March 2015

ASSESMENT OF THE IMPACT OF IND AS (IFRS) ON AUTOMOBILE

SECTOR

CA H J MANKAD

MEMBER OF ICAI

M.NO. 154850

SUMMARY From Paragraph Section1 Introduction IN 1 Section 2 Overview of Ind As 101 2.1 Section 3 Accounting for Revenue 3.1 Section 4 Accounting for Provision for Warranty 4.1 Section 5 Accounting for Hedge and Derivative Instruments 5.1 Section 6 Accounting for Securitizations of Receivables 6.1 Section 7 Accounting for Deferred Tax Asset & Liability 7.1 Section 8 Accounting for Embedded Derivative 8.1 Section 9 Accounting for Product Development Cost -Intangible Asset 9.1 Section 10 Accounting for Property Plant & Equipment 10.1 Section 11 Conclusion 11.1 Appendix 1 References

Section 1 Introduction IN 1 The main objectives of the discussion paper are

1) To highlight the areas of financial reporting which will have a major impact on first IFRS Financial Statement of the Automobile Companies.

2) To help clients understand the impact of IFRS on the financial reporting process. 3) To help the KPMG Teams to have an overview of the specific accounting issues in Automobile Sector.

IN 2 Based on the experience in the Automobile Sector, I have outlined the list of the significant accounting areas to be consider by automobile sector while moving to IFRS.

Section 2 Overview of Ind As 101 2.1 The below figure describes the major points which are relevant for preparing the first Ind As balance sheet.

Explicit & Unreserved Statement on compliance with Ind As

Impact: High

2.2 An entity’s first Ind AS financial statements are the first annual financial statements in which the entity adopts Ind ASs, in accordance with Ind Ass notified under the Companies Act, 2013 and makes an explicit and unreserved statement in those financial statements of compliance with Ind ASs. (Para 3 of Ind As 101) Accounting Policies Impact: High 2.3 An entity shall use the same accounting policies in its opening Ind AS Balance Sheet and throughout all periods presented in its first Ind AS financial statements. Those accounting policies shall comply with each Ind AS effective at the end of its first Ind AS reporting period, except for which an entity has selected the exception from applying Ind As from retrospective application. (Para 7 of Ind As 101) 2.4 An entity shall not apply different versions of Ind ASs that were effective at earlier dates. An entity may apply a new Ind AS that is not yet mandatory if that Ind AS permits early application. (Para 8 of Ind As 101) 2.5 An entity shall, in its opening Ind AS Balance Sheet: (a) Recognise all assets and liabilities whose recognition is required by Ind ASs; (b) Not recognise items as assets or liabilities if Ind ASs do not permit such recognition; (c) Reclassify items that it recognised in accordance with previous GAAP as one type of asset, liability or component of equity, but are a different type of asset, liability or component of equity in accordance with Ind ASs; and (d) Apply Ind ASs in measuring all recognised assets and liabilities. (Para 10 of Ind As 101) 2.6 The accounting policies that an entity uses in its opening Ind AS Balance Sheet may differ from those that it used for the same date using its previous GAAP. The resulting adjustments arise from events and transactions before the date of transition to Ind ASs. Therefore, an entity shall recognize those adjustments directly in retained earnings (or, if appropriate, another category of equity) at the date of transition to Ind ASs. (Para 11 of Ind As 101)

Overview of

Ind As 101

Explicit Unreserved

Statement on

compliance with Ind

As

Accounting

Policies

Opening IFRS

Balance sheet

Comparative

Information &

Reconciliations

Exemption

Exceptions from

retrospective

application

Opening IFRS Balance sheet Impact: High 2.7 The MCA through notification dated 16 February 2015 has issued the Companies (Indian Accounting Standards) Rules, 2015 (Rules) which lay down a roadmap for companies other than insurance companies, banking companies and non-banking finance companies (NBFC) for implementation of Ind AS converged with IFRS. The Rules will come into force from the date of its publication in the Official Gazette. 2.8 The Ind As is applicable to companies as follows:

Particulars Phase 1 Phase 2 Voluntary Adoption

Year of adoption FY 2016-17 FY 2017-18 FY 2015-16

Comparative year FY 2015-16 FY 2016-17 FY 2014-15

Transition Date (Opening IFRS Balance sheet)

01.04.2015 01.04.2016 01.04.2014

Adoption Date (Comparative Financial Statement)

FY 2015-16 FY 2016-17 FY 2014-15

First Reporting Period

FY 2016-17 FY 2017-18 FY 2015-16

Comparative Information & Reconciliations Impact: High 2.8 An entity’s first Ind AS financial a shall include 1) At least three Balance Sheet, 2) Two Statements of profit and loss, 3) Two Statements of cash flows and 4) Two Statements of changes in equity 5) Related notes, including comparative information for all statements presented. 2.9 An entity first Ind AS financial a shall include 1. Reconciliations of its equity reported in accordance with previous GAAP to its equity in accordance with Ind ASs for both of the following dates:

(A) the date of transition to Ind ASs; and (B) the end of the latest period presented in the entity’s most recent annual financial statements in

accordance with previous GAAP.

2. A reconciliation to its total comprehensive income in accordance with Ind ASs for the latest period in the entity’s most recent annual financial statements. The starting point for that reconciliation shall be total comprehensive income in accordance with previous GAAP for the same period or, if an entity did not report such a total, profit or loss under previous GAAP.

Carve Out Ind AS 101, requires an entity to provide comparatives as per the existing notified Accounting Standards. It is provided that, in addition to aforesaid comparatives, an entity may also provide comparatives as per Ind As on a memorandum basis. Entities that provide comparatives would have to provide reconciliations which have to provide reconciliations which are similar to IFRS

Exemption from Ind As Impact: High 2.10 The Automobile companies can opt for following exemption while preparing the first Ind As balance sheet. (Note: There are 23 exemptions as per Ind As 101, the below mentioned are the relevant exemptions for automobile sector) (A) Deemed cost

Exemption 1. Measurement of item of property, plant and equipment at the date of transition to Ind As at its fair value

and use that fair value as its deemed cost at that date. 2. A first-time adopter may elect to use a previous GAAP revaluation of an item of property, plant and

equipment at, or before, the date of transition to Ind ASs as deemed cost at the date of the revaluation, if the revaluation was, at the date of the revaluation, broadly comparable to:

( a ) fair value; or ( b ) cost or depreciated cost in accordance with Ind ASs, adjusted to reflect, for example, changes in a general or specific price index.

3. As per carve outs Ind AS 101 provides an entity an option to use carrying values of all assets as on the date of transition in accordance with previous GAAP as an acceptable starting point under Ind AS.

Applicability of the Exemption

1. investment property, accounted for in accordance with the cost model in Ind AS 40, Investment Property; and

2. intangible assets that meet: ( i ) the recognition criteria in Ind AS 38 (including reliable measurement of original cost); and ( i i ) the criteria in Ind AS 38 for revaluation (including the existence of an active market).

An entity shall not use these elections for other assets or for liabilities. (B) Cumulative translation differences

Exemption A first-time adopter need not comply with these requirements for cumulative translation differences that existed at the date of transition to Ind As. If a first-time adopter uses this exemption:

(a) the cumulative translation differences for all foreign operations are deemed to be zero at the date of transition to Ind ASs; and (b) the gain or loss on a subsequent disposal of any foreign operation shall exclude translation differences that arose before the date of transition to Ind ASs and shall include later translation differences. (C ) Compound financial instruments Exemption Ind AS 32 Financial Instruments: Presentation requires an entity to split a compound financial instrument at inception into separate liability and equity components. If the liability component is no longer outstanding, retrospective application of Ind AS 32 involves separating two portions of equity. The first portion is in retained earnings and represents the cumulative interest accreted

on the liability component. The other portion represents the original equity component. However, in accordance with this Ind AS, a first-time adopter need not separate these two portions if the liability component is no longer outstanding at the date of transition to Ind ASs. (D ) Designation of previously recognised financial instruments Exemption An entity can designate the financial instruments in the first Ind As balance sheet if the recognition criteria laid down in Ind As 109 are met: 1. Any Financial Liability through profit or loss 2. Financial Asset through profit or loss 3. An investment in Equity Instrument at Fair Value through OCI

(E ) Revenue from contracts with customers Exemption 1. A first-time adopter may use one or more of the following practical expedients when applying Ind AS 115

retrospectively:

(a) for completed contracts, an entity need not restate contracts that begin and end within the same annual reporting period;

(b) for completed contracts that have variable consideration, an entity may use the transaction price at the date the contract was completed rather than estimating variable consideration amounts in the comparative reporting periods; and

(c) for all reporting periods presented before the beginning of the first Ind AS reporting period, an entity need not disclose the amount of the transaction price allocated to the remaining performance obligations and an explanation of when the entity expects to recognize that amount as revenue.

2. A first-time adopter is not required to restate contracts that were completed before the earliest period presented. A completed contract is a contract for which the entity has transferred all of the goods or services identified in accordance with previous GAAP

(F) Business Combination Exemption

1. A first-time adopter may elect not to apply Ind AS 103 retrospectively to past business combinations (business combinations that occurred before the date of transition to Ind ASs).

2. However, if a first-time adopter restates any business combination to comply with Ind AS 103, it shall restate all later business combinations and shall also apply Ind AS 110 from that same date.

Exception from Retrospective Application of Ind As 101 Impact: High

2.11 The exception from the retrospective application is applicable from the transition date. The exceptions which are to be applied prospectively from the date of transition.

2.12 Suppose an entity which is covered in the Phase 1 of the roadmap then the date of transition would be 01.04.2015 (Refer Para 2.8),these exceptions will be applicable from 01.04.2015 & therefore, these standards will not be effective for the period prior to 01.04.2015.

(A) Derecognition of financial asset and financial liabilities

Requirement as per Standard

As required by Ind As 109, at the date of transition to Ind As an entity shall apply derecognition criteria laid down Ind As 109 retrospectively, if the information needed to apply Ind AS 109 to financial assets and financial liabilities derecognised as a result of past transactions was obtained at the time of initially accounting for those transactions. Exceptions If the information needed to apply Ind AS 109 to financial assets and financial liabilities derecognised as a result of past transactions is not obtained at the time of initially accounting for those transactions, then the derecognition criteria will apply prospectively.

(B) Hedge Accounting

Requirement as per Standard

As required by Ind As 109, at the date of transition to Ind AS an entity shall: (a) Measure all derivatives at fair value; and (b) Eliminate all deferred losses and gains arising on derivatives that were reported in accordance with previous GAAP as if they were assets or liabilities.

Exceptions from

Retrospective Application

Derecognition of

financial asset

and financial

liabilities

Hedge

Accounting

Non-

Controlling

Interest

Classificatio

n &

Measureme

nt of

financial

asset

Impairment of

financial asset

Embedded

Derivative

Government

Loans

Exceptions

1. An entity shall not reflect in its opening Ind AS Balance Sheet a hedging relationship of a type that does not qualify for hedge accounting in accordance with Ind AS 109.

2. Transactions entered into before the date of transition to Ind ASs shall not be retrospectively designated as hedges.

(C) Non- Controlling Interest

Requirement as per Standard

1. Disclosure of the total comprehensive income is attributable to the owners of the parent and to the

non-controlling interest even if this results in the non-controlling interest having a deficit balance.\

2. Accounting for changes in the parent’s ownership interest in a subsidiary that do not result in a loss

of control;

3. Accounting for a loss of control over a subsidiary, and the related requirements of paragraph 8A of

Ind AS 105, Non-current Assets Held for Sale and Discontinued Operations.

Exceptions 1. A first-time adopter has an option to apply these requirement prospectively from the date of

transition. 2. if a first-time adopter elects to apply Ind AS 103 retrospectively to past business combinations, it shall

also apply Ind AS 110 retrospectively.

(D) Classification and Measurement of financial asset

Requirement of Standard

1. An entity shall classify financial assets as subsequently measured at amortized cost, fair value through other comprehensive income or fair value through profit or loss on the basis of both:

(a) The entity’s business model for managing the financial assets and (b) The contractual cash flow characteristics of the financial asset.

Exceptions

1. An entity shall assess whether a financial asset meets the conditions of measuring a financial asset at amortized cost, fair value through other comprehensive income or fair value through profit or loss as per Ind AS 109 on the basis of the facts and circumstances that exist at the date of transition to Ind AS.

(E) Impairment of financial asset

Requirement of Standard

An entity shall recognize a loss allowance for expected credit losses on

1. a financial asset ,

2. a lease receivable,

3. a contract asset or

4. a loan commitment and a financial guarantee contract to which the impairment requirements apply.

Exceptions

1. As on the date of the transition to Ind As, an entity shall use reasonable and supportable information that is available without undue cost or effort to determine the credit risk at the date that financial instruments were initially recognized and compare that to the credit risk at the date of transition to Ind As.

2. In order to determine the loss allowance on financial instruments initially recognized (or loan commitments or financial guarantee contracts to which the entity became a party to the contract) prior to the date of initial application, both on transition and until the derecognition of those items, an entity shall consider information that is relevant in determining or approximating the credit risk at initial recognition.

(F) Embedded Derivatives

Requirement of Standard

If a hybrid contract contains a host that is not an asset within the scope of this Standard, an embedded derivative shall be separated from the host and accounted for as a derivative under this Standard if, and only if:

(i) the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host

(ii) a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and

(iii) the hybrid contract is not measured at fair value with changes in fair value recognised in profit or loss (ie a derivative that is embedded in a financial liability at fair value through profit or loss is not separated).

Exception

1. A first-time adopter shall assess whether an embedded derivative is required to be separated from

the host contract and accounted for as a derivative on the basis of the conditions that existed later of

(i) the date it first became a party to the contract and (ii) date a reassessment required as per Ind As 109

(G) Government Loans

Requirement of Standard

An entity has obtained the loan from the Government below market interest rate, then as per IAS 20,

1. The loan shall be recognized and measured accordance with Ind As 109.

2. The benefit of the below market rate of interest shall be

Initial Carrying Value as per Ind As 109 (A) Rs XXXX

Less: Proceeds received (B) (Rs XXXX)

Benefit/ Government Assistance (A-B) Rs XXXX

3. The benefit shall be recognized in profit or loss on a systematic basis over a periods which the entity

recognizes as expense the related cost for which the grants are intended to compensate.

Exception

1. If the an entity may apply the requirements in Ind AS 109 and Ind AS 20 retrospectively to any government loan originated before the date of transition to Ind ASs, provided that the information needed to do so had been obtained at the time of initially accounting for that loan.

2. If the entity does not have information that is needed at the time of initially accounting for that loan, then the company shall classify the all government loans received as a financial liability or an equity instrument in accordance with Ind As 32.

Section 3 Accounting for Revenue 3.1 The Automobile companies recognize the revenue on the principles laid down in Accounting Standard 9 “Revenue Recognition”. As per the notification issued by MCA the companies shall recognize the revenue on the basis of the new standard i.e. Ind As 115 “Revenue from Contracts from Costumers” which is in line with IFRS 15. The below mentioned figure highlights the key impact in revenue recognition as per the Ind As 115

Sold But Not Delivered (SBND) Certificate

Impact: High

3.2 It is a general practice in automobile sector that, the companies collect the SBND Certificates or Risk & Reward

Certificate from the dealers stating that risk & rewards of the vehicles are transferred to the dealers even though

the physical possession of the vehicles has not been transferred to the dealer.

3.4 The main objective of the automobile company is to recognize revenue in the books for the vehicles which are

lying in a factory and whose SBND has been received. Hence the value of the closing stock will reduce to the extent

of the recognition of the revenue.

3.5 Since the automobile companies satisfy the performance obligation at a point in time & therefore, it shall recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (i.e. an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset. 3.6 Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Control includes the ability to prevent other entities from directing the use of, and

Application of Ind As

115

Sold But Not

Delivered (SBND)

Certificates

Warranty as a separate

performance obligation to be

satisfied over a point in time

Financing

Component

Product Warranty

(Replacement of

the parts in case of

damage)

Service Warranty (Free

Service of the Vehicles

up to certain Kms &

charging the same after

certain Kms )

obtaining the benefits from, an asset. The benefits of an asset are the potential cash flows (inflows or savings in outflows) that can be obtained directly or indirectly in many ways, such as by: (a) Using the asset to produce goods or provide services; (b) Using the asset to enhance the value of other assets; (c) Using the asset to settle liabilities or reduce expenses; (d) Selling or exchanging the asset; (e) Pledging the asset to secure a loan; and (f) Holding the asset. (Para 33 of IFRS 15) 3.7 In addition, an entity shall consider indicators of the transfer of control, which include, but are not limited to, the following:

(a) The costumer has legal title over the asset (b) The entity has transferred physical possession of the asset (c) The costumer has significant risk & rewards of ownership of an asset (d) The costumer has accepted the asset

3.8 The basic principle of the transfer of the control is that, the costumer has a direct ability to use the assets & generate the cash flows from the use of the asset. 3.9 In case of SBND Certificate, the dealer has no ability to use the asset (i.e. car) to generate cash flows for the business as the asset is in possession of the automobile company. 3.10 Hence, as per the Ind As 115, the automobile companies which were recognizing the revenue on the basis of the SBND Certificates shall not be able to recognize the revenue until the possession of the asset (i.e. car) has been transferred to the costumer. Whether Warranty is a separate performance obligation as per Ind As 115? Impact: High 3.11 There are two types of warranties which are provided by the automobile companies:

1) Product Warranty – The warranty relates to the replacement of the parts of the vehicle, in case there is any defect in the vehicle.

2) Service Warranty – The warranty relates to the free servicing of the vehicles up to certain kilometers while purchase of the new vehicle.

3.12 The below figure describes the warranty as a separate performance obligation.

Y N Y N N Y

Start

Whether the

costumer has

option to buy to

buy warranty

separately?

Whether the

warranty is

required by

law?

Warranty is a

separate

performance

obligation

Warranty is not a

separate

performance

obligation

Whether the period

covered in warranty

is a longer to cover

the life of the asset?

Warranty is not a

separate

performance

obligation

A

N

Y 3.13 As per the practice followed in the automobile sector, the costumer has no option to buy warranty separately as it is embedded in the selling price of the vehicle. 3.14 The warranty is provided to the costumer by virtue of the industry practice & there is no statutory obligation to provide the warranty to the costumer. 3.15 The period of the warranty is for initial years only & it is valid till the vehicle runs for a specified kilometers. Therefore, the warranty period is shorter compared to the useful life of the asset. 3.16 The nature of the task performed by the entity is as follows:

(A) Replacement of the defective parts of the vehicle (B) Free Servicing of the vehicle

A

Whether the nature of

the task performed is in

addition to the to

assurance that the

product complies with

agreed specification?

Warranty is not a

separate

performance

obligation

Warranty is a separate

performance obligation

END

3.17 The below figure describes the task performed during the warranty period:

3.18 The Free Service Warranty is a separate performance obligation, which is satisfied at a point in time when the dealer renders the service & raises the debit note on the automobile company. 3.19 Since at the time of the sale, the warranty service has not been rendered & it will be rendered subsequently at later point in time. Therefore, the revenue has to be deferred to the year when:

(A) Dealer renders the warranty service to the costumer; or (B) The automobile company reimburse the dealer for the servicing expense incurred by the dealer in

providing warranty services. Whichever is earlier.

3.20 The service warranty amount is separately measurable as the same is included in the transaction price of the vehicle. The automobile company has an estimate about the service warranty component included in the transaction price.

Nature of the Task

performed in

warranty period

Replacement of

the defective

part

Free Service during

the warranty period

The main purpose of the

replacement is the product

complies with agreed upon

specifications

The free service is a service

which is addition to the

assurance that the product

complies with agreed

specifications

3.21 The following is an accounting entries to be passed:

Accounting Entry as per IGAAP Accounting Entry as per Ind As

Debtors A/c Dr To Sales To Duties & Taxes (Being entry passed for recognizing the revenue)

Debtors A/c Dr To Sales of Vehicle A/c To Deferment of Service Warranty To Duties & Taxes (Being entry passed for recognizing the revenue) Deferment of Service Warranty Dr To Revenue from Warranty (Being Entry Passed for recognizing the revenue from rendering the warranty service)

Financing Component in the Transaction Price Impact: Low 3.22 As per the practice followed by the automobile sector, the automobile company generally have a wholly owned subsidiary which provide the finance to the costumers for purchasing the vehicle from the dealers. 3.23 There can be a situation where, the automobile companies give loans to the costumers for purchasing the vehicles from the dealer. It can been in case where, loans have been provided by the automobile company to its employees for purchasing a vehicle. In this scenario, the transaction price may include a financing component. 3.24 In determining the transaction price, an entity shall adjust the promised amount of consideration for the effects of the time value of money if the timing of payments agreed to by the parties to the contract (either explicitly or implicitly) provides the customer or the entity with a significant benefit of financing the transfer of goods or services to the customer. In those circumstances, the contract contains a significant financing component. A significant financing component may exist regardless of whether the promise of financing is explicitly stated in the contract or implied by the payment terms agreed to by the parties to the contract. (Para 60 of IFRS 15) 3.25 Therefore, the automobile company shall adjust the promised amount of the consideration with the discounting rate and to derive the present value of the consideration & recognize the revenue at the present value. 3.26 Lets understand the same with the example. Tata Motors has a policy of giving loans to the employees for purchasing the Tata Nano. The cost of Tata Nano is Rs 2,00,000/- & the employee has paid the upfront payment of Rs 30,000/- & remaining shall be paid over in 4 years. The principal repayment is Rs 42,500 & Interest is 9% The discount rate applicable is 10%. The below table describe the method of determining PV of Future Cash flow

Year Outstanding Principal

Principal Interest @9%

Closing Principal

Total Outflow

Pv @10% PV Cash flows

1 1,70,000 42,500 15,300 1,27,500 57,800 0.91 52,598

2 1,27,500 42,500 11,475 85,000 53,975 0.83 44,799

3 85,000 42,500 7,650 42,500 50,150 0.75 37,612

4 42,500 42,500` 3,825 Nil 46,325 0.68 31,501

Total 1,66,510

Tata Motors can recognize the revenue of Rs 1, 96,510 (Rs 30,000 + Rs 1, 66,510)

Section 4 Accounting for Provision for Warranty Impact: High

4.1 The practice followed by the automobile company is to provide the warranty of the vehicles which are manufactured by the companies. The period of warranty differs from the type of the products manufactured.

Sr No. Type of Vehicle Warranty provided

1 Trucks 4-5 Years

2 Buses 3-4 Years

3 Passenger Vehicles 0-1 Year

4.2 The estimated liability of the product warranty is recorded when product is sold. The automobile companies make an estimate using an historical information on the nature, frequency and average cost of warranty claims and management estimates regarding possible future incidence based on corrective actions on product failures. The timing of outflows will vary as and when warranty claim will arise - being typically up to 3 to 4 years. 4.3 The automobile companies also consider the effect of the inflation of material and labour cost for making an estimate of warranty provision in the books. 4.4 As per Ind As 37 the constructive obligation is an obligation that derives from an entity’s actions where: (a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and (b) as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities. 4.5 The providing warranty is an “Constructive Obligation” of the automobile companies as there is no statutory binding for providing the warranty to costumers in India. 4.6 The automobile companies do not use the Present Value Factors which are used for discounting the probable cash outflows while measuring the provision for warranty. 4.7 Where the effect of the time value of money is material, the amount of a provision shall be the present value of the expenditures expected to be required to settle the obligation. (Para 45 of Ind As 37) 4.8 The discount rate (or rates) shall be a pre-tax rate (or rates) that reflect(s) current market assessments of the time value of money and the risks specific to the liability. The discount rate(s) shall not reflect risks for which future cash flow estimates have been adjusted. (Para 47 of Ind As 37) 4.9 The “material” has not been defined nor quantified in the standard and framework. As per Para QC11, the materiality is an entity specific aspect & therefore, IASB has not quantified any threshold for materiality. 4.10 The below table describe the materiality of warranty provision in the books of automobile companies

Sr No. Name of Automobile Company Provision for Warranty as on March 31, 2014 (Rs in Crores)

Profit for the year as on March 31, 2014 (Rs in Crores)

% of the Warranty on Profit for the year

1 Tata Motors Limited 409.48 (1,025.80) 39.91%

2 Mahindra & Mahindra 338.54 3,738.35 9.05%

4.11 The warranty is an important aspect of financial statements where the significant management judgments are involved. Therefore, the automobile companies need to use the discount rates & compute the present value of the entity constructive obligation towards the warranty payable to the costumers. 4.12 Let take an example to understand the impact of use of present value in the measuring the amount of provision. Mahindra & Mahindra has sold around 50,000 tractors during the FY 2013-14. The warranty rate derived by the management per tractor on the basis of the past experience & after giving effect of inflation is Rs 500. The management expects that 50% of the tractors will have no defect & remaining 50% may contain some defects during warranty period. The warranty period is of 2 years & management expects that the liability of the 20% of 50% of detective tractors will arise in first year and the balance 80% will arise in subsequent year. The management uses the discounting rate of 10%. Provision for Warranty under IGAAP = 25000 Tractors* Rs 500 = Rs 1.25 Crores Provision for Warranty under Ind As 37

Year No of Tractors Rate per Tractor Provision Amount (Rs in Crores)

PVF @10% PV of Provision (Rs in Crores)

1 5000 500 0.25 0.91 0.23

2 20000 500 1 0.83 0.83

Total 1.06

Net Impact on P&L = Increase in profit by Rs 19 Lakhs

Section 5 Accounting for Hedge and Derivative Instruments Accounting as per IGAAP 5.1 The Automobile companies generally uses foreign currency forward contracts to hedge its risks associated with foreign currency fluctuations relating to highly probable forecast transactions. 5.2 The Automobile Company designates such forward contracts in a cash flow hedging relationship by applying the hedge accounting principles set out in Accounting Standard 30- Financial Instruments: Recognition and Measurement as per IGAAP. 5.3 The forward contracts are stated at fair value at each reporting date. Changes in the fair value of these forward and option contracts that are designated and effective as hedges of future cash flows are recognized directly in Hedging Reserve Account under Reserves and Surplus, net of applicable deferred income taxes and the ineffective portion is recognized immediately in the Statement of Profit and Loss. 5.4 Amounts accumulated in Hedging Reserve Account are reclassified to Profit and Loss in the periods during which the forecasted transaction occurs. If the forecasted transaction is no longer expected to occur, the net cumulative gain or loss recognized in Hedging Reserve Account is immediately transferred to the Statement of Profit and Loss. Foreign currency options and other derivatives are stated at fair value as at the year end with changes in fair value recognized in the Statement of Profit and Loss. 5.5 Premium or discount on forward contracts other than those covered in (ii) above is amortized over the life of such contracts and is recognized as income or expense Accounting as per Ind As 109 5.6 The Qualifying criteria of Hedge Accounting as per Ind As 109 is different from the AS 30.

1. Hedge Effectiveness Requirement Impact: High (A) As per AS 30, the hedge effectiveness was measured with respect to quantitative thresholds of the

actual outcome shall be in the range of 80 – 125%. (B) As per Ind As 109, the following requirements to be satisfied for Hedge Accounting

(i) There is an economic relationship between the hedged item and the hedging instrument (ii) The effect of credit risk does not dominate the value changes that result from that economic

relationship (see paragraphs B6.4.7–B6.4.8); and (iii) The hedge ratio of the hedging relationship is the same as that resulting from the quantity of the

hedged item that the entity actually hedges and the quantity of the hedging instrument that the entity actually uses to hedge that quantity of hedged item. However, that designation shall not reflect an imbalance between the weightings of the hedged item and the hedging instrument that would create hedge ineffectiveness (irrespective of whether recognised or not) that could result in an accounting outcome that would be inconsistent with the purpose of hedge accounting.

2. Assessment of Hedge Effectiveness Impact: High

(A) As per AS 30, the hedge is assessed on an ongoing basis and determined actually to have been highly effective throughout the financial reporting periods for which the hedge was designate.

(B) As per Ind As 109, the entity shall at a minimum, perform ongoing assessment

(i) At each reporting date (ii) Upon Significant change in the circumstances affecting the hedge effectiveness requirements Whichever is earlier

3. Effectiveness of Hedge can be reliably measured

Impact: Low

(A) As per AS 30, the effectiveness of the hedge can be reliably measured, i.e., the fair value or cash flows of the hedged item that are attributable to the hedged risk and the fair value of the hedging instrument can be reliably measured.

(B) There is no such requirement as per Ind As 109. 4. Eligible Hedging Instruments and Eligible Hedge Items

Impact: High

(A) As per AS 30, there is no specific condition relating to use of eligible hedge item & hedge instruments. (B) As per Ind As 109, the hedging relationship consists only of eligible hedging instruments and eligible

hedged items.

5. Risk Management Documentation

(A) The requirement of the documentation relating to the hedge is same in the both standards. 5.7 Accounting for the amount that has been accumulated in the cash flow hedge reserve

Impact: High

(A) As per AS 30, there were two accounting choices relating to accounting for the forecast transaction subsequently results in the recognition of a nonfinancial asset or a non-financial liability, or a forecast transaction for a non-financial asset or non-financial liability becomes a firm commitment for which fair value hedge accounting is applied, then the entity should adopt (1) or (2) below:

(1) It reclassifies, i.e., recognizes, the associated gains and losses that were recognized directly in the appropriate equity account in accordance with paragraph 106 into the statement of profit and loss in the same period or periods during which the asset acquired or liability assumed affects profit or loss. OR

(2) It removes the associated gains and losses that were recognized directly in the equity account in accordance with paragraph 106, and includes them in the initial cost or other carrying amount of the asset or liability.

(B) As per Ind As 109, the accounting for the forecast transaction subsequently results in the recognition of a

nonfinancial asset or a non-financial liability, or a forecast transaction for a non-financial asset or non-financial liability becomes a firm commitment for which fair value hedge accounting is applied, then the entity shall (1) It removes the associated gains and losses that were recognized directly in the equity account, and

includes them in the initial cost or other carrying amount of the asset or liability.

5.8 Voluntary Revocation of the Hedge Accounting Impact: High

(A) As per AS 30, the entity can discontinue Hedge Accounting by voluntary revocation of the designation.

(B) The entity right of the voluntary revocation of the designation has been taken away because

(i) In pratice,entity often revoke the designation of a hedging relationship and redesignate it as a new

hedging relationship in order to apply a different method of assessing hedge ineffectiveness than the

method that was originally documented (expecting that the new method offers a better chance of

passing the hedge effectiveness assessment).

(ii) Other examples include entities revoking the designation of a hedging relationship because they want

to adjust the hedge ratio following a change in the relationship between the hedged item and the

hedging instrument (typically in response to a change in the basis risk).

(iii) In accordance with IAS 39 all these types of changes to the hedging relationship are treated as a

discontinuation of the original hedging relationship and a (re-)start of a new hedging relationship,

which creates a disconnection with risk management.

(iv) The reason is that IAS 39 does not allow adjustments to a hedging relationship after its initial

designation that were not envisaged (documented) at the inception of the hedge to be treated as

adjustments of an existing hedging relationship that continues.

5.9 Accounting for Derivative other than Hedge Instruments Impact: Low

(A) The derivative which is not designated as Hedge Instrument shall be measured at fair value through profit or loss account.

(B) The treatment of the derivative as per AS 30, is in line with Ind As 109.

Note:

1. As per Ind As 101, entity shall not reflect in its opening Ind AS Balance Sheet a hedging relationship of a type that does not qualify for hedge accounting in accordance with Ind AS 109.

2. Transactions entered into before the date of transition to Ind ASs shall not be retrospectively designated as hedges

Section 6 Accounting for Securitizations of Receivables Impact: High 6.1 The Automobile Companies generally have a wholly owned subsidiary (“Finance Company”) which is engaged in providing the vehicle loans or finance to the costumers for purchasing the vehicle from the dealer. 6.2 The wholly owned subsidiary is formed to finance the costumer to purchase the vehicles. The subsidiary generally securitize the pool of the receivables to the special purpose vehicle.

6.3 The finance company apply the criteria laid of “true sale” laid down in the guidance note issued by ICAI on Securitization. The principles laid down in the Guidance Note are in same lines with the principles in the USGAAP. 6.4 The derecognition criteria of the finance asset laid down in Ind As 109 is When an entity transfers a financial asset, it shall evaluate the extent to which it retains the risk and rewards of

ownership of the financial asset. There can be three scenarios as under:

Scenario 1 if the entity transfers all risk and rewards of ownership of financial asset, the entity shall derecognise

the financial asset.

Scenario 2 if the entity retains substantially all risk and rewards of ownership of financial asset, the entity shall

continue to recognize the financial asset.

Scenario 3 If the entity neither transfers nor retains substantially all the risk and rewards of ownership of financial

asset, the entity shall determine whether it has retained control of the financial asset & if entity determines that it

has not retain the control, it shall derecognize the financial asset. (Para 3.2.6 of Ind As 109)

6.5 The transfer of the risk and rewards is evaluated by comparing the entity's exposure before and after the

transfer with the variability of the amount and timing of the net cash flows of the transferred asset. (Para 3.2.7 of

Ind As 109).

6.6 An entity has retained substantially all risk and rewards of ownership of a financial asset if its exposure to the

variability in the present value of the future net cash flow from the financial asset does not change significantly as

a result of the transfer.

6.7 An entity has transferred the substantially all risk and rewards of ownership of the financial asset if its exposure

to such variability is no longer significant in relation to the total variability in present value of the future cash flow

associated with financial asset.

6.8 The examples where an entity has transferred substantially all risk and rewards of the ownership are:

(a) An unconditional sale of the financial asset.

(b) A sale of a financial asset to gather with an option to repurchase the financial asset at its fair value at the time

of repurchase.

(c) A sale of a financial asset together with a call or put option which is deeply out of money.(Para B3.2.4 of Ind As

109).

6.9 The example when an entity has retained substantially all risk and rewards of ownership can be a sale of the

short term receivables in which the entity guarantees to compensate the transferee for credit losses that are likely

to occur. (Para B3.2.5 of Ind AS 109)

Transfer of Risk and Rewards in Recourse Transactions.

6.10 In the Securitization transaction, specifically in recourse obligation, the originator may guarantee to the

transferee the consideration for the credit loss incurred on the financial asset. Since the Para 4.15 is only

applicable in the cases where a short term receivable is transferred e.g. credit cards dues from costumers/personal

loans.

6.11 In Securitization an originator may guarantee to compensate for loss incurred by the investors of the SPV in

event of the SPV is not able to collect the receivables against which the securities are issued to them (Credit

Enhancement).This can lead to a discussion whether the originator is bearing a credit risk of the performance of

the borrowers and the treatment of the guarantee as an off balance sheet items is appropriate considering the

substances over form principle.

Accounting for the Recourse Obligation

6.12 FASB is of the opinion that the in case of the recourse obligations, the originator shall derecognise the

financial asset but it shall also create a provision at the fair value for the recourse obligation on the date of the

entering in the agreement.

6.13 Since the recourse obligation are covered under the definition of the financial guarantee contract as per Ind

As 109 & the financial guarantee contracts are initially measured at fair value of the recourse obligation. (Para

5.1.1 of Ind As 109)

6.14 The recourse obligation is subsequently measured at a higher of

(a) The amount determined as per IAS 37 Provisions, Contingent Liability and Contingent Asset.

And

(b) The amount initially recognized (Para 4.2.1 of Ind As 109)

6.15 Since we are disclosing a recourse liability for the transferred financial asset in statement of financial position,

the portion of the transferred financial asset shall be recognized against which the provision is made to comply

with the matching concept.

6.16 If an entity neither transfers nor retains substantially all the risk and rewards of ownership of the financial

asset, and retained control of a transferred asset, the entity shall continue to recognize the transferred asset to the

extent of its continuing involvement. (Para 3.2.16 of Ind As 109)

6.17 In case of Securitization, the right of the servicing the asset is with the originator as it retains the control over

the transferred asset. Therefore, the originator has to recognize the financial asset to the extent to its continued

involvement as under:

(1) the amount of the asset

(2) the maximum amount of consideration received that the entity could be required to repay.

(1) or (2) whichever is lower. (Para 3.2.16 a of Ind As109)

Transfer of risk and rewards in case of non-recourse transaction.

6.18 In the case of the "true sale", where there is no recourse on the obligator to compensate the investors or SPV

then it satisfies the condition of derecognition of the financial asset & no provision for the recourse obligation is to

made.

Accounting for Servicing Rights & Obligations

6.19 In Securitization transaction the right of serving the financial asset (to collect the receivables from the

borrowers) can be with the originator. The originator may collect the servicing fees from the SPV in consideration

of the servicing the financial asset. There can be two scenarios as under

Scenario 1 If the fee to be received is not expected to compensate the entity adequately for performing the

servicing, a service liability for the service obligation shall be recognize at fair value.

Scenario 2 If the fee to be received is expected to be more than adequate compensation for the servicing, the

servicing asset shall be recognized for servicing rights. (Para 3.2.10 Ind As109)

6.20 In Securitization transaction, the originator transfers substantial risk and rewards to SPV except the right of

servicing the receivable in the consideration of the fees.

Derecognition Criteria.

6.21 An entity can derecognise the financial asset when and only when:

(A) The contractual rights to the cash flows from the financial asset expire, or

(B) it transfer the financial asset and transfer qualifies for derecognition (Para 3.2.3 of Ind As109).

6.22 There can be a situation where, the financial asset has been fully written off (derecognise) in the books due to

credit loss impairment and the same is transferred to SPV, the amortize cost of the financial asset would be NIL &

the consideration received will be the gain for the originator. In case of recourse transaction, the part of the

financial asset shall be recognised to the extent of the continuing involvement.

Derecognition of the financial asset (Non Recourse)

6.23 On derecognition of a financial asset in its entirety, the difference between:

(A) The carrying amount at the date of derecognition and

(B) The consideration received

Shall be recognized in profit or loss. (Para 3.2.12 of Ind As 109)

Derecognition of the financial asset (Recourse)

6.24 An entity may provide transferee with credit enhancement in form of credit guarantee that could be limited

or unlimited to a specified amount. There can be two scenarios as under:

Scenario 1 If entity retains the substantially all risk and rewards of ownership of transferred asset, the asset

continues to recognized in its entirety.

Scenario 2 If entity retain some, but not substantially all of the risk and rewards of the ownership and has retained

the control, derecognition is precluded to the extent of cash or other assets that entity is required to pay. (Para

B3.2.16 .N of Ind As 109)

6.25 As the recourse transaction fall within Scenario 2, hence the carrying value of the asset on the date of

derecognition should be reduced by an amount of the cash or other assets that entity is required to pay.

Treatment in case of derecognition criteria is not met.

6.26 In the case where the derecognition criteria is not met the entity shall continue to recognize the financial

assets in the books.

RBI Guidelines on Accounting for the Securitization Asset

6.27 The RBI has prescribe Minimum Retention Requirement (MRR) to ensure that the originating banks have a

continuing stake in the performance of securitized assets so as to ensure that banks carry out the proper due

diligence of loans securitized.

6.28 The MRR is generally 5% - 10% of the book value of the loans being securitized.

6.29 The RBI has also prescribe the Minimum Holding Period (MHP) for Originating Banks can securitize loans only

after these have been held by them for minimum period in their books.

6.30 In terms of Para 20.1 of the RBI Circular DBOD No. BP.BC.60/21.04.048/2005-06, dated February 01, 2006, any

profit/premium arising on account of securitization of loans should be amortized over the life of the securities

issued or to be issued by SPV.

6.31 The amount of profit received in cash may be held under an accounting head “Cash Profit on Loan Transfer

Transaction Pending Recognition”. The profit shall be amortized from this account.

6.32 The MRR is an Off Balance Sheet Exposure to the Originating Bank in the securitization. As per the RBI

Guidelines the banks shall disclose the MRR in Notes to Account as an off balance sheet item.

GAAP Difference between Recognition of Profit on Derecognition of the Asset

Impact : High

6.33 There is the GAAP difference in the treatment of the profit on the securitization, as under Ind As 109 the gain

is recognized directly to profit or loss on the derecognition of the financial asset while as per the RBI Guidelines the

profit is to be deferred/amortized for the period of the securities issued to the investors by SPV.

Note:

As per Ind As 101, the first time adopter, is not required to apply the derecognition criteria of the financial

asset & liability retrospectively, it can apply the derecognition criteria from the date of transition

Section 7 Accounting for Deferred Tax Asset & Liability

Impact: High

Accounting under IGAAP

7.1 Tax expense comprises current and deferred taxes. 7.2 Current tax is the amount of tax payable on the taxable income for the year as determined in accordance with the provisions of the Income Tax Act, 1961. Current tax is net of credit for entitlement for Minimum Alternative Tax (MAT). 7.3 Deferred tax is recognized, on timing differences, being the difference between taxable income and accounting income that originate in one period and are capable of reversal in one or more subsequent periods. Deferred tax assets in respect of unabsorbed depreciation and carry forward of losses are recognized if there is virtual certainty that there will be sufficient future taxable income available to realize such losses. Other deferred tax assets are recognized if there is reasonable certainty that there will be sufficient future taxable income to realize such assets. 7.4 Deferred tax assets and liabilities are measured based on the tax rates that are expected to apply in the period when asset is realized or the liability is settled, based on tax rates and tax laws that have been enacted or substantively enacted by the balance sheet date. 7.5 In respect of the deferred tax asset/liability arising due to tax holidays availed by the entity, AS 22 provides the guidance of the accounting relating to deferred tax asset/liability.

Accounting as per Ind As 12 & Income Computation and Disclosure Standards (ICDS)

7.6 The recognition of the deferred tax asset/liability under Ind As 12 would be a temporary difference rather than

timing difference.

7.7 Temporary differences are differences between the carrying amount of an asset or liability in the balance sheet and its tax base. Temporary differences may be either:

(a) Taxable temporary differences, which are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled; or

Major Impact

Areas

Applicability of

ICDS Standards

Balance sheet

approach instead of

Income approach

No Guidance for

tax holiday units

Tax Base in

Consolidation

financial Statement

(b) Deductible temporary differences, which are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. (Para 5 of IAS 12)

7.8 The taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable). (Para 5 of IAS 12) 7.9 The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. 7.9 The CBDT has recently issued Income Computation and Disclosure Standards (ICDS) which comprises of 12 standards & it would be applicable from AY 2016-17 (i.e. PY 2015-16). The taxable profit would be computed with respect to ICDS Standards. 7.9 The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount. (Para 7 of Ind As 12) 7.10 The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods.(Para 8 of Ind As 12) 7.11 The tax base of the asset would be determined as per ICDS Standards issued by CBDT. Recognition of Deferred Tax Asset & Liability Impact: High 7.12 A deferred tax liability shall be recognized for all taxable temporary differences, except to the extent that the deferred tax liability arises from: (a) The initial recognition of goodwill; or (b) The initial recognition of an asset or liability in a transaction which:

(i) is not a business combination; and (ii) at the time of the transaction, affects neither accounting profit nor taxable profit

7.13 A deferred tax asset shall be recognized for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilized, unless the deferred tax asset arises from the initial recognition of an asset or liability in a transaction that:

(a) is not a business combination; and

(b) at the time of the transaction, affects neither accounting profit nor taxable profit Measurement of Deferred Tax Asset & Liability Impact: Low 7.14 Deferred tax assets and liabilities shall be measured at the tax rates that are expected to apply to the period when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period. (Para 47 of Ind As 12)

7.15 The measurement of deferred tax liabilities and deferred tax assets shall reflect the tax consequences that would follow from the manner in which the entity expects, at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities. (Para 51 of Ind As 12) 7.16 Deferred tax assets and liabilities shall not be discounted. (Para 53 of Ind As 12) Reassessment of Deferred Tax Asset Impact: High 7.17 As per AS 22, Where an enterprise has unabsorbed depreciation or carry forward of losses under tax laws, deferred tax assets should be recognized only to the extent that there is virtual certainty supported by convincing evidence that sufficient future taxable income will be available against which such deferred tax assets can be

realized. (Para 17 of AS 22)

7.18 The carrying amount of a deferred tax asset shall be reviewed at the end of each reporting period. An entity shall reduce the carrying amount of a deferred tax asset to the extent that it is no longer probable that sufficient taxable profit will be available to allow the benefit of part or all of that deferred tax asset to be utilized. Any such reduction shall be reversed to the extent that it becomes probable that sufficient taxable profit will be available. (Para 56 of Ind As 12) 7.19 Virtual certainty refers to the extent of certainty, which, for all practical purposes, can be considered certain. Virtual certainty cannot be based merely on forecasts of performance such as business plans. Virtual certainty is not a matter of perception and is to be supported by convincing evidence.

7.20 The probable refers to the lesser extent of certainty then required in AS 22 which, for all practical purposes, can be considered certain. Recognition of the deferred tax asset & liability outside profit or loss account Impact: High 7.21 Deferred tax shall be recognized outside profit or loss if the tax relates to items that are recognized, in the same or a different period, outside profit or loss. Therefore, current tax and deferred tax that relates to items that are recognized, in the same or a different period: (a) In other comprehensive income, shall be recognized in other comprehensive income. (b) Directly in equity, shall be recognized directly in equity 7.22 There is no option available in AS 22. Tax Base in Consolidated Financial Statement Impact: Low 7.23 In the Consolidated Financial Statement, the parent company consolidates the financials line to line basis. AS22 does not have any guidance on the recognition of the deferred tax asset and liability in the consolidated financial asset & liability. 7.24 The tax base is determined by reference to the tax returns of each entity in the group. In some jurisdictions, in consolidated financial statements, temporary differences are determined by comparing the carrying amounts of assets and liabilities in the consolidated financial statements with the appropriate tax base. The tax base is determined by reference to a consolidated tax return in those jurisdictions in which such a return is filed. (Para 11 of Ind As 12)

7.25 The automobile companies in India, which are parent companies are not required to file consolidated financial statements with Income Tax Department. Therefore, the automobile companies can follow the line by line method of consolidation of deferred tax asset or liability. 7.26 The offsetting requirement under Ind As 12 is in same lines with AS 22.

Section 8 Accounting for Embedded Derivative

Impact: High

8.1 As per Ind As 109, If a hybrid contract contains a host that is an asset within the scope of this Standard, an entity shall not separate an embedded derivative from the host contract. 8.2 If a hybrid contract contains a host that is not an asset within the scope of this Standard, an embedded derivative shall be separated from the host and accounted for as a derivative under this Standard if, and only if:

(a) the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host;

(b) a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and

(c) the hybrid contract is not measured at fair value with changes in fair value recognized in profit or loss (i.e. a derivative that is embedded in a financial liability at fair value through profit or loss is not separated).

8.3 If an embedded derivative is separated, the host contract shall be accounted for in accordance with the appropriate Standards. This Standard does not address whether an embedded derivative shall be presented separately in the balance sheet.

8.3 The financial asset is defined as per Ind As 32 is any asset that is

(a) Cash; (b) An equity instrument of another entity; (c) A contractual right:

(i) to receive cash or another financial asset from another entity; or

(ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favorable to the entity; or

(d) A contract that will or may be settled in the entity’s own equity instruments and is:

(i) a non-derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments; or

(ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. For this purpose the entity’s own equity instruments do not include puttable financial instruments classified as equity instruments in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments.

8.4 The derivative shall be valued at fair value through profit and loss.

8.5 Since, there is no concept of “embedded derivative” in IGAAP, the company needs to identify the embedded derivative in the hybrid contract as on the date of transition which satisfies the condition mentioned in Ind As 109. 8.6 The following are the example of the Hybrid Contract in which the embedded derivative is embedded derivative:

A. Lease Contracts B. Debt Instruments C. Compound Instruments D. Foreign Currency Notes

Note:

A first-time adopter shall assess whether an embedded derivative is required to be separated from the host

contract and accounted for as a derivative on the basis of the conditions that existed later of

(i) the date it first became a party to the contract and (ii) date a reassessment required as per Ind As 109

Section 9 Accounting for Product Development Cost- Intangible Asset 9.1 The Automobile companies incurs the Product Development Cost on the upcoming new products in the market. 9.2 The Product Development Cost (PDC) is an Internally Generated Intangible Asset. The automobile companies spend the huge amounts on the development of the new products or new variant of the existing models to retain their market share & to increase profitability. The automobile company recognize the PDC as per AS 28 “Intangible Asset”. 9.3 The below mentioned figure lays down the impact areas of Ind As 38:

Impact Areas

Recognition Amortization

Cost of Internally

Generated

Intangible Asset

Subsequent

Measurement

AS 26 The overheads that are necessary to generate the asset and that can be allocated on a reasonable and consistent basis to the asset Ind As 38 The overheads cannot be allocated to the cost of the intangible asset.

AS 26

The company has to

measure the

intangible asset as

per cost model

Ind As 38

The company has a

choice to follow the

Cost Model or

Revaluation Model

For subsequent

measurement.

Finite Life Infinite Life

AS 26

There is a rebuttable

presumption that the

useful life of the

intangible asset is 10

years.

Ind As 38

An entity shall assess whether the useful life of an intangible asset is finite or indefinite and, if finite, the length of, or number of production or similar units constituting, that useful life.

AS 26

There is no guidance

relating to intangible

assets with indefinite life

Ind As 38

An intangible asset shall be regarded by the entity as having an indefinite useful life when, based on an analysis of all of the relevant factors, there is no foreseeable limit to the period over which

the asset is expected to

generate net cash inflows

for the entity.

Cost of the Internally Generated Intangible Asset

Impact: High

9.4 The cost of an internally generated intangible asset is the sum of expenditure incurred from the date when the intangible asset first meets the recognition criteria & prohibits reinstatement of expenditure previously recognized as an expense. 9.5 The cost of an internally generated intangible asset comprises all directly attributable costs necessary to create, produce, and prepare the asset to be capable of operating in the manner intended by management. Examples of directly attributable costs are:

(a) Costs of materials and services used or consumed in generating the intangible asset; (b) Costs of employee benefits (as defined in Ind AS 19) arising from the generation of the intangible asset; (c) Fees to register a legal right; and (d) Amortization of patents and licenses that are used to generate the intangible asset. (e) Ind AS 23 specifies criteria for the recognition of interest as an element of the cost of an internally

generated intangible asset. (Para 66 of Ind As 38) 9.6 The companies can allocate overheads that are necessary to generate the asset and that can be on a reasonable and consistent basis to the asset which was allowed as per AS 26 “Intangible Asset”. Subsequent Measurement Impact: High

9.7 An entity shall choose either the cost model or the revaluation model as its accounting policy. If an intangible asset is accounted for using the revaluation model, all the other assets in its class shall also be accounted for using the same model, unless there is no active market for those assets. Cost model 9.8 After initial recognition, an intangible asset shall be carried at its cost less any accumulated amortization and any accumulated impairment losses. Revaluation model 9.9 After initial recognition, an intangible asset shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated amortization and any subsequent accumulated impairment losses. (Para 74 of Ind As 38) 9.10 For the purpose of revaluations, fair value shall be measured by reference to an active market. Revaluations shall be made with such regularity that at the end of the reporting period the carrying amount of the asset does not differ materially from its fair value. (Para 75 of Ind As 38) 9.11 The accounting policy choice of Revaluation model was not available under AS 26.

Amortization Method- Finite Useful Life Impact: Low 9.12 The depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life. 9.13 Amortization shall begin when the asset is available for use, i.e. when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. 9.14 Amortization shall cease at the earlier of the date that the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with Ind As 105 and the date that the asset is derecognized. 9.15 The amortization method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity. If that pattern cannot be determined reliably, the straight-line method shall be used. 9.16 These methods include the (A) Straight-line method, (B) The diminishing balance method and (C) The units of production method. The method used is selected on the basis of the expected pattern of consumption of the expected future economic benefits embodied in the asset and is applied consistently from period to period, unless there is a change in the expected pattern of consumption of those future economic benefits. 9.17 The amortization method which is used by the automobile companies is generally units of production method. 9.18 The automobile companies can amortize the PDC on the lower of

(A) Business Case Volume – At the start of the development of the new product, the company estimates the volume of the product which it is going to sell during the product life cycle.

(B) Budgeted Volume-

At the start of the manufacturing of the new product, the company estimates the volume of the product which it is going to sell during the product life cycle.

(C) Actual Volume

The volume of the product that the company that is actually manufactured during the product life cycle.

Intangible Asset with the indefinite useful life Impact: High 9.19 An intangible asset with an indefinite useful life shall not be amortized. (Para 107 of Ind As 38) 9.20 In accordance with Ind AS 36, an entity is required to test an intangible asset with an indefinite useful life for impairment by comparing its recoverable amount with its carrying amount (a) Annually, and (b) Whenever there is an indication that the intangible asset may be impaired. (Para 108 of Ind As 38)

Note:

The company has an option to avail an exemption of the deemed cost under Ind As 101 for Intangible

Asset as on transition date.

As per Carve outs to Ind As the deemed cost is the “carrying value” of the intangible asset as on the

date of transition.

Section 10 Accounting for Property Plant and Equipment

10.01 The below mentioned figure lays down the impact areas of Ind AS 16

Asset Retirement Obligations (ARO)

Impact: High

10.02 In the automobile industry, the land on which the industries are established are generally obtained on

Finance Lease, as per the terms of the lease, the land has to be returned after the demolishing the buildings

erected on the land to the lessor, in case of termination of the lease.

10.03 As per Ind As 37, the cost of the dismantling the building shall be discounted and added to the cost of the

asset.

10.04 There can be two scenarios

Scenario 1: The lease of the land is for 99 years and the same is not renewable after 99 years

The Asset Retirement Obligation shall be added to the cost of the asset, as the management has to return the land

as per the terms of the agreement in same condition as it was taken.

Therefore, the cost of the dismantling the building shall be discounted and added to the cost of the leasehold land.

Scenario 2: The lease of the land is for 99 years and the same is renewable after 99 years

The Asset Retirement Obligation shall not be added to the cost of the asset, as the lease is renewable after 99

years.

Therefore, the management shall determine at the end of each reporting period, whether they have an intent to

renew the lease after the 99 years & if the management has no intention to continue with the lease then, it shall

create the Asset Retirement Obligation liability from the period when the management decides to discontinue with

the lease.

Impact Areas

Asset Retirement

Obligations

Foreign Exchange

Differences Componentization

of the fixed asset

Impact of Deferred

Payment

arrangements

Componentization of Fixed Asset

Impact: High

10.05 As per Ind As 16, The cost of an item of property, plant and equipment shall be recognized as an asset if, and only if: (a) It is probable that future economic benefits associated with the item will flow to the entity; and (b) The cost of the item can be measured reliably. (Para 7 of Ind As 16) 10.06 The Standard does not prescribe the unit of measure for recognition, i.e. what constitutes an item of property, plant and equipment. Thus, judgment is required in applying the recognition criteria to entity specific circumstances. It may be appropriate to aggregate individually insignificant items, such as moulds, tools and dies, to apply the criteria to the aggregate value. (Componentization) (Para 9 of Ind As 16) 10.07 Therefore, Ind As 16, the principle of componentization is applicable which was not permitted as per AS 10. 10.08 The automobiles companies needs to exercise the judgment in the case of the componentization of the fixed asset is applicable & determine the useful life of that component of fixed asset & depreciate it separately from the main asset. Impact of Deferred Payment Terms Impact: High 10.09 The cost of an item of property, plant and equipment is the cash price equivalent at the recognition date. If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognized as interest over the period of credit unless such interest is capitalized in accordance with Ind AS 23. (Para 23 of Ind As 16) 10.10 As per AS 10, the principle of measuring the cost is not cash price equivalent, therefore, the difference between the cash price equivalent and the total payment is capitalized in the cost of fixed asset. Foreign Exchange Differences Impact: High 10.11 As per Para 46A of AS 11, at the option of the entity, the exchange differences arising on reporting of long term foreign currency monetary items at rates different from those at which they were initially recorded during the period, or reported in previous financial statements, in so far as they relate to the acquisition of a depreciable capital asset, can be added to or deducted from the cost of the asset and shall be depreciated over the balance life of the asset, and in other cases, can be accumulated in a ‘‘Foreign Currency Monetary Item Translation Difference Account” in the enterprise’s financial statements and amortized over the balance period of such long term asset or liability, by recognition as income or expense in each of such periods. 10.12 As per Para 28 of Ind As 21, exchange differences arising on the settlement of monetary items or on translating monetary items at rates different from those at which they were translated on initial recognition during the period or in previous financial statements shall be recognized in profit or loss in the period in which they arise. 10.13 When monetary items arise from a foreign currency transaction and there is a change in the exchange rate between the transaction date and the date of settlement, an exchange difference results. When the transaction is settled within the same accounting period as that in which it occurred, all the exchange difference is recognized in

that period. However, when the transaction is settled in a subsequent accounting period, the exchange difference recognized in each period up to the date of settlement is determined by the change in exchange rates during each period. 10.14 The A first-time adopter may continue the policy adopted for accounting for exchange differences arising from translation of long-term foreign currency monetary items recognized in the financial statements for the period ending immediately before the beginning of the first Ind AS financial reporting period as per the previous GAAP. (Para D13AA of Ind As 21)

10.15 The company has a choice to continue with the existing policy as per Para 46A of AS 11 as on transition date, but company shall comply with the Ind As 21, after the transition date.

Note:

The company has an option to avail an exemption of the deemed cost under Ind As 101 for Intangible

Asset as on transition date.

As per Carve outs to Ind As the deemed cost is the “carrying value” of the tangible assets as on the

date of transition.

The Company has an option to apply for an exemption by applying an accounting policy as per Para

46A of AS 11 on transition date.

Section 11 Conclusion

11.1 The following points shall be of the significant importance in IFRS Convergence:

Paradigm shift in financial reporting

The adoption of Ind AS would entail a significant change in the financial reporting framework used by Indian

companies to report their financial results. As a consequence, the reported earnings (net income) and financial

position (net worth) reported by all these companies would undergo a change. Impact of this change would vary

from sector to sector and company to company, with some sectors/companies being significantly impacted.

Benefits of the move to Ind AS The move to Ind AS standards will significantly enhance the quality of and transparency in financial reporting by Indian companies. It will also enhance the international comparability of financial statements of Indian companies and make the Indian capital markets more attractive. It will also reduce capital costs and facilitate international fund-raising by Indian companies. First to adopt certain global standards With these Ind AS standards, India will be adopting some of the latest global standards before the rest of the world does. While India has been working on IFRS convergence, IFRS itself, as a body of standards, continues to evolve. Recently, the International Accounting Standards Board (IASB) issued new standards on revenue recognition and financial instruments, and these standards are mandatorily applicable internationally only from 2017 and 2018 respectively. The notified Ind AS standards are converged with these newer standards, including those on revenue and financial instruments, considering the timing of India’s move to IFRS. Early adoption of these standards as compared to the global adoption timelines, would not only ensure that our standards remain current with or ahead of their IFRS equivalents, but also provide a stable platform of reporting for Indian companies for a period of time after they move to Ind AS. If these standards are not early adopted, Indian companies would have to adopt these newer standards a year or two after they move to Ind AS, potentially hampering comparability and increasing cost of compliance. 11.12 The below figure describes the overview of Ind As Conversion Process*.

*Source: KPMG First Notes

Appendix 1 References

1. Annual Report of the following companies A. Tata Motors Limited B. Mahindra & Mahindra C. Tata Motors Finance Limited D. M & M Finance E. Bajaj Auto

2. Ind As notified by Ministry of Corporate Affairs (MCA) 3. Carveouts notified by Ministry of Corporate Affairs (MCA) 4. Accounting Standards issued by ICAI 5. Guidance Notes issued by ICAI