Tuesday, August 31, 2010

Consolidated Financial Statements & CONTROL

1.1 Meaning of Consolidated Financial Statements

Consolidated Financial Statements (CFS) are the financial statements of a group presented as those of single economic entity. A group is a parent and all its subsidiaries. A parent is an investor that controls another entity called subsidiary. The parent and subsidiary (ies) constitute a Group.

A parent company is required to prepare CFS of the Group as a whole. CFS are:

1. Consolidated Balance Sheet

2. Consolidated Comprehensive Income Statement

3. Consolidated Statement of Changes in Equity

4. Consolidated Statement of Cash Flows

5. Notes and other statements

6. Statement of Restatement Analysis

1.2 Meaning of Control

Control: is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.

Criteria in deciding control over another entity are:

i. Majority voting power (more than half of the voting rights);

ii. Power to govern financial and operating policies of the entity under a statute or agreement;

iii. Power to remove majority of the board members and control of the entity is by that board;

iv. Power to cast majority votes at board meetings.

1.2.1 Potential voting rights: Financial instruments which are convertible into equity shares with voting rights are termed as instruments having potential voting rights. Examples are share warrants, convertible debentures, convertible preference shares, etc. While evaluating control the potential voting rights are taken into account. However, it is necessary to take into account all facts and circumstances including terms of exercise and other agreements before counting such potential voting rights.

Example 1.1 Planet Ltd. holds 45% stake in IStaR Ltd. out of the 20 million equity shares of the investee company. In addition, it holds 20 million out of the 30 million share warrants issued by the company. Does Planet Ltd. control IStaR Ltd.?

Solution 1.1 Total voting rights of IStaR Ltd.:

Current 20 million

Potential 30 million

Total 50 million

Out of which Planet Ltd. holds.:

Current 9 million

Potential 20 million

Total 29 million

So Planet Ltd. holds majority voting right of IStaR Ltd. on the basis of current and potential voting rights. IStaR Ltd. is a subsidiary of Planet Ltd.

It is not relevant to analyze whether the Planet Ltd. intends to exercise the warrants or it has the financial ability to exercise the warrants. Only issue evaluated is whether it has ‘authority’ to exercise the warrants.

Even ‘out-of-money call option’ held by the investor is counted as potential shares despite the fact that the options are currently worthless. The issue is the right to exercise not that whether the entity will exercise or not.

1.2.2 Dual control and issue of consolidation: Dual control may occur in rare situation when an entity establishes control through majority voting rights but another company has appointed majority Board members. In this case both the entities which have control should consolidate.

Wednesday, August 11, 2010

The Opening IFRS Balance Sheet

Adopting International Financial Reporting Standards (IFRS) present challenges that many people underestimate. The International Accounting Standards Board (IASB) on November 24, 2008 has issued Reconstructed version of IFRS 1: First Time Adoption of International Financial Reporting Standards applicable to the entities on or after January 1, 2009 although earlier application is permitted. The Institute of Chartered Accountants of India (ICAI) has issued Ind- AS 41 talking about the transition requirements on the lines of IFRS 1 (Revised).

When a company prepares its first IFRS financial statements for the year ending 31st March 2012 with one year comparatives, the date of transition to IFRS will be 1st April 2010 and the opening IFRS balance sheet will be prepared at that date. A company required to present two full years of comparative information should prepare an opening balance sheet at 1st April 2009. The opening IFRS balance sheet is the starting point for all subsequent accounting under IFRS.

An entity in its opening balance sheet shall:
• Recognize all assets and liabilities whose recognition is required by IFRSs (e.g. derivative financial instruments);
• Not recognize items as assets and liabilities if IFRS do not permit such recognition (e.g. general reserves);
• Reclassify items that it recognized 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 IFRS (e.g. netted-off assets where netting is not permitted);
• Apply IFRSs in measuring all recognized assets and liabilities (e.g. impairments of property, plant and equipment and intangible assets)

The exception to this is where one of the optional exemptions or mandatory exemptions does not require or permit recognition, classification and measurement in accordance with IFRS.

The adjustments as a result of applying IFRS for the first time are recorded in retained earnings or another equity category. For example, a company that is required to re-measure available-for-sale (AFS) investment to fair value should recognize the adjustment in the AFS reserve. Similarly if a company elects to adopt a revaluation model in IAS 16 should recognize the difference between the cost and fair value of property, plant and equipment in the revaluation reserve. Companies might also be required to consolidate entities that were earlier not consolidated under the local GAAP. Companies will be required to consolidate any entity over which it is able to exercise control. Subsidiaries that were previously excluded from the group financial statements are consolidated as if they were first time adopters on the same date as the parent. The difference between cost of the parent’s investment in the subsidiary and subsidiary’s net assets under IFRS is treated as goodwill.

The deferred tax and minority interest balance included in the opening IFRS balance sheet will be dependent on other adjustments made. These balances should therefore be calculated after all adjustments are made.

The preparation of opening IFRS balance sheet may require the calculation and /or collection of information which was not calculated earlier in our local GAAP. Converging to IFRS will be a bigger change for some companies than for others. With mandatory transition proposed to begin in 2011, it makes sense for management to start sizing up the volume and variety of financial, business, tax, and operational changes—the objective being to avoid a resource demanding effort at the eleventh hour. Perhaps just as important, sufficient lead time will allow companies to discover transition-related changes which have the potential to deliver future dividends, such as overhaul of an inflexible information technology system or rethinking of accounting choices and not just treating them as a compliance exercise. The earlier we begin, the greater the benefits are likely to be.

Saturday, August 7, 2010

CAs in city feel India may not be ready for IFRS

International Financial Reporting Standards will be mandatory for financial statements from April 2011

With the commencement of the next financial year, the Indian Accounting Standards are all set to go global by converging with the International Financial Reporting Standards (IFRS). While it will enable Indian firms to access and understand the balance sheets of firms in the international markets, many chartered accountants (CA) in Pune feel that the country may not be ready for the transition.

According to the CAs, for an economy to make the transition, an enormous amount of training is required, not just for the CAs but for a vast group of people likely to be affected by the new accounting norms.

Dolphy D’Souza, national leader, IFRS, is of the view that only big accounting firms like KPMC and a few others have the expertise in IFRS as of now. “While Indian Institute of Chartered Accountants (ICAI) is training CAs, we need to train audit committee members, regulators, financial analysts, board members and even the investors for them to understand the market.”

With the IFRS, the real estate sector will also see massive changes in accounting norms. While revenue recognition now takes place simultaneously with the construction of a project, with IFRS, it can be done only after an entire project is completed. Even mergers and acquisitions norms will undergo a sea change, said D’Souza.

Many feel that the present course by ICAI need to be more of a hands on programme rather than remaining restricted to theoretical concepts.

Ramesh Lakshman, a practising CA, cites that the language in which the standards has been written is extremely complicated to grasp.

G Ramaswamy, vice president, ICAI, said, “ICAI has 100-hour course running in six cities to train chartered accountants and a few short term courses in the form of workshops. We need a batch of 30 for a course. While Pune has already had two workshops, soon we may also have the course in the city.”

IFRS will be mandatory in India for financial statements from April 1, 2011 as per notifications by ICAI and Reserve Bank of India. The changes will be implemented in phases with the first phase including companies listed with BSE and NSE, companies whose shares or other securities are listed on a stock exchange outside India, companies, whether listed or not, having net worth of more than INR1,000 crore.

Sunday, August 1, 2010

IASB proposes improvements to insurance accounting

The International Accounting Standards Board (IASB) today published for public comment an exposure draft of improvements to the accounting for insurance contracts. The exposure draft proposes a single International Financial Reporting Standard (IFRS) that all insurers, in all jurisdictions, could apply to all contract types on a consistent basis.

When the IASB was established in 2001 there were no international financial reporting requirements for insurance contracts. In 2004 the IASB introduced IFRS 4 Insurance Contracts as an interim standard that permitted many existing international accounting practices to be retained, whilst beginning a more comprehensive review of insurance accounting as a second phase of the project. The proposals published today are the result of that review.

The IASB launched its public consultation when it published a discussion paper, Preliminary Views on Insurance Contracts, in 2007. In developing the proposals released today, the IASB considered more than 160 comment letters received on the discussion paper, as well as feedback from interested parties through an extensive outreach programme, including interaction with the IASB’s Insurance Working Group and a targeted field test with preparers. The IASB will undertake further outreach during the exposure draft’s comment period, including a second round of field tests, to ensure that the IASB considers the views of all interested parties before it issues an IFRS.

Commenting on the exposure draft, Sir David Tweedie, chairman of the IASB, said:

A fundamental review of insurance accounting was long overdue, with current practice resulting in financial information that is impenetrable to all but the most expert of users.

The publication of this exposure draft marks an important milestone in this review process. The proposed standard better reflects the economics of insurance contracts, and would result in more relevant, understandable and comparable information being available to investors.

The exposure draft Insurance Contracts is open for comment until 30 November 2010 and can be accessed via the ‘Comment on a Proposal’ section of www.ifrs.org

To find out more, visit the Insurance Contracts section of the IASB website viahttp://go.ifrs.org/insurance_contracts. Materials available on the website include a podcast introduction to the proposals by Warren McGregor, member of the IASB, as well as a high level executive summary of the proposals (Snapshot).

An interactive webcast introducing the proposed standard will be held at 10.00am London time on Friday 6 August, and repeated at 3.00pm London time on the same day for the benefit of interested parties in different time zones.

To register, go to: http://www.ifrs.org/Meetings/Live+webcast+Insurance+accounting.htm