The finance function of companies are going through an interesting and challenging phase. The accounting and regulatory changes have implications that go beyond matters of accounting and reporting, also potentially impacting the information systems of many entities. It is thus imperative for CFOs and finance leaders to meet these increasing demands by building better relationships with audit committees and other stake holders, using innovative technologies and sophisticated data analytics and developing the right mix of capabilities in the finance function.
Partner and National Leader
Financial Accounting Advisory Services (FAAS), EY India
New Accounting pronouncement
Ind AS 116 – Leases
The Ministry of Corporate Affairs (MCA) notified the Companies (Indian Accounting Standards) Amendment Rules, 2019, which relates to the pronouncement of Ind AS 116 Leases to replace the existing standard (Ind AS17) from accounting periods beginning 1 April 2019 and thereafter.
The new standard proposes an overhaul in the accounting for lessees by completely letting go off the previous “dual” finance vs. operating lease model and will not allow Indian corporates to shy away from finance lease accounting anymore. The guidance in the new standard requires lessees to adopt a single model approach which brings leases on the balance sheet on day one, in the form of a right-of-use asset and a lease liability.
The scope of Ind AS 116 includes leases of all assets, with certain exceptions. A lease is defined as a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.
Lessees are required to initially recognize a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term. The lease liability is measured at the present value of the lease payments to be made over the lease term. The right-of-use asset is initially measured at the amount of the lease liability, adjusted for lease prepayments, lease incentives received, the lessee’s initial direct costs (e.g., commissions) and an estimate of restoration, removal and dismantling costs. Lessees accrete the lease liability to reflect interest and reduce the liability to reflect the lease payments made. The related right-of-use asset is depreciated in accordance with the depreciation requirements of Ind AS 16 Property, Plant and Equipment. For lessees that depreciate the right-of-use asset on a straight-line basis, the aggregate of interest expense on the lease liability and depreciation of the right-of-use asset generally results in higher total periodic expense in the earlier periods of a lease. Lessees re-measure the lease liability upon the occurrence of certain events (e.g., change in the lease term, change in variable rents based on an index or rate), which is generally recognized as an adjustment to the right-of-use asset.
- Lessor accounting
Lessor accounting is substantially unchanged from today’s accounting under Ind AS 17.Lessors will continue to classify all leases using the same classification principle as in Ind AS 17 and distinguish between two types of leases: operating and finance leases.
- Identifying lease components
Identifying non-lease components of contracts (e.g., maintenance services provided with an equipment arrangement that is treated as a lease) may change practice for some lessees. Today, lessees may not focus on identifying lease and non-lease components because their accounting treatment (e.g., the accounting for an operating lease and a service contract) is often the same. However, because most leases are recognized on lessees’ balance sheets under Ind AS 116, lessees may need to put more robust processes in place to identify the lease and non-lease components of contracts, unless lessee elects, by class of underlying asset, not to separate non-lease components from lease components and instead account for both as a single lease component.
- Embedded leases
While current leasing guidance also requires embedded leases to be identified and accounted for separately, most lessees were not always diligently doing so because typically, they were off-balance-sheet. The general rule under the new model is that an arrangement contains a lease if (1) there is an explicit or implicit identified asset in the contract, and (2) the customer controls use of the identified asset. Thus, under the new guidance, balance sheet amounts get misstated if embedded leases are not identified and accounted for appropriately.
- Practical expedients
- Entities are permitted to make an election whether to reassess contracts to identify the ones containing a lease or apply practical expedient such that contracts that do not contain a lease under Ind AS 17 are not required to be reassessed.
- A lessee has the option to, but is not required to, apply the standard to leases of intangible assets.
- A lessee may elect, by class of underlying asset, not to separate non-lease components from lease components and instead account for both as a single lease component.
- For leases with a lease term of 12 months or less, lessees have an accounting policy election that allows them not to recognize lease assets or liabilities, by class of underlying asset.
- For leases with underlying asset of low value, lessees have an accounting policy election not to recognize lease assets or liabilities, on a lease-by-lease basis.
- The standard may be applied to a portfolio of leases with similar characteristics, provided that it is reasonably expected that the effects will not differ materially from applying the standard to the individual leases within that portfolio.
Based on the accounting options provided under Ind AS 116, entities have three different accounting approaches at the time of transition.
- Full retrospective approach:
Comparative periods are restated as if Ind AS 116 is applied from the commencement of the lease, as such entities will present a third balance sheet as at the beginning of the preceding period in addition to the minimum comparative financial statements.
- Modified retrospective approach – Option A:
Under this approach, the lease liability is recognized at the date of initial application and is measured at the present value of the remaining lease payments discounted using lease incremental borrowing rate at the date of initial application. The Right of Use (ROU) asset is measured as if the standard had been applied since the commencement of each lease, but discounted using incremental borrowing rate at the date of initial application. Difference between ROU asset and lease liability is recognized in the opening retained earnings on the date of initial application.
- Modified retrospective approach – Option B
Under this approach, the lease liability is measured as mentioned in option A above. However, the ROU asset is measured at an amount equal to the amount of lease liability, adjusted by the amount of any prepaid or accrued lease payments relating to that lease recognized in the balance sheet immediately before the date of initial application.
- Full retrospective approach:
The new standard provides lessees with various accounting policy choices and practical expedients, such as:
Companies need to carefully evaluate and select the practical expedients which they deem most appropriate.
The company will need to provide a disclosure of “standards issued but not yet effective”. In this disclosure, company needs to provide that this standard has not been applied while preparing the financial statements and also disclose the known or reasonably estimable information relevant to assessing the possible impact that the application of the new standards will have on the entity’s financial statements in the period of initial application.
On application of the standard, lessee accounting will significantly undergo a change. Most leases will come onto the balance sheet – with the exception of short- term and low value leases. One of the most critical aspects on the application of this standard is managing voluminous data. In order to facilitate smooth transition, we believe that following are the critical factors to effectively manage the transition:
Understand the current leasing landscape of the company with special emphasis on lease and service contracts, understand the nature of lease contracts, volume of leasing arrangements and other contracts which may be classified as leases.
Review lease contracts, understand and analyze the key terms of such contracts in light of possible impacts of the new guidance.
Based on the understanding and review of contracts, identify changes resulting from the new lease standard (e.g., data gaps, processes, controls, systems and tax), specially focusing on contracts not classified as lease contracts previously.
- Abstract and evaluate:
Quantify the accounting impact on transition, disclosures and key financial metrics; design solutions for accounting change (e.g., new accounting policies, processes, controls and systems) to capture new lease data requirements and understand the impact on the financial statements.
In a nutshell, adopting the new lease accounting standard will require companies to have proper controls and develop the accounting and reporting framework for applying the new standard.
Practical application and enhanced presentation and disclosure requirements on account of implementation of the new revenue standard – Ind AS 115
The Ministry of Corporate Affairs (MCA)notified Ind AS 115 (corresponding to IFRS15) on 28 March 2018, which came into effect from 1 April 2018. Ind AS 115 replaces “Ind AS 11 - Construction Contracts”, “Ind AS 18 – Revenue” and “Guidance Note on Accounting for Real Estate Transactions”, erstwhile Ind ASs. It is a single source of revenue guidance for entities across industries. The new standard is a significant change in approach, is principle-based and provides more application - based guidance than the erstwhile Ind ASs.
For detailed guidance regarding the standard, refer our publication Applying Ind AS – Guide to the New Revenue Recognition Standard.
The key requirements of the standard are as follows:
Ind AS 115 requires an entity to focus on the customers’ point of view to decide revenue recognition. It prescribes a five-step model for revenue recognition.
- Step 1:
Identify the contract(s) with a customer
Contracts may be written, oral or implied by customary business practices, but revenue can be recognized only on those contracts that are enforceable and have commercial substance.
- Step 2:
Identify the separate performance obligations in the contract
Performance obligations are explicitly or implicitly promised goods or services in a contract as well those arising from customary business practices. An entity needs to identify performance obligations which are distinct.
- Step 3:
Determine the transaction price
The transaction price is the amount of consideration to which an entity expects to be entitled. It includes variable consideration, impact of significant financing components, fair value of non-cash consideration and impact of consideration payable to the customers.
- Step 4:
Allocate the transaction price to the separate performance obligations
The standard requires allocation of the total transaction price to the various performance obligations based on their relative stand-alone selling prices, with limited exceptions.
- Step 5:
Recognize revenue when (or as) the entity satisfies a performance obligation
Revenue recognition can occur either over time or at a point in time depending upon the fulfillment of three criteria as listed in Ind AS 115. Revenue recognition for a performance obligation occurs over time only if it meets one of the three prescribed criteria. Ind AS 115 focuses on the “control approach” to determine revenue recognition as against the “risk and rewards” model under Ind AS 18, which generally resulted in recognition of revenue at a point in time.
Ind AS 115 prescribes extensive qualitative and quantitative disclosures. Two of these disclosures, viz., disclosures for remaining performance obligations and disaggregation of revenue, may be particularly challenging. These disclosures may also bring additional transparency in the financial statements.Nevertheless, the following table summarizes, at a high level, the types of changes that many entities could expect when they adopt Ind AS115. This is not an exhaustive list.
Ind AS 115 requirements
Disclosure requirements – Ind AS 18
- by categories that depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors
- sufficient information to enable users of financial statements to understand relationship between the disclosures
of disaggregated revenue and revenue information that is disclosed for each reportable segment.
Revenue by segment and by significant category in accordance with Ind AS 108 Operating Segments
- Further disaggregation within segments
- Disaggregation by multiple categories
- The opening and closing balances of receivables, contract assets and contract liabilities from contracts with customers
- Revenue included in the contract liability balance at the beginning of the period
- Revenue from performance obligations satisfied (or partially satisfied) in previous periods
- Correlation between timing of satisfaction of its performance obligations to the typical timing of
payment and the effect that those factors have on the contract asset and contract liability balances
- Significant changes in the contract asset and the contract liability balances during the reporting period
Potential Management Discussion & Analysis (MD&A) discussion of significant work in progress and deferred revenue
- Additional quantitative requirements for contract balances
- More prescriptive requirements for narrative discussion
- Applies to all contract
- When the entity typically satisfies its performance obligations
- Significant payment terms
- Nature of goods and services promised to be transferred and any
performance obligations to arrange for another party to transfer goods or services (i.e. if the entity is acting as an agent);
- Obligations for returns, refunds etc.
- Types of warranties and related obligations
- Aggregate amount of the transaction price
allocated to the unsatisfied
- An explanation of when the entity expects to recognise this amount as revenue
Potential MD&A discussion of ‘backlog’
- Disclosures for all unsatisfied performance obligations at the
reporting date (when not applying the practical expedient)
- Detailed disclosures of performance obligations when the entity is acting as
either a principal or an agent
- Only includes amounts included in the transaction price
- methods used to recognise revenue
- significant judgements made in evaluating when a customer obtains control of promised goods or services
- inputs and assumptions used in determining the transaction price, estimating the variable
consideration, allocating the transaction price etc.
General requirements for disclo- sures of sources of estimation uncertainty in accordance with Ind AS 1.125
- New narrative and quantitative disclosures about
judgements used when determining timing and measurement of revenue recognition
Assets recognised from the costs to obtain or fulfil a contract:
- Judgements made in determining the amount of the costs incurred to obtain or fulfil a contract with a customer
- method used to determine the amortisation for each reporting period
- closing balances of assets recognised from the costs incurred to obtain or fulfil
- a contract with a customer, by main category of asset
- impairment losses recognised
No legacy requirements
- New narrative and quantitative disclosures about the balances and amortisation (including impairment losses) of contract costs assets
Adoption of the new standard does not comprise of only accounting compliance alone. It affects a wider gamut of things, including processes, controls, disclosures etc. We believe that even those entities that have not had significant changes in the measurement and timing of revenue recognition, will need to identify necessary changes to policies, procedures, internal controls and systems to ensure that revenue transactions areappropriately evaluated through the lens of the new model.
The key risks arising out of application of the new standard include the following:
- Completeness and accuracy of disclosures
In light of the expanded disclosure requirements and the potential need for new systems to capture the data needed for these disclosures, we believe that entities will need to ensure that they have the appropriate systems and checklists in place to collect and disclose the required information.
- Revision to accounting policies,key estimates and judgements:
Companies may need to review and revise their accounting policies and procedures, delegation of authority matrices, maker-checker policies etc.Detailed documentation of accounting conclusions arrived at, including the underlying key estimates and judgements is critical. Companies also need to ensure that Board of Directors and Audit committees have all the information they need to discharge their responsibilities. Modifications to the financial statement close process may also be required in order to accommodate the revised accounting requirements and increased reporting/disclosure requirements. Consistent roll-out and application of these revised policies and procedures throughout the organization is key. Companies may also consider identifying, developing and testing new data requirements, reconciliations and reports and how information technology systems and analytics could be used to facilitate the same.
- Robust internal control mechanism
Management may need to establish data governance, policies, and standards for identifying and resolving data gaps and implement processes to verify the quality of information needed for implementation of the new standard. Robust internal control mechanisms will ensure utmost quality, compliance and completeness of the financial statements, including quantitative and qualitative disclosures.
- Key tax issues
The Central Government in September 2016 had notified ICDS IV Revenue recognitionto specifically deal with recognition of revenue from sale of goods and rendering of services. However, there still exist significant differences in recognition and measurement principles between ICDS and Ind AS. These differences could significantly result in distinction between the company’s top line and profitability as per accounting standards and as per tax laws. It could also give rise to increase in deferred tax assets or liabilities. It is also pertinent to note that ICDS does not apply to the computation of ‘book profits’for the purpose of Minimum Alternate Tax (‘MAT’). Further, the tax auditor is required to certify that the computation of total incomeis made in accordance with ICDS. In order to facilitate tax audit, companies may consider preparing a reconciliation with profit and loss account and balance sheet to ensure that all adjustments required on account of ICDS have been considered. Alternatively, companies may need to maintain two separate books of accounts – one for accounting purposes and the other for tax purposes.
Amendment to government grants
The Ministry of Corporate Affairs (MCA) notified the Companies (Indian Accounting Standards) Second Amendment Rules, 2018 (the Rules) on 20 September 2018. The Rules amended Ind AS 20 – Accounting for Government Grants and Disclosure of Government Assistance, thereby aligning it with IAS 20. These amendments are applicable from 1 April 2018 onwards.
Prior to the Rules, Ind AS 20 required that government grant related to assets shall be presented by setting up the grant as deferred income. Further, it also stated that non- monetary grant shall be recognized at fair value. The Rules amend Ind AS 20 and provide the following alternatives to entities:
- A government grant in the form of a non- monetary asset may be accounted either at fair value or at a nominal amount. As per the pre-amended (or original) standard, such a grant was necessarily required to be initially recognized at fair value.
- Government grants related to assets, including non-monetary grants at fair value, shall be presented in the balance sheet either by setting up the grant as deferred income or by deducting the grant in arriving at the carrying amount of the asset. In consequence to this, in case of repayment of such grant, the same shall be recognized by increasing the carrying amount of the asset or reducing the deferred income balance by the amount repayable. The cumulative additional depreciation that would have been recognized in profit or loss to date in the absence of the grant shall be recognized immediately in profitor loss. In case of repayment of grant, the company shall also be required to consider the possible impairment of the new carrying amount of the asset.
Corresponding changes have also been made to Ind AS 16 – Property, Plant and Equipment as well as Ind AS 38 – Intangible
Assets to accommodate the above alternative accounting treatment.Ind AS 12 – Income Taxes has also been amended to state that deferred tax is not required to be recognized in respect of non- taxable government grant, where the grant is deducted from the carrying amount of the asset.
Based on the above amendment, the transition considerations shall be as follows:
- In case of a company, which is a first-time adopter of Ind AS from financial year 2018-19, this amendment may be applied retrospectively since the same accounting policies should be used in the opening Ind AS balance sheet and throughout all periods presented in the first Ind AS financial statements. The accounting policies shall comply with each Ind AS effective at the end of its first Ind AS reporting period. The company cannot apply different versions
of Ind ASs that were effective at earlier dates. Thus, the company needs to apply the amended Ind AS 20 for all periods presented in its financial statements for 2018-19, including its opening Ind AS balance sheet as at 1 April 2017.
- But in case of a company, which is already preparing Ind AS financial statements, government grants would have been accounted for at fair value in earlier reporting periods. In the financial year 2018-19, in the absence of transition provisions in Ind AS 20, such change may be applied retrospectively, provided it is permitted by Ind AS 8 and the company voluntarily decides to change its accounting policy from fair value to nominal amount. Ind AS 8 permits a change in an accounting policy only if it is required by an Ind AS or it results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity’s financial position, financial performance or cash flows.
Since most large companies are already preparing their financial statements as per Ind AS, management will need to assess whether a changed accounting policy results in a reliable and more relevant financial information. In order to ensure that such an assessmentis made judiciously (such that a voluntary change in an accounting policy does not effectively become a matter of free choice), companies making a voluntary change in an accounting policy need to disclose, inter alia, “the reasons why applying the new accounting policy provides reliable and more relevant information.
In case the accounting policy is applied retrospectively, the company shall adjust the opening balance of each affected component of equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied.This effectively means that the company may be required to present a third balance sheet (opening balance sheet) whenever a change in accounting policy has been applied retrospectively.
Accounting for increase in liability due to enhancement of gratuity ceiling
On 29 March 2018, the gratuity ceiling has been enhanced from INR10 lakhs to INR20 lakhs (vide notification no. S.O. 1420 (E) to The Payment of Gratuity (Amendment) Act, 2018. Since this leads to a significant increase in liability, companies sought guidance on the accounting for the increased liability due to increase in the gratuity ceiling and alsowhether a one-time exemption/relief would be available to companies.
The gratuity benefit is an employee benefit and accordingly, any increase in company’s liability due to enhancement of the gratuity ceiling from INR10 lakhs to INR20 lakhs would be accounted for as per the principles of AS 15, Employee Benefits or Ind AS 19, Employee Benefits, as the case may be. As per Ind AS 19/AS 15, past service cost is the change in the present value of the defined benefit obligation for employee service in prior periods, resulting from a plan amendment (the introduction or withdrawal of, or changes to, a defined benefit plan) or a curtailment (a significant reduction by the entity in the number of employees covered by a plan). Accordingly, the increase in liability arising due to enhancement of gratuity ceiling from INR10 lakhs to INR20 lakhs is a past service cost.
Past service cost needs to be charged off to the statement of profit and loss as per Ind AS 19/AS 15. One time exemptions/reliefs are not provided by the applicable standards.
This could result in a significant increase in charge to the Statement of Profit and Lossfor Companies covered by the Payment of Gratuity Act, 1972.
Presentation and disclosures
Format for publishing financial statements
The MCA, vide its notification dated 11 October 2018, amended Schedule III of Companies Act, 2013. The Bombay Stock Exchange and the National Stock Exchange have hosted an announcement on their website, dealing with amendments in Division I, Division II and Division III of Schedule III to the Companies Act, 2013 made by the Ministry of Corporate Affairs, vide this notification.
The MCA, vide this notification, has introduced Division III to Schedule III of Companies Act 2013, which provides guidelines for preparation of financial statements of a Non - Banking Financial Company (NBFC) that is required to comply with Ind AS.
Further, Division II of Schedule III (applicable to non-NBFC corporates required to comply with Ind AS) has also been amended to include new presentation and disclosure requirements in respect of trade payables (e.g., micro, small and medium enterprises), trade receivables and loans receivable.
Till date, although not mandatorily required by Schedule III, companies were presenting the split of trade payables into the following categories, in compliance with the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 in the notes to the Ind AS compliant financial statements:
- Outstanding dues of micro enterprises and small enterprises
- Outstanding dues of creditors other than micro enterprises and small enterprises
Schedule III now mandatorily requires companies to present such split of trade payables on the face of the Balance Sheet.
Trade receivables are currently segregated into three components – considered good (secured), considered good (unsecured) and doubtful. Companies now need to further segregate trade receivables into the following categories:
- Considered good – secured
- Considered good – unsecured
- Amounts which have a significant increase in credit risk
- Credit impaired amounts
Loans receivable will also need to be presented in a manner similar to trade receivables.
In accordance with the above announcement, the Securities and Exchange Board of India (SEBI) has clarified the following for applicability of formats for presentation of financial results:
- Listed entities are advised to follow the existing formats till the quarter ending 31 December 2018. However, entities, desiring to submit financial statements as per the new format prescribed by the MCA, may have the option to present results in the new format in addition to existing formats prescribed under the Companies Act, 2013.
- Entities will follow the amended formats, new Schedule III of Companies Act, 2013, for annual financial statement/quarter ending on or after 31 March 2019.
The requirement with respect to trade receivables creates a dichotomy. This is because, as per Ind AS 109 – Financial Instruments, trade receivables can be accounted for as per the lifetime expected credit loss model (simplified approach).
However, for the purpose of disclosures, companies need to continue to track the increase in credit risk and credit impaired amounts of trade receivables. This could be an onerous task for companies with a large trade receivables portfolio. The finance teams will need to work cohesively with the risk management team(s) to come up with such detailed disclosures. Companies will need to develop processes and guidelines to help the finance teams, treasury teams and the business teams to determine the amounts which have a significant increase in credit risk and credit impaired amounts. Periodic tracking mechanisms and trigger points will need to be determined and communicated throughout the organization. Data collation templates and disclosure checklists may need to be modified to incorporate these changes.
Key ITFGs issued
Accounting for benefits in the nature of exemption from payment of taxes and duties on import/export of goods as government grant
Issues addressed and conclusion
Certain companies may be exempted from payment of taxes and duties on import/export of goods upon fulfilment of certain condi- tions under a government scheme.
Government grants are assistance by government in the form of transfers of resources to an entity in return for past or future
The manner in which a grant is received does not affect the accounting method to be adopted in regard to the grant. Thus, a grant is accounted for in the same manner whether it is received in cash or as a reduction of a liability to the government. Thus, the benefit of exemption from payment of taxes and duties levied by the government is a government grant and should be accounted for as per the provisions of Ind AS 20.
The classification of the grant as related to an asset or to an income will require exercise of judgement and careful examination of the facts, objectives and conditions attached to the scheme. The purpose of the grant and the costs for which the grant is intended to compensate would also be required to be ascertained carefully.
There was a confusion on whether the exemption from payment of taxes and duties on import/export of goods was to be treated as a government grant or as a government assistance other than a government grant. However, this clarification has made it crystal clear that exemption from payment of taxes and duties on import/export of goods are a government grant.
Presentation of interest leviable due to delay in payment of the taxes in the statement of profit and loss
In case there is a delay in the payment of taxes, interest is generally levied on the outstanding dues. The question that arises is whether such an interest charge should be presented as a finance cost or as a part of other expenses. In this regard, Schedule III, Division II and Note 4 of the General Instructions for the Preparation of the Statement of Profit and Loss, states that the finance costs shall be classified as
The local taxes not paid by due date represent interest bearing liabilities. Companies would need to evaluate whether the interest payable for delay in payment of taxes is compensatory in nature for time value of money or penal in nature. This requires exercise of judgment based on evaluation of facts of the case. Based on such an evaluation, if it is concluded that interest is compensatory in nature then it shall be included in finance cost, and if it is penal in nature, then it shall be classified under “other expenses”.
Companies need to evaluate their tax provisions to ascertain that it does not include any interest cost of penal nature.This could impact the EBITDA since interest costs which are penal in nature would be classified as other expenses, thereby reducing EBITDA.
Classification of investments in units of money market mutual funds
Money market mutual funds are money-market instruments such as treasury bills, certificates of deposit and commercial paper that are traded in an active market or are puttable by the holder to the fund at net asset value (NAV) at any time.
Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and are subject to an insignificant risk of changes in value. Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent, it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. In case of money market mutual funds, management needs to assess whether they are held for meeting short-term cash commitments or not. Such an assessment can generally be inferred from such documentary sources as investment policy, investment manuals, minutes of relevant committee meetings, etc. and can be corroborated by the actual experience of buying and selling those investments. However, it is to be noted that such investments are to be held only as means of settling liabilities, and not as an investment or for any other purposes. Therefore, whether this condition is met or not requires an assessment of the particular facts and circumstances of a case.
Units of a money market mutual fund that are traded in an active market or that can be put back by the holder at any time to the fund at their net asset value may generally meet the condition of the investment being highly liquid.
As a general proposition, the third condition, that the investment must be convertible into a known amount of cash and the risk of change in the value of the investment should not be more than insignificant is usually not expected to be met by units of a money- market (or other) mutual fund, which can be put back by the holder to the fund at any time for redemption at net asset value (or can be sold in an active market). This is because even though the money market instruments have a relatively short life, their value keeps changing primarily due to changes in interest rates. Consequently, the amount of cash that will be received from redemption or sale of the units may not be known at the time of the initial investment and the value of such units may be subject to a more than insignificant risk of change during the period of their holding.
Accordingly, it requires careful assessment of each of the investments of the entity considering the definition given under Ind AS 7 as well as the purpose of holding the investments. Companies should satisfy themselves and should be able to demonstrate that the investment is subject to an insignificant risk of change in value for it to be classified as a cash equivalent.
Money market mutual funds generally may not meet the definition of cash equivalent due to changes in their value. However, assessment of whether money market mutual funds meets the definition of cash equivalents requires a careful assessment by management and exercise of judgements on a case to case basis. It is imperative that such assessments are carefully documented by management and validated by auditors.
Accounting treatment of the incentive receivable from the government
In India, government gives incentives in the form of taxation benefits, etc. to promote industry or for some other reasons, depending on the case. Although under such schemes, there may not be a one-to-one agreement between the entity and the government as to the rights and obligations, but there is an understanding between the government and the potential applicant/company that on complying the stipulated conditions attached to the scheme, the entity will be granted benefits of the scheme. If the entity has complied with the conditions attached to the scheme then it rightfully becomes entitled to the incentives attached to the scheme.
As per Ind AS 109, a financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. A contract need not necessarily be in writing. Accordingly, such incentive receivable will fall under the definition of financial instruments and will be accounted for as a financial asset as per Ind AS 109.
There has been a diversity in practice with respect to treatment of government grant receivables as financial assets. Companies that have not considered government grant receivables as financial assets, will now need to do so. Once classified as financial assets, all relevant provisions of Ind AS 109 will become applicable – including fair valuation on initial recognition, provision for expected credit loss and significant disclosures related to financial instruments. This could be a significant change in practice for some companies.
Accounting treatment of the financial guarantee given by a subsidiary company
When a financial guarantee is issued by a subsidiary to a bank for a loan availed by its parent company, without charging any fees or commission, the economic substance of the arrangement is that the subsidiary has effectively made a distribution to its parent.
Initial recognition in the separate financial statements of the subsidiary The financial guarantee obligation should be recognized at fair value with a corresponding debit to equity.
Subsequent measurement in the separate financial statements of the subsidiary
The financial guarantee should be subsequently measured at the higher of the expected credit loss determined in accordance with Ind AS 109 - Financial Instruments and the amount initially recognized (i.e., fair value) less any cumulative amount of income recognized in accordance with Ind AS 115 - Revenue from Contracts with Customers.
Accounting in the separate financial statements of the parent
The fair value of the guarantee shall be credited to profit or loss (unless the distribution clearly represents a recovery of a part of the cost of the investment measured at fair value through other comprehensive income) with a corresponding debit to the carrying amount of the loan. Such an adjustment to the loan would have the effect of adjusting the guarantee fees in the determination of effective interest rate on the loan. This treatment should be done irrespective of the fact whether the subsidiary has charged guarantee fees or not.
This clarification is bound to impact most companies since most companies were not accounting for such transactions. Going forward, parent company needs to account for the guarantee charge irrespective of whether the subsidiary company is charging the parent company or not. ICAI needs to clarify whether this principle will apply to all other kind of transactions between parent and subsidiary companies where there is no crosscharge.
Accounting treatment of the financial guarantee given by a parent in case of repayment of the loan by the subsidiary before the tenure
In case a parent guarantees a loan taken by its subsidiary, the parent shall recognize the “financial guarantee obligation” in its separate financial statement with the corresponding impact in the “investment in subsidiary” on initial recognition, after considering the terms of the guarantee. With regard to subsequent measurement, financial guarantee contract is subsequently measured at the higher of: (i) the amount of the loss allowance and (ii) the amount initially recognized less, when appropriate, the cumulative amount of income recognized in accordance with the principles of Ind AS 115. In case, the subsidiary repays the loan using the early repayment option, it shall be construed as a change in an accounting estimate and shall be recognized prospectively. An accounting estimate that gives rise to changes in assets, liabilities and equity, shall be adjusted in the carrying amount of the related asset, liability or equity item in the period of the change. After early repayment of the loan by the subsidiary, since no obligation exists for parent in respect of the financial guarantee provided by the parent, the parent may reverse the amount of obligation with corresponding recognition of revenue.
It is a common practice for companies to provide guarantee on behalf of group companies.
Inclusion of Dividend Distribution Tax (DDT) on preference shares in calculating effective interest rate (EIR)
If redeemable preference shares, issued at a fixed price and redeemable after a fixed tenure from the date of issue, are concluded to be a financial liability in entirety, the dividend paid on such preference shares is in the nature of interest and shall be accounted for as an expense in the statement of profit and loss.
As per the Guidance Note on Division II - Ind AS Schedule III to the Companies Act, 2013 issued by the Institute of Chartered Accountants of India, dividend on preferences shares, whether redeemable or convertible, is of the nature of “interest expense”, only where there is no discretion of the issuer over the payment of such dividends.
Accordingly, the corresponding Dividend Distribution Tax on such portion of non-discretionary dividends should also be presented in the Statement of Profit and Loss under “interest expense”. Since the preference shares are considered to be a financial liability and the dividend thereon is accounted as an interest expense in the statement of profit and loss, the related dividend distribution tax should be regarded as part of interest cost and should therefore form a part of EIR calculation.
DDT is commonly accounted for as a part of current tax expense. Going forward, DDT on redeemable preference shares should be accounted for as interest cost.
New EAC opinions, clarifications and other pronouncements
Disclosure of impairment loss on longterm investments as an exceptional item
If investment in joint ventures or associates have been accounted for in accordance with Ind AS 27 – Separate Financial Statements, they are scoped out of Ind AS 109 – Financial Instruments. For such investments, the provisions of Ind AS 36 – Impairment of Assets shall apply. However, Ind AS 36 merely requires, inter alia, disclosure of the line item(s) of the statement of profit and loss in which the impairment losses are included. There was no clarity on how the impairment loss needs to be presented as a part of the statement of profit and loss, specifically whether it can be shown as an exceptional item.
The term “exceptional item” has not been defined in Ind ASs. However, Ind AS 1, “Presentation of Financial Statements”, requires that when items of income or expense are material, an entity shall disclose their nature and amount separately, either in the statement of profit and loss or in the “Notes to Accounts”. Also, Part II of Division II of Schedule III to the Companies Act, 2013 (Ind AS Schedule III), which prescribes the format of statement of profit and loss, applicable for companies adopting Ind ASs, requires presentation of “exceptional items” as a separate line item in the statement of profit and loss.
Further, the educational material states that as per Ind AS 1, materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor.
Reference could also be drawn from Accounting Standard (AS) 5, Net profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies, when items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and the amount of such items should be disclosed separately. Based on this, generally, items of income or expense fulfilling the above mentioned criteria are classified as exceptional items and are disclosed separately. Thus, exceptional items are those items which meet the test of materiality (size and nature) and the test of incidence.
In this context, the EAC opined that impairment loss on longterm investments may be presented as an exceptional item on the face of the statement of profit and loss, if it meets the test of materiality and incidence. However, management needs to quantify the impairment loss correctly and also provide
all the disclosures required by Ind AS 36 –
Impairment of Assets.
Determination of materiality and incidence shall require an exercise of significant management judgement for all relevant items of income and expense. If managementconcludes that an item is material and non- recurring, the item may be disclosed as an exceptional item.
Provision for unencashable portion of Half-pay leave (HPL) as per AS 15/ Ind AS 19
Companies may provide Half-pay leaves to their executive and/or non-executive employees and the same may have different features such as accumulating/non- accumulating, encashable/non-encashable, etc. Irrespective of whether the half-pay leaves are encashable or non-encashable, from an accounting angle, their nature is similar since non-encashable leaves also provide a right to the employee to receive salary and wages for the period for which an employee avails leave as during that period, the employee does not render any services to the employer.
The EAC opined that accumulating Half-pay leave creates an obligation on the enterprise because any unused entitlement increases the employee’s entitlement to avail leave in future. Thus, a provision should be recognized for all these benefits and recorded as part of the cost of service rendered during the period in which the service was rendered which resulted the entitlement. The provision should be created in accordance with AS 15/Ind AS 19 Employee Benefits and should be reviewed at each reporting date to recognize the effects of changes in estimates in this regard.
Additional information may need to be collated by the management and provided to the actuary for actuarial valuation of the employee benefits, depending upon the inherent features of the plan.
Provisioning for expected credit loss (ECL) on the amount due in the course of business from Government organizations
Ind AS requires companies to provide impairment on contractual rights to receive cash or any other financial asset. Ind AS also allows usage of the provision matrix for computation of expected credit loss on trade receivables. However, in case of trade receivables from the government authorities, it generally takes long to liquidate the debts of such entities, although the collectability is generally certain. Thus, companies believed that the accounting standards should provide an exemption from making provision for
expected credit loss on dues from government authorities.
The EAC opined that although it takes long to liquidate the debts where the clients/ customers are central government/state government/autonomous bodies/Public Sector Undertakings, there is no exemption from making a provision for the expected credit loss
Several companies, who had large contracts with government entities, were following divergent practices with respect to provisioning for expected credit loss (ECL) on trade receivables from government entities.
This EAC opinion will require companies, who were not creating an ECL, to start doing so, thereby impacting the statement of profit and loss.
Treatment of prepayment penalty incurred for foreclosure of existing loan and availing new loan/borrowing
It is a general practice for companies to prepay an existing loan and avail a new loan, which they may be getting at a lower rate of interest or at terms that are more beneficial to their business. In such cases, the question that arose was that should the prepayment penalty be accounted for similar to transaction cost for acquisition of the new loan or should it be recognized as a gain or loss in the statement of profit and loss, on extinguishment or derecognition of the old loan.
Ind AS 109 defines transaction costs as “incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or financial liability. An incremental cost is the one that would not have been incurred if the entity had not acquired, issued or disposed of the financial instrument”. Further, at the time of initial recognition, financial liability shall include only the transaction costs that are directly attributable to the acquisition or issue of the new financial liability and not the transaction cost of disposal of the existing financial liability. Prepayment penalty is the transaction cost of disposal of the existing financial liability (loan), which is payable to the existing loan provider rather than the incremental cost of acquisition or issue of the new financial liability (new loan) from a different new bank. Such a penalty is incurred to extinguish the existing liability and to get the benefits due to lower cost liability (loan) and not for acquiring the new financial liability (loan).
Therefore, such penalty cannot be treated as directly attributable to the acquisition of the new financial liability. Accordingly, the prepayment penalty cannot be considered as transaction cost of the new loan; rather should be treated as transaction cost of extinguishment of existing loan, which in accordance with Ind AS 109 should be recognized as part of the gain or loss on extinguishment/derecognition of the old loan in the statement of profit and loss.
Companies who were considering prepayment penalties as a part of transaction cost, may now need to charge it off in the statement of profit and loss.
Recent regulatory updates
Amended regulations pertaining to Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements)
The Securities and Exchange Board of India (SEBI), on 9 May 2018, released the SEBI (Listing Obligations and Disclosure Requirements) (Amendment) Regulations,2018 (SEBI (LODR (Amendment) Regulations, 2018 or Corporate Governance Amendments or the amendments), in order to adopt and give effect to several recommendationsthat the SEBI Committee on Corporate Governance, formed on 2 June 2017, under the Chairmanship of Mr. Uday Kotak (Kotak Committee) proposed in a report submitted on 5 October 2017. The SEBI also issued a circular on 10 May 2018 for implementation of certain recommendations of the Kotak Committee.
SEBI aims to put into effect these Corporate Governance Amendments in a phased timeline from 1 October 2018 to 1 April 2020, so that the companies are able to adjust to new governance requirements as well as overcome any implementation challenges. The following are the key amendments to the SEBI LODR Regulations, which the listed entities need to consider while preparing financial statement for the year ended 31 March 2019.
Eligibility criteria for independent directors
The amendments extend the definition of an “independent director” to exclude even those persons who are members of the “promoter group” of a listed entity.
The amendments are also made to the definition in order to exclude the possibilities of “board inter-locks”, i.e., the definition would now exclude persons who are non-independent directors of another company on the board of which any non-independent director of the listed entity is an independent director.
Companies need to comply with the amended definition of independent directors with effect from 1 October 2018.
Example of a “board inter-lock” situation
If Mr. A is an executive director on company A (being a listed company) and is also an independent director on the board of company B, then no non-independent director of company B can be an independent director on the board of company A.
Further, in the Corporate Governance Report, the board is required to state their confirmation that independent directors fulfil the conditions specified in the SEBI (LODR) Regulations and are independent of the management.
This amendment shall take effect from 31 March 2019.
Directors and Officers Insurance for independent directors
The amendments introduce a new requirement for top 500 listed entities to undertake Directors and Officers (D and O) Insurancefor all their independent directors of such quantum and for such risks as may be determined by its board of directors.
Market capitalization would be calculated as on 31 March of the preceding financial year for determining top 500 listed entities. Companies need to comply with the D and O Insurance requirement with effect from 1 October 2018.
No alternate directors for independent directors
The amendments prohibit an alternate director from being appointed or continue to hold office as an independent director of a listed entity. This shall take effect from 1 October 2018.
Disclosures on resignation of independent directors
The amendments introduce a new requirement for the listed entities to disclose, as a part of the Corporate Governance Report (w.e.f. 31 March 2019) and also to the stock exchanges (w.e.f. 1 April 2019), the detailed reasonsfor resignation of the independent directors before the expiry of their tenure along witha confirmation given by such director(s) that there are no other material reasons other than those provided. This amendment shall take effect from the year ending 31 March 2019.
The revised eligibility criteria of independent directors is applicable from 1 October 2018, therefore the listed entities need to ensure the composition of independent directors
is complied with revised eligibility criteria. Moreover, the reason for resignation for independent directors needs to be disclosed in the Corporate Governance Report for the year ended 31 March 2019. Additionally, with effect from 1 April 2019, companies will need to intimate the stock exchanges. Accordingly, secretarial team should ensure that appropriate disclosure is made to the stock exchanges and also in Corporate Governance Report.
Enhanced monitoring of group entities
Currently, the Companies Act requires a secretarial audit for every listed entity and unlisted companies above a certain threshold.However, there is no specific provision for secretarial audit under SEBI LODR Regulations.
The amendments extend the requirement of a secretarial audit to material unlisted Indian subsidiaries of listed entity along with the requirement to annex with its annual report, a secretarial audit report given by a practicing company secretary. The amendment shall be in effect from the year ending 31 March 2019. SEBI is required to prescribe the form of the secretarial audit report. Currently, the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014, prescribes the format of the secretarial audit report. Clarification is awaited from SEBI whether the listed entities can use the said format till the time it prescribes the form of the audit report.
Definition of “material subsidiary”
The amendments widen the ambit of material subsidiary to mean a subsidiary whose income or net worth exceeds 10% (from the current 20%) of the consolidated income or networth, respectively, of the listed entity and its subsidiaries in the immediately preceding accounting year.
The revised definition shall take effect from 1 April 2019. Therefore, it is important to note that for the purpose of conducting a secretarial audit of material unlisted Indian subsidiary for the year ending 31 March 2019, the threshold of 20% needs to be considered and in subsequent years, 10% threshold needs to be considered.
Corporate governance requirements with respect to subsidiary of listed entity
Currently, the SEBI (LODR) Regulations state that the management of the unlisted subsidiary is required to periodically bring to the notice of the board of directors of the listed entity, a statement of all significant transactions and arrangements entered into by the unlisted subsidiary. However, under the explanation for the term “significant transaction or arrangement”, the term “unlisted material subsidiary” has been used.
The Kotak Committee is of the opinion that significant transactions which could be higher than the prescribed limits of even those companies which are not material subsidiaries should come under the purview of the board of the listed entity. Therefore, the amendment dropped the word “material” from the explanation to Regulation 24(4) of SEBI LODR Regulations. This amendment shall take effect from 1 April 2019.
- The listed entities will have to identify and engage practicing company secretary for conducting secretarial audit of its material unlisted Indian subsidiary. Moreover, since secretarial audit report is required to be annexed to the annual report, the entities will need to finalize the secretarial audit
before completion of annual report.
- The management of unlisted subsidiaries that are not material shall also update the board of the listed entity about all the significant transactions and arrangements.
Related party transactions
Disclosure of related party transactions (RPTs)
Amendment to disclosures
The amendments have introduced, as a part of the “related party disclosure” in the annual report, disclosures of transactions of the listed entity with any person or entity belonging to the promoter or promoter group which hold(s) 10% or more shareholding in the listed entity. This disclosure should be in the format prescribed in the relevant accounting standards for annual results. All listed entities will need to comply with this amendment in the annual reports filed for the year ending 31 March 2019 and thereafter. It is to be noted that the transactions with such related parties need to be given separately in annual report and not as a part of financial statements.
Further, the amendments introduce a new requirement for a listed entity to submit disclosures of related party transactions on a consolidated basis as per the format specified in the relevant accounting standards for annual results to stock exchanges and to publish the same on its website. This requirement needs to be complied within 30 days from the date of publication of the standalone and consolidated financial results for the half-year by the listed entity. All listed entities will need to comply with this amendment from the half-year ending 31 March 2019.
Definition of “related party”
Further the definition of “related party” has been modified w.e.f. 1 April 2019, to include any person or entity belonging to the promoter or promoter group of the listed entity and holding 20% or more shareholding in the listed entity. This follows on from Kotak Committee’s observations that certain promoters/promoter group entities were not getting categorized as related parties under the SEBI (LODR) Regulations, as they did not strictly fall under the definition of “related parties” under the relevant accounting standards.
Therefore, post 1 April 2019, the listed entities shall give disclosure of transactions with related party, including but not limited to transactions with any person or entity belonging to the promoter or promoter group of the listed entity and holding 20% or more shareholding in the listed entity.
It is to be noted that disclosure to be made to stock exchange shall not include transactions with any person or entity belonging to the promoter or promoter group which hold(s) 10% or more shareholding in the listed entity
Royalty and brand payments to related parties
Many companies make payments towards royalty/brand usage as part of recognizing value in brand strength and product technology. For shareholders to be able to comprehend the terms and conditions of such payouts, the amendments intend that all companies make better disclosures on the value companies derive from a brand ortechnology, for which they have agreed to pay royalty, brand, or technical fees to the parent company/promoters.
The amendment specifies a threshold of 2% of the annual consolidated turnover of the listed entity as per its last audited financial statements for transactions involving payment made to a related party with respect to brand usage or royalty, either transacted individually or taken together with previous transactions during a financial year.
Currently, the SEBI (LODR) Regulations require listed entities to formulate a policy on materiality of related party transactions and on dealing with related party transactions.The amendments intend that companies also disclose, as a part of their materiality policy, clear threshold limits duly approved by the board of directors. Such materiality policy is required to be reviewed and updated by the board of directors at least once every three years.
Though amendments with respect to royalty, brand payments to related parties and materiality policy are applicable w.e.f. 1 April 2019, such material transactions with related parties shall require prior approval of audit committee before 1 April 2019.
- As per the revised definition, the listed entities are required to evaluate if any person belonging to promoter or promoter group holds 20% or more of the equity or preference share capital of the company. Though the revised definition is applicable from 1 April 2019, any transaction with such identified related parties shall require a prior approval of audit committee before 1 April 2019.
- Further the listed entities are also required to disclose the transactions with any person or entity belonging to the promoter or a promoter group which holds 10% or more shareholding in the listed entity. The definition of related parties given under relevant accounting standard does not include the above parties. Therefore, the listed entities would require to manually identify the transactions with such related parties. Further considering the volume of transactions, the listed entities may evaluate to update their systems and processes to capture such related party transactions.
- Considering the inconsistency of shareholding limit, given in definition of the related parties viz., 20% and disclosure of related party transactions viz., 10% or more, companies may consider keeping the same threshold to identify related party transactions to eliminate practical challenges in having separate thresholds for approvals (mandatorily required for 20% and above) and disclosures (required for 10% and above).
- SEBI has also made amendment with respect to disclosure of royalty and brand payments to related parties and board approved thresholds for material related party transaction. These amendments shall take effect from 1 April 2019. Accordingly, the listed entities will have to update their systems, process not just to capture the related party disclosures that are applicable for the year ended 31 March 2019, but also for the amendments applicable from 1 April 2019.
Disclosures and transparency
Submission of annual reports
Timeline for submission of annual report to stock exchange and publishing on website
The SEBI (LODR) Regulations require submission of annual report to the stock exchange within 21 working days of it being approved and adopted in the Annual General Meeting (AGM) as per the provisions of the Companies Act. The SEBI (LODR) Regulations also require sending the annual report to shareholders in not less than 21 days before the AGM.
The amendments, aiming to reduce the above time-gap between disclosures to the shareholders and submission to stock exchange, require the listed entity to submit to the stock exchange and publish on its website:
- A copy of the annual report sent to the shareholders along with the notice of the AGM not later than the day it is dispatched to the shareholders;
- In an event of any changes to the annual report, the revised copy along with details of and explanation for the changes is required to be sent not later than 48 hours after the AGM.
Submission of annual report in electronic mode
Currently, the SEBI (LODR) Regulations requires sending soft copies of full annual reports to all those shareholders who have registered their email addresses with the listed entity. While it requires sending hard copies of statements containing the salient features of all the documents, as per Section 136 of the Companies Act read with the Companies (Accounts) Rules, 2014, to those shareholders whose email addresses are not registered. Further, it also requires sending hard copies of full annual reports to those shareholders who request for the same.
The amendments now clarify that the listed entity needs to send soft copies of full annual report to all those shareholders who have registered their email addresses, either with the listed entity or with any depository.
Both of the above requirements with respect to the “submission of annual reports” are applicable in respect of the annual reports filed for the year ending 31 March 2019 and thereafter.
Disclosure of expertise/skills of directors
The Companies Act and the SEBI (LODR) Regulations require the disclosure of a brief profile of a director on his/her appointment, including expertise in specific functional areas, without providing any matrix of skills/ expertise/competence of the board on a regular basis. The amendments now require disclosing the following, in a phased manner:
- List of core skills/expertise/competencies identified by the board as required in the context of its business(es) and sector(s) for an efficient functioning. It also requires disclosure of those skills/expertise/ competencies that its board members actually possess, without disclosing the names of the directors. This is to be made effective from the financial year ending 31 March 2019.
- Skills/expertise/competencies of each and every member of the board along with their names is required from the financial year ending 31 March 2020.
Disclosures on audit and non-audit services rendered by the auditor
Currently Schedule III requires disclosure of payments made to the firm of auditors on account of audit fees, taxation matters, company law matters, other services and reimbursement of expenses. There is no requirement in either the Companies Act or the SEBI (LODR) Regulations on disclosure of fees for all services paid by the listed entity and its subsidiaries to all entities in the network firm/network entity of which the auditor is a part of.
In the interest of improving transparency, the amendments introduce a new requirement
to disclose total fees for all services paid by the listed entity and its subsidiaries, on a consolidated basis, to the statutory auditor and all entities in the network firm/network entity of which the statutory auditor is a part.
All listed entities will need to comply with this amendment by disclosing in the “Corporate Governance Report” section of the annual reports filed for the year ending 31 March 2019 and thereafter.
Disclosures pertaining to credit rating
Currently, there is no specific provision in the Companies Act regarding the disclosure of credit ratings however, the SEBI (LODR) Regulations require disclosure of revision in credit rating for different instruments from time to time to the stock exchanges, as and when changes happen.
The amendments require listed entity to disclose, under a separate section on its website, all credit ratings obtained for all outstanding instruments which shall be updated immediately as and when there is any revision in the ratings. Further, as a part of the Corporate Governance Report, a list of all credit ratings obtained by the listed entity for all debt instruments or for any fixed deposit program, or any scheme or proposal involving mobilization of funds, needs to be disclosed along with any revisions thereto during the relevant financial year.
All listed entities need to comply with this amendment with effect from 1 October 2018.
Searchable formats of disclosures
The amendments introduce the requirement for the listed entity to make disclosures pertaining to:
- to stock exchanges, in eXtensible Business Reporting Language (XBRL) format, in accordance with the guidelines specified by the stock exchanges from time to time;
- to stock exchanges and on the entity’s website in a format that allows users to find relevant information easily through a searching tool.
The above requirement shall not apply to any statutory requirement to make disclosures in formats which may not be searchable, such as copies of scanned documents.
All listed entities will need to comply with this amendment from the date of notification of these amendments, i.e., 9 May 2018.
Currently, there is no specific provision for the same in the Companies Act and SEBI (LODR) Regulations.
Disclosures of key changes in financial indicators
The amendments introduce a requirement for all the listed entities to disclose in the MD&A section of the annual report:
- Details of significant changes (i.e., change of 25% or more as compared to the immediately previous financial year) in the key financial ratios, along with detailed explanations thereof, including:
- Debtors turnover
- Inventory turnover
- Interest coverage ratio
- Current ratio
- Debt equity ratio
- Operating profit margin (%)
- Net profit margin (%), or
- Sector-specific equivalent ratios, as applicable
- Details of any change in return on net worth as compared to the immediately previous financial year along with a detailed explanation thereof.
All listed entities will need to comply with this amendment in the annual reports filed for the year ending 31 March 2019 and thereafter. Currently, there is no specific provision in the Companies Act and the SEBI (LODR) Regulations for the same.
Utilization of proceeds of preferential issue and Qualified Institutional Placement (QIP)
Currently, SEBI (ICDR) Regulations, 2009 require periodic disclosure on the utilization of issue proceeds in case of public issues. However, these disclosures are not required for funds raised by the way of preferential allotments and QIPs.
The amendments introduce a requirement to disclose details of utilization of funds raised through preferential allotment or QIP as specified under Regulation 32(7A) as a part of the Corporate Governance Report.
All listed entities will need to comply with this amendment in the annual reports filed for the year ending 31 March 2019 and thereafter.
Disclosure pertaining to directors
Currently, the SEBI (LODR) Regulations require disclosure of a number of other boards or committees, in which a director is a member or a chairperson. The amendments introduce an additional requirement to disclose separately the names of the listed entities, where the person is a director and the category is of directorship.
All listed entities will need to comply with this amendment in the annual reports filed for the year ending 31 March 2019 and thereafter.
Disclosures pertaining to disqualification of directors
The amendments introduce a requirement to disclose a certificate from a company secretary in practice that none of the directors on the board of the company have been debarred or disqualified from being appointed or continuing as the directors of companies by the board/MCA or any such statutory authority. Currently, there is no specific provision in the Companies Act and the SEBI (LODR) Regulations for the same.
All listed entities will need to comply with this amendment in the annual report filed for the year ending 31 March 2019 and thereafter.
Prior intimation of board meeting to discuss bonus issue
Currently, the SEBI (LODR) Regulations 29(f) requires prior intimation to the stock exchange about the meeting of the board in which a proposal for declaration of bonus shares is going to be discussed. However, proviso to Regulation 29(f) states that where the declaration of bonus by the listed entity is not on the agenda of the meeting of board, prior intimation is not required to be given to the stock exchanges.
The announcement of issue of bonus shares generally has a market price impact and therefore, its disclosure becomes critical. Accordingly, the amendments require the proviso to Regulation 29(f) of SEBI (LODR) Regulations, to be deleted with effect from 1 October 2018.
Views of committees not accepted by the board of directors
The amendments extend the requirement to disclose, along with the reasons thereof, where the board has not accepted any recommendation of any committee of the board which is mandatorily required, in the relevant financial year. However, such disclosure requirement shall only apply where recommendation of/submission by the committee is required for the approval of the board and shall not apply where prior approval of the relevant committee is required for undertaking any transaction under SEBI (LODR) Regulations.
Currently, except for Section 177(8) of the Companies Act (in relation to audit committee), there is no provision for a disclosure to the shareholders, if recommendations of the relevant committee are not accepted by the board.
All listed entities will need to comply with this amendment in the annual reports filed for the year ending 31 March 2019 and thereafter.
Disclosure of board evaluation
[SEBI Circular: SEBI/HO/CFD/CMD/CIR/P/2018/79, dated 10 May 2018]
The Companies Act and the SEBI (LODR) Regulations contain broad provisions on board evaluation, i.e., evaluation of the performance of: (i) the board as a whole, (ii) individual directors (including Independent Directors and chairperson) and (iii) various committees of the board. The provisions also specify responsibilities of various persons/committees for the conduct of such an evaluation and the disclosure requirements that are a part of the listed entity’s corporate governance obligations.
In order to strengthen disclosures on board evaluation, SEBI, in its circular, has specified that every listed entity may consider the following as a part of its disclosures on board evaluation:
- Observations of board evaluation carried out for the year
- Previous year’s observations and actions taken
- Proposed actions based on current year observations
Disclosures on long-term and medium-term strategy
[SEBI Circular: SEBI/HO/CFD/CMD/CIR/P/2018/79, dated 10 May 2018]
The circular recommends listed entities to disclose their medium and long-term strategy in the annual reports under the Management Discussion and Analysis (MD&A) section. In addition, entities should articulate a clear set of long-term metrics specific to the company’slong-term strategy to allow taking appropriate measurement of progress. However, each entity may define its own time frame with respect to medium and long-term since it would vary across entities/sectors.
- It is to be observed that the management of the listed companies will have to effectively plan and prepare to implement all the activities so that they are compliant as on the effective dates of the different provisions of the new SEBI (LODR) Regulations. The entities will have to gear up their systems and processes for annual report preparation as the amendment requires additional disclosures as well, along with the reduced timelines for submission of annual report.
- Generally, the disclosures of key financial indicators and changes in them are made in the investor presentations/earnings call. However, this requirement to disclose in MD&A strengthens the focus around a mix of qualitative and quantitative analysis with respect to the company’s business and financial performance. Going forward, the entities will need to benchmark with the ratios disclosed by the peer entities and ensure that they are consistent. This will result into an informed decision-making by investors and would also put an onus on the management to appropriately explain any variance in the disclosed financial indicators.
- Ind AS 109 Financial Instruments requires fair valuation of financial assets and financial liabilities. Increase or decrease in credit ratings will have an impact on fair valuation of financial asset and liabilities. Accordingly, credit rating disclosure for all outstanding instruments of the issuer will help enhance transparency in credit risk across issuers, instruments and sectors.
- Further, if the company intends to give the disclosure of its long-term and medium- term strategy, it may need to appropriately document these strategies and get them approved from its board of directors. Further companies will also have to align the disclosure made in MD&A section with the investor presentation.
- The listed entities will have to update the Corporate Governance report checklist in order to incorporate additional disclosures such as names of other listed entities in which person is director and category of directorship, chart or matrix of skills, expertise of board of directors, utilization of funds raised through preferential allotment or QIP, etc.
- It is expected that in the long term, these amendments will improve transparency and cultivate the spirit of governance amongst the management of the listed companies.
Enhanced monitoring of group entities
Group Governance Unit/Committee and Policy
[SEBI Circular: SEBI/HO/CFD/CMD/CIR/P/2018/79, dated 10 May 2018]
There are currently no provisions under the Companies Act or the SEBI (LODR) Regulations with respect to group governance unit/ governance committee or a group governance policy.
In order to improve monitoring of group entities, the SEBI’s circular recommends where a listed entity has a large number of unlisted subsidiaries:
- The listed entity may monitor their governance through a dedicated group governance unit or a governance committee comprising of the members of the board of the listed entity
- A strong and effective group governance policy may be established by the entity
- However, the decision of setting up of such a unit/committee and having such a group governance policy may be left to the board of the listed entity
Further, it is to be noted that SEBI circular has not amended the SEBI (LODR) Regulation in the above respect.
Companies with a large number of subsidiaries may need to put in place a strong monitoring mechanism so that directors of the holding company are aware of all the significant transactions on a timely basis. In addition, companies may also need to have an effective governance program in place even for its subsidiaries, such that it aligns with the governance program at the listed parent entity’s board, which results in same values, ethics, controls and processes that are being reflected across the group.
Governance practices for all unlisted subsidiaries, whether in India or overseas, may need to be such that it recognizes the differences in legal environment, tax regimes and local business cultures. With an increase in complexity of transactions, increased risks and responsibilities of directors, having all significant transactions and arrangements of all unlisted subsidiaries under the purview of the listed parent entity’s board creates a strong group governance framework that can prevent costly financial and reputational damage.
Timeline for annual general meetings of listed entities
The amendments introduce a requirement that reduces the timeline for holding AGM within a period of five months from the date of closing of the financial year. This requirement is applicable to top 100 listed entities by market capitalization, determined as on 31 March of every financial year.
The amendments seek to align the timeline for holding AGM with the global practices and to avoid bunching of AGMs (especially in August/September), which results in lower shareholders’ participation.
Currently, the Companies Act requires listed entities in India to hold AGM within six months from the end of the financial year.There is no specific provision in the SEBI (LODR) Regulations on this.
Webcast of proceedings of the meeting
The amendments introduce a requirement that the top 100 listed entities shall provide a one-way live webcast of the proceedings of the AGM. The top 100 listed entities shall be determined on the basis of market capitalization, as at the end of the immediate previous financial year.
Currently, the Companies Act and the SEBI (LODR) Regulations do not mandate webcast of the meeting proceedings.
The management of the listed companies will have to effectively plan and prepare for arranging AGM within five months from the end of financial year and a one-way live webcast. Accordingly, the management will have to expedite the process of closure of books, completion of audit, approval of financials by board, etc. in order to comply with above requirements.
By making a meeting accessible via a webcast will substantially increase its exposure and reach.
The internet platform overcomes constraints of physical presence and webcast allows large number of shareholders to remotely participate at the same time. This results in efficient decision-making for approval of audited accounts, election of directors, appointment of auditors and various other initiatives, thereby facilitating accomplishment of business goals and strategic objectives.
Amendments to matters to be included in the Board’s report (Companies (Accounts) Rules, 2014)
The MCA, vide its notification dated 31 July 2018, has brought the Companies (Accounts) Amendment Rules, 2018. The following additional disclosures are required to be made in the board report of every company (except small company or One Person Company):
- Whether maintenance of cost records specified by the central government is required by the company and whether such accounts are maintained; and
- A statement that company has complied with provisions relating to the constitution of “internal complaints committee” under Sexual Harassment of Women at Workplace (Prevention, Prohibition and Redressal) Act, 2013.
- A new sub-rule has been added specifying the matters to be included in the board’s report of One Person Company and small company.
The listed entities will be required to give above additional disclosures in board report.
Notification of the Companies (Registered Valuers and Valuation) Fourth Amendment Rules, 2018
The Ministry of Corporate Affairs (MCA), on 13 November 2018, has made amendments to the Companies (Registered Valuersand Valuation) Rules, 2017 vide Fourth Amendment Rules.
It is clarified that these rules would apply for valuation in respect of any property, stocks, shares, debentures, securities or goodwill or any other assets or net worth of a company or its liabilities under the provision of the act or these rules. Further, amendments have been made as regard to the eligibility, qualifications and experience requirements for registration as a valuer.
As per section 247 of the Companies Act, only registered valuers can carry out valuation under the Companies Act. The listed entities, while appointing registered valuer for the purpose of conducting valuation for applicable assets or liabilities, shall take into account the revised eligibility criteria.
The Companies (Amendment) Ordinance, 2018
The Companies (Amendment) Ordinance, 2018 received the President of India’s assent on 2 November 2018 bringing into force further amendments to certain provisions of the Companies Act, 2013 (Act).
The key corporate governance-related reforms include the following:
- Significant beneficial ownership disclosure: [Section 90]
The Companies (Amendment) Act, 2017 requires significant beneficial owners to make a declaration to the company specifying the nature of his interest. Considering the importance of the disclosure, the punishment for non-compliance is enhanced to the effect that the contravention is punishable with a fine or an imprisonment (up to one year) or both, instead of being punishable with only a fine.
- Disqualification of Director [Section 164]
If a director does not comply with the provisions of Section 165 relating to maximum number of directorships, a person may hold (i.e., maximum 10 public companies and maximum 20 in other companies), he/she shall be disqualified under section 164 of the act.
Enhancing the penalty for contravention will result in stringent and strict consequences for violation. Further, the amendment shall also curtail the abuse of provision with respect to the number of directorships held by a director in different corporates.
National Financial Reporting Authority Rules, 2018
The MCA has notified the National Financial Reporting Authority (NFRA) Rules, on 13 November
2018. The rules cover the following key aspects:
- Classes of companies and bodies corporately governed by the authority –
- All listed companies/listed body corporates, whether listed in a stock exchange in India or outside India
- Unlisted companies with prescribed limits
- All banks/insurance/electricity companies
- Any corporate/company or a person or any class of bodies corporates or companies or persons, on a reference made to the authority by the central government in public interest;
- Foreign subsidiary or associate company of any Indian company mentioned above with prescribed income/net worth
- Functions and duties of the authority
- Monitoring and enforcing compliance with accounting and auditing standards
- Overseeing the quality of services and suggesting measures for improvement
- Undertaking investigation of auditors
- Recommending accounting standards and auditing standards
- NFRA Rules requires filing of an annual return by the auditor with the authority on or before 30 April every year.
- The rules also provide for disciplinary proceedings, manner of enforcement of orders passed in disciplinary proceedings and punishment in case of non-compliance.
The introduction of NFRA will build a transparent mechanism for accounting, auditing and financial reporting. NFRA will not be just an advisory body but it has been empowered to regulate accounting standards and auditing policies along with the powers to investigate certain matters related to professional misconduct by chartered accountants in corporate bodies. It has a huge role to play in the field of financial reporting for effective corporate governance.
Disclosure of reasons for delay in submission of financial results by listed entities (Applicable from 19 November 2018)
- Listed companies are required to disclose detailed reasons for delay in submission of financial results to the stock exchanges within one working day of the stipulated deadline.
- In case a company decides to delay announcement of results prior to the due date, reasons have to be disclosed within one working day of taking such a decision (applicable from 19 November 2018).
The listed entities will be required to give the above additional disclosures if there is delay in
submission of financial results.
Supreme Court of India’s ruling on coverage of allowances under basic wages for calculation of provident fund calculations
The Supreme Court of India, in its ruling pronounced on 28 February 2019, has ruled that allowances of the following nature are excluded from “basic wages” and are not subject to provident fund contributions:
- Allowances which are variable in nature; or
- Allowances which are linked to any incentive for production resulting in greater output by an employee; or
- Allowances which are not paid across the board to all employees in a particular category; or
- Allowance which are paid especially to those who avail the opportunity.
In its ruling, the Supreme Court has relied on the principles of “universality” and “contingency”, laid down in its earlier decisions in the case of Bridge and Roof Co. and Manipal Academy of Higher Education.
Employers will need to review the impact of this ruling, if any, on the provident fund contributions made for its employees. The ruling may specifically impact the following:
- Provident fund contributions for domestic workers with basic salary less than INR15,000 per month
- Provident fund contributions for international workers as proviso to Para 26A of the Provident Fund Scheme is not applicable for international workers
Domestic workers with basic salary exceeding INR15,000 per month may not get impacted due to this ruling where provident fund contributions are made by the employer on full basic salary or on minimum INR15,000 per month, such domestic workers may be covered under proviso to Para 26A of the Provident Fund Scheme. However, the Supreme Court has not dealt on this aspect in this ruling.
New Auditing standards update
The ICAI had issued the revised auditor’s reporting standards Revised SA 700 – Forming an Opinion and Reporting on Financial Statements, Revised SA 705 – Modifications to the Opinion in the Independent Auditor’s Report, Revised SA 706 - Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report and Revised SA 720 – The Auditor’s Responsibilities relating to Other Information. These standards are effective for audits of financial statements for periods beginning on or after 1 April 2018. SA 701 - Communicating Key Audit Matters in the Independent Auditor’s Report (new) has also been issued and is effective for audits of financial statements for periods beginning on or after 1 April 2018.
These standards are arguably the most important ones because they deal with processes that culminate into the end product of an auditor’s work i.e., the auditor’s report. They are crucial for the management since they lay down the principles and procedures on how an auditor forms an opinion and the manner in which he communicates it, which determines how the society in general or specific stakeholders will make important economic decisions.
Revised SA 700 – Forming an Opinion and Reporting on Financial Statements
Revised SA 700 has also brought about changes in the auditor’s report
Revised SA 705
Revised SA 706
Revised SA 720 - The Auditor’s Responsibilities relating to Other Information
SA 701 – Communicating Key Audit Matters (KAM) in the Independent Auditor’s Report
Revised SA 700 – Forming an Opinion and Reporting on Financial Statements
Revised SA 700 deals with the responsibility of the auditor in forming an opinion on the financial statements. This standard also deals with content and form of the auditor’s report that is issued as an outcome of the audit of the financial statements.
In order to enable the auditor form an opinion on the financial statements, management is required to prepare the financial statements in a manner that such financial statements appropriately disclose the important accounting policies that are selected and subsequently applied, the accounting estimates which are made by management are rational and adequate disclosures are present, allowing the users of the financial statements to properly understand the impact of material events and transactions on the information that is conveyed in financial statements, etc. Based on the information furnished, the auditor shall express his/her unmodified opinion when he/she concludes that such financial statements are prepared and presented, in all the required material respects, as per the relevant financial reporting framework.
Revised SA 700 has also brought about changes in the auditor’s report
Earlier structure of auditor’s report: Report on the financial statements
Revised structure of auditor’sreport:
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Revised SA 705
The objective of this standard on Auditing (SA) deals with the auditor’s responsibility to issue an appropriate report in circumstances when, in forming an opinion in accordance with SA 700 (Revised), the auditor concludes that a modification to the auditor’s opinion on the financial statements is necessary. This also deals with how the form and content of the auditor’s report is affected when the auditor expresses a modified opinion.
Revised SA 706
The objective of this standard is to draw users’ attention by way of clear additional communication towards a matter that is of such importance, that it is fundamental to users’ understanding of the financial statements; or any other matter that is relevant to users’ understanding of an audit and the auditor’s responsibilities or the auditor’s report. If the auditor considers it necessary to draw users’ attention to a matter presented or disclosed in the financial statements that, in the auditor’s judgment, is of such importance that it is fundamental to users’ understanding of the financial statements, the auditor shall include an “Emphasis of Matter” paragraph in the auditor’s report provided: (a) The auditor would not be required to modify the opinion in accordance with SA 705 (Revised) as a result of the matter; and (b) When SA 701 is applied, the matter has not been determined to be a key audit matter to be communicated in the auditor’s report. The revised standard does not substitute emphasis of matter/other matters’ paragraphs with key audit matters.
Revised SA 720 - The Auditor’s Responsibilities relating to Other Information
This standard deals with the auditor’s responsibilities relating to other information, whether financial or non-financial information (other than financial statements and the auditor’s report thereon), included in an entity’s annual report. It has enhanced the responsibilities of the auditor to consider whether there is any material inconsistency between (a) “other information” and the financial statements; and (b) “other information” and auditor’s knowledge obtained in the audit. For this purpose, “other information” includes documents that are provided to stakeholders along with financial statements and the annual report, including the director’s report, chairman’s statement and corporate governance statement/report.
SA 701 – Communicating Key Audit Matters (KAM) in the Independent Auditor’s Report
SA 701 deals with the responsibilities of an auditor to communicate the key audit matters in the audit report. For this purpose, key audit matters are defined as those matters that are in the auditor’s professional judgment and were of most significance in the audit of the financial statements of the current period. Key audit matters are selected from matters communicated with those charged with governance. Some examples of KAM are:
- Areas that require complex and significant management judgement in financial statements
- Certain complex areas relating to revenue recognition
- Provisions and contingencies
- Taxation matters (multiple tax jurisdictions, uncertain tax positions and deferred tax assets)
- Assessment of impairment
- Put arrangements over non-controlling interests
- IT systems and controls
- Significant difficulties encountered during the audit–related party transactions
- Limitations on group audit
The purpose of communicating key audit matters is to enhance the communicative value of the auditor’s report by providing greater transparency about the performed audit. Communicating key audit matters provides additional information to intended users of the financial statements (intended users) to assist them in understanding those matters that, in the auditor’s professional judgment, were of utmost significance in the audit of the financial statements of the current period. Communicating key audit matters may also assist intended users in understanding the entity and areas of significant management judgment in the audited financial statements. The communication of key audit matters in the auditor’s report may also provide intended users a basis to further engage with management and those charged with governance about certain matters relating to the entity, the audited financial statements, or the audit that was performed.
- As a result of these amendments and new provisions, management is expected to ensure that the draft of annual report, including director’s report, is provided to the auditors such that they have a sufficient time to review the same before the audit report is finalized.
- Management also needs to ensure that information presented throughout the annual report, in the various sections are consistent.
- There would be more proactive engagement and improved discussions between the management and the auditors, to ensure that investors receive relevant and well- described information that is consistent across all communications in the annual report.
- Management will need to exercise sharper focus and consider industry best-practices on reporting sensitive information, which was not earlier disclosed.
- These amendments may equip the investors and analysts with a lot of data and they could pose better questions and challenge the audit committee and management regarding the adequacy of disclosures.
- The new and revised auditor’s reporting standards are expected to enhance transparency to facilitate users of financial statements in understanding significant judgements made by the auditor in forming opinion on the financial statements, since they are directly related to areas of significant management judgement in preparing the financial statements.
- Increase robust communication between those charged with governance, management and the auditor, especially on the key audit matters (i.e., those matters which, in the auditor’s professional judgement, are of utmost significance in the audit of the financial statements of the current period and are selected from matters communicated with those charged with governance).