AMORTISED COST CALCULATION: THE EFFECTIVE INTEREST RATE (EIR)

IAS 39 mandates some financial assets and liabilities to be subsequently measured at ‘amortized cost’.  This measurement concept is a management theory put in accounting practice. It means that the contractual interest rate each period should be adjusted to amortize the transaction costs over the expected life of the financial instrument. The amortization is calculated on an effective interest rate (EIR) / yield-to-maturity (YTM) basis. The EIR is the rate that exactly discounts the stream of principal and interest cash flows excluding any impact of credit losses, to the initial net proceeds. It is important to note that EIR method does not take into account any future credit impairments anticipated on that instrument.

The carrying amount of the financial instrument subsequently measured at amortized cost is computed as:

Transaction costs are an integral part of the amortized cost calculation. They are defined as costs that are directly attributable to the acquisition, issue or disposal of a financial instrument. Transactions costs are those that are paid to external parties, such as fees and commissions paid to agents, brokers and dealers, levies paid to regulatory agencies, stock exchanges, taxes and duties. Transaction costs may include internal costs, but such costs must be incremental in acquisition, issue or disposal of a financial instrument. Transaction costs will neither include any internal financing, holding and administrative costs nor do they include premium or discount.

Effective Interest Rate Calculation Example

A bank gives a loan to its customer as per the following terms:

Loan Amount: 100,000/-

Maturity: 5 years

Interest: 1^st year – 6%, 2^nd year – 8%, 3^rd year – 10%, 4^th year – 12% and 5^th year 18%

The loan repayments are interest only each year and principal repayment at maturity.

The effective interest rate (IRR) is calculated as the rate that exactly discounts estimated future cash flows through the expected life of the instrument.

100,000 = 6000/ (1+IRR)¹+ 8000/ (1+IRR)² + 10000/ (1+IRR)³ + 12000/ (1+IRR)⁴ + (18000+100000)/ (1+IRR)⁵

Solving this equation on excel we get an IRR = 10.2626%

(Hint: In Excel to calculate EIR use the function XIRR with estimated dates of the expected future cash flows)

The amortized cost of the loan at the end of each period will be accounted as follows:

YEAR	AMORTISED COST AT THE START OF THE YEAR  (A)	EIR (B) = (A) * 10.2626%	CASH FLOW  (C)	AMORTISED COST AT THE END OF THE YEAR             (D) = (A)+ (B) – (C)
1	100,000	10,263	6,000	104,263
2	104,263	10,700	8,000	106,963
3	106,963	10,977	10,000	107,940
4	107,940	11,077	12,000	107,017
5	107,017	10,983	118,000	0

ICAI E-CELL

ICAI ENTREPRENEURSHIP CELL

The ICAI Entrepreneurship Cell, will foster entrepreneurship for all CAs who avoid incubating the latent entrepreneurial spirit.  The ICAI E-Cell will show Chartered Accountants of India the doors of opportunity but a dedicated team will also help walk through by providing mentoring, financial, networking with other entrepreneurs and knowledge inputs.

The ICAI E-Cell will comprise of CA members, regulators, mentors and service providers from the industry who span a variety of functional areas, sectoral domains and are passionately committed to help aspiring entrepreneurs succeed commercially

In all I wish to act as a “Founder & Chief Catalyst” to create “ecrats” (entrecrats) out of the present day “acrats” (accountcrats).

Sr.No 10 ~ GUPTA POOJA CANDIDATE FOR ICAI CENTRAL COUNCIL ELECTIONS

A prayer to my GOD..

Dear God,
So far I've done all things right..
I haven't gossiped
haven't lost my temper,
haven't been greedy, grumpy, nasty, selfish, or overindulgent. 
I'm really glad about that..

But in a few hours, God,

I'm gonna be get out of bed..
And from then on, I'm going to need a lot more help..
Please be with me always
Yours,
Gupta Pooja
♥ ♥

An Appeal

An Appeal

Dear Companion,

This is to bring to your kind notice that my nomination for the Central Council Elections have been accepted.  The elections are on 7^th and 8^th December, 2012 in Ahmedabad, Pune and Mumbai and on 8^th December, 2012 in other parts of the region. I had begun my journey in the year 2000 which forever changed the way I’d perceived access to my fellow professionals. My journey is far, far from finished! I need your support and able guidance to finish what I have started.

My Profile

Chartered Accountant by qualification;

Teacher by profession; Author by choice..

A qualified Chartered Accountant, Company Secretary, LL.B and Masters in Finance from University of Frankfurt, Germany., now I’m pursuing Doctorate of Philosophy (PhD) from Central University of Gujarat.

In my professional path; I come from leading multinational banks (Standard Chartered Bank & Societe Generale Bank) at senior positions in Mumbai and in Spain & Germany with Pricewaterhouse Coopers (PwC). Always having an academic bent of mind, I’m now with a management college as Head – Finance faculty.

Have served as Regional Council Member (Western) of ICAI and in-charge of numerous committees during my tenor. Convener of the study group AS 30/ AS 31 and AS 32- Financial Instruments Standards and Revised Schedule VI. Nominated as the member of ASB of ICAI for one term (2009 -10). I’m one of the lead faculty speaking on IFRS at the ICAI forum. Ive been a speaker on IFRS at various other forum including the International Banking & Finance Conference by the Indian Merchant Chambers (IMC).

I’d been honoured 1^st position –CA Young Leader Corporate -2008 award for demonstrating exceptional courage, excellence and through professionalism in India Inc!

Authored a book “Financial Instruments Standards – A Guide on IAS 32, IAS 39 and IFRS 7” published by Tata McGraw Hill and is sold internationally. I’ve written articles on IFRS by invitation with The Financial Express and The Hindu Business Line.

Closing Moments

Growing together, beautifully

To add to all this I’m the only youngest lady contestant – a true believer in the principles of Transparency, Honesty and Service in my life. I do not wish to make tall promises at this juncture but from the humble beginnings I hope to create a brighter future for our professional community and also to expand the work of my predecessors to meet the motto of “Growing together, beautifully”. It is indeed a Herculean task but I am confident your kind support would enable me to overcome all odds.

I seek your good wishes for my future.

New Schedule VI – Generally Asked Questions & Answers (GAQA)

In the Part 1 and Part 2 of the ‘Ten Minutes’ series of New Schedule VI an overview of the Balance sheet and Profit and Loss account changes were dealt with. In this last Part I’d like to touch upon my perspective of certain practical issues in putting Schedule VI in place.

Issue 1:

The aggregate amount of both long term and shot term loans guaranteed by directors or “others” under each head is to be disclosed. Who does this “others” signify?

Solution:

The words “others” would mean any person or entity other than a director. It is therefore, not restricted to mean only promoters or related parties. In the normal course, a person or entity will generally guarantee a loan of the company only if it is associated with the company in some manner.

Issue 2:

A liability is to be classified as current if the company has an unconditional right to defer its settlement for at least 12 months after the reporting date. How will a 5-year loan which the company has taken is repayable on demand? Based on the past experience, it is not expected that the lender will demand the repayment within next 12 months.

Solution:

As the company does not have an unconditional right to defer the settlement of loan for at least 12 months after the reporting date, it will classify the loan as current. This is despite the fact that based on the past experience, it is not expected that the lender will demand the repayment within the next 12 months.

Issue 3:

Do we need to classify Capital advances between non-current and current categories? If yes, on what basis?

Solution:

Capital advances are advances given for procurement of fixed assets which are non-current assets. Companies do not expect to realize them in cash in the next 12 months or within their normal operating cycle. Rather, over the period, these get categorized as one or more fixed assets. Hence capital advances should be treated as non-current assets.

Issue 4:

In the New Schedule VI “Proposed Dividend” needs to be disclosed in the footnotes. Earlier proposed dividend was being disclosed under the head “Provisions”. Does it mean that proposed dividend is not required to be provided for going forward?

Solution:

The Indian Accounting Standard (AS) 4 – Contingencies and Events Occurring after the Balance Sheet date requires that dividends in respect of the period covered by the financial statements, which are proposed or declared by the company after the balance sheet date but before approval of financial statements, should be adjusted. The new schedule VI has stated an accounting standards override. This simply means that accounting standards will override the New Schedule. The companies will have to continue to create a provision for dividends in respect of the periods covered by the financial statements and disclose the same as provision in the balance sheet. 

Ten Minutes - Revised Schedule VI (Part 2/3)

New Schedule VI – Profit & Loss Account

The old version of Schedule VI did not have any format for Profit and Loss account. The New Schedule VI lays down a format for the presentation of P& L account. This format of P& L does not list any appropriation item on its face. Further, the New Schedule VI format prescribes that below the line adjustments to be presented under “Reserves and Surplus” in the balance sheet. The classification of expenses is based on their nature and not on their function.

What is classification of expenses based on nature or function?

In nature based classification of expenses an entity aggregates expenses within profit or loss according to their nature, for example; purchases of materials, transport costs, employee benefits, depreciation, marketing costs, etc and the expenses are not reallocated among functions within the entity. The main advantage of using this “nature of expense” method is that it is simple to apply because allocation of expenses according to functional classifications is not necessary.

In function based classification of expenses or “cost of sales” (as it usually called) an entity classifies expenses according to their function as part of cost of sales or, for example, the costs of distribution or administrative activities. At a minimum, an entity discloses its cost of sales under this method separately from other expenses. While this presentation can provide more relevant information to users, the allocation of costs to function can often be arbitrary.

Five Important Changes to the Profit & Loss Account – New Schedule VI way

1. Any item of income or expense which exceeds 1% of the revenue from operations or Rupees 100,000, whichever is higher, needs to be disclosed separately.

2. The old Schedule VI required the parent company to recognize dividends declared by subsidiary companies even after the date of the balance sheet if they were pertaining to the period ending on or before the balance sheet date. Such requirement no longer exists in New Schedule VI. Such requirement no longer exists in new Schedule VI. Accordingly, as per Indian Accounting Standard (AS) 9 Revenue Recognition, dividends should be recognized as income only when the right to receive dividends is established by the balance sheet date.

3. For companies other than finance companies, revenue from operations need to be disclosed separately as revenue from:

i. Sale of products;

ii. Sale of services; and

iii. Other operating revenues

4. Exchange gain or loss on foreign currency borrowings (net) to the extent considered as an adjustment to interest cost needs to be disclosed separately as a finance cost

5. Granular approach in terms of quantitative disclosures for significant items of P&L account such as raw material consumption, stocks, purchases and sales have been simplified and replaced with disclosure of “broad heads” only. The broad heads need to be decided based on materiality and presentation of true and fair view of the financial statements.

Ten Minutes - Revised Schedule VI (Part 1/3)

The New Schedule VI introduces many new concepts and disclosure requirements. It also does away with several statutory disclosure requirements.

The practical application of the New Schedule VI throws up several questions, the answers to which may not be straight forward. Through the medium of the blog I intend to set out an overview of the key changes and implications, critical issues and some perspectives thereon. In three parts I will first list down some important changes related to the Balance Sheet, second part will cover key changes to Profit and Loss account and the last part will be some practical issues and perspectives.

Ten Important Changes to the Balance Sheet – New Schedule VI way

1.       The new schedule VI prescribes a vertical format for presentation of balance sheet. Thus, a company will not have an option to use horizontal format for presentation of financial statements.

2.        The Balance Sheet presentation will now be Current and Non-Current classification. This is more in line with the Ind AS/ IFRS concept of presentation of financial statements. The application of this classification will require assets and liabilities to be broken into their current and non-current portions. Examples are:

a.       Long term sundry debtors will have to be classified under the head ‘Other Non Current Assets’;

b.       In case of distillery/ winery, wines in the process of maturing will be current assets even if it takes several years to mature;

c.       For a builder, buildings under construction are current assets.

3.     Number of shares held by each shareholder holding more than 5% shares now needs to be disclosed. Any specific indication of the date of holding is not available, then such information will be based on shares held as on the balance sheet date.

4.       Details pertaining to aggregate number and class of shares allotted for consideration other than cash, bonus shares and shares bought back will be disclosed if such an event has occurred during a period of five years immediately preceding the balance sheet date.

5.       Any debit balance in Profit and Loss Account will be disclosed under ‘Reserves & Surplus’ on the liability side of the balance sheet. Earlier P and L account was shown on the asset side of the balance sheet.

6.             Share application money pending allotment is a new concept called ‘quasi-equity’. The application money not exceeding the capital offered for issuance and to the extent not refundable will be shown separately on the face of the balance sheet. The amount in excess of subscription or if the requirements of minimum subscription is not met will be shown under ‘Other current liabilities’.

7.          Sundry Debtors replaced with the new term ‘Trade Receivables’. This term is defined as dues arising only from goods sold or services rendered in the normal course of business. Hence amount due on account of other contractual obligations, which were earlier included in sundry debtors, can no longer be included in trade receivables.

8.       Capital advances are required to be presented separately under ‘Loans & Advances’ rather than as a part of capital work-in-progress or fixed assets.

9.          All defaults in repayment of loans and interest to be specified account wise. Earlier such disclosure was required in CARO (Companies Auditor’s Report Order) section of audit report and only for defaults in repayment of dues to financial institution, bank and debenture holders.

1.      Some of the additional disclosure requirements:

a.       Terms of repayment of loans and period;

b.       Investments in capital of partnership firms, names of the firms with names of all their partners, total capital and the shares of each partner;

c.       Aggregate provision for diminution in value of investments – separately for long term and current investments;

d.       Stock-in-trade held for trading purposes – separately from other finished goods;

e.       Rights, preferences and restrictions attached to each class of shares including restrictions on the distribution of dividends and repayment of capital.

TRUE & FAIR: HOW MUCH?

While reading through the annual report of one of the listed company (TRF Ltd – A Tata Enterprise) in India my attention was drawn to a small paragraph in the ANNEXURE TO NOTICE - Explanatory Statements pursuant to Section 173(2) of the Companies Act, 1956. Although, the paragraph was concise but it provided enormous information on the company’s profitability.

Reasons for loss or inadequate profits:

The financial mis-statements were noticed in a particular division for earlier years. This was done by a group of officers who were discharged from the Company and Company has initiated necessary legal proceedings against them. A new team, who had taken charge of the division had reviewed the costs of the projects under execution and corrected the same where ever necessary. Consequently, the Company had to book losses in the division bringing down the overall profits of the Company.

This paragraph quite evidently mentions “mis-statements” by group of officers in a division. The company has initiated legal proceedings against them. Is it an indication by the company that money has been siphoned off by this group of officers or alternatively can we believe that the company has detected fraud in this division?

The highlights section in the annual report throws light on the profitability.

Consolidated PBT 2009- 10: 7,387 lakhs Rupees

Consolidated PBT: 2010- 11: 712 lakhs Rupees

Fall in profits by: 90.36%

The company has a functioning audit committee since 1997 which meets the representative of internal auditors (Big 4 company) and statutory auditors (another Big 4 company) regularly. To any one’s guess what is discussed regularly in such meeting with representatives of Big 4s.

The auditor’s report (Big 4 is a statutory auditor) states that:

Based on our audit and on consideration of the reports of other auditors on separate financial statements and on other financial information of the components, and to the best of our information and according to the explanations given to us, in our opinion the Consolidated Financial Statements give a true and fair view in conformity with the accounting principles generally accepted in India

Few questions which I do not know who will answer:

Did the auditors not detect the fraud when the company initiated legal action against a group of officers of a particular division?

Did the auditors not read the annual report of the company?

Did the auditors not find the drop in profitability compared to earlier year by 91% alarming and material?

What was the corporate governance from the audit committee’s perspective?

Who is answerable to the present shareholders of the company?

And finally;

HOW MUCH TRUE & FAIR WERE/ ARE THE FINANCIAL STATEMENTS AS OPINED BY THE AUDITORS?

For your reference and read as a case study of corporate governance link of the company annual report is attached.

The Companies (Accounting Standards) Amendment Rules, 2011

The Ministry of Corporate Affairs (MCA as it is called generally) has given the accounting fraternity 2 notifications just before the new year's eve as a welcome gift. The notifications deal with AS - 11 relating to "The Effects of Changes in Foreign Exchange rates".

http://www.mca.gov.in/Ministry/notification/pdf/Companies_Amendent_AS_Rules_2011.pdf

In the first notification (link above), two changes are introduced:

1. The Companies (Accounting Standards) Rules 2006 will be rechristened as the "Companies (Accounting Standards) Amendment Rules, 2011" and;

2. The foreign exchange gains/ losses can now be capitalised till 2020 (31-3-2020). Earlier the capitalisation was allowed till 31-3-2012.

http://www.mca.gov.in/Ministry/notification/pdf/Companies_Second_Amendent_AS_Rules_2011.pdf

The notification now called "The Companies (Accounting Standards) (Second Amendment) Rules, 2011 inserted a new paragraph in AS 11. The paragraph 46A is reproduced as under:

” 46A. (1) In respect of accounting periods commencing on or after the 1st April, 2011, for an enterprise which had earlier exercised the option under paragraph 46 and at the option of any other enterprise (such option to be irrevocable and to be applied to all such foreign currency monetary items), 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, with the exception of exchange differences dealt with in accordance with the provisions of paragraph 15 of the said rules.

(2) To exercise the option referred to in sub-paragraph (1), an asset or liability shall be designated as a long term foreign currency monetary item, if the asset or liability is expressed in a foreign currency and has a term of twelve months or more at the date of origination of the asset or the liability:

Provided that the option exercised by the enterprise shall disclose the fact of such option and of the amount remaining to be amortized in the financial statements of the period in which such option is exercised and in every subsequent period so long as any exchange difference remains unamortized.”