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Accounting and Auditing UpdateIssue no. 11/2017

June 2017

Editorial

Sai VenkateshwaranPartner and HeadAccounting Advisory Services KPMG in India

Ruchi RastogiExecutive DirectorAssuranceKPMG in India

As banks transition to Ind AS, they would need to assess their business model while classifying their financial instruments under Ind AS 109, Financial Instruments. In this month’s Accounting and Auditing Update (AAU), we explain the concept of a business model assessment in two scenarios: loans advanced and investments made in debt instruments by banks. The accounting for these two scenarios has been explained with the help of case studies.

In phase I of the Ind AS transition, many companies have opted for deemed cost exemption in relation to the accounting of property, plant and equipment. Our article explains the deemed cost exemption and also highlights the challenges/implications in accounting on Ind AS transition when a company chooses to apply the deemed cost exemption for its property, plant and equipment. This article also covers the implication on Minimum Alternate Tax (MAT) computation both on transition and in subsequent annual financial statements.

In our Companies Act, 2013 (2013 Act) section, we describe the key responsibilities of directors. The article also compares the requirements of the 2013 Act with the Securities and Exchange Board of India’s (SEBI) regulations with regard to directors.

Ind AS framework on leases is based on the substance of lease rather than form. Land in India is typically available on lease. Our article emphasises the need to assess all of the lease classification indicators before classifying a lease as an operating or a finance lease.

As is the case each month, we also cover a regular round-up of some recent regulatory updates in India and internationally.

We would be delighted to receive feedback/suggestions from you on the topics we should cover in the forthcoming editions of AAU.

© 2017 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.

Table of contents

Business model analysis for loans and debt investments 01

09Key responsibilities of directors

Application of substance over form under Ind AS – lease of land 1 9

Deemed cost accounting under Ind AS 23

Regulatory updates 29


In India, banks have historically adopted an ‘originate and hold’ business model for their lending portfolios. However, financial institutions may engage in various business activities to manage their liquidity requirements, pursue growth opportunities and achieve their business objectives. Such activities may include sale or securitisation of loans, syndication of loans and sale of investments to manage liquidity or based on prudential regulations.

Indian Accounting Standard (Ind AS) 109, Financial Instruments, requires entities to classify financial assets on the basis of their business model for managing the financial assets and on the basis of the contractual cash flow characteristics of the financial asset. The business model for a group of financial assets reflects how the assets are managed together to achieve a particular business objective. Therefore, the business model is not based on the management’s intent for a specific loan or investment but is based on fact and is determined at a higher level of aggregation. A single reporting entity may have more than one business model for managing its financial assets.

The case studies included in this article aim to demonstrate the business model assessment by a bank for:

• Loans advanced, where it has a portfolio of loans which are managed differently, and

• Investments made by a bank in debt instruments, where each portfolio of investment aims to achieve a different business objective.

This article aims to:

– This article aims to provide an overview of the business model assessment by banks for loans advanced and investments made in debt instruments.

Business model analysis for loans and debt investments

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Case study 1Key characteristics of loans

Bank B (the bank) has a corporate and an investment banking division. The corporate banking division provides loans to corporates either by extending loans on a stand-alone basis or by acting as an arranger in case of a loan syndication (through its syndication desk).

The bank has a credit committee, which reviews loan applications made by various corporates. It determines the credit standing and solvency of prospective borrowers. After approving the loan, the committee, on the basis of the credit policy of the bank and other factors (such as the sector to which

the corporate belongs, its credit rating, the nature of the collateral provided, the amount of the loan and the repayment period), determines the pricing of the loan and quantum of risk that should be held by the bank. The balance portion of the loan is managed by the syndication desk and may be sold to other banks as a participation feature. As per the policy of the bank, the credit committee generally provides a six month timeline to the syndication desk to process this sale, after which the risk exposure may be reassessed.

When selling a participation feature, the bank enters into a sale agreement with another bank (participating bank). As per the sale

agreement, the risks of default of the loan and rewards (in the form of principal and interest payments) in the loan get transferred to the participating bank. The borrower is intimated about the sale arrangement and of the fact that the risk of default for the portion of the loan sold lies with the participating bank. The bank, however, may still be responsible for collection of cash flows from the borrower and for distributing them to the participating bank(s). Considering that all risks and rewards pertaining to the portion of the loan sold are transferred to the participating bank, that portion of the loan is derecognised by the bank from its financial statements based on the guidance in Ind AS 109.

On 1 April 2017, the bank enters into the following lending arrangements:

On 1 October 2017, the syndication desk had not been able to sell 40 per cent of the loan advanced to C Limited (INR800 million) and continued to hold the loan for collection. As per the decision of the credit committee, the corporate banking division was required to sell that portion of the loan as a participating feature to another bank within 6 months (i.e. by 30 September 2017).

Name of company

Details of industry and company

Details of loan advanced

Credit committee decision

A Limited A Limited is a reputed real estate developer. It has a credit rating of BBB. It needs a loan for its new township project.

A loan of INR1,000 million is issued with interest rate of 14 per cent per annum, payable annually. The loan is repayable at the end of five years.

Considering the Bank’s credit risk policies, the credit committee has decided to retain 30 per cent of the loan and the remaining portion is managed by the syndication desk. The syndication desk may hold this portion for collection for a certain period and then sell a participation feature in the loan to another bank at a later date.

C Limited C Limited is in the business of exploring oil and gas. It has a credit rating of AA. It requires funds for oil exploration activities and has applied for a loan.

Loan of INR2,000 million is issued, with an interest rate of 12.5 per cent per annum. The loan is repayable in 20 equal semi-annual instalments.

Considering the industry and risk exposure of the loan, the credit committee of the bank has decided to hold 60 per cent of the loan for collection with the remaining portion being managed by the syndication desk. This portion may be sold as a participation feature in the loan to another bank at a later date.

D Limited D Limited is a pharmaceutical company and manufactures medicines in India. It has a credit rating of AAA. It is setting up another plant in an Export Oriented Unit (EOU) in order to increase production to meet demand from overseas markets.

Loan of INR600 million is issued, with an interest rate of 11.3 per cent per annum payable on a quarterly basis. The loan is repayable over a period of five years in 10 equal half-yearly instalments.

Considering the industry and the credit risk exposure arising from the loan, the credit committee of the bank has decided to hold the entire loan for collection.

Accounting issueOne of the essential aspects in determining the classification of a financial asset under Ind AS 109 is to ascertain the objective of the business model within which the financial asset is held. In case study 1 above, a portion of the loans granted by Bank B is held to collect contractual cash flows, while the remaining portion is managed by the syndication desk and may be sold to another bank. This indicates

that each portion of the loan meets a different business objective. In the above case, the bank needs to determine the business model within which each portion of the loan is held. Further, the bank needs to evaluate whether it needs to reassess the business model for each loan based on the occurrence or non-occurrence of a subsequent event .

On the basis of the business model and the contractual cash flow

characteristics of the financial asset, the bank is required to classify the loans on initial recognition into one of the following three categories:

• Fair Value through Profit and Loss (FVTPL)

• Fair Value through Other Comprehensive Income (FVOCI)

• Amortised cost.

Accounting guidanceThe following figure summarises the assessment of the business model as specified in Ind AS 109 and the resultant measurement category.

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Figure 1: Business model assessment for loans and debt investments

(Source: KPMG in India’s analysis read with Insights into IFRS, KPMG IFRG Ltd’s publication, 13th edition, September 2016)

Do the cash flows meet the SPPI1 criterion?

FVTPL

Is the financial asset held-to-collect contractual cash flows?

Is the financial asset held to achieve a dual objective?

FVOCI - debt

• Manage assets on fair value basis

• Maximise cash flows through sale

• Collection of contractual cash flows is incidental to objective

• Objective of business model is to hold assets to collect contractual cash flows

• Sales are incidental to the objective of the business model

• Both, collecting contractual cash flows and sales are integral to achieve objective

• Model typically has more sales (in frequency and volume) than the held-to-collect business model

Amortised cost

No

No

No

Yes

Yes

Yes

1. SPPI criterion - The contractual terms of the financial asset being assessed for classification give rise to cash flows that are Solely Payments of Principal and Interest (SPPI) on the principal amount outstanding.

AnalysisCase 1

The term loans originated by Bank B have similar characteristics and form part of a single portfolio of loans. The Key Management Personnel (KMP) of the bank determine the objective of the business model within which the loans are held and managed. As stated above, a portion of the loans is managed by the corporate banking desk, which monitors the credit risk associated with the loan and collects the contractual cash flows over its term. The remaining portion of the loans is managed by the syndication desk which collects contractual cash flows for a certain period of time and limits the bank’s risk exposure by seeking to sell or sub-participate the loan at an appropriate time. The KMP

of the bank assess the performance of the corporate banking desk (based on management of credit quality and recovery of contractual returns) separately from the performance of the syndication desk (based on recovery of contractual returns as well as fair value related information).

In the scenario above, it may be appropriate to separate the portfolio of loans into two sub-portfolios based on the objective and manner in which the loans are managed. One sub-portfolio comprises loans (or a portion of loans) managed by the corporate banking desk for collection of contractual cash flows and the other sub-portfolio comprises loans (or portion of loans) managed by the syndication desk for collection as well as sale of participation rights.

This is supported by the observations in the Report of the Working Group on Implementation of Ind AS by Banks in India (the Working Group report) issued by the Reserve Bank of India (RBI). The Working Group report clarifies that where the bank’s internal policy documents require a single financial instrument to be split into two parts, with each part being managed differently, each of these parts may have a different classification. Hence, the portfolio can be bifurcated into two sub-portfolios for further analysis. The bank is required to determine the business model for each sub-portfolio. The following is an overview of the sub-portfolios and their classification based on the business model.

The ‘loans held by the bank’ sub-portfolio is managed by the bank to collect its contractual cash flows over the life of the loans (a ‘held-to-collect’ business model). This objective is demonstrated by the fact that the the performance of the portfolio is monitored by the KMP based on its credit quality and contractual returns. The cash flows on the loan represent payments of principal and interest (i.e. SPPI criterion is met). Hence, the loan

is eligible for classification into the ‘amortised cost’ category.

The sub-portfolio of loans managed by the syndication desk is held for collection of contractual cash flows for a certain period of time. At a subsequent stage these loans (or portions of loans) are sold to other banks to manage the bank’s credit exposure. When sold, these loans are derecognised it from the bank’s financial statements since substantially all risks and rewards

are transferred to the participating bank. Further, the performance of this sub-portfolio is monitored and managed on a fair value basis. This indicates that the business model is to hold the loans for collecting contractual cash flows and for sale. The cash flows on the loan represent payments of principal and interest (i.e. SPPI criterion is met). Hence, this portion of the loans may be classified as measured at FVOCI.

Table 2: Analysis of loans

Particulars

Sub-portfolio 1 Sub-portfolio 2

Loans managed by corporate banking deskLoans managed by syndication

desk

Loan advanced to D Limited

Loan advanced to A Limited

Loan advanced to C Limited

Loan advanced to A Limited

Loan advanced to C Limited

Per cent (%) 100 30 60 70 40

Amount (INR in million) 600 300 1,200 700 800

Business Model Held-to-collect Held-to-collect Held-to-collect

Both held to collect and for sale

Both held to collect and for sale

Classification Amortised cost Amortised cost Amortised cost FVOCI FVOCI

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(Source: KPMG in India’s analysis, 2017)

Considerations on first-time adoption

The RBI has observed in its Working Group report that in certain situations a single financial instruments may have to be split up into two separate classifications. While Ind AS 109 permits a portion of a financial asset to be separately considered for derecognition, it does not specify whether a financial asset may be split up for classification on initial recognition. The RBI in its Working Group report specifies that the Institute of Chartered Accountants of India (ICAI) may consider this aspect further in its application guidance/educational material for Ind AS 109. Consequently, banks and other entities in the financial services sector should consider the impact of any guidance that may be issued in the future on this subject.

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In the case study 1, the syndication desk was unable to sell a participation feature in the portion of the loan advanced to C Limited within the six month time frame prescribed by the credit committee. This portion of the loan continues to be held for collection by the bank. The cash flows of this asset are therefore realised in a

manner different from the bank’s expectations (which was based on relevant and objective information available at the time of initial recognition and classification). As per Ind AS 109, this occurrence would not give rise to a prior period error in the bank’s financial statements nor result in a change in classification of other financial

assets held within that business model.

However, the bank should analyse the reason for not having been able to sell this portion of the loan and assess the business model for new loans originated.

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Case study 2Key characteristics of investments

Bank B has a treasury department which invests in debt and equity securities in accordance with the bank’s Board approved ‘investment policy’. It has a proprietary trading desk (prop desk) which actively trades in securities with the intention of benefiting from short-term fluctuation in prices of securities.

The Bank also has a separate desk for Asset Liability Management (ALM) purposes, which manages the Bank’s solvency and liquidity requirements including its investments in financial assets that

are intended to meet the Statutory Liquidity Ratios (SLR) as per prudential norms. The ALM desk transacts in an identified portfolio of securities, with the ultimate goal of managing the bank’s liquidity function.

Based on RBI’s Master Circular on Prudential norms for classification, valuation and operation of investment portfolio by banks (the Regulations), the bank categorises its securities under the ‘Held To Maturity’ (HTM), ‘Available For Sale’ (AFS) and ‘Held For Trading’ (HFT) categories, as appropriate.

The securities acquired by the ALM desk may be held until maturity or subsequently sold in order to

manage the liquidity and prudential requirements. Although securities may be identified as HTM or AFS on initial recognition, on an annual basis, the ALM desk re-evaluates its decision regarding managing its securities (i.e. whether they would be held until maturity of the instrument, or would be subsequently sold to manage the availability of funds). Accordingly, investments are transferred from the HTM to the AFS category during the year (the annual quantum of such transfers approximates four to five per cent of the HTM securities at the beginning of the year).

Accounting issueIn case study 2 above, the bank has invested in a portfolio of securities and needs to determine the business model under which the portfolio of securities are held.

On the basis of the business model and the contractual cash flow characteristics of the financial asset, the bank is required to classify the investments on initial recognition into one of the following categories:

• FVTPL

• FVOCI debt

• FVOCI equity

• Amortised cost

On 31 March 2017, the investments held in the following prudential categories are:

During the quarter ended 30 June 2017, the treasury department purchased the following debt securities:

Category Amount

Held to maturity INR60 million

Available for sale INR110 million

Held for trading INR30 million

Security Amount Investment proposal

Investments purchased by the prop desk

9.4% Corporate bonds of XYZ Limited INR 1,000 each

INR40 million These are purchased by the prop desk at a discount of 10% to face value.

Investments purchased by the ALM desk

8% Government securities maturing in 2025 INR20 million Securities are expected to be held until maturity.

Debentures and bonds of various companies INR70 million These bonds have been procured to meet a long-term cash obligation.

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AnalysisThe securities acquired by the bank may be divided into two separate portfolios in order to assess the objective of the business model within which these are held. The objectives of the portfolios are determined by the KMP of the bank. Considering the differences in the business objective that the securities held by the prop desk and the ALM desk of the bank seek to achieve, these securities are analysed as separate portfolios.

A. Securities managed by the prop desk

The prop desk invests in securities to take advantage of short-term variability in their market prices, and earn profits by trading in them. This demonstrates that the investments held by the prop desk are not held or managed to collect their contractual cash flows and are in fact, held for trading. The prop desk evaluates the performance of the portfolio of securities based on their fair values and also reports to the KMP on the same basis. In this case study, although the bank would receive periodical coupons on the 9.4 per cent corporate bonds of XYZ Limited, the collection of these coupons is incidental to achieving its objective of making a profit from

sale of the securities by taking advantage of short-term price gains. Hence these bonds should be classified as and measured at FVTPL.

B. Securities managed by the ALM desk

The ALM desk transacts in securities to manage the bank’s liquidity needs as well as meet the SLR requirements. Although the objective for which a security is acquired may be identified on initial recognition, the ALM desk re-evaluates this objective on an annual basis. Therefore, securities may be tagged as HTM initially but may be identified for sale at a later date based on the bank’s liquidity needs and SLR requirements. Therefore, the securities held by the ALM desk are considered to form part of the same portfolio of investments, irrespective of their categorisation as HTM or AFS under prudential regulations.

Accordingly, while determining the business model for its portfolio of securities, the ALM desk should consider how groups of financial assets are managed together to achieve the business objective, and not how it intends to manage each individual security forming part of that portfolio. In the current case study, the ALM desk has

procured two financial assets, which are analysed below:

• 8 per cent government securities for INR20 million, acquired with the intent to hold them until their maturity (2025). The ALM desk may reconsider this objective based on the fair value of the securities and liquidity requirements, and sell them prior to their maturity date.

• Debentures and bonds of various companies of INR70 million, which have been acquired specifically to meet certain long-term cash obligations. The objective of investing in these bonds is therefore, to earn contractual cash flows for a certain period of time and subsequently to realise their fair value to meet the liquidity requirements of the bank.

The analysis above indicates that the portfolio of securities managed by the ALM desk are held in a business model whose objective is achieved by both collecting contractual cash flows and selling the securities. The securities in this portfolio should, therefore, be classified as and measured at FVOCI (debt), assuming that they meet the SPPI criterion.

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Consider this

In case study 1 above, banks would need to re-evaluate the business model under which the loans are held, if the terms of the sale between the syndicating bank and the participating bank would not result in transfer of all risks and rewards and therefore, would not result into derecognition of the loan ‘sold’ to the participating bank.

Considerations on first-time adoption

Currently, RBI prudential regulations prescribe the classification of the investments into the HTM, AFS and HFT categories presented in the financial statements. This classification is different as compared to the classification and measurement requirements prescribed by Ind AS 109. As observed in the Working Group report, the RBI needs to suitably align/withdraw its guidelines on classification of investment portfolios.

If the regulation is amended and aligned with the requirements of Ind AS 109, banks may consider the impact on classification of the following categories:

Investments classified as ‘Held to Maturity’

As per RBI norms, securities are classified as HTM when acquired with the intention to hold them until maturity. However, on an annual basis, banks are permitted to sell or transfer securities held under this category into other categories. In the current case study, the ALM desk reviews its decision for categorising its securities under the HTM category at the beginning of each financial year. Considering this and the analysis above, the investments amounting to INR60 million forming part of the ALM desk’s portfolio on the date of transition to Ind AS, would be classified as and measured at FVOCI (assuming they meet the SPPI criterion).

Investments classified as ‘Held for Trading’

As per RBI norms, securities are classified as HFT when banks acquire them with the intent to trade in them by taking advantage of short-term price/interest rate movements. Investments categorised as HFT are generally purchased and managed by the prop desk. In the current case study, securities amounting to INR40 million have been categorised as HFT by the bank. Accordingly, on transition to Ind AS, these securities would be classified as and measured at FVTPL.

Investments classified as ‘Available for Sale’

As per RBI guidelines, securities are classified as AFS when they do not fit into any of the above categories. Such investments would generally be procured to achieve a dual objective. In the current case study, securities amounting to INR110 million are categorised as AFS on the date of transition to Ind AS. Accordingly, these securties would be classified and measured at FVOCI.

Introduction

A company operates through its directors, who are key to the effective functioning and governance of the company. The directors are responsible for meeting the objects of a company, decide the strategy and policies of the company and are accountable to various stakeholders of a company. This aspect would be ensured only when the directors of the company understand their role and responsibilities towards the company and other stakeholders.

The Companies Act, 2013 (2013 Act) tries to address the concern and accordingly, through its various sections prescribed onerous responsibilities for the directors.

In the previous edition of AAU, we covered the role and responsibilities related to independent directors of a company under the 2013 Act and the Securities and Exchange Board of India (SEBI) (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations).

Continuing with our series on the role of directors, in this article, we will cast our lens on the responsibilities and other related areas of directors (other than independent directors) under the 2013 Act vis-à-vis the Listing Regulations.


– Provide an overview of the role and responsibilities of directors/managerial personnel (other than independent directors), their remuneration, and disqualifications under the Companies Act, 2013 and the SEBI Listing Regulations.

Key responsibilities of directors

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ScopeA company could have the following different types of directors (other than independent directors) subject to the conditions prescribed:

• Resident director

• Woman director

• Director elected by small shareholders

• Additional director

• Alternate director

• Nominee director

• Managing Director (MD)

• Whole-Time Director (WTD)

• Manager.

Additionally, every listed company and every unlisted public company having a paid-up share capital of INR10 crore is required to appoint a whole-time Key Managerial Personnel (KMP)1.

1. Key managerial personnel in relation to a company, means:a. Chief Executive Officer or the managing director or the managerb. The company secretaryc. The whole-time directord. The Chief Financial Officer ande. Such other officer as may be prescribed.

2. Officer who is in default, inter alia, means any of the following officers of a company who should be liable to any penalty or punishment by way of imprisonment, fine or otherwise under the provisions of the 2013 Act:a. Whole-time directorb. KMP and c. In case of no KMP, directors as specified by the board.

Requirements prescribed under the Listing Regulations

The board of directors of a listed entity should have an optimum combination of executive and non-executive directors with at least one woman director. However, at least 50 per cent of the board of directors should comprise of non-executive directors.

Responsibilities of the directorsThe 2013 Act entrusts crucial responsibilities to the board of directors, non-compliance of such responsibilities is likely to expose the officers who would be in default2 to severe punishments. Some of these responsibilities are as follows:

• Approval of the financial statements (Section 134(1)): Financial statements (including consolidated financial statements) of a company are required to be approved by the board of directors before they are signed on behalf of the board for submission of the auditor’s report on it, at least by the following:

– The chairperson of the company where he is authorised by the board, or

– Two directors out of which one should be a managing director and the Chief Executive Officer, if he is a director in the company, or

– The Chief Financial Officer and the company secretary of the company, wherever they are appointed, or

– In the case of a one person company, only by one director.

• Disclosure of interest (Section 184): Every director is required to disclose his/her concern or interest (including their shareholding) in any company, corporate, firms or other association of individual in the board meeting.

Additional disclosure is required in case of any direct/indirect

concern or interest in a contract or arrangement entered into with the following:

– A body corporate in which such director or in association with any other director, holds more than two per cent shareholding of that body corporate, or is a promoter, manager, Chief Executive Officer of that body corporate or

– A firm or other entity in which, such director is a partner, owner or member, as the case may be.

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• Matters to be included in the Board’s report (Section 134(3)): The financial statements of a company should accompany a report by its board of directors which, inter alia, includes the following statements:

– Directors’ responsibility statement: A declaration by the directors assenting performance of various obligations such as preparation of annual accounts on a going concern basis, consistent application of accounting policies, adequacy and the effectiveness of the internal financial control (discussed under ‘Reporting on internal financial controls’), etc.

– Risk management policy: Indicate development and implementation of risk management policy for the company including identification of elements of risk, if any, which in the opinion of the board could threaten the existence of the company.

– CSR policy: Indicate development and implementation of the Corporate Social Responsibility (CSR) initiatives taken during the year.

– Board evaluation: Indicate the manner in which formal annual evaluation has been made by the board of its own performance, its committees and individual directors.

• Prohibition on insider trading (Section 195): No person including any director or KMP of a company is permitted to enter into insider trading unless such a communication is required in the ordinary course of business or profession, employment, or under any law.

• Prohibition on loan to directors (Section 185): A company is not allowed to give a loan (directly or indirectly) to any of its directors or to any other person in whom the director is interested. However, a loan could be given to a MD or a WTD, if the amount falls in either of the given categories:

– Part of the conditions of service extended by the company to all its employees or

– Pursuant to any scheme approved by the members by a special resolution.

• Filing of annual return (Section 92(1)): Every company is required to prepare and file an annual return with the Registrar of

Companies (ROC) containing the particulars as they stood on the close of the financial year. It, inter alia, includes, details relating to the promoters, directors, KMP along with changes therein since the close of the previous financial year, remuneration of directors and KMP, etc.

Such a return is required to be signed by a director and the company secretary, or where there is no company secretary, by a company secretary in practice.

• Buy-back of securities (Section 68(6)): A company which proposes to buy-back its shares, should file with the ROC and the SEBI a declaration of solvency signed by at least two directors of the company, one of whom should be the managing director and verified by an affidavit to the effect that the Board of Directors of the company has made a full inquiry into the affairs of the company as a result of which they have formed an opinion that it is capable of meeting its liabilities and will not be rendered insolvent within a period of one year from the date of declaration adopted by the board.

Requirements under the Listing Regulations

Listing Regulations also prescribe various onerous responsibilities over the board of directors which are in line with the provisions of the 2013 Act. Some of the additional responsibilities that it encompasses are as follows:

• Disclosure of material interest: The members of the board and the KMP should disclose any direct or indirect material interest in any transaction or matter affecting the listed entity.

• Maintain operational transparency: The board of directors and senior management3 should ensure operational transparency at all times in their conduct and maintain confidentiality of information so as to foster a culture of good decision-making.

• Alignment of remuneration: Board is authorised to align the KMP and the remuneration of the board of directors with the longer term interest of the entity and its shareholders.

• Ability to step back: The board should have the ability to step back to assist executive management by challenging the assumptions underlying: strategy, strategic initiatives (such as acquisitions), risk appetite, exposures and the key areas of the listed entity‘s focus.

• Enable functioning of independent directors: The board of directors and senior management should facilitate the independent directors to perform their role effectively as a member of the board of directors and its committee.

• Periodic review of compliance reports: The board should periodically review the compliance reports pertaining to the laws applicable to the listed entity as well as steps taken to rectify instances of non-compliance.

3. Senior management should mean officers/personnel of the listed entity who are members of its core management team excluding board of directors and should comprise all members of management one level below the executive directors including all functional heads.

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4. In such a case, a director would not be eligible to be reappointed for a period of five years from the date on which the said company fails to file the financial statements/annual returns or repay the deposits, dividend, redeem debentures/interest thereon.

5. Public companies meeting any of the given criteria is required to constitute the committee:• Paid-up share capital of INR10 crore or more• Turnover of INR100 or more• Outstanding loans, borrowings, debentures or deposits exceeding INR50 crore.

Reporting on Internal Financial Controls (IFC)Directors of a listed company are required to state whether they have laid down IFC to be followed by the company and that such IFC are adequate and are operating effectively (Section 1345(5)(e)).

However, Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014 requires the board’s report of every company to state the details in respect of adequacy of IFC with reference to financial statements.

The Guidance Note on Audit of Internal Financial Controls Over Financial Reporting issued by the Institute of Chartered Accountants of India (ICAI) in September 2015 suggested following in respect of reporting of IFC for the given class of companies:

• Listed companies: The director’s responsibility statement should state that the IFC are adequate and operating effectively. The board’s report should state the adequacy of the IFC with respect to financial statements.

• Other companies: The board’s report should state adequacy of the IFC with respect to financial statements.

Ineligibility of appointment/reappointment of a directorDirectors are required to ensure compliance with the responsibilities entrusted under the 2013 Act. Additionally, Section 164 of the 2013 Act specifically provides the cases where:

• The directors would not be considered eligible to be appointed as a director or

• If already appointed, then would not be eligible to be reappointed

as a director of that company or other company.

These events, inter alia, includes the following situations:

• Disqualification by an order of a court or Tribunal

• Non-payment of any calls on the shares held by the director

• Conviction on account of any offence dealing with related party transactions at any time during the last preceding five years

• Non-allocation of Director Identification Number (DIN)

• Non-filing of financial statements or annual returns for any continuous period of three financial years4

• Failure to repay the deposits accepted by it or interest thereon or to redeem any debentures on the due date or pay interest due thereon or pay any dividend declared for a continuous period of one year4.

Role of directors in constitution of the committees• CSR committee (Section

135): Every company making a contribution towards CSR is required to constitute a CSR committee which should comprise of three or more directors, out of which at least one director should be an independent director.

However, as per the Companies (Corporate Social Responsibility Policy) Rules (Rule 5(1)), an unlisted public company/private company which is not required to appoint an independent director, should have a CSR committee without an independent director.

The CSR committee would be responsible for the formulation

and recommendation to the board of directors, a CSR policy indicating the activities to be undertaken by the company, recommendation of the amount of expenditure to be incurred on the CSR activities and monitoring of CSR policy from time to time.

• An audit committee and nomination and remuneration committee (Section 177 and Section 178): Every listed company and an unlisted public company5 is required to constitute the following committees:

– An audit committee which should comprise of a minimum of three directors with independent directors in majority.

The committee would, inter alia, be responsible for recommendation of appointment, remuneration, terms of appointment of auditors of the company, review and monitor the auditor’s independence and performance and evaluation of internal financial controls and risk management systems.

– A nomination and remuneration committee which should comprise of three or more non-executive directors out of which not less than one-half should be independent directors.

The committee is required to formulate the criteria for determining qualifications, positive attributes and independence of a director and recommend to the board a policy, relating to the remuneration for the directors, key managerial personnel and other employees.

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• Stakeholders’ relationship committee (Section 178(5)): The board of directors of a company having more than 1,000 shareholders, debenture holders, deposit holders and any other security holders at any time during a financial year is required to formulate a stakeholders’ relationship committee. The committee should consist of a chairperson who should be a non-executive director and such other members as may be decided by the Board.

The committee would consider and resolve the grievances of security holders of the company.


• Maximum limit for membership in a committee: A director could be a member in 10 committees or could act as a chairperson of five committees across all listed entities in which he is a director.

While determining the limit of a director to act as a chairperson, following inclusion/exclusions are required:

– Include the limit of the committees on which a director may serve in all public limited companies (listed or unlisted)

– Exclude all other companies including private limited companies, foreign companies and companies formed under Section 8 of the 2013 Act.

Additionally, for the purpose of determination of this limit, only chairpersonship and membership of the audit committee and the stakeholders’ relationship committee should be considered.

• Types of committees: Every listed entity is required to formulate the following committees:

– Audit committee: An independent audit committee should comprise of minimum three directors as members who should be financially literate and at least one director should have accounting or related financial management expertise.

The audit committee would, inter alia, be responsible for approval of appointment of Chief Financial Officer, review of the management discussion and analysis of financial conditions and results of operations and review of the statement of application of funds raised through an issue.

– Nomination and remuneration committee: The nomination and remuneration committee should comprise of the following:

a. At least three directors

b. All directors of the committee should be non-executive

c. At least 50 per cent of the directors should be independent directors.

The committee would be, inter alia, responsible for identification of persons qualified to become directors and could be appointed in senior management as per the specified criterion and recommendation to the board of directors their appointment and removal.

– Stakeholders’ relationship committee: The chairperson of the committee should be a non-executive director.

Such a committee would be responsible for resolving the grievances of the security holders of the listed entity including complaints related to transfer of shares, non-receipt of annual report and non-receipt of declared dividends.

– Risk management committee: Top 100 listed companies (based on the market capitalisation) are required to constitute a risk management committee. The majority members of the committee should comprise of members of board of directors including its chairperson.

The board of directors is required to define the role and responsibility of the risk management committee. It should also delegate monitoring and reviewing of the risk management plan to the committee and such other functions as it may deem fit.

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6. Remuneration means any money or its equivalent given or passed to any person for services rendered by him and includes perquisites as defined under the Income-tax Act, 1961.

7. The remuneration in excess of these limits could be paid with the approval of the shareholders in a general meeting without CG approval.

Remuneration6 of directorsRemuneration payable by companies having profits

As per Section 197 of the 2013 Act, total managerial remuneration payable by a public company, to its directors (including MD and WTD) and its manager in respect of any financial year should not exceed 11 per cent of the net profits of the company for that financial year computed in the specified manner.

However, the company with the approval of the Central Government (CG) and its shareholders, could authorise the payment of remuneration exceeding 11 per cent of the net profits of the company, subject to the provisions of Schedule V of the 2013 Act.

Following table provides the maximum amount of remuneration7 payable when there are one or more than one Managing Director (MD), Whole-Time Director (WTD) or manager in the company:

Remuneration payable by companies having inadequate or no profits

In case a company has no profits or its profits are inadequate in any financial year, then it may without CG approval, pay remuneration based on the effective capital of the company and should not exceed the limits specified below:

Managerial personnel functioning in a professional capacity

If the managerial personnel is functioning in a professional capacity and possesses graduate level qualification with an expertise and specialised knowledge in the field in which the company operates then approval of the CG is not required if such managerial person, at any time during the last two years before or on after the date of appointment, does not have:

a. Any interest in the capital of the company/its holding company/any of its subsidiaries directly or indirectly or through any other statutory structures and

b. Any direct/indirect interest or related to the directors/promoters of the company or its holding company/any of its subsidiaries.

Any employee of a company holding shares of the company not exceeding 0.5 per cent of its paid-up share capital under any scheme

formulated for the allotment of shares to such employees including Employees Stock Option Plan (ESOP) or by way of qualification should be deemed to be a person not having any interest in the capital of the company.

However, a special resolution is required to be passed for payment of remuneration at the general meeting of the company for a period not exceeding three years.

Remuneration payable to Should not exceed*

Any one MD or WTD or a manager 5 per cent of net profits

More than one MD or WTD or manager 10 per cent of net profits (to all such directors and manager taken together)

Directors (other than MD or WTD) 1 per cent of net profits (if there is a MD or WTD or manager)

3 per cent of net profits (in other case)

Where the effective capital isLimit of yearly remuneration payable should not exceed#

Negative or less than INR5 crore INR60 lakh

INR5 crore and above but less than INR100 crore INR84 lakh

INR100 crore and above but less than INR250 crore INR120 lakh

INR250 crore and above INR120 lakh plus 0.01 per cent of the effective capital in excess of INR250 crore

(Source: KPMG in India’s analysis, 2017 based on the provisions of Section 197 of the 2013 Act)

*These percentages would be exclusive of any fees payable to directors.

(Source: KPMG in India’s analysis, 2017 based on the provisions of Schedule V to the 2013 Act)

#Limits specified could be doubled if a special resolution is passed.

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Additionally, following are the conditions which a company needs to satisfy to apply the remuneration for situations where it has inadequate or no profits:

a. Resolution to be passed: Payment of remuneration should be approved by a resolution passed by the board and in the case of a company covered under Section 178(1) of the 2013 Act also by the Nomination and Remuneration Committee.

b. Default in payment of any debt: A company has not committed any default in repayment of any of its debts (including public deposits) or debentures/interest payable thereon for a continuous period of 30 days in the preceding financial year before the date of appointment of such managerial person. In case of default, the company obtains prior approval from secured creditors for the proposed remuneration and the fact of such prior approval has been obtained and is mentioned in the explanatory statement to the notice convening the general meeting.

c. Notice: A statement along with a notice calling the general meeting should be given to the shareholders containing the specified information.

Remuneration in excess of specified limits without CG approval

A company could, without CG approval, pay remuneration to a managerial person in excess of the amounts provided for companies having no profits or inadequate profits subject to specified conditions, in the following circumstances:

• Excess remuneration has been paid by any other company

– Such other company is either a foreign company or has got the approval of its shareholders in general meeting to make such payment.

– The other company treats this amount as managerial remuneration for the purpose of Section 197 and

– The total managerial remuneration payable by

such other company to its managerial persons is within permissible limits under Section 197.

• Newly incorporated company for a period of seven years from the date of its incorporation

• Sick company for whom a scheme of revival or rehabilitation has been ordered by the Board for Industrial and Financial Reconstruction (BIFR) or National Company Law Tribunal (NCLT), for a period of five years from the date of sanction of scheme of revival

• Remuneration has been fixed by the BIFR or the NCLT.

Disclosure in board’s report

The board’s report of every listed company is required to disclose certain key elements with respect to the remuneration payable to directors. These, inter alia, include ratio of remuneration of each director to the median remuneration of the employees of the company for the financial year, percentage increase in remuneration of each director in the financial year, etc.

Requirements under the Listing Regulations

• The board is required to recommend all fees or compensation, if any paid to the non-executive directors, including independent directors and should require approval of the shareholders in the general meeting.

Shareholders’ approval should specify the limits for the maximum number of stock options that may be granted to non-executive directors, in any financial year and in aggregate.

• The shareholders’ approval is not required for payment of sitting fees to non-executive directors made within the limits specified under the 2013 Act (for payment without approval of the CG).

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Retirement of directors by rotationThe 2013 Act specifically provides that not more than two-thirds of the total number of directors (excluding independent directors) of a public company should be persons whose period of office is liable to determination by retirement of directors by rotation and be appointed by the company in general meeting. However, the articles of a company could provide for retirement of all directors at every AGM.

The company may fill up the vacancy by appointing the retiring director or some other person at every AGM at which a director retires.

Casual vacancyIn case of a public company, if the office of any director appointed by the company in the general meeting is vacated before his/her term of office expires in the normal course, the resulting casual vacancy would in default be filled by the board of directors in its meeting.

Vacation of office of directorSection 167 of the 2013 Act provides a list of situations in which an office of a director should mandatorily get vacated. These, inter alia, include vacation on account of disqualification of a director, failure to disclose interest in contracts or arrangements in which he/she has direct/indirect interest, etc.

A private company through its articles could provide additional grounds for vacation of the office of a director.

Resignation of a directorA director of a company could resign by giving a prior notice in writing to the company. The board should intimate the ROC after taking note of the resignation and should also place the fact of such resignation in the report of directors laid in the immediately following general meeting of the company.

The resignation would come into effect from the date on which the notice is received by the company or such other date as specified by the

director in the notice, whichever is later.

The director would continue to be liable for the offences which has occurred during his/her tenure after his resignation.

Removal of a directorA company could remove a director (not being a director appointed by the Tribunal) before the expiry of his tenure by passing an ordinary resolution and after providing reasonable opportunity of being heard.

Vacancy created by the removal of a director should be filled by the company or by the board by appointing another director in the removed director’s place at the meeting at which he/she has been removed. However, a special notice for any resolution to remove a director or to appoint a person in place of the director so removed would be required.


The Listing Regulations does not contain specific provisions for the retirement, resignation or removal of a director (other than an independent director).

However, every listed entity is required to inform the stock exchange(s) of all events which are material, all information which is price sensitive and/or have bearing on performance/operation of the listed entity which, inter alia, includes change in the board of directors or the managing director by death, resignation, removal or otherwise.

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Consider this

– Board members are required to disclose their shareholding (held by them or on behalf of others) in a listed entity in which they are proposed to be appointed as directors.

– A company is not allowed to give a loan (directly or indirectly) to any of its directors or to any other person in whom the director is interested except if it has been given to the MD or the WTD under the specified conditions.

– Top 100 listed companies (based on the market capitalisation) are required to constitute a risk management committee in addition to other committees.

– The 2013 Act and the Listing Regulations pose challenges in the form of onerous responsibilities of the directors. Directors should ensure compliance with the prescribed requirements else severe prosecutions and penalties could follow.

Recommendations of the Company Law Committee (CLC) and the Companies (Amendment) Bill, 2016 (Amendment Bill)The CLC and the Amendment Bill proposed the following in relation to appointment and remuneration of directors (other than independent directors):

• Placement of remuneration policy on the website: Companies should be allowed to place the remuneration policy on their websites, if any, and to disclose only the salient features of the policy, along with the web-link in their Board’s report.

• Loan to directors, etc: Companies could give loans to any other person in whom a director is interested, subject to a prior approval of the company by a special resolution. However, the Amendment Bill prohibits companies to give loans to a director of a company or holding

company, or any partner or his/her relative and firms in which the director and his/her relatives are partners.

Additionally, the Amendment Bill provides a definition of ‘any person in whom the director is interested’.

• Managerial remuneration: Following has been proposed in relation to managerial remuneration8:

– Managerial remuneration should be approved by the shareholders.

– Revision of Schedule V to the 2013 Act to allow an approval by an ordinary resolution if the managerial person is not a promoter, and a professional with domain knowledge/ relevant experience; and is not related to any director or promoter of the company, does not hold more than two per cent of the paid-up equity share

capital of the company or its holding company.

In other cases, the requirement for a special resolution should be retained.

– The limits of yearly remuneration prescribed in Schedule V should be enhanced.

– Requirement for a government approval should be omitted and necessary safeguards in the form of additional disclosures, audit, higher penalties, etc. may be prescribed.

• Appointment of the KMP: The CLC proposes that the requirement for a managerial person to be resident in India for 12 months prior to appointment to be done away with, subject to the satisfaction of other applicable regulatory clearances.

8. This proposal has been finalised by MCA (refer ‘Remuneration of directors’ section).

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The framework for the Preparation and Presentation of Financial Statements in accordance with Ind AS suggests that one of the key qualitative characteristics of financial statements prepared in accordance with Ind AS is ’substance over form’. It means that in order for the financial statements to faithfully represent the transactions that it purports to represent, the transactions should be accounted for and presented in accordance with the substance of the transaction and not merely its legal form.

In this article, we aim to highlight the challenges in classification of lease of land into operating and finance with the help of an example.


– Highlight the considerations to be evaluated while classifying a lease of land into an operating or a finance under Ind AS.

Application of substance over form under Ind AS – lease of land

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Classification of lease of land into operating vs finance leaseIn India, it is a common practice that entities take land for 90-99 years leases. Ind AS requires lease of land to be classified into operating or finance lease based on general classification criteria for classification of leases into operating and finance. Leases of land were excluded from the scope of AS 19, Leases under Indian GAAP.

The classification of lease into operating or finance lease is based on the substance of the arrangement and not its legal form.

Some of the key factors which are likely to indicate that the lease of land is a finance lease are:

• the lease transfers ownership of the asset to the lessee by the end of the lease term

• the lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised

• the lease term is for the major part of the economic life of the asset even if title is not transferred

• at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset, and

• the leased assets are of such a specialised nature that only the lessee can use them without major modifications.

In determining whether lease of land is operating or finance, one of the important considerations is that land normally has an indefinite economic life. However, the fact that lease term is shorter than economic life would not mean that lease of land will always be an operating lease,

an overall assessment of facts and circumstances is required to be carried out to determine whether substantially all the risks and rewards incidental to ownership of the asset have been transferred.

Period of lease and present value of the residual valueIn majority of cases of leases of land in India, the title of the land is not passed to the lessee at the end of the lease term. The International Accounting standards Board (IASB) in its basis for conclusions of IAS 17, Leases clarified that in a 999-year lease of land and building, the significant risks and rewards associated with the land during the lease term are transferred to the lessee during the lease term, regardless of whether title will be transferred. The IASB further clarified that the present value of the residual value of the property with a lease term of several decades would be negligible and therefore, accounting for the land element as a finance lease is consistent with the economic position of the lessee.

Therefore, a long lease term may indicate that a lease of land is a finance lease. This is not because the lease term will thereby cover the major part of the economic life of the land, but because in a long lease of land the risks and rewards retained by the lessor through its residual interest in the land at the end of the lease are not significant when measured at inception. Conversely, a short lease of land is unlikely to be a finance lease because the risks and rewards retained by the lessor through its residual interest in the land at the end of the lease when measured at inception are likely to be significant.

Depending on the facts and circumstances, leases of land with terms as short as 50 years could be finance leases. In addition, a lease with a short minimum contractual period but a fixed price renewal option that is reasonably certain to be exercised may also be a finance lease.

Present value of minimum lease paymentsIn our experience, many leases of land are granted for an up-front premium with immaterial annual lease payments. In such cases, the amount of the up-front premium generally approximates the present value of the lease payments. However, for leases of land that include material recurring lease payments it will often be difficult to assess whether the present value of the minimum lease payments amounts to substantially all of the fair value of the land, because of difficulties in estimating the rate implicit in the lease.

Estimating the rate implicit in a lease requires judgment. A lessee could use different approaches to determine the rate implicit in a lease e.g. it could use a risk-free rate or calculate the discount rate at which the present value of the minimum lease payments equals substantially all of the fair value of leased land.

In the first approach, of using risk-free rate, the rationale is that it is very difficult to estimate the rate implicit in the lease. As the implicit rate is expected to be higher than the risk-free rate. Therefore, if the present value of the minimum lease payments is less than substantially all the fair value of the land when discounted at the risk-free rate, then there is little doubt that this would also be the case if the minimum lease payments were discounted at the (higher) interest rate implicit in the lease, if the rate were unknown.

In the second approach, the calculated discount rate could be compared to other relevant information, such as the risk-free rate, market property yields, the lessee’s incremental borrowing rate, etc. Judgement would be required to interpret the results of these calculations.

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Contingent rentals and other contingent paymentsThe presence of contingent rentals might indicate that the lease of land is an operating lease, if the nature of contingency provides the evidence that the lessor has not transferred substantially all the risks and rewards of ownership of the land. However, the presence of contingent rentals does not automatically indicate that a lease of land is an operating lease. As part of the assessment of the lease, an entity should also consider:

• Whether there are other whether there are other indicators that the lease is a finance lease

• The nature of the contingency and whether the contingency provides evidence about the extent to which the lease transfers risks and rewards of ownership of the land, and

• The materiality of the contingency in the context of the lease as a whole.

There could be other substantive mechanisms through which the lessor’s return varies with changes

in the fair value of the land during the lease term and such indicators might indicate that lease of land is an operating lease. Those indicators could be as follows:

• Renewal premiums based on the market value of land at the date of renewal

• Purchase options for which the exercise price is the fair value of land at the date on which the option is exercised

• One-off payments from the lessee to the lessor if there is a change in the planning status of the land, and

• The lessor’s ability to terminate the lease and enter into a new lease on more favourable terms.

Economic indifferenceIf it would make little economic difference to the entity whether it leased or bought an asset, then this indicates that the lease is a finance lease because the entity prima facie considers that any risks and rewards that are not transferred by the lease contract are not significant.

IllustrationCompany A has taken a land on lease for 90 years. The lease rentals are payable as follows:

Upfront payment: INR2 crores

Annual payments: INR400,000 payable annually for first 10 years

The lease rentals may be enhanced from time to time. The lessee shall only be liable to vacate the land in case of breach of conditions as mentioned in lease deed.

In this case, it should be evaluated whether the lease of land should classified as an operating or as a finance lease. Under Ind AS, lease of land should be classified into an operating or a finance based on the general lease classification criteria. The above lease arrangement needs to be analysed on the basis of various indicators of classification of lease of land into operating vs finance. The analysis of various factors for classification of lease into operating and finance is explained in the table below:

Factors Analysis

Ownership of the asset is transferred to the lessee at the end of the lease term

The title of the land does not transfer to the lessee at the end of the lease term.

Option to purchase the asset at the end of its lease

The lessee does not have an option to purchase the land at the end of the lease term.

Present value of minimum lease payments is substantially equal to fair value of leased asset

The amount to be paid as lease payments comprises an upfront payment of INR2 crores and immaterial annual lease payments of INR400,000 which are to be paid over a period of 10 years. Post expiration of 10 years, no further payment is to be made for balance 80 years as the lease term is for a period of 90 years.

Other factors The lessee should evaluate following factors:• Renewal premiums based on the market value of land at the

date of renewal• One-off payments from the lessee to the lessor if there is a

change in the planning status of the land, and• The lessor’s ability to terminate the lease and enter into a

new lease on more favourable terms.

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In this case, though there is a long lease term of 90 years but the lessee should evaluate whether the present value of minimum lease payments is substantially equal to fair value of the leased land. Also whether the lessee

has the same risks and rewards as the freehold land.

Ind AS does not provide a bright-line threshold lease term which would help classify a lease of land as a finance lease. Therefore, in this

case, judgement would be required to applied to determine the nature of the lease and it is important to consider all other potential indicators of lease classification.

Consider this

– The classification of a lease of land is assessed based on the general classification guidance under Ind AS 17, Leases.

– The assessment of the land classification is made at inception of the lease based on the expected conditions and outcomes at that time and is not revised merely because the value of the residual asset at the end of the lease increases over time.

– The lease classification is based on an overall assessment of whether substantially all the risks and rewards incidental to ownership of the asset have been transferred from the lessor to the lessee.


– Highlight the deemed cost exemption available under Ind AS 101 and the related implication on the accounting of property, plant and equipment.

Deemed cost accounting under Ind AS

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Introduction

The corporates in India covered in Phase I of Ind AS road map have implemented Ind AS with the financial year beginning 1 April 2016, transition date being 1 April 2015. With companies having applied the Ind AS principles in the current financial year, many of the companies which have presented their financial results under Ind AS have disclosed adjustments in respect to deemed cost for their Property, Plant and Equipment (PPE).

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BackgroundThe application of Ind AS introduces many new concepts in corporate financial reporting, as a result, corporates in India encountered significant practical implementation issues. Ind AS 101, First-time Adoption of Indian Accounting Standards provides specific guidance on requirements for the preparation and presentation of financial statements for the first-time adopter of Ind AS. As a starting point, the guidance under Ind AS requires companies to apply the new guidance while preparing its opening Ind AS balance sheet at the date of transition by incorporating the following steps:

• Recognise all assets and liabilities whose recognition is required in accordance with Ind AS

• De-recognise all assets or liabilities in case Ind AS prohibit such recognition

• Reclassify asset, liability or component of equity in accordance with Ind AS, and

• Apply Ind AS for the purpose of measuring all recognised assets and liabilities.

Due to the significance of the impacts of the above adjustments, Ind AS 101 provides certain exemptions and exceptions to facilitate smooth transition from Accounting Standards (AS) to Ind AS e.g. certain key options for accounting are business combination exemption, share-based payment transactions, deemed cost exemptions, consolidation, etc.

In the following section, we aim to explain the deemed cost guidance in relation to PPE in Ind AS 101 and key challenges/implications that have emerged while applying the deemed cost exemption to PPE.

Exemption for deemed cost accountingInd AS 101 provides a first-time adopter an optional exemption to measure its PPE at deemed cost. Appendix A to Ind AS 101 defines deemed cost as ‘an amount used as a surrogate for cost or depreciated cost at a given date. Subsequent depreciation or amortisation assumes that the entity had initially recognised the asset or liability at the given date and that its cost was equal to the deemed cost.’

At the date of transition an entity can elect to apply any one of the following approaches to compute the ‘deemed cost’ of PPE:

• Fair value of PPE at the date of transition: Measure an item of PPE at the date of transition to Ind AS at its fair value and use that fair value as its deemed cost at that date (Paragraph D5 of Ind AS 101).

• Previous GAAP revalued amount of PPE (if certain conditions are met): A first-time adopter may elect to use a previous GAAP revaluation of an item of PPE at, or before, the date of transition to Ind AS as deemed cost at the date of the revaluation, if the revaluation was, at the date of the revaluation, broadly comparable to:

– Fair value; or

– Cost or depreciated cost measure broadly comparable to Ind AS adjusted to reflect, for example, changes in a general or specific price index. (Paragraph D6 of Ind AS 101)

• Carrying value of PPE as per previous GAAP at the date of transition: A first-time adopter (in situations where there is no change in functional currency) may elect to continue with the

carrying value for all of its PPE, measured as per its previous GAAP, and use that carrying value as its ‘deemed cost’ at the date of transition without making any further adjustments based on application of other Ind AS. However, the first-time adopter is not permitted to continue with the previous GAAP carrying value as deemed cost on a selective basis for some of the items of PPE and use a fair value as deemed cost approach for the remaining items1.

• Event-driven valuation: A first-time adopter could adopt an even-driven fair value measurement as deemed cost for Ind AS at the date of that measurement. Date of valuation could be on or before the date of transition. For example, when an entity was privatised and at that point valued and recognised some or all of its assets and liabilities at fair value - at the date of valuation.

The above mentioned exemption is also available for:

a. Investment property, accounted for in accordance with the cost model in Ind AS 40, Investment Property

b. Intangible assets that meet:

– the recognition criteria in Ind AS 38, Intangible Assets (including reliable measurement of original cost); and

– the criteria in Ind AS 38 for revaluation (including the existence of an active market).

An entity should not use above options for other assets or for liabilities.

1. ICAI on 27 April 2017 issued an Exposure Draft (ED) for limited amendment to Ind AS 101 with regard to carrying value as per previous GAAP under deemed cost approach. The ED proposes that a first-time adopter may elect to apply carrying value as per previous GAAP as the deemed cost for a class of PPE instead of all its PPE. For example, an entity may choose to apply carrying value as per the previous GAAP as the deemed cost for plant and machinery and apply fair value as the deemed cost for land and building. Further the amendment allows a first-time adopter to make adjustments to the deemed cost (carrying value of PPE as per previous GAAP) which may arise due to application of other Ind AS.

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Implications of deemed cost exemption on accounting of PPEIn the following section, we have highlighted various issues/implications that are likely to arise when an entity opts to follow deemed cost exemption for accounting of its PPE on transition to Ind AS.

Carrying value as per previous GAAP as deemed cost to be applied on all the items of PPE

Generally, when a first-time adopter chooses fair value, previous GAAP revalued amount, or event driven valuation, these optional exemptions may be applied selectively to some or all items of PPE as per previous GAAP of a first-time adopter if specific criteria are met. These exemptions would not need to be applied to all classes of PPE or to all items within a class of PPE; instead, the exemption may be applied to individual items. However, when a first-time adopter chooses carrying value as per previous GAAP as deemed cost exemption, then the option of applying this option on a selective basis to some of the items of PPE and using fair value for others is not available under Ind AS 101. This approach has been clarified by the Ind AS Transition Facilitation Group (ITFG) in its bulletin 52.

Accordingly, in consolidated financial statements of a group, if deemed cost exemption chosen is carrying value of PPE as per previous GAAP, then the entire group would have to follow carrying value as per previous GAAP as the deemed cost of PPE. However, while preparing stand-alone financial statements for individual entities within the group, Ind AS 101 does not prevent different entities within a group to choose different basis for arriving at deemed cost of their PPE3.

Capitalisation of loan processing fees

The first-time adopter may have capitalised loan processing fees as part of the relevant PPE as per previous GAAP. However, as per Ind AS 109, Financial Instruments, such costs are accounted as a part of a loan. According to Ind AS 101, when such an entity adopts carrying value of PPE as per previous GAAP as its deemed cost on the date of transition to Ind AS then no further adjustment to the deemed cost of the PPE at the date of transition should be made (even if certain transition adjustments might arise from the application of other Ind AS).

Additionally, paragraph 10 of Ind AS 101 provides that Ind AS will be applied in measuring all recognised assets and liabilities except for mandatory exceptions and voluntary exemptions from other Ind AS. Therefore, an issue arose whether an adjustment should be made to the amounts of the loans outstanding and this issue was raised at the ITFG.

In the given case ITFG has clarified4 that an entity should apply the requirements of Ind AS 109 retrospectively for loans outstanding on the date of transition to Ind AS that are measured at amortised cost. Hence, the loan processing fees would form part of the amortised cost measurement of the loan liability. Accordingly, the carrying amount of the PPE as at the date of transition should be reduced by the amount of processing cost (net of cumulative depreciation impact) to reflect the Ind AS accounting treatment for loan processing fees. The difference between the adjustments to the carrying amount of the loan and PPE, respectively should be recognised in retained earnings.

The ITFG further clarified that adjustment to PPE would be in the nature of a consequential adjustment (to PPE) to enable an adjustment to the carrying amount

of the loan as required by Ind AS. This would also reflect the correct economic reality and result in faithful representation of the effects of these transactions on transition to Ind AS. Hence, this consequential adjustment (to PPE) would not be considered as an adjustment to the carrying value of PPE as the previous GAAP (deemed cost of PPE).

Government grant received by the first-time adopter

A first-time adopter may have received a government grant in the past and the entity had deducted the grant from the carrying amount of the related PPE under previous GAAP instead of recognising the gross amount of the grant. If such an entity elects to apply the deemed cost exemption of previous GAAP carrying value then as per Ind AS 20, Accounting for Government Grants and Disclosure of Government Assistance, an asset related grant should not be deducted from the cost of PPE and instead, should be accounted for as a deferred income.

The issue has been discussed by ITFG in its bulletin 55 and they pointed out that in such a case relevant guidance under Ind AS 101 should be considered. Ind AS 101 does not provide an exemption from retrospective application of the provisions of Ind AS 20 in relation to government grants. Accordingly, the entity should recognise the asset related government grants outstanding on the date of transition as deferred income in accordance with the requirements of Ind AS 20 with a corresponding adjustment to PPE and retained earnings. The carrying amount of the PPE as at the date of transition would be increased by the amount of government grant deducted as per previous GAAP (net of cumulative depreciation impact).

The ITFG further clarified that the adjustment to PPE would reflect the correct economic reality and result in faithful representation of the effects of these transactions on transition to Ind AS.

2. Ind AS Transition Facilitation Group (ITFG) of Ind AS (IFRS) Implementation Committee of the ICAI issued its revised bulletin 5 dated 17 April 2017

3. Educational Material on Indian Accounting Standard (Ind AS) 101 First-time Adoption of Indian Accounting Standards issued by ICAI

4. Ind AS Transition Facilitation Group (ITFG) of Ind AS (IFRS) Implementation Committee of the ICAI issued its revised bulletin 5 dated 17 April 2017

5. Ind AS Transition Facilitation Group (ITFG) of Ind AS (IFRS) Implementation Committee of the ICAI issued its bulletin 7 dated 31 March 2017

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Reversal of the effects of paragraph 46/46A of AS 11, The Effects of Changes in Foreign Exchange Rates

Certain first-time adopters could have availed of the option under paragraph 46 of AS 11 to capitalise foreign exchange differences on long-term foreign currency items to the cost of the related PPE and also avail of the deemed cost exemption for carrying value under PPE under Ind AS 101. An issue arises whether such a first-time adopter would be required to adjust the carrying amount of PPE as Ind AS does not allow an option (like paragraph 46 of AS 11) to allow capitalisation of foreign exchange differences on long-term foreign currency items to the cost of the related PPE.

This issue was discussed at the ITFG and it opined6 that when an entity that avails carrying value as previous GAAP as the deemed cost exemption then it would be required to carry forward the entire previous GAAP carrying amount for all of its PPE on transition to Ind AS. Under Ind AS 101, it would not be allowed to make any further adjustments to the deemed cost of PPE.

Therefore, such an entity would not be permitted to reverse the impact of paragraph 46/46A of AS 11 from the deemed cost of PPE on transition to Ind AS.

Capitalisation of an item of PPE not falling under the definition of an asset

An entity that recognises PPE at carrying value as per the previous GAAP as deemed cost for its PPE could have capitalised an item under previous GAAP when such item may not meet the definition of an asset. It is important to note that the deemed cost exemption is only available for PPE items, it cannot be availed for those items that do not meet the definition of an asset as per previous GAAP and the definition of PPE as per Ind AS 16, Property, Plant and Equipment.

The ITFG further clarified6 that capitalisation of an item which does not meet the definition of tangible asset, will be considered as error made under AS (previous GAAP). Therefore, as per principles given under Ind AS 101 (paragraph 26 of Ind AS 101), the entity should make a separate disclosure of such an error under the reconciliation required from previous GAAP to Ind AS i.e. such disclosure should distinguish the correction of those errors from changes in accounting policies.

Reversal of impairment

A first-time adopter could also elect to measure its PPE at its deemed cost measured as per previous GAAP revaluation on or before the date of transition, and the revaluation was broadly comparable to fair value, cost, or depreciated cost in accordance with Ind AS. An issue could arise whether an entity would be allowed to reverse the impairment provision recognised in its books as at the date of transition when it opts deemed cost exemption (revalued amount) for its PPE. In this case, the ITFG opined6 that when an entity has elected for a deemed cost exemption then such a cost would be the cost of PPE in the opening balance sheet and any accumulated depreciation and provision for impairment under previous GAAP would have no relevance. Accordingly, the provision for impairment provided before the date of such measurement as per previous GAAP cannot be reversed in later years.

In case the deemed cost determination date is different from date of transition, the entity should apply appropriate Ind AS accounting policies and depreciation policies to that asset from the deemed cost determination date to the date of transition. The depreciation policy applied during the intervening period from the deemed cost determination date to the date of transition would have to be in accordance with the requirements of applicable Ind AS.

Accordingly, the impairment loss for the period between the deemed cost determination date to the date of transition can be reversed, if permitted as per the principles of Ind AS 36, Impairment of Assets.

However, if the entity does not opt for the deemed cost exemption given under Ind AS 101 but elects to apply Ind AS 16 retrospectively, then impairment loss can be reversed, if permitted as per the principles of Ind AS 36.

Treatment of revaluation surplus

A first-time adopter could opt to continue with the revalued carrying value of its PPE as at the date of transition to Ind AS and elect to apply the cost model (i.e. to carry the PPE at cost less accumulated depreciation and impairment losses) for the subsequent measurement of the PPE.

In such a case, if an entity had deemed the revalued amount of PPE as its cost on the date of transition to Ind AS, then it would not be permitted to carry a revaluation reserve under Ind AS. Additionally, if the entity elects to apply the cost model approach for the PPE in its opening balance sheet under Ind AS as opposed to the application of the revaluation model on the same date as per its previous GAAP, then adjustments would be accounted as transition adjustments on transition to Ind AS6. Therefore, the balance outstanding in the revaluation reserve would be transferred to retained earnings or if appropriate, another category of equity. Accordingly, the entity would be required to disclose the details of this adjustment in the financial statements and provide a description of the nature and purpose of such an amount.

However, when revaluation surplus is transferred to retained earnings, the entity should apply the requirements of the Companies Act, 2013 while evaluating dividend declaration.

6. Ind AS Transition Facilitation Group (ITFG) of Ind AS (IFRS) Implementation Committee of the ICAI issued its bulletin 8 dated 8 May 2017

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In case an entity elects to use the revaluation model under Ind AS then the revaluation surplus at the date of transition is measured as the difference between the carrying amount of the asset at the transition date and its deemed cost.

Depreciation accounting

Ind AS 16 prescribes that PPE item should be depreciated on a systematic basis over its useful life. Each part of an item of PPE with a cost that is significant in relation to the total cost of the item is depreciated separately.

The requirements of Ind AS in respect of depreciation are relevant to each item of PPE as follows:

• From the date of acquisition if the first-time adopter does not elect a deemed cost exemption;

• From the date of transition if the first-time adopter elects the deemed cost exemption and deemed cost is determined at the date of transition; or

• From the date of the revaluation or other determination of fair value if the first-time adopter elects the deemed cost exemption and deemed cost is determined before the date of transition.

Ind AS 101 prohibits retrospective application of some aspects of other Ind AS. In this regard para 14 of Ind AS 101 provides that estimates made under previous GAAP may not be revised at the date of transition or in the first Ind AS financial statements unless it is determined that they were made in error.

Depreciation is an accounting estimate and therefore, changes in the depreciation method or changes in the estimate of useful lives are normally dealt with prospectively. On transition to Ind AS, if errors are discovered with respect to depreciation recognised under previous GAAP, then those errors

are corrected in the opening Ind AS balance sheet and disclosed separately in the reconciliations required from previous GAAP to Ind AS.

A first-time adopter that elects to not to apply the deemed cost exemption is required to apply Ind AS 16 retrospectively to its PPE based on the requirements of Ind AS 101. If such an entity had applied depreciation rates specified under Schedule XIV of the Companies Act, 1956 under previous GAAP (without considering the useful life of its PPE), on transition to Ind AS the company is required to recompute depreciation by assessing the useful life of each asset in accordance with requirement of Ind AS 16 and Schedule II to the Companies Act, 2013.

While the depreciation rates in Schedule XIV were intended to be minimum rates (and an estimate of useful life was required to be made), some companies may have applied these depreciation rates in order to comply with Companies Act, 1956 requirements (without considering the useful life of its PPE). These companies would be required to recompute depreciation on a retrospective basis in order to comply with Ind AS 167.

Previous GAAP depreciation and impairment - presentation

As per principles of Ind AS 101, if an entity elects deemed cost exemption on the date of transition (i.e. carrying values of PPE as per the previous GAAP) as the cost of its PPE, then any accumulated depreciation and provision for impairment under previous GAAP will have no relevance and would be treated as ‘nil’ on the date of transition and there will be no reversal8.

An entity may provide an additional disclosure of the gross block of assets, accumulated depreciation

and provision for impairment under previous GAAP voluntarily in the notes forming part of the Ind AS financial statements. The accounting treatment would be similar as if fair value were to be taken as deemed cost.

Adjustment relating to PPE in MAT computationThe Finance Act 2017, introduced provisions relating to Minimum Alternate Tax (MAT) computation for Ind AS compliant companies by bringing a separate formulae for computation of book profit for companies that prepare financial statements under Ind AS. These provisions should be read together with the existing provisions for computation of MAT under Section 115JB of the Income-tax Act 1961 (IT Act).

Adjustments to book profits for MAT computation as required by the Finance Act, 2017 can be grouped into following two categories:

• Adjustments relating to first-time adoption of Ind AS

• Adjustments relating to annual Ind AS financial statements.

Adjustments relating to first-time adoption of Ind AS

When preparing its opening Ind AS balance sheet on 1 April 2015 or other transition date, a first-time adopter of Ind AS would typically record a number of adjustments relating to the transition from Accounting Standards to Ind AS. Generally, these adjustments would be recorded in retained earnings (other equity) in the opening balance sheet. Considering that some of these items may never be reclassified to the statement of profit and loss, the Finance Act, 2017 requires that such items should be included in book profits for computation of MAT at an appropriate point in time.

7. Ind AS Transition Facilitation Group (ITFG) of Ind AS (IFRS) Implementation Committee of the ICAI issued its bulletin 3 dated 2 July 2016

8. Ind AS Transition Facilitation Group (ITFG) of Ind AS (IFRS) Implementation Committee of the ICAI issued its bulletin 8 dated 8 May 2017

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Adjustment to PPE due to deemed cost could be as follows:

• When fair value is considered as deemed cost: As per the Finance Act, 2017 the one time fair-value of adjustment of the PPE on the date of transition would be included in the book profits for the purpose of MAT calculation in the year in which the asset is retired/disposed/realised/otherwise transferred.

Other adjustments such as asset restoration obligations, foreign exchange capitalisation/decapitalisation, borrowing costs adjustments, etc. will be considered in the transition amount (i.e. recognised in book profits over a period of five years)

• Adjustment to PPE when revaluation model is adopted as an accounting policy: One-time adjustment to retained earnings (other equity) when an entity transitions to revaluation model will not be included in the transition amount (i.e. not included in book profits over a period of five years). The one-time adjustment due to application of revaluation model pertaining to PPE would be included in book

profits at the time when the asset is realised/disposed/retired/ otherwise transferred.

• Fair value is not used as deemed cost: When an entity applies Ind AS 16 retrospectively, or uses carrying value as per previous GAAP as the deemed cost approach then there could be adjustments due to asset restoration obligations, foreign exchange capitalisation/decapitalisation, borrowing costs adjustments, etc. These adjustments will be considered as transition amount and will be considered in the transition amount (i.e. recognised in book profits over a period of five years)

Adjustments relating to annual Ind AS financial statements

MAT would be calculated using the profits as per the statement of profit and loss before OCI as per Ind AS as the starting point and only those adjustments as are specified in Section 115JB of the IT Act or for gains and losses recognised on accounting for demergers would be made.

The OCI comprises items of income and expense, including

reclassification adjustments that are not recognised in profit or loss as required or permitted by Ind AS. In the OCI section of the statement of profit and loss, items are classified by nature and grouped into those in accordance with other Ind AS:

• will be reclassified to profit or loss in the future when certain conditions are met, and

• will never be reclassified to profit or loss.

Therefore, changes in revaluation surplus of PPE would be included in book profits at the time of realisation/disposal/retirement/ otherwise transferred. Any other item would be included in book profits every year as the gains and losses arise.

Accordingly, it follows that those components of OCI which are to be subsequently reclassified to profit and loss would be considered for book profit as per the Ind AS financial statements i.e. in the period in which such amounts are actually reclassified.

Conclusion

The article highlights some of the issues relating to deemed cost accounting that entities may face on transition to Ind AS. However, the companies affected by the Ind AS road map should deliberate the facts and circumstances of each transaction and consider the clarifications issued by ITFG and ICAI in this regard to understand the impact of the guidance under Ind AS.

Consider this

– When the deemed cost exemption is used to establish the cost of an item of PPE, it becomes the new cost basis at that date. Any accumulated depreciation recognised under previous GAAP before that date is set to be zero.

– If deemed cost is measured at a revalued or other fair value-based amount under previous GAAP before the date of transition, then the measurement of that asset between that date and the date of transition complies with Ind AS requirements.

– The election of the deemed cost exemption is independent of the first-time adopter’s accounting policy choice for the subsequent measurement of PPE i.e. mere use of the term ‘deemed cost’ would not mean that there is a change in accounting policy.

Regulatory updates

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SEBI issues norms for listing of non-convertible redeemable preference shares and non-convertible debentures issued in a scheme of arrangement

Background

The SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations) provide the procedure (through a circular dated 30 November 2015) to be followed by listed entities for undertaking schemes of arrangements such as amalgamations, mergers, reconstruction, etc.

During the year ended 31 March 2017, various developments took place with respect to such schemes of arrangements. The key developments are as follows:

• Notification of related sections of the Companies Act, 2013: On 7 December 2016, the Ministry of Corporate Affairs (MCA) notified certain sections of the Companies Act, 2013 (2013 Act) including sections relating to compromises, arrangements, amalgamations (including fast track amalgamations and demergers), reduction of capital and variations of shareholders’ rights.

These sections became effective from 16 December 2016 and the National Company Law Tribunal (NCLT) assumed jurisdiction of the High Courts as the sanctioning authority for certain sections such as compromises, arrangements, reduction of capital and variations of shareholders’ rights.

• Revised regulatory framework: On 17 January 2017, SEBI gave an in-principle approval for the revised regulatory framework for the schemes of arrangements and issued two circulars highlighting the following important changes:

– The schemes of arrangement for merger of a wholly-owned subsidiary with the parent entity would not be required to be filed with SEBI (under the Listing Regulations). Such schemes would be filed with stock exchanges for the purpose of disclosures

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– Where under a scheme of arrangement the allotment of shares takes place only to a select group of shareholders or shareholders of unlisted companies then the pricing provisions of Chapter VII of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 would be applicable.

• Revision in the Listing Regulations: On 10 March 2017, SEBI revised certain obligations in the Listing Regulations (given in circular dated 30 November 2015) and laid down the detailed requirements to be complied with by the listed entities while undertaking schemes of arrangement for listing of equity or warrants pursuant to the scheme.

The circular did not provide guidance for listing of the Non-Convertible Redeemable Preference Shares (NCRPS) or Non-Convertible Debentures (NCDs) which could also be issued, in lieu of specified securities in a scheme of arrangement.

New development

On 26 May 2017, SEBI issued a circular (SEBI circular on listing of NCRPS/NCDs) which lays down the additional conditions to be complied when NCRPS/NCDs are issued in lieu of the specified securities and such NCRPS/NCDs are proposed to be listed on the recognised stock exchanges.

These additional conditions have been classified under the following heads:

a. Conditions to be complied before the scheme of arrangement is submitted for sanction by the NCLT

b. Conditions to be complied after the scheme of arrangement is sanctioned by the High Court/NCLT and at the time of making application for relaxation under Rule 9(7) of the Securities Contracts (Regulation) Rules, 1957.

The above conditions have to be complied with in addition to the requirements specified under the SEBI circular dated 10 March 2017.

Please refer KPMG in India’s First Notes dated 6 June 2017 which provides an overview of the conditions specified under the above two heads.

(Source: SEBI circular on listing of NCRPS/NCDs dated 26 May 2017)

SEBI (Issue of Capital and Disclosure requirements) (Second Amendment) Regulations, 2017The SEBI through its notification dated 31 May 2017 issued SEBI (Issue of Capital and Disclosure requirements (ICDR)) (Second Amendment) Regulations, 2017 which amends SEBI ICDR Regulations, 2009.

The SEBI ICDR (Second Amendment) Regulations, 2017 provides the following:

1. Systemically important NBFC – The amended regulation includes systemically important Non-Banking Financial Companies (NBFCs) in the list of qualified institutional buyer. The systemically important NBFC is defined as ‘a NBFC registered with the Reserve Bank of India and having a net-worth of more than INR500 crore as per the last audited financial statements’.

2. Monitoring agency – The regulations amend the existing criteria and limit as mentioned in Regulation 16 of the ICDR Regulations 2009 in relation to the appointment of monitoring agency for the use of proceeds of the issue. The amendment is as follows:

Existing Provision

i. If the issue size exceeds INR500 crore, the issuer shall make arrangements for the use of proceeds of the issue to be monitored by a public financial institution or by one of the scheduled commercial banks named in the offer document as

bankers of the issuer. However, nothing contained in this clause shall apply to an offer for sale or an issue of specified securities made by a bank or public financial institution (or an insurance company).

ii. The monitoring agency shall submit its report to the issuer in the format specified in Schedule IX on a half yearly basis, till the proceeds of the issue have been fully utilised.

New Provision

i. If the issue size, excluding the size of offer for sale by selling shareholders, exceeds INR1,000 crore, the issuer shall make arrangements for the use of proceeds of the issue to be monitored by a public financial institution or by one of the scheduled commercial banks named in the offer document as bankers of the issuer. However, nothing contained in this clause shall apply to an issue of specified securities made by a bank or public financial institution (or an insurance company).

ii. The monitoring agency shall submit its report to the issuer in the format specified in Schedule IX on a quarterly basis, till at least 95 per cent of the proceeds of the issue, excluding the proceeds under offer for sale and amount raised for general corporate purposes, have been utilised.

iii. The Board of Directors and the management of the company shall provide their comments on the findings of the monitoring agency as specified in Schedule IX.

iv. The issuer shall, within 45 days from the end of each quarter, publically disseminate the report of the monitoring agency by uploading the same on its website as well as submitting the same to the stock exchange(s) on which its equity shares are listed.

(Emphasis added to the changes)

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Additionally, the amended regulations provide a new Schedule IX which provides the format of report to be submitted by monitoring agency.

3. Applicability of regulations related to Preferential issue – The new provision amends Regulation 70 of the SEBI ICDR Regulation 2009 and provides that the Regulation 72(2) (Conditions for preferential issue) and Regulation 78(6) (Lock-in of specified securities) would not be applicable to Scheduled Bank listed under the second schedule of the Reserve Bank of India Act, 1934 or a Public Financial Institution as defined in Section 2(72) of the 2013 Act.

(Source: SEBI notification SEBI/LAD-NRO/GN/2017–18/006 dated 31 may 2017)

SEBI prescribed fine for non-compliance with provisions in ICDR Regulations

Background

Regulation 111A of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR Regulations) provides that the entity or any person who contravenes any of the provisions of ICDR Regulations should be liable for the imposition of a fine by the respective stock exchange(s), in the manner specified in the circulars or guidelines.

Regulation 111B of ICDR Regulations 2009 provides that if the listed entity fails to pay any fine imposed upon it by the recognised stock exchange(s), within the specified period, the stock exchange may initiate such other action in accordance with law, after giving a notice in writing.

New development

The SEBI through its circular dated 15 June 2017 imposes a fine on the companies for non-compliance of the following provisions of ICDR Regulations:

• Regulation 95(1) Delay in completion of bonus issue

• Regulation 75 Companies not allotting the shares on conversion of convertible securities within 18 months

• Regulation 108(2) Issuer not approaching the exchange for listing of equity shares within 20 days from date of allotment.

The circular prescribes the following fine structure for first non-compliance and for each subsequent and consecutive non-compliance

• Fine of INR20,000 per day of non-compliance till the date of compliance

• In case non-compliance continues for more than 15 days – additional fine of 0.01 per cent of paid up capital of the entity or INR1 crore whichever is less.

Note: Paid up capital for the purpose of imposition of fine should be the paid up capital as on the first day of the financial year in which non-compliance occurs.

Additionally, the circular prescribed the following procedure for stock exchanges to be followed in case of non-compliance

• The amount of fine realised by a stock exchange should be credited to the ‘Investor Protection Fund’

• The names of the non-complaint listed entity that are liable to pay a fine or non-compliance should be disseminated on the website of the stock exchange along with the amount of fine imposed, details of fines received, etc.

• The notice should be issued to the non-complaint listed entity to pay a fine within 15 days from the date of notice

• In case any non-complaint listed entity fails to pay the fine, appropriated enforcement action, including prosecution should be initiated against such entity

• Further it has been clarified with respect to bonus issue delays:

– The date of commencement of trading should be considered as ‘implemented’

– The recognised stock exchange should grant approvals to the bonus shares allotted to persons other than the promoter in the interest of the investors, subject to compliance with other requirements

– The approval for the promoter’s bonus shares should be granted by the stock exchange after payment of the requisite fine by the company.

(Source: SEBI circular CIR/CFD/DIL/57/2017 dated 15 June 2017)

MCA issues draft Companies (Registered Valuers and Valuation) Rules, 2017

Background

Section 2471 of the 2013 Act governs the provisions relating to the valuation by registered valuers under the 2013 Act. It requires that wherever valuation with respect to any property, stocks, shares, debentures, securities or goodwill or any other assets or net worth of a company or its liabilities is required to be made under the provisions of the 2013 Act, it should be valued by a person having such qualifications and experience and registered as a valuer in such manner, on such terms and conditions as may be prescribed. Such a registered valuer should be appointed by the audit committee or by the Board of Directors (in the absence of audit committee) of that company.

The registered valuer has been entrusted with various significant responsibilities under the 2013 Act. These are as follows:

• Make an impartial, true and fair valuation of assets

• Exercise due diligence while performing the functions as a valuer

• Conduct valuation in accordance with the Rules as may be prescribed

• Not to undertake valuation of any assets in which he/she has

1. Not yet notified by MCA

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2. Registration Authority means the Insolvency and Bankruptcy Board of India established under the Insolvency and Bankruptcy Code, 2016.

a direct or indirect interest or becomes so interested at any time during or after the valuation of assets.

New development

On 26 May 2017, the MCA issued the draft Companies (Registered Valuers and Valuation) Rules, 2017 (Valuation Rules). The Valuation Rules provide detailed guidance on various aspects of a registered valuer.

Overview of the Valuation Rules

• Eligibility for being a registered valuer: An individual or a partnership entity could practice as a registered valuer only if the individual or the partnership entity has obtained a certificate of registration from the Registration Authority2.

The Valuation Rules prescribe various conditions which are to be met by an individual or a partnership entity for grant of certificate of registration. These inter alia, include passing of a valuation examination by an individual. However, individuals that have completed 50 years of age and been substantially involved in at least 10 valuation assignments of assets amounting to INR5 crore or more during the five years preceding the commencement of the Valuation Rules, are exempt from the valuation examination.

• Eligibility for recognition of valuation professional organisation: An organisation may be recognised as a valuation professional organisation for valuation of a specific class or classes of assets subject to the specified conditions which, inter alia, includes placing of a code of conduct for valuers who are its members. The code of conduct should contain all the provisions given in Schedule I of the Valuation Rules.

Additionally, a certificate of recognition as a valuation professional organisation is required to be obtained from the Registration Authority.

• Compliance with valuation standards: A registered valuer is required to make valuations as per the valuation standards as may be notified by the Central Government (CG). Till the time such valuation standards are being notified by the CG, the valuations should be performed in accordance with the following:

a. An internationally accepted valuation methodology

b. Valuation standards adopted by any valuation professional organisation, or

c. Valuation standards specified by the Reserve Bank of India (RBI) and SEBI or any other statutory regulatory body.

• Valuation report: Valuation Rules prescribe the items to be covered in the valuation report of a registered valuer. These, inter alia, includes, purpose of valuation and appointing authority, disclosure of valuer interest/conflict, valuation methodology and major factors that influenced the valuation.

• Cancellation or suspension of certificate of registration or recognition: The Registration Authority could cancel or suspend the registration of a valuer or recognition of a valuation professional organisation in the following circumstances:

a. Such an action is required in the public interest or

b. There has been violation of the provisions of the 2013 Act, Valuation Rules or any condition of registration or recognition, as the case may be.

• Forms: Schedule II of the Valuation Rules also provides the formats of the following important forms:

a. Form A: Application for registration as a valuer by an individual

b. Form B: Application for registration as a valuer by a partnership entity

c. Form C: Certificate of registration

d. Form D: Application for certificate of recognition

e. Form E: Certificate of recognition.

The period to provide comments on the draft Valuation Rules closed on 27 June 2017.

Please refer KPMG in India’s First Notes which provide a detailed analysis of the draft Valuation Rules.

(Source: Draft Companies (Registered Valuers and Valuation) Rules, 2017 issued by MCA on 26 May 2017)

Clarification regarding due date of transfer of shares to Investor Education and Protection Fund (IEPF) Authority

Background

Section 124 of the 2013 Act requires every company to transfer the amount of dividend which remains unclaimed and unpaid (upto 30 days from the date of the declaration) to the Unpaid Dividend Account opened by the company with any scheduled bank. The amount should be transferred within seven days from the date of expiry of the said period of 30 days.

Further, the section provides that in case any amount transferred to the Unpaid Dividend Account which remains unpaid or unclaimed for a period of seven years from the date of such transfer shall be transferred by the company along with interest accrued to the Investor Education Protection Fund (IEPF).

The MCA through its notification dated 28 February 2017, has amended the IEPF Authority (Accounting, Audit, Transfer and Refund) Rules, 2016. The amended rules provide that where the period of seven years for transfer of unclaimed dividend to the IEPF is due during 7 September 2016 to 31 May 2017, the due date of such transfer would be deemed to be 31 May 2017.

Area of focus Questions

Disclosures about fair value measurements - main focus on Level 3 disclosures

• How useful are the disclosures?• Which factors affect the usefulness – e.g. generic disclosures or

disclosures for aggregated groups of assets and/or liabilities?• Which disclosures are the most costly to prepare?• Would other disclosures be useful?

Prioritising Level 1 inputs (P*Q) or the unit of account – measuring quoted investments in subsidiaries, joint ventures and associates at fair value

• How often do issues arise in this area?• Are there material differences between fair value on the basis of P*Q

compared to other valuation techniques?• Which techniques are used in practice, and why?

Application of the concept of ‘Highest and Best Use’ (HBU) for non-financial assets

• Is the assessment of an asset’s HBU challenging, and why?• How common is it that an asset’s HBU differs from its current use

and what issues arise in such circumstances?• Is there diversity in practice?

Application of judgement in specific areas

• Is it challenging to assess whether a market is active?• Is it challenging to assess whether an input is unobservable and

significant to the entire measurement? (Source: Measuring fair value - Share your experience of IFRS 13, KPMG IFRG Limited’s publication, May 2017)

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Main areas of focusBased on the feedback received in the first phase of the PIR, the RFI is now seeking responses to a number of questions including the following:

In addition, the RFI explores the need for further guidance, such as education material, on measuring the fair value of biological assets and unquoted equity instruments.

(Source: RFI for IFRS 13 issued by IASB and KPMG in India’s IFRS Notes dated 2 June 2017)


New development

In the context to the transfer of unpaid or unclaimed dividend amount to IEPF, the IEPF Authority is considering to open the special demat accounts for this purpose. In view of this and till the opening of demat accounts, MCA through its notification dated 29 May 2017 extended the due date for transfer of shares to IEPF fund. The MCA has not yet announced the revised due date.

(Source: MCA circular 06/2017 dated 29 May 2017)

IASB seeks feedback for post-implementation review of IFRS 13

Background

The International Accounting Standards Board (IASB) conducts a Post-Implementation Review (PIR) of each new International Financial Reporting Standard (IFRS), generally after the standard has been implemented for two

years internationally. A PIR is an opportunity for the IASB to assess the effect of the new requirements of an IFRS and amendments thereto on investors, preparers and auditors.

IFRS 13, Fair Value Measurement was originally issued in May 2011 and was applicable internationally to annual periods beginning on or after 1 January 2013. It provides a single IFRS framework for measuring fair values and requires disclosures about fair value measurements.

In India, Indian Accounting Standard (Ind AS) 113, Fair Value Measurement, which is converged with IFRS 13, was notified by the Ministry of Corporate Affairs (MCA) and is applicable to all companies that are required to or elect to present their financial statements in accordance with Ind AS.

New development

The IASB is conducting the PIR of IFRS 13 in two phases. During the first phase, the IASB held meetings with many stakeholders to identify potentially challenging areas of

application. Although the general consensus from stakeholders was that IFRS 13 has worked well and brought significant improvements to financial reporting, a number of areas were flagged in which it was felt that practical improvements could be made to the standard. Since IFRS 13 has given rise to a number of implementation issues, IASB has issued a Request For Information (RFI) on this standard. The RFI launches the second phase of the PIR.

The RFI aims to assess whether:

• IFRS 13 provides information that is useful to users of financial statements

• The issues identified in the first phase create challenges in implementing IFRS 13, which can result in inconsistent application, and

• Unexpected costs have arisen when applying the standard.

The RFI is open for comments until 22 September 2017.

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KPMG in India’s IFRS instituteVisit KPMG in India’s 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.

MCA issues further relaxations from certain provisions of the Companies Act, 2013

23 June 2017

Background

The Ministry of Corporate Affairs (MCA) through its notifications dated 5 June 2015, provided certain exceptions/modifications/adaptations to some of the provisions of the Companies Act, 2013 (2013 Act) for the following class of companies:

• Private companies

• Companies formed with the charitable objects, etc. (Section 8 companies)

• Government companies.

New development

The MCA through its notifications dated 13 June 2017 and 22 June 2017, provided further exceptions/modifications/adaptations to the provisions of the 2013 Act for the above mentioned class of companies (i.e. private companies, Section 8 companies and government companies).

These exceptions/modifications/adaptations would be available to the companies which have not defaulted in filing of its financial statements under Section 137 or annual return under Section 92 of the 2013 Act with the Registrar of Companies.

This issue of First Notes provides an overview of the exceptions/modifications/ adaptations made to the 2013 Act for private companies, Section 8 companies and government companies.

Our issue of First Notes provides an overview of the notified provisions.

Voices on Reporting Newsletter - Annual update

As you are aware, KPMG in India conducts Voices on Reporting – a monthly series of knowledge sharing calls to discuss current and emerging issues relating to financial reporting.

In our recent session of Voices on Reporting webinar on 22 June 2017, we covered key financial reporting and regulatory matters that are expected to be relevant for stakeholders as they approach the quarter ending 30 June 2017.

The session included updates from the Ministry of Corporate Affairs (MCA), the Institute of Chartered Accountants of India (ICAI), the Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI), etc. Some of the recent emerging issues on which we provided an update in the session are as follows:

• Ind AS reminders – Phase II of implementation of Ind AS road map

• Updates on recent Ind AS Transition Facilitation Group (ITFG) Bulletins

• SEBI circular on non-convertible redeemable preference shares and debentures issued in a scheme of arrangement

• Recent clarification on certain accounting and disclosure requirements in financial statements of banks issued by RBI

First NotesIFRS NotesIASB issues exposure draft of amendment to IAS 16

23 June 2017

The IFRS Interpretations Committee (the Committee), in July 2014 considered a request for clarification on accounting for net proceeds received during the course of testing Property Plant and Equipment (PPE), in case the net proceeds exceed the costs of testing. However, after

extensive discussion on this topic, the Committee recommended to the International Accounting Standards Board (IASB) to propose an amendment to IAS 16, Property, Plant and Equipment to prohibit deducting sales proceeds from the cost of PPE.

Accordingly, on 20 June 2017, the IASB issued an Exposure Draft on Property, Plant and Equipment – Proceeds before Intended Use (the Exposure Draft) proposing a narrow-scope amendment to IAS 16.

The last date for comments on the exposure draft is 19 October 2017.

This issue of IFRS Notes provides an overview of the proposed amendments in the Exposure Draft.

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.


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