How-to IFRS Series..(1/5)

PURPOSE

I propose to start series of articles on How-to in IFRS? Some of it comes from my working experience at foreign banks and the Big 4 and some from my teaching notes at the IFRS certification courses. Hope you will enjoy the read..!! Happy reading :)

How-to

Know your Related Parties?

OVERVIEW

Related party transactions (RPT) are a very common in business nowadays. They are often assumed to be not a good thing. Though this may be true is some corporate scams where the board of directors and promoters take shareholders for a ride, in most cases there are valid commercial reasons for dealing with related parties.

The Companies Act, 2013 in India comprehensively provides guidance on the related parties which is not a part of this article. I expressly only write about how to know your related party according to IAS 24.

WHO IS ENTITY’S RELATED PARTY?

A party is related to an entity, if the party:

1.    is controlled by the entity, or controls the entity (including common control, joint control, significant influence);

2.    is an associate of the entity;

3.    is a joint venture;

4.    is a member of key management personnel of the entity

5.    is a close member of the family of any individual in (1) or (4)

6.    is an entity jointly controlled or significantly influenced by any individual in (4) or (5)

7.    is a post-employment benefit plan for the benefit of employees of the entity or a related party of the entity   

FEW MORE TIT-BITS

*  Key management personnel include all those who have authority and responsibility for planning, directing, and controlling the activities of an entity. These persons need not necessarily be directors.

*      Close members of the family definition provides a list of persons included in the family as:

o   Domestic partner

o   Children

o   Children of domestic partner

o   Dependants

o   Dependants of domestic partner

It is an inclusive definition but by no means the list is exhaustive. The

definition tries to address cross-border and cross-cultural dimension 

issues as far as possible.

WHAT TO DISCLOSE?

§        Regardless of the existence of related party transactions, we have to disclose the following:

a.     Relationships between parents and subsidiaries

b.    If control exists, such a relationship

c.     Key management personnel compensation in total plus short-term benefits, post-employment benefits, other long term benefits, termination benefits and share based payments

§         Minimum disclosures for RPT:

a.     Transaction amount

b.    Outstanding Balances

c.     Doubtful debt provisions for outstanding balances and expenses recognised

§       Disclosure categories

The above disclosures are required for each of the category listed under:

a.     Parent

b.    Entities with joint control or significant influence over the entity

c.     Subsidiaries

d.    Associates

e.     Joint ventures

f.      Key management personnel

g.     Other related parties

LET’S KNOW HOW-TO WITH CASE EXAMPLE

Facts: CureMe Pharma Ltd is a large MNC operating from India and is known to properly disclose all its related party transactions in the financial statements prepare under IFRS. The company is seeking advice from IFRS specialists on which of the transactions and to what extent be reported, and how the notes to accounts should appear.

1.    Remuneration and other payments made to CEO Mr. Gupta during the year 2014-15 were:

a.     Annual salary of 5 crores (including contribution to employee provident fund of 1 crore)

b.    Share options and other share based payments of 1 crore

c.     Reimbursement of his travel expenses for business amounting to 12 lakhs

2.    Sales made during the year 2014-15 to:

a.     LifeMe Pharma Ltd., parent company: 50 crores

b.    BeingMe Pharma Marketing Ltd., an associate: 2.5 crores

3.    Trade receivables at March 31, 2015, include:

a.     Due from LifeMe Pharma Ltd. 10 crores (net of provisions 7 crores)

b.    Due from BeingMe Pharma Marketing Ltd. 50 lakhs (these receivables are fully backed by corporate guarantee from BeingMe)

Solution:

      I.   All the above mentioned transactions are required to be disclosed in CureMe Pharma Ltd.’s financial statements prepared under IFRS.

The only exception is the reimbursement of the travel expenses of the CEO amounting to 12 lakhs; as this is not KMP compensation.

    II.          Notes to Accounts – Extract – Related Party Transactions

1)    CureMe Pharma Ltd., enters into related party transactions in the normal course of business. During the year 2014-15, these transactions were entered into with related parties as defined under IAS 24. The transactions resulted in balances due from those parties that, at March 31, 2015, were:

i)     With the parent company (LifeMe Pharma Ltd.)

a.   Sales = INR 50 crores

b.  Trade Receivables due from parent company = INR 10 crores

c.   Provision for doubtful debts = INR 3 crores  

ii)   With an associate

a.   Sales = INR 2.5 crores

b.  Included in trade receivables due from an associate * INR 50 lakhs

*Amount due from an associate is secured by a corporate guarantee given by the associate.

iii)  For the year ended March 31, 2015, the following payments were made to its CEO Mr. Gupta, part of the key management personnel:

a.   Short term benefits (Salary) = INR 4 crores

b.   Post-employment benefits (employee provident fund contribution) = 1 crore

c.   Share based payments including ESOP = 1 crore

d.  Total = INR 6 crores

IFRS 9 (Ind AS 109) - India first country to mandatorily early converge!!

Abstract of the Ministry of Corporate Affairs (MCA) Notification - Companies (Indian Accounting Standards) Rules, 2015 

G.S.R dated 16 Feb 2015

Effective from: 1-April-2015

Obligation to comply with Indian Accounting Standards (Ind AS)

1. The Companies and their auditors shall comply with the Indian Accounting Standards (Ind AS) specified in Annexure (39 standards in total) to these rules in preparation of their financial statements and audit respectively, in the following manner, namely:- 

• any company may comply with the Indian Accounting Standards (Ind AS) for financial statements for accounting periods beginning on or after 1st April, 2015, with the comparatives for the periods ending on 31st March, 2015, or thereafter; 
  
  
• the following companies shall comply with the Indian Accounting Standards (Ind AS) for the accounting periods beginning on or after 1st April, 2016, with the comparatives for the periods ending on 31st March, 2016, or thereafter, namely:- 
  a) companies whose equity or debt securities are listed or are in the process of being listed on any stock exchange in India or outside India and having net worth of rupees five hundred crore or more; 
  b) companies other than those covered by sub-clause (a) and having net worth of Rupees five hundred crore or more;
  c) holding, subsidiary, joint venture or associate companies of companies covered by sub-clause (a) and sub-clause (b) as the case may be; and 
  
  
• the following companies shall comply with the Indian Accounting Standards (Ind AS) for the accounting periods beginning on or after 1 st April, 2017, with the comparatives for the periods ending on 31st March, 2017, or thereafter, namely:-
  a) companies whose equity or debt securities are listed or are in the process of being listed on any stock exchange in India or outside India and having net worth of less than Rupees five hundred crore;
  b) Unlisted companies having net worth of Rupees two hundred and fifty crore or more but less than rupees five hundred crore;
  c) holding, subsidiary, joint venture or associate companies of companies covered under sub-clause (a) and sub-clause (b), as the case may be.
  
  

“Comparatives” shall mean comparative figures for the preceding accounting period. 

For the purposes of calculation of net worth of companies, the following principles shall apply, namely:- 

the net worth shall be calculated in accordance with the stand-alone financial statements of the company as on 31st March, 2014 or the first audited financial statements for accounting period which ends after that date; 

Standards in Annexure to the rules once required to be complied with in accordance with these rules, shall apply to both stand-alone financial statements and consolidated financial statements.

Exemptions 

• The insurance companies, banking companies and non-banking finance companies shall not be required to apply Indian Accounting Standards (Ind AS) for preparation of their financial statements either voluntarily or mandatorily.

Fully Depreciated Assets

Have you come across a situation when you find that the block of assets are fully depreciated in the books but the company is still using them in its operation to generate revenue? 

In this case, the original estimate of assets useful life proved to be incorrect.

These assets are used beyond their useful life, they are fully depreciated and their carrying amount in the books is zero. What depreciation expense can you recognize in the profit or loss?

None, of course – because the carrying amount of the assets cannot be sub zero. As a result, the matching principle does not work here. The expenses simply do not match the benefits gained from these assets.

The standard IAS 16 Property, Plant and Equipment defines the useful life as either:

· The period over which an asset is expected to be available for use by an entity, or

· The number of production or similar units expected to be obtained from the asset by an entity.

Now this is extremely important: IAS 16 requires entities to review assets’ useful lives at least at each financial year-end.

A survey proves that more than 95% of the companies do not revise the useful lives of their assets and book the depreciation charge based on the original rates determined for the block of assets. As a result, the companies are using fully depreciated assets for their production processes.

What is the solution then?

When faced with such a kind of situation the company can either:

1. Review the useful life of its assets at the end of each financial year; (IAS 8 - Change in Accounting Estimate) or

2. Use Revaluation Model (IAS 8 - Change in Accounting Policy)

Review the useful life of its assets at the end of each financial year:

If you change useful life of the assets then it is treated as a Change in Accounting Estimate as per IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. If the revised useful life is different from the original life then, set the new remaining useful life, take the carrying amount and recognize the depreciation charge based on the carrying amount and new remaining useful life.

No restatement of previous periods’ financial statements is required. IAS 8 requires recognizing change in accounting estimates prospectively.

Revaluation Model:

IAS 16 permits 2 models for subsequent measurement of your property, plant and equipment: cost model and revaluation model.

Revaluing assets with zero carrying amount will effectively mean that there is a Change in the Accounting Policy and hence the company will need to apply IAS 8.

IAS 8 mentions that an Accounting Policy can be changed in the following scenario: 

1. The change is required by an IFRS. With our situation, this definitely is not the case.

2. The change results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity’s financial position, financial performance or cash flows.

In our case, the second situation will match to an extent. But are we really considering the after effects of moving from a cost model to revaluation model for our block of assets? 

Accounting policy means using the prescribed rules and standards how you will report certain transactions in the financial statements – not only now, but also in the future.

So, do you think that changing your accounting policy from cost model to revaluation model would make you provide better information about your assets, not only now but also in the future?

· Revaluation model is used for buildings and land in most of the cases, because it’s easy to get the fair value of these assets regularly. In case of movable assets like plant or machine getting fair value from the market gets a bit difficult. 

· Revaluation of the assets have to be done with sufficient regularity, i.e. atleast annually. 

· Entire class of assets and not an individual assets needs to be revalued. 

· To determine the fair value of the class of assets, IFRS 13 Fair Value Measurement standard needs to be applied. This standard is complex and difficult for movable assets. 

If after considering the above concerns if it is still beneficial for your company to switch from cost model to revaluation model, the new depreciation accounting policy need not be applied retrospectively, just prospectively – no restatement of previous periods.

DRAFT NOTIFICATION - PRIVATE COMPANIES – COMPANIES ACT 2013

On perusal of the Companies Act 2013, many provisions applicable to the private companies were onerous for the smooth functioning of a company. The Draft Notification by the Ministry of Corporate Affairs dated 24-06-2014 is in the welcome direction of conducting business rather than getting entangled in compliance. Let’s have a look at the proposed changes in the notification applicable for private limited companies in India:

SN	Chapter/ Section number/ Sub-section(s) in the Companies Act, 2013	Exceptions/ Modifications/ Adaptations
1.	Section 43 – Kinds of Share capital & Section 47 – Voting Rights	Both whole sections shall not apply
2.	Section 62 (1) (a) – Rights offer to the existing shareholders shall be made by notice specifying the no. of shares offered and limiting the time not being less than 15 days and not exceeding 30 days from the date of offer within which the offer, if not accepted, shall be deemed declined Section 62 (2) – The notice referred to above shall be despatched by RP or Speed Post or electronic mode to all existing shareholders atleast 3 days before the opening of issue	Shall apply with the following modification:- Words ‘not being less than fifteen days and not exceeding thirty days’ shall be substituted with ‘not being less than seven days and not exceeding fifteen days’
3.	Section 62 (1) (b) – Further issue of shares under the Employee Stock Option Plan (ESOP) shall be subject to special resolution passed by company and subject to such conditions as may be prescribed	Shall apply except that instead of special resolution, ordinary resolution would be required
4.	Section 73 (2) – Acceptance of Deposits from public	Shall not apply to private companies having 50 or less number of members if they accept monies from their members not exceeding 25% of aggregate of the paid up capital and free reserves or 100% of the paid up capital, whichever is more, and inform the details of such monies to the Registrar in the prescribed manner.
5.	Section 101- Notice for General Meeting Section 102- Statement to be annexed to notice Section 103 – Quorum for meetings Section 104 – Chairman of meetings Section 105 – Proxies Section 106 – Restriction on Voting Rights Section 107 – Voting by show of hands Section 109 – Demand for poll	All whole Shall apply unless - otherwise specified in respective sections or - unless articles of the private company otherwise provide.
6.	Section 141 (3) (g) – An auditor can be appointed by maximum 20 companies	Shall not apply in respect of appointment of auditors by private companies.
7.	Section 160 - Right of persons other than retiring directors to stand for directorship.	Shall not apply
8.	Section 162 - Appointment of 2 or more persons as directors of the company by a single resolution shall not be moved unless a proposal to move such a motion has first been agreed to at the meeting without any vote being cast against it.	Shall not apply
9.	Section 180 – Restrictions on powers of Board.	Shall not apply to private companies having 50 or less number of members
10.	Section 185 - no company shall, directly or indirectly, advance any loan, including any loan represented by a book debt, to any of its directors or to any other person in whom the director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person	Shall not apply to Private companies - (a) which have borrowings from banks or financial institutions or any bodies corporate not more than twice of their paid up share capital or Rs. 50 crore, whichever is lower; and  (b) in whose share capital no other body corporate has invested any money
11.	Section 188 – Related party transactions	Shall not apply
12.	Section 196 (4) and (5) – Appointment and remuneration of managing director, whole-time director or manager.	Shall not apply
13.	Section 203 (3) - Whole-time key managerial personnel (KMP) shall not hold office in more than one company except in its subsidiary company at the same time	Shall not apply

The draft notification has been laid before both the Houses of Parliament and if notified will be of paramount importance to the private companies in India. 

CLASSIFICATION OF FINANCIAL INSTRUMENTS (CATEGORIES) - IAS 39

Classification of Financial Instruments into 4 categories of Financial Assets and 2 categories of Financial Liabilities are important for subsequent measurement. Only the categories decide how a financial asset or liability will be subsequently measured.  

FAIR VALUE MEASUREMENT ~ IFRS 13

Prior to IFRS 13: Fair Value Measurement standard, fair value was defined as “an amount exchanged between knowledgeable willing parties at an arm’s length transaction”. As per this definition fair value is the price at which parties are ready to "enter" into the transaction. The notion was therefore "entry price"

The change in IFRS 13 of the definition of fair value concentrates on exit price. The new definition "Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." It means that an entity shall look at how the market participants will price the asset or liability at a measurement date. The notion here is now the "exit price".

The objective of IFRS 13 was to define fair value in a single IFRS and to set out disclosures about fair value measurements.

What must an entity do to calculate Fair Value?

1. determine the particular asset or liability that is the subject of measurement ;
2. for a non-financial asset, determine the valuation base that is appropriate for the measurement;
3. know which is the principal (or most advantageous) market for the asset or liability 
4. know the valuation techniques (e.g. DCF approach, NPV, IRR models, Black Scholes Option Pricing, etc.) appropriate for the measurement, considering: 

• the availability of data with which to develop inputs that represent the assumptions that market participants would use when pricing the asset or liability; and 
• the level of the fair value hierarchy (level 1, level 2 or level 3) within which the inputs are categorized. 

IFRS 13 requires comprehensive disclosures like:

• Valuation techniques and inputs used to develop fair value measurement for both recurring (financial instruments appearing on balance sheet at the end of each reporting date) and non-recurring measurements (assets/liabilities presented on balance sheet in certain circumstances);
• The changes in fair value on profit or loss or other comprehensive income for recurring fair value measurements using significant Level 3 inputs.

COMPANIES ACT 2013: CHECKLIST

The Companies Act 2013 comes into force from 1-April-2014 for the Indian corporate. There are sea changes brought in this Act from the earlier one. Let's have a quick browse on the checklist:

WHAT COMPANIES WILL HAVE TO DO?

IMMEDIATELY

• Devise and implement policies on corporate social responsibility and vigil mechanism (if any one of the criteria satisfied ~ networth of Rs.500 crore or more, turnover of Rs. 1,000 crore or more, a net profit of Rs. 5 crore or more during any financial year)
  
• Finalise a new code for independent directors and identify and notify the related parties to their respective accounts departments
  
• Print new stationery, bills, etc, with name, address of the registered office, Company Identification No. (CIN), telephone, fax, email and website
  
• File returns with the Registrar of Companies on changes in top 10 shareholders
  
• Get certificate of independence from directors
  
• Maintain register of key management personnel (KMP)

WITHIN THREE MONTHS

• File returns on public deposits

WITHIN ONE YEAR

• Reconstitute boards with at least one woman director and two independent directors