GAAP Advisors - Enabling Excellence in Financial Reporting in India | 49th Edition
CA Manish C. Iyer
Financial Reporting Advisor | Ind AS, IFRS and Indian GAAP | Author | Independent Director
Welcome to 49th Edition of GAAP Advisors TASK Weekly newsletter
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This edition of newsletter has the following sections:
+ Why register on GAAP Advisors
+ Recent Developments – Change to Independent Auditor’s Report issued by IAASB due to Amendments in IAS 1 issued by IASB
+ From Issue Repository – Demerger of Business
+ Standards Applied for Responding to Issues This Week
+ From Review Repository – Demerger of Business
+ From Accounting Policy Repository
+ From Key Audit Matters Repository
+ From Term Repository – Test
+ Features of TASK
+ TASK Statistics at the time of writing this section of newsletter
+ Top 5 TASK Rankers at the time of writing this section of newsletter
+ Daily winners for this Week
+ Note of Thanks
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Recent Developments - Changes to Independent Auditors Report due to amendment to IAS 1
IAASB has issued amendments to ISA in response to amendments to IAS 1 issued by IASB. The amendments can be accessed from the link given below:
IAS 1 has been amended to replace significant accounting policy with material accounting policy. The amendment provides guidance on what accounting policies are considered to be material and therefore, are expected to be disclosed by an entity. Disclosure of immaterial accounting policies result in obscuring information. Entities will have to review the accounting policies that they disclose in their financial statements to ensure that the accounting policies disclosed are material accounting policies. The amendment will be effective from 1 January 2023. ISAs are framework neutral. However, ISAs contain illustrations based on IFRS. Therefore, IAASB has amended illustrations in ISAs to relace ‘summary of significant accounting policies’ with ‘material accounting policy information’.
The amendment is yet to be notified in Ind AS. Usually the amendment notification comes in the month of March. The amendment, if notified, will be applicable for accounting periods beginning on or after 1 April 2023.
From Issue Repository – Demerger of Business - Issue Id: 4433 - Framework: Indian Accounting Standards:
Facts of the Case as submitted by the querist:
The company A has two business A and B. The company A has demerged its business A to company C on a going concern basis w.e.f from 1 April 2022.The Company A and Company C is a common control company.
The Company C has issued the shares to shareholders of the Company.
Issue/Query as submitted by the querist:
1. Whether fair value of assets and libilities is required to be done for the demerged business or it should be transfer at cost as both the Companies is in the common control (In books of Company A).
2. What is accounting treatment of shares issued by the Company C to the shareholder of the Company.( In books of Company A).
GAAP Advisors Response:
1. There is no specific guidance on accounting for demerger of business as such. However, paragraph 33 of Ind AS 105, Non-current Assets Held for Sale and Discontinued Operations, require the post-tax gain or loss recognised on the measurement to fair value less costs to sell or on the disposal of the assets or disposal group(s) constituting the discontinued operation to be disclosed in the statement of profit and loss. Paragraph 32 of Ind AS 105 defines a discontinued operation as follows:
A discontinued operation is a component of an entity that either has been disposed of, or is classified as held for sale, and
(a) represents a separate major line of business or geographical area of operations,
(b) is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations or
(c) is a subsidiary acquired exclusively with a view to resale.
2. Therefore, if business A meets the definition of discontinued operation, Company A shall recognise the gain or loss on demerger in profit or loss in accordance with paragraph 33 of Ind AS 105. However, the querist has not submitted whether business A meets the definition of discontinued operation given in paragraph 32 of Ind AS 105. Therefore, one may argue that paragraph 33 of Ind AS 105 is not applicable to the given case. In absence of any specific guidance on accounting for demerger of business that is not a discontinued operation, attention is drawn to the following requirements of paragraphs 10 to 12 of Ind AS 8, Accounting Policies, Changes in Accounting Estimates and Errors:
10. In the absence of an Ind AS that specifically applies to a transaction, other event or condition, management shall use its judgement in developing and applying an accounting policy that results in information that is:
(a) relevant to the economic decision-making needs of users; and
(b) reliable, in that the financial statements:
(i) represent faithfully the financial position, financial performance and cash flows of the entity;
(ii) reflect the economic substance of transactions, other events and conditions, and not merely the legal form;
(iii) are neutral, ie free from bias;
(iv) are prudent; and
(v) are complete in all material respects.
11. In making the judgement described in paragraph 10, management shall refer to, and consider the applicability of, the following sources in descending order:
(a) the requirements in Ind ASs dealing with similar and related issues; and
(b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Conceptual Framework for Financial Reporting under Indian Accounting Standards (Conceptual Framework) issued by the Institute of Chartered Accountants of India.
12. In making the judgement described in paragraph 10, management may also first consider the most recent pronouncements of International Accounting Standards Board and in absence thereof those of the other standard-setting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources in paragraph 11.
3. Applying paragraph 11 of Ind AS 8, Company shall refer to and consider applicability requirements in Ind AS dealing with similar or related issues. Paragraph 33 of Ind AS 105 provides guidance on accounting for disposal of assets and liabilities that constitute a disposal group or discontinued operation. Appendix A of Ind AS 105 defines disposal group as follows:
A group of assets to be disposed of, by sale or otherwise, together as a group in a single transaction, and liabilities directly associated with those assets that will be transferred in the transaction. The group includes goodwill acquired in a business combination if the group is a cash-generating unit to which goodwill has been allocated in accordance with the requirements of paragraphs 80–87 of Ind AS 36, Impairment of Assets, or if it is an operation within such a cash-generating unit.
A business is also a disposal group. Therefore, the requirements of paragraph 33 would be applicable for demerger of business A. Accordingly, Company A shall recognise gain or loss on disposal of business A in profit or loss.
4. Consideration in the given case is non-cash, that is, shares of Company C. One may argue that the consideration for Company A is Zero as Company C has issued its shares to shareholders of Company A and not to Company A. Another argument could be that Company A has distributed its non-cash assets constituting the business A to its shareholders. However, we do not agree with this argument as the shareholders are receiving shares of Company C and not the assets of business A. The transaction has been structured such that Company C has directly issued its shares to shareholders of Company A rather than issuing the same to Company A and Company A distributing them to its shareholders. Therefore, basis the requirements of paragraph 10 of Ind AS 8 to develop and apply an accounting policy that results in information that reflects economic substance of the transaction, the consideration for the transfer of business A is taken as shares of Company C which is non-cash.
5. With regard to measurement of consideration for the transfer, attention is drawn to the requirements of paragraph 72 of Ind AS 16, Property, Plant and Equipment, which states as follows:
The amount of consideration to be included in the gain or loss arising from the derecognition of an item of property, plant and equipment is determined in accordance with the requirements for determining the transaction price in paragraphs 47-72 of Ind AS 115. Subsequent changes to the estimated amount of the consideration included in the gain or loss shall be accounted for in accordance with the requirements for changes in the transaction price in Ind AS 115.
6. Disposal of business A would involve disposal of items of property, plant and equipment of business A. Therefore, the consideration shall be determined in accordance with the requirements for determining the transaction price in paragraphs 47-72 of Ind AS 115, Revenue from Contracts with Customers. Paragraph 66 of Ind AS 115 states as follows:
To determine the transaction price for contracts in which a customer promises consideration in a form other than cash, an entity shall measure the non-cash consideration (or promise of non-cash consideration) at fair value.
7. Therefore, Company A shall measure the consideration at fair value of shares of Company C. Paragraph 71 of Ind AS 16 provides guidance on determination of gain or loss on derecognition as follows:
The gain or loss arising from the derecognition of an item of property, plant and equipment shall be determined as the difference between the net disposal proceeds, if any, and the carrying amount of the item
8. Therefore, Company A shall determine the gain or loss arising from disposal of business A as the difference between the fair value of shares of Company C and the carrying amount of the assets and liabilities of business A. As stated in 3 above, Company A shall recognise the gain or loss in profit or loss.
9. Company A has, in substance, received and simultaneously distributed the shares of Company C received as consideration to its shareholders. This is distribution of non-cash assets to owners. Appendix A, Distribution of Non-cash Assets to Owners, of Ind AS 10, Events after the Reporting Period, provides guidance on accounting for such distributions. However, paragraph 5 of that Appendix scopes out distribution of non-cash asset that is ultimately controlled by the same party or parties both before and after the distribution. Thus, Appendix A of Ind AS 10, as such, does not apply to common control transactions. However, basis the requirements of paragraph 11 of Ind AS 8, Company A is required to apply the requirements of Appendix A of Ind AS 10 to distributions of non-cash assets to its shareholders.
10. Paragraph 11 of Appendix A of Ind AS 10 states as follows:
An entity shall measure a liability to distribute non-cash assets as a dividend to its owners at the fair value of the assets to be distributed.
11. Therefore, Company A shall recognise a liability to distribute shares of Company C at the fair value of the shares of Company C. The corresponding effect will be reduction in equity. This is a distribution of non-cash assets to owners in their capacity as owners and therefore, recognised directly in equity.
12. Paragraph 14 of Appendix A of Ind AS 10 states as follows:
When an entity settles the dividend payable, it shall recognise the difference, if any, between the carrying amount of the assets distributed and the carrying amount of the dividend payable in profit or loss.
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13. As receipt of consideration and distribution to shareholders is simultaneous and both being measured at fair value, no difference shall arise between carrying amount of shares of Company C distributed and the carrying amount of dividend payable. Accordingly, no gain or loss in profit or loss is recognised on distribution of shares of Company C to shareholders of Company A.
14. Attention of querist is drawn to the requirements of paragraph 119 and 122 of Ind AS 1, Presentation of Financial Statements:
119. In deciding whether a particular accounting policy should be disclosed, management considers whether disclosure would assist users in understanding how transactions, other events and conditions are reflected in reported financial performance and financial position. Each entity considers the nature of its operations and policies that the users of its financial statements would expect to be disclosed for that type of entity. Disclosure of particular accounting policies is especially useful to users when those policies are selected from alternatives allowed in Ind ASs. An example is disclosure of a regular way purchase or sale of financial assets using either trade date accounting or settlement date accounting (see Ind AS 109, Financial Instruments). Some Ind ASs specifically require disclosure of particular accounting policies, including choices made by management between different policies they allow. For example, Ind AS 16 requires disclosure of the measurement bases used for classes of property, plant and equipment.
122. An entity shall disclose, along with its significant accounting policies or other notes, the judgements, apart from those involving estimations (see paragraph 125), that management has made in the process of applying the entity’s accounting policies and that have the most significant effect on the amounts recognised in the financial statements.
15. Therefore, Company A shall disclose the accounting policy for demerger of business A and judgements made to apply that accounting policy in its notes in accordance with paragraph 119 and 122 of Ind AS 1.
16. In the given case, the one of the prevalent practice as exemplified in the Review Repository section of this newsletter is to apply the requirements of Appendix C of Ind AS 103 either under the garb of common control transaction or resulting in gain or loss being recognised directly in equity either as adjustment to retained earnings or to capital reserve and not impacting the financial performance for disposal of business in separate financial statements of the transferor entity. We do not agree with such mirror accounting. Even in Ind AS 109, financial assets and financial liabilities are accounted differently. Accounting for business combination under common control from the perspective of acquirer cannot be used as accounting for demerger of business from the perspective of transferor. Paragraph 33 of Ind AS 105 requires gain or loss on disposal of discontinued operation to be recognised in profit or loss. Further, paragraph 33 of Ind AS 105 is applicable for common control transactions too else common control transactions would have been scoped out. In absence of any such scope exclusion, paragraph 33 of Ind AS 105 applies to disposal of discontinued operation under common control. Simply because the business does not meet the definition of discontinued operation, one cannot argue that the gain or loss will be recognised in equity rather than in profit or loss. It is also preposterous that Company A sells its business for no consideration. Therefore, we do not agree with the argument that Company A has transferred the business indirectly to its shareholders and the transaction being under common control, paragraph 33 of Ind AS 105 and Appendix A of Ind AS 10 can be avoided to ensure no impact of demerger in profit or loss.
Standards Applied for Responding to Issues This Week
From Review Repository – Demerger of business
Components Impacted: Statement of Profit and Loss, Statement of Changes in Equity, Statement of Cash Flows and Notes
The company has presented the following Statement of Changes in Equity:
The area where we want the readers to focus has been highlighted. The company has loss on disposal of assets / settlement of liabilities attributable to marine business undertaking which has been adjusted from Opening balance of Retained Earnings. The company has disclosed the following in Note 43:
The company transferred net assets of Marine Business to its wholly owned subsidiary. Thus, the transaction is common control transaction. The company has transferred net assets of ₹397.18 crore for consideration of ₹200 crore. The transaction results in a gain of ₹197.18 crore which the company has recognised as adjustment to the opening balance of retained earnings. The said accounting has been done as per the approved court scheme. However, one may consider whether the accounting specified in the court scheme was in accordance with Ind AS basis our discussion on accounting for demerger of business in Issue Repository section of this newsletter.
Considering the requirements of paragraph 33 of Ind AS 105, the company should have recognised gain or loss on disposal of discontinued operation in profit or loss. However, it is not clear from Note 43 whether the marine business meets the definition of discontinued operation in paragraph 32 of Ind AS 105. Accounting for disposal of business cannot be different if the business is a discontinued operation and if the business is not a discontinued operation. The presentation and disclosure could be different but not the recognition and measurement. Further, the retrospective application required by paragraph 9 of Appendix C of Ind AS 103 is for accounting for transfer in the books of transferee and not the transferor. Therefore, mirroring the same accounting in the books of transferor is not in compliance with the requirements of Ind AS 105. Even Ind AS 109, Financial Instruments, has different accounting requirements for financial assets and financial liabilities within the scope of the same standard. Moreover, Ind AS 105 does not include a scope exclusion for common control transactions. Therefore, the argument that the transaction is a common control transaction and accordingly the loss is recognised in equity is also not tenable. Accordingly, it is doubtful that the accounting treatment given in approved court scheme is in accordance with Ind AS.
The menace of court scheme accounting continues under Ind AS Framework too. To add salt to injury, Schedule III was amended to require following disclosure in notes:
Where the Scheme of Arrangements has been approved by the Competent Authority in terms of Sections 230 to 237 of the Companies Act, 2013, the company shall disclose that the effect of such Scheme of Arrangements have been accounted for in the books of account of the Company in accordance with the Scheme and in accordance with accounting standards and any deviation in this regard shall be explained.
In this regard, attention is drawn to the following requirements of paragraph 16 of Ind AS 1:
An entity whose financial statements comply with Ind ASs shall make an explicit and unreserved statement of such compliance in the notes. An entity shall not describe financial statements as complying with Ind ASs unless they comply with all the requirements of Ind ASs.
Paragraph 16 of Ind AS 1 states that a company required to comply with Ind AS shall make an explicit and unreserved statement of compliance with Ind AS in notes. Paragraph 16 further states that such a statement can be made only if that company complies with all the requirements of Ind AS. Therefore, where a company accounts as per court scheme and discloses deviation from accounting standards as required by Schedule III, can that company make the explicit and unreserved statement of compliance required by paragraph 16 of Ind AS 1. The definition of ‘materiality’ in paragraph 7 of Ind AS 1 was amended to clarify obscuring information. Here, the law itself requires disclosure of obscuring information. Paragraph 2 of General Instructions for Preparation of Financial Statements of a Company required to comply with Ind AS of Division II of Schedule III to the Companies Act, 2013, states that the requirements of Ind AS shall prevail over the requirements of the Schedule. Therefore, disclosing full compliance with all requirements of Ind AS and deviation from Ind AS in notes to the same financial statements is obscuring for a user of those financial statements to which the independent auditor may draw attention to in his / her independent auditor report. Whether the attention to be drawn should be in the form of Emphasis of Matter or Qualification is left to professional judgement of the independent auditor and the Standards on Auditing.
Given the diverse practices followed, I invite comments from readers on accounting for demerger of business as comment to this post on LinkedIn and suggestions to stop the menace of court scheme accounting.
From Accounting Policy Repository – Offsetting Financial Instruments - Policy Id: 7525 - Applicable Standards: Ind AS 32, Financial Instruments: Presentation
As reported by Company (No views expressed – Views of readers are invited):
Financial Assets and Liabilities are offset and the net amount is reflected in the balance sheet where there is a legally enforceable right to offset the recognised amounts and there is an intention to settle the liability simultaneously. The legally enforceable right must not be contingent on future events and must be enforceable in the normal course of business and in the event of default, insolvency or bankruptcy of the Company or counterparty.
From Key Audit Matters Repository - Key Audit Id: 2252 – Valuation of claims under settlement - As reported (No views expressed – Views of readers are invited):
Key Audit Matter:
The Company has certain significant open legal proceedings under arbitration for various complex matters with the Clients and other parties, continuing from earlier years, which are as under:
• Non acceptance of certain work by the client.
• Cost overrun in certain contracts.
• Reimbursement of the cost incurred by the company for the client.
Due to complexity involved in these litigation matters, the recognition of claims / variations are included in revenues when it is highly probable of recovery based on estimate and assessment of each item by the management based on their experience of recovery
Refer notes 1.j, 44 to the Standalone Financial Statements
How was the matter addressed by auditor:
Principal Audit Procedures
Our audit procedures included the following:
• Assessing the procedures implemented by the Company to identify and gather the risks it is exposed to.
• Obtaining an understanding of the risk analyses performed by the Company, with the relating supporting documentation, and studying written statements from internal and external legal experts, where applicable.
• Discussion with the management on the development in these litigations during the year ended March 31, 2022.
• Obtaining representation letter from the management on the assessment of these matters as per SA 580 (revised) – written representations.
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Financial Reporting Advisor | Ind AS, IFRS and Indian GAAP | Author | Independent Director
1ySYSINNOVA Infosystems Private Limited Thank you so much for spreading the word on #GAAPAdvisors #TASK
Financial Reporting Advisor | Ind AS, IFRS and Indian GAAP | Author | Independent Director
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Financial Reporting Advisor | Ind AS, IFRS and Indian GAAP | Author | Independent Director
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head audit & risk management at hc
2y--since it mentions transfer on going concern basis i guess it is not a discontinued operations------we must also note under income tax act 2(19AA) -- transfer in demerger has to be at book values........ else it would not fulfill definition of Demerger under income tax act...non compliance to definition of demerger will have tax implications to the entity and to shareholders.....
Financial Reporting Advisor | Ind AS, IFRS and Indian GAAP | Author | Independent Director
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