalments have not been disclosed. Omission of above disclosure requirements is not in compliance with the requirements of the Revised Schedule VI. Many companies have reported substantial amount of longterm liabilities under the head Others without specifying the nature of such liabilities. In order to enhance the readability of the financial statements, the Revised Schedule VI prescribes disclosure of all the important information that may assist the users in understanding the financial statements. The FRRB is of the view that different nature of long-term liabilities apart from trade payables should be shown separately specifying their nature rather than clubbing them under a common head Others. In some financial statements, sundry creditors for goods were shown as separate line item under the head current liabilities. In other cases, under the head trade payables, a sub-head sundry creditors has been shown as a separate line item. The term sundry creditors was prescribed under the prerevised Schedule VI where as the term trade payables exist under the Revised Schedule VI. The term sundry creditors is wider in nature as compared to the term trade payables as it includes dues payable in respect of statutory or other contractual obligations that may not have occurred due to goods purchased or services received in the normal course of business. Hence, sundry creditors for goods are trade payables which should be shown under the sub-head trade payables instead of the head sundry creditors. Also presentation of sub-head sundry creditors under trade payable would not be a correct presentation of information.

16 13 Reporting requirements under the Revised Schedule VI Companies are required to bifurcate employee benefits liabilities measured under AS 15, Employee Benefits into current and non-current liabilities. FRRB observations In certain cases, liabilities towards employee benefits are shown under short-term provisions without bifurcating current and non-current portion. The FRRB stated that any liability towards employee benefits payable within a period of 12 months and the company does not have unconditional right to defer its settlement for 12 months after the reporting date should be classified as current and should be shown under the head short-term provisions and remaining liabilities should be shown under the head longterm provisions.

17 14 Assets Reporting requirements under the Revised Schedule VI Tangible assets that are not yet ready for use are required to be classified as capital work-in-progress and intangible assets still under development are required to be classified as intangible assets under development. A reconciliation of the gross and net carrying amounts of each class of assets at the beginning and at the end of the reporting period showing additions, disposals, acquisitions through business combinations and other adjustments and the related depreciation and impairment losses/reversals is required to be disclosed separately under fixed assets. Corresponding amounts for the immediately preceding reporting period for all items shown in the financial statements including notes should be given except in the case of first financial statements laid before the company (after its incorporation). Non-current investments are required to be classified as trade investments and other investments and are further classified as: a. Investment property b. Investments in equity instruments c. Investments in preference shares d. Investments in government or trust securities e. Investments in debentures or bonds f. Investments in mutual funds g. Investments in partnership firms h. Other non-current investments (specify nature). Under AS 13, Accounting for Investments, investments are required to be classified into long-term investments and current investments. The Revised Schedule VI requires investments to be classified as non-current and current investments. FRRB observations In certain cases, accounting policy of intangible assets stated that expenses incurred on intangibles under development e.g. for acquiring intellectual property rights or licenses for projects that are still under development have been classified as capital work-in-progress. The FRRB stated that capitalisation of expenses incurred on the intangible assets still under development under the head capital work-in-progress is not in compliance with the reporting requirements under the Revised Schedule VI. Certain companies have shown additions/deletions to fixed assets in a single column while their cash flow statement showed that cash flows have arisen on account of purchase and sale of fixed assets during the period. The FRRB observed that the disclosure of additions and deletions in a single column indicate that such figures have been reported on net basis. As per the presentation requirements of the non-current assets, additions/deletions of fixed assets should be reported separately on gross basis. In the absence of such information, the gross value of fixed assets purchased and sold could not be ascertained. The FRRB observed that many companies omit to report the comparative figures of the previous year relating to opening balance, additions and depreciation charged for each class of fixed assets. The FRRB observed that in certain cases investments were not classified into trade investments and other investments. Investments in subsidiaries have been classified as other investments and investments in money market have been classified as trade investments. Trade investments refer to those investments that are made to promote the business of the company. Thus, subsidiaries established to promote the business of the company are trade investments. Similarly, investments in money market are made to earn income by way of dividends/interest or for capital appreciation which cannot be considered to have been made for promotion of business of the company. Thus, they do not qualify for disclosure as trade investments. Many companies have invariably classified long term investments into non-current investments. Non-current investments are those investments that are realisable beyond 12 months from the date of the balance sheet. The FRRB noted that investments are classified into long-term and other investments on the basis of date of their original investment. However, they are classified into noncurrent and current on the basis of their realisation. Thus, it may not be necessary that all long-term investments would qualify as non-current investments.

18 15 Assets Reporting requirements under the Revised Schedule VI Capital advances are required to be presented under long-term loans and advances. Trade receivables which are outstanding for a period exceeding six months from the date when they become due for payment are required to be disclosed in the financial statements. Bank deposits with more than three months but upto 12 months maturity should be disclosed separately under other bank balances. Details of short-term loans and advances given to related parties are also required to be disclosed. Items in the nature of advances which are recoverable in cash or kind are required to be disclosed as loans and advances. Section 22 of the Micro, Small and Medium Enterprises Development Act, 2006, requires every buyer to give certain disclosures in the financial statements e.g. the principal amount and the interest due thereon remaining unpaid to any supplier (to be shown separately) as at the end of each accounting year, etc. FRRB observations Accounting policy of certain companies stated that capital advances are included in capital work-in-progress which is not in line with the requirements prescribed under the Revised Schedule VI. Capital advances refer to advances paid for acquisition of fixed assets where capital work-in-progress refers to the expenditure incurred on capital assets which are in the process of construction or completion. Hence, capital advances are not in the nature of capital work-in-progress but over the period they are expected to be converted into fixed assets which are noncurrent assets. Therefore, they should be classified as long-term loans and advances. In certain cases, it was unclear whether the trade receivables have been classified based on the date of their original transaction or on the date when trade receivables become due for payment. The FRRB observed that in certain cases a broad head of cash and bank balances with sub-classifications cash and cash equivalents and other bank balances was not presented. Term-deposit with banks with original maturity of three months or less from the date of acquisition should only be classified as cash and cash equivalents. Term deposits with more than three months but upto 12 months maturity should be classified as other bank balances. The non-current portion of each of the above balances along with term-deposits of more than 12 months maturity should be classified as other non-current assets with separate disclosure thereof. The aggregate amount of short-term loans and advances given to related parties without stating any details thereof is a noncompliance with the reporting requirements under the Revised Schedule VI. Assets which are in the nature of loans and advances e.g. advance tax, MAT credit entitlement, advance excise duty, etc. cannot be classified as other current assets as they are in the nature of loans and advances. Even if there are no dues as at the end of the year, the company should still disclose the required information. If all the disclosures required stand at nil, the fact should be disclosed rather than omitting the information from the financial statements.

19 16

20 17 The IASB issues an exposure draft on the Conceptual Framework for financial reporting This article aims to: Provide a summary of the important proposals set out in the Exposure Draft on the Conceptual Framework for Financial Reporting issued by the International Accounting Standards Board in May Introduction 1 The International Accounting Standards Board (IASB) in May 2015 issued an Exposure Draft (ED) on the Conceptual Framework for Financial Reporting (Conceptual Framework). The IASB s existing Conceptual Framework was developed in 1989 by the predecessor body, the International Accounting Standards Committee. As a result of a joint project between the Financial Accounting Standards Board (FASB) and the IASB, in 2010 the material on the objective of financial reporting and qualitative characteristics of financial information was revised. Thereafter, the IASB published a Discussion Paper (DP) - A Review of the Conceptual Framework for Financial Reporting in July This ED sets out the proposals laid down by the IASB for a revised Conceptual Framework. The Conceptual Framework is important because it provides the foundation for the decisions that the IASB makes while developing a standard. Though this is not a standard in itself, and does not override any standard developed by the IASB, it provides a backbone to the standard setting process. The existing Conceptual Framework has largely been able to help the IASB achieve its stated objectives of developing global standards and bring about transparency, accountability and efficiency around the world, but the IASB felt that some improvements were required. For illustration: There were gaps in the existing Conceptual Framework. For example; the existing Conceptual Framework provides very little guidance on presentation and disclosure of financial information. Some parts of the existing Conceptual Framework are out of date and redundant. For example; the existing guidance on when assets and liabilities should be recognised. Guidance in some areas of the existing Conceptual Framework is unclear and less helpful than it could be. For example; it is unclear what role measurement uncertainty plays in deciding how to measure assets, liabilities, income or expenses. 1. Exposure draft on Conceptual Framework for Financial Reporting issued by the International Accounting Standards Board (IASB) in May With an objective to improve financial reporting and provide a more complete, clear and updated set of concepts, the IASB has released this ED for comments.

21 18 In this article, we provide a high level summary of the important proposals set out in the ED which are as follows: Objective - The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors (users of financial statements) in making decisions about providing resources to the entity. The IASB now proposes: To place more emphasis on the importance of providing information needed to assess management s stewardship of the entity s resources To reintroduce an explicit reference to the notion of prudence and state that prudence is important to achieve neutrality and hence, a faithful representation, and To state explicitly that a faithful representation reports the substance of a transaction rather than merely its legal form. Qualitative characteristics - The fundamental qualitative characteristics of financial information are relevance and faithful representation. If financial information is to be useful, it must be relevant and faithfully represent what it purposts to represent. One factor affecting the relevance of financial information is the level of measurement uncertainty. Some respondents to the DP raised concerns that, since 2010, the Conceptual Framework has no longer identified reliability as a qualitative characteristic of useful financial information. Their main concern seems to be that measurement uncertainty makes financial information less useful. In response, the IASB proposes to clarify that measurement uncertainty is one factor that can make financial information less relevant. Hence, there is a trade-off between the level of measurement uncertainty and other factors that make information relevant. Other aspects of reliability, as it was described in the pre-2010 Conceptual Framework, are very similar to aspects of the qualitative characteristic of faithful representation, as described in the existing Conceptual Framework and in the ED. The IASB thinks that the term faithful representation describes those aspects better than the term reliability. Elements - The existing definitions of assets and liabilities have worked well but the IASB believes that they could be refined. The table below illustrates the definitions of elements of the financial statements as per existing Conceptual Framework and the proposed definitions in the ED. Element Asset Liability Equity Income Definition as per the existing Conceptual Framework An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. 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. Equity is the residual interest in the assets of the entity after deducting all its liabilities. Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions to equity participants. Proposed definitions in the ED An asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits. A liability is a present obligation of the entity to transfer an economic resource as a result of past events. The ED retains the existing definition of equity. Income is increases in assets or decreases in liabilities that result in increases in equity, other than those relating to contributions from holders of equity claims. Expenses Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. Expenses are decreases in assets or increases in liabilities that result in decreases in equity, other than those relating to distributions to holders of equity claims. The IASB does not propose to change the definitions of liabilities and equity to address the problems that arise in classifying instruments with characteristics of both liabilities and equity. It is exploring those problems in its Financial Instruments with the Characteristics of Equity research project. Measurement - It is the process of quantifying in monetary terms information about an entity s assets, liabilities, income and expenses. The IASB proposes to introduce guidance on measurement. The ED describes various measurement bases which are as follows: Historical cost - Measures based on historical cost provide monetary information about assets, liabilities, income and expenses using information derived from the transaction or event that created them. The historical cost measures of assets or liabilities do not reflect changes in the prices. However, the measures do reflect changes such as the consumption or impairment of assets and the fulfillment of liabilities.

22 19 Current value - Measures based on current value provide monetary information about assets, liabilities, income and expenses using information that is updated to reflect conditions at the measurement date. Due to updating, current values capture any positive or negative changes, since the previous measurement date, in estimates of cash flows and other factors included in those current values. Current value measurement bases include: Fair value - it is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. Value in use and fulfilment value - these are entity specific values. Value in use is the present value of the cash flows that an entity expects to derive from the continuing use of an asset and from its ultimate disposal. Fulfillment value is the present value of the cash flows that an entity expects to incur as it fulfils a liability. The ED also provides guidance on factors to be considered when selecting a measurement basis. Relative importance of each of the factors will depend upon facts and circumstances. Factors to consider are as follows: Relevance Faithful representation Enhancing qualitative characteristics Factors specific to initial measurement. The ED states that sometimes more than one measurement basis may be needed to provide relevant information about an asset, liability, income or expense. The ED also provides basis for measurement of equity. The ED states that although total equity is not measured directly, some individual classes or categories of equity may be measured directly. Recognition and derecognition Recognition is the process of capturing an asset or a liability for inclusion in the statement of financial position. Failure to recognise items that meet the definition of an element makes statement of financial position and the statement of financial performance less complete and can exclude useful information from financial statements. It is not possible to define precisely when recognition of an item that meets the definition of an element will provide useful information to users of financial statements. Consequently, judgement is required when deciding whether to recognise an item and recognition requirements may need to vary between standards. The ED proposes recognition criteria based on the qualitative characteristics of useful financial information. An entity recognises an asset or liability if such recognition provides users of the financial statements with: Relevant information about the asset or liability A faithful representation of the asset or liability and of any resulting income and expenses, and Information that results in benefits exceeding cost of providing that information. Those criteria may not always be met when one or more of the following applies: It is uncertain whether an asset or liability exists There is only a low probability of future inflows (outflows) of economic benefits from the asset (liability), or The level of measurement uncertainty is so high that the resulting information has little relevance. Derecognition is the removal of all or part of a previously recognised asset or liability from an entity s statement of financial position. The existing Conceptual Framework does not provide guidance on derecognition. The ED proposes that the guidances aimed at providing faithful representation of: the assets and liabilities retained after a transaction or other event that led to derecognition, and the change in the entity s assets and liabilities as a result of that transaction or other event. Normally decisions about derecognition are straightforward. However, some derecognition decisions are more difficult when the two aims described above conflict with each other. The discussion in the ED concentrates on these cases. Presentation and disclosure - The ED includes high-level concepts that describe what information is included in the financial statements and how that information should be presented and disclosed. The IASB is also working on the Disclosure Initiative, which is a collection of implementation and research projects aimed at improving disclosure in IFRS financial reporting. In the Disclosure Initiative, the IASB will seek to develop the concepts proposed in this ED to provide additional guidance on presentation and disclosure.

23 20 Presentation and disclosure as communication tool - The ED states that efficient and effective communication of the information presented or disclosed in the financial statements improves its relevance and contributes to a faithful representation of the assets, liabilities, equity, income and expenses. Efficient and effective communication includes: a. Classifying information in a structured manner that report similar items together and dissimilar items separately b. Aggregating information so that it is not obscured by unnecessary detail, and c. Using presentation and disclosure objectives and principles instead of rules that could lead to purely mechanistic compliance. Information about financial performance - The ED does not specify whether the statements of financial performance comprise a single statement or two statements. It describes the statement, or section, of profit or loss as the primary source of information about an entity s financial performance for the period, and requires a total or subtotal for profit or loss to be provided. It does not define profit or loss, but states that the income and expenses included in the statement of profit or loss are the primary source of information about an entity s financial performance for the period. The IASB proposes, for the first time, to provide conceptual guidance on whether to present income and expenses in profit or loss or in other comprehensive income (OCI). The ED states that income or expenses could be reported outside the statement of profit or loss and included in OCI only if: the income or expenses relate to assets or liabilities measured at current values, and excluding those items from the statement of profit or loss would enhance the relevance of the information in the statement of profit or loss for the period. The ED also proposes a presumption that items of income or expenses included in other comprehensive income in one period will be reclassified into the statement of profit or loss in some future period (recycled). The diagram below represents the guidance provided in the ED with regard to presentation of income and expense in profit or loss/oci: Rebuttable presumption that income and expenses are included in profit or loss. Profit or loss is a required total or subtotal. Statement of profit or loss 20X5 20X4 Revenue from customers 234, ,367 Cost of sales (112,764) (106,259) Taxes (21,546) (20,587) Profit (loss) for the year 18,897 16,763 The statement of profit or loss is the primary, but not the only, source of information about an entity s financial performance. Presumption that income and expenses included in OCI in one period are subsequently included in profit or loss. Statement of comprehensive income 20X5 20X4 Profit (loss) for the year 18,897 16,763 Currency translation 68 (51) Fair value adjustment cash flow hedging (2,764) 6, Taxes (215) 87 Other comprehensive income for the year (2,546) 4,253 Total comprehensive income for the year 16,351 21,016 Income and expenses are included in OCI only if that enhances the relevance of profit or loss and if they relate to assets or liabilities remeasured to current values. Source: IFRS-Exposure Draft May 2015/ Snapshot: Conceptual Framework for Financial Reporting

24 21 Reporting entity Based on comments and feedback received on the 2010 Exposure Draft (ED) on the reporting entity concept, the IASB proposes to issue guidance on description and boundaries of a reporting entity. The ED describes a reporting entity concept as an entity that chooses, or is required, to present general purpose financial statements. It does not have to be a legal entity and can comprise only a portion of an entity or two or more entities. The ED proposes to determine the boundary of a reporting entity that has one or more subsidiaries on the basis of control. The ED states that when one entity (the parent) has control over another entity (the subsidiary), the boundary of the reporting entity can be determined by either direct control only (leading to unconsolidated financial statements) or by direct and indirect control (leading to consolidated financial statements). Direct and indirect control Consolidated financial statements Reporting entity Parent Subsidiary Direct control Unconsolidated financial statements Source: IFRS-Exposure Draft May 2015/ Snapshot: Conceptual Framework for Financial Reporting

25 22 The IASB thinks that consolidated financial statements are generally more likely to provide useful information to users than unconsolidated financial statements. In consolidated financial statements, an entity reports on both: its own (directly controlled) assets and liabilities, and its indirect assets and liabilities (those of its subsidiaries: the entities that it controls). In unconsolidated financial statements, an entity reports only on its own (directly controlled) assets and liabilities. If an entity prepares both consolidated and unconsolidated financial statements, the unconsolidated financial statements need to disclose how users may obtain the consolidated financial statements. Conclusion The comment period for this ED is open till 26 October The IASB aims to finalise the revised Conceptual Framework in The proposed changes in the ED may not have an immediate effect on the financial statements of several reporting entities using IFRS around the globe. However, entities may be affected by these proposed changes if they need to use the Conceptual Framework to develop or select accounting policies when no standard specifically applies to a transaction. The IASB proposes, in a separate Exposure Draft Updating References to the Conceptual Framework, to update references to the Conceptual Framework in standards. A transition period of 18 months is proposed to be set out by the IASB for that amendment. That would allow time for preparers to identify, understand and adjust possible implications of the revised Conceptual Framework when they use it to develop or select an accounting policy. Stakeholders expect the Conceptual Framework project to resolve a number of long-standing issues. It is therefore vital for all stakeholders to assess whether their aspirations would be met by the proposals.

26 23 The IASB proposes clarifications to the new revenue standard This article aims to: Provide an overview of key clarifications proposed by the International Accounting Standards Board (IASB) to IFRS 15, Revenue from Contracts with Customers Highlight what the Financial Accounting Standards Board (FASB) is proposing to do in the concerned areas. Evolution of IFRS May 2014 IFRS 15 issued 22 July 2015 Effective date revised to July 2015 The IASB proposals issued 28 October 2015 Comment deadline 1 January 2018 Revised effective date of IFRS 15 Source: KPMG s presentation - New revenue standard - A clearer view of IFRS - 15 July 2015

27 24 Introduction In May 2014, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB), jointly issued a new revenue standard - IFRS 15, Revenue from Contracts with Customers, and Topic 606, Revenue from Contracts with Customers. After issuing the standard, the IASB and the FASB formed the Transition Resource Group (TRG) for revenue recognition to support the implementation of the standard. One of the objectives of the TRG is to inform the IASB and the FASB about any implementation issues which would help the Boards (IASB and FASB) determine what, if any, action should be undertaken to address those issues. The TRG has met five times and discussed about 73 issues. Additionally, many stakeholders represented that the new revenue standard has far reaching impacts and that additional time is required to develop accounting policies, update information technology systems, and change processes and internal controls. Accordingly, on 22 July 2015, the IASB confirmed a one year deferral of the effective date of IFRS 15. This decision is consistent with that of the FASB s decision on 9 July 2015 for a one year deferral of the new revenue standard. On 30 July 2015, the IASB published proposed clarifications (exposure draft (ED)) for public consultation with respect to the following topics: Identifying performance obligations Principal vs agent considerations Licencing, and Transitional relief. The IASB expects these to be the only amendments to the IFRS 15 before entities are required to apply the new standard. The IASB s deadline for receiving comments is 28 October This article provides an overview of key clarifications proposed by the IASB to IFRS 15 and also highlights what the FASB is proposing to do in these areas. I. Identifying performance obligations Current requirements At contract inception, an entity would need to identify each promise to deliver goods or services in a contract with a customer. Under IFRS 15, a promise constitutes a performance obligation, if the promised good or service is distinct. A good or service is distinct if it meets the following two criteria: a. The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer, and b. The entity s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. Concerns The concept of distinct within the context of a contract is new. The TRG considered issues relating to the criterion regarding when a promised good or service is separately identifiable (i.e. distinct within the context of a contract) and supporting guidance given in the standard. The TRG informed the Boards about the potential diversity in stakeholders understanding of what it means for a good or service to be highly dependent on, or highly interrelated with, other goods or services promised in the contract. Proposed clarifications The IASB proposes to add some new examples and to amend some of the existing examples that accompany IFRS 15 to clarify the application of the requirements on identifying performance obligations. The IASB would not amend other parts of the new standard. The examples illustrate when goods or services in a contract are accounted for: As a bundle, single performance obligation Individually, separate performance obligations. The new examples illustrate following cases: Installation services Multiple items Equipment and consumables. FASB s proposals The FASB is proposing more words and more new examples than the IASB, and the plans are to: Rearticulate the principle of when a good or service is separately identifiable in the context of the contract Redraft the existing indicators Specify that goods and services which are immaterial at the contract level can be ignored when identifying performance obligations Include a practical expedient for shipping and handling services. II. Principal vs agent considerations Current requirements When another party, in addition to the entity, is involved in providing goods or services to a customer, IFRS 15 requires an entity to determine whether it is: a. The principal in the transaction (recognise revenue and costs gross), or b. The agent (recognise commission as revenue). If the entity obtains control of the goods or services of another party before it transfers control to the customer, then the entity s performance obligation is to provide the goods or services itself. Therefore, the entity is acting as principal. IFRS 15 provides a list of indicators for evaluating when an entity s performance obligation is not to provide the goods and services itself and the entity is therefore acting as an agent. Concerns The TRG discussed a number of issues regarding the guidance on principal vs agent in IFRS 15. Some stakeholders questioned whether control is always the basis for determining whether an

28 25 entity is a principal or an agent, and how the control principle and the indicators in the standard work together. Questions were also raised on how to apply the control principle to contracts involving intangible goods or services. Proposed clarifications The IASB has decided to clarify the following aspects of the guidance on principal vs agent considerations: Relationship between control principle and related indicators in the standard Applying control to intangible goods or services. Relationship between control principle and related indicators The IASB proposes: To reframe the indicators of control as indicators of when an entity controls a specified good or service before transfer, rather than as indicators that an entity does not control the specified good or service before transfer. To add guidance to explain how each indicator supports the assessment of control as defined in IFRS 15. To remove the indicator relating to the form of the consideration. To clarify that the indicators are not an exhaustive list and merely support the assessment of control. They do not replace or override that assessment. Different indicators might provide more persuasive evidence to support the assessment of control in different scenarios. Applying control to intangible goods or services A new paragraph (paragraph B34A) has been proposed which requires an entity to identify the specified good or service before applying the control principle to that specified good or service. The proposed additional paragraph is expected to achieve the following: A better framework (i.e. clarify the thought process) to be applied when assessing whether an entity is a principal or an agent. To emphasise the importance of appropriately identifying the specified good or service (which could be a right to a good or service to be provided by another party) that will be transferred to the customer. To help clarify that the specified good or service (i.e. the unit of account for the principal vs agent evaluation) is each distinct good or service (or distinct bundle of goods or services). To emphasise that control (as defined in paragraph 33 of IFRS 15) is the determining factor when assessing whether an entity is a principal or an agent. FASB s proposals It is expected that FASB s proposals would be similar to that of IASB s proposals. III. Licencings Current requirements IFRS 15 provides specific application guidance on assessing whether revenue from a distinct licence of intellectual property is recognised at a point in time or over time. If the licence is not distinct from other promises in the contract, then the general model in Step 5 of the standard is applied. Otherwise, the entity applies different criteria to determine what the distinct licence provides to the customer, and therefore when to recognise the revenue. If the licence provides: A right to use the intellectual property as it exists at the time the licence is granted, then revenue is recognised at a point in time. A right to access the intellectual property as it exists throughout the licence period, then revenue is recognised over time. A licence provides a right to access to the entity s intellectual property if: The contract requires, or the customer reasonably expects, that the entity will undertake activities that significantly affect the intellectual property to which the customer has rights The rights granted by the licence directly exposes the customer to any positive or negative effects of the entity s activities, and Those activities do not result in the transfer of a good or service to the customer as those activities occur. If all the criteria are not met, then the licence provides a right to use the entity s intellectual property that is satisfied at a point in time. Concerns The TRG discussed issues relating to the application of the licences guidance in IFRS 15. The main issues discussed relates to determining the nature of the entity s promise in granting a licence of intellectual property. Proposed clarifications The IASB plans revised drafting to clarify the application guidance on licencing and new examples to improve the operability and understandability of the guidance. The proposal is expected to clarify whether revenue from a licence is recognised either: Upfront on the day the licence is granted, or Over time during the licence period. Determining the nature of the entity s promise in granting a licence of intellectual property The IASB proposes to provide additional guidance on when activities change the intellectual property to which the customer has rights. The core idea is to focus on the functionality of the licence, for example: Movies recognise revenue upfront because functionality exists once the movie has been shot. Brands recognise revenue over time because the functionality changes constantly as the entity updates the brand.

29 26 Consideration in the form of sales-based or usage-based royalties Current requirements IFRS 15 includes an exception to the general requirement of estimating variable consideration. Under this, an entity recognises revenue for a sales-based or usage-based royalty promised in exchange for a licence of intellectual property when the later of the following events occurs: The customer s subsequent sales or usage occurs, and The satisfaction or partial satisfaction of the performance obligation to which some or all of the sales-based or usagebased royalty has been allocated. Concern The TRG s main concern was the scope and applicability of the sales-based and usage-based royalties exception. Proposed clarifications The IASB plans to clarify when and how to apply the exception. The proposal is to recognise sales and usage based royalties as the sales or usage occur if the royalty relates only to a licence of intellectual property, or the licence of intellectual property is the pre-dominant item to which the royalty relates. Royalty that relates to more than one thing should be recognised either as an exception (sales-based or usage-based) or as per the requirements of variable consideration. This proposal clarifies that a royalty is either entirely inside or entirely outside the scope of the exception. FASB s proposals The FASB is proposing more new words and examples than the IASB such as: When to recognise revenue - new classification of all licences as either functional or symbolic. Licences that are not distinct - clarification of when to apply the licences guidance. Sales or usage-based royalties - similar to IASB s proposals. Contractual restrictions - additional guidance and new examples. IV. Transitional relief Current requirements IFRS 15 currently has three choices for transition: Full retrospective approach with no practical expedients an entity would restate contracts at the start of the earliest presented comparative period. Partial retrospective approach with practical expedients an entity would restate contracts at the start of the earliest period presented, except those covered by any practical expedients it has elected. Cumulative effect approach restate all contracts that were not completed under the existing revenue requirements at the start of the current period. Proposals The IASB is proposing two additional practical expedients on transition to IFRS 15: To permit an entity to use hindsight in (i) identifying the satisfied and unsatisfied performance obligations in a contract that has been modified before the beginning of the earliest period presented, and (ii) determining the transaction price. To permit an entity that elects to use the full retrospective approach, to not restate completed contracts at the beginning of the earliest period presented. FASB s proposals The FASB is likely to propose that on transition an entity could elect to use hindsight when determining the effects of contract modifications. However, the FASB is not expected to propose a practical expedient for completed contracts when applying the retrospective transition approach. Impact The IASB has issued clarifications instead of amending the main principles of the standard. The IASB considered the need to balance being responsive to issues raised to help entities implement IFRS 15 and the risk of creating a level of uncertainty about the standard to the extent that the IASB s actions might be disruptive to the implementation process while determining its response and clarifications. The IASB expects that any further implementation issues are unlikely to lead to standard setting and is unlikely to propose any further amendments until after the post-implementation review of IFRS 15. It may be noted that the IASB is required to conduct a post-implementation review (PIR) of each new standard, about two to three years after it becomes effective. The clarifications discussed in the ED would be finalised by the IASB post receiving comments on this ED. Comment period ends on 28 October Therefore, in some ways, Ind AS 115 which is based on IFRS 15 is a complete standard and the key principles in the standard are unlikely to be amended by the IASB in the near term. The clarifications provided by the IASB may help in the consistent application of this standard in India. Next steps The IASB intends to consider the comments it receives on these proposals and decide whether to proceed with the amendments to IFRS 15. It expects to complete its redeliberations by the end of The FASB is additionally proposing to provide clarifications in the areas of non-cash consideration, collectability and the presentation of sales tax. Since Ind AS 115 is aligned with IFRS 15, the regulators in India such as the Ministry of Corporate Affairs (MCA) and the Institute of Chartered Accountants of India (ICAI) should keep a close watch on the recent developments by the IASB on IFRS 15. Since India will be one of the first countries to adopt IFRS 15, Indian entities should assess the impact of the new revenue standard on their financial reporting earlier and accordingly modify their information technology systems, business processes and internal controls so that the information required for reporting and disclosure purposes is appropriately captured. (Source: IFRS Notes 2015/06 issued by KPMG on 7 August 2015)

30 27 Regulatory updates Revision of Non-Banking Financial Companies (Approval of Acquisition or Transfer of Control) Directions, 2014 The Reserve Bank of India (RBI) through its notification dated 26 May 2014 issued Non-Banking Financial Companies (Approval of Acquisition or Transfer of Control) Directions, 2014 which are applicable to every Non-banking Financial Company (NBFC) whether accepting deposits or not. The said directions, inter alia, required prior approval of the RBI for acquisition or transfer of control of NBFCs. The RBI has revised the said directions through a notification dated 9 July Revised directions are as follows: Requirement of prior approval of the RBI Prior written permission of the RBI will be required for: a. Any takeover or acquisition of control of an NBFC, which may or may not result in change of management. b. Any change in the shareholding of an NBFC, including progressive increases over time, which would result in acquisition/transfer of shareholding of 26 per cent or more of the paid-up equity capital of the NBFC. No prior approval would be required in case of any shareholding going beyond 26 per cent due to buy-back of shares/reduction in capital, provided, it has approval of a competent court. NBFCs are required to report to the RBI about such change in shareholding not later than one month from the date of its occurrence. c. Any change in the management of the NBFC which would result in change in more than 30 per cent of the directors, excluding independent directors. Prior approval would not be required for those directors who get re-elected on retirement by rotation. NBFCs should continue informing the RBI regarding any change in the directors/management as required in Non- Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998, Non-Systemically Important Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015 and Systemically Important Non-Banking Financial (Non-Deposit Accepting Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015.

31 28 Application for prior approval NBFCs shall submit an application in the prescribed format/ manner for obtaining prior approval of the RBI along with the prescribed documents to competent authority. Requirement for prior public notice about change in control/ management a. A public notice of at least 30 days shall be given before effecting the sale of, or transfer of the ownership by sale of shares or transfer of control, whether with or without sale of shares. Such notice shall be given by the NBFCs and other party, after obtaining prior permission of the RBI. b. The public notice shall indicate the intention to sell or transfer ownership/control, the particulars of transferee and the reasons for such sale or transfer of ownership/ control. Also, it should be published in at least one leading national and in one leading local (covering the place of registered office) vernacular newspaper. The above mentioned directions has been made applicable with immediate effect i.e. the same will apply on any takeover or acquisition of control, any change in the shareholding or any change in the management occurring after the date of this notification. Any violation of the aforementioned directions would result in adverse regulatory action including cancellation of certificate of registration of the NBFC. (Source Notification RBI/ /122 by the RBI dated 9 July 2015) Revised format of annual return for all non-deposit taking NBFCs On 10 November 2014, the Reserve Bank of India (RBI) issued revised regulatory framework for NBFCs that required, all nondeposit taking NBFCs (NBFCs-ND) with assets less than INR500 crore, to submit an annual return. The RBI through its notification dated 9 July 2015 prescribed the format of annual return to be filed by all non-deposit taking NBFCs meeting the following criteria: NBFCs-ND with assets size between INR crore (NBS 8), and NBFCs-ND with assets size below INR100 crore (NBS 9). The annual return should be submitted within 30 days of closing of the financial year. However, considering that most of these NBFCs will be filing such return for the first time, the annual return for the year ended 31 March 2015 may be filed by 30 September The NBFCs that have already submitted the prescribed return for the quarter ending 31 March 2015 are not required to submit the annual return for the year ended 31 March The MCA extends the last date for filing of annual return and financial statements forms Form for filing an annual return (MGT-7) - Section 92(4) of the Companies Act, 2013 (2013 Act) requires that every company should file with the Registrar of Companies (ROC), a copy of the annual return within 60 days from the date on which the annual general meeting (AGM) is held. Rule 11(1) of the Companies (Management and Administration) Rules, 2014 requires that every company should prepare its annual return in the Form MGT-7. Form for filing financial statements (AOC-4/AOC-4 XBRL) - Section 137 of the 2013 Act requires that every company should file with the ROC the following items: a copy of the financial statements, including consolidated financial statements (CFS), if any, documents which are required to be attached with such financial statements under the 2013 Act, that have been duly adopted at the AGM of the company. The above items should be filed with the ROC within 30 days of the date of the AGM with such fees and additional fees as may be prescribed in the 2013 Act. Rule 12(1) of the Companies (Accounts) Rules, 2014 requires that every company should file the financial statements with the ROC together with Form AOC-4. Rule 12(2) provides that the class of companies notified by the Central Government should mandatorily file their financial statements in the extensible Business Reporting Language (XBRL) format and that the Central Government may specify the manner of filing under such notification for such class of companies. The Ministry of Corporate Affairs (MCA) through a general circular dated 13 July 2015 issued the following clarifications: By 30 September 2015, the electronic version of the Forms AOC-4, AOC-4 XBRL and MGT-7 will be available for filing. By October 2015, a separate form for filing of CFS AOC-4 CFS will be made available. Till 31 October 2015, the Forms AOC-4, AOC-4 XBRL and MGT-7 can be filed with the ROC without payment of additional fees. Till 30 November 2015, companies to which XBRL is not applicable but are required to file CFS would be able to do so in a separate form for CFS AOC-4 CFS without payment of additional fees. (Source General Circular No. 10/2015 by the MCA dated 13 July 2015 and KPMG s First Notes dated 14 July 2015) (Source Notification RBI/ /119 by the RBI dated 9 July 2015)

32 29 Issue of shares under the Employees Stock Options Scheme and/or sweat equity shares to persons resident outside India As per Regulation 8 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000, an Indian company can issue shares under the Employees Stock Options Scheme, to its employees or employees of its joint venture or wholly owned subsidiary abroad who are resident outside India, directly or through a trust, provided that: a. the scheme has been drawn in terms of regulations issued under the Securities Exchange Board of India Act, 1992 (SEBI Act), and b. face value of the shares to be allotted under the scheme to the non-resident employees does not exceed 5 per cent of the paid-up capital of the issuing company. The Reserve Bank of India (RBI) through its notification dated 16 July 2015 has revised the above mentioned guidelines. According to the revised guidelines, an Indian company may issue employees stock option and/or sweat equity shares to its employees/directors or employees/directors of its holding company or joint venture or wholly owned overseas subsidiary/ subsidiaries who are resident outside India, provided that: a. The scheme has been drawn either in terms of regulations issued under the SEBI Act or the Companies (Share Capital and Debentures) Rules, 2014 notified by the Central Government under the Companies Act 2013, as the case may be. b. The employee s stock option/sweat equity shares issued to non-resident employees/directors under the applicable rules/ regulations are in compliance with the sectoral cap applicable to the said company. c. Issue of employee s stock option/sweat equity shares in a company where foreign investment is under the approval route shall require prior approval of the Foreign Investment Promotion Board (FIPB) of the Government of India (GOI). d. Issue of employee s stock option/sweat equity shares under the applicable rules/regulations to an employee/director who is a citizen of Bangladesh/Pakistan shall require prior approval of the FIPB of the GOI. The issuing company should furnish a return (as per the Form-ESOP) to the RBI within 30 days from the date of issue of employees stock option or sweat equity shares to the prescribed competent authority. (Source Notification RBI/ /128 by the RBI dated 16 July 2015) The MCA clarifications regarding circulation and filing of financial statements under the Companies Act, 2013 The Ministry of Corporate Affairs (MCA) received representations from various stakeholders in relation to circulation and filing of financial statements under the Companies Act, 2013 (2013 Act). On 21 July 2015, the MCA issued a general circular no. 11/2015, which has provided the following relaxations: a. Where a general meeting has been called upon by giving a notice shorter than 21 days (in accordance with the provisions of Section 101 of the 2013 Act), it has been clarified that financial statements, to be considered in the same general meeting, may also be circulated at such shorter notice. b. In case of a foreign subsidiary, which is not mandatorily required to get its accounts audited as per legal requirements prevalent in the country of its incorporation and such accounts are not audited, the Indian holding company may

33 30 file such unaudited accounts to comply with requirements of Section 136(1) and 137(1) of the 2013 Act as applicable. These, however, would be translated in English, if the original accounts are not in English. However, the format of the accounts of foreign subsidiaries should be in accordance with the requirements under the 2013 Act. In case this is not possible, a statement indicating the reasons for deviation may be filed alongwith the accounts. For a detailed overview of the clarifications issued by the MCA, refer to KPMG s First Notes dated 24 July (Source General circular no. 11/2015 by the MCA dated 21 July 2015) The SEBI (Prohibition on Raising Further Capital From Public and Transfer of Securities of Suspended Companies) Order, 2015 In terms of Section 21 of the Securities Contracts (Regulation) Act, 1956 read with Section 11A of the Securities and Exchange Board of India, Act (SEBI Act), all listed companies are mandated to comply with listing conditions prescribed under the equity listing agreement. Section 11A of the SEBI Act empowers the SEBI to prohibit any company from issuing prospectus, etc., soliciting money from public for issue of securities and to specify requirements, for transfer of securities and matters incidental thereto. It has come to the notice of the SEBI that several listed companies continuously fail to comply with listing conditions stipulated under the equity listing agreement and consequently trading in their shares is suspended by the concerned recognised stock exchange. Therefore, to ensure effective enforcement of the listing conditions, improve compliance environment among the listed companies and to protect the interests of investors in securities and the securities market, the SEBI through its general order dated 20 July 2015 has ordered that: a. A suspended company, its holding and/or subsidiary, its promoters and directors shall not, issue prospectus, any offer document, or advertisement soliciting money from the public for the issue of securities, directly or indirectly; till the suspension is revoked by the concerned recognised stock exchange or securities of such company are delisted in accordance with the applicable delisting requirements, whichever is earlier unless the SEBI relaxes the restriction. b. The suspended company and the depositories shall not effect transfer, by way of sale, pledge, etc., of shares of a suspended company held by promoters/promoter group and directors till three months after the date of revocation of suspension by the concerned recognised stock exchange or till securities of such company are delisted in accordance with the applicable delisting requirements, whichever is earlier. The concerned recognised stock exchange and depositories shall co-ordinate with each other for ensuring compliance with this requirement. Such promoter/director may file an objection, if any, before the concerned recognised stock exchange who may, on satisfactory reasons shown by such promoter/director, remove this restriction in accordance with its applicable rule, regulations and bye-laws. (Source General order no. 1 by the SEBI dated 20 July 2015)

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35 KPMG in India offices Ahmedabad Commerce House V 9th Floor, 902 & 903 Near Vodafone House, Corporate Road, Prahlad Nagar Ahmedabad Tel: Fax: Bengaluru Maruthi Info-Tech Centre 11-12/1, Inner Ring Road Koramangala, Bengaluru Tel: Fax: Chandigarh SCO (Ist Floor) Sector 8C, Madhya Marg Chandigarh Tel: /781 Fax: Chennai No.10, Mahatma Gandhi Road Nungambakkam Chennai Tel: Fax: Delhi Building No.10, 8th Floor DLF Cyber City, Phase II Gurgaon, Haryana Tel: Fax: Hyderabad /2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad Tel: Fax: Kochi Syama Business Centre, 3rd Floor, NH By Pass Road, Vytilla, Kochi Tel: Fax: Kolkata Unit No ,6th Floor, Tower 1,Godrej Waterside, Sector V,Salt Lake, Kolkata Tel: Fax: Mumbai Lodha Excelus, Apollo Mills N. M. Joshi Marg Mahalaxmi, Mumbai Tel: Fax: Pune 703, Godrej Castlemaine Bund Garden Pune Tel: /65 Fax:

36 KPMG in India s IFRS institute - Re-launched KPMG in India is pleased to re-launch its IFRS institute - a web-based platform, which seeks to act as a wide-ranging site for information and updates on IFRS implementation in India. The website provides information and resources to help board and audit committee members, executives, management, stakeholders and government representatives gain insight and access to thought leadership publications that are based on the evolving global financial reporting framework. IFRS Notes The IASB proposes clarifications to the new revenue standard 7 August 2015 On 30 July 2015, the International Accounting Standards Board (IASB) published for public consultation proposed clarifications with respect to the following topics: a) Identifying performance obligations b) Principal vs agent considerations c) Licencing, and d) Transitional relief. The IASB s deadline for receiving comments is 28 October Our issue of IFRS Notes provides an overview of key clarifications proposed by the IASB to IFRS 15, Revenue from Contracts with Customers and also highlights what the FASB is proposing to do in these areas. Missed an issue of Accounting and Auditing Update or First Notes? MCA clarifications regarding circulation and filing of financial statements under the Companies Act, July 2015 The Ministry of Corporate Affairs (MCA) received representations from various stakeholders in relation to circulation and filing of financial statements under the Companies Act, 2013 (2013 Act). On 21 July 2015, the MCA issued a general circular no.11/2015, which provided clarifications with regard to the following provisions of the 2013 Act: Section 101 notice of meeting Section 136 right of member to copies of audited financial statements Section 137 copy of financial statements to be filed with the Registrar of Companies. 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 On 19 August, 2015 we will be covering the following topics: I. Overview of Ind AS 28, Investment in Associates and Joint Ventures, Ind AS 111, Joint Arrangements and Ind AS 112, Disclosure of Interests in Other Entities II. Key differences between AS 23, Accounting for Investment in Associates in Consolidated Financial Statements and Ind AS 28 and between AS 27, Financial Reporting of Interests in Joint Ventures and Ind AS 111 III. Overview of key clarifications to IFRS 15, Revenue from Contracts with Customers proposed by the IASB. Our issue of First Notes provides an overview of the clarifications issued by the MCA. Feedback/queries can be sent to aaupdate@kpmg.com Previous editions are available to download from: Latest insights and updates are now available on the KPMG India app. Scan the QR code below to download the app on your smart device. Play Store App Store 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, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. Printed in India. (024_NEW0815)