Accounting and Auditing Update - home.kpmg · In this issue of the Accounting and Auditing Update...

www.kpmg.com/in

Accounting and Auditing UpdateIssue no. 23/2018

June 2018

Editorial

© 2018 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

The new revenue standard, Ind AS 115, Revenue Contracts with Customers, provides guidance that applies to contracts with customers in all sectors. Accordingly, the standard may change the way banks account for customer loyalty programmes. Banks provide various incentives to credit card holders as part of their marketing schemes. In this issue of the Accounting and Auditing Update (AAU), we discuss the impact of Ind AS 115 on the accounting of customer loyalty programmes.

A company may have to give credit to its customers when there is a delay in delivery of goods under a contract. Under current Indian GAAP, there is no specific guidance on accounting treatment of liquidated damages. The Expert Advisory Committee of the Institute of Chartered Accountants of India has considered the issue in relation to accounting of liquidated damages. The article summarises the guidance that is available under Indian GAAP and also compares it with the Ind AS 115 guidance to explain how the accounting would be impacted under the new revenue standard.

Companies may issue share warrants to private equity investors or to their lenders. Warrants issued to investors or lenders enable them to purchase additional shares in future at discounted/fixed prices. Under Ind AS, the issuer of such share warrants would need to classify them as equity or liability based on their contractual terms. However, such classification is generally not straight forward and may require significant judgement. The article on accounting of share warrants summarises the concept of equity and liability under Ind AS 32, Financial Instruments: Presentation and discusses certain practical issues such as anti-dilution features, contingent settlement provisions, reclassification of liability into equity, etc.

As is the case each month, we also cover a regular round-up of some recent regulatory updates.

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

Sai VenkateshwaranPartner and HeadAccounting Advisory Services KPMG in India

Ruchi RastogiPartnerAssuranceKPMG in India



Table of contents

Customer loyalty programmes on credit cards

Accounting treatment of liquidated damages

Accounting for share warrants

Regulatoryupdates

0 1 01

05

09

13

0 2

0 3

0 4


Banks provide various incentives to credit card holders as part of their marketing scheme. Such schemes include cash-backs, complementary goods or services and other customer loyalty programmes, where award/loyalty points accrue to customers on each card swipe. These award points can then be redeemed by customers for various third-party goods or services.

Currently, under the Indian Generally Accepted Accounting Principles (GAAP), banks estimate the probable redemption of debit card and credit card award points using an actuarial method by employing an independent actuary. Provisions for such award points are recognised as per AS 29, Provisions, Contingent Liabilities and Contingent Assets.

Under Indian Accounting Standards (Ind AS), accounting for revenue and customer loyalty programmes would be governed by Ind AS 115, Revenue from Contracts with Customers1. Ind AS 115 provides a five-step model for revenue recognition, and also provides specific guidance for options provided to customers to purchase additional goods and services.

In this article, we aim to demonstrate the accounting, recognition and measurement of award credits granted by banks on credit cards as per the principles of Ind AS 115.

Example: Credit cards issued by bank A

The retail banking group of bank A (the bank) has issued different types of credit card to its select banking customers. In order to incentivise the use of the credit card, it has issued various schemes, including a customer loyalty programme. Schemes would vary for each type of credit card. In the current case, bank A considers its programme for ‘silver’ card-holders, where one reward point is allotted for every INR100 spent by the customer. 100 reward points are equivalent to INR20 (the value/price that the bank would pay a third party to take over the points liability). The bank has provided customers with a catalogue of products which are sold by a third party that is participating in the customer loyalty programme with the bank. Customers can redeem their reward points to purchase any of the products given in the catalogue. The number of points that need to be redeemed for each product has been specified against each product in the catalogue. While redeeming their award points, customers need to apply to bank A, either through a physical form, or through an online application. Reward points that would not be redeemed within two years of them being granted, will expire. The bank recovers 1.5 per cent of transaction price as interchange revenue on every card swipe.

This article aims to:Illustrate the accounting for customer loyalty programmes on credit cards under Ind AS 115.

Customer loyalty programmes on credit cards

01 - Accounting and Auditing Update - Issue no. 23/2018


1. Ind AS 115 was notified by the Ministry of Corporate Affairs on 28 March 2018, to be effective for accounting periods beginning from 1 April 2018.

Accounting and Auditing Update - Issue no. 23/2018 - 02


While finalising its financial information for the month of April 2019, bank A observed that it had earned an interchange fee of INR100 million on ‘silver’ credit cards, and 65 million reward points had been accrued to the ‘silver’ credit-card holders. On the basis of its historical experience, bank A expects 90 per cent of the total reward points granted during the month to be redeemed.

Accounting issue

Considering the complexity of credit card arrangements and the involvement of multiple parties, bank A should

analyse the transaction, and evaluate all conditions specified in Ind AS 115, to determine:

• The ‘customer’ in the current transaction

• Whether loyalty points accrued to the card-holders would be a separate performance obligation, and what would be the transaction price allocated to that, and

• Whether bank A would be acting as a principal or an agent in the current transaction.

Accounting guidance and analysis

Ind AS 115 prescribes a five-step approach when determining the amount and timing of revenue. Figure 1 below evaluates each of these steps in context of the above illustration.

Step 1: Identify the contract

In order to identify the contract, bank A is first required to determine the customer. With multiple parties involved in the transaction, it can be challenging to identify the party which is the customer. Depending on facts and circumstances of each case, card issuers may identify either the merchant, or the card holders as their customer2.

In the current illustration, bank A is of the view that since the merchants bear the cost of interchange, at the time of swiping the card, they would be considered as the customer of the bank. The question then arises whether the arrangement to provide loyalty points to the card holders (who are not identified as customers within the contract) would be within the purview of Ind AS 115.

As per the Basis for Conclusions of IFRS 15, Revenue from Contracts with Customers (with which Ind AS 115 is converged), any promise to provide goods or services to the customer’s customer (in this case, the card holder), would be a valid performance obligation, within the context of this standard. Accordingly, though the customer in this case is the merchant, the agreement to provide reward points to the card holder would be accounted for in accordance with Ind AS 115.

Step 2: Identify the separate performance obligation in the contract

Ind AS 115 provides additional guidance on determining whether the customer options for additional goods or services would be considered as a separate performance obligation. This has been considered and evaluated in Figure 2 on the next page.

2. The view of the card issuer should be substantiated with reasons for the conclusion.

Identify the contract with customer

Agreements with customers of

customer are valid contracts

Generally, interchange fees

received by a bank on every card swipe

Separate performance obligation, if material

right received by customer on entering

into the contract

Based on relative stand-alone selling prices of goods or

services

Determine whether bank is a principal

or an agent for third party goods

Separate performance

obligation in the contract

Determine the transaction price

Recognise revenue

STEP 1 STEP 2 STEP 3 STEP 4 STEP 5

Allocate the transaction price

to separate performance

obligation

Figure 1: Evaluation of the five-step model

Source: KPMG in India’s analysis 2018, read with Insights into IFRS, KPMG IFRG Ltd’s publication, 14th edition, September 2017



Figure 2: Determining whether customer options for additional goods or services are separate performance obligations

Source: Revenue Issues In-Depth, KPMG IFRG Ltd.’s publication, Second edition, May 2016

Source: KPMG in India’s analysis, 2018

Could the customer obtain the right to acquire the additional goods or services without entering into the sale agreement?

Does the option give the customer the right to acquire additional goods or services at a price that

reflects the stand-alone selling price for those goods or services?

The option does not give rise to a performance obligation.

The option may be a material right, and if so, it gives rise to a

performance obligation.

No

Yes

No

Yes

In the current case, the reward points granted to the card holders provide them with accumulated rights (material right), which can be used to purchase third party goods or services in the future at discounted prices, accordingly, the grant of such points are considered as a separate performance obligation.

Step 3: Determine the transaction price

When determining the transaction price for the reward points, card issuers are required to first determine the transaction that gives the card holders a right to receive the reward points. In the current illustration, card holders would receive a reward point on swiping of the card above a particular amount (INR100). Each card swipe would result in payment of interchange fees by the merchant to the bank. Accordingly, the transaction price may be considered as the interchange fees received by the bank.

Step 4: Allocate the transaction price to separate performance obligations

The transaction price is allocated to each performance obligation based on the relative stand-alone selling prices of the goods or services being provided. While the stand-alone selling price of the interchange fees would be the same as the transaction price (INR100 million), the stand-alone selling price of the reward points would be calculated on the basis of the likelihood of their redemption. Accordingly, the transaction price would be allocated between the service and the points on a relative selling price basis provided in the table below:

Performance obligation

Stand-alone selling prices

Selling price ratio Price allocation Calculation

Service3 100 89.5% 89.5 (100*89.5%)

Points 11.74 10.5% 10.5 (100*10.5%)

Total 111.7 100.0% 100

3. Service provided by the bank to the merchant for which interchange fees has been charged

4. 65 million points*(20/100) (INR20 for every 100 points accrued)*90% (likelihood of redemption)

Amount (INR in million)



Step 5: Recognise revenue when (or as) each performance obligation is satisfied

The amount allocated to the service provided by the bank (INR89.5 million) should be recognised by it as revenue for the month of April 2019 (since the performance obligation is satisfied at a point in time). However, the accounting for the reward points granted to the customers would depend on whether the bank is acting as a principal or an agent while providing the customer loyalty scheme.

In the above illustration, bank A has the primary responsibility for fulfiling its promise to redeem the reward points, and deliver the third party goods to the card holders. At the same time, the bank has the discretion to set the price of the third party goods (based on the number of reward points that can be redeemed against each good). On evaluating the above factors, the bank determines that it obtains control of the third party goods (more than momentarily) prior to transferring those goods to the customer.

Basis this evaluation, it can be concluded that the bank is acting as a principal and accordingly, it will recognise revenue on gross basis, once the reward points are redeemed by the customer (at a point in time). In April 2019, it will recognise the amount allocated to the reward points (INR10.5 million) as a contract liability. The accounting entry for the transaction will be:

Date Accounting entry

Dr/Cr Amount (INR in million)

30 April 2019

Cash Dr 100

Revenue Cr 89.5

Contract liability Cr 10.5

Consideration of breakage while evaluating stand-alone selling price of reward points

Breakage refers to the portion of rights of customers (in this case card holders) which have not been/which are not expected to be exercised by them.

In the current illustration, bank A has considered 90 per cent of the total reward points to be redeemed, and thus has estimated the breakage to be 10 per cent. While estimating the breakage, the bank should ensure that there is a high probability that recognition of the breakage would not result in a significant reversal of revenue.

Consider this…

• When determining the stand-alone selling price of a customer option for additional goods or services, an entity estimates the likelihood that the customer will exercise the option (breakage). This initial estimate is not subsequently revised because it is an input into the estimate of the stand-alone selling price of the option. Under Ind AS 115, an entity does not reallocate the transaction price to reflect changes in stand-alone selling prices after contract inception. The customer’s decision to exercise the option or allow the option to expire affects the timing of recognition of the amount allocated to the option, but it does not result in reallocation of the transaction price. However, an entity should continue to consider whether a provision for onerous contracts is required to be recognised.

• Sometimes coupons are handed over to the customers at the point of sale and these coupons are often a form of marketing offer. Typically, these coupons have little or no effect on the revenue accounting when they are granted. If there is no general marketing offer, then the entity assesses whether the coupon conveys a material right. This assessment includes consideration of the likelihood of redemption which will often be low, and therefore reduces the likelihood that the coupon will be identified as a material right. As a result, the coupons are often recognised as a reduction in revenue on redemption.

• Customer loyalty programmes generally do not include a significant financing component even though the time period between when the customer loyalty points are earned and redeemed may be greater than one year. This is because the transfer of the related goods or services to the customer i.e. use of the loyalty points — occurs at the discretion of the customer.

Introduction

Under the current Indian Generally Accepted Accounting Principles (GAAP), there is no specific guidance on accounting treatment of liquidated damages under a contract i.e. credits given to the customers on account of delay in delivery under a contract. These credits could be in the form of price discounts, rebates, marketing and spare parts support at concessional or zero cost, etc.

Therefore, an issue arises as to how to account these credits i.e. whether a provision for liquidated damages should be recognised in the statement of profit and loss as and when incurred or it should be reduced from the revenue from such products and services.

In this article, we aim to highlight the accounting treatment of liquidated damages under current GAAP and the corresponding impact under Indian Accounting Standard (Ind AS) 115, Revenue from Contracts with Customers.

Accounting treatment under current GAAP

The Expert Advisory Committee (EAC) of the Institute of Chartered Accountants of India (ICAI)1 has considered the issue on accounting of liquidated damages and has issued an opinion on ‘Accounting treatment of liquidated damages on unexecuted portion of the contract’.

In the given case, the company has to supply goods to the customer as per the agreed schedule of delivery. However, at a particular time a portion of the contracted supplies is delayed on which customer imposes liquidated damages. Such damages are recovered by the customer for the period of delay between the due date of supply of goods as per the delivery schedule and the actual date of delivery of the said goods.

The issue relates to whether the provision for liquidated damages should be made in respect of unexecuted portion of the contract for the period of delay from the due date of delivery till the date of financial statements or till the date of actual delivery of goods.

The EAC considered the guidance provided by AS 1, Disclosure of Accounting Policies, AS 29, Provisions, Contingent Liabilities and Contingent Assets and Framework for the Preparation and Presentation of Financial Statements issued by ICAI to resolve the issue.

The EAC noted that in this case there is no clause in the contract to exit from the sales contract(s) entered with the customer, with or without the payment of penalty and the past experience of the company shows that in most cases, although the customers extend the due date of supply, the liquidated damages are recovered in full. Accordingly, the EAC highlighted that the terms and conditions of the sales contract(s) are binding and legally enforceable with the customers.

This article aims to:Provide an overview of the accounting treatment of liquidity damages under current GAAP and impact under Ind AS 115.

Accounting treatment of liquidated damages



1. ICAI journal - The Chartered Accountant, September 2014



Based on the given facts, the EAC considered the liquidated damages akin to penalty and provided that there is a contractual obligation on the part of the company to pay for the liquidated damages as soon as there is a delay in the supply of goods beyond the due date as per the delivery schedule.

Further, this obligation cannot be avoided by the company’s future course of actions as it does not have any realistic alternative but to settle the contractual obligation (i.e., making the payment of such liquidated damages). Thus, there exists a present obligation arising from past event, viz., delay beyond scheduled delivery and settlement of which is expected to result in an outflow of resources embodying economic benefits.

Accordingly, in the given case, the company should recognise a provision in respect of liquidated damages for the period of delay between the due date of supply of goods as per the delivery schedule and the expected date of delivery of the said goods and not only for the period of delay till the date of financial statements, in the light of evidence provided by events occurring after the balance sheet date, as per paragraph 36 of AS 29.

Additionally, the company should disclose its accounting practice in respect of liquidated damages, considering the materiality of the items and transactions and their impact on the financial statements from the perspective of users of financial statements.

Accounting treatment under Ind AS 115

The new standard on revenue recognition for Ind AS compliant companies i.e. Ind AS 115 has been made effective for accounting periods beginning on or after 1 April 2018.

Ind AS 115 provides a new approach of revenue recognition i.e. revenue should be recognised when (or as) an entity transfers control of goods or services to a customer at the amount to which an entity expects to be entitled. To achieve this, the new standard establishes a five-step model that entities would need to apply to determine when to recognise revenue, and at what amount. These are explained in the diagram below:

Identify the contract with the customer

Identify the performance obligations in the contract

Determine the transaction

price

StepStepStepStepStep

Allocate the transaction price to

the performance obligation in the

contract

Recognise revenue when

(or as) the entity satisfies a performance

obligation.

As per the standard, an entity is required to recognise the revenue at the amount of the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales tax).

The nature, timing and amount of consideration promised by a customer affect the estimate of the transaction price.

While determining the transaction price, an entity is required to consider the effects of all of the following:

• Variable consideration

• Constraining estimates of variable consideration

• Existence of a significant financing component in the contract

• Non-cash consideration

• Consideration payable to a customer.


Variable consideration

Ind AS 115 addresses that an amount of consideration could vary because of discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, or other similar items. Additionally, it recognises the penalties involved in a contract in case of delayed delivery. For instance, where an entity agrees to transfer control of a good or service in a contract with customer at the end of 30 days for INR1,00,000 and if it exceeds 30 days, the entity is entitled to receive only INR95,000. Such a reduction of INR5,000 would be regarded as a variable consideration.

Therefore, applying the principles of Ind AS 115 to the given case, the company would need to evaluate and apply judgement to reduce the amount of liquidated damages (as part of variable consideration) from the transaction price.

Further, the company would be required to update the estimated transaction price to represent faithfully the circumstances present at the end of the reporting period and the changes in circumstances during the reporting period.

Consider this…

• The accounting of liquidated damages would undergo a significant change under Ind AS vis-à-vis current GAAP.

• The nature, timing and amount of consideration promised by a customer affect the estimate of the transaction price. Also, the impact of consideration payable to a customer is to be considered for determining the transaction price.

• Companies would need to apply the five-step model and accordingly, evaluate the penalties as part of the variable consideration while determining the transaction price.



Introduction

Share warrants are instruments that give the holder a right, but not an obligation, to purchase the entity’s shares at specified price (generally at discounted prices) and date. Warrants are often issued to the investors investing in start-ups, the lenders in a debt arrangement or the private equity investor(s) to provide them with specific rights. For example, warrants issued to investors to enable them to purchase additional shares in future at discounted/fixed prices thereby providing additional value to the holder of these warrants. In certain cases, these warrants are conditional and get triggered based on specific conditions in future (example Initial Public Offer (IPO), Qualified Institutional Placement (QIP), purchase of shares by a new investor, existing investor or occurrence of other liquidity event that could be mentioned in the share purchase agreement) which are generally outlined in the initial investment agreement between the company and the investor. Based on the terms, these are either classified as equity or debt instruments in line with the requirements of Indian Accounting Standard (Ind AS) 32, Financial Instruments: Presentation. The classification of the warrants into equity or liability is generally not straight forward and requires significant judgement e.g. when warrants are attached to existing debt or equity shares.

In this article, we aim to illustrate some of the practical application issues with respect to the classification of warrants and the valuation of such instruments.

Is warrant an equity or a liability?

Classification of a warrant either as liability or equity determines accounting of these instruments. This would in turn significantly affect an entity’s balance sheet, including significant accounting ratios particularly when these instruments are liability classified.

There are various considerations which need to be evaluated when determining the classification of the warrants, including the substance of the contractual arrangement. A careful analysis is required for all the terms and conditions attached to the warrants as these terms will affect the initial and the subsequent measurement of these instruments.

Figure 1, on the next page, summarises the concept of a financial liability and equity.

This article aims to:Highlight the principles of Ind AS that would affect the classification of share warrants.

Accounting for share warrants




Figure 1: Identifying financial liabilities and equity


Financial liability

Contractual obligation to deliver cash or another financial asset or to exchange instruments under

potentially unfavourable conditions

Certain contracts settled in the entity’s own equity

Contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities

Equity

Generally, a warrant would not create any obligation to deliver cash, instead, it would be settled by the issuer company by issuing additional shares of the company. Therefore, one may say that warrants would be classified as ‘equity’ and not a ‘financial liability’. However, in practice, other facts and circumstances could add complexities, for example, the number of shares issued against a warrant are not fixed, but variable, the warrants may be issued with other conditions, warrants not being issued at a fair value, etc.

Figure 2 summarises the classification of financial instruments as debt or equity instruments.

Figure 2: Classification of financial instruments into financial liability and equity


Contractual obligation to deliver cash/another financial asset to another party, or to exchange financial assets or financial liabilities with another party under potentially unfavourable conditions (for the issuer of the instrument).

If the warrant will or may be settled in the issuer’s own equity instruments:

• Is it a non-derivative that comprises an obligation for the issuer to deliver a fixed number of its own equity instruments or

• Is it a derivative that will be settled only by the issuer exchanging a fixed amount of cash or other financial assets for a fixed number of its own equity instruments?

Financial liability

Equity

Fixed-for-fixed requirement

No

No

Yes

Yes




The following examples will clarify the concept explained in Figure 2:a. Company A issues share warrants to the investor B.

The share warrants give the investor rights to convert the warrants into a fixed number of equity shares for fixed amount in its functional currency. Whether the instrument meets the fixed for fixed criteria?

In example a, the warrants will be classified in their entirety as equity instruments since the ‘fixed-for-fixed’ criteria has been met.

b. Will the classification of the instrument change if in the above example the fixed amount is denominated in foreign currency instead of the functional currency?

In example b, though the warrant is denominated in a foreign currency, it would not affect its classification, this is because Ind AS 32 has a specific exception in the definition of a financial liability based on which exchange of a fixed number of shares in any currency will enable the financial instrument to be classified as equity.1

c. Continuing with the example ‘a’ above if investor B, instead of having the option to convert the fixed number of equity shares, is entitled to a fixed percentage of company A’s issued and outstanding shares. Will the fixed-for-fixed criteria be met?

In example c, the fixed-for-fixed criteria will not be met since the number of equity shares to be received upon conversion will vary when there are changes in the number of outstanding shares of A.

Practical issuesChange in conversion ratio - Impact of anti-dilution features

Often the warrant agreements have clauses to protect the right of the holder of the instrument from the possible impact of dilution caused due to issue of bonus, share splits, etc. As a general rule, if the number of warrants that are issued upon exercise is variable, it would be classified as a financial liability. However, it is to be noted that if the effect of proportionate adjustment in these circumstances is to preserve the rights of the warrant-holders to other equity holders then it would not preclude equity classification. However, if the effect of adjustment is to increase the conversion ratio if the share price of the company declines or new shares are issued at a lower price (anti-dilution), it would indicate that it is like underwriting the value of the conversion option. This only favours the existing warrant holders at the cost of the other shareholders. Therefore, in those situation, any anti-dilution clause which in substance compensates the holder for the fair value losses fails the fixed-for-fixed criteria and accordingly would be classified as liability.

Contingent settlement provisions

Sometimes the warrants can be exercised by the investor only on the occurrence of certain contingent events as specified in the agreement. The occurrence or non-occurrence of these events are outside the control of the entity and the holder of the instrument.

If the issuer of a warrant is able to control the outcome of an event that would otherwise trigger a payment obligation, i.e. it is able to avoid payment, then no liability arises. Conversely, if the holder can control the outcome, the holder is effectively able to demand payment and the instrument is classified as a liability.

However, there could be situations when neither party controls the ‘event’. Examples of such uncertain events are changes in stock market index, interest rate, taxation requirements or the issuer’s future revenues or debt-to-equity ratio.

The classification of warrants in such cases generally is liability, subject to the following exceptions:

i. The part of the contingent settlement provision that could require settlement in cash or another financial asset is not genuine; or

ii. The issuer can be required to settle in cash or another financial asset only in the event of its own liquidation (as long as liquidation is neither predetermined nor at the option of the holder).

The following examples clarify the concepts discussed above:

a. Company A issues warrants to investor B. The warrants issued can be exercised by B only on the happening of a specific liquidity event such as IPO/QIP which is planned for in three years’ time and requires the approval of a regulator. The warrants are redeemable in cash only if the IPO/QIP does not take place within three years.

In example a, the company does not have an unconditional right to avoid the payment as the warrants can be redeemed in cash if the IPO/QIP does not happen as planned. The happening of IPO/QIP is beyond the control of the company.

The answer does not change even if the likelihood of IPO/QIP not happening or company settling the instrument in cash is remote.

b. If in example a, company A can convert the warrants into fixed number of equity instruments any time after three years or company can redeem the warrant in cash only on the happening of IPO/QIP and no time is stipulated for such IPO/QIP. Will the classification change?

In example b, the issuer would have the unconditional ability to avoid the obligation if it can decide whether to launch an IPO or not. Also in case IPO does not happen the holder is only left with an option to convert the warrants into equity which meets the fixed-for-fixed criterion.

1. The classification of the warrant would vary under International Accounting Standard (IAS) 32, Financial Instruments: Presentation. As per IAS 32, an obligation denominated in a foreign currency represents a variable amount of cash in functional currency and accordingly, the instrument is to be classified as a liability.



Other aspects

Undertaking from the holder that the warrants will not be called for settlement in cash

In many cases, entities may consider that some of the features of the instrument are protective in nature and investor may not exercise some of the rights particularly related to redemption in cash. They may obtain a letter of undertaking from the holder of warrants indicating that the issued warrants would not be redeemed in cash. Such an undertaking, unless it is legally enforceable and irrevocable, is not sufficient to classify the instrument as equity rather than as a financial liability.

For example, assume that the holder of warrant has signed such a letter of undertaking but is able to sell the instrument. Furthermore, assume that the subsequent purchaser would not be restricted by the letter of undertaking that was signed by the seller. In this scenario, the instrument would be classified as a financial liability.

Consider this…

Under Indian GAAP, typically, such warrants would be accounted for only when the warrants are finally exercised and converted into shares. However, with companies transitioning to Ind AS/IFRS, these instruments could impact the balance sheet of the investee companies as some of these instruments would get classified as a liability. In particular, accounting for warrants issued as part of private equity financing transaction/arrangements could become challenging and would depend on the contractual terms. Entities involved in such transactions would need to re-assess their instruments and understand the various terms and conditions, rights and obligations and assess if there is a change in the classification of such warrants from equity under Indian GAAP to a financial liability under Ind AS or IFRS.

MCA notified sections to Companies (Amendment) Act, 2017

On 13 June 2018, the Ministry of Corporate Affairs (MCA) notified certain sections of the Companies (Amendment) Act, 2017 to be effective from 13 June 2018. The key provisions notified are:

Declaration of beneficial interest in any share: Section 89 of the Companies Act, 2013 (2013 Act) currently requires that every person who holds or acquires beneficial interest in a share of a company should make a declaration to the company regarding the particulars of such interest, including nature of interest. The term ‘beneficial interest’ was not defined in the 2013 Act.

The Amendment Act, 2017 clarifies that the ‘beneficial interest in a share’ would include, directly or indirectly, through any contract, arrangement or otherwise, the right or entitlement of a person alone or together with any other person to:

a. Exercise or cause to be exercised any or all of the rights attached to such share or

b. Receive or participate in any dividend or other distribution in respect of such share.

Additionally, a new Section 90 (Register of significant beneficial owners in a company) has been inserted which, inter alia, prescribe that a register of beneficial owners should be maintained by a company and filed with the Registrar of Companies (RoC).

Subsequent to notification of the revised section on declaration of beneficial interest in shares, MCA issued Companies (Significant Beneficial Owners) Rules, 2018. The rules provide the procedure for filing declaration of beneficial interest by the significant owner, for filing of return and maintenance of register by companies on such declaration. Further, the rules provide the forms for filing the aforementioned declaration and return.

Annual General Meeting (AGM): The Amendment Act, 2017 has permitted an unlisted company to hold its AGM at any place in India provided consent has been given by all the members in writing or by an electronic mode in advance. (Section 96)

Place of keeping and inspection of registers, returns, etc.: Currently, under 2013 Act, companies can keep the registers or copies of return at a place other than registered office if a special resolution in this regard is passed at AGM and a copy of such resolution is submitted to RoC. The Amendment Act, 2017 exempts companies to give the copy of such special resolution in advance to RoC.

Additionally, a proviso has been inserted which provides the conditions where the copies of a prescribed return and registers would not be available for inspection. (Section 94) (Source: MCA notification S.O. 2422(E) dated 14 June 2018)

Regulatory updates





The MCA issued amendment to certain rules under the 2013 Act

The MCA issued following rules to amend the existing rules under the 2013 Act

• The Companies (Management and Administration) Second Amendment Rules, 2018

Currently under the Companies (Management and Administration) Rules, 2014, every listed company is required to file with the RoC, a return in Form No. MGT.10, with respect to changes in the shareholding position of promoters and top 10 shareholders of the company, in each case, representing increase or decrease by two per cent or more of the paid-up share capital of the company. The return has to be filed within 15 days of such change. Now, the amended rules omitted this requirement and accordingly form no. MGT.10 has also been removed from the rules.

Additionally, as per the amendment, any item of business specified under Rule 22(16), required to be transacted by means of postal ballot, may be transacted at a general meeting by a company which is required to provide the facility to members to vote by electronic means under Section 108 of the 2013 Act in the prescribed manner.

• The Companies (Appointment and Qualification of Directors) Third Amendment Rules, 2018

The amended Rules have revised the following forms:

– Form no. DIR-3: Application for allotment of director Identification Number before appointment in an existing company or Limited Liability Partnership (LLP)

– Form no. DIR-6: Intimation of change in particulars of a director/designated partner to be given to the central government.

(Source: MCA notifications dated 14 June 2018)

ICAI issued exposure drafts for amendments to Ind AS

The International Accounting Standards Board (IASB) issues amendments to International Financial Reporting Standard (IFRS) as part of its annual improvements process. Annual improvements are part of the IASB’s process for maintaining IFRS and contain interpretations that are minor or narrow in scope. Amendments made as part of annual improvement process either clarify the wording in an IFRS or correct relatively minor oversights or conflicts between existing requirements of IFRS.

In order to keep Ind AS updated with the revisions made to IFRS, the Institute of Chartered Accountants of India (ICAI) on 12 June 2018 issued following Exposure Drafts to propose amendments to Ind AS:

Annual Improvements to Ind AS (2018)

Ind AS 103, Business Combinations and Ind AS 111, Joint Arrangements

The amendment to Ind AS 103 proposes to clarify that when an entity obtains control of a business that is a joint operation, then the acquirer would remeasure its previously held interest in that business. Such a transaction would be considered as a business combination achieved in stages and accounted for on that basis.

Further, paragraph B33CA is proposed to be added to Ind AS 111 to clarify that if a party that participates in a joint operation, but does not have joint control, obtains joint control over the joint operation (which constitutes a business as defined in Ind AS 103), it would not be required to remeasure its previously held interests in the joint operation.

Ind AS 12, Income Taxes

This amendment proposes to clarify that the income tax consequences of distribution of profits (i.e. dividends), including payments on financial instruments classified as equity, should be recognised when a liability to pay dividend is recognised. The income tax consequences should be recognised in profit or loss, other comprehensive income or equity according to the past transactions or events that generated distributable profits were originally recognised.

Also the amendment, by moving the requirement of recognition from paragraph 52B to 57A, aims to clarify that the requirement for recognition applies to all income tax consequences and not only to the situation where there are different tax rates for distributed and undistributed profits as described in paragraph 52A of Ind AS 12.

Ind AS 23, Borrowing Costs

The amendment proposes to clarify that in computing the capitalisation rate for funds borrowed generally, an entity should exclude borrowing costs applicable to borrowings made specifically for obtaining a qualifying asset, only until the asset is ready for its intended use or sale. Borrowing costs related to specific borrowings that remain outstanding after the related qualifying asset is ready for intended use or for sale would subsequently be considered as part of the general borrowing costs of the entity.

Transitional provisions: The transitional provision introduced in Ind AS 23 aim to clarify that an entity should apply the amendments to the borrowing costs incurred on or after the date the entity first applies the amendments.



The amendments are expected to be effective on or after 1 April 2019 with early adoption permitted.

Plan Amendment, Curtailment or Settlement, Amendments proposed to Ind AS 19, Employee Benefits related to pension accounting

In line with the amendments to IAS 19, Employee Benefits, ICAI issued narrow scope amendments to Ind AS 19 in case of a plan amendment, curtailment or settlement. The amendment specifies how companies should determine pension expenses when changes to a defined benefit pension plan occur.

The amendments require a company to use the updated assumptions from this remeasurement to determine current service cost and net interest for the remainder of the reporting period after the change to the plan. Currently, Ind AS 19 does not distinguish between the periods before and after the change in plan for the purpose of determining current service cost and net interest. The amendments are expected to provide useful information to users of financial statements by requiring the use of updated assumptions.

The amendment also proposes that the effect of asset ceiling should be disregarded when calculating gain or loss on settlement of plan, and it must be dealt with separately in other comprehensive income.


Prepayment Features with Negative Compensation, Amendments to Ind AS 109, Financial Instruments

The exposure draft proposes an exception to current rule on prepayment for financial assets containing prepayment features with reasonable negative compensation. Such financial assets could be measured at amortised cost or at Fair Value Through Other Comprehensive Income (FVOCI), if they meet the other relevant requirements of Ind AS 109.

To be eligible for the exception, the fair value of the prepayment feature would have to be insignificant on initial recognition of the asset. If this is impracticable to assess based on the facts and circumstances that existed on initial recognition of the asset, then the exception would not be available.

In line with amendments issued to IFRS 9, Financial Instruments, the exposure draft also provides that the financial assets prepayable at current fair value would be measured at Fair Value Through Profit and Loss (FVTPL). The same would apply if the prepayment amount includes the fair value cost to terminate a hedging instrument if the amount is inconsistent with the current Ind AS 109 prepayment rules.


Long-term interests in associates and joint ventures

An entity’s net investment in its associate or joint venture includes investment in ordinary shares and other interests that are accounted using the equity method, and other long-term interests, such as preference shares and long term receivables or loans, the settlement of which is neither planned, nor likely to occur in the foreseeable future. These long term interests are not accounted for in accordance with Ind AS 28, instead, they are governed by the principles of Ind AS 109.

As per para 10 of Ind AS 28, the carrying amount of an entity’s investment in its associates and joint ventures increases or decreases (as per equity method) to recognise the entity’s share of profit or loss of its investee associates and joint ventures. Paragraph 38 of Ind AS 28 further states that the losses that exceed the entity’s investment in ordinary shares are applied to other components of the entity’s interest in the associate or joint venture in the reverse order of their superiority.

In this context, exposure draft clarifies that the accounting for losses allocated to long-term interests would involve the dual application of Ind AS 28 and Ind AS 109.

The amendments are expected to be effective retrospectively from 1 April 2019 with early adoption permitted.

Exposure Draft (ED) of amendments to Ind AS 40

The exposure draft proposes to provide entities with a choice for measurement of investment property using either the cost or the fair value model, and bring the requirements of Ind AS 40 in line with that of IAS 40, Investment Property. It further incorporates consequential changes that would be brought by application of Ind AS 116, Leases. The provisions proposed to be amended are relating to:

• Choice between cost model and fair value model- Entities have a choice to measure the investment properties either using a cost model, or a fair value model, and apply that policy to all the investment properties. The ED also specifies the entities and investment properties which are exempted from provision of the above principle.

• Fair value model - After initial recognition, entities that choose the fair value model are required to measure all their investment properties/right-of-use assets at fair value, and measure the gain or loss arising from a change in the fair value in the statement of profit and loss for the period in which it arises. Also the ED provides the list of transactions where the above mentioned approach will not be applied.

The amendments are expected to be effective on or after 1 April 2020.

The last date for comments on the exposure drafts issued by ICAI is 11 July 2018.(Source: Exposure drafts issued by ICAI dated 12 June 2018)



ICAI issued valuation standards

Introduction

Section 247 of the 2013 Act governs the provisions relating to the valuation by registered valuers. On 18 October 2017, MCA notified Section 247 of the 2013 Act and issued Companies (Registered Valuers and Valuation) Rules, 2017, which provide that the central government may constitute a committee to advise on matters and to make recommendations on formulation and laying down of valuation standards and policies for compliance by the companies and registered valuers.

New development

The ICAI through its notification dated 10 June 2018 issued following Indian Valuation Standards (Ind VS):

1. Ind VS 101- Definitions

2. Ind VS 102- Valuation Bases

3. Ind VS 103- Valuation Approaches and Methods

4. Ind VS 201- Scope of Work, Analyses and Evaluation

5. Ind VS 202- Reporting and Documentation

6. Ind VS 301- Business Valuation

7. Ind VS 302- Intangible Assets

8. Ind VS 303- Financial Instruments

The ICAI has issued Ind VS to standardise the principles, practices and procedures followed by registered valuers and other valuation professionals in valuation of assets, liabilities or a business. Additionally the standards provides concepts, principles and procedures considering internationally accepted practices and legal framework and practices prevalent in India.

Further, in respect of valuation engagements under other statutes like Income-tax Act 1961, Securities Exchange Board of India (SEBI), Foreign Exchange Management Act (FEMA) etc., the application of Ind VS would be on recommendatory basis for the members of ICAI.

Effective date: The Ind VS are applicable for the valuation reports issued on or after 1 July 2018. Further, the Ind VS will be effective till Valuation Standards are notified by the central government under Rule 18 of the Companies (Registered Valuers and Valuation) Rules, 2018.(Source: Ind VS issued by ICAI dated 10 June 2018)

ICAI withdrew the Guidance Note on Accounting for Real Estate Transactions (for entities to whom Ind AS is applicable)

In May 2016, ICAI issued a Guidance Note on Accounting for Real Estate Transactions applicable entities to whom Ind AS is applicable. The guidance note is based on principles of Ind AS 11, Construction Contracts and Ind AS 18, Revenue.

On 28 March 2018, MCA notified Ind AS 115, Revenue from Contracts with Customers (which is based on IFRS 15, Revenue from Contracts with Customers) as part of the Companies (Indian Accounting Standards) Amendment Rules, 2018. The new standard is effective for accounting periods beginning on or after 1 April 2018, replaces existing revenue recognition standards Ind AS 11, and Ind AS 18. Accordingly, ICAI through its notification dated 1 June 2018 withdraws the Guidance Note on Accounting for Real Estate Transactions (for entities to whom Ind AS is applicable).(Source: ICAI’s notification dated 1 June 2018)

SEBI amends regulations relating to Insolvency and Bankruptcy Code, 2016

In 2016, the Insolvency and Bankruptcy Code, 2016 (the Code) was issued which consolidates and amends the laws relating to reorganisation and insolvency resolution. The key policy charter of the Code is to facilitate the time bound and early assessment of the viability and liquidity of an enterprise.

With an aim to further simplify and facilitate the process of resolution under the Code, SEBI through its notifications dated 31 May 2018 issued amendments to following regulations which are effective from 1 June 2018.

SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations)

The amended regulations provide relaxations to a listed entity. Following are the key relaxations:

• The provisions relating to Audit Committee, Nomination and Remuneration Committee, Stakeholders’ Relationship Committee and Risk Management Committee would not be applicable during the insolvency resolution process period in respect of a listed entity which is undergoing Corporate Insolvency Resolution Process (CIRP) under the Code.

• The shareholders’ approval in case of material related party transactions would not be required for listed companies whose resolution plan has been approved under the Code.

• The provision relating to compliance in case of reclassification of promoter would not apply if the re-classification of existing promoter or promoter group of the listed entity is as per the resolution plan approved under Section 31 of the Code subject to specified conditions.



SEBI (Delisting of Equity Shares) Regulations, 2009 (Delisting Regulations)

Regulation 3 of the Delisting Regulations has been amended to provide an exemption to a listed entity where delisting of equity shares made pursuant to a resolution plan approved under Section 31 of the Code. Additionally, it provides the conditions to be satisfied by a listed entity to avail the exemption.

Regulation 30 of the Delisting Regulations has also been amended to permit application for listing of delisted equity shares by a company which has undergone CIPR under the Code.

SEBI (Substantial Acquisition of Shares and Takeover), Regulations 2011 (Shares and Takeover Regulations)

Regulation 3(2) of the Shares and Takeover Regulations has been amended to permit the acquirer to acquire shares or voting rights beyond the specified permissible limit for non-public shareholding, in case of acquisition pursuant to a resolution plan approved under CIRP.

SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR Regulations)

The amendment to ICDR Regulations clarifies that the provisions of preferential issue of specified securities under Chapter VII of the ICDR Regulations (except the lock-in provisions) would not apply to the rehabilitation scheme approved by the Board of Industrial and Financial Reconstruction under the Sick Industrial Companies (Special Provisions) Act, 1985 or the resolution plan approved under CIRP.

(SEBI notification no. SEBI/LAD-NRO/GN/2018/20, SEBI/LAD-NRO/GN/2018/21,

SEBI/LAD-NRO/GN/2018/22, SEBI/LAD-NRO/GN/2018/23 dated 31 May 2018)

SEBI issued guidelines for preferential issue of units by InvITs

Regulation 2(1)(zo) of SEBI (Infrastructure Investment Trusts) Regulations, 2014 (InvIT Regulations) defines a preferential issue. Further, Regulation 14(4) of InvIT Regulations provides that InvITs may raise funds by any subsequent issue of units after an initial offer through preferential allotment, in a manner as specified by SEBI from time to time.

Accordingly, SEBI issued a circular dated 5 June 2018 to provide the detailed guidelines for preferential issue by InvITs. The guidelines provide the manner in which any subsequent issue of units after an initial offer should be made by an InvIT.

The key provisions discussed in the circular are as follows:

• No preferential issue of units by the InvIT has been made in the six months preceding the relevant date.

• Allotment pursuant to preferential issue shall be completed within 12 days

• The units shall be issued only in dematerialised form

• The units in a preferential issue shall be offered and allotted to a minimum of two investors and maximum of 1,000 investors in a financial year

• The preferential issue shall be made at a price not less than the average of the weekly high and low of the closing prices of the units quoted on the stock exchange during the two weeks preceding the relevant date.

The circular provides detailed provisions which is divided under following broad heads:

• Conditions for preferential issue

• Placement document

• Pricing

• Restriction on allotment

• Transferability of units.

(Source: SEBI circular SEBI/HO/DDHS/DDHS/CIR/P/2018/89 dated 5 June 2018)

MCA issued amendment to AS 11

On 18 June 2018, MCA issued Companies (Accounting Standards) Amendment Rules, 2018 to issue amendments to AS 11, The Effects of Changes in Foreign Exchange Rates.

Currently, AS 11 provides that in case of disposal of a non-integral foreign operation the cumulative amount of the exchange differences which have been deferred and which relate to that operation should be recognised as an income or as an expense in the same period in which the gain or loss on disposal is recognised. Additionally, AS 11 specifies what would constitute a disposal of interest by an entity in a non-integral foreign operation.

In this regard, MCA amended AS 11 to clarify that the remittance from a non-integral foreign operation by way of repatriation of accumulated profits does not form part of a disposal unless it constitutes return of the investment.

(Source: MCA notification G.S.R. 569(E). dated 18 June 2018)



KPMG in India’s IFRS instituteVisit KPMG in India’s IFRS institute - a web-based platform, which seeks to act as a wide-ranging site for information and updates on IFRS implementation in India.

The website provides information and resources to help board and audit committee members, executives, management, stakeholders and government representatives gain insight and access to thought leadership publications that are based on the evolving global financial reporting framework.

FRRB issued its observations on compliance with financial reporting requirements by listed and other companies

8 May 2018

Recently, the Financial Reporting Review Board (FRRB) of the ICAI issued its third volume of ‘Study on Compliance of Financial Reporting Requirements’ (the study). The study highlights instances of non-compliance by certain companies with regard to the reporting requirements prescribed

under:

• Accounting Standards

• Standards on Auditing

• Schedule II and schedule III to the Companies Act, 2013/Revised Schedule VI to the Companies Act, 1956

• Other relevant laws and regulations including:

– Companies (Auditor’s Report) Order (CARO)

– Banking Regulation Act, 1949 and

– IRDAI (Preparation of Financial Statements and Auditor’s Report of Insurance Companies) Regulations, 2002.

This issue of First Notes provide an overview of the key observations of the FRRB with respect to AS and Schedule II and III to the 2013 Act as provided in its study.

First NotesIFRS NotesInd AS Transition Facilitation Group (ITFG) issues Clarifications Bulletin 15

18 April 2018

The Ind AS Transition Facilitation Group (ITFG) in its meeting considered certain issues received from the members of the Institute of Chartered Accountants of India (ICAI), and issued its Clarifications’ Bulletin 15 on 5 April 2018 to provide clarifications on 10 application issues relating to Indian

Accounting Standards (Ind AS).

This issue of IFRS Notes provides an overview of the clarifications issued by ITFG through its Bulletin 15.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.


The KPMG name and logo are registered trademarks or trademarks of KPMG International.

This document is meant for e-communication only.

Introducing

‘Ask a question’write to us at [email protected]

Follow us on: kpmg.com/in/socialmedia

Previous editions are available to download from: www.kpmg.com/in

Feedback/queries can be sent to [email protected]

Voices on Reporting – Webinar

KPMG in India is pleased to present Voices on Reporting – a series of knowledge sharing calls to discuss current and emerging issues relating to financial reporting.

The Securities and Exchange Board of India (SEBI), on 9 and 10 May 2018, issued certain amendments to the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations).These amendments give effect to the approved recommendations of the Kotak Committee on Corporate Governance (the Committee) report.

Many amendments are effective from 1 October 2018 and 1 April 2019 onwards.

In our recent session of Voices on Reporting webinar on 18 May 2018, we discussed the key amendments in the SEBI Listing Regulations based on the recommendations of the Kotak Committee report.

The audio recording and presentation of the session can be accessed at KPMG in India website.

Date post:	07-Sep-2019
Category:	Documents
Upload:	others
View:	2 times
Download:	0 times

Accounting and Auditing Update - home.kpmg · In this issue of the Accounting and Auditing Update...

Documents