Accounting and Auditing Update - KPMG · The International Accounting Standards Board (IASB) has published a Discussion Paper (DP) – Financial Instruments with Characteristics of

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Accounting and Auditing UpdateIssue no. 24/2018

July 2018

© 2018 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

The International Accounting Standards Board (IASB) has published a Discussion Paper (DP) – Financial Instruments with Characteristics of Equity (FICE). This DP seeks to improve information about financial instruments issued by entities. Currently, IAS 32, Financial Instruments: Presentation (Ind AS 32) sets out how an issuer distinguishes between a financial liability and equity. This standard works well for many simpler financial instruments. However, the classification requirements of IAS 32 results in significant practice issues when applied to complex financial instruments e.g. those with characteristics of equity. Therefore, the DP lays down clearer classification principles that are meant to help issuers distinguish between liability and equity. In this issue of the Accounting and Auditing Update (AAU), we discuss the key proposals of the DP and issues addressed by the IASB.

A parent entity may lose control of a subsidiary or gain control in an associate by acquiring further voting rights. Ind AS provides detailed guidance to account for such changes – loss of control or new acquisitions. Our article on this topic explains the accounting requirements

under Ind AS when there is a loss of control in a subsidiary and step acquisition in an associate leading to control with the help of an illustration.

The Expert Advisory Committee of the Institute of Chartered Accountants has considered the issue on the classification of temporary income in relation to a construction contract. The article summarises the guidance that is available under Indian GAAP and also compares it with the Ind AS. Additionally, the article highlights the guidance under Ind AS 115, Revenue from Contracts with Customers in relation to the financing component. When the entity has received advance payments from a customer for providing promised goods or services, then it would need to evaluate whether the payment terms provide it with a significant benefit of financing.

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

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

Sai VenkateshwaranPartner and HeadAccounting Advisory Services KPMG in India

Ruchi RastogiPartnerAssuranceKPMG in India

Editorial

© 2018 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

02 Change in ownership interests in investees 07

03 Construction contracts – income from surplus funds 15

01 The changing future of financial instruments accounting 01

04 Regulatory updates 19


© 2018 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© 2018 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

This article aims to:

– Discuss the key features of the discussion paper on financial instruments with characteristics of equity published by IASB.

The changing future of financial instruments accounting

01


Recently, the International Accounting Standards Board (IASB) issued a discussion paper DP/2018/1 - Financial Instruments with Characteristics of Equity (FICE). This discussion paper aims to improve the information companies provide in their financial statements about financial instruments they have used. Therefore, the discussion paper focusses on defining the principles for the classification of financial liabilities and equity instruments, and does not intend to fundamentally change the existing classification requirements.

The discussion paper outlines a suggested approach with an aim to help companies issuing financial instruments to classify them as either debt or equity and providing investors with better information about such instruments.

The IASB’s proposed approach is based on two features, i.e. timing feature and amount feature, and would provide additional information relating to financial liabilities and equity instruments through separate presentation of income and expenses on the face of financial statements and additional disclosure in the notes to the financial statements.

The period to provide comments to the discussion paper ends on 7 January 2019.

Background

IAS 32, Financial Instruments: Presentation establishes principles for distinguishing financial liabilities from equity instruments. It applies to the classification of financial instruments as financial assets, financial liabilities or equity instruments. The distinction between a liability and equity plays a significant role in how entities provide information in their financial statements. For example, changes in the carrying amount of a financial liability would be recognised in the statement of profit and loss whereas change in equity would not.

Currently, the entities are applying the requirements of IAS 32 to a financial instrument to classify such instrument either as a financial liability or an equity instrument.

It was observed that the classification requirements of IAS 32 result in significant practice issues when applied to complex financial instruments such as instruments combining features of both bonds and ordinary shares (new forms of financing). In the past, IFRS interpretation committee has received several queries in this area and referred some of these cases to IASB.

On the basis of the queries received and to address the emerging issues regarding the classification of financial liabilities, IASB decided to develop the FICE project. The project discusses the classification of financial


instruments from the perspective of the issuer, as financial liabilities or equity instruments. Further, the project does not address other accounting requirements for financial instruments, such as:

• Recognition and measurement requirements in IFRS 9, Financial Instruments or

• Disclosure requirements in IFRS 7, Financial Instruments: Disclosures.

What’s the issue?

The classification of financial instruments as liabilities or equity instruments has a significant impact on presentation in the financial statements, on their measurement and on how they affect an entity’s financial performance. However, the increasing complexity of financial instruments is making it difficult to distinguish between liabilities and equity. The IASB observed following challenges relating to current classification requirements:

• IAS 32 does not always provide a clear rationale for its requirements and

• The distinction provided by classifying financial instruments as financial liabilities or equity instruments can provide only a limited amount of information in relation to features of the financial instruments.

Proposal under the discussion paper

Classification principles

The IASB has proposed an approach which establishes principles for classification of financial instruments by reference to two features that are regarded as important i.e. the timing feature and amount feature.

According to the proposed approach, a financial instrument would classify as a financial liability if it contains:

a. An unavoidable contractual obligation to transfer cash or another financial asset at a specified time other than at liquidation (the timing feature), and/or

b. An unavoidable contractual obligation for an amount independent of the entity’s available economic resources (the amount feature).

Financial instruments would be classified as equity instruments if they do not contain either of the above two features.

The proposed approach requires an entity to analyse the above mentioned features to find the correct classification of financial instruments. Information about

02

Example

Licences of biological compounds and drug formulae are examples of right to use licences (i.e. point in time recognition) under Ind AS 115. In respect to to such licences, it is generally being considered that the entity is not likely to undertake future activities that will significantly affect the underlying IP i.e. the underlying IP is complete. Assessment of future activities includes only those activities that do not transfer a separate good or service to the customer. For example, R&D services provided to a customer as a separate performance obligation under the contract does not consider these activities in making an assessment for the underlying IP.

An example of a licence that is not considered as distinct would be a drug compound that requires proprietary R&D services from the entity.


to make assessments that will inform their decisions about providing resources to the entity.

The table below provides how the IASB’s proposed approach would classify financial liabilities and equity instruments:

The above defined approach requires two broad assessments of financial position and financial performance that depend on information about different sets of features of claims. They are:

a. Assessments of funding liquidity and cash flows, including whether an entity will have the economic resources required to meet its obligations as and when they fall due. These assessments are driven by information about requirements to transfer economic resources at a specified time other than at liquidation (the timing feature)

Classification of derivatives

The IASB developed separate classification principles to apply the proposed approach to derivative financial instruments because of particular challenges associated with derivatives on own equity. A derivative on own equity would be classified in its entirety. The individual legs of the exchange would not be separately classified. The discussion paper proposes that such a derivative may be classified as an equity instrument, a financial asset or a financial liability in its entirety.

Further, IASB proposes that such a derivative on own equity would be classified as a financial asset or a financial liability if:

• It is net-cash settled i.e. the derivative could require the entity to deliver cash or another financial asset, and/or contains a right to receive cash, for the net amount at a specified time other than at liquidation (timing feature) and/or

• The net amount of the derivative is affected by a variable that is independent of the entity’s available economic resources (amount feature).

Presentation

The discussion paper proposes a new approach that would enhance information provided through presentation on the face of the financial statements, including:

• Information about the amount feature of financial liabilities that would be provided through separately presenting financial liabilities with different types of amount features in the statements of financial position and financial performance; and

• Information about equity instruments that would be provided by attributing total income and expense to equity instruments other than ordinary shares.

Obligation for an amount independent of the entity’s available economic resources

No obligation for an amount independent of the entity’s available economic resources

Obligation to transfer cash or another financial asset at a specified time other than at liquidation

Liability (e.g. simple bonds)

Liability (e.g. shares redeemable at fair value)

No obligation to transfer cash or another financial asset at a specified time other than at liquidation

Liability (e.g. bonds with an obligation to deliver a variable number of the entity’s own shares with a total value equal to a fixed amount of cash)

Equity (e.g. ordinary shares)

Amount feature

Timing feature

(Source: IASB’s Discussion Paper DP/2018/1 - Financial Instruments with Characteristics of Equity issued in June 2018)

b. Assessments of balance sheet solvency and returns (measured on an accrual basis), including whether an entity has sufficient economic resources required to meet its obligations at a point in time, and whether the entity has produced a sufficient return on its economic resources to satisfy the return that its claims oblige it to achieve. These assessments are driven by information about the amount of the obligation (the amount feature).

03


Disclosures

The IASB’s proposed approach also includes additional information about both financial liabilities and equity instruments that would be provided through disclosure in the notes to the financial statements.

Further, IASB proposes following improvements to the disclosure requirements for financial liabilities and equity instruments:

• Priority on liquidation i.e. each class of financial liabilities and equity instruments ranked in order of priority on liquidation.

• Potential dilution of ordinary shares i.e. any actual or potential increase in the number of issued ordinary shares as a result of settling a financial instrument regardless of whether the effect is dilutive or anti-dilutive.

• Contractual terms and conditions i.e. particular contractual terms of financial liabilities and equity instruments, for example, contractual terms that are relevant to understanding the amount and timing features of a financial instrument.

04

Example




Issues addressed by IASB’s proposed approach

Challenges Applying the proposed approach would:

Application of the ‘fixed-for-fixed’ condition to derivatives on the issuer’s own equity.

Provide a clear principle for classifying derivatives on own equity. Classification would be based on the timing and amount features as described above. In particular, the approach would clarify that, for a derivative to be classified as equity, the net amount of the derivative would not be affected by any variables that are independent of the issuer’s available economic resources. ‘Fixed-for-fixed’ derivatives on own equity would still be classified as equity instruments.

Accounting for put options written on equity instruments including those on non controlling interests

a. Achieve consistent classification outcomes for arrangements with similar economic effects on the issuer, e.g. convertible bonds and written put options

b. Provide more guidance on accounting within equity, for example, accounting entries to be made on initial recognition and on expiry or on exercise of the put options, and

c. Require separate presentation of income and expenses in OCI for liabilities with amounts linked to share price, for example, shares that the entity may be required to redeem or repurchase at fair value.

Accounting for bonds that are contingently convertible to equity

Clarify classification of liability and equity components, and clarify how the contingency would (or would not) affect the classification. Consistent with any other derivatives on own equity, the contingent conversion option would be classified as equity only if the net amount of the option is unaffected by any variables that are independent of the issuer’s available economic resources.

Inconsistency between classification requirements for stand-alone foreign currency share options and the requirements for share options embedded in a foreign currency convertible bond

Achieve consistent classification outcomes regardless of whether the derivative is a stand-alone financial instrument or embedded in another financial instrument. Stand-alone or embedded derivatives on own equity would be classified as derivative assets or liabilities if their net amount is affected by a foreign currency variable. Separate presentation of income or expenses in other comprehensive income may be required.

Classification of callable preference shares with step up dividend clauses that allow the entity to defer payment indefinitely

Require the issuer to classify such instruments as financial liabilities if the amount feature is independent of the entity’s available economic resources (e.g. if the step-up results in the amount due on the instrument on liquidation is equal to those of a cumulative instrument). The classification would be determined without the need to consider the issuer’s economic incentives to pay dividends.

(Source: IASB’s Discussion Paper June 2018 | Snapshot: Financial Instruments with Characteristics of Equity)

05


Next steps

The discussion paper is open for public comments and IASB seeks comments on the financial reporting challenges discussed in the discussion paper and possible approaches to address the challenges. The IASB also seeks comments on the proposed approach and whether it should be developed to address the challenges identified.

The IASB would consider the comments received on the discussion paper to decide for further course of action and accordingly develop an exposure draft to amend the existing requirements.

06


– Illustrate the accounting for change in control or significant influence on an investee.

Change in ownership interests in investees


07

In the current dynamic economic environment, there is a need for diversification and synergy of resources. Entities may restructure their group, which may involve making investments or divesting their resources.

The accounting for these transactions may sometimes be complicated, especially under the Indian Accounting Standards (Ind AS) regime. An investor and an investee may have various kinds of investment relationships e.g.:

• Investments made without establishing any relationship: Ind AS 109, Financial Instruments

• Investor controls the investee: Ind AS 110, Consolidated Financial Statements (consolidation)

• Investor has significant influence or joint control: Ind AS 28, Investment in Associates and Joint Ventures and Ind AS 111, Joint arrangements (equity accounting).

Complexities further arise when there is a change in relationship between the investor and the investee, which necessitates a change in the method of accounting.

In this article, we aim to illustrate the accounting for a change in control or significant influence status of investees of a Non-Banking Financial Company (NBFC) due to change in its equity interests.

Example: Investments held by company N

N Private Limited (company N), an NBFC, has made various investments, including investments in certain companies accounted for as an associate and a subsidiary. On 1 April 2018, company N has the following investments:


CompanyEquity holding

RelationshipAccounting method

Company A

30 per cent

Significant influence (Associate)

Equity accounting

Company C

60 per cent

Control (Subsidiary) Consolidation

08

Example




Due to certain strategic decisions, company N is required to procure an additional 60 per cent shares in company A for INR180,000 million, and dispose of 20 per cent shares in company C for INR400 million.

The above transactions will result in a change in relationship between the entities, and as a result, in the accounting method. Details of the transaction are given below:

CompanyEquity holding

Fair value of existing/retained interest

Net assets Remarks

Company A

90 per cent

Existing interest in A: INR90,000 million

Fair value of net assets: INR300,000 million

Carrying amount of interest in A on 1 April 2018 is INR87,500 million (includes share of revaluation reserve of INR500 million).Fair value of Non-Controlling Interest (NCI) on 1 April 2018 is INR70,000.

Company C

40 per cent

Retained interest in C: INR800 million

Carrying amount of net assets: INR1,750 million

Other Comprehensive Income (OCI) (net of amounts allocated to NCI) includes foreign currency translation reserve of INR180 million.NCI on 1 April 2018 is INR700 million.

09


Accounting issue

Company N needs to evaluate the accounting for a change in relationship with company A from an associate to subsidiary (acquisition of control) and with company C, from a subsidiary to an associate (loss of control) in accordance with Ind AS.

Accounting guidance and analysis

As per Ind AS, any change in equity interests, which causes a change in the method of accounting is considered to be a significant economic event, and accounted for as if the investor’s equity interest is sold at fair value and immediately reacquired at that price.

Loss of control

Figure 1 below explains the accounting impact in the consolidated financial statements of company N, when it loses control over company C.

Subsidiary Associate

Figure 1: Accounting impact when there is loss of control

Impact

• Discontinue consolidation

• Recognise the fair value of the consideration received, if any

• Recognise the distribution of shares to the new owners of the subsidiary (if loss of control involves such distribution)

• Reclassification of amounts from OCI to retained earnings/statement of profit and loss

• Retained interest measured at fair value, subsequently accounted as per Ind AS 28

• Recognise profit/loss on loss of control

Loss of control

(Source: KPMG in India’s analysis 2018, read with Insights into IFRS, KPMG IFRG Ltd’s publication, 14th edition, September 2017)

10

Example




Discontinue consolidation

An investor consolidates an investee from the date it obtains control over it, till the date on which it loses control. Accordingly, when company N loses control over company C due to change in its equity interest, it should derecognise the individual assets (including goodwill) and liabilities of C, and the NCI pertaining to subsidiary, including any components of OCI attributable to them.

Recognise profit/loss on loss of control

The amount recognised in the statement of profit and loss on loss of control is computed as below:

Reclassification of amounts from OCI to retained earnings/profit or loss

As per Ind AS 110, amounts recognised in OCI (net of amounts allocated to NCI), pertaining to the subsidiary should be reclassified to the statement of profit and loss or transferred directly to retained earnings (as required by Ind AS), in a similar manner as would be the case on disposal of the subsidiary. Accordingly, the amounts pertaining to the foreign currency translation reserve (INR180 million) should be transferred from OCI to the statement of profit and loss.

Retained interest measured at fair value

The 40 per cent interest held in company C should be measured at fair value (i.e. INR800 million) on the date of divestment of the entity’s interest. This amount is deemed to be the cost of investee when applying the equity method in accordance with Ind AS 28.

ParticularsAmount (INR in million)

Add:

Fair value of consideration received 400

Fair value of any retained interest 800

Carrying amount of the NCI, including its share of OCI 700

Less:

Carrying amount of net assets of C (1,750)

Total profit/loss on loss of control 150


It is to be noted that on disposal of a subsidiary that includes a foreign operation, the cumulative amount of the exchange differences related to that foreign operation that have been attributed to the NCI forms part of the NCI that is derecognised and is included in the calculation of the gain or loss on disposal, but it is not reclassified to profit or loss.

11

Associate


Accounting entry

N should record the following accounting entry to reflect its loss of control:

Date Accounting entry Dr/Cr Amount (INR in million)

1 April 2018 Cash Dr 400

Non-controlling interest1 Dr 700

Foreign currency translation reserve Dr 180

Investment in C Dr 800

Net assets of S Cr 1,750

Profit or loss Cr 330

Acquisition of control

When an entity obtains control over an existing associate that meets the definition of a business, in accordance with Ind AS 103, Business Combinations, the accounting for such a transaction would be similar to the accounting for a business combination achieved in stages (as prescribed in Ind AS 103).

Figure 2 below explains the accounting impact in the consolidated financial statements of company N, when it acquires control over company A.

Post this, investment in C will be accounted for in accordance with Ind AS 28.

1. This includes NCI’s share of foreign currency translation reserve pertaining to company C

Subsidiary

Figure 2: Accounting impact on acquiring control over existing associate

Impact

• Compute goodwill

• Recognise profit/loss on deemed sale of previously held equity investment

• Reclassification of amounts of previously held equity investment from OCI to retained earnings/statement of profit and loss

• Subsequently accounted as per Ind AS 110

Acquire control

12

(Source: KPMG in India's analysis 2018, read with Insights into IFRS, KPMG IFRG Ltd's publication, 14th edition, September 2017)"

Example




Computation of goodwill

Goodwill represents the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised. It is generally computed as the difference between the sum of consideration transferred (measured at fair value) and the NCI2 in the acquiree, and the net of the acquisition date amounts of the identifiable assets acquired and the liabilities assumed.

In a step acquisition, the fair value of any non-controlling equity interest in the acquiree company, that is held immediately before obtaining control is also used in the determination of goodwill, i.e. it is remeasured to fair value at the date of acquisition3 with any resulting gain or loss recognised in profit or loss. Accordingly, the goodwill is computed as below:

Profit/loss on deemed sale of investment

The accounting treatment in a step acquisition effectively considers that the investment in the acquiree that was held before obtaining control is sold, and subsequently repurchased at the date of acquisition (at its fair value). Accordingly, a gain or loss on the sale of the investment is computed as below5:

Reclassification of amounts from OCI to retained earnings/profit or loss

On obtaining control, amounts recognised in OCI, related to the previously held equity interest are recognised on the same basis as would be required if the acquirer had disposed of the previously held equity interest directly. Accordingly, INR500 million in OCI related to N’s share of the revaluation reserve of A would be reversed and credited to retained earnings as it is not permitted to be transferred to the statement of profit and loss as per Ind AS 16, Property, Plant and Equipment.


Add:

Consideration transferred (generally measured at fair value) 180,000

Amount of NCI in the investee company4 70,000

Acquisition date fair value of N’s previously held interest in A 90,000

Less:

Net of acquisition date amounts of the identifiable assets acquired and liabilities assumed, measured at fair value

(300,000)

Goodwill 40,000


Add:

Fair value of 30 per cent interest in A on 1 April 2018 90,000

Carrying amount of 30 per cent interest in A on 1 April 2018 (87,500)

Gain on previously held interest in A, recognised in profit or loss

2,500


Fair value movements on equity investments that are reported in OCI (as elected in accordance with Ind AS 109 would not be reclassified to the statement of profit and loss.

2. Ordinary NCI may be measured either at fair value or at their proportionate share in the fair value of the identifiable assets and liabilities of the acquire.

3. The date of acquisition for a business combination achieved in stages is the date on which the acquirer obtains control of the acquiree.

4. In the current scenario, N elects to measure NCI at fair value, accordingly, goodwill includes a portion attributable to NCI.

5. This gain or loss is disclosed on the same basis as if the investment had been disposed of to a third party.

13


Equity interest measured at fair value

On the date of acquisition, N derecognises its interest in associate A and recognises the net assets acquired in subsidiary A, along with the NCI pertaining thereto. N has an option to initially recognise the NCI either at

fair value or at a proportionate interest in identifiable net assets of the acquiree. Thereafter, N would be required to consolidate the financial statements of A with effect from 1 April 2018, in accordance with Ind AS 110.

Date Accounting entry Dr/Cr Amount (INR in million)

1 April 2018 Identifiable net assets of A Dr 300,000

Goodwill Dr 40,000

Revaluation reserve Dr 500

Cash Cr 180,000

NCI (equity) Cr 70,000

Investment in associate A Cr 87,500

Retained earnings Cr 500

Profit or loss (gain on previously held interest) Cr 2,500

Consider this

• After a parent has obtained control of a subsidiary, it may change its ownership interest in that subsidiary without losing control. This can happen, for example, when a parent buys shares from, or sells shares to the NCI, or through the subsidiary issuing new shares or reacquiring its shares. Transactions that result in changes in ownership interests while retaining control are accounted for as transactions with equity holders in their capacity as equity holders. As a result, no gain or loss on such changes is recognised in profit or loss, instead it is recognised in equity. Also, no change in the carrying amounts of assets (including goodwill) or liabilities is recognised as a result of such transactions. (NCI being a component of equity).

• If an entity acquires an interest in a non-wholly owned subsidiary, that is not a business, then the requirements of Ind AS 110 would continue to apply, because the scope of the standard is not limited to subsidiaries that are businesses.

• If an entity acquires additional interests while continuing to apply equity accounting, then it does not remeasure the existing interest if an acquisition results in a change in status from an associate to a joint venture, or vice versa. Reserves, such as cumulative foreign currency translation reserve, should not be reclassified to profit or loss or

transferred to retained earnings, because doing so would be inconsistent with the continuation of equity accounting and the existing carrying amount.

• In a business combination achieved by contract alone, the acquirer receives no additional equity interests in the acquiree. Therefore, if the acquirer held no equity interest in the acquiree before the business combination, then 100 per cent of the acquiree’s equity would be attributed to NCI. If in such circumstances, the acquirer elects to measure NCI at fair value at the date of acquisition, then this would not include any control premium because it is an NCI.

Accounting entry

14


– Highlight an issue of classification of an item of income into ‘other operating revenue’ and ‘other income’ under current GAAP and Ind AS based on an EAC opinion

– Accounting of surplus funds under Ind AS 115, Revenue from Contracts with Customers.

Construction contracts – income from surplus funds


15

When an entity follows Ind AS, Part II of Schedule III to the Companies Act, 2013 (2013 Act) provides the format of the statement of profit and loss and specifically requires disclosure of aggregate of ‘revenue from operations’ and ‘other income’ on the face of the statement of profit and loss.

Further, note 2(A) to general instructions for the preparation of statement of profit and loss (Part II of Schedule III) requires separate disclosure in the notes, revenue from:

a. Sale of products

b. Sale of services and

c. Other operating revenues.

The aggregate of ‘other income’ has to be disclosed on the face of the statement of profit and loss. In accordance with the note 4 of general instructions for the preparation of statement of profit and loss ‘other income’ is required to be classified as:

a. Interest income (in case of a company other than a finance company)

b. Dividend income

c. Net gain/loss on sale of investments

d. Other non-operating income (net of expenses directly attributable to such income).

As mentioned above, revenue from operations and other income has been explained in the Schedule III but term ‘other operating revenue’ has not been defined under AS/Ind AS or 2013 Act. Lack of definition has resulted in practical issues relating to classification of an item of income into ‘other operating revenue’ and ‘other income’.

The Institute of Chartered Accountants of India (ICAI) has issued a Guidance Note on the Schedule III to the 2013 Act (GN). The GN explains the term ‘other operating revenue’ and states that it includes revenue arising from a company’s operating activities, i.e. either its principal or ancillary revenue-generating activities, but does not include revenue arising from the sale of products or rendering of services. Therefore, whether a particular income would be classified as ‘other operating revenue’ or ‘other income’ has to be decided based on the facts of each case and detailed understanding of the company’s activities.

In this article, we aim to highlight the issue of classification of an item of income into ‘other operating revenue’ and ‘other income’ under AS as well as under Ind AS with the help of an opinion issued by the Expert Advisory Committee (EAC) (the committee) of the ICAI1 on ‘Accounting treatment of temporary income in relation to construction contract’.

Case study - Accounting treatment of temporary income in relation to a construction contract

A Ltd. (the company) is in the business of construction of warships. The contracts are awarded to A Ltd. on fixed price basis except certain variable components such as foreign exchange variation and cost of spares, etc. The terms of the contract are as follows:

• The payment for fixed price part is on the basis of completion of milestones. The payment terms for fixed price portion of the contract are generally spread over 10-12 milestones starting with initial payment of 10 per cent on signing of the contract.

• The payment for variable component is based on actual cost to A Ltd.

A Ltd. recognises revenue on the basis of percentage of completion method as per AS 7, Construction Contracts.

As the gestation period of the contracts for shipbuilding is longer, it so happens that during initial period when the funds are made available, such funds become temporarily surplus funds for A Ltd. However, in the later part of execution of the contract, the cost incurred on the project exceeds the stage payments received on the vessel leading to a negative cash flow. Further, the last stage payment of the project is deferred till one year after the delivery of the vessel.

Accordingly, A Ltd. deploys such surplus funds in short-term fixed deposits. The interest earned initially on the temporary surplus compensates to a certain extent for the period of deficit cash flow for A Ltd., especially at the later part of the execution of the project.

Issue

A Ltd. needs to assess whether the interest earned on deposits of temporary surpluses of milestone payments should be considered as ‘other operating revenue’ or ‘other income’ to be presented in the statement of profit and loss


1. EAC opinion issued by ICAI in January 2018.

16

Additionally, we will highlight the accounting of surplus funds when an entity would apply Ind AS 115.

Example




Guidance under AS

The classification of income would also depend on the purpose for which the particular asset is acquired or held. For example, a group engaged in manufacture and sale of industrial and consumer products also has one real estate arm. If the real estate arm is continuously engaged in leasing of real estate properties, then the rent arising from leasing of real estate is likely to be classified as ‘other operating revenue’. However, if a consumer products company which owns a 10 storied building, gives one of the floors in the building temporarily on rent, then lease rent would not be classified as ‘other operating revenue’; rather, it would be classified as ‘other income’.

With respect to other income, the GN provides that all kinds of interest income for a company other than a finance company should be disclosed under ‘other income’. Examples of other income are interest on fixed deposits, interest from customers on amounts overdue, etc.

Accordingly, in the given case, since A Ltd. is engaged in construction of warships, the amount of interest income from temporary investments of milestone payments cannot be classified as ‘other operating revenue’; rather the same should be classified as ‘other income’.

Guidance under Ind AS – presentation of other income

The Ind AS based Schedule III to the 2013 Act (Division II) and Ind AS 1, Presentation of Financial Statements also provide similar basis (as explained in AS) of classification of an income into ‘other operating revenue’ and ‘other income’.

Further, the Ind AS Transition Facilitation Group (ITFG) in its Bulletin 13 (Issue 5)2 also clarified that disclosure of income in the financial statements should be governed by the GN on Ind AS Schedule III. According to the GN on Ind AS Schedule III, interest income for financial assets measured at amortised cost and for financial assets measured at Fair Value Through Other Comprehensive Income (FVOCI), calculated using effective interest method, should be presented in separate line items under ‘other income’.

Therefore, the interest income from surplus funds would be presented as other income (as per opined in the committee’s decision).

2. ICAI-ITFG Clarifications’ Bulletin 13 dated 16 January 2018.

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Treatment under Ind AS 115 - Significant financing component in a contract

In this case, A Ltd. is in the business of construction of warships and would need to consider the new standard on revenue recognition i.e. Ind AS 115. This standard is effective for accounting periods beginning on or after 1 April 2018.

Ind AS 115 provides a new approach of revenue recognition i.e. revenue should be recognised when (or as) an entity transfers control of goods or services to a customer at the amount to which an entity expects to be entitled. To achieve this, the new standard establishes a five-step model that entities would need to apply to determine when to recognise revenue, and at what amount. These are as follows:

• Step 1: Identify the contract with the customer

• Step 2: Identify the performance obligations in the contract

• Step 3: Determine the transaction price

• Step 4: Allocate the transaction price to the performance obligation in the contract

• Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation.

At step 3, an entity has to determine its transaction price. This step also requires an entity to consider the effects of a significant financing component in the contract. In the case of significant financing, an entity should adjust the promised amount of the consideration for the effects of the time value of money if the timing of payments agreed to by the parties to the contract (either explicitly or implicitly) provides the customer or the entity with a significant benefit of financing the transfer of goods or services to the customer.

The objective for adjusting the promised amount of consideration for a significant financing component is that an entity should recognise revenue at an amount that reflects the price that a customer would have paid for the promised goods or services if the customer had paid cash for those goods or services when (or as) they transfer to the customer (i.e. the cash selling price).

In a construction contract, it is common that certain amount is received as an advance from customer in the initial period. Also certain amount is withheld as retention money based on the terms of the contract, which is not paid until the satisfaction of conditions specified in the contract or until the defects, if any, have been rectified.

The new standard also includes a practical expedient that allows entities to not account for a significant financing


component if the period between the payment and performance is 12 months or less. For contracts with an overall duration greater than one year, the practical expedient applies if the period between performance and payment for the performance is one year or less.

In the given case, if the period between milestone payments and performance is more than one year then it should evaluate if it has received any significant benefit of financing. A Ltd. has received advance payments from the customer for providing promised goods or services, then it would need to evaluate whether the payment terms provide it with a significant benefit of financing. While making such an evaluation judgement is to be exercised and consideration be given to factors such as whether the arrangement has been entered in the normal course of business, the advance payment is per typical payment terms within industry and having a primary purpose other than financing, it is a security for future supply of limited goods or services or other relevant factors depending on facts and circumstances of each case.

Therefore, A Ltd. would need to firstly consider the period between the performance and payment for that performance. For contracts where revenue is recognised at a point in time, the period considered would be between transfer of control of the good and the payment. For over-time contracts, the analysis is the same as for point-in-time. However, the amount being financed will change over time as the entity performs its obligations under the contract. This is because only the portion of the property not yet transferred to the customer is still being financed.

Apart from period between performance and payment, the effect of deferred and advance payments would also need to be considered. Advance payments from the customer lead to higher amount of revenue being recognised than contract price because the entity accepts a lower amount in return for financing. The entity would recognise interest expense related to the financing component and a corresponding liability/revenue.

However, deferred payments reflect that the entity provides finance to the customer and therefore, the amount of revenue recognised would be less than the contract price and the entity needs to recognise the difference as finance income.

The effects of financing (i.e. interest revenue or interest expense) are to be recognised separately from revenue from contracts with customers in the statement of profit and loss.

In some circumstances, there could be retention money that would be paid by the customer on completion of

obligation under the contract. In such cases, Ind AS 115 explicitly states that a contract would not have significant financing payments. However, advance or deferred payments by a customer are not exempted from the evaluation for time value of money.

Therefore, an entity would need to consider the time value of money of both advance and deferred payments to determine the existence of significant financing component in a contract.

Consider this

• The statement of profit and loss specifically requires disclosure of aggregate of ‘revenue from operations’ and ‘other income’ on the face of the statement of profit and loss.

• Whether a particular income constitutes ‘other operating revenue’ or ‘other income’ has to be decided based on the facts of each case and detailed understanding of the company’s activities.

• Under the new revenue standard (i.e. Ind AS 115), companies would be required to evaluate the existence of significant financing component in a contract, particularly in contracts involving advance or deferred payments.

• If it is concluded that a significant financing component is present, then resultant interest income (when the customer pays in arrears) or interest expense (when the customer pays in advance) would not be presented as revenue; rather these would be recognised as finance income or expense in the statement of profit and loss.

18

Regulatory updates


19

MCA notified sections of the Companies (Amendment) Act, 2017 and modified certain rules under the Companies Act, 2013

The Ministry of Corporate Affairs (MCA) issued two notifications on 5 July 2018 notification no. S.O. 3299 E. and S.O. 3300 E. to notify certain provisions of the Companies (Amendment) Act, 2017 (the Amendment Act).

Following are some of the key provisions of the Amendment Act recently notified:

• Company to Report Satisfaction of Charge (Section 82): Under 2013 Act Section 82(1) requires companies to intimate to the Registrar of Companies (RoC) within 30 days of the payment or satisfaction in full of registered charge. The Amendment Act provides that RoC may on application by the company allow such intimation to be made within 300 days of payment or satisfaction on payment with additional fees as prescribed. This section is applicable from 5 July 2018.

• Prohibition on acceptance of deposits from public (Section 73): Currently, Section 73(2) of the 2013 Act permits a company to accept deposits from its members and public, subject to specified conditions. One of the conditions requires a company to deposit an amount, not less than 15 per cent of the amount of its deposits maturing during a Financial Year (FY) and the FY next following, in a scheduled bank (in a separate bank account) to be called as ‘deposit repayment reserve account’. The Amendment Act changes the requirement for maintaining a deposit repayment reserve account in a scheduled bank to 20 per cent of the amount of deposits maturing during the following financial year.

Further, the requirement to provide a deposit insurance in respect of the amount of deposits accepted by the company has been dispensed with. Additionally, companies which have made good the default committed in the past would be allowed to accept deposits after five years from the date of the default remediation. These notified amendments are effective from 15 August 2018.

• Repayment of deposits (Section 74): The timeline for repayment of deposits accepted by the company before the commencement of the 2013 Act has been modified by the Amendment Act. It clarifies that the amount of deposits accepted by a company before the commencement of the 2013 Act should be repaid on within the following periods (whichever is earlier):

– Within three years from the date of commencement of the 2013 Act (earlier the time period was one year), or

– Before the expiry of the period for which the deposits were accepted (earlier it was the date on which such payments are due).

Additionally, renewal of such deposits would take place as per the provisions of Chapter V of the 2013 Act and related Rules.

This notified amendment is effective from 15 August 2018.

On 5 July 2018, the MCA also issued following amendment rules:

• Companies (Registration of Charges) Amendment Rules, 2018: The notification amends Rule 8 of the Companies (Registration of Charges) Rules, 2014. According to the amendment, a company or a charge holder would (from the date of satisfaction in full of any registered charge) give an intimation of the same to the RoC in the Form CHG-4 within a period of 300 days instead of 30 days. The amended rules are effective from 6 July 2018.

• The Companies (Acceptance of Deposits) Amendment Rules, 2018: The notification amends following provisions of the Companies (Acceptance of Deposits) Rules, 2014:

– Rule 4 of the amended rules provides that a certificate of the statutory auditor of the company should be attached along with the circular for invitation of deposits from its members, stating that the company has not committed any default in the repayment of deposits or interest on such deposits. In case a company had committed a default then certificate should state that the company had made good the default and a period of five years has lapsed since the rectification of default.

– Pursuant to amendment in Section 74 of the 2013 Act, the requirement of deposit insurance from the regulations have been omitted. Accordingly Rule 5 relating to the details of deposit insurance forming part of Register of Deposits has been omitted.

– Rule 13 provides that the amount of deposits in ‘deposit repayment reserve account’ with a scheduled commercial bank at any time should not fall below 20 per cent (instead of 15 per cent) of the amount of deposits maturing during the financial year.

– The new Form DPT-1 and DPT-3 have been issued.

The amended rules are effective from 15 August 2018.


20

Example




• Companies (Appointment and Qualification of Directors) Fourth Amendment Rules, 2018: Rule 11 of Companies (Appointment and Qualification of Directors) Rules 2014 has been amended to provide that every individual who has been allotted a Director Identification Number (DIN) as on 31 March of a financial year is required to submit e-form DIR-3-KYC to the central government on or before 30 April of immediate next financial year. Also the directors who have already been allotted DIN as at 31 March 2018 are also required to submit e-form DIR-3 KYC on or before 31 August, 2018. In case of default, central government has the authority to deactivate the DIN of the defaulters. The amended rules are effective from 10 July 2018.

(Source: MCA notifications no. S.O. 3299 E. and S.O. 3300 E. , Companies (Registration of Charges) Amendment Rules, 2018, Companies (Acceptance of Deposits) Amendment Rules, 2018, Companies (Appointment and Qualification of Directors) fourth Amendment Rules, 2018 dated 5 July 2018)

ICAI issued Ind AS disclosure checklist

The disclosure component of the Ind AS plays a critical role similar to other components of Ind AS and also disclosure requirements under Ind AS are enhanced in comparison to the Accounting Standards (AS). With an aim to provide a compilation of all the disclosures required by Ind AS at one place, The Institute of Chartered Accountants of India (ICAI) issued Ind AS: Disclosure Checklist.

The disclosure checklist provides disclosures requirements under Ind AS applicable to entities preparing financial statements voluntarily and mandatorily in accordance with Ind AS. The disclosures checklist is based on Ind AS that are effective as on 1 April 2018, and includes disclosures required under Ind AS 115, Revenue from Contracts with Customers.

(Source: Ind AS: Disclosure Checklist issued by ICAI dated 30 June 2018)

21


Exposure drafts issued by ICAI

Recently, ICAI has issued following exposure drafts:

• AS 19, Employee Benefits The Companies (Indian Accounting Standards) Rules, 2015 lays down the road map for entities for implementation of Ind AS converged with IFRS in a phased manner. For other class of companies not covered under the corporate road map (i.e. primarily unlisted entities with net worth less than INR250 crore, including non-corporate entities) AS as notified under Companies (Accounting Standards) Rules, 2006 continue to remain applicable.

The MCA had requested the Accounting Standards Board (ASB) of ICAI to upgrade AS in order to bring them nearer to the requirements of Ind AS. In this context, ICAI has recently issued exposure drafts of AS 19, Employee Benefits

The exposure draft of AS 19 is based on principles of Ind AS 19, Employee Benefits and it will replace existing AS 15, Employee Benefits. The requirements of proposed AS 19 and Ind AS 19 are largely similar, except that AS 19 provides certain relief to small and medium-sized entities from certain recognition, measurement and disclosure requirements. Additionally, the exposure draft does not include guidance similar to Appendix B, The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction of Ind AS 19. Appendix B provides guidance on interaction of ceiling of asset recognition and minimum funding requirements in case of defined benefit obligations.

The period to provide comments ends on 10 August 2018.

• SA 800 (Revised), Special Considerations – Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks: The Standard on Auditing (SA) 800 (Revised) deals with special considerations in the application of the SAs to an audit of financial statements that are prepared in accordance with a special purpose framework. The exposure draft includes limited amendments to provide clarity about how the new and revised SAs1 apply in the context of special purpose financial statements.

These amendments are not intended to substantively change the underlying premise of these engagements in accordance with the extant SAs. The exposure draft

is based on ISA 800 (Revised), Special Considerations - Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks issued by International Auditing and Assurance Standards Board (IAASB) in January 2016.

• SA 805 (Revised), Special Considerations – Audits of Single Financial Statements and Specific Elements, Accounts or Items of a Financial Statement: The SA 805 (Revised) deals with special considerations in the application of the SAs to an audit of a financial statement or a specific element, account, or item of a financial statement. The exposure draft includes limited amendments to provide clarity about how the new and revised SAs1 apply in the context of special purpose financial statements.

These amendments are not intended to substantively change the underlying premise of these engagements in accordance with the extant SAs. The exposure draft is based on ISA 805 (Revised), Special Considerations – Audits of Single Financial Statements and Specific Elements, Accounts or Items of a Financial Statement issued by IAASB in January 2016.

• SA 810 (Revised), Engagements to Report on Summary Financial Statements: The SA 810 (Revised) deals with the auditor’s responsibilities relating to an engagement to report on summary financial statements derived from financial statements audited in accordance with SAs by the same auditor.

The limited amendments to SA 810 (Revised) leverage the additional transparency in the auditor’s report on the audited financial statements resulting from new and revised SAs, in particular SA 700 (Revised), Forming an Opinion and Reporting on Financial Statements, and new SA 701, Communicating Key Audit Matters in the Independent Auditor’s Report. The exposure draft is based on ISA 810 (Revised), Engagements to Report on Summary Financial Statements issued by IAASB in March 2016.

The period to provide comments on above exposure drafts relating to SA 800 (Revised), SA 805 (Revised) and SA 810 (Revised) ends on 25 August 2018.

(Source: Exposure Drafts of AS 19, SA 800 (Revised), SA 805 (Revised) and SA 810 (Revised) issued by ICAI dated 10 July 2018)

1. SA 260(Revised), Communication with Those charged with Governance SA 570 (Revised), Going ConcernSA 700 (Revised) Forming an Opinion and Reporting on Financial Statements, SA 705 (Revised), Modifications to the Opinion in the Independent Auditor’s Report. SA 706(Revised), Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report.SA 720 (Revised), The Auditor’s Responsibilities relating to Other Information.

22

Example




On 10 December 2015, the Central Board of Direct Taxes (CBDT) issued a circular no. 21/2015, to specify the monetary limits and other conditions for the filing of appeals by the tax department on merits before the Income-tax Appellate Tribunal (ITAT), High Courts and Special Leave Petitions (SLPs) before the Supreme Court.

In order to reduce the litigation on income-tax matters, the CBDT issued circular (no. 3/2018) on 11 July 2018. This circular increases the threshold limit for filing of appeal before judicial authorities.

The following table provides the revised monetary limits:

Additionally, the circular provides a definition of tax effect, computation formula for determination of tax effect and exceptions to specified monetary limits.

For detailed discussion on this topic, refer KPMG in India’s Tax Flash News - CBDT Circular: revision of monetary limits and certain conditions for the tax department to file appeals before the Income-tax Appellate Tribunal, High Courts and Supreme Court dated 13 July 2018

(Source: Circular no. 3/2018 dated 11 July 2018 issued by CBDT)

The CBDT revised monetary limits and certain conditions for the tax department to file appeals

The CBDT amends the Tax Audit Report (Form 3CD)

The CBDT through its notification dated 20 July 2018 amended the Income-tax Rules, 1962 with respect to the Tax Audit Report (Form 3CD). This form is required to be certified by an auditor under Section 44AB of the Income-tax Act, 1961 (IT Act). The amended rules will come into force from 20 August 2018.

The amended form 3CD requires following key additional disclosures:

• Deduction claimed under Section 32AD of the IT Act on investment in new plant and machinery in notified backward areas

• Disclosure with respect to payment basis deduction under Section 43B(g) of the IT Act of any sum payable by the taxpayer to the Indian Railways for the use of railway assets

• The amount received and date of receipt of the deemed dividend reference to in Section 2(22)(e) of the IT Act

• Information relating to amount received as a gift that are chargeable to tax as per Section 56(2)(x) of IT Act

• Break-up of the total expenditure of entities registered or not registered under the Goods and Services Tax (GST).

Please refer KPMG in India’s Tax Flash News KPMG Flash News: CBDT amends the Tax Audit Report (Form 3CD) dated 25 July 2018 for a detailed overview of the above amendments.

(Source: Notification no. G.S.R. 666(E). dated 20 July 2018 issued by CBDT)

Sr. No.

Appeals/SLPs in income-tax matters

Current monetary limit of tax effect (INR)

Revised monetary limit of tax effect (INR)

1. Before the ITAT 10 lakh 20 lakh

2. Before the High Court 20 lakh 50 lakh

3. Before the Supreme Court 25 lakh 1 crore

23


24

Example




25

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Gurugram Building No.10, 8th Floor DLF Cyber City, Phase II, Gurugram, Haryana – 122 002, Tel: +91 124 307 4000. Fax: +91 124 254 9101

Hyderabad Salarpuria Knowledge City, ORWELL, 6th Floor, Unit 3, Phase III, Sy No. 83/1, Plot No 2, Serilingampally Mandal, Raidurg Ranga Reddy District, Hyderabad, Telangana – 500081 Tel: +91 40 6111 6000 Fax: +91 40 6111 6799

Jaipur Regus Radiant Centres Pvt Ltd., Level 6, Jaipur Centre Mall, B2 By pass Tonk Road Jaipur, Rajasthan, 302018. Tel: +91 141 - 7103224

Kochi Syama Business Center 3rd Floor, NH By Pass Road, Vytilla, Kochi – 682019 Tel: +91 484 302 7000 Fax: +91 484 302 7001

Kolkata Unit No. 603 – 604, 6th Floor, Tower – 1, Godrej Waterside, Sector – V, Salt Lake, Kolkata – 700 091. Tel: +91 33 4403 4000 Fax: +91 33 4403 4199

Mumbai Lodha Excelus, Apollo Mills, N. M. Joshi Marg, Mahalaxmi, Mumbai – 400 011. Tel: +91 22 3989 6000 Fax: +91 22 3983 6000

Noida Unit No. 501, 5th Floor, Advant Navis Business park, Tower-B, Plot# 7, Sector 142, Expressway Noida, Gautam Budh Nagar, Noida – 201305. Tel: +91 0120 386 8000 Fax: +91 0120 386 8999

Pune 9th floor, Business Plaza, Westin Hotel Campus, 36/3-B, Koregaon Park Annex, Mundhwa Road, Ghorpadi, Pune – 411001. Tel: +91 20 6747 7000 Fax: +91 20 6747 7100

Vadodara iPlex India Private Limited, 1st floor office space, No. 1004, Vadodara Hyper, Dr. V S Marg, Alkapuri, Vadodara – 390 007. Tel: +91 0265 235 1085/232 2607/ 232 2672


Notes

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 notified certain provisions of the Companies (Amendment) Act, 2017

28 May 2018

On 3 January 2018, the Companies (Amendment) Act, 2017 (Amendment Act, 2017) received the assent of the President of India.

Recently, MCA through its notification dated 7 May 2018 notified certain sections of the Amendment Act, 2017. Additionally, MCA issued amendment to certain rules

under the Companies Act, 2013 (2013 Act). The notified provisions are effective from 7 May 2018.

This issue of First Notes aims to provide an overview of the recently notified sections of the Amendment Act, 2017 and the amendments issued to the rules to the 2013 Act.

Voices on Reporting

Quarterly update publication

Voices on Reporting – quarterly update publication (for the quarter ended 30 June 2018) provides summary of key updates from the Ministry of Corporate Affairs, the Securities and Exchange Board of India, the Reserve Bank of India and the Institute of Chartered Accountants of India.

We will continue to provide a summary of relevant updates in future also. We hope you find this summary to be of use and relevance.

.

First NotesIFRS NotesInd AS Transition Facilitation Group (ITFG) issues Clarifications Bulletin 15,

18 April 2018

The Ind AS Transition Facilitation Group (ITFG) in its meeting considered certain issues received from the members of the Institute of Chartered Accountants of India (ICAI), and issued its Clarifications’ Bulletin 15 on 5 April 2018 to provide clarifications on 10 application issues relating

to Indian Accounting Standards (Ind AS).

This issue of IFRS Notes provides an overview of the clarifications issued by ITFG through its Bulletin 15.

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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Documents

Accounting and Auditing Update - KPMG · The International Accounting Standards Board (IASB) has published a Discussion Paper (DP) – Financial Instruments with Characteristics of