Accounting and Auditing Update May 2015

May 2015

ACCOUNTINGAND AUDITINGUPDATE

In this issue

The ICAI provides guidance on provisions relating to depreciation under the Companies Act, 2013 p1

Accounting of investment property p5

Share application money – accounting and disclosures p9

Guidance note on accounting for rate regulated activities p12

Disclosure of discounts while presenting revenue p15

Proposals for changes to accounting for income taxes under U.S. GAAP p17

Regulatory updates p19

© 2015 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.

Just as companies are completing their first year-end reporting under the Companies Act, 2013, the Institute of Chartered Accountants of India (ICAI) has issued an application guide on the provisions of Schedule II to the Companies Act, 2013. This application guide addresses certain practical issues arising in the effective implementation of the Schedule II to the Companies Act, 2013. We welcome the issuance of application guidance and in this issue, we provide an overview of the application guide along with the significant differences in the requirements of Schedule XIV to the Companies Act, 1956 vis-à-vis Schedule II to the Companies Act, 2013. Additionally, we also highlight the accounting issues faced by the rate regulated entities and the ICAI’s guidance note on accounting for rate regulated activities that has been recently issued.

The introduction of Real Estate Investment Trust (REIT) Regulations by the Securities and Exchange Board of India (SEBI) is aimed towards transforming the commercial real estate sector in India by improving liquidity and capital raising opportunities for developers and by providing exit opportunities for existing private equity players. This month, we cover the important aspects relating to accounting and disclosure requirements for investment property as envisaged under the Ind AS.

As part of our ongoing coverage of key aspects of the Companies Act, 2013, we highlight the requirements with respect to the share application money along with the key differences in relation to the Companies Act, 1956.

We also provide a synopsis of a recent EAC opinion on accounting of discounts by a company along with a discussion on the accounting treatment of discounts and other components of variable consideration under Ind AS 115, Revenue from Contracts with Customers.

Finally, in addition to our regular round up of regulatory updates, we also provide an update on the proposed amendment on accounting for income taxes on intercompany transfers and balance sheet classification of deferred tax asset and liability including transition guidance under U.S. GAAP.

As always, we would like to remind you that in case you have any suggestions or inputs on topics we cover, we would be delighted to hear from you.



Jamil Khatri

Head of Audit, KPMG in IndiaGlobal Head of Accounting Advisory Services

Sai Venkateshwaran

Partner and Head,Accounting Advisory Services, KPMG in India


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The ICAI provides guidance on provisions relating to depreciation under the Companies Act, 2013This article aims to:

– Provide an overview of the application guide issued by the Institute of Chartered Accountants of India (ICAI) addressing certain practical issues arising in the implementation of the Schedule II to the 2013 Act relating to depreciation of the assets

– Highlight the significant differences in the erstwhile Schedule XIV to the Companies Act,1956 vis-à-vis Schedule II to the Companies Act, 2013.

Paradigm shift from rate based approach to useful life approach – tangible assets

Requirements under the 1956 Act

• The accounting standards stated that the depreciation amount of a tangible asset had to be systematically allocated over its useful life

• Additionally, the Schedule XIV to the 1956 Act specified minimum rates of depreciation to be provided by a company

• If management’s estimate to the useful life of a tangible asset as per AS 6, Depreciation Accounting, at the time of acquisition of the asset, or the remaining useful life on a subsequent review was shorter than that envisaged in Schedule XIV to the 1956 Act, depreciation was provided at a higher rate

• Under Schedule XIV to the 1956 Act, residual value of tangible assets could not exceed five per cent of the original cost of the asset.


• Schedule II to the 2013 Act enshrines within itself the principle for recognising depreciation on the assets over their useful lives and provides as follows:

– Part C of the Schedule II to the 2013 Act lays down indicative useful lives of certain tangible assets

– Useful life of tangible assets should not be ordinarily different from the useful life specified in Part C of the Schedule II to the 2013 Act and the residual value should not be more than five per cent of the original cost of the tangible assets

– The 2013 Act also permits companies to depreciate assets over their useful lives which may be different from the specified useful lives as per Part C of the Schedule II to the 2013 Act. Where a company adopts a different useful life or uses a different residual value as prescribed in Part C of Schedule II to the 2013 Act, the company is required to disclose such difference and provide justification in the financial statements that is duly supported by technical advice.


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Application guide

The application guide provides following guidance:

• Determination of useful life of assets is a matter of judgement and may be decided on a case to case basis. As the 2013 Act permits companies to depreciate assets over their useful lives which may be different from the specified useful lives as per Part C of the Schedule II to the 2013 Act, the companies should involve technical experts to determine the useful life of the assets and maintain adequate details about the technical assessment of the useful lives of the tangible assets

• According to AS 6, a company needs to determine useful life/residual value and compare it with the useful life/residual value mentioned in the Schedule II to the 2013 Act. The application guide provides following illustrations:

Situation 1: Management of a company has estimated the useful life of an asset to be 10 years while the life envisaged under the Schedule II is 12 years. In this case, the company should depreciate the asset using 10 years and provide a disclosure of justification for using lower life. The company cannot use 12 years life for depreciation.

Situation 2: Management of a company has estimated the useful life of an asset as 12 years and the life envisaged under the Schedule II is 10 years. In this case, the company has an option to depreciate the asset using either 10 years prescribed in the Schedule II or the estimated useful life i.e. 12 years. If the company depreciates the asset over 12 years, it needs to disclose justification for using higher life. The company should apply the option selected consistently.

The application guide mentions that residual value should also be determined as a corollary to the above situations explained for useful life.

• Determination of the useful life of a depreciable asset is a matter of estimation and would be based on various factors including experience with similar types of assets. Such estimation is expected to be more difficult for an asset using new technology or used in the production of a new product or in the provision of a new service but is nevertheless required on some reasonable basis.

Factors for determining the useful life have been provided in the application guide

• Useful life of an asset could be shorter than its economic life based on the asset management policy of an entity

• AS 6 elaborates guidance on determination of residual value and application guide mentions that the possible effects of future price-level changes (i.e. inflation) in estimating residual value should not be considered because anticipated increases in residual value as a result of inflation would represent gain contingencies that should be recognised only when realised

• Electricity companies should continue to charge depreciation in accordance with the Electricity Act.

Intangible assets


• The Schedule II to the 2013 Act states that for intangible assets, the provisions of the accounting standards applicable for the time being in force would apply except for amortisation of intangible assets (toll roads) created under ‘Build, Operate and Transfer’ (BOT), ‘Build, Own, Operate and Transfer’ (BOOT) or any other form of Public Private Partnership (PPP) (collectively termed as ‘BOT assets’) route in case of road projects.

Application guide

• The application guide provides that a company may use revenue based amortisation for ‘BOT assets’. For amortisation of other intangible assets, AS 26, Intangible Assets, should be applied.

Component approach


• The Schedule II to the 2013 Act requires that useful life and depreciation for significant components of an asset should be determined separately. However, it is important to note that under AS 10, Accounting for Fixed Assets, use of component approach is not mandatory.

Considering the fact that identification of components would require a careful assessment of the facts

and circumstances, the Ministry of Corporate Affairs has made the component approach mandatory for financial year commencing on or after 1 April 2015.

Application guide

• The application guide mentions that the determination as to whether a part of an asset is significant, requires a careful assessment of the facts and circumstances. The following factors should be assessed at the minimum:

– comparison of the cost allocated to the item to the total cost of the aggregated property, plant and equipment, and

– consideration of potential impact of componentisation on the depreciation expense.

• Additionally, the application guide prescribes following factors for determination of cost of a component:

– Break up cost provided by the vendor

– Cost break up given by internal/external technical expert

– Current replacement cost of component of the related asset and applying the same basis on the historical cost of asset.

A company needs to identify only material/significant components separately for depreciation. Identification of significant components is a matter of judgement and decided on case-to-case basis on the facts and circumstances of each case. A company may consider 10 per cent of the original cost of the asset as a threshold to determine whether a component is material/significant. In addition, a company also needs to consider impact on retained earnings, current year profit or loss and future profit or loss to decide materiality. A component that has a material impact from either perspective, the said component would be considered material and require separate identification. Identification of separate parts of an asset and determination of their useful life is not merely an accounting exercise; rather, it involves technical expertise. Hence, it may be necessary to involve technical experts to determine the parts of an asset.


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• If the useful life of the component is higher than the useful life of the principal asset, then higher useful life can be used only when the management intends to use the component even after the expiry of useful life of the principal asset

• The application guide specifically mentions that components should be identified for the opening block of assets existing as at 1 April 2014 (if a company opts to follow component accounting voluntarily) and as at 1 April 2015 mandatorily. The application guide clarifies that component accounting cannot be restricted only to new assets acquired on or after adoption of component approach by the company.

Determination of depreciation on assets running on double/triple shift


• The Schedule XIV to the 1956 Act prescribed different rates of depreciation for assets being used under single/double/triple shifts. For example, for general plant and machinery, the rates of depreciation prescribed under the Schedule XIV were 4.75 per cent, 7.42 per cent and 10.34 per cent respectively.


• Part C to the Schedule II to the 2013 Act does not prescribe separate rates/lives for assets working on extra shifts. It states that for the period of time, an asset is used in double shift, depreciation will increase by 50 per cent or by 100 per cent in case of triple shift. For example, if a company uses an asset for double shift for 100 days in a year and for the rest of the year it is used in single shift basis, double shift rates will apply for 100 days only.

Application guide

• Application guide mentions that challenges are arising in determining the remaining useful life for assets working in multiple shifts when a company transitions from the Schedule XIV to the 1956 Act to the Schedule II to the 2013 Act. The Schedule II does not treat each shift as a single unit of account i.e. in case each shift is treated as a single unit of account then for an asset being used in triple shift, extra

depreciation could be 200 per cent. Further, depreciation includes impact due to efflux of time, obsolescence of technology and number of shifts used by companies could vary.

• Accordingly, the application guide mentions that the Schedule II to the 2013 Act and AS 6, Depreciation Accounting, aim to allocate the depreciable amount of an asset over its remaining useful life.

• The application guide mentions that in case management of a company determines lower useful life than the life determined under the Schedule II to the 2013 Act, the asset should be depreciated over such lower life as required by AS 6. If the management of a company determines useful life to be longer than the life determined under the Schedule II to the 2013 Act, then the use of longer life is acceptable provided management has appropriate justification based on technical advise for the same.

Depreciation on revalued assets


• Schedule XIV to the 1956 Act prescribed that depreciation was required to be provided on the original cost. Considering this requirement, the ICAI’s Guidance Note on Treatment of Reserve created on Revaluation of Fixed Assets (guidance note) permits an amount equivalent to the additional depreciation on account of the upward revaluation of fixed assets to be transferred from the revaluation reserve to the statement of profit and loss.


• The 2013 Act, on the other hand, requires depreciation to be provided on historical cost or amount substituted for the historical cost. Therefore, companies are required to charge depreciation on the revalued amount to the statement of profit and loss.

It was unclear whether the accounting treatment permitted under the guidance note would continue to remain valid.

Application guide

• The application guide mentions that the accounting treatment given in the guidance note which allows an amount equivalent to the additional depreciation on account of upward revaluation to be recouped from the revaluation reserve may not apply.

• AS 10, Accounting for Fixed Assets, allows amount standing to the credit of revaluation reserve to be transferred directly to the general reserve on retirement or disposal of revalued asset. The application guide permits transfer of a portion of revaluation reserve to general reserve as the asset is used by the company. In such a case, the amount of the revaluation reserve transferred would be the difference between depreciation based on the revalued carrying amount of the asset and depreciation based on its original cost.

Full depreciation on assets below certain threshold


• The provision of Schedule XIV to the 1956 Act allowed 100 per cent depreciation of the cost of an asset having individual value of INR5,000 or less was based on practices followed by the companies based on the materiality of the financial impact of such charge.


• The above requirement of the 1956 Act have not been carried forward in the Schedule II to the 2013 Act.

Application guide

• The application guide stipulates that life of an asset is a matter of estimation, therefore, materiality of the impact of such charge should be considered with reference to the cost of asset. The size of the company will also be a factor to be considered for such policy

• Accordingly, a company may have a policy to fully depreciate assets upto certain threshold limits considering materiality aspect in the year of acquisition.


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Transitional provisions


• The transitional provisions under the Schedule II to the 2013 Act prescribes that the carrying amount of the asset as on 1 April 2014:

– Should be depreciated over the remaining useful life of the asset

– After retaining the residual value, may be recognised in the opening balance of retained earnings or may be charged off to the statement of profit and loss, where the remaining useful life of the asset is nil.

Application guide

• The ICAI announcement on “Tax effect of expenses/income adjusted directly against the reserves and/or Securities Premium Account” requires that any expense charged directly to reserves and/or securities premium account should be net of tax benefits expected to arise from the admissibility of such expenses for tax purposes. Similarly, any income credited directly to a reserve account or a similar account should be net of its tax effect.

• Based on the above announcement, the application guide clarifies that if the company opts to adjust the carrying amount of the assets to the retained earnings in accordance with the transitional provisions of the Schedule II to the 2013 Act, the tax effect of the same has to be also adjusted against the retained earnings.

(Source - KPMG’s First Notes dated 24 April 2015 and 8 May 2015)


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This article aims to:

– Provide an overview of the Real Estate Investment Trust Regulations issued by the Securities and Exchange Board of India and

– Highlight the key differences in accounting of investment property as per Ind AS and IFRS.

Accounting of investment property

Background1

Commercial property demand

The Indian commercial real estate sector is expected to witness a transformation with the introduction of Real Estate Investment Trust (REIT) regulations by the Securities and Exchange Board of India (SEBI). While, in the last couple of years, private equity firms have shown increasing interest to acquire commercial real estate assets, launch of REITs is expected to be a major game changer and could be an important reform in the real estate sector in recent years. REITs are expected to have advantages to different stakeholders including:

• Developers – improving liquidity and capital raising opportunities for mid-tier developers

• Institutional investors – provides an exit opportunity for existing private

equity players, developers and financial investors. It will also attract long term investors such as pension and insurance funds looking for moderate risk vs. return opportunities

• Retail investors – reduces ticket size for investing in real estate sector along with a transparent investment alternative in real estate sector with experienced professional and independent oversight.

Overview of the SEBI REIT regulations

Some of the important points of the SEBI REIT regulations are as follows:

• A REIT would need to be set up as a trust registered with the SEBI

• The trust will need to have a trustee (registered with the SEBI), sponsor and manager

• The REIT can have up to three sponsors (each sponsor to hold at least five per cent units), and the sponsors should hold at least 25 per cent of the total units of the REIT post issue for a period of three years from the date of listing followed by 15 per cent thereafter

• The REIT needs to have a manager with at least five years of experience in fund management/advisory services or property management in real estate industry or in development of real estate (at the manager or associate level)

• Listing of the units offered is mandatory

1. KPMG’s publication Analysis of REIT Regulations March 2015


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• Ticket size for investors in REIT is INR2 lakhs for public (initial as well as follow-on) offer and INR1 lakh post listing with minimum 200 public unit holders at all times

• The REIT needs to have at least 80 per cent of the value of the REIT assets in completed and rent-generating real estate and of the balance 20 per cent a maximum of 10 per cent can be invested in under-construction properties/completed but not rent-generating properties

• Net asset value (NAV) declaration to be given twice a year to be in line with international valuation standards and valuation standards as specified by the ICAI for valuation of real estate assets

• At least 75 per cent of the revenues of the REIT (other than gains arising from disposal of properties) to be from rental, leasing and letting of real estate assets at all times and at least 90 per cent of the net distributable cash flows of the REIT to be distributed to the unit holders.

These factors have increased interest in the area associated with the accounting for the completed and rent generating real estate held by a REIT. Such properties are classified as investment properties in accordance with Ind AS 40, Investment Property.

What is an investment property?

Ind AS 40 defines investment property as a property (land or a building - or part of a building - or both) held (by the owner or by the lessee under a finance lease) to

– earn rentals

– for capital appreciation, or

– both.

Investment property is not for :

a. use in the production or supply of goods or services or for administrative purposes or

b. sale in the ordinary course of business.

The business model of a company (i.e., the company’s intention regarding that property) is the primary criterion for classification of a property as an investment property. Owner-occupied property is property held (by the owner or by the lessee under a finance lease) for use in the production or supply of goods

or services or for administrative purposes. Ind AS 16, Property, Plant and Equipment, applies to owner-occupied property. Land and buildings (including those under construction) that are intended to be sold in the ordinary course of business should be classified as inventories. While land and buildings that are intended to be held for capital appreciation only, or for both earning rentals and capital appreciation, should be classified as investment properties.

For example, a retail site owned by a an entity, but leased out to third parties in return for rental income, is an investment property. However, a factory owned and used by an entity is not an investment property because it is used in the production of goods.

Investment property includes property that is being constructed or developed for future use as an investment property. Hence, such capital work-in-progress would be classified as an investment property under development in the financial statements.

Currently, Indian GAAP, does not have an equivalent/similar standard as Ind AS 40. However, AS 13, Accounting for Investments, under Indian GAAP, defines an investment property as an investment in land or buildings that are not intended to be occupied substantially for use by, or in the operations of, the investing enterprise and requires an entity to account for them as long-term investments. Companies holding land and building with a view to benefit from capital appreciation classify such properties as investment properties within AS 13 and recognise such properties at cost and adjust them for any permanent diminution (including depreciation).

Issues around classification as an investment property

Although the definition of an investment property appears relatively straightforward, determining what is or is not an investment property raises some practical issues, some of which have been discussed below.

Dual use properties

Property often has dual purposes whereby part of the property is used for own use activities that would result in the property being considered as property, plant and equipment under Ind AS 16 and part of the property is used as an investment

property. A portion of a dual-use property would be classified as an investment property only if the portion could be sold separately or leased out separately under a finance lease.

When a portion of the property could not be sold separately or leased out under a finance lease separately, the entire property is classified as an investment property only if an insignificant portion is held for use in the production or supply of goods or services or for administrative purposes.

Ancillary services

In many cases, the owner of a property provides ancillary services to its tenants. In such cases, the key principle to identify an investment property is to decide whether the services provided are a relatively insignificant component of the arrangement as a whole. The standard gives two examples of properties for which ancillary services are provided:

• an office building for which security and maintenance services are provided by the owner could be an investment property because these ancillary services generally, are an insignificant component of the arrangement

• an entity owns and manages a hotel, services provided to guests would be significant to the arrangement as a whole. An owner managed hotel would be considered as an owner-occupied property, rather than an investment property.

It may be difficult to determine whether ancillary services are so significant that a property does not qualify as an investment property. For example, an owner of a hotel may sometimes transfer some responsibilities to third parties under a management contract. The terms of such contracts vary widely. At one end of the spectrum, the owner’s position may, in substance be that of a passive investor. At the other end of the spectrum, the owner may simply have outsourced day-to-day functions while retaining significant exposure to variation in the cash flows generated by the operations of the hotel.

Judgement would be needed to determine whether a property qualifies as an investment property.

Equipment and furnishings

Equipment and furnishings physically attached to a building are considered to


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be part of an investment property. So, for example, lifts, escalators, air conditioning units, decorations and installed furniture, such as built-in cabinetry, would be included as part of the cost and fair value of the investment property and would not be classified separately as property, plant and equipment under Ind AS 16.

Recognition

Measurement at initial recognition

An investment property should be measured initially at its cost. Transaction costs should be included in the initial measurement. The cost of a purchased investment property comprises its purchase price and any directly attributable expenditure. Directly attributable expenditure includes, for example, professional fees for legal services, property transfer taxes and other transaction costs.

If payment for an investment property is deferred, its cost is the cash price equivalent. The difference between this amount and the total payments is recognised as an interest expense over the period of credit.

Measurement after initial recognition

After initial recognition, an entity should measure all of its investment properties in accordance with the requirements for cost model as given in Ind AS 16, Property, Plant and Equipment which requires an item of property, plant and equipment to be carried at its cost less any accumulated depreciation and any accumulated impairment losses.

The initial cost of a property interest held under a lease and classified as an investment property would be as prescribed for a finance lease under Ind AS 17, Leases. It means that the asset would be recognised at the lower of the fair value of the property and the present value of the minimum lease payments. An equivalent amount would be recognised as a liability in accordance with Ind AS 17.

Any premium paid for a lease is treated as part of the minimum lease payments and would be included in the cost of the asset, but would be excluded from the liability.

Further Ind AS 40 requires all entities to measure the fair value of investment property, for the purpose of disclosure even though they are required to follow the cost model.

Difference with IFRS

While, broadly there are no significant differences in the classification of an asset as an investment property (except as mentioned below), between IFRS and Ind AS, still there is a significant difference in the measurement basis between the two standards.

Fair valuation

Under IFRS, subsequent to initial recognition, entities have an accounting policy choice for measuring all investment properties (including investment property under development) using the fair value model with the gain or loss arising from movement in fair valuation between two reporting periods recognised in the income statement. IFRS places a preference for measuring investment property at fair value, noting that it will be very difficult to justify a voluntary change in accounting policy from the fair value model to the cost basis of measurement.


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Transitional provisions

Ind-AS 101, First-time Adoption of Indian Accounting Standards, provides a suitable starting point for accounting in accordance with Ind AS, sets out the procedures that an entity would follow when it adopts Ind AS for the first time as the basis for preparing its financial statements, an entity transitions at a cost that does not exceed the benefits, and ensures that the entity’s first Ind AS financial statements contain high quality information that is transparent for users and comparable over all periods presented.

A number of exemptions are available in Ind AS 101 from the general requirement for retrospective application of Ind AS accounting policies. In the case of investment property, on transition to Ind AS, instead of recomputing the carrying value of an investment property under Ind AS, a company has certain choices with respect to calculating investment property balances on the transition date. In the event that a company elects such a choice, the amounts so substituted are referred to as the ‘deemed cost’ of the

investment property. Specific choices include:

• Revalue some or all items of investment property to their fair value as at the transition date

• In case investment properties have been previously revalued under Indian GAAP, then those revalued amounts can be considered as the deemed cost, provided that those revalued amounts at the date of revaluation are broadly comparable (i) to the fair values or (ii) cost or depreciated cost in accordance with Ind AS adjusted to reflect, for instance, the changes in the general or specific price index

• An event-driven valuation e.g. when a company was privatised and at that point valued and recognised some or all of its assets and liabilities at fair value

• Continue Indian GAAP carrying values of all items of investment property as at transition date without any modification, except for recognising asset retirement obligations. This exemption, if exercised, is required to be applied to all items of investment properties without any exception.

Conclusion

One of the significant benefits for companies holding investment properties under IFRS is the use of the fair valuation model which, in addition to reflecting the regular rental income from the letting out of such properties, also reflects the impact of the movement in fair valuation of such investment properties between two periods in the statement of profit and loss.

It is relevant to note that the SEBI notified the SEBI (Real Estate Investment Trusts) Regulations, 2014 (‘REIT Regulations’) in September 2014. Net asset value (NAV) declaration to be given twice a year to be in line with international valuation standards and valuation standards as specified by the ICAI for valuation of real estate assets.

Considering, the significance being attached to fair valuation under REIT Regulations, entities in India which will be required to prepare financial statements under Ind AS might lose out on the option of reflecting their investment properties at fair value in their financial statements though this is somewhat mitigated by fair value disclosure requirements contained in Ind AS 40.


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Share application money – accounting and disclosuresThis article aims to:

– Highlight the requirements of the Companies Act, 2013 with respect to share application money

– Bring out the key differences in Companies Act, 2013 vis-à-vis Companies Act, 1956.

Raising the yard stick on compliance under the Companies Act, 2013

In the past, certain companies have had a practice of using share application money as a route to borrow money for business as they are unsecured, free of interest costs and later refunded. This assisted in maintaining the liquidity requirements by promoters and also aided funding from bankers. The Companies Act, 2013 (the 2013 Act) aims to change and bring in restrictions and to incorporate certain safeguards on fund raising efforts by the companies.

Section 23 of the 2013 Act sets out the method of raising funds through equity by public and private companies as given in the chart.

Private companies

Rights or bonus issue

Section 23(2)(a)

Private placement

Section 23(2)(b)

Public companies

Public offerSection 23(1)(a)

Rights or bonus issue

Section 23(1)(c)

Private placement

Section 23(1)(b)

Source - KPMG in India’s analysis


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Private placements

The Companies Act, 1956 (1956 Act) did not prescribe restrictions and rules for private placement and the company could allot shares to its investors through a special resolution by shareholders for public companies and through board approvals for private companies. Part II of Chapter III of the 2013 Act lays down detailed procedures, a company should comply with respect to issues and allotment of shares other than by way of public offer.

One amongst such new compliance requirements is allotment of securities within prescribed time limits. Any company (whether private or public) making an offer for subscription of securities, should allot it within 60 days from the date of receipt of the application money and if it fails to do so, should refund it back within 15 days from the date of completion of 60 days (there was no such restrictions under the 1956 Act for private companies). In case the company fails to comply with the provisions of the 2013 Act, it should repay the money along with interest at the rate of 12 per cent per annum from the expiry of the sixtieth day.

The Reserve Bank of India requires any company receiving foreign direct investment (FDI), to issue shares or convertible debentures to its investors within 180 days of receipt of such funds or refund such amounts. The requirements of the 2013 Act are more stringent as it applies to all private placements and in effect the timelines have been reduced to two months (i.e. 60 days).

A double whammy situation

In addition, one needs to be watchful of non-compliance of the above mentioned requirement of non-allotment of securities within 60 days, as it triggers acceptance of deposit rules as well. The definition of the term ‘deposit’ under Rule 2(c) of the Companies (Acceptance of Deposits) Rules, 2014 includes share application money received and held by a company, pursuant to securities not allotted within 60 days from the date of receipt and not refunded to the subscribers within 15 days from the date of completion of 60 days. A company would need to comply with the provisions of deposit rules as non-compliances could attract heavy penalty.

The Ministry of Corporate Affairs has recently through a notification dated

31 March 2015 provided extension of timeline, if a company had received any amount by way of subscriptions to any shares, stock, bonds or debentures on or before 31 March 2014 against which allotment is pending as on that date, to 1 June 2015, by which the company should either return back such amounts or allot shares or comply with the rules.

To summarise, share application money should be allotted and securities should be issued within the prescribed time limits by a company.

Time limit for refund of share application money when minimum subscription amount is not received in case of a public offer

Under the 1956 Act, if the stated minimum amount has not been subscribed, all moneys received from applicants of shares should have been repaid to them without interest on expiry of 120 days after the first issue of prospectus. If such money is not repaid within 130 days after the issue of prospectus, the directors of the company were jointly and severally liable to repay the money with interest at the rate of six per cent per annum from the expiry of that period.

However, as per Section 39(3) of the Companies Act, 2013 and Companies (Prospectus and Allotment of Securities) Rules, 2014, if the stated minimum amount has not been subscribed and the sum payable on application is not received within a period of 30 days from the date of issue of the prospectus then the amount should be repaid within a period of 15 days from the closure of the issue. If any such money is not repaid within such period, the directors of the company who are officers in default should jointly and severally liable to repay that money with interest at the rate of 15 per cent per annum.

It is evident that the Government wants companies to retain public monies only for a minimal period and return it back if not allotted, at the earliest.

Time limit for refund of application money in case of public offer

Under Section 26(1) of the 2013 Act every prospectus issued by a public company should, inter alia, include a declaration that refund of application money would be made within prescribed time. In this regard, the Companies (Prospectus and Allotment of Securities) Rules, 2014 prescribe that the application money should be refunded within 15 days from the closure of the issue or such lesser time as may be specified by the Securities and Exchange Board of India or else the application money should be refunded to the applicants forthwith, failing which interest shall be due to be paid to the applicants at the rate of 15 per cent per annum for the delayed period.

Similar requirement also existed under the 1956 Act i.e. Part I of the Schedule II to the 1956 Act prescribed that the declaration included in a prospectus should, inter alia, state that the application money should be refunded within a period of 10 weeks and interest in case of any delay in refund at the prescribed rate under Section 73(2)/(2A) of the 1956 Act.

Implication of share application money on earnings per share

Share application money pending allotment or any advance share application money as at the balance sheet date, which is not statutorily required to be kept separately and is being utilised in the business of the company is treated in the same manner as dilutive potential equity shares for the purpose of calculation of diluted earnings per share as per AS 20, Earnings Per Share.


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Disclosure requirements under the 2013 Act and IFRS

The Schedule III to the Companies Act, 2013 has same requirements as in the Revised Schedule VI to the 1956 Act. The Schedule bifurcates the disclosure requirement with regard to share application money pending allotment, based on economic substance into two parts – the part against which shares will be allotted is in the nature of equity and the part which is due for refunds is in the nature of liability. Share application money pending allotment (and not due for refund) has to be shown as a separate category under the head ‘equity’ on the face of the balance sheet but is not included in the ‘Shareholders Funds’.

The share application money which is due for refund (e.g., in the event of over-subscription or minimum subscription requirement not met) has to be presented under ‘Other Current liabilities’ along with interest accrued thereon, if any. In case of share application money pending allotment, the terms and conditions including the number of shares proposed to be issued, the amount of premium, if any, and the period before which shares should be allotted have to been disclosed.

The company also needs to disclose whether it has sufficient authorised capital to cover the share capital amount resulting from allotment of shares against share application money. If authorised capital is insufficient, then excess share application money would be disclosed as current liabilities. Further, the period for which share application money has been pending beyond the stipulated time for allotment along with the reasons for delay should be disclosed.

Under IFRS, the presentation of share application money pending allotment depends on whether there is any possibility that the company may be required to repay the amount received, for example, if the share issue is conditional on uncertain future events then the amount received should be shown as a liability. However, if there is no possibility of the prepayment being refunded, so that the company’s obligation is to deliver only a fixed number of shares, then the amount should be credited to a separate category of equity.

The Indian GAAP disclosure bifurcates between equity and liability as detailed above.

Tax related matters

In the recent past, many companies had received notices from the Income tax department for transfer pricing adjustments on account of issue of shares at a price lower than an arm’s length price resulting in short receipt of consideration.

The Courts have observed that to apply Chapter X of the Income tax Act, 1961 (the IT Act), income should arise from an international transaction. This income should be chargeable to tax under the IT Act. There is no charge in the IT Act on account of capital amounts received and/or arising on account of issue of shares by an Indian entity to a non-resident entity. Chapter X of the IT Act does not contain any charging provision but is a machinery provision to arrive at an arm’s length price of a transaction between associated enterprises. Chapter X of the IT Act does not change the character of the receipts but only permits re-quantification of income uninfluenced by the relationship between associated enterprises. Also, the definition of the income does not include within its scope capital receipts arising out of capital account transactions unless specified in Section 2(24) of the IT Act as income.

The Central Board of Direct Taxation (CBDT) has also vide its instruction 2/2015 dated 29 January 2015 acknowledged the above judgement in the case of Vodafone India Services Private Limited and held that premium on share issue is a capital account transaction and does not give rise to income.

To conclude, the Courts have laid out two key principles that ‘transfer pricing provision should not be applied in the absence of any income from a transaction’ and ‘transaction of issue of share at a premium is capital in nature and therefore not subject to taxation’.

Further, specific anti-avoidance provisions are existing in the tax laws to curb the practice of issuance of shares by Indian companies at a price other than the fair market value. One of such provisions seek to tax the Indian company issuing the shares to another Indian resident for a consideration higher than the fair market value of the shares. As per another section, recipient of shares may be taxed in case consideration paid for such shares is lower than net asset value of the issuing company. It is not clear whether such provision for taxation of the recipient

of the shares is applicable at the time of issue of shares or not, however, one needs to be mindful of these provisions to avoid any questioning by the tax authorities and payment of tax.

Share application money given to subsidiary company by a holding company for evaluating provision for diminution in value of investments

An Expert Advisory Committee (EAC)1 opinion has been issued by the Institute of Chartered Accountants of India (ICAI) on the issue whether share application money received in advance by a subsidiary company should be considered for making provision for diminution in the value of investments by the holding company, even though the shares for the same are yet to be allotted.

As per AS 13, Accounting for Investments, investments are assets held by an enterprise for earning income by way of dividends, interest and rentals, for capital appreciation, or for other benefits to the investing enterprise. Assets held as stock–in-trade are not ‘investments’. The word advance as defined by the ‘Guidance Note on Terms used in Financial Statements’ issued by the ICAI means payment made on account of but before completion of, a contract, or before acquisition of goods or receipt of services.

Although the share application money pending allotment may not give any benefits to the company by way of dividend, interest, capital appreciation, etc., till shares are allotted against it to the company, this application money held for shares may be considered to be held for ‘other benefits’ and the transaction may not be refundable. Therefore, considering substance over form, the EAC concluded that these are in the nature of long-term investments and accordingly, provision for diminution in value of investments other than temporary should be considered against the same. The committee went ahead to conclude that even if the share application money would have been refundable and shown as advances, an appropriate provision against such advances should be made based on their recoverability.

1. The EAC Opinion issued in the ICAI Journal - November 2013


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Guidance note on accounting for rate regulated activitiesThis article aims to:

– Provide an overview of the requirements of the recently issued guidance note on accounting for rate regulated activities.

Introduction

Some of the largest corporations and private companies in India are involved in businesses that are regulated in one form or the other by a statute in India. These are generally, industries in which general public interest is largely present such as electricity, insurance, mining, telecommunication, etc. In order to protect general public interest, regulate competition and address social and economic issues in the economy, price or rate regulation in certain sectors administered by the Government. Such regulatory authorities are usually set up under a legislation in India which governs their constitution, powers, functions, etc. Regulation can take many forms depending upon the industry and objectives to be achieved. Rate regulation is one of the main forms of regulation often found in the utility sector or in sectors dealing with ‘public goods’ or other important goods and services.

To address the accounting issues faced by rate regulated entities, the Institute of Chartered Accountants of India (ICAI) issued a Guidance Note on Accounting for Rate Regulated Activities in 2012. However, the ICAI did not issue an effective date for this guidance note as

some areas needed to be addressed for effective implementation.

On 30 January 2014, the International Accounting Standards Board (IASB) issued IFRS 14, Regulatory Deferral Accounts. It provides interim guidance on accounting for regulatory deferral account balances by first-time adopters of IFRS while the IASB considers more comprehensive guidance on accounting for the effects of rate regulation.

On 18 February 2015, the ICAI has issued second edition of the Guidance Note on Accounting for Rate Regulated Activities which incorporates certain changes in presentation requirements and makes it consistent with Ind AS 114, Regulatory Deferral Accounts which corresponds to IFRS 14. It also provides illustrative examples for the effective and consistent application of this guidance note. The guidance note is effective from accounting period beginning on or after 1 April 2015.

Scope

While there are several methods for rate regulation such as cost-of-service regulation, price cap regulation or a hybrid mechanism, this guidance note only deals with the effects on an entity’s financial

statements of its operating activities that provide goods or services whose prices are subject to cost-of-service regulation. Therefore, an entity should apply this guidance note only if it meets the following criteria:

i. regulators establish the price that an entity must charge to its customers and those prices are binding on the customers

ii. prices determined by regulation are designed to recover the specific costs incurred by an entity in providing regulated goods or services and to earn a specified return. The specified return could be a minimum or range and need to be a fixed or guaranteed return.

Apart from the above, if a regulation specifies different rates for different categories such as different classes of customers or volumes purchased, this guidance note is applicable to related operating activities of such entities only if such a regulator has approved the methodology and rates for each such categories and all customers are bound by the same rates.


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Scope exclusions

Activities of an entity which are subject to other forms of regulation are not covered by this guidance note. The guidance note provides following examples of activities

that are outside its scope:

• activities that are subject to other forms of regulations (not price regulations) such as telecom sector in India which is covered by the Telecom Regulatory Authority of India (TRAI)

• where prices charged to customers by an entity is regulated through a ‘price cap’ i.e. an entity can not charge more than the set prices. Though the prices are regulated and binding on the customers, however, prices are not determined to recover the entity’s specific costs to provide the goods or services

• the guidance note does not cover regulatory accounting where a regulatory entity maintains accounts in a form permitted by the regulator to obtain information needed for regulatory purposes

• where entities have both regulated and non-regulated activities, this guidance note applies to only those set of activities of an entity that meet the two criteria (mentioned in the scope section).

Understanding of a regulatory asset and a regulatory liability

The guidance note explains that in a cost-of-service regulation, there is a direct link between the costs that an entity expects to incur and its expected revenue as rates are set to allow entities to recover its expected costs. Such rates are periodically reviewed by regulators. There is, however, an inherent time lag between the costs incurred by an entity and their recovery through tariffs. Recovery of certain costs may be provided by regulators either before or after incurrence of costs.

Regulatory assets

The Framework for the Preparation and Presentation of Financial Statements (the Framework) defines an asset as ‘a resource controlled by the enterprise as a result of a past events from which future economic benefits are expected to flow to the enterprise’.

According to the guidance note, in a cost-of-service regulation, the resource is the right conferred by the regulator whereby the costs incurred by the entity

result in future cash flows. In such cases, incurrence of costs creates an enforceable right to set rates at a level that permits the entity to recover those costs, plus a specified return, from an aggregate customer base.

Control criterion is met as entity has a right to recover the costs incurred through its relationship with its customer base as a whole and therefore creates a present right to recover the costs incurred from an aggregate customer base.

Regulatory liabilities

The Framework defines a liability as a ‘present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits’.

According to the guidance note, in a cost-of-service regulation, an obligation arises because of a requirement to refund to customers excess amounts collected in previous periods. In such cases, collecting amounts in excess of costs and the allowed return creates an obligation to return the excess collection to the aggregate customer base.

The guidance note clearly states that regulatory assets and liabilities recognised as a result of application of this guidance note are not financial instruments since the entity does not have a legal right to request reimbursement from, or the obligation to make payments to customers for fixed or determinable amounts under a contract.

Also, such regulatory assets are outside the purview of intangible assets as per AS 26, Intangible Assets, since they are not covered in the definition of an intangible asset. It would thus be appropriate to classify regulatory assets and liabilities separately from other assets and liabilities.

Recognition of regulatory asset and regulatory liability

The guidance note provides that a regulatory asset should be recognised when it is probable that the future economic benefits associated with it will flow to the entity as a result of the actual or expected actions of the regulator under the applicable regulatory framework and the amount can be measured reliably. The probability criteria is met when there is a reasonable assurance that future economic benefits will flow from the regulatory asset to the entity.

A regulatory asset can be recognised when the regulatory framework provides for the recovery of the incurred costs and the entity has incurred such costs. If the recovery of the incurred costs is at the discretion of the regulator, it is a contingent asset, which would not be recognised till the approval of the regulator is received.

Similarly, in a cost-of service regulation, the tariffs are subject to ‘truing up’ based on actual costs incurred and prudence checks by the regulators, if the costs incurred by the entity are lower than those initially considered for rate determination, the entity has no realistic alternative to making a refund to the customers. If tariffs are set assuming certain levels of additions to asset base and actual additions by the entity are lower, the entity is required to refund a portion of the tariffs collected to its customers due to lower additions to the asset base. This guidance note states that a regulatory liability should be recognised

• when an entity has a present obligation as a result of a past event

• it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and

• a reliable estimate can be made of the amount of the obligation.

For example, an electricity distribution entity may have an obligation to share gains from reduction of distribution losses with the customers in a specified ratio which would be passed on to the customers as adjustments to future tariffs. Such amounts should be recognised as a liability if on the balance sheet date it is probable that the entity would be required to make refund upon review by the regulator and a reliable estimate can be made of the amount of refund.

Measurement of regulatory assets and regulatory liabilities

On initial recognition and at the end of each subsequent reporting period, the guidance note states that regulatory assets and liabilities should be measured at the best estimate of the amount expected to be received or refunded or adjusted as future cash flows under the regulatory framework. A regulatory asset or liability should not be discounted to its present value. Estimates of the amounts expected to be recovered, refunded, or adjusted as future cash flows under the


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regulatory framework should be based on judgement of the management of the entity keeping in mind various factors as stated in the guidance note. Further, an entity should review the estimates of the amount expected to be recovered, refunded, or adjusted at least at the end of each reporting period to reflect the current best estimate. Also, an entity should test cash generating unit in which the regulatory assets and regulatory liabilities are included.

Presentation

In the balance sheet: Regulatory assets and regulatory liabilities are presented as current/non-current without (offsetting rate regulated assets and liabilities) as

• separate line items,

• with the total of all regulatory assets and all regulatory liabilities.

In the statement of profit and loss: The net movement in all regulatory assets and regulatory liabilities is presented in the

statement of profit and loss as a separate line item. Further, tax expense for the deferred tax expense/saving related to regulatory account balances is presented as a separate line item in the statement of profit and loss.

Disclosure requirements

The guidance note require detailed disclosures which focus on providing users of the financial statements with the information to evaluate the nature of, risk associated with, and effects of rate regulation on an entity’s financial position, financial performance and cash flows.

In case an entity is subject to different regulators, detailed disclosures are required to be given for each set of operating activities.

It also requires reconciliation in a tabular format of the carrying amount in the balance sheet of the regulatory asset and regulatory liability to include certain prescribed components.

In case an entity derecognises regulatory assets and regulatory liabilities, it should disclose reasons for the same, a description of the operating activities affected and the amount of regulatory assets and regulatory liabilities derecognised.

Conclusion

Rate regulated entities should gear up to consider whether changes to existing accounting processes and information systems are needed to track rate regulated assets and liabilities. Entities should assess whether their systems can generate the information required for presentation and disclosures in a coordinated and timely manner.


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Disclosure of discounts while presenting revenue This article aims to:

– Provide a synopsis of a recent EAC opinion on the accounting of discounts given by a company

– Discuss accounting treatment of discounts under Ind AS 115.

Generally companies offer various types of discounts and incentives to attract customers. Some discounts are offered for prompt payments whereas some are based on quantum of purchases or other factors to attract and to retain customers. Trade discounts are offered at the time of purchase for example, when goods are purchased in bulk or to retain loyal customers. Cash discounts are offered to encourage the customers for immediate payment of cash or payment within a short period. In practice, companies are following divergent practices for accounting treatment and presentation of discounts. It is either considered as a reduction of revenue or presented as a

marketing expense. Currently, in India, the accounting of discounts is primarily governed by AS 9, Revenue Recognition, and other pronouncements issued by the Institute of Chartered Accountants of India (ICAI).

For example, Guidance note on Terms used in the Financial Statements, issued by the ICAI states as below:

“3.13 Cash Discount

A reduction granted by a supplier from the invoiced price in consideration of immediate payment or payment within a stipulated period.”

“16.04 Trade Discount

A reduction granted by a supplier from the list price of goods or services on business considerations other than for prompt payment.”

The ICAI has also issued a technical guide on accounting issues in the retail sector which provides guidance on determining whether discount coupons should be considered as marketing expenses or whether revenue should be attributed to such coupons. The guidance is summarised in the table below.

Thus, based on the above principles, certain companies have been considering discounts offered to customers as marketing expense and others treat it as reduction from revenue.

Recently, the Expert Advisory Committee (EAC)1 of the ICAI has opined on the manner of disclosure of revenue as per AS 9.

Brief facts of the case

a. A company is engaged in business of owning and running hotels and resorts

b. The company’s primary revenue streams comprises revenue from sale of rooms, sale of food, other facilities such as health club, tours and sports activities and revenue from running ayurvedic treatment centre

c. The company offers discounts to customers based on various factors; this helped the company to increase its turnover year on year

d. The company recognises revenue from sale of rooms, food, facilities and services as and when the services are rendered

S. No. Marketing expense Revenue attribution

1 No link between initial sales and offer (e.g. random distribution of discount coupons).

Clear link of the offer (products at a discount in future) with the current sale (revenue) transaction.

2

No linkage with loyalty - the customer need not achieve any specified level of transactions or remain a customer for a specified period of time (e.g. discount of five per cent offered for all purchases over INR5,000 during a particular weekend).

Offers (products at a discount or free of cost in future) are exercisable only after the customer has completed a specified cumulative level of revenue transactions or remains a customer for specified period of time.

3Could be a combined transaction - purchase of one product entitling the buyer to a second product at a discount or free of cost simultaneously e.g. buy three chocolates at the price of two.

Normally, two distinct transactions at different points of time

1. EAC opinion issued in the ICAI Journal, The Chartered Accountant, November 2014

Source: The ICAI’s Technical Guide on Accounting Issues in the Retail Sector


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e. The company recognises revenue at gross amount and treats discount as an expense; the presentation followed on the face of the statement of profit and loss is as below:

Gross revenue from operations

2,00,000

Less: Duties & taxes 20,000

Revenue from operations (net of taxes)

1,80,000

Less: Discounts 30,000

Net revenue from operations 1,50,000

Accounting treatment of discounts allowed by the company and presentation in the statement of profit and loss as per AS 9

The EAC has clarified that:

a. Any discount allowed on invoice price for prompt payment or for payment within stipulated time is cash discount and any other discount allowed on invoice price is trade discount

b. In the given case, the basic objective of providing discount is to use it as a marketing strategy to attract guests so as to give the company an edge over its competitors and thereby helping it to increase its turnover. The discount is not allowed for prompt payment; it is allowed for increasing its turnover, therefore, the nature of the discount being allowed by company is that of a trade discount

c. Appendix A to AS 9 which, inter alia, provides as follows:

“9. Trade discounts and volume rebates

Trade discounts and volume rebates received are not encompassed within the definition of revenue, since they represent a reduction of cost. Trade discounts and volume rebates given should be deducted in determining revenue.”

Trade discount is not encompassed within the definition of revenue since it represents a reduction of cost and accordingly, the revenue is determined and recognised after deducting the trade discount.

d. Revenue is the charge made to customers which in case of trade discount is the amount net of discount. Thus, revenue to be presented in the statement of profit and loss should be net of the discount

e. The presentation being followed by the company to present the revenue on gross basis and then to present the trade discount as deduction from the revenue is not correct and not in accordance with requirements of AS 9.

Accounting treatment under Ind AS 115, Revenue from Contracts with Customers2

The core principle of the revenue recognition model under Ind AS 115 is that an entity should recognise as revenue the amount that reflects the consideration to which the entity expects to be entitled in exchange for goods or services when (or as) it transfers control to the customer.

Ind AS 115 introduces a new framework- five step model - for the analysis of revenue transactions. The steps are as follows:

Step 1: Identify the contract with the customer

Step 2: Identify the performance obligations in the contract

Step 3: Determine transaction price

Step 4: Allocate the transaction price to the performance obligations

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

Under the standard, the impact of discounts and incentives given to customers is considered when determining the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding the amounts collected on behalf of third parties (for example, some sales taxes). The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both.

The nature, timing and amount of consideration promised by a customer affect the estimate of the transaction price. An entity while determining transaction price, would be required to consider following:

a. variable consideration (and the constraint)

b. significant financing component

c. non-cash consideration

d. consideration payable to a customer.

Under Ind AS 115, the amount of consideration could vary because of (would be determined after considering)items such as discounts, rebates, refunds, right of return, credits, price concessions, incentives, performance bonuses, penalties, or similar items.

Thus, under Ind AS, as in the present case on which EAC has opined, trade discount would be considered as a reduction from revenue. It is important to note that the concept of variable consideration is expected to bring major changes to current practice as the concept is much wider than what is currently practiced in India.

Other areas

In the case of areas as highlighted in the technical guide, e.g. no linkage with loyalty - where discount is offered for all purchases above a particular threshold during a particular weekend. In this case, under Ind AS 115, the guidance on variable consideration may apply if an entity’s customary business practice and facts and circumstances indicate that the entity may accept a price lower than stated in the contract. In other words, the contract contains an implicit price concession, or the entity has a history of providing price concessions or price support to its customers.

Also, Ind AS 115 provides guidance on customer options for additional goods or services. For example, purchase of one product entitles the buyer to a second product at a discount or free of cost simultaneouly. Under Ind AS 115, an entity would account for a customer option to acquire additional goods or services as a performance obligation if the option provides the customer with a material right. The new standard provides guidance on calculating the stand-alone selling price of a customer.

Disclosures under Ind AS 115

Ind AS 115 requires an entity to disclose a reconciliation of the amount of revenue recognised in the statement of profit and loss with the contracted price showing separately each of the adjustments made to the contract price, for example, on account of discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, etc., specifying the nature and amount of each such adjustment separately.

2. Ind AS have been placed on website of MCA and would be notified shortly. Please refer to MCA circular at http://www.mca.gov.in/Ministry/pdf/Notification_20022015.pdf


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Proposals for changes to accounting for income taxes under U.S. GAAPThis article aims to:

– Provide an update on proposed amendment on accounting for income taxes on intercompany transfers and balance sheet classification of deferred tax.

The Financial Accounting Standards Board (FASB) issued this proposed update as part of its initiative to reduce complexity in the accounting standards (the Simplification Initiative). The objective of the Simplification Initiative is to identify, evaluate and improve areas of generally accepted accounting principles (U.S. GAAP) for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to the users of the financial statements.

The objective of this article is to understand the income tax consequences on intra-entity transfer and balance sheet classification of deferred tax asset or liability under the proposed update including transition guidance.

Analysis of proposed update on accounting for income taxes on intra-entity assets transfers

In consolidation, intercompany balances, transactions, and profit or loss on transfers of assets (if they remain within the group) are eliminated and no immediate gain or loss is recognised. However, intercompany transfers of assets, such as the sale of inventory, depreciable assets, or intellectual property between tax jurisdictions, have cash tax effects

because generally those are taxable events for the seller (typically resulting in taxable gain) and the buyer (typically resulting in a new tax basis in the buyer’s tax jurisdiction). Under the current U.S. GAAP in ASC paragraph 740-10-25-3, the selling entity defers recognising any tax expense resulting from an intra-entity asset transfer, including taxes currently payable or paid. The buying entity does not recognise deferred income taxes for any basis differences for the transferred asset. This is an exception to the accounting model for comprehensive recognition of income taxes in Topic 740, Income Taxes.

The FASB proposes to eliminate the exception in the U.S. GAAP that precludes recognising current and deferred income tax consequences for an intra-entity asset transfer until the asset has been sold to an outside party (i.e. an entity under the proposed update would recognise the current and deferred income taxes on an intra-entity asset transfer when the transfer occurs). The proposed update would align the recognition of income tax consequences of intra-entity asset transfers with IAS 12, Income Taxes under International Financial Reporting Standards (IFRS).

This proposed update could eliminate the need to (a) identify and track the deferred charge for income taxes paid or payable to the selling entity’s tax jurisdiction, (b) decide when to recognise the deferred charge in the income statement, and (c) assess the deferred charge for impairment. An entity recognising current income taxes paid or payable in the period in which an intra-entity transfer occurs could be helpful and appropriate to users of financial statements in comparing current income tax expense and the effective tax rate to cash paid for income taxes.

The change in accounting for intercompany transfers could be applied on a modified retrospective basis at the beginning of the period of adoption with a cumulative effect adjustment to beginning retained earnings.


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Analysis of proposed update on balance sheet classification of deferred taxes

Under current U.S. GAAP in ASC paragraph 740-10-45-4, in a classified statement of financial position, deferred tax liabilities and assets are separated and classified into a current amount and a non-current amount on the basis of the classification of the related asset or liability or according to the expected reversal date of temporary differences. In an attempt to implement Simplification Initiative, the FASB proposes that deferred tax liabilities and assets be classified as non-current in a classified statement of financial position. The proposed update is expected to eliminate an entity to separate and classify deferred tax liabilities and assets into a current amount and a non-current amount in the statement of financial position.

The proposed update is expected to align the presentation of deferred tax liabilities and assets with IAS 1, Presentation of Financial Statements under IFRS.

The proposed update might amend paragraphs ASC 740-10-45-4 and ASC 740-10-45-6 and supersede paragraphs ASC 740-10-45-5 and ASC 740-10-45-7 through 45-10 and their related headings, with a link to transition paragraph ASC 740-10-65-5.

The change in classification of deferred tax balances on the balance sheet would be applied prospectively.

Disclosure requirements

The FASB has not proposed any change in income taxes disclosures under ASC 740 pursuant to this proposed update as it is evaluating income tax disclosures more broadly than the issue addressed in this proposed update.

Effective dates

The proposed Accounting Standards Updates (ASUs) are expected to be effective for public business entities for annual and interim periods in fiscal years beginning after 15 December 2016, with no early adoption allowed. For other entities, the guidance would be effective for annual periods in fiscal years beginning after 15 December 2017, and interim periods in fiscal years beginning after 15 December 2018. Early adoption would be allowed for entities other than public business entities, but not before 15 December 2016, and only if both ASUs are adopted at the same time.


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Regulatory updates

Updated version of the Companies (Auditor’s report) Order unveiled by the MCA

Section 227(4A) of the Companies Act, 1956 (1956 Act) required that the auditor’s report of certain class of companies should include a statement on certain prescribed matters. These reporting requirements were prescribed under the Companies (Auditor’s Report) Order, 2003 (CARO - 2003) by the Ministry of Corporate Affairs (MCA). Section 227(4A) of the 1956 Act ceased to be operational from 1 April 2014 after notification of Section 143(11) under the Companies Act, 2013 (2013 Act).

Though Section 143(11) of the 2013 Act provides requirements similar to Section 227(4A) of the 1956 Act, the MCA had not prescribed CARO related requirements. Consequently, after consulting with the Institute of Chartered Accountants of India, the MCA on 10 April 2015 issued the Companies (Auditor’s Report) Order, 2015 (CARO - 2015) prescribing certain reporting requirements for auditors of certain class of companies. CARO - 2015 will be effective from the date of its publication in the Official Gazette.

For a detailed overview of the CARO - 2015, please refer to KPMG’s First Notes dated 16 April 2015.

(Source – MCA Order dated 10 April 2015)

Review of guidelines on corporate governance for non-banking finance companies (NBFCs)

With a view to address the concerns raised by the industry participants and the difficulties faced by them in the effective implementation of the Revised Regulatory Framework for NBFCs (the Framework) issued by the Reserve Bank of India (RBI) on 10 November 2014, the RBI, vide notification dated 10 April 2015, has issued the NBFC - Corporate Governance (Reserve Bank) Directions, 2015. The directions, inter alia, provide following changes/clarifications:

• With regard to the quarterly statements on change of directors, the ‘certification that fit, and proper criteria in selection of directors’ can be given by the managing director. Unlike the earlier framework where it had to be certified by both, the managing director as well as the auditor. However, it should be noted that the statement pertaining to the quarter ended 31 March need to be necessarily certified by the auditors.

• The age limit of 35 to 70 years for independent/non-executive directors of an NBFC has been done away with and provisions in the Companies Act, 2013 in this regard should apply.

• Circulation of minutes of the meeting of board to directors within two business days is not mandatory and provisions in the Companies Act, 2013 in this regard should apply.

The directions are effective from 10 April 2015.

(Source – Notification by the RBI dated 10 April 2015)

Clarification under Section 186(7) of the Companies Act, 2013

As per the provisions of the Section 372(A)(3) of the Companies Act, 1956, no loan could be given to any body corporate at interest rates lower than the prevailing bank rate, being the standard rate made public under Section 49 of the Reserve Bank of India Act, 1934 which is the rate at which a bank is prepared to buy or re-discount bills of exchange or other commercial paper eligible for purchase. In this regard, the MCA vide General Circular No. 06/2013 dated 14 March 2013 has clarified that in cases where the effective yield (effective rate of return) on tax free bonds is greater than the yield on prevailing bank rate, there was no violation of Section 372(A)(3) of the Companies Act, 1956.

Similarly, under Section 186(7) of the Companies Act, 2013, no loans can be given by a company at a rate of interest


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lower than the prevailing yield of one year, three year, five year or 10 year Government Security closest to the tenor of the loan. In order to address the requests raised by various stakeholders, the MCA, vide general circular dated 9 April 2015, has clarified that in cases where the effective yield (effective rate of return) on tax free bonds is greater than the prevailing yield of one year, three year, five year or 10 year Government Security closest to the tenor of the loan, there is no violation of Section 186(7) of the Companies Act, 2013.

(Source – General Circular No. 06/2015 issued by MCA dated 9 April 2015)

Fine structure for non-compliance with the requirement of Clause 49(II)(A)(1) of the Equity Listing Agreement

Clause 49 of the SEBI1 Equity Listing Agreement relating to Corporate Governance, mandates, inter alia, that the Board of Directors of Directors of listed entities should have an optimum combination of executive and non-executive directors with at least one woman director.

The SEBI, vide cicular dated 15 September 2014, had extended the timeline to comply with the aforesaid requirement to 31 March 2015.

According to the SEBI, vide circular dated 8 April 2015, fines would be imposed on listed companies for non-compliance with the requirements of Clause 49(II)(A)(1) of the Equity Listing Agreement. The structure of fines is as follows:

• Listed entities complying between 1 April 2015 and 30 June 2015: INR50,000

• Listed entities complying between 1 July 2015 and 30 September 2015: INR50,000 + INR1,000 per day with effect from 1 July 2015 till the date of compliance

• Listed entities complying on or after 1 October 2015: INR142,000 + INR5,000 per day from 1 October 2015 till the date of compliance

• For any non-compliance beyond 30 September 2015, the SEBI may take any other action, against the non-compliant entities, their promoters and/

or directors or issue such directions in accordance with law, as considered appropriate.

(Source – Circular No. CIR/CFD/CMD/1/2015 issued by the SEBI dated 8 April 2015)

Provisioning pertaining to fraud accounts

The RBI, vide notification dated 1 April 2015, has prescribed a uniform provisioning norm in respect of advances where there are potential threats of recovery on account of fraud, as follows:

• The entire amount due to the bank (irrespective of the quantum of security held against such assets), or for which the bank is liable (including in case of deposit accounts), is to be provided for over a period not exceeding four quarters commencing with the quarter in which the fraud has been detected.

• However, where there has been delay, beyond the prescribed period, in reporting the fraud to the RBI, the entire provisioning is required to be made at once. In addition, the RBI may also initiate appropriate supervisory action where there has been a delay by the bank in reporting a fraud, or provisioning there against.

(Source – Notification by the RBI dated 1 April 2015)

Clarification on auditor’s report in respect of financial statements of a company for accounting years beginning before 1 April 2014

The Institute of Chartered Accountants of India, vide announcement dated 16 April 2015, has suggested that in case of companies whose financial years ended at a date other than 31 March 2014, the statutory auditors should report on Section 227(3)(f) of the Companies Act, 1956 and relevant clauses of the Companies (Auditor’s Report) Order, 2003 only for that part of the financial year upto which the concerned provisions of the Companies Act, 1956 were in force (i.e., upto 31 March 2014). Also, the statutory auditors should clearly bring out this fact in the relevant portions of their audit reports. The announcement also prescribes an illustrative manner of disclosure in the auditor’s report.

(Source – The ICAI’s announcement dated 16 April 2015)

Secretarial standards issued by the Institute of Company Secretaries of India (ICSI)

Section 118(10) of the Companies Act, 2013 requires every company to observe secretarial standards with respect to general and board meetings specified by the ICSI and explanation under Section 205(1) of the Companies Act, 2013 requires a company secretary to ensure that every company complies with the applicable secretarial standards issued by the ICSI.

The ICSI vide notification dated 23 April 2015, has issued following secretarial standards which are effective from 1 July 2015:

1. SS-1: Meetings of the Board of Directors - The standard prescribes a set of principles for convening and conducting meetings of the board of directors and matters related thereto and is applicable to the meetings of Board of Directors of all companies incorporated under the Companies Act, 2013 (the 2013 Act) except one person company in which there is only one director on its board.

2. SS-2: General meetings - The standard seeks to prescribe a set of principles for the convening and conducting of general meetings and matters related thereto. The standard is applicable to all types of general meetings of all companies incorporated under the 2013 Act except one person company and class or classes of companies which are exempted by the Central Government through notification. Also, the principles enunciated in this standard are applicable mutatis-mutandis to meetings of debenture-holders and creditors. A meeting of the members or class of members or debenture holders or creditors of a company under the directions of the Court or the Company Law Board (CLB) or the National Company Law Tribunal (NCLT) or any other prescribed authority should be governed by this standard without prejudice to any rules, regulations and directions prescribed for and orders of, such courts, judicial forums and other authorities with respect to the conduct of such meetings.

(Source – Notification by the ICSI dated 23 April 2015)

1. Securities and Exchange Board of India


21

Companies (Amendment) Bill, 2014

The Union Cabinet, vide press release dated 29 April 2015, has approved the following amendments in the Companies (Amendment) Bill, 2014:

• Removal of declaration to be filed by companies before commencement of business or exercising its borrowing powers - As per Section 11 of the Companies Act, 2013 (the 2013 Act), a company having a share capital shall not commence any business or exercise any borrowing powers unless a declaration is filed by a director in such form and verified in such manner as may be prescribed with the Registrar of Companies. The declaration should confirm that every subscriber to the memorandum has paid the value of the shares agreed to be taken by him and the paid-up share capital of the company is not less than the prescribed limits in the 2013 Act on the date of making of this declaration. The Union Cabinet has vide press release dated 29 April 2015 approved for removing this requirement of mandatory filing of declaration by companies with the Registrar of Companies.

• Rationalising procedures for laying draft notifications granting exemptions to various classes of companies/ modifying provisions of the 2013 Act in Parliament - Section 129 of the 2013 Act deals with the preparation of financial statements in accordance with the accounting standards. It permits the Central Government to, on its own or on an application by a class or classes of companies, by notification, exempt any class or classes of companies from complying with any of the requirements of this section or the rules made thereunder, if it is considered necessary to grant such exemption in the public interest and any such exemption may be granted either unconditionally or subject to such conditions as may be specified in the notification.

To ensure speedier issue of final notifications, the Union Cabinet has vide press release dated 29 April 2015 rationalised the procedures for laying draft notifications granting exemptions to various classes of companies or modifying provisions of the 2013 Act in the Parliament.

(Source – Press Release by Union Cabinet dated 29 April 2015)

Companies (Incorporation) Amendment Rules, 2015

The MCA vide notification dated 1 May 2015 has issued Companies (Incorporation) Amendment Rules, 2015 which shall come into force from the date of their notification in the Official Gazette. Following are some of the important amendments made with respect to Companies (Incorporation) Rules, 2014:

1. Companies (Incorporation) Rules, 2014 provided that where share capital of a one person company exceeds INR50 lakhs or its average annual turnover during the relevant period exceeds INR2 crores, it shall cease to be entitled to continue as a one person company. The amended Rules now require that both conditions are required to be met i.e. share capital exceeding INR 50 lakhs and average annual turnover exceeding INR2 crores for cessation of a one person company.

2. Companies (Incorporation) Rules, 2014 permitted a private company other than a company registered under Section 8 of the Companies Act, 2013 having paid up share capital of INR50 lakhs or less or average annual turnover during relevant period is INR2 crores or less to convert itself into one person company by passing a special resolution in the general meeting. The amended Rules now require that both conditions are required to be met i.e. conditions of having paid-up share capital of INR50 lakhs or less and average annual turnover during relevant period is INR2 crores or less.

3. Rule 5 of the Companies (Incorporation) Rules, 2014 which dealt with penalty for non-compliance has been replaced with Rule 7A of the Companies (Incorporation) Amendment Rules, 2015. As per this, the amount of penalty for non-compliance with the provisions of the Rules has been revised from INR10,000 to INR5,000. Further, amount of extended fine has also undergone reduction from INR1,000 to INR500 for every day after the first offence during which such contravention continues under the amended Rules.

4. To simplify the filing of forms for incorporation of a company, the MCA has introduced an integrated process for incorporation effective from 1 May 2015. Under this, application

of allotment of Director Identification Number up to three directors, reservation of a name, incorporation of company and appointment of directors of the proposed company is to be filed in integrated Form No. INC – 29, for one person company, private company, public company and producer company with the registrar along with prescribed fee.

(Source – Notification by the MCA dated 1 May 2015)

Distribution of mutual fund products by the non-banking financial companies (NBFCs)

On 4 December 2006, the RBI had issued Guidelines for distribution of mutual fund products by the NBFCs which required prior approval from the RBI for distributing mutual fund products by the NBFCs which met the minimum eligibility criteria. The RBI vide notification dated 30 April 2015, has removed the requirement of NBFCs for taking prior approval from the RBI for distributing mutual fund products considering that such activities is on non-risk sharing basis and purely as a customer service. The minimum eligibility criteria for application has also been removed.

Some of the additional requirements introduced in the guidelines on distribution of mutual fund products by the NBFCs are:

• The code of conduct prescribed by the SEBI, as amended from time to time and as applicable, should be complied with by the NBFCs undertaking these activities

• The NBFCs should have put in place a comprehensive Board approved policy regarding undertaking mutual funds distribution. The services relating to the same should be offered to its customers in accordance with this policy. The policy will also encompass issues of customer appropriateness and suitability as well as grievance redressal mechanism. The code of conduct prescribed by the SEBI, as amended from time to time and as applicable, should be complied with by the NBFCs undertaking these activities.

(Source – Notification No. RBI/ 2014-15/ 578 dated 30 April 2015)


22

Securities Contracts (Regulation) (Amendment) Rules, 2015

The Ministry of Finance, vide notification dated 25 February 2015, has issued the Securities Contracts (Regulation) (Amendment) Rules, 2015. Following changes have been made to the erstwhile Securities Contracts (Regulation) Rules, 1957 by the amended rules:

1. Earlier Rules defined ‘public shareholding’ as equity shares of the company held by public and shall excluded shares which were held by custodian against depository receipts issued overseas. As per the amended Rules, ‘public shareholding’ means equity shares of the company held by public including shares underlying the depository receipts if the holder of such depository receipts has the right to issue voting instruction and such depository receipts are listed on an

international exchange in accordance with the Depository Receipts Scheme, 2014. However, equity shares of the company held by the trust set-up for implementing employee benefit schemes under the regulations framed by the Securities and Exchange Board of India (SEBI) would be excluded from the definition of public shareholding.

2. Rule 19A of the earlier rules on continuous listing requirement required that where the shareholding in a listed company falls below 25 per cent, at any time, such company should bring the public shareholding to 25 per cent, within a maximum period of 12 months from the date of such fall in the manner specified by the SEBI.

A new sub rule 4 after rule 19A(3) has been added that states that as a consequence to the Securities Contracts (Regulation) (Amendment) Rules, 2015, where the public

shareholding in a listed company falls below 25 per cent, such a company should increase its public shareholding to at least 25 per cent in the manner specified by the SEBI within a period of three years, as the case may be, from the date of notification of:

a. the Depository Receipts Scheme, 2014 in cases where the public shareholding falls below 25 per cent as a result of such scheme which is effective from 15 December 2014

b. the Securities and Exchange Board of India (Share Based Employee Benefits) Regulations, 2014 in cases where the public shareholding falls below 25 per cent, as a result of such regulations which are effective from 28 October 2014.

(Source – Notification by the Ministry of Finance dated

25 February 2015)


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Introducing KPMG in India IFRS InstituteKPMG in India is pleased to re-launch 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.

The ICAI provides an updated guidance on provisions relating to depreciation under the Companies Act, 2013

(Addendum to First Notes issued on 24 April 2015)

On 10 April 2015, the Institute of Chartered Accountants of India

(ICAI) has issued an application guide to address certain practical issues arising in the implementation of the Schedule II to the Companies Act, 2013 (2013 Act) relating to depreciation of the assets. The application guide also provides examples for a better understanding of the Schedule II to the 2013 Act. As opposed to the Schedule XIV of the Companies Act, 1956, the Schedule II to the 2013 Act brings along a number of changes in how Indian companies compute depreciation.

Recently, the ICAI has issued a revised version of the application guide which provides an updated guidance for computing depreciation for assets working in double/triple shift.

Our issue of First Notes summarises the key aspects added by the application guide on computation of depreciation for assets working in double/triple shift.

KPMG in India is pleased to present Voices on Reporting – a monthly series of knowledge sharing

calls to discuss current and emerging issues relating to financial reporting

On 22 April 2015, we covered following topics : I. an overview of the key changes and

implementation challenges for companies that adopt ICDS from this year

II. an overview of the financial reporting and regulatory developments introduced under the Indian GAAP during the year ended 31 March 2015.

Missed an issue of Accounting and Auditing Update or First Notes?

IFRS NotesThe IASB proposes to defer the effective date of the new revenue standard

On 28 April 2015, the International Accounting Standards Board (IASB) voted to publish an exposure draft (ED) proposing a one-year deferral of the effective date of the revenue standard to 1 January 2018.

The IASB and FASB Joint Transition Resource Group have discussed a number of application issues and some companies have called for more time to implement the new requirements, due to the significance of the changes they face and the complexity of the IT solutions needed. The U.S. Financial Accounting Standards Board (FASB) has voted

The IASB will consult on the proposed deferral of the effective date by one-year before it is confirmed, as it is required by its due process. Early application of the standard would, however, still be permitted.

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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Accounting and Auditing Update May 2015