GAAP Advisors TASK Weekly Newsletter | 155th Edition
CA Manish C. Iyer
Ind AS, IFRS and Indian GAAP Advisor | Author of 16 eBooks on Ind AS | Independent Director
Welcome to 155th Edition of?GAAP Advisors?TASK?Weekly newsletter
It gives me immense pleasure welcoming you to the 155th edition of?GAAP Advisors?TASK?Weekly newsletter.?I thank all 16000+ subscribers on LinkedIn. A link to the PDF of this edition of the newsletter will be shared. Please add your comments and viewpoint in the PDF for readers to have wider perspective.
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EBOOKS PUBLISHED (Click here to Order All eBooks)
1.?????? 25 Issues and Non-compliance Examples on Ind AS Application
a. ?Volume 1
b. ?Volume 2
c. ?Volume 3
d. Volume 4
e. Volume 5
f.? ?Volume 6
g. Volume 7
h. Volume 8
2.?????? 51 Issues of Financial Instruments Standards (Ind AS 32, 107 and 109)
a. Volume 1
3.?????? Practical Guide on Material Accounting Policy Information containing analysis of 400+ accounting policies from 18 listed companies’ financial statements
a. Volume 1
Package of all Eight Volumes of 25 Issues and Non-compliance Examples on Ind AS at a discount of 36% | Original price: ?4720 | Discounted price: ?3000. To order this package, click the following link:
Package of all Ten eBooks on Ind AS authored and published by CA Manish C. Iyer at a discount of 33% | Original price: ?7487 | Discounted price: ?5000. To order this package, click the following link:
The views expressed herein are the personal views of the author and are not binding on the reader. The reader is requested to seek the help of an expert before taking any action or refraining from any action based on the views expressed herein.
This edition of newsletter has the following sections:
+ Non-refundable deposits for client specific transmission line
+ Standards Applied for Responding to Issues This Week
+ Observation relating to Ind AS 7
+ About Volume 1 of Practical Guide on Material Accounting Policy Information
+ From Practical Guide on Material Accounting Policy Information eBook – Investment in Subsidiary and Associate Companies
+ Note of Thanks
Non-refundable Deposits for Client Specific Transmission Line - Framework: Indian Accounting Standards:
Facts of the case:
Company 'X' is an electricity transmission company which has license to set up all transmission line/cable for the related state government. It has total control on the installed transmission line. For installation of client’s specific transmission line, company takes deposits (not refundable) from them and accounted it as liabilities. Under previous GAAP, after installation of all assets it used to capitalize the asset and transfer liabilities account to "deposits reserves" in reserve and surplus head. Thereafter each year company charge depreciation of related asset to reserves directly.?
Issue/Query:
What would be the treatment under Ind AS.
Response:
Before I discuss the response, I would like to highlight the practice followed by companies regulated by tariff regulation to account as required by tariff regulations under the alibi of law prevails over standards. In this regard, attention is drawn to the following requirements of Rule 4A of Companies (Accounts) Rules, 2014 which was inserted vide notification dated 4th September 2015:
"The financial statements shall be in the form specified in Schedule III to the Act and comply with the Accounting Standards or Indian Accounting Standards as applicable:
Provided that the items contained in the financial statements shall be prepared in accordance with the definitions and other requirements specified in the Accounting Standards or the Indian Accounting Standards, as the case may be."
Therefore, in my view, basis the requirement of rule 4A of Companies (Accounts) Rules, 2014 and amendments thereto, the financial statements of all companies including those subject to tariff regulations are required to be prepared in accordance with the Accounting Standards or Indian Accounting Standards, as applicable. Accordingly, I do not agree with the practice of financial reporting in accordance with requirements of tariff regulations. In my view, the tariff regulations are limited to only determination of tariff and do not govern financial reporting. However, the same is a legal matter. Therefore, where a company prepares financial statements based on tariff regulations, the auditor is recommended to obtain a legal opinion as to why rule 4A of Companies (Accounts) Rules, 2014 needs to be overlooked. Given below is my response as per Indian Accounting Standard (Ind AS) framework as sought by the querist.
Paragraph 9 of Ind AS 116, Leases, states as follows:
“At inception of a contract, an entity shall assess whether the contract is, or contains, a lease. A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.?Paragraphs B9–B31?set out guidance on the assessment of whether a contract is, or contains, a lease.”
Therefore, at inception of the contract to set-up client specific transmission line the control of which is retained by the company, the company shall assess whether the contract is, or contains, a lease.
Paragraph B9 of Ind AS 116 states as follows:
“To assess whether a contract conveys the right to control the use of an identified asset (see paragraphs B13–B20) for a period of time, an entity shall assess whether, throughout the?period of use, the customer has both of the following:
(a) the right to obtain substantially all of the economic benefits from use of the identified asset (as described in?paragraphs B21–?B23); and
(b) the right to direct the use of the identified asset (as described in?paragraphs B24–B30).”
The contract has identified transmission line as the asset.
Paragraph B14 of Ind AS 116 states as follows:
“Even if an asset is specified, a customer does not have the right to use an identified asset if the supplier has the substantive right to substitute the asset throughout the period of use. A supplier’s right to substitute an asset is substantive only if both of the following conditions exist:
(a) the supplier has the practical ability to substitute alternative assets throughout the period of use (for example, the customer cannot prevent the supplier from substituting the asset and alternative assets are readily available to the supplier or could be sourced by the supplier within a reasonable period of time); and
(b) the supplier would benefit economically from the exercise of its right to substitute the asset (ie the economic benefits associated with substituting the asset are expected to exceed the costs associated with substituting the asset).”
In the given case, the querist has not submitted any details to determine whether the company has substantive right to substitute the transmission line throughout the period or use. However, basis the limited facts submitted by the querist, it can be concluded that even if the company has the practical ability to substitute transmission line throughout the period or use, the company cannot benefit economically from exercise of its right to substitute the transmission line. Therefore, the customer has right to use an identified asset, the client specific transmission line.
The querist has submitted that the transmission line is specific to the client. Therefore, the customer has the right to obtain all of the economic benefits from use of the identified asset. Accordingly, the first condition in paragraph B9(a) is met.
Paragraph B24 of Ind AS 116 provides the following guidance on the customer having the right to direct the use of the identified asset:
“A customer has the right to direct the use of an identified asset throughout the period of use only if either:
(a) the customer has the right to direct how and for what purpose the asset is used throughout the period of use (as described in paragraphs B25–B30); or
(b) the relevant decisions about how and for what purpose the asset is used are predetermined and:
(i) the customer has the right to operate the asset (or to direct others to operate the asset in a manner that it determines) throughout the period of use, without the supplier having the right to change those operating instructions; or
(ii) the customer designed the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose the asset will be used throughout the period of use.”
Paragraph B25 to B27 of Ind AS 116 provide guidance on the customer having the right to direct how and for what purpose the asset is used as follows:
“B25 A customer has the right to direct how and for what purpose the asset is used if, within the scope of its right of use defined in the contract, it can change how and for what purpose the asset is used throughout the period of use. In making this assessment, an entity considers the decision-making rights that are most relevant to changing how and for what purpose the asset is used throughout the period of use. Decision- making rights are relevant when they affect the economic benefits to be derived from use. The decision-making rights that are most relevant are likely to be different for different contracts, depending on the nature of the asset and the terms and conditions of the contract.
B26 Examples of decision-making rights that, depending on the circumstances, grant the right to change how and for what purpose the asset is used, within the defined scope of the customer’s right of use, include:
(a) rights to change the type of output that is produced by the asset (for example, to decide whether to use a shipping container to transport goods or for storage, or to decide upon the mix of products sold from retail space);
(b) rights to change when the output is produced (for example, to decide when an item of machinery or a power plant will be used);
(c) rights to change where the output is produced (for example, to decide upon the destination of a truck or a ship, or to decide where an item of equipment is used); and
(d) rights to change whether the output is produced, and the quantity of that output (for example, to decide whether to produce energy from a power plant and how much energy to produce from that power plant).
B27 Examples of decision-making rights that do not grant the right to change how and for what purpose the asset is used include rights that are limited to operating or maintaining the asset. Such rights can be held by the customer or the supplier. Although rights such as those to operate or maintain an asset are often essential to the efficient use of an asset, they are not rights to direct how and for what purpose the asset is used and are often dependent on the decisions about how and for what purpose the asset is used. However, rights to operate an asset may grant the customer the right to direct the use of the asset if the relevant decisions about how and for what purpose the asset is used are predetermined (see paragraph B24(b)(i)).”
The querist has not submitted any details on whether the customer has the right to direct how and for what purpose the asset is used. However, from the limited facts, it can be reasonably judged that the customer has the right to change when the output is produced, that is, the company can decide when to use the transmission line and when not. For example, during holidays, the customer may not use the transmission line. Therefore, the customer has the right to direct how and for what purpose the transmission line is used. Accordingly, the second condition in paragraph B9(b) is also met. Thus, the contract with the client contains a lease of transmission line. The company is the lessor and the customer is the lessee.
Paragraph 61 of Ind AS 116 states as follows:
“A lessor shall classify each of its leases as either an?operating lease or a?finance lease.”
Therefore, the company shall classify the contract as either an operating lease or finance lease.
Paragraphs 62 – 64 of Ind AS 116 provide guidance on classification of lease as either operating lease or finance lease as follows:
“62 A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.
63 Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract. Examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease are:
(a) the lease transfers ownership of the underlying asset to the lessee by the end of the lease term;
(b) the lessee has the option to purchase the underlying asset at a price that is expected to be sufficiently lower than the?fair value?at the date the option becomes exercisable for it to be reasonably certain, at the?inception date, that the option will be exercised;
(c) the lease term is for the major part of the?economic life?of the underlying asset even if title is not transferred;
(d) at the inception date, the present value of the lease payments amounts to at least substantially all of the fair value of the underlying asset; and
(e) the underlying asset is of such a specialised nature that only the lessee can use it without major modifications.
64 Indicators of situations that individually or in combination could also lead to a lease being classified as a finance lease are:
(a) if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee;
(b) gains or losses from the fluctuation in the fair value of the residual accrue to the lessee (for example, in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and
(c) the lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.”
As the transmission line is client specific, the customer has the right to use the transmission line for its entire economic life even if the title is not transferred. Therefore, the company shall classify the lease as finance lease.
Paragraph 67 of Ind AS 116 states as follows:
“At the commencement date, a lessor shall recognise assets held under a finance lease in its balance sheet and present them as a receivable at an amount equal to the?net investment in the lease.”
Therefore, the company shall derecognise the transmission line from property, plant and equipment and recognise a receivable at an amount equal to the net investment in the lease.
Appendix A of Ind AS 116 defines the term ‘net investment in the lease’ as follows:
“The?gross investment in the lease?discounted at the?interest rate implicit in the lease.”
Therefore, to understand net investment in the lease, we need to understand the following terms:
·?????? Gross investment in the lease; and
·?????? Interest rate implicit in the lease
Appendix A of Ind AS 116 defines the above terms as follows:
“Gross investment in the lease:
The sum of:
(a) the?lease payments?receivable by a?lessor?under a?finance lease; and
(b) any?unguaranteed residual value?accruing to the lessor.
Interest rate implicit in the lease:
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The rate of interest that causes the present value of
(a) the?lease payments?and
(b) the?unguaranteed residual value?to equal the sum of
(i) the?fair value?of the?underlying asset?and
(ii) any?initial direct costs?of the lessor.”
Appendix A of Ind AS 116 defines ‘lease payments’ as follows:
“Payments made by a lessee to a lessor relating to the right to use an underlying asset during the lease term, comprising the following:
(a)?fixed payments?(including in-substance fixed payments), less any lease incentives;
(b)?variable lease payments?that depend on an index or a rate;
(c) the exercise price of a purchase option if the lessee is reasonably certain to exercise that option; and
(d) payments of penalties for terminating the?lease, if the lease term reflects the lessee exercising an option to terminate the lease
For the lessee, lease payments also include amounts expected to be payable by the lessee under residual value guarantees. Lease payments do not include payments allocated to non-lease components of a contract, unless the lessee elects to combine non-lease components with a lease component and to account for them as a single lease component. For the lessor, lease payments also include any residual value guarantees provided to the lessor by the lessee, a party related to the lessee or a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee. Lease payments do not include payments allocated to non-lease components.”
Appendix A of Ind AS 116 defines ‘fixed payments’ as follows:
“Payments made by a?lessee?to a?lessor?for the right to use an?underlying asset?during the?lease term, excluding?variable lease payments.”
The non-refundable deposit given by the customer to the company meets the definition of fixed payments. Therefore, the non-refundable deposit given by the customer to the company is a lease payment. The company shall, therefore, consider the same when determining gross investment in the lease and thereby net investment in the lease. Therefore, the company shall not recognise the non-refundable deposit received from the customer directly in reserve.
The above accounting was based on our significant judgement that the contract contains a finance lease. Given below is the accounting for non-refundable deposit when the company classifies the lease as operating lease.
Paragraph 81 of Ind AS 116 states the recognition and measurement of operating leases as follows:
“A lessor shall recognise lease payments from operating leases as income on either a straight-line basis or another systematic basis. The lessor shall apply another systematic basis if that basis is more representative of the pattern in which benefit from the use of the underlying asset is diminished.”
Therefore, where the company classifies the lease as operating lease, the company shall recognise the non-refundable deposit as lease rent received in advance. The company shall recognise lease rent income in profit or loss by amortising the non-refundable deposit on a straight-line basis over the lease term.
Paragraph 84 of Ind AS 116 states as follows:
“The depreciation policy for depreciable underlying assets subject to operating leases shall be consistent with the lessor’s normal depreciation policy for similar assets. A lessor shall calculate depreciation in accordance with?Ind AS 16?and?Ind AS 38.”
Therefore, the company shall depreciate the transmission line in accordance with Ind AS 16, Property, Plant and Equipment.
Paragraph 48 of Ind AS 16 states as follows:
“The depreciation charge for each period shall be recognised in profit or loss unless it is included in the carrying amount of another asset.”
Therefore, the practice of recognising depreciation directly as reduction of deposit without impacting the profit or loss for the period is not in accordance with Ind AS 16. The company shall recognise depreciation on the transmission lines that it controls in profit or loss.
Attention of the readers is drawn to the depreciation requirements of Accounting Standard (10), Property, Plant and Equipment, contained in paragraph 50 of AS 10:
“The depreciation charge for each period should be recognised in the statement of profit and loss unless it is included in the carrying amount of another asset.”
Therefore, as per AS 10, the practice followed by the company to recognise depreciation directly in reserves without impacting profit or loss was not in accordance with AS 10. Thus, the company has made errors in its previous GAAP financial statements which it shall rectify retrospectively in accordance with the following requirements contained in paragraph 42 of Ind AS 8, Accounting Policies, Changes in Accounting Estimates and Errors:
“Subject to paragraph 43, an entity shall correct material prior period errors retrospectively in the first set of financial statements approved for issue after their discovery by:
(a) restating the comparative amounts for the prior period(s) presented in which the error occurred; or
(b) if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.”
The company is transitioning from previous GAAP to Ind AS. Attention of the readers is also drawn to the following requirements of paragraph 26 of Ind AS 101, First-time Adoption of Indian Accounting Standards:
“If an entity becomes aware of errors made under previous GAAP, the reconciliations required by paragraph 24(a) and (b) shall distinguish the correction of those errors from changes in accounting policies.”
Therefore, the company shall distinguish the impact of rectification of error in profit or loss and statement of changes in equity from changes in accounting policies in the reconciliations disclosed required by paragraph 24(a) and 24(b) of Ind AS 101.
Standards Applied for Responding to Issues Submitted on https://gaapadvisors.com This Week:
·?????? AS 21 – Consolidated Financial Statements
o?? Total No. of Issues in Issue Repository: 36
·?????? Companies (Indian Accounting Standards) Rules, 2015
o?? Total No. of Issues in Issue Repository: 99
·?????? Ind AS 1 – Presentation of Financial Statements
o?? Total No. of Issues in Issue Repository: 296
·?????? Ind AS 7 – Statement of Cash Flows
o?? Total No. of Issues in Issue Repository: 42
·?????? Ind AS 8 – Accounting Policies, Changes in Accounting Estimates and Errors
o?? Total No. of Issues in Issue Repository: 206
·?????? Ind AS 27 – Separate Financial Statements
o?? Total No. of Issues in Issue Repository: 86
·?????? Ind AS 32 – Financial Instruments: Presentation
o?? Total No. of Issues in Issue Repository: 392
·?????? Ind AS 101 – First-time Adoption of Indian Accounting Standards
o?? Total No. of Issues in Issue Repository: 171
·?????? Ind AS 103 – Business Combinations
o?? Total No. of Issues in Issue Repository: 190
·?????? Ind AS 109 – Financial Instrument
o?? Total No. of Issues in Issue Repository: 1518
·?????? Ind AS 110 – Consolidated Financial Statements
o?? Total No. of Issues in Issue Repository: 141
·?????? Ind AS 112 – Disclosure of Interests in Other Entities
o?? Total No. of Issues in Issue Repository: 9
Click here to Order a copy of all 10 eBooks on Ind AS Original price: ?7487 | Discounted price ?5000
and / or
Observation relating to Ind AS 7:
What has the Company Reported:
A company has disclosed the following in the Cash flows from Operating Activities section of the Statement of Profit and Loss:
Observations:
Paragraph 120 of Ind AS 19, Employee Benefits, states as under:
"An entity shall recognise the components of defined benefit cost, except to the extent that another Ind AS requires or permits their inclusion in the cost of an asset, as follows: (a) service cost (see paragraphs 66–112 and paragraph 122A) in profit or loss;
(b) net interest on the net defined benefit liability (asset) (see paragraphs 123–126) in profit or loss; and
(c) remeasurements of the net defined benefit liability (asset) (see paragraphs 127–130) in other comprehensive income."
Paragraph 18 of Ind AS 7, Statement of Cash flows, states as under:
"An entity shall report cash flows from operating activities using either:
(a)?? the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or
(b)?? the indirect method, whereby profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows."
Therefore, remeasurement of defined benefit plans are recognised in other comprehensive income section of the Statement of Profit and Loss in accordance with paragraph 120 of Ind AS 19. However, the company has adjusted the remeasurement of defined benefit plans to net profit before tax. Paragraph 18 of Ind AS 7 requires only those adjustments that are stated in profit or loss section of the Statement of Profit and Loss. Therefore, the company is perceived to have not complied with the requirements of Ind AS 7.
About Volume 1 of Practical Guide on Material Accounting Policy Information:
Companies following Ind AS will have to publish material accounting policy information in their financial statements for the year ended 31 March 2024. The change is not just a change of heading but requires thorough review of all significant accounting policies published in previous financial statements. If applied in true spirit, material accounting policy information could reduce the accounting policy disclosures by more than one half.
Volume 1 of Practical Guide on Material Accounting Policy Information contains analysis of 400+ accounting policies from published financial statements of 18 listed companies. The book also contains the following annexures:
1.???Clarification from Accounting Standards Board (ASB) of?The Institute of Chartered Accountants of India?on accrual of interest on credit impaired financial assets.
2.????Guideline by Reserve Bank of India on Implementation of Indian Accounting Standards in NBFCs dated 13 March 2020.
3.????National Financial Reporting Authority (NFRA) Circular dated 20 October 2022 on Non-accrual of interest on borrowings by the companies in violation of Indian Accounting Standards
4.????NFRA Circular date 29 March 2023 on Incorrect accounting policies on Revenue and Trade Receivables published by large listed companies.
THE EBOOK CAN BE BOUGHT FROM THE FOLLOWING LINK:
From Practical Guide on Material Accounting Policy Information eBook?– Investment in Subsidiary and Associate Companies:
As reported by Company:
Investment in subsidiary and associate Companies
The Company has elected to recognise its investments in subsidiary and associate companies at cost in accordance with the option available in Ind AS 27, ‘Separate Financial Statements’. The details of such investments are given in Note 5. Impairment policy applicable on such investments is explained in note 1.3(e) above.
Contingent consideration (earn out) is remeasured at fair value at each reporting date and changes in the fair value of the contingent consideration are recognised in the Statement of Profit and Loss.
(Asian Paints Limited Financial Year Ended 31 March 2023)
Analysis for Material Accounting Policy Information:
Primary condition – Accounting policy relates to material transaction, other event or condition:
The company has presented investment in subsidiaries as a separate line item in Balance Sheet. Accordingly, the primary condition is met.
Secondary conditions – Any one of these need to be met:
Conclusion:
As both the primary and secondary conditions are met, the company shall continue disclosure of the accounting policy on investment in subsidiaries and associates.
Note of Thanks
GAAP Advisors?thanks all 16000+ subscribers on LinkedIn and other readers of newsletter for taking their time out in knowing how?GAAP Advisors?enables?Excellence in Financial Reporting in India. I request all readers to kindly add their comments to the PDF of this edition of the newsletter. A link of the PDF of this edition of the newsletter will be shared in the post announcing the publishing of this edition of the newsletter.?GAAP Advisors?thanks all subscribers of repositories for contributing to support the mission of spreading the knowledge and awareness of financial reporting standards in?Collaborative Manner Creating Value For All.?GAAP Advisors?thanks all participants of?TASK?for spending time in learning financial reporting in India.?GAAP Advisors?also thanks all?2900+?registrants?for their faith in the repository services rendered by?GAAP Advisors.
Click here to Order a copy of all 10 eBooks on Ind AS Original price: ?7487 | Discounted price ?5000
and / or
Ind AS, IFRS and Indian GAAP Advisor | Author of 16 eBooks on Ind AS | Independent Director
3 个月Vineet Jain and CA Anurag Gupta Thank you so much for spreading the word
Ind AS, IFRS and Indian GAAP Advisor | Author of 16 eBooks on Ind AS | Independent Director
3 个月CA Jay Raval Thank you so much for spreading the word
Ind AS, IFRS and Indian GAAP Advisor | Author of 16 eBooks on Ind AS | Independent Director
3 个月Dr. Ashok Kumar Dubey Thank you so much for spreading the word