Thursday, September 29, 2016

Effective Interest Rate (EIR): Floating (Variable)- Rate Financial Instruments

I have been receiving a number of queries on calculation of effective interest rate for floating (variable) rate financial assets or financial liabilities – which are to be subsequently measured at amortised cost.

Let’s first start with the definition of ‘Effective Interest Method’. Indian Accounting Standard (Ind AS) 109, Financial Instruments in Appendix A states that ‘the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset or financial liability to the gross carrying amount of a financial asset or to the amortised cost of a financial liability. When calculating the effective interest rate, an entity shall estimate the expected cash flows by considering all the contractual terms of the financial instrument (for example, prepayment, extension, call and similar options) but shall not consider the expected credit losses (ECL). The calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs, and all other premiums or discounts. There is a presumption that the cash flows and the expected life of a group of similar financial instruments can be estimated reliably. However, in those rare cases when it is not possible to reliably estimate the cash flows or the expected life of a financial instrument (or group of financial instruments), the entity shall use the contractual cash flows over the full contractual term of the financial instrument (or group of financial instruments).’

The definition is lucid and almost explains the calculation of effective interest rate in all the scenarios. The Application Guidance in Appendix B of the standard while elucidating on amortising yield enhancing fees and/or costs over the expected life of financial asset or financial liability mentions EIR of floating (variable) rate instruments. For floating (variable)-rate financial assets or financial liabilities, periodic re-estimation  of cash flows to reflect the movements in the market rates of interest alters the effective interest rate. If the floating (variable)-rate financial asset or financial liability is recognized initially at an amount equal to the principal receivable or payable on maturity, re-estimating the future interest payments normally has no significant effect on the carrying amount of the asset or the liability.


To sum it up, in the floating (variable)-rate financial asset or liability any fees, transaction costs, premiums or discount will be amortised at EIR till the next interest repricing date. If such transaction costs are not material to be included in the EIR calculation then amortised cost of financial asset or financial liability would be the carrying amount.

Wednesday, September 28, 2016

Clarification by SEBI regarding Revenue recognition and Excise Duty Restrictions




Transition to Indian Accounting Standards (Ind AS) has brought a set of challenges for companies as well as the regulators. SEBI vide its circular dated 5 July 2016 (CIR/CFD/FAC/62/2016) requires listed companies to comply with the formats prescribed under the SEBI Circular dated 30 November 2015, for reporting financial results till 31 December 2016. The 31 March 2017 financial results onwards are required in the formats prescribed in Revised Schedule III of the Companies Act 2013.

The format prescribed by SEBI permits ‘Income from Operations’ to be disclosed net of excise duty. However, Schedule III of the Companies Act, 2013 (2013 Act) notified on 6 April 2016, requires ‘Revenue from Operations’ to be disclosed inclusive of excise duty.

The Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) issued a notification on behalf of SEBI, on 20 September 2016, which clarifies that companies should follow a uniform approach in their revenue disclosures. Accordingly, ‘Income from Operations’ may be disclosed inclusive of excise duty, instead of net of excise duty, as specified in the 2013 Act.

This clarification is based on the guidance in the SEBI circular(CIR/CFD/FAC/62/2016) dated 5 July 2016, which stated that ‘in case of any technical difficulty in the interpretation of any specific item in the formats or implementation of this circular while publishing the financial results, the listed entities shall be guided by the relevant provisions of the Companies (Indian Accounting Standards) Rules, 2015 (Ind AS Rules)/Companies (Accounting Standards) Rules, 2006 (AS Rules) and Schedule III to the 2013 Act and may make suitable modifications, as applicable’.

The clarification is also consistent with the view proposed by the Ind AS Transition Facilitation Group (ITFG) of the Institute of Chartered Accountants of India (ICAI) in its 4th bulletin. The ITFG -4, based on guidance in Ind AS 18- Revenue and Schedule III of the 2013 Act, considered excise duty to be a liability of the manufacturer, which forms part of the cost of production. Accordingly, revenue should be presented as a gross amount inclusive of excise duty, which should therefore be reflected as an expense.