With the implementation of Indian Accounting Standards (Ind AS) being applicable to large corporates from 1 April 2016, the Institute of Chartered Accountants of India (ICAI) on 11 January 2016 announced the formation of the Ind AS Transition Facilitation Group (ITFG) in order to provide certain clarifications on issues arising due to applicability and/or implementation of Ind AS under the Companies (Indian Accounting Standards) Rules, 2015 (Rules 2015).
Earlier this year, the ITFG had its first and second meeting and issued its first and second bulletin to provide guidance on issues relating to the application of Ind AS.
The ITFG held its third and fourth meeting on 23 May 2016 and 22 June 2016, respectively, and issued its third bulletin (Bulletin 3) on 2 July 2016 to provide clarifications on 14 issues in relation to the application of Ind AS, as considered in its meetings. This edition of IFRS Notes provides an overview of these issues.
Overview of the clarifications in ITFG’s Bulletin 3
The interpretations arising from ITFG’s responses are summarised below:
- Voluntary adoption of Ind AS and adoption of Division II of the Revised Schedule III: If a company voluntarily adopts Ind AS from the Financial Year (FY) 2015-16, then such a company may use the format specified in Division II of the Revised Schedule III of the Companies Act, 2013 (2013 Act) for the preparation of financial statements as per Ind AS for FY 2015-16. The format specified in Division II is in compliance with Ind AS notified under Rules 2015 and will mandatorily apply to companies implementing Ind AS from FY 2016-17 onwards. However, there is no prohibition for early or voluntary adoption of this format.
- Core Investment Companies (CIC): Rule 4 of Rules, 2015, read with the Companies (Indian Accounting Standards) Rules, 2016, provides that Non-Banking Financial Companies (NBFCs) with a net worth of more than INR500 crore should comply with Ind AS for accounting periods beginning on or after 1 April 2018, with comparatives for the periods ending on 31 March 2018. In relation to this the ITFG has clarified that all CICs should be regarded as NBFCs as they are specifically included in the definition of NBFCs as per Rule 2 of Rules 2015. Therefore, CICs should comply with the road map specified for NBFCs and apply Ind AS from FY 2018-19, even if the Reserve Bank of India (RBI) may have exempted a class of CICs from complying with certain regulations/directions governing CICs in India.
- Functional currency: The ITFG considered a situation where a company has two distinct businesses that may have different functional currencies. In this situation, the ITFG has clarified that paragraph 8 of Ind AS 21, The Effects of Changes in Foreign Exchange Rates, provides that functional currency is the currency of the primary economic environment in which the entity operates. Therefore, functional currency should be identified at the entity level, considering the economic environment in which the entity operates, and not at the level of a business or division and guidance should be drawn from paragraphs 9 to 14 of Ind AS 21.
- Applicability of the Ind AS road map to group companies: The following issues relating to the applicability of the Ind AS road map have been clarified in this bulletin:
- If a parent company voluntarily or mandatorily adopts Ind AS then its holding, subsidiary, joint venture or associate company, whether through direct or indirect association (for example, through another subsidiary) should comply with Ind AS from the financial year in which the parent company starts complying with Ind AS.
- The ITFG has recommended a consistent approach, considering the definitions provided under Ind AS, for the purpose of preparing financial statements and determining the relationship with another entity for applicability of Ind AS. Accordingly, if a company that is now required to apply Ind AS had an associate under previous Generally Accepted Accounting Principles (GAAP), that no longer meets the definition of an associate under Ind AS, such an associate company would not be required to comply with Ind AS (unless it otherwise falls within the Ind AS road map).
- If a company becomes a holding, subsidiary, joint venture or associate company of a company falling within the Ind AS road map during a financial year, then that company is required to comply with Ind AS and prepare Ind AS financial statements for that financial year. Further, for quarterly reporting purposes, such a company is required to prepare interim Ind AS financial statements from the quarter in which it the acquisition occurs.
- If the company ceases to meet the threshold criteria in the Ind AS road map immediately before the mandatory application date then such company will not be required to comply with Ind AS even if it met the criteria on a prior date. For example, if a company met the criteria defined in the Ind AS road map on 31 March 2014 but not on 31 March 2015, it would not be required to comply with Ind AS.
- Property, plant and equipment: The ITFG has clarified the following issues relating to recognition and measurement of Property, Plant and Equipment (PPE):
- A company that has elected to continue with the carrying value under previous GAAP as the deemed cost for all of its PPE on transition to Ind AS may have capital spares that were recognised as inventory under previous GAAP but are eligible for capitalisation under Ind AS. On transition to Ind AS such capital spares should be recognised as a part of PPE if they meet the criteria under Ind AS 16, Property, Plant and Equipment, and the previous GAAP carrying value of such spares can be considered as their deemed cost in accordance with paragraph D7AA of IndAS 101, First-time Adoption of Indian Accounting Standards.
- Capital work in progress is considered to be in the nature of PPE under construction and the provisions of Ind AS 16 apply to it. Accordingly, the option under paragraph D7AA of Ind AS 101, to continue with the carrying value under previous GAAP as deemed cost, is also available with regards to capital work in progress.
- A company that does not elect to apply the deemed cost exemption upon first time adoption of Ind AS is required to apply Ind AS 16 retrospectively to its PPE based on the requirements of Ind AS 101. If such a company had applied depreciation rates specified under Schedule XIV of the Companies Act, 1956 under previous GAAP (without considering the useful life of its PPE), on transition to Ind AS the company is required to recompute depreciation by assessing the useful life of each asset in accordance with requirement of Ind AS 16 and Schedule II to the 2013 Act.
While the depreciation rates in Schedule XIV were intended to be minimum rates (and an estimate of useful life was required to be made), some companies may have applied these depreciation rates in order to comply with Companies Act, 1956 requirements (without considering the useful life of its PPE). These companies would be required to recompute depreciation on a retrospective basis in order to comply with Ind AS 16.
- Deemed cost of an investment in a subsidiary: A company may elect to apply the deemed cost exemption on transition to Ind AS and accordingly measure its investment in its subsidiary at its fair value on the date of transition. Subsequently, Ind AS 27 Separate Financial Statements, permits such a company to measure its investment in its subsidiary at either its cost or in accordance with Ind AS 109, Financial Instruments (at fair value) in its separate financial statements. A company that has used fair value as the measurement basis for the deemed cost on transition, may therefore continue to carry its investment in the subsidiary at the transition date fair value, which is deemed to be its cost under Ind AS.
- Foreign exchange difference on long-term foreign currency monetary item: Upon first time adoption of Ind AS paragraph D13AA of Ind AS 101 permits a company to continue the policy adopted under previous GAAP for accounting for exchange differences arising from translation of long-term foreign currency monetary items that were recognised in the previous GAAP financial statements. Accordingly, a company that had a long-term foreign currency loan and availed of the option under paragraph 46/46A of AS 11, The effects of changes in foreign exchange rates under previous GAAP may continue to capitalise the exchange gain/loss on such foreign currency loans into the cost of the related asset.
However, if the company has also entered into a foreign currency swap transaction for hedging such a long-term foreign currency loan, it will not be permitted to apply hedge accounting to these swaps. This is because the company has no corresponding foreign exchange exposure that affects profit or loss, as it capitalises the exchange differences.
- Toll roads and revenue based amortisation: Paragraph 7AA of
Ind AS 38, Intangible Assets read with paragraph D22 of Ind AS 101,
specifically permits revenue based amortisation of intangible assets arising from service concession arrangements only in respect of toll roads recognised in the financial statements for the period ending immediately before the beginning of the first Ind AS reporting period. This method of amortisation is not generally permitted for intangible assets related to toll roads that are recognised subsequently. However, Schedule II to the 2013 Act permits revenue-based amortisation for such intangible assets without reference to any financial year, which seems inconsistent with the guidance in Ind AS 101.
The ITFG has clarified that in harmonisation of the Companies (Accounts) Rules, 2014 and Ind AS 38 and Ind AS 101, principles of Ind AS 38 should be followed for all intangible assets relating to service concession arrangements including toll roads once Ind AS is applicable to an entity. Accordingly, revenue based amortisation is generally not expected to apply to such intangible assets.
The clarifications in ITFG’s Bulletin 3, issued by the ICAI, shall assist companies while implementing Ind AS, specifically companies falling within Phase I of the Ind AS road map and transitioning to Ind AS from 1 April 2016.
Some of the clarifications are expected to resolve diversity in practice and enable a more consistent application of the Ind AS principles by the transitioning companies. However, the ITFG may consider providing further clarity on the issue relating to application of hedge accounting to derivatives that hedge foreign currency risk on long term foreign currency loans. An alternate view is possible on the basis of the hedge accounting principles in Ind AS 109, Financial Instruments. The foreign exchange differences capitalised by companies (based on paragraph 46/46A of AS 11), are expected to affect profit or loss in the form of depreciation charged on the related asset in later years. This may indicate that hedge accounting could be applied to derivatives that are transacted to hedge such a foreign currency exposure. Hence, the ITFG may consider providing further clarity on this issue.
To access the text of the ITFG Bulletin 3, please click here.