New developments

The Institute of Chartered Accountants of India (ICAI) has, on 24 and 30 June 2016, issued certain clarifications in the form of Frequently Asked Questions (FAQs) on the application of the ‘deemed cost’ exemption and consolidation requirements under the Indian Accounting Standards (Ind AS).

Further, the Ind AS Transition Facilitation Group (ITFG) constituted by the ICAI issued an update to its second bulletin (that covers Ind AS application issues discussed at its second meeting held on 12 April 2016) with additional guidance on the accounting for premium on the redemption of non- onvertible debentures.

This IFRS note provides an overview of the following clarifications:

• FAQ on the application of the deemed cost exemption
• FAQ on consolidation
• ITFG update on second bulletin

Overview of the guidance

1.    FAQ on the application of the ‘deemed cost’ exemption

Ind AS 101, First-time Adoption of Indian Accounting Standards permits an entity (in situations where there is no change in functional currency) on the date of transition to Ind AS, to continue with the carrying value for all of its property, plant and equipment (PPE), measured as per its previous GAAP, and use that carrying value as its ‘deemed cost’ at the date of transition.

‘Deemed cost’ is definedas ‘an amount used as a surrogate for cost or depreciated cost at a given date. Subsequent depreciation or amortisation assumes that the entity had initially recognised the asset or liability at the given date and that its cost was equal to the deemed cost’.

The issue discussed is whether, on application of the exemption above and in view of the definition of deemed cost, the accumulated depreciation and provision for impairment under previous GAAP would be treated as ‘nil’ on the date of transition and how would the impact - in case of a reversal in impairment losses (recognised prior to the date of transition) - be recognised.

This issue was previously referred to the Accounting Standards Board (ASB) by the ITFG and the ASB issued the following clarification on 30 June 2016.

ICAI guidance

The ICAI clarified that when an entity elects the deemed cost on the transition date (i.e. carrying values of PPE as per the previous GAAP) as the cost of its PPE, then any accumulated depreciation and provision for impairment under previous GAAP will have no relevance. 

It further explained that ‘deemed cost’ is a surrogate for the cost or depreciated cost, for the purpose of subsequent depreciation or amortisation, therefore, the deemed cost becomes the starting point for the subsequent measurement under Ind AS. Accordingly, in this case, the provision for impairment recognised prior to the date of transition cannot be reversed in later years.

An additional disclosure of the gross block of assets, accumulated depreciation and provision for impairment under previous GAAP may be voluntarily provided in the notes forming part of the Ind AS financial statements. 

Our comments

This is an important clarification from a conceptual point of view as it states that the deemed cost is the new starting point for the subsequent measurement of PPE under Ind AS. The components of such deemed cost prior to transition are of no relevance since this amount is merely a surrogate for cost, as if the PPE had been initially recognised at this cost on the date of transition.

This ICAI clarification reiterates and builds on the view expressed in Question no. 18 of the ICAI Educational Material on Ind AS 101 published in June 2015.

Companies that are transitioning to Ind AS should carefully consider the impact if they apply this exemption. Additionally, they should evaluate the Information Technology (IT) system changes to reflect the new gross block from the date of transition to Ind AS.

2.  FAQ on consolidation

The guidance provided in this FAQ relates to two questions and is summarised below:

• Are subsidiaries in the legal form of an LLP or a partnership firm required to be consolidated?
  
  Ind AS 110, Consolidated Financial Statements requires that an entity which controls one or more other entities must consolidate all controlled entities. Since ‘entities’ include those in the form of a company or other forms, a parent entity is required to consolidate subsidiaries that are in the form of a Limited Liability Partnership (LLP) or a partnership firm under Ind AS. Consolidation under the relevant standards will also be required by the parent, if the LLP or a partnership firm is an associate or a joint venture of the parent entity.

• Is a company that has no subsidiaries, but has an investment in an associate or a joint venture, required to prepare consolidated financial statements under the Companies (Accounting Standards) Rules, 2006?
  
  Section 129(3) of the Companies Act, 2013 requires a company with one or more subsidiaries to prepare consolidated financial statements of the company and all subsidiaries. ‘Subsidiary’ has been defined to include associate companies and joint ventures. Therefore, a company that does not have any subsidiaries would still be required to prepare consolidated financial statements that include its associate and joint venture companies in accordance with AS 23, Accounting for investments in associates in consolidated financial statements and AS 27, Financial reporting of interests in joint ventures respectively.

Our comments

The clarification regarding consolidated financial statements to include a LLP or a partnership firm is on the lines of the guidance currently being followed under Indian GAAP and IFRS.  Additionally, it may be helpful if the ICAI clarifies the position with respect to the application of Ind AS for the separate financial statements of LLPs/partnership firms. In the absence of such a clarification, such LLPs/partnership firms may be required to maintain parallel set of accounts.

With respect to the clarification regarding the preparation of consolidated financial statements when an entity does not have a subsidiary but an associate or a joint venture: This clarification is along the lines of IFRS and recent amendment of AS 21, Consolidated Financial Statements (on 30 March
2016). 

3.    ITFG update

In June 2016, the ITFG issued an update to its second bulletin to include its response on an additional Ind AS application issue (issue no.7) that was considered in its meeting on 12 April 2016. This issue was not covered in the original bulletin issued by the ITFG in May 2016.

Accounting issue

The issue relates to the accounting treatment for premium on the redemption of non-convertible debentures that are outstanding at the date of transition to Ind AS. The ITFG discussed whether any retrospective adjustments were required under Ind AS on transition, if the issuing company had previously utilised the Securities premium account (basis section 78 of the Companies Act, 1956) to provide for the redemption premium in full.

ITFG guidance

The non-convertible debentures are classified as a financial liability under Ind AS 109, Financial Instruments since the issuer has a contractual obligation to redeem these debentures at a specified premium. Ind AS 109 requires financial liabilities to be classified as ‘subsequently measured at amortised cost’ unless these are derivatives or otherwise qualify for being designated as ‘at fair value through profit or loss (FVTPL)’.

If the debentures qualify for designation as FVTPL, these would be measured at fair value on the date of transition to Ind AS and the difference between fair value and the previous carrying amount recognised in retained earnings as a transition adjustment. Hence, no retrospective adjustments would be required in this situation.

If such debentures are not designated as FVTPL and are therefore subsequently measured at amortised cost, the issuer is required to retrospectively calculate the Effective Interest Rate (EIR) as on the date of issue and compute the amortised cost as at the date of transition based on this EIR. The adjustment arising from the difference between the amortised cost and the carrying amount is to be recognised at the date of transition. To the extent that the issuer had previously utilised the securities premium account, it may credit the adjustment to this account with a corresponding debit to the relevant account that was credited earlier (debenture liability).

Our comments

Redeemable, non-convertible debentures generally do not qualify for designation as FVTPL liabilities. Therefore, issuers may be required to classify and subsequently measure these liabilities at amortised cost under Ind AS. Amortised cost is calculated by applying the EIR to the gross carrying amount and accruing interest expense over the period of the liability.

The EIR is determined on the initial recognition of the financial liability and is the rate that exactly discounts estimated future cash flows through the expected life of the debentures to their amortised cost. The estimate of the expected cash flows used in calculation of the EIR includes fees, transaction costs and all other premiums or discounts. Therefore, the premium payable by the issuer on the redemption of the debentures will form part of the EIR and is consequently recognised as part of interest expense over their life.

Companies that have previously adjusted the entire redemption premium against the securities premium account and recognised the full liability, are therefore required to reverse the unamortised premium expense on transition to Ind AS. This would be subsequently recognised as an interest expense through statement of profit and loss over the remaining period until the redemption of the debentures. This may have a significant impact on the determination of future profits under Ind AS.

Consequently, companies that have issued debentures or preference shares that are redeemable at a premium, and have a significant residual term remaining until maturity should carefully evaluate the impact of this guidance issued by the ITFG.

Additionally, entities should consider whether the borrowing cost from non-convertible debentures qualifies to be capitalised under Ind AS 23, Borrowing Costs.

Next steps

Companies that fall within phase 1 of the Ind AS implementation road map issued by the Ministry of Corporate Affairs will prepare their first Ind AS financial statements for the financial year ending 31 March 2017. Several of these companies may be required to disclose their interim financial results under Ind AS for the quarter ended 30 June 2016. The guidance issued by the ICAI through its FAQs and the views of the ITFG should be considered by such companies in computing their opening adjustments and preparing their Ind AS financial statements

To access the text of the:

• ICAI FAQs on the deemed cost of PPE, please click here.
• ICAI FAQs on consolidation, please click here.
• Updated ITFG clarification bulletin 2, please click here.