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Issue no. 04/2016

November 2016

Editorial

© 2016 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.

Sai Venkateshwaran

Partner and HeadAccounting Advisory Services KPMG in India

Ruchi Rastogi

Executive DirectorAssuranceKPMG in India

In our previous issues of the Accounting and Auditing Update (AAU), we have covered aspects of Data and Analytics (D&A) tools, including their potential to provide benefits to auditing processes and insights that they are expected to provide to companies. In our final article on D&A tools, we highlight how D&A is expected to be a game changer and next gen audit would no longer be about past performance. These tools are capable of testing large quantities of records in an efficient and consistent manner. The article summarises the attributes of future audits and key challenges D&A tools are likely to pose.

As many of the Ind AS financial results for the second quarter of 2016 are being published, the accounting of machinery spares is emerging as an important implementation issue. Certain machinery spare parts could be treated as items of inventory (if specified conditions were met) under Accounting Standards (AS). On the application of recent changes in AS and new standards in Ind AS, certain machinery spare parts would be treated as part of property, plant equipment and not

inventory. Our article focusses on the new accounting principles and their impact even beyond accounting.

We also highlight the guidance on two new concepts in the area of financial instruments accounting: ‘derivatives arising from contracts for purchase or sale of non-financial items’ and ‘expected credit losses model’ for assessment of impairment of trade receivables. The current ‘AS’ do not provide specific guidance on derivatives arising from contracts of purchase or sale of non-financial items or on the method for impairment assessment of trade receivables. Our articles explain these concepts with the help of illustrative examples and detailed flowcharts.

As entities work towards preparing Consolidated Financial Statements (CFS) under Ind AS, one standard that would apply is Ind AS 112, Disclosure of Interests in Other Entities. This standard is completely in line with the International Financial Reporting Standard (IFRS) 12, Disclosure of Interests in Other Entities. It integrates the disclosure requirements for subsidiaries, associates, joint arrangements and unconsolidated structured

entities. In this issue of AAU, we focus on the disclosures required for associates when preparing CFS with the help of illustrations.

In addition to covering recent regulatory updates, we also discuss the guidance on combined and carve-out financial statements issued by the Institute of Chartered Accountants of India. We furthermore highlight some areas where careful evaluation would be needed while preparing combined and carve-out financial statements.

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


Table ofcontents


Changing landscapes using Data and Analytics in audit

Spare parts – change in accounting under Ind AS and AS

Contracts for purchase or sale of non-financial items

Associates – Disclosures under Ind AS

Impairment assessment for trade receivables

Combined and carve-out financial statements

Regulatory updates

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Changing landscapes using Data and Analytics in audit

This article aims to

• Explain utilisation of Data and Analytics in future audits and challenges it raises

How would financial statement audits be designed if auditing were a new service that had just been invented? There is little doubt that the audit processes would be designed to make optimal use of today’s technological advances in order to enable auditors to provide effective and efficient service possible within the bounds of economic viability.

The auditing profession has evolved in response to the changing business environment. Initially audits were primarily substantive in nature as businesses operated in a simple environment. As businesses started to operate in more complex environments with greater volumes of transactions, the auditing profession adopted the current risk-based approach, relying on the control environment and sample testing. Risk-based audit approach has evolved over time to address the large volume of data being generated in businesses. This audit methodology involves obtaining an understanding of the risk of material misstatement in a financial statement, and the internal controls implemented by the business to mitigate these risks. The auditor would evaluate the design and operating effectiveness of these controls by testing these controls for a sample of transactions.

The current revolution that business are experiencing with the explosion of the internet, phenomena like e-commerce, online marketplaces, cloud computing and large scale use of Enterprise Resource Planning (ERP) systems, have significantly disrupted the way business is conducted. Businesses have been quick to adapt to these changes which has resulted in inventive business models encompassing these new phenomena. This has thrown a challenge to the auditing profession to evolve and adapt. Use of D&A tools in audit is considered as one of the key next steps in the evolution of the profession.

D&A tools today are capable of testing large quantities of records in an efficient and consistent manner - a marked improvement over the sampling techniques used in previous audit methodologies. Through these tools, auditors are able to obtain a better understanding of complex business operations. Potential benefits of D&A tools are as follows:

• assist auditors to get better insights into large volumes of transactions

• provide flexibility of analysing data from different perspectives

• automate routine calculations over large data, and

• identify outliers.

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This empowers audit professionals and enhances the ability to use their skills in more value adding pertinent areas. D&A tools can reduce the amount of time dedicated to mundane tasks, allowing more time to be spent by the auditor on complex and judgemental aspects of the audit. These tools have the ability to provide the auditor with deeper insights by leveraging the large transaction related data generated by businesses and enhancing his/her ability to identify higher risk transactions and outliers. These insights enable the auditor to make better risk assessments on the financial statements.

Future audits Future audits are expected to leverage technological advances and D&A capabilities through tools and techniques along with skill sets required to perform next generation audits:

Dynamic and rapid IT adoption: Businesses have evolved rapidly with the widespread adoption of technology, leading to a ‘disruption’ from an operational point of view. The nature of business as we know it is changing and increasingly moving online. ‘E-commerce’, ‘cloud computing’ ‘Internet of Things’ and ‘electronic payments’ are becoming the norm, businesses are moving towards a paperless ecosystem and generating vast amounts of data in electronic form. ERP systems can help to capture not only transaction related data, but a wealth of ancillary data relating to the transaction, which can be used for analysis. This is the new world that auditors need to evolve to in order to remain relevant and increase value addition. D&A tools allow auditors to effectively use these large data sets to perform analysis and gain a better understanding of the business and the environment in which it operates. Thus, D&A tools would allow the auditor to focus on the outliers, where the risk of misstatement is potentially higher.

High degree of auditor proficiency in information technology and the audited subject matter: Audit teams must have necessary skill sets to handle these ever-changing dynamics. There is growing awareness of the need to increase auditor IT and analytics proficiencies. Audit functions are investing time and resources in training, skilling and re-skilling auditors to equip them with technical and analytical skills to get ahead of the D&A curve. Auditors need to equip themselves with the skill sets of IT professionals, including database management, knowledge of D&A software for analysis and the analytical skills of a data scientist in order to be able to leverage the large volumes of data they would now have access to.

Audit evidence to be provided by highly automated procedures: Large volumes of data produced by ERP systems pose a challenge to auditors. The traditional approach of sample testing is rapidly losing relevance in an online world where millions of transactions are generated by businesses every day. Businesses are also increasingly relying on automated or IT assisted manual controls (e.g. work flows for transaction approvals) to conduct and manage their transactions. These factors, coupled with an online market place, have thrown open the challenge to auditors on how to effectively use this to conduct a higher quality audit and provide deeper insights. D&A tools can help auditors effectively cover large sets of transactions highlighting trends and outliers and analyse data based on multiple variables. D&A tools can be used when benchmarking internal and external business metrics which play a key role in measuring and providing insights into performance.

Prepared by client requirements: A key input in a traditional audit scenario is prepared by client information that auditors require at the time of audits. Preparing this information requires investment of time by finance personnel. While ERP systems do permit

automation of certain requirements in the form of system generated reports, this may still involve customisation to suit the specific information requirements. D&A tools allow interaction directly with the ERP system database with the help of customised scripts to generate the requested data in the desired formats. This could help reduce the time spent by finance personnel on preparing schedules resulting in more productive utilisation of resources.

Reporting to audit committees and boards: Future audits are likely to leverage the capabilities of interactive and innovative tools resulting in a more efficient and robust audit reporting process. The traditional regulatory focussed reporting will be combined with more specific analytical findings presented in a manner that is expected to be perceived better by various stakeholders. Audit committees and boards can take comfort in the enriched coverage over transactions provided by D&A audit tools. D&A also enables the use of interactive visualisations, which helps in interpretation of patterns and trends. This also provides the ability to drill down in an analysis from a macro view to a micro view. This can result in auditors being able to share deeper insight and value to those charged with governance, based on the same data sets used for the audit of financial statements.

Challenges While D&A tools are becoming key for auditors, they pose certain challenges which require careful consideration:

Quality of data: D&A tools and techniques encompass working with large data sets hence completeness of the population being analysed must be factored into the audit process. Incomplete data have the capacity to render even the most robust D&A tools ineffective. Auditors would need to ensure a robust quality check on the input data used for any D&A analysis.


Focus on relevant data - The large volumes of data with a multitude of variables may result in the risk of irrelevant data being analysed. Analysis of data that is not relevant to the audit or is not well-understood could have negative consequences to audit quality and also lead to inefficient audits. Strong business understanding, clear focus on the end result and the relevance of data being analysed are critical to effective use of D&A tools.

Professional judgement and skepticism: D&A tools cannot substitute the requirement to exercise professional judgement and the use of professional skepticism. D&A tools enhance the auditor’s ability to deal with large volumes of data, help analyse patterns and identify outliers enabling better assessment of risk areas. However, this is unlikely to be a substitute for professional judgement. Further, auditors would also need to rely on their business understanding and experience while reviewing the output of the D&A procedures performed.

Level of assurance: The ability to easily audit large sets of transactions using D&A tools is unlikely to translate into the ability of an auditor to give an absolute assurance. Instead, these tools help the auditor to obtain better focus on higher risk transactions and deeper insight into the business and the environment in which the entity operates. These inputs in conjunction with control testing and substantive audit procedures could enable an auditor to continue to provide reasonable assurance.

Consider this….

Cognitive intelligence: Emerging technology with immense possibilities for use in audits is cognitive intelligence. Cognitive technologies comprises offerings in the field of artificial intelligence which would permit computers to perform tasks that only humans used to be able to perform. Auditing is particularly suited to cognitive technology because of the increasing challenge to tackle immense volumes of structured and unstructured data related to an entity’s financial and non-financial information. Early application of such technology involves the reading of contracts and segregating critical clauses and highlighting deviations and inconsistencies. Another possible application of cognitive intelligence would be to read the accounts receivable balances and review the credit profile of these customers, by scanning the internet for latest credit reports, news articles, regulatory filings and other information.

Disruptive D&A technologies: Machine learning and natural language processing could make it possible to scan through financial statements and compare the disclosures with the applicable regulations and disclosure guidelines to highlight deviations or inconsistencies. This could also be extended to benchmarking disclosures with the financial statements of peer group companies or those having similar disclosure requirements. D&A tools in conjunction with visual recognition technology and drone cameras could be used to increase the effectiveness of inventory physical counts.

D&A in data security: The rapid growth of online and digital transactions has left businesses susceptible to data theft, breaches and unauthorised transactions. D&A tools help to review large populations of transactions allowing the discovery of patterns and trends, benchmark results and highlight anomalies. These indicators could then be further investigated or highlighted to management to ensure authenticity by the auditor.

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Conclusion

D&A is a ‘game-changer’ in terms of the way next-gen audits are expected to be performed. From leveraging robust tools and techniques to breaking down complex data from client ERP’s and other systems to enabling the human element in audits to be more focussed, D&A is likely to be key to making the transition into next-gen audits. In today’s digital business environment, historical trends may not provide

an understanding of the current business environment. The next-gen audit is no longer just about past performance, it goes much deeper, discovering patterns and making sense of them to generate insights into current business performance. It is not just about reporting back, it is about enhancing value and giving actionable insights on performance

– value and insights that were not achievable before.

Sources: American Institute of Chartered Public Accountants, Inc’s (AICPA) publication: Audit analytics and continuous audit – looking towards the future published in 2015, KPMG International’s publication Dynamic audit- Unlocking value of data and analytics in audit published in 2014.

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Spare parts – change in accounting under Ind AS and AS

Current scenario upto 31 March 2016Spare parts accounting has been a subject matter of opinion of various Expert Advisory Committees (EACs) in the past. The principles of accounting that are being followed under the Accounting Standards 10 (AS 10), Accounting for Fixed Assets state that machinery spares which are not specific to a particular item of fixed asset but can be used generally with various items of fixed assets (property, plant and equipment) are treated as inventories under AS 2, Valuation of Inventories.

Recent developmentsSpare parts accounting is likely to change for companies in India i.e. classification of such spare parts may change from inventories to Property, Plant and Equipment (PPE). The reasons are two-fold: one, application of Ind AS from 1 April 2016 and second revision of AS relating to PPE and inventories from 1 April 2016.

In this article, we aim to provide an overview of the changes to the accounting of spares under Ind AS and AS.

Accounting under Ind ASUnder Ind AS 16, Property, Plant and Equipment, spare parts, stand-by equipment and servicing equipment - e.g. tools and consumable lubricants

- are classified as property, plant and equipment if they meet the definition, including the requirement to be used over more than one period. Therefore, there is no requirement for such items to be used only in connection with an item of property, plant and equipment.

The depreciation on an item of spare part begins when the asset is available for use i.e. when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. In case of a spare part, as it may be readily available for use, it may be depreciated from the date of purchase of the spare part. When determining the useful life of the spare part, the life of the machine in respect of which it can be used can be one of the determining factors1.

Transition to Ind AS – application of Ind AS 101, First-time Adoption of Indian Accounting StandardsAs per the Ind AS road map for phase I companies, the companies need to transition from AS to Ind AS from 1 April 2015. Ind AS 101 contains all of the transitional recognition, measurement, presentation and disclosure requirements applicable for a first-time adopter preparing its first annual and interim financial statements in accordance with Ind AS.

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• Highlight the accounting of spares that meets the definition of property, plant and equipment under Ind AS and AS


1. Ind AS Transition Facilitation Group (ITFG) bulletin 2 issued on 10 May 2016.

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A first-time adopter does not apply the transitional requirements of individual standards or interpretations unless specifically required to do so.

On transition to Ind AS, instead of recomputing the carrying value of PPE under Ind AS, a company has certain choices with respect to calculating PPE balances on the transition date. A first-time adopter at the date of transition can choose to continue with the carrying value of all PPE measured as per the previous GAAP, and use it as its deemed cost without making any further adjustments based on application of other Ind AS (paragraph D7AA of Ind AS 101).

Alternatively, Ind AS 101 also permits a first-time adopter to elect to measure an item of PPE at the date of transition to Ind AS at its fair value and use that fair value as its deemed cost on transition.

On transition to Ind AS, a company that has recorded spares as part of inventory in its previous GAAP financial statements (AS) is required to recognise them as a part of PPE if they meet the criteria under Ind AS 16 (after taking into account the effect of deferred taxes).

The ITFG in its Bulletin 5 (issued on 1 October 2016) has clarified that Ind AS 16 should be applied retrospectively to

determine the amount at which such spare parts would be recognised in the first Ind AS financial statements. Further, depreciation on such spares should be provided when they are available for use.

The ITFG has also clarified that the exemption provided by Ind AS 101 to continue the previous GAAP carrying values of all PPE at the date of transition as deemed cost under Ind AS cannot be used for spare parts that were not recognised as fixed assets, i.e. PPE, under the previous GAAP. While paragraph D7AA does not permit any further adjustments to be made to the previous GAAP carrying value on transition, it does not prevent recognition of an additional asset as PPE if so required by another Ind AS. Therefore, spares that meet the definition of PPE should be capitalised on transition by retrospectively applying Ind AS 16.

The PPE definition requires that spares should be available for use for ‘more than one period’. Since the accounting policies are determined for preparing and presenting financial statements on an annual basis, the term ‘more than one period’ used in the above definition should be generally construed to mean the annual period as per the ITFG. This is relevant in assessing whether spare parts meet the definition of PPE.

Revised ASFrom 1 April 2016, AS 2, Valuation of Inventories and AS 10, Property, Plant and Equipment have been revised and are aligned with Ind AS. Therefore, spare parts, stand-by equipment and servicing equipment would be classified as property, plant and equipment if they meet the PPE definition, including the requirement to be used for more than one period.

On the date of revised AS 10 becoming applicable i.e. 1 April 2016, spare parts, which hitherto were being treated as inventory under AS 2, and are now required to be capitalised at their respective carrying amounts. The spare parts so capitalised should be depreciated over their remaining useful lives prospectively.

This change is expected to lead to duplication of efforts for the phase II companies following Ind AS road map as the transition provisions of revised AS 10 are not same as requirements of Ind AS 101.


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Consider this….

• Impact beyond accounting: The change in spare parts accounting is expected to have not just an accounting impact but an impact that is likely to require changes to systems, processes, IT systems and internal controls relating to accounting of inventories and PPE in relation to spares. The change will impact companies that are:

– Transitioning to Ind AS from 1 April 2015

– Transitioning to revised AS from 1 April 2016.

Such companies may not be able to track machinery spares capitalised as PPE despite they physically being stored at warehouse. Therefore, companies need to plan for this change and invest time.

• Transition to Ind AS for phase II companies: For phase II companies, the date of transition to Ind AS would be 1 April 2016. During their Ind AS transition year (2016-17), such companies would have to prepare financial statements both under AS and Ind AS i.e. there would be duplication of efforts. Therefore, in 2016-17 such companies would account for machinery spares that qualify as PPE:

– Under AS by applying AS 10 prospectively

– Under Ind AS by applying Ind AS 16 retrospectively.

• Deferred tax: Deferred tax assets and liabilities are adjusted to reflect any adjustments to book value recognised as a result of adopting Ind AS; and to measure deferred tax assets and deferred tax liabilities, in accordance with the requirement of Ind AS.

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Contracts for purchase or sale of non-financial itemsThis article aims to

• Identify the types of contracts to buy or sell non-financial items that fall within the scope of the financial instruments standards.

Ind AS 109, Financial Instruments applies to contracts to buy or sell non-financial items that:

• Can be settled net in cash; and

• Are not entered into, or continue to be held, for the purpose of receipt or delivery of the non-financial item in accordance with the entity’s expected purchase, sale or usage requirements.

Contracts that meet the criteria above are considered to be derivative instruments under Ind AS 109 and those that do not, are considered executory contracts that are outside the scope of Ind AS 109. This article highlights the relevant guidance and illustrates its application to a group of contracts.

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Contract 1 Contract 2 Contract 3

Nature of contract

Import of oil seeds from a foreign supplier

Purchase of oil seeds from a domestic producer/supplier

Contract to sell oil seeds on the commodity exchange

Quantity and rate

100 MT at USD400 per MT to be delivered as on 31 March 2017

50 MT at INR30,000 per MT to be delivered as on 31 January 2017

50 MT at USD450 per MT, maturing as on 15 January 2017

Net settlement clause included in the contract

Yes Yes Yes

Net settlement in practice for similar contracts

Yes – company Z has net settled some of these contracts in the past. There have also been several instances of the oil seeds being sold prior to or shortly after taking delivery. These instances of net settlement constitute approximately 30 per cent of the value of total import contracts.

Yes – company Z has net settled some of the domestic purchase contracts. However, these instances constitute only 1 per cent of the total domestic purchase contracts in value. The remaining contracts are settled by taking delivery of the oil seeds which are used for further processing.

Yes – these contracts are required to be net settled with the exchange on the maturity date.

Company Z enters into these type of derivative contracts to hedge the risks on its domestic oil seeds purchase contracts.

Key terms of contracts to buy/sell non-financial itemsCompany Z is engaged in the business of importing oil seeds for further processing as well as trading purposes. It enters into the following types of contracts as on 1 October 2016:

Accounting issueCompany Z is required to determine if the contracts entered into for purchase and sale of non-financial items are derivatives within the scope of Ind AS 109 or are executory contracts outside the scope of Ind AS 109.


Source: KPMG in India analysis, 2016

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Accounting guidanceFigure 1 illustrates the guidance mentioned in Ind AS 109 on analysis of contracts to purchase or sell non-financial items:

Source: KPMG’s Insights into IFRS 13th edition, 2016/17 and KPMG in India’s analysis

Can the contract be settled net in cash/another financial instrument/by exchanging financial instruments, or is the non-financial item readily convertible into cash?

Is the contract entered into and held in accordance with the entity’s expected purchase, sale or usage requirements?

Does the entity have a past practice for similar contracts of:• net settlement, or• taking delivery and selling within a short period of time

Yes

Yes

Yes

Yes

No

No

No

No

FVTPL

Executory contract

Has the entity elected to apply the ‘fair value option’ if FVTPL accounting would eliminate or significantly reduce an accounting mismatch?

Ind AS 109 is applicable to those contracts that can be settled net in cash or another financial instrument, including if the non-financial item is readily convertible into cash. However, contracts that were entered into and continue to be held for the purpose of the receipt or delivery of a non-financial item in accordance with an entity’s expected purchase, sale or usage requirements are not included in the scope of Ind AS 109 (this is the ‘normal sales and purchases’ or ‘own-use’ exemption).

If the entity has a past practice of net settlement for similar contracts, such contracts would not be considered to meet the ‘own-use’ exemption.

Contracts that meet the ‘own-use’ exemption and are excluded from the scope of Ind AS 109 may give rise to accounting mismatches. For example, an entity may enter into derivative contracts to hedge the risks arising from such executory contracts and may be monitoring their net exposure on a fair value basis. The derivatives would be measured at fair value through profit or loss (FVTPL) whereas the executory contracts would not be recognised in the financial statements, leading to an accounting mismatch. Ind AS 109 therefore permits an entity to irrevocably designate such contracts as FVTPL even if they meet the ‘own-use’ exemption.


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Analysis

Contract 1The following factors indicate that this contract does not meet the ‘own-use’ exemption:

• The contract permits net settlement, and

• There is a past practice of a significant proportion (30 per cent in this illustration) of similar contracts being settled on a net basis either in cash or by sale of the oil seeds prior to delivery/shortly after taking delivery.

Therefore, this contract would fall within the scope of Ind AS 109 and should be recognised as a derivative instrument as on 1 October 2016. The contract would be in the nature of a forward contract to buy 100 MT of oil seeds as on 31 March 2017 at USD400 per MT. Company Z would have to recognise the fair value changes (based on change in forward purchase rate) on this contract in the statement of profit and loss at each reporting date.

Contract 2Contract 2 also permits net settlement in cash. Further, there have been some instances of similar domestic purchase contracts being settled net in cash in the past. However, these have been infrequent in nature and insignificant in proportion to the total value of similar contracts (i.e. 1 per cent in this illustration). Company Z is in the practice of taking delivery of the oil seeds purchased under similar contracts and using them for further processing in its plants.

This indicates that the domestic purchase contract meets the criteria for the ‘own-use’ exemption and should be considered as an executory contract. Therefore, this contract would not fall within the scope of Ind AS 109.

Contract 3This contract is in the nature of a derivative contract transacted on a commodity exchange and is required to be net settled in cash on maturity. Therefore, this derivative contract would be covered by Ind AS 109 and required to be classified and measured at FVTPL.

Fair value option

The derivative contracts (similar to contract 3) are transacted to hedge the risks on the domestic purchase contracts. While the derivatives are required to be measured at FVTPL, the domestic purchase contracts meet the ‘own-use’ exemption and are considered as executory contracts. These are typically not recognised until physical delivery of the oil seeds (depending on the terms of purchase). This gives rise to an accounting mismatch in the statement of profit and loss.

Ind AS 109 permits a contract to buy or sell a non-financial item that can be settled net in cash/another financial instrument to be irrevocably designated at inception as measured at FVTPL even if it was entered into for the purpose of receipt or delivery of the non-financial item in accordance with the entity’s expected purchase, sale or usage requirements (i.e. meets the ‘own-use’ exemption). This option (known as the ‘fair value option’) is available only if it eliminates or significantly reduces an accounting mismatch that would otherwise arise.

Consequently, company Z may opt to irrevocably designate contract 2 (and similar contracts) as measured at FVTPL to eliminate the inconsistency described above.


Consider this….

• If company Z does not elect to apply the fair value option and measure contract 2 at FVTPL, it may elect to apply hedge accounting to contract 3. Since contract 3 is a derivative that was entered into to hedge the risks arising from the domestic oil seeds purchase contracts (similar to contract 2), it may be designated in a hedging relationship provided it meets the qualifying criteria. However, hedge accounting for hedges of risks arising from non-financial items is often complex due to the large volumes involved and the absence of individual correlation between the derivatives (hedging instruments) and the hedged items when managing net exposures. Therefore, the use of the fair value option generally involves lower cost and effort.

• The existence of a past practice of net settlement is a matter of judgement since Ind AS 109 does not specify any bright lines or thresholds. We consider that infrequent and unforeseeable incidents of net settlement in the past would generally not be considered as indicative of a past practice of net settlement for all similar contracts.

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Associates – Disclosures under Ind AS

Under Ind AS, entities have to mandatorily prepare consolidated financial statements. There is one standard that integrates the disclosure requirements for subsidiaries, associates, joint arrangements and unconsolidated structured entities (Ind AS 112, Disclosure of Interests in Other Entities). Ind AS 112 is based on the IFRS standard IFRS 12, Disclosure of Interests in Other Entities issued by the International Accounting Standards Board (IASB). Ind AS 112 requires descriptive disclosures of an entity’s interests in other entities to provide better information to help identify following:

• Profit or loss

• Cash flows available to the reporting entity

• Determine the value of a current or future investment in the reporting entity.

In contrast, current Accounting Standard (AS) 23, Accounting for Investment in Associates, requires prescriptive disclosures. These disclosures mainly deal with providing a list and description of associates alongwith proportion of ownership interest in the associate. Additionally. AS 23 requires disclosures of investor’s share of the profit or loss of such investments in the consolidated statement of profit and loss.

In this article, we aim to provide an overview of the disclosure requirements in Ind AS in relation to associates with the help of illustrative formats.

Underlying objective of disclosures under Ind AS 112An entity needs to disclose information that helps users of its financial statements to evaluate the nature of its interests in associates. This includes:

• the nature, extent and financial effects of its interests in such investees, including the nature and effects of contractual relationships with the other investors with joint control or significant influence; and

• the nature of, and changes in, the risks associated with its interests in such investees.

Additionally, an entity needs to disclose its significant judgement and assumption in determining that an entity has significant influence over another entity.

Aggregation

The disclosures required by Ind AS 112 may be aggregated for interest in similar entities and the method of aggregation should be disclosed. An entity need to make a quantitative and qualitative

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• Provide the disclosure requirements for associates with illustrative formats.


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analysis and take into account the different risk and return characteristics of each entity in order to determine the aggregation level. Certain examples of aggregation levels could be – by nature of activities, by industry or geography for each of subsidiaries, joint ventures, joint operation, associates and unconsolidated structured entities.

However, in respect of the disclosure of summarised financial information for interest in material associates, the IFRS Interpretations Committee has clarified that those disclosures need to be provided for each investee and they cannot be aggregated.

Material associates

The Ind AS standard requires an entity to disclose a list and description of investments in associates that are material to the reporting entity rather than for significant associates. The

Conceptual Framework for Financial Reporting under IFRS defines materiality and the term ‘significant’ has not been defined in IFRS and can be interpreted differently. Therefore, the IASB replaced the term ‘significant’ with ‘material’. The IASB noted that materiality should be assessed in relation to an entity’s consolidated financial statements or other primary financial statements in which associates are accounted for using the equity method.

Significant restrictions

Additionally, an entity should disclose significant restrictions on the ability of an associate to transfer cash dividends to the entity or to repay loans or advances made by the entity. These restrictions might arise from borrowing arrangements, regulatory requirements and/or contractual arrangements between investors.

If the financial statements used in applying equity accounting are as at a date or for a period that is different from that of the consolidated or individual financial statements, then the entity should disclose the reporting date of the financial statements of that investee, and the reason for using a different date or period.

If an entity has ceased recognising its share of losses of an equity-accounted associate, then it should disclose its unrecognised share of losses of the investee, both for the reporting period and cumulatively.

Descriptive information

An entity has to disclose certain information for each material associate. The Table 1 below describes an illustrative format for material associates for an entity, which are equity accounted.

Table 1: Illustrative format for material associates of an entity

Summarised financial information

An entity should disclose the following for each material associate:

• whether the investee is accounted for using the equity method or at fair value

• summarised financial information about the investee.

The IFRS Interpretations Committee clarified that the disclosure of summarised financial information for interests in material associates needs to be provided for each investee - i.e. the disclosures cannot be aggregated.

Summarised financial information for each material associate should include, but is not limited to, current assets, non-current assets, current liabilities,

non-current liabilities, revenue, profit or loss from continuing operations, post-tax profit or loss from discontinued operations, Other Comprehensive Income (OCI) and total comprehensive income. An entity also discloses dividends received from the investee.


Name of the investee Associate 1 Associate 2

Nature of relationship with the entity XX XX

Principal place of business, and country of incorporation (if this is different) XX XX

Ownership interest/voting rights held XX XX

Fair value of ownership interest (if listed) XX XX

Table 2 below provides an illustrative format of the summarised financial information for material associates

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Associate 1 Associate 2

2015-16 2016-17 2015-16 2016-17

Revenue XX XX XX XX

Profit from continuing operations XX XX XX XX

Post-tax profit from discontinued operations XX XX XX XX

Other comprehensive income XX XX XX XX

Total Comprehensive income XX XX XX XX

Attributable to NCI XX XX XX XX

Attributable to investee’s shareholders XX XX XX XX

XX XX XX XX

Current assets XX XX XX XX

Non-current assets XX XX XX XX

Current liabilities XX XX XX XX

Non-current liabilities XX XX XX XX

Net assets XX XX XX XX

Attributable to NCI XX XX XX XX

Attributable to investee’s shareholders XX XX XX XX

The summarised financial information should comprise amounts included in the Ind AS financial statements of the associate. The IFRS Interpretations Committee observed that these are the consolidated financial statements of the investee (if it has subsidiaries) or the individual financial statements of the investee (if it does not have subsidiaries). This means that the amounts relate to the whole investee and not the reporting entity’s interest.

The amounts include adjustments made by the entity in applying the equity method - e.g. fair value adjustments made as part of the acquisition accounting. There is no guidance on whether these adjustments should be made on a net basis (reflecting only the reporting entity’s interest) or grossed up to relate to the investee as a whole.

In addition, there is no guidance on how the following are dealt with in the summarised financial information:

• goodwill that forms part of the carrying amount of the equity-accounted investee, and

• inter-company eliminations - e.g. unrealised profit.

Table 3 below provides an illustrative format of the summarised financial information for material associates

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Associate 1 Associate 2

2015-16 2016-17 2015-16 2016-17

Group’s interest in net assets of investee at beginning of year

XX XX XX XX

Total comprehensive income attributable to the group XX XX XX XX

Dividends received during the year XX XX XX XX

Group’s interest in net assets of investee at end of year XX XX XX XX

Elimination of unrealised profit on downstream sales XX XX XX XX

Goodwill XX XX XX XX

Carrying amount of interest in investee at the end of year XX XX XX XX

An entity also presents a reconciliation of the summarised information presented to the carrying amount of its interest in the associate in the balance sheet.

Immaterial associates

An entity should disclosure the aggregate carrying amount of its interests in all individually immaterial associates that are equity accounted. An entity also discloses for all individually immaterial associates together - its aggregated share of the following:

• profit or loss from continuing operations;

• post-tax profit or loss from discontinued operations;

• OCI; and

• total comprehensive income.

Table 4 below describes an illustrative format for information for immaterial associates

Contingencies

If an entity has contingent liabilities that require disclosure in accordance with Ind AS 29, Provisions, Contingent Liabilities and Contingent Assets, then the amounts related to the entity’s interests in joint ventures or associates are disclosed separately from other contingent liabilities. This includes the entity’s share of contingent liabilities incurred jointly with other investors with joint control or significant influence.

Source: Ind AS 112, Disclosure of Interests in Other Entities and KPMG International’s publication Guide to annual financial statements – IFRS 12 supplement issued in December 2014

Name of the investee 2015-16 2016-17

Carrying amount of interest in immaterial associates XX XX

Group’s share of:• profit from continuing operations • Post-tax profit from discontinued operations• Other comprehensive income

XX

XX

XX

XX

XX

XX

Total comprehensive income XX XX

Impairment assessment for trade receivables

Indian Accounting Standard (Ind AS) 109, Financial Instruments requires the recognition of an impairment loss allowance for expected credit losses on a financial asset (being a debt instrument) that is measured at amortised cost or fair value through other comprehensive income (FVOCI).

The general approach to impairment assessment under Ind AS 109 requires the loss allowance to be measured at an amount equal to 12-month expected credit losses for financial instruments where the credit risk has not increased significantly since initial recognition. For those financial instruments where the credit risk has increased significantly, the loss allowance is measured at an amount equal to lifetime expected credit losses.

However, Ind AS 109 also provides a simplified approach to measure impairment losses on trade receivables, lease receivables and specific contractual rights to receive cash/another financial

asset. This article illustrates a method that may be used by an entity to apply the simplified approach to measure impairment losses on trade receivables.

Key characteristics of the trade receivables

An Indian company, M Limited, manufactures office equipment and has a portfolio of trade receivables of INR461 million at its half-yearly reporting date, 30 September 2016. M Ltd supplies equipment nationally to a large number of small clients. Its past experience indicates that loss patterns on its trade receivables differ based on the region in which its customers are located. Further, receivables that have been outstanding for more than one year have historically been uncollectable and result in a loss being incurred, irrespective of the region in which they originate.

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• Illustrate the simplified approach for measuring an impairment loss on trade receivables.


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Region Trade receivables at 30 September 2016 (in INR million)

Impairment allowance as at 30 June 2016 (in INR million)

North 137 2.85

South 98 1.80

East 74 1.50

West 152 3.00

Total 461 9.15

M Limited monitors the current and expected economic scenario on an ongoing basis and categorises it as stable, improving or worsening in nature. When preparing its business forecasts for the next financial year, M Limited has obtained information that suggests that the domestic economic environment is likely to worsen, specifically for businesses operating in the western region.

Accounting issue

Ind AS 109 requires an entity, at each reporting date, to measure and recognise a loss allowance for expected credit losses on all financial assets. The assessment of expected credit losses should be based on reasonable and supportable forward-looking information that is available without any undue cost or effort. M Limited is preparing its

interim financial statements for the half-year ended 30 September 2016 and is therefore required to assess impairment on its portfolio of trade receivables under Ind AS 109.

The outstanding amount of trade receivables for each region is as follows:


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Accounting guidance

Figure 1 illustrates the guidance on impairment in Ind AS 109.

Source: KPMG in India’s analysis 2016 based on Ind AS 109

Is the asset credit impaired at initial recognition?

Is the asset a trade receivable or a contractual right to receive cash or another financial asset (arising under Ind AS 11 or 18)?

Is the asset a lease receivable for which the entity has elected to measure impairment based on lifetime expected credit

losses?

Has there been a significant increase in credit risk since initial recognition?

Recognise 12-month expected credit losses

Recognise changes in lifetime expected credit losses

Recognise lifetime expected credit losses

No

Yes

Yes

Yes

Yes

No

No

No

Ind AS 109 permits the use of practical expedients for measurement of expected credit losses if they are in compliance with the general principles, i.e. result in measurement of expected credit losses in a way that reflects:

• An unbiased and probability-weighted amount that is determined by evaluating a range of possible outcomes,

• The time value of money, and

• Reasonable and supportable information that is available without undue cost or effort at the reporting date about past events, current

conditions and forecasts of future economic conditions.

Ind AS 109 provides an example of a practical expedient – a provision matrix – for calculation of expected credit losses on trade receivables. A provision matrix may generally have the following features:

• It is based on historical credit loss experience, adjusted as appropriate to reflect current conditions and reasonable and supportable forecasts of future economic conditions,

• It might specify provision rates based on the number of days that a trade receivable is past due, and

• Appropriate grouping or segmentation may be used if the historical experience shows different loss patterns for different customer segments, e.g., geographical region, customer rating, product type, etc.


Analysis

M Limited uses the provision matrix as a practical expedient to measure expected credit losses on its portfolio of trade receivables as at 30 September 2016. Based on its historical experience, it segments its receivables based on the geographical region to which its customers belong.

Table 1 provides the ageing of M Limited’s trade receivables for the western region, at 30 September 2016 and as at the past 10 quarterly interim reporting dates. Receivables that are more than one year old are considered uncollectable. This illustration is based on the assumption that the trade receivables have a short duration and do not carry a contractual interest rate. Therefore, the effective interest rate of these receivables is considered to be zero and discounting of expected cash shortfalls has not been performed.

Table 1: Historical ageing of trade receivables held by M Limited (in INR million)

Source: KPMG in India’s analysis, 2016

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Reporting date Balance Not due 0-90 days 90-180 days 180-270

days 270-360

days More than 360 days

September-16 152.00 86.00 42.00 18.50 3.00 2.00 0.50

June-16 144.00 81.00 48.00 9.00 4.00 1.00 1.00

March-16 116.00 69.00 29.00 10.60 4.00 2.00 0.40

December-15 117.00 60.00 35.00 15.30 5.00 1.00 0.70

September-15 96.00 44.00 32.00 15.30 3.00 1.50 0.20

June-15 136.00 76.00 40.00 13.00 4.60 2.00 0.40

March-15 164.00 91.00 53.00 12.30 5.00 2.00 0.70

December-14 160.00 94.00 48.00 12.00 3.50 1.50 1.00

September-14 151.00 79.00 56.00 9.00 4.50 2.20 0.30

June-14 147.00 72.00 59.00 9.00 5.70 1.00 0.30

March-14 150.00 85.00 47.00 11.00 4.50 2.00 0.50


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A provision matrix is developed by M Limited to compute the historical observed default rates. These are determined by computing the historical ‘flow rate’ of trade receivables, based on their ageing and arriving at an average loss rate. This is demonstrated in Table 2 below:

Reporting date Not due 0-90 days 90-180 days 180-270 days 270-360 days More than

360 days

September-16 56.58% 51.85% 38.54% 33.33% 50.00% 50.00%

June-16 56.25% 69.57% 31.03% 37.74% 25.00% 50.00%

March-16 59.48% 48.33% 30.29% 26.14% 40.00% 40.00%

December-15 51.28% 79.55% 47.81% 32.68% 33.33% 46.67%

September-15 45.83% 42.11% 38.25% 23.08% 32.61% 10.00%

June-15 55.88% 43.96% 24.53% 37.40% 40.00% 20.00%

March-15 55.49% 56.38% 25.63% 41.67% 57.14% 46.67%

December-14 58.75% 60.76% 21.43% 38.89% 33.33% 45.45%

September-14 52.32% 77.78% 15.25% 50.00% 38.60% 30.00%

June-14 48.98% 69.41% 19.15% 51.82% 22.22% 15.00%

March-14

Average 54.08% 59.97% 29.19% 37.27% 37.22% 35.38%

Table 2: Computation of ‘flow rate’ based on historical ageing of trade receivable

The flow rate indicates the percentage of trade receivables in an ageing bracket that have not been collected during the quarter and have therefore moved into the next ageing bracket. For example, INR85 million of trade receivables were not due as at 31 March 2014. Of these, INR59 million were not collected during the following quarter and moved into the 0-90 days ageing bracket as at 30 June 2014. Therefore, the flow rate for the 0-90 days ageing bracket at 30 June 2014 is 69.41 per cent (59/85*100). The flow rate for all ageing brackets has been computed in this manner. Accordingly, M Limited has determined the historical average flow rates for all ageing brackets.

These average flow rates are then used to determine the credit loss rate (determined as a product of the average flow rates for the applicable ageing brackets) to be applied to the trade receivables as at 30 September 2016. This loss rate is adjusted by a forward-looking estimate that includes the probability of a worsening domestic economic environment in the western region over the next few quarters. The computation of the credit loss rate and the expected credit loss amount is illustrated in table 3.



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For example, of the INR86 million receivables that are currently not due, 59.97 per cent is expected to move into the 0-90 days bracket. 29.19 per cent of the receivables in the 0-90 days bracket are expected to move into the 90-180 days ageing bracket, and so on. The credit loss rate computed in table 3 above is a product of the flow rates for the applicable ageing brackets. The adjusted credit loss rate includes the forward-looking estimate to reflect the probability of worsening economic

conditions. The adjusted credit loss rate has been computed by applying an increase of approximately 5 per cent to the historical credit loss rate for all ageing brackets. Using this method, the total expected credit loss on the portfolio of trade receivables as at 30 September 2016 is measured as INR4.01 million.

M Limited is required to measure its total impairment allowance on trade receivables on 30 September 2016 at INR4.01 million. At 30 June 2016,

the impairment allowance for trade receivables for the western region was INR3 million. Therefore, the additional impairment loss to be recognised in the statement of profit and loss for the quarter ended 30 September 2016 is INR1.01 million.

M Limited should perform a similar analysis to compute the expected credit loss for trade receivables for the other three regions.

Ageing bracket

Balance (INR

million)

0-90 days

90-180 days

180-270 days

270-360 days

More than 360

days

Not collected

Credit Loss Rate

Adjusted credit

loss rate

ECL (INR

million)

Not due 86.00 59.97% 29.19% 37.27% 37.22% 35.38% 100.00% 0.86% 0.90% 0.77

00-90 days 42.00 29.19% 37.27% 37.22% 35.38% 100.00% 1.43% 1.50% 0.63

90-180 days 18.50 37.27% 37.22% 35.38% 100.00% 4.91% 5.15% 0.95

180-270 days 3.00 37.22% 35.38% 100.00% 13.17% 13.80% 0.42

270-360 days 2.00 35.38% 100.00% 35.38% 37.00% 0.74

More than 360 days

0.50 100.00% 100.00% 100.00% 0.50

Total 152.00 4.01

Table 3: Credit loss rate and impairment loss computation



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Consider this….

• Trade receivables generally have a short duration and do not carry a contractual interest rate. Therefore, they are measured on initial recognition at the transaction price. Accordingly, the effective interest rate for trade receivables is considered to be zero and discounting of expected cash shortfalls to reflect the time value of money would not be required when measuring expected credit losses. However, companies should consider the impact of any financing element in the trade receivables which may have to be separated at initial recognition, especially once Ind AS 115, Revenue from Contracts with Customers becomes applicable.

• The use of historical loss experience to determine lifetime expected credit losses is permitted as a practical expedient under Ind AS 109. However, companies are required to adjust data based on their credit loss experience on the basis of current observable data to reflect the effects of current conditions and forecasts of future conditions. Further, information about historical credit loss rates should be applied to groups of receivables that are consistent with groups for which the historical loss rates were observed.


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Combined and carve-out financial statements

On 28 September 2016, the Institute of Chartered Accountants of India (ICAI) issued its Guidance Note on Combined and Carve-out Financial Statements (guidance note). This guidance note specifies indicative situations in which combined/carve-out financial statements may be prepared and provides guidance on their preparation and required disclosures.

BackgroundConsolidated Financial Statements (CFS) are generally used to present the financial position and performance of a group, i.e. a parent and its subsidiaries, as a single economic entity.

However, there may be some situations where presentation of financial information for a set of entities, which may or may not be part of a group, is relevant. These include transactions for acquisition or disposal of a number of entities that do not form a group, group loan arrangements, regulatory filings

or initial public offerings (e.g., by Real Estate Investment Trusts or Infrastructure Investment Trusts), takeovers and spin-offs. In such cases, preparation of CFS would not be appropriate, and instead combined financial statements may be prepared to present relevant financial information. In circumstances where additional financial information is required for one or more parts of an entity/entities, such as in case of a demerger or spin-off of a segment, carve-out financial statements may be prepared.

While situations requiring presentation of combined or carve-out financial information are quite common today, no guidance was available in India on the preparation of such information, leading to diversity in practice. This guidance note has been issued by ICAI with a view to bridging that gap.

This article aims to highlight key aspects of this guidance note.

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• Provide an overview of the guidance note on combined and carve-out financial statements.

• Highlight the areas that require careful evaluation while presenting combined and carve-out financial statements.

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Overview of the guidance note

ScopeThe guidance note is applicable to the preparation and presentation of combined/carve-out financial statements both, under Ind AS as well as Accounting Standards (AS).

The guidance note is not applicable to general purpose financial statements, since the combined/carve-out financial statements are ‘special purpose financial statements’.

The preparation of combined/carve-out financial statements would involve areas of judgement based on the purpose for which the financial statements are prepared. Combined financial statements can be prepared in cases where:

a. Two or more entities are combined in their entirety. Examples are as following:

• Filings in accordance with statutory or regulatory requirements such as initial offerings by Real Estate Investment Trusts, Infrastructure Investment Trusts, etc.

• Combined financial statements of commonly controlled entities if one or more individuals control several entities that are related/unrelated in their operations.

• Combined financial statements of two or more companies under the same group for the purpose of borrowings from banks or other financial institutions.

b. Two or more carve-out businesses of the same or different entities are combined. For example, transactions such as acquisition or disposition negotiations/agreement, for instance, a group of entities which do not form a group from a legal point of view but are the subject matter of an acquisition or disposal.

c. One or more entities are combined with one or more carve-out businesses. For example, carve-out financial statements to be prepared

for a demerger, spin-off, hiving off or any other related restructuring of a segment/division/business of the same entity or acquisition of a segment/division/business of another entity.

Procedure for preparation of combined financial statements for combining two or more entitiesThe guidance note states that the procedures for preparing combined financial statements of combining entities is the same as that for CFS as per the applicable AS or Ind AS. Additionally, it provides the following guidance:

• Intra-group transactions and profits or losses should be eliminated while preparing combined financial statements.

• Following items should be treated in a similar manner as and when CFS are prepared under the applicable AS or Ind AS:

– Non-controlling interests

– Foreign operations

– Different financial reporting periods

– Accounting policies

– Income tax.

• In case the combining entities or any one of them are under common control, the carrying amounts pertaining to a subsidiary, as reflected in the CFS of the parent, should be used for the purpose of preparing combined financial statements (top-down approach).

For example, company A has three subsidiaries – X, Y and Z. X has better creditworthiness and approaches the bank for a loan which will be used by both X and Y. Bank requires combined financial statements of X and Y for loan appraisal purposes. Combined financial statements of X and Y should be prepared using the amounts contained in A’s CFS pertaining to subsidiaries X and Y.

Procedure for preparation of combined financial statements where at least one of the combining businesses is a carve-out businessAs per the guidance note, carve-out business refers to an identifiable set of activities and liabilities, pertaining to an economic activity carved out of the aggregate activities of an entity. A division, segment or business activity of an entity may also signify a carve-out business.

For example, a toll road project of company A having various other projects is sought to be combined with a toll road project of company B; each of the companies have remaining projects which would continue to operate independently. Combined financial statements are prepared in such cases even if they involve one or more carve-out businesses as the combining businesses. Accordingly, such businesses (including carve-out business) are combined using the procedures similar to those for preparing CFS as per the applicable AS or Ind AS.

Procedure for preparation of carve-out financial statementsCarve-out financial statements are prepared where information with regard to carve-out business is required. However, difficulties in allocation may arise while preparing carve-out financial statements such as payroll accounting where a group of employees provide services to a particular carve-out business along with the remaining group, etc.

The guidance note prescribes the following in such cases:

• An appropriate method should be adopted and applied to allocate transactions or balances to the carve-out assets and liabilities and income and expenses pertaining to the concerned projects (collectively termed as ‘carve-out business’). The method used should provide the fairest approximation to the amounts actually attributable to the carve-out business.


• An appropriate basis may be followed for allocation of common income and expenditure to a carve-out business according to the relevant circumstances. However, a disclosure of the basis adopted for allocation should be made.

• As per the guidance note, basis of allocation may vary as per circumstances and could be based on control, usage, legal ownership or any other appropriate basis. For example, finance lease liabilities may be allocated in line with the allocation of the related assets, group third party debt assumed by the carve-out business may be allocated by reference to the terms of the separation agreement, etc.

• Additionally, the guidance note also necessitates identification of the extent of relationships between the carve-out business and the remaining group and provides the following manner of presentation of balances with the remaining group:

– Trading balances - present as an element of debtors or creditors

– Short-term or long-term funding balances (having characteristics of debt) - present as debt financing

– Short-term or long-term funding balances (not having characteristics of debt) - classify as capital and present as a part of equity, aggregated with the owners’ contribution (capital) and reserves of the carve-out business.

Aspects common to combined/carve-out financial statements

Impairment

• The guidance note requires an independent assessment of the presence/absence of the impairment indicators based on the position post

combination for each period covered by the combined/carve-out financial statements.

Provisions relating to measurement, recognition and disclosure of impairment to be governed by the applicable AS.

Taxation

• As per the guidance note, tax expenses for a combining/carve-out business should be determined as if the combining/carve-out business is a separate taxable entity.

• In doing so, the tax expenses actually incurred by the combining businesses (reflecting the benefits, reliefs and charges) after considering the tax effects of any adjustments should be aggregated.

• However, where the information relating to the tax expenses actually incurred is not available, the tax expenses should be recomputed on the basis of the results of the combining business.

Others

The guidance note provides additional guidance in the following areas:

• Transaction costs: Transaction costs such as finder’s fees, advisory, legal and valuation consulting fees, etc., should be recognised as expenses in the periods in which the costs are incurred and the services are received. However, the costs to issue debt or equity securities should be recognised in accordance with the applicable AS or Ind AS.

• Exceptional items: These should be allocated to the carve-out business and accounted for in accordance with the applicable AS or Ind AS.

• Capital: If it is not possible to arrive at the amount of share capital pertaining to combining/carve-out businesses, the difference between the assets and liabilities of the

combining/carve-out businesses, being net asset value, may be presented as capital as per the guidance note. Further, the balances (not having the characteristics of debt) treated as part of equity should be considered as a component of equity.

• Cash flow statements: The guidance note requires that the cash flow statement should be prepared in accordance with the applicable AS or Ind AS using direct/indirect method depending upon the information available.

DisclosuresThe guidance note prescribes the following disclosures while preparing combined/carve-out financial statements:

1. Disclosure of the fact that the information presented may not be representative of the position which might prevail after the transaction.

2. Disclosure of the fact that resulting financial position shown may not be that which might have existed if the carve-out/combining businesses had been a stand-alone business.

3. In addition to the above, the following should be disclosed in the combined/carve-out financial statements:

a. purpose of preparation of combined/carve-out financial statements

b. a list of combining businesses together with a brief description of activities

c. statement of compliance with the applicable AS or Ind AS

d. the principal accounting policies followed when preparing combined/carve-out financial statements

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e. the basis for allocation, critical assumptions, judgements, and estimates involved in the preparation of combined/carve-out financial statements

f. other disclosures as per the requirements of applicable AS or Ind AS to the extent relevant

g. where the accounting policies are not uniform in respect of combining businesses, disclosure of that fact along with the accounting framework followed

h. extent of balances (not having the characteristics of debt) treated as part of equity

i. the basis of pricing inter-group transfers and any change therein.

Additional disclosures that will assist users’ understanding of combined/carve-out financial statements should also be made as per the guidance note.

Consider this….

The issuance of this guidance note by ICAI is expected to provide a framework for the preparation of combined/carve-out financial statements in India and reduce diversity in practice. However, preparers must ensure that the nature of special-purpose financial information being prepared addresses the information needs of users, meets legal and regulatory requirements and is appropriate for its intended use.

Some areas where careful evaluation is needed are as follows:

• Fit for purpose: While preparing combined/carve-out financial statements there should be an underlying purpose. The scope paragraph of the guidance note does not carry a caution for preparers to assess that the combined financial statements should address the reason why they are being prepared, what information is intended to be conveyed by the combined/carve-out financial statements and who are its intended users and other legal and regulatory requirements.

• Approach to preparation: Globally, combined/carve-out financial statements are prepared by using either the top-down (extraction of financial information from consolidated financial statements) approach or the bottom-up (build-up financial information from components being combined or carved out) approach. While the top-down approach is more commonly used, preparers may need to evaluate the most appropriate approach based on facts and circumstances along with assessing the predominant practice prevailing in the industry. The method of compiling financial information as well as the final results may differ based on the approach used, hence further guidance may be required on their application.


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• First-time adoption of Ind AS: Another important consideration is the accounting framework being applied when preparing the combined/carve-out financial statements. In this context, further clarity may be useful in determining the approach to be followed when the components being carved-out or combined have adopted Ind AS in the past or are adopting Ind AS for the first-time. For example, whether the first-time adoption options or exemptions would be available to a component that is adopting Ind AS for the first time, or whether Ind AS 101, First time adoption of Indian Accounting Standards should be applied when preparing combined financial statements.

• Subsequent events: The treatment of subsequent events that occur after the end of the reporting period for which combined financial statements are being prepared, is another area where further analysis or guidance may be required. Preparers should assess the extent to which financial information should be adjusted for subsequent events, especially in situations where the combined/carve-out financial statements are authorised for issue at a later date than the consolidated financial statements of the parent group from which they are extracted.

• Earnings per share disclosure: It may be difficult to provide disclosures relating to earnings per share in the combined/carve-out financial statements as the number of shares that may be issued to existing investors may only be determined at a later stage based on the final valuation/price.

• Unrelated entities: In the event that two unrelated entities or components are combined and acquired by a new company, it may be appropriate to apply the Ind AS guidance on acquisition accounting for business combinations.

• Common control: The guidance note does not specify in the definition of common control where the shareholding of the combined entities may be held by various family members. More clarity is needed on how would one evaluate control in the absence of a written agreement to act in concert.


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Regulatory updates

ICAI issues FAQs on elaboration of terms used in Ind AS 109 and presentation of dividend distribution tax

BackgroundThe Ministry of Corporate Affairs (MCA), through its notification on 16 February 2015, issued the Indian Accounting Standards (Ind AS), which are converged with the International Financial Reporting Standards (IFRS). The MCA also issued an implementation road map for companies mandating the adoption of Ind AS in a phased manner with the first phase commencing on or after 1 April 2016 for all companies with a net worth of INR500 crore or more (along with their holding, subsidiary, joint venture or associate companies).

New developmentConsidering the practical difficulties being faced by companies while implementing Ind AS, the Accounting Standards Board (ASB) of the Institute of Chartered Accountants of India (ICAI), on 3 November 2016 issued certain clarifications in the form of Frequently Asked Questions (FAQs) on two topic.

Elaboration of terms ‘infrequent number of sales’ or insignificant in value’ used in Ind AS 109

Issue

Paragraph 4.1.1(a) of Ind AS 109, Financial Instruments requires an entity to classify financial assets on the basis of an entity’s business model for managing the financial assets.

Ind AS 109 provides guidance to determine if the business model of an entity is to hold financial assets to collect contractual cash flows (‘held to collect’ business model). In order to determine the business model, it is necessary to consider the following:

• Frequency of sales,

• Value and timing of sales in prior periods,

• Reasons for sales, and

• Expectations about future sales activity.

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34

The application guidance of Ind AS 109 states that sales of assets before maturity may be consistent with a ‘held to collect’ business model if those sales are infrequent (even if significant in value) or insignificant in value both individually and in aggregate (even if frequent). This is reiterated in the Basis of Conclusions to IFRS 9, Financial Instruments, which provides an example of a situation where a change in the regulatory treatment of a particular type of financial asset may cause an entity to undertake a significant rebalancing of its portfolio in a reporting period. Such an instance is considered consistent with a ‘held to collect’ business model.

However, neither the terms ‘infrequent number of sales’ or ‘insignificant in value’ have been defined nor any threshold for value or number has been specified in the standard. The ASB considered the following issues:

• Interpretation of terms ‘infrequent number of sales’ or ‘insignificant in value’ and indicative rebuttable thresholds for sales that are more than insignificant in value.

• Relation between the terms ‘immaterial’ and ‘insignificant’

Response

Interpretation of infrequent number of sales or insignificant in value

The guidance given in Ind AS 109 indicates that determining an entity’s business model involves significant judgement. Accordingly, the ASB has clarified that no rule of thumb in terms of indicative percentage can be provided to determine ‘infrequent number of sales’ or ‘insignificant in value’, since it may not be applicable in all cases considering the differing quantum, configuration and nature of financial assets in different entities.

An entity’s management may, therefore, exercise judgement in determining the situations in which sales of financial assets occurring before the maturity date may not be considered inconsistent with

the ‘held to collect’ business model. In doing so, it may specify certain guiding criteria - for example, sale of a security initially rated as AAA and subsequently rated as BB may not be considered inconsistent with the entity’s business model as the intent is for the entity to rebalance its portfolio rather than waiting till the maturity date.

Relation between ‘immaterial’ and ‘insignificant’

With regard to relation between terms ‘immaterial’ and ‘insignificant’, the ASB clarified that the term ‘materiality’ is already present in Ind AS which also does not lay down any criteria based on indicative fixed percentages. The term ‘insignificant’ has not been defined and can be interpreted to mean ‘less than material’ or almost ‘negligible’.

Presentation of dividend and Dividend Distribution Tax (DDT) under Ind AS

Issue

Ind AS 32, Financial Instruments: Presentation requires an issuer to classify financial instruments as a financial liability or an equity instruments based on their contractual terms. Instruments that have features of both, a liability and an equity instrument, are classified as compound financial instruments under Ind AS 32.

The ASB considered the presentation requirements for dividend and dividend distribution tax on financial instruments classified as equity or as compound instruments by the issuer.

Response

Dividend

As per paragraph 35 of Ind AS 32, ‘interest, dividends, losses and gains relating to a financial instrument or a component that is a financial liability shall be recognised as income or expense in profit or loss. Distributions to holders of an equity instrument shall be recognised by the entity directly in equity.’

Further paragraph 36 of Ind AS 32 states that ‘the classification of a financial instrument as a financial liability or an equity instrument determines whether interest, dividends, losses and gains relating to the instrument are recognised as income or expense in the statement of profit and loss. Thus, dividend payments on shares wholly recognised as liabilities are recognised as expenses in the same way as interest on a bond.’

Therefore, based on the above, the ASB has clarified that dividends on each category of financial instruments should be presented as follows:

• Financial instrument classified as debt: Charge dividend/interest paid on it to the statement of profit and loss.

• Financial instrument classified as equity: Recognise dividend/interest paid on it in the statement of changes in equity.

• Compound financial instrument: Charge dividend or interest allocated to debt portion to the statement of profit and loss and recognise the portion of dividend or interest pertaining to equity in the statement of changes in equity.

Dividend distribution tax

The ASB is of the view that in India, the rate of income tax for a company on its taxable income does not change if the company distributes dividend. The DDT is a tax that is computed on the basis of the amount of dividend distributed to shareholders rather than based on the amount of profits earned and it arises at the point of time when profits are distributed. In India, dividends are not taxable in the hands of shareholders as DDT is paid by the company that paid the dividend. According to ASB, had there been no DDT mechanism, dividend would have been taxable in the hands of recipients (though recently dividend exceeding specified limit has been made taxable).


Therefore, with respect to the presentation of DDT, the ASB is of the view that the relevant guidance is in paragraph 61A of Ind AS 12, Income Taxes. Para 61A states that ‘current tax and deferred tax shall be recognised outside profit or loss if the tax relates to items that are recognised, in the same or a different period, outside profit or loss. Therefore, current tax and deferred tax that relates to items that are recognised, in the same or a different period:

• in other comprehensive income, shall be recognised in other comprehensive income.

• directly in equity, shall be recognised directly in equity.’

Accordingly, the ASB has clarified that the presentation of DDT paid on dividends should be consistent with the presentation of the transaction that creates those income tax consequences, as follows:

• Dividend charged to statement of profit and loss: Charge DDT to the statement of profit and loss.

• Dividend recognised in statement of changes in equity: Recognise DDT in the statement of changes in equity.

• Dividend on compound financial instruments: Recognise the portion of DDT related to dividend/interest on the debt component in the statement of profit and loss and the portion of DDT related to the equity component in the statement of changes in equity.

(Source: ICAI FAQs on elaboration of terms used in Ind AS 109 and Dividend distribution tax dated 3 November 2016 and KPMG in India’s IFRS Notes dated 10 November 2016)

Disclosure of financial information in offer document/placement memorandum for InvITs

BackgroundThe Securities and Exchange Board of India (SEBI) (Infrastructure Investment Trusts) Regulations, 2014 (InvIT

Regulations) notified on 26 September 2014 prescribes the general conditions for making a public offer and private placement and broad guidelines for making initial and continuous disclosures. The SEBI had constituted a Committee (the Committee) consisting of representatives from the ICAI and the industry to prescribe specific requirements relating to accounting and auditing norms for Infrastructure Investment Trusts The committee worked in sub-groups and issued two consultation papers:

• On 15 June 2016, SEBI issued a consultation paper proposing continuous financial disclosures and other continuous disclosures to be made by InvITs

• On 8 July 2016, had issued a consultation paper proposing guidelines for financial disclosures in the offer document/placement memorandum and valuation of the units of InvITs.

New developmentOn 20 October 2016, SEBI issued a circular (CIR/IMD/DF/114/2016) which prescribes the detailed requirements for disclosure of financial information in offer document/placement memorandum for InvITs.

The disclosure requirements are sub-categorised into these following sections:

• Financial Information of InvIT: This section provides financial information to be disclosed in the offer document/placement memorandum such as period, nature, content and basis of preparation of financial information and additional financial disclosures and requirement of audit of financial information.

• Projections of InvIT’s Revenues and Operating Cash flows

• Management Discussion and Analysis of InvIT’s operations

• Other Disclosures for InvIT

• Historical Financial information of Investment Manager and Sponsor(s)

• Framework for calculation of Net Distributable Cash Flows (NDCFs)

• Principles for preparation of combined financial statements

• Minimum Disclosures for key financial statements.

(Source: SEBI circular CIR/IMD/DF/114/2016 dated 20 October 2016)

SEBI issued a clarification for listed insurance companies

BackgroundThe SEBI issued SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations) on 2 September 2015. Further, on 30 November 2015, SEBI through its circular (CIR/CFD/CMD/15/2015) prescribed the following formats for listed entities under the new Listing Regulations for publishing their financial results:

• Formats for presenting the quarterly financial results including segment reporting by:

– Companies other than banks

– Banks

– Half-yearly statement of assets and liabilities

• Format for limited review report and audit report.

On 5 July 2016, SEBI issued a circular (reference No. CIR/CFD/FAC/62/2016), which provides

• Certain relaxations in reporting of Ind AS financial results for first three quarters

• Format of financial results to be published in the newspapers

• Clarifies that for the period ending on or after 31 March 2017, listed entities should provide their unaudited/audited quarterly/half yearly financial statements as the case may be as per the formats of the balance sheet and statement of profit and loss as prescribed in Schedule III to the Companies Act, 2013 (2013 Act).

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Additionally it has been clarified that banking companies and insurance companies should follow the formats as prescribed under the respective acts/regulations as specified by their regulators.

New developmentSEBI through its notification dated 24 October 2016, in light of recent listing of insurance companies, issued clarification for listed insurance companies in consultation with Insurance Regulatory and Development Authority of India (IRDAI).

SEBI has provided following clarifications related to disclosure requirements of listed insurance companies:

a. The companies (life and non-life) should submit the following disclosures for quarters ending 30 September 2016 and 31 December, 2016 in the format as specified by IRDAI:

• Format for quarterly financial results

• Format for reporting of segment wise revenue, results and capital employed along with the quarterly results.

b. With respect to the format for the newspaper publishing purpose (stand-alone/consolidated), the insurance companies should continue to follow the format as specified under the aforesaid circulars issued by SEBI. Additional disclosures may also be made as prescribed by IRDAI.

c. The other requirements specified under the aforesaid circulars should continue to apply to insurance companies.

Additionally, IRDA, through its circular dated 25 October 2016, has prescribed formats to ensure compliance with the above SEBI Regulations.

(Source: SEBI circular CIR/CFD/DIL/115/2016 dated 24 October 2016)

RBI modifies guidelines on schemes related to stressed assets

BackgroundThe Reserve Bank of India (RBI), has issued various notifications in the past, aimed at strengthening the ability of lenders in India to deal with stressed assets. Some of these include notifications DBR.BP.BC.No.101/21.04.132/2014-15 dated 8 June 2015 and DBR.No.BP.BC.103/21.04.132/2015-16 dated 13 June 2016, which provided guidelines for a scheme of Strategic Debt Restructuring (SDR) and Sustainable Structuring of Stressed Assets. These schemes provided an avenue for reworking the financial structure of entities facing genuine difficulties and requiring coordinated deep financial restructuring.

New developmentOn 10 November 2016, the RBI, through its notifications DBR.No.BP.BC.33/21.04.132/2016-17 and DBR.No.BP.BC.34/21.04.132/2016-17, made certain revisions to the guidelines referred to above.

These changes are aimed at achieving the following:

i. Harmonisation of stand-still clause as applicable in case of SDR scheme with other guidelines

ii. Clarifying on the Deemed date of Commencement of Commercial Operations (DCCO), and

iii. Partial modification of certain guidelines based on the experience gained in using these tools in resolving the stressed assets as well as feedback received from stakeholders, and taking into consideration the requirements of the construction sector.

(Source: RBI notification DBR.No.BP.BC.33/21.04.132/2016-17 and DBR.No.BP.BC.34/21.04.132/2016-17 dated 10 November 2016 and KPMG in India’s First Notes dated 23 November 2016)

RBI issued amendments to transfer/issue of security by a person resident outside India regulations.

The RBI through its notification dated 24 October 2016 issued Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Eleventh Amendment) Regulations, 2016 (amended regulations).

The amended regulations permitted that a wholly owned subsidiary set up in India by a non-resident entity, operating in a sector where 100 per cent foreign investment is allowed through automatic route and there are no Foreign Direct Investment (FDI) linked conditions, such entities can issue of equity shares, preference shares, convertible debentures, or warrants against the pre-incorporation and pre-operative expenses up to a limit of 5 per cent of capital or USD500,000, whichever is less, subject to following conditions:

a. Such company should report the transaction in the Form FC-GPR to RBI within 30 days from the date of issue of equity shares, preference shares, convertible debentures, or warrants but not later than one year from the date of incorporation or such time as RBI or Government of India permits.

b. The valuation of the equity shares, preference shares, convertible debentures, or warrants should be subject to provisions given in Regulations.

c. A certificate issued by the statutory auditor affirming that the amount of pre-incorporation/preoperative expenses against which equity shares/preference shares/convertible debentures/warrants have been issued has been utilised for the purpose for which it was received should be submitted along with the FC-GPR form.


The amendments are effective from the date of their publication in the Official Gazette i.e. 24 October 2016.

(Source: RBI notification FEMA. 373/ 2016-RB dated 24 October 2016)

Exposure draft on Amendments to Ind AS 7

The ICAI on 3 November 2016 has issued the exposure draft of changes proposed in Ind AS 7, Statement of Cash Flows. The amendments are proposed are in line with the amendments issued by International Accounting Standards Board (IASB) to IAS 7, Statement of Cash Flows in January 2016. The exposure draft sought comments and the last date to provide comments is 2 December 2016. The exposure draft proposes that an entity should provide disclosures that enable users of financial statements to evaluate changes in liabilities arising from financing activities, including both changes arising from cash flows and non-cash changes.

(Source: ICAI notification dated 3 November 2016)

Demonetisation of INR500 and 1000 notes

The Ministry of Finance (MOF) through its notification dated 8 November 2016 announced that bank notes of denominations of the existing series of the value of INR500 and INR1000 (hereinafter referred to as specified bank notes) shall cease to be legal tender with effect from the 9 November 2016.

Additionally, it provides that specified bank notes held by a person other than a banking company or Government Treasury may be exchanged at any Issue Office of the Reserve Bank or any branch of public sector banks, private sector banks, foreign banks, Regional Rural Banks, Urban Cooperative Banks and State Cooperative Banks for a period up to and including the 30 December 2016, subject to the specified conditions.

(Source: MOF notification S.O. 3407(E) dated 8 November 2016)

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KPMG in India’s IFRS institute Visit KPMG in India’s IFRS institute - a web-based platform, which seeks to act as a wide-ranging site for information and updates on IFRS implementation in India.The website provides information and resources to help board and audit committee members, executives, management, stakeholders and government representatives gain insight and access to thought leadership publications that are based on the evolving global financial reporting framework.

RBI modifies guidelines on schemes related to stressed assets

23 November 2016

On 10 November 2016, RBI through its notifications DBR.No.BP.BC.33/ 21.04.132/2016-17 and DBR.No.BP.BC.34/21.04.132/2016-17, made certain revisions to the guidelines referred above.

These changes are aimed at achieving the following:

1. Harmonisation of stand-still clause as applicable in case of SDR scheme with other guidelines

2. Clarification on the deemed Date of Commencement of Commercial Operations (DCCO), and

3. Partial modification of certain guidelines based on the experience gained in using these tools in resolving the stressed assets as well as feedback received from stakeholders, and taking into consideration the requirements of the construction sector.

This issue of First Notes provides a synopsis of the significant modifications made by RBI to the schemes related to stressed assets.

KPMG in India’s Ind AS - Practical perspectives, aims to put a finger on the pulse of India Inc’s adoption of Ind AS and capture emerging trends and practices.

Our impact assessment is based on Nifty 50 companies which would be the first group of companies to report Ind AS results. The Nifty 50 companies have started reporting their financial results for the quarter ended 30 September 2016.

Out of the companies comprising Nifty 50 index, eight companies are banks, one is Non-Banking Financial Company (NBFC) and two companies follow a different date of transition to Ind AS. Therefore, our analysis would comprise the remaining 39 companies.

This can be accessed on KPMG in India website - ‘Ind AS- Practical perspectives’ webpage

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

IFRS NotesICAI issues FAQs on elaboration of terms used in Ind AS 109 and presentation of dividend distribution tax

10 November 2016

Considering the practical difficulties being faced by companies while implementing Ind AS, the Accounting Standards Board (ASB) of the Institute of Chartered Accountants of India (ICAI), on 3 November 2016 issued certain

clarifications in the form of Frequently Asked Questions (FAQs) on the following topics:

1. Elaboration of terms ‘infrequent number of sales’ or insignificant in value’ used in Ind AS 109

2. Presentation of dividend and Dividend Distribution Tax (DDT) under Ind AS

This issue of IFRS Notes provides overview of the clarifications issued by ICAI.

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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