Accounting and Auditing Update - April 2014

April 2014

ACCOUNTINGAND AUDITINGUPDATE

In this issue

The Companies Act, 2013 Rules now notified p1

Providing for unhedged foreign currency exposures p7

Doing an IPO in the U.S. markets p11

Accounting for government grants p15

Brands – acquisition and accounting p19

Service concession arrangements p22

The Companies Act, 2013 Impact on auditors p24

Regulatory updates p27

In India, we tend have a record of dramatic announcements very close to the financial year-end that have immediate effects. The Government has not disappointed us this year too and we saw the issuance of the final rules on most parts of the Companies Act, 2013, in the last couple of days of March 2014. Stakeholders are probably in the midst of analysing the immediate and longer term impact of these rules, most of which are effective from 1 April 2014. We present in this issue, some of our initial analysis and coverage on this topic and we expect to cover more in future issues.

This month, we analyse and highlight some of the practical issues faced by banks as they look to implement the Reserve Bank of India’s (RBI) guidelines on unhedged foreign currency exposures. This appears to be an area where greater co-ordination between the RBI, Securities and Exchange Board of India and Institute of Chartered Accountants of India could help in timely and accurate compliance.

As the economic sentiment in the country seems to be turning positive and capital market valuations are increasing, there is an increased interest by many companies in exploring opportunities to initial public offering (IPO) overseas, especially in the U.S. markets. Some of the recent liberalisation of regulations in this area is also a key factor in these considerations. In this issue, we share some of our insights into what is involved in the journey to an U.S. IPO.

We also highlight this month, some of the complexities in accounting for government grants and assistance in India and for brands purchased in a defensive acquisition. Both of these areas are ones where Indian GAAP provides somewhat limited guidance and this has resulted in diversity emerging in practical application.

Finally, in addition to out round of regulatory developments, we also cast our lens this month on recent developments in the area of service concession accounting under U.S. GAAP. The recent developments point to another area where there is likely a greater convergence emerging globally.

Leaving aside the obvious implementation challenges that come with a legislation of this size, the Companies Act of 2013 represents hope in a curious way. While most of the country is consumed with election related coverage, the wheels of progress and reform of a 57 year old legislation seems to have finally reached an intended destination. On that positive note, I hope you find this issue of the Accounting and Auditing Update to be a good read.

In case you have any suggestions or inputs on topics we cover, we would be delighted to hear from you.

Editorial

© 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

V. VenkataramananPartner, KPMG in India

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TheCompanies Act, 2013

This article aims to

• Summarise key changes in the final rules of the 2013 Act.

• Provide our observations on the challenges posed by the 2013 Act.


Rules now notified

The new landscape

The Ministry of Corporate Affairs (MCA) has notified most of the sections and has largely operationalised the Companies Act, 2013 (2013 Act). This is a landmark legislation with far-reaching consequences on all companies incorporated in India. The MCA has also published Rules relating to several chapters, and the remaining ones in respect of the notified sections are expected to be released by 31 March 2014. All of the notified sections of the new 2013 Act are either already effective or will be effective from 1 April 2014.

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Key highlights

• Depreciation rates in the 2013 Act are indicative in nature. Revenue-based amortisation permitted for toll road intangible assets under service concession

• With respect to related parties in relation to the company, the coverage of related parties rationalised to include only directors and key managerial personnel of the company and its holding company, and not its subsidiary and associate companies. Further, senior management personnel are no longer covered as related parties

• Definition of relative changed to cover fewer relationships

• Limits for approaching the shareholders to seek an approval for related party transaction has been revised upwards such that shareholder approval is a higher bar

• Exemption for inter-corporate loans and guarantees for wholly owned subsidiaries and guarantees, in respect of certain loans to subsidiaries subject to certain conditions

• The limits for appointment of internal auditor, women director, independent director and setting up of committees have undergone a change

• Definition of total share capital in the context of meaning of subsidiary and associate now includes only equity and convertible preference share capital

• Scope of internal control seems to have been restricted to those with reference to financial statements as against covering operational aspects as well

• E-voting is now mandatory for listed companies and other companies having less than 1,000 shareholders.

Key changes in final rules

Related party transactions

The 2013 Act places a lot of emphasis on related party transactions. The 2013 Act, in keeping with the spirit of raising the bar on governance, prescribes rather onerous requirements for related party transactions. The final Rules make several important changes summarised as under:

• The draft Rules had a very wide coverage of related parties spanning holding, subsidiary, and associate companies. The final Rules rationalise the coverage to include only directors and key managerial personnel or his/her relative in relation to the company and its holding company. It does not include directors and key managerial personnel of subsidiary and associate companies. Further, the definition of related parties in the draft Rules included senior management personnel (one level below the board) including functional heads under related parties. This requirement has been dispensed with in the final Rules.

• The definition of relative has undergone a change, and now covers only eight relationships as against the 15 relationships in the draft Rules. Third generation of relatives – grandparents and grandchildren have been excluded from the list of relatives. However, the concept of financially dependent relatives has not been considered in the final Rules.

• In relation to the approval of the Board for related party transactions – management needs to provide basis of pricing and other commercial

terms, as well as factors considered in determining the price and other related aspects considered irrelevant by them. This will compel management to maintain details and rationale in relation to determining the pricing and other terms of every transaction in order to demonstrate whether prices are at an arm’s length.

• The limits for obtaining prior approval of shareholders vide special resolution has undergone a change with the limits being enhanced in several cases. For example, the threshold limits for sale, purchase and supply of goods which was the higher of five per cent of annual turnover or 20 per cent of net worth, has been revised to more than 25 per cent of annual turnover, and in case of selling and buying property and availing or rendering of any services, the limit has been changed from five per cent of annual turnover or 20 per cent of net worth, to more than 10 per cent of net worth This is a positive move to enhance the limits, since lower limits would have meant that companies would have had to approach the shareholders for their prior approval, for most related party transactions that are not at an arm’s length or not in the ordinary course of business.

• No relief has been provided in the final Rules for transactions between fellow subsidiaries and transactions with a joint venture, where all the shareholders would be precluded from voting on the transactions.

Our observations

We welcome the changes made in relation to the coverage and definition of related parties. This is expected to ease the administrative burden on companies of tracking wide ranging relationships, as well as seeking pre-approvals for transactions that are not in ordinary course of business or not at an arm’s length without diluting the intent of the Act. Further, extensive reporting of related party transactions to the regulators and shareholders will entail transparency in the process. However, the fact that the definition of relative still does not bring in the concept of financial dependency could continue to pose implementation challenges.

The requirements to obtain pre-approval from audit committee, board and shareholders might inhibit related party transactions to be undertaken swiftly and might call for advance planning by companies. Companies will have to put in place processes and systems to track related parties and transactions in order to be fully compliant with the requirements.


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Inter-corporate loans and investments

Section 185 of the 2013 Act, amongst other matters, states that no company shall, directly or indirectly, advance any loan to any other person in whom the director is interested, or give any guarantee or provide any security in connection with a loan taken by any other person in whom the director is interested. The expression ‘any other person in whom the director is interested’ could potentially cover amongst others, a subsidiary company. This created hardship for corporates who wanted to lend to or provide guarantees on behalf of their subsdiaries for genuine business purposes. The MCA partly addressed this in their recent circulars. The final Rules exempts loans made by, guarantees given or security provided by a holding company to its wholly owned subsidiaries, from the requirements of section 185. Further, guarantee given or security provided by a holding company to a bank or financial institution for the purpose of loan taken by any subsidiary is also exempt. These loans should, however, be utilised by the subsidiary company for its principal business activities.

On a related note, the final Rules exempts a company’s investment in a wholly owned subsidiary, loan or guarantee given or security provided to its wholly owned subsidiary company or a joint venture company, from calculating the limits prescribed under section 186. This change brings the new section in line with the provisions of the erstwhile Act.

Our observations

The changes in the final Rules address the concerns and genuine hardship that companies faced in financing their subsidiaries. The new requirements provide safe harbour with respect to both loans and guarantees given by a holding company to its wholly owned subsidiaries.

Definition of subsidiary and associate

In order to determine whether a company is a subsidiary or associate, the 2013 Act requires consideration of not just equity share capital but also preference share capital of the investee company. The definition of subsidiary and associate refers to investor’s holding in total share capital of the company. The final Rules have defined total share capital as including equity share capital as well as convertible preference shares. The MCA has not clarified whether both optionally and compulsorily convertible preference shares are to be considered.

Our observations

Excluding redeemable preference shares from the definition of total share capital is a positive development, especially since redeemable preference shares are more akin to debt than equity. However, it would have assisted if the MCA had specified the treatment of optionally convertible preference shares.

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Governance and monitoring framework

The 2013 Act makes several changes in the governance framework of companies and requires additional measures to be put in place by companies and also aligns itself with certain good international practices. The 2013 Act places heightened emphasis on independent directors and internal audit function. The key changes are summarised as under.

• Unlisted public companies will now be required to appoint at least two independent directors as against the requirement of the draft Rules to have at least one third of directors on the board as independent directors. The final Rules also provide that if companies are required to appoint more than two independent directors in order to comply with any regulation or to comply with the requirement of minimum number of independent directors for constituting an audit committee, then such increased number of directors will be the minimum number of independent directors to be appointed.

• Moreover, the thresholds related to paid up capital, turnover, and borrowings applicable for appointment of independent directors, constitution of the audit committee and of the nomination and remuneration committee, in unlisted public companies have also undergone a change. (Refer Table 1)

• As per the 2013 Act, a director was disqualified from being appointed to the Board of Directors if convicted in any offence and not just an offence under the Companies Act. The final Rules clarify that if a director is disqualified from being appointed to the Board of Directors only if the director is convicted in an offence committed under the Companies Act.

• The final Rules require all listed companies to appoint an internal auditor. In addition, unlisted public companies were also required to appoint an internal auditor if certain criteria related to share capital, turnover and outstanding borrowings were achieved. The final Rules now also require private limited companies to appoint internal auditors based on the turnover and borrowings criteria. (Refer Table 2)

• The criteria applicable for unlisted public companies for appointment of internal auditor have also undergone a change with a new turnover criteria introduced in addition to the other criteria provided in the draft Rules. (Refer Table 3)

• The final Rules have also clarified that the internal auditor may or may not be an employee of the company and that non practicing Chartered Accountants can also be appointed as internal auditors.

Table 1 - Criteria for appointment of independent directors, audit committee and nomination & remuneration committee

Criteria Final Rules Draft Rules

Paid up capital ≥INR100 million ≥INR1,000 million

Turnover ≥INR1,000 million ≥INR3,000 million*

Aggregate outstanding loans, debentures, deposits

>INR500 million >INR2,000 million

*Applicable only for independent directors

Table 2 - Appointment of internal auditor for private companies

Criteria Final Rules

Turnover ≥INR2,000 million

Outstanding loans or borrowings from banks or public financial institutions at any point of time during the preceding financial year

>INR1,000 million

Table 3 - Appointment of internal auditor in unlisted public companies

Criteria Final Rules Draft Rules

Paid up share capital ≥INR500 million ≥INR100 million

Turnover ≥INR2,000 million -

Outstanding loans or borrowings from banks or public financial institutions at any point of time during the preceding financial year

>INR1,000 million >INR250 million

Outstanding deposits at any point of time during the preceding financial year

>INR250 million >INR250 million*

*Deposits accepted


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Our observations

Having responsible and professional independent directors and internal auditors could go a long way in boosting investor confidence.

In order to ensure that directors have adequate bandwidth to deal with their enlarged responsibilities, the 2013 Act has put a cap on the number of directorships, and the recent decision of SEBI to amend the listing agreement puts a cap on independent directorships as well. All of these can result in a significant demand supply mismatch in the short to medium term till the organisations and the environment mature and all of these requirements become business as usual. With the limits being rationalised in the final Rules, companies may find it somewhat easier to source the right talent to enable directors and internal auditors to discharge their duties diligently.

Useful lives to compute depreciationThe MCA has published an amendment to Schedule II of the 2013 Act (to be notified shortly) to the effect, companies are provided with the option of depreciating assets over their useful lives which could be different from the useful lives prescribed in Schedule II. Further, the determination of residual value could also deviate from the five per cent stated in Schedule II. However, if a company chooses to use a useful life or residual value different from the limits indicated in Schedule II, it will be required to disclose a justification for the same in the financial statements. Moreover, the useful life of continuous process plants is now notified to be 25 years from 8 years under the pre-revised Schedule II. The notification also clarified that the amortisation of intangible assets will be in accordance with the applicable accounting standards except for intangible assets created under toll road projects. Such assets are to be depreciated using a revenue based amortisation method. This change reverts back to the position under the erstwhile Companies Act. (Refer Illustration 1).

Illustration 1- Amortisation of intangible assets (Toll Roads)

Cost of creation of intangible asset INR5,000 million

Total period of agreement 20 years

Time used in creation of asset 2 years

Amortisation period of the asset 18 years

Total revenue expected to be generated over 18 years

INR6,000 million

Actual revenue generated in Year 3 (first year since creation of asset)

INR50 million

Amortisation charge for the year INR41. 6 million (50/6000*5000)

Amortisation rate for first year 0.83 per cent (41.6/5000*100)

Amortisation charge(Actual revenue for the year/Projected revenue upto end of concession period )* Cost of asset


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Our observations

We welcome the MCA’s move permitting companies to align their depreciation policy for tangible assets in line with the useful life of the asset, as is the case internationally. Further, the requirement to disclose justification for deviation can also, in a transparent manner, provide reasons to the users of financial statements. Revenue-based amortisation, will maintain status quo for companies having toll road projects.

Internal financial controlsOne of the matters prescribed in the final Rules, relating to the matters to be included in the Board report is on the adequacy and operating effectiveness of internal financial controls with reference to the financial statements for all listed companies, as well as unlisted public companies having paid up share capital in excess of INR250 million. Section 134(5)(e) of the 2013 Act, requires the directors’ responsibility statement of listed companies to specifically assert on adequacy and operating effectiveness of internal financial controls. This creates a dichotomy especially for listed companies as to which of these requirements apply. It seems that the final rules aim at rationalising the scope to cover internal financial controls with reference to financial statements, but in absence of a change in the relevant section of the 2013 Act the spirit of change might not be implementable.

Other changes

• Additional disclosure requirements included on various financial statement matters.

• In addition to the various other conditions, the final Rules additionally prescribe that companies would be prohibited from issuing any shares with differential voting rights, if they have defaulted on repayment of loans from banks and public financial institutions or interest thereon, payment of dividend on preference shares, payment of statutory dues for employees, or in depositing moneys into the Investor Education and Protection Fund. Since there is no reference period for such default, it appears that any default, even if subsequently rectified, would preclude a company from issuing such shares.

• E-voting is now made mandatory for listed companies and other companies having not less than 1,000 shareholders. This could potentially enhance the level of participation by minority shareholders, specifically, the institutional investors.

• The final Rules prescribe additional matters which shall not be considered in a board meeting through video conferencing or other audio visual means like the approval of the prospectus, the audit committee meetings for consideration of accounts; and the approval of the matter relating to amalgamation, merger, demerger, acquisition and takeover.

Conclusion

The Companies Act, 2013 is a culmination of several years of discussion on how to shape the corporate law in India. The 2013 Act will see the light of day on 1 April 2014. The 2013 Act would provide a fillip to the governance environment in companies. The rationalisation and reliefs provided in the final Rules can go a long way in assisting companies implement this new Act.

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Providing for unhedged foreign currency exposures challenging but, inevitable


• Summarise the requirements of the RBI’s circular on the unhedged foreign currency exposures

• Discuss the implementation challenges that banks are likely to face.


The Reserve Bank India’s (RBI) concerns on the level of unhedged foreign currency exposures in India is not a recent development. The RBI has been closely monitoring this area as the risk of these unhedged exposures impacts not only individual corporate borrowers but, also potentially the entire financial system in India.

Post October 2001, the RBI has issued various guidelines advising banks to closely monitor the unhedged foreign currency exposures of their corporate customers and factor the risk into the pricing of facilities offered to corporate customers. However, taking into account the extent of unhedged foreign currency exposures in the system, the RBI has recently introduced incremental provisioning and capital requirements for bank exposures to corporates with significant unhedged foreign currency exposures. The RBI issued draft guidelines on 2 July 2013 and followed it with final guidelines1 on 15 January 2014 (the guidelines or the circular) which is effective from 1 April 2014. These guidelines need to be applied for all entities which have borrowed from banks including borrowing in Indian Rupees and other currencies.

1. Source: RBI/2013-14/448 DBOD.No.BP.BC.85/21.06/200/2013-14 - Capital and Provisioning Requirements for Exposures to entities with Unhedged Foreign Currency Exposure dated 15 January 2014

Current requirements

MethodologyAs per the guidelines, a three step process is required to be followed to ascertain the incremental provisioning and capital requirements.

Step 1 - Ascertaining the amount of ‘Unhedged Foregin Currency Exposures’ (UFCE): ‘Foreign Currency Exposures’ (FCE) have been defined as the gross sum of items on the balance sheet of a corporate customer that has an impact on the statement of profit and loss due to movement in exchange rates.

Step 2 - Estimating the extent of likely loss: The loss to the entity in case of movement in USD – INR exchange rate is to be calculated using annualised volatilities and for this purpose, the largest annual volatility seen in USD – INR rates during the period of last ten years should considered as the movement of the USD – INR rate in an adverse direction. The circular sets out guidance for computation of the volatility for USD-INR.

The largest annual volatility computed as per the guidance provided is to be used for computation of likely loss by multiplying it with the UFCE arrived at in step 1.

Step 3 - Estimating the riskiness of the unhedged position and providing appropriately: once the loss figure has been computed as per step 2 above, it is compared with the customer’s EBID (Earnings before Interest and Depreciation) as per the latest quarterly results certified by the customer’s statutory auditors. EBID has been defined as the EBID for DSCR (Debt Service Coverage Ratio) which is Profit after tax + depreciation + interest on debt + lease rentals, if any.

All exposures (whether in foreign currency or in INR) would attract incremental provisioning and capital (over and above the present requirements) as per the table below:

It has been reiterated in the circular that banks have to monitor the UFCE on a monthly basis and the calculation of incremental provisioning and capital requirements should be done at least on a quarterly basis. However, during periods of high USD – INR volatility, the calculations should be done at monthly intervals. .

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Likely Loss/EBID (%)

Incremental provisioning requirement on the total

credit exposures over and above extant standard asset

provisioning

Incremental capital requirement

Upto 15 per cent 0 0

More than 15 per cent and upto 30 per cent

20 bps 0


40 bps 0


60 bps 0

More than 75 per cent 80 bps25 per cent increase

in risk weight

Source: RBI circular on Capital and Provisioning Requirements for Exposures to entities with Unhedged Foreign Currency Exposure dated 15 January 2014 (RBI/2013-14/448 DBOD.No.BP.BC.85/21.06/200/2013-14)

Additional requirementsIn addition to the above, the guidelines require:

• Banks to ensure that the risk of unhedged foreign currency exposures is effectively incorporated in their credit rating system and ensure that the loan pricing policies adequately reflect the overall credit risks.

• That the quantification of the currency induced credit risk should form a part of the bank’s ‘Internal Capital Adequacy Assessment Programme’ (ICCAP) and it is addressed in a comprehensive manner.

• Banks to disclose the incremental provisioning and capital and polices to manage currency induced credit risk as a part of the financial statements certified by the statutory auditors.

Certain relaxationsThe guidelines have provided for the following exemptions/relaxations:

• For calculating the UFCE, only items maturing or having cash flows over a period of next five years only may be considered. Further, the UFCE may exclude items which are effective hedge of each other and for this purpose two types of hedges may be considered i.e., financial hedge and natural hedge. A financial hedge through a derivative may only be considered where the entity at the inception of the derivative contract has documented the purpose and the strategy for hedging and assessed its effectiveness as a hedge at periodic intervals. A natural hedge may be considered when cash flows arising out of the operations of the company offset the risk arising from the FCE. In respect of natural hedges, for computing UFCE, an exposure may be considered as naturally hedged if the offsetting exposure has the maturity/cash flow within the same financial year.

• In case of projects under implementation where annual EBID is not available, the calculation of the incremental provisioning and capital requirements may be based on projected average EBID for the three years from the date of commencement of commercial operations, subject a minimum floor of 20 bps of provisioning requirement.

• While computing UFCE of foreign MNCs, intra group foreign currency exposures may be excluded if the bank is satisfied that such foreign currency exposure are appropriately hedged or managed robustly by the parent.

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Likely implementation challenges

The table below highlights some of the key challenges which banks are likely to face:

In conclusionThe guidelines come into effect on 1 April 2014, which means that by 30 June 2014 banks need to implement the methodology and put in the place a mechanism to comply with the guidelines. Accordingly, banks have no choice but, to place the implementation of these guidelines high on their priority list and begin work at the earliest. In certain identified areas, the RBI could consider providing some additional implementation guidance and also consider, if they can persuade ICAI/SEBI to incorporate the required changes to reporting and disclosure practices to enable consistent compliance with these guidelines and availability of the required information.

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Para ref of the circular

Description of the requirement

Our observations

Para 2a and para 3

FCE refers to gross sum of all items in the balance sheet that have an impact on the statement of profit and loss. Items maturing or having cash flows over a period of the next five years only may be considered. UFCE may exclude items which are effective hedge of each other. Banks have to monitor UFCE on a monthly interval.

One of the significant challenges expected, is the ability of a bank to obtain timely, comprehensive and accurate data from customers. Banks will need to establish a robust system to enable this data collation from their customers on a monthly basis including data formats covering all information needed to calculate the UFCE. Secondly, the responsibility for data gathering, analysis, computation and assessing incremental provisioning and capital requirements will need to be allocated to different functions within the bank adding to their existing workload.

Certain aspects such as how foreign currency loans on which exchange differences are capitalised using current rules and exchange differences on amortising foreign currency loans with greater than five years maturity will be treated, is also not clear currently.

In addition, current financial reporting requirements of the Institute of Chartered Accountants of India (ICAI) or Securities and Exchange Board of India (SEBI) do not require the disclosure of information in a manner and with a periodicity that is adequate for compliance with these guidelines.

Para 2a Hedging through derivatives may only be considered where the entity at inception of the derivative contract has documented the purpose and the strategy for hedging and assess its effectiveness at periodic intervals.

Based on the reading of the para, it may appear to suggest that banks will be able to consider financial hedges only for entities which have applied the hedging provisions of AS 30, Financial Instruments: Recognition and Measurement. AS 30 is currently neither recommendatory nor mandatory standard and a large number of entities do not apply hedge accounting as envisaged in AS 30.

Para 2c Once loss figure is calculated, it may be compared with the annual EBID as per the latest quarterly results certified by the statutory auditors.

The requirement to publish reviewed quarterly results exists only for listed coporates. Accordingly, it is not clear how EBID should be computed for unlisted customers.

Further, it is also not clear whether EBID information to be used is the last audited yearly EBID or the annual EBID needs to be extrapolated based on quarterly results certified by the auditors.

The information is required on lease rentals, interest, depreciation, etc.; however, all this information may not be directly ascertainable from the Quarterly Results format of the SEBI, hence, banks would need to establish a separate information flow to gather this data from their clients.

Para 8 Banks should ensure that the foreign currency induced risks are effectively incorporated in their internal credit rating models and pricing policies reflect the credit risks.

Market practice is yet to emerge on how the effects of the additional provisioning or capital requirements will be transmitted to corporate customers. In the absence of this empirical data, incorporation in facility pricing may be challenging

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• Explain some of the key aspects that a company should consider when undertaking a listing process in the U.S.

• Highlight developments in the Indian regulatory environment.

Doing an IPO in the U.S. markets key considerations

During the last decade, the demand for foreign equities has grown appreciably among U.S. investors driven by a need for enhanced portfolio diversification, and a desire to tap into the higher economic growth rates found in many countries outside the U.S.A. - particularly in the emerging markets, thereby, often a more attractive valuation for issuers when compared to their local markets. Thus, in addition to the sheer size and availability of capital, the U.S. capital markets have been a favoured destination for capital raising for several companies.

A securities listing in the U.S., however, provides companies with significant challenges to deal with. Some of the key challenges include being subject to the U.S. regulatory environment, increased cost of compliance on account of provisions of the Sarbanes Oxley Act and the rigorous accounting, disclosure and review by the Securities Exchange Commission (SEC). These challenges are in addition to the other challenges that an initial public offering (IPO) presents, namely legal and tax structuring, articulating the entity’s business plans to a wide investor class, enhanced corporate governance requirements and having adequate reporting tools and management bandwidth to cope with these demands.

Steps for a U.S. listing for a foreign private issue (FPI)

1. Assessing readiness The process of going public often requires a fundamental shift in the company’s financial reporting, various processes and controls. Also, there can be a significant increase in the level of compliance requirements. Few key laws that a company needs to comply with for a U.S. listing include the Securities Act of 1933 and Securities Exchange Act of 1934. Given that the listing has pervasive impacts on all functions within a company, it is imperative that it is well planned and thought through. Therefore, performing a readiness assessment well in advance of a planned IPO in the U.S. markets is advisable. A thorough readiness assessment should ideally span across financial and non-financial areas like IT systems, compliance, corporate governance, resources, etc., sufficiently ahead of its listing plan.

2. Which entity to list from the group

Another aspect that is important and needs to be carefully thought about is whether the group wants to be a FPI or a ‘domestic issuer’ i.e., list a domestic U.S. entity or an entity that is not a domestic U.S. entity (foreign entity). A FPI means any issuer (other than a foreign government) incorporated or organised under the laws of a jurisdiction outside of the United States of America, unless:

• more than 50 per cent of its outstanding voting securities are directly or indirectly owned of record by U.S. residents

• any of the following applies:

– the majority of its executive officers or directors are U.S. citizens or residents

– more than 50 per cent of its assets are located in the United States

– its business is administered principally in the United States.

The decision of listing a U.S. domestic entity vs. a foreign entity assumes significance as under the U.S. federal securities laws and the rules and practice of the U.S. SEC, FPIs are not regulated in precisely the same way as domestic U.S. issuers. In particular, FPIs are allowed a number of key benefits not available to domestic U.S. issuers such as ability to use U.S. GAAP, IFRS or local GAAP, quarterly reporting not required, etc. These are discussed in detail below.

3. Financial statement requirements in a registration statement

a. Choosing the GAAP

One of the key questions to address is under which GAAP the financial statements should be prepared. While U.S. domestic companies are required to file financial statements with the SEC only in accordance with U.S. GAAP, FPIs have a choice to file using U.S. GAAP, IFRS as per IASB1 or local GAAP of the issuer. If filing is by way of local GAAP then reconciliation with the U.S. GAAP is required (both for annual and interim).

b. Period of financial statements

Companies which are not fulfilling the criteria of ‘emerging growth company’ (EGC) under the JOBS Act, audited financial statements must cover a period of last three years. However, if in an initial registration statement, the financial statements are presented in accordance with the U.S. GAAP (rather than reconciled to U.S. GAAP), the earliest of the three years of financial statements may be omitted if that information has not previously been included in a filing made under the Securities Act or the U.S. Securities Exchange Act of 1934 (the Exchange Act). This accommodation does not apply to financial statements presented in accordance with IFRS as per IASB, unless the issuer is applying IFRS as per IASB for the first time. However, a company fulfilling the criteria of EGC under the JOBS Act can choose to provide only two years of audited financial statements.

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JOBS Act

A significant thrust for accessing U.S. capital markets was provided to companies in April 2012 by the enactment of the Jumpstart Our Business Startups (JOBS) Act by President Obama.

The JOBS Act aims to increase the number of companies electing to complete an IPO and allowing them to focus resources on growth of their businesses and reduce financial, corporate governance and other regulatory requirements for ‘emerging growth companies’ (EGCs), a new class of issuer. An EGC is a company that had gross revenues of less than USD 1 billion during most recently completed fiscal year.

The JOBS Act has brought about several changes to make IPO a level playing field for several companies. The provisions of the JOBS Act have reduced the costs and risks associated with IPO in EGCs in three distinct areas - in the IPO process, in the IPO registration statement disclosure requirement and finally in the post IPO reporting requirements.


1. International Accounting Standards Board

c. Select historical financial data

Another important piece of information that is required in the registration statement is the ‘select historical financial information’, comprising income statement and balance sheet data for each of the last five fiscal years. It is prepared on the same basis (i.e., U.S. GAAP, IFRS, etc.) as the primary audited financial statements and also presented in the same currency. An EGC, however, has a choice to provide only two years of ‘select historical financial information’.

d. Interim financial statements

The issuer is also required to provide consolidated interim unaudited financial statements, if the registration statement becomes effective more than nine months after the end of the last audited fiscal year. These must cover at least the first six months of the fiscal year and should include a balance sheet, income statement, statement of cash flows, statement of changes in equity and selected notes disclosures.

e. Post listing filing obligations

Post listing, a FPI is required to file its annual report in Form 20-F within four months after the end of the fiscal year covered by the report. Unlike, domestic U.S. issuers, FPIs are not required to file quarterly reports (including quarterly financial information) on Form 10-Q. They also are not required to use Form 8-K for current reports, and instead furnish (not file) current reports on Form 6-K with the SEC.

f. Additional financial information for recent and probable acquisitions

The SEC rules require that in addition to financial statements of the issuer, registration statements generally require inclusion of the audited financial statements for a significant acquisition of a ’business’ that has taken place 75 days or more before the offering, or, in the case of the most material acquisitions, as soon as the acquisition becomes ‘probable’. In addition, where a material acquisition has occurred or is probable, pro forma financial information complying with S-X Article 11 for the most recent fiscal year and the most recent interim period will generally also be required

in the registration statement. Whether financial statements for recent and probable acquisitions must be included in the filing also depends upon the ‘significance’ of the acquisition. Significance of an acquired business is evaluated under S-X Rule 3-05 based upon three criteria (which in turn are derived from S-X Rule 1-02(w)):

• the amount of the issuer’s investment in the acquired business compared to the issuer’s total assets

• the issuer’s share of the total assets of the acquired business compared to the issuer’s total assets

• the issuer’s share of ‘pre-tax income’ from continuing operations of the acquired business compared to the issuer’s pre-tax income from continuing operations.

The above evaluation is based on a comparison between the issuer’s and the target’s most recent annual audited financial statements.

General rules for an acquisition that occurred more than 75 days before the offering are as follow:

• if the acquired business exceeds 20 per cent of any of the three significance criteria, then one year of audited financial information is required of the acquired company, as well as the interim financial information that would be required under S-X Rules 3-01 and 3-02

• if it exceeds 40 per cent, then two years of audited financial statements and the appropriate interim financial information are required

• if it exceeds 50 per cent of any of the three criteria (or if securities are being registered to be offered to the security holders of the acquired business), then three years of audited and the appropriate interim financial information are required. However, if the issuer is an EGC, then two years of audited financials for the acquired business may be presented in the EGC’s initial registration statement, regardless of whether the issuer presents two or three years of its own financial statements.

Exception from providing separate financial statements of acquired businesses

Separate financial statements for an acquired business do not need to be presented once the operating results of the acquired business have been included in the issuer’s audited consolidated financial statements for at least nine months. However, if the financial statements have not been previously filed by the issuer or the acquired business is of such significance to the issuer that omission of such financial statements would materially impair an investor’s ability to understand the historical financial results of the registrant. Therefore, in such cases, audited financial statements of the significant acquisition would be required to be filed. Where the acquired business met at least one of the significance tests at the 80 per cent level, the income statements of the acquired business should normally continue to be furnished.

4. Corporate governance Public companies must have an appropriate governance structure in place including board and committees, code of business conduct, whistle blower programme, policies and procedures, fraud and enterprise risk assessment. The issuer company will also be covered by the Foreign Corrupt Practices Act (FCPA). Two sets of provisions under the FCPA are applicable to the SEC-reporting companies. One requiring it to keep accurate books and records and to maintain a system of internal accounting controls; the other set, the anti-bribery provisions, prohibits the bribery of non-U.S. government officials.

Further, the company also needs to comply with the requirements of Sarbanes Oxley Act. Although the JOBS Act relieves EGCs of the obligation to have their independent auditors provide an attestation on internal controls under section 404(b) of SOX, they are still required to put in place internal controls sufficient for management to provide the certifications required by the section 404(a). Further, the CEO and CFO of a FPI are also required to provide separate certifications relating to controls in the annual report (Form 20-F).

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Indian regulatory developments

On a related note, the Ministry of Finance (MoF) issued a press release on 27 September 2013, permitting unlisted companies to list and raise capital abroad. This was subsequently notified on 11 October 2013. The guidance allows unlisted Indian companies to raise capital abroad without the requirement of prior or simultaneous listing in India. The approval for listing is, however, subject to the condition that the stock exchanges would have to be International Organisation of Securities Commissions (IOSCO)/Financial action Task Force (FATF) compliant or those with whom Securities and Exchange Board of India (SEBI) has a bilateral agreement. That gives Indian unlisted companies a choice of over 100 jurisdictions including the U.S., U.K., Singapore and Hong Kong.

The money raised via an overseas listing can only be utilised to repay overseas debt or fund acquisitions abroad. In case the funds are not utilised for these two purposes, they would have to be remitted back to India within 15 days and deposited with Reserve Bank of India (RBI) recognised authorised dealer (AD). The recent RBI circular on 8 November 2013 (RBI/2013-14/363 A.P. (DIR Series) Circular No. 69), further mentions that such amount brought into India shall be utilised for eligible purposes. Further Press note 7 (2013 series of the Government of India) dated 3 December 2013, mentions that the amount brought into India and deposited with the recognised AD may be used domestically.

Initially, this scheme will be implemented on a pilot basis for a period of two years from the date of its notification. After the initial period of two years, the impact of this arrangement will be reviewed. This could mean that it is a temporary relaxation and not a structural change for the long term. The exact process and details of terms and conditions needs more clarity and the nuances of the scheme should hopefully become clearer once more clarifications/guidelines are issued by the relevant authorities.

Way forwardGiven the steps taken by the Ministry of Finance for overseas listing, and the favourable response to the JOBS Act, there seems to be a possibility of Indian companies accessing the U.S. capital markets. Many unlisted mid-sized firms that were planning to list in the Indian market may explore this alternative of overseas listing by striking a balance between meeting regulatory requirements and cost structures for overseas markets.

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• Explain the accounting of the government grants under Indian GAAP.

• Highlight key matters for accounting consideration relating to government assistance and grants.

Accounting for government grantsGovernment assistance is a key catalyst for the economic development of a country. Government funding programmes help in providing the financial support to entities for different purposes such as promotion of exports, generation of employment in the rural or backward areas, to encourage innovations through research and development activities and so on. The Government of India periodically extends such benefits to entities and comes up with various schemes such as capital contribution, tax subsidies, export promotion programmes, etc.

AS 12, Accounting for Government Grants, is the governing literature for all government grant transactions under Indian GAAP. Whilst the principles laid out are relatively straight forward, there are certain aspects of grants that have not been covered (like government assistance which can not reasonably have a value placed upon them and transactions with government which can not be distinguished from the normal trading transactions of an enterprise). Issues arise in applying the principles on account of varying nature of grants offered by the Government, such as:

• whether the particular assistance is within the scope of AS 12 or not

• is the grant in the nature of a capital grant or revenue grant

• when should the benefit arising from particular government grant be recognised, etc.

If the number of Expert Advisory Committee (EAC) opinions on this area is anything to go by, the practical issues faced at the time of recognising and accounting for government assistance are indeed many.

This article endeavours to discuss the key matters for consideration around government assistance and grants.

Identification of a grant

AS 12 defines government grants as “assistance by government in cash or kind to an enterprise for past or future compliance with certain conditions. They exclude those forms of government assistance which can not reasonably have a value placed upon them and transactions with government which can not be distinguished from the normal trading transactions of the enterprise”.

The first step in all such transactions is the evaluation of the assistance received. This would involve identifying if the assistance is in the nature of government grant as defined above or merely a form of additional income to the entity. Identification of grant could be straightforward in most cases as there would always be a benefit in the form of cash or kind that will flow to the entity. Having said that, the following situations need to be kept in mind:

• Assistance monetary/non-monetary given by a government authority in a public-private-partnership arrangements (i.e., service concession arrangements) need to be closely

analysed. It is common that the government offers assets/properties free-of-cost to the private company (i.e., concessionaire) as a part of the arrangement. The Exposure Draft of Guidance Note on Accounting for Service Concession Arrangements states that infrastructural facilities to which the operator is given access are not recognised as fixed assets of the operator. However, since the Guidance Note is not in force yet, the reporting entity may record such assets at a nominal value. Such assistance is generally reported in the explanatory notes to the financial statements. However, in the absence of guidance, the detail and the nature of disclosure vary significantly in practice. Further, the fair value of such asset/property is not frequently disclosed in the notes.

• The government sometimes offers entities operating in a particular sector or location exemption from paying income taxes (often referred to as tax holidays). While these benefits do represent government assistance, such incentives that are provided to an entity

in the form of benefits that are available in determining taxable profit or tax loss, or are determined/ limited on the basis of income tax liability, are not covered by the AS 12. These are generally disclosed in the explanatory notes as additional information for the users.

• If a government provides free technical/marketing advice or other services/ guarantees, then the assistance is not normally recognised in the financial statements. Similarly, a government procurement contract, or similar arrangement, whereby a government body agrees to buy certain output produced by an entity is not normally distinguished from the normal operations of the entity and is not treated as a government grant.

• Loans taken by reporting entities under the government schemes at subsidised interest rates do not trigger any accounting of the assistance under AS 12. However, this would not necessarily be the case, should one was to apply Ind-AS or IFRS principles.

Classification of a grant

Once it is determined that the transaction is in the nature of a government grant, the reporting entity determines the accounting treatment to be followed depending on the nature of the grant. There are two approaches for recognition and measurement of grants:

• the capital approach – under which a grant is treated as a promoter contribution or shareholders’ funds

• the income approach – under which a grant is recognised in the statement of profit and loss systematically over a period of time.

Careful considerations need to be given to the eligibility criteria for grants and the conditions attached for availing the grants. For example, the manifesto of the grant scheme, the actual sanction letter and the spirit of the conditions attached need to be carefully interpreted to ascertain which approach should be followed.

Where grants are offered to a reporting entity with no specific condition for capital purchase/expenditure, the grant may take the form of a promoter contribution/shareholders’ funds. They may be given with reference to the overall project/investment to support the capital outlay in general. Such grants are recognised as a ‘capital reserve’ in the financial statements of the reporting entity.

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Government grants related to specific fixed assets are government grants whose primary condition is that an entity qualifying for them should purchase, construct or otherwise acquire such assets. Other conditions may also be attached restricting the type or location of the assets or the periods during which they are to be acquired or held. For such grants, a reporting entity has an accounting policy choice to either account for such grant as a reduction in cost of the fixed asset or treat it as deferred income which is recognised in the statement of profit and loss on a systematic and rational basis over the useful life of the asset.

Such allocation to income is usually made over the periods and in the proportions in which depreciation on related assets is charged. Grants related to non-depreciable assets are credited to capital reserve under this method, as there is usually no charge to income in respect to such assets. However, if a grant related to a non-depreciable asset requires the fulfillment of certain obligations, the grant is credited to income over the same period over which cost of meeting such obligations is charged to income. Whereas, if a grant related to revenue, the grant is accounted as a reduction for the related expenditure or as ‘other income’.

Certain grants could have conditions which indicate requirement to meet capital expenditure as well as revenue expenditure. To determine appropriate accounting for such grants needs careful evaluation for the purpose of grant.

The below table summarises the recognition and measurement principles for key government assistance.

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Nature of the grant Accounting treatment

Cash received for the purchase of specific fixed asset

This is the most common form of capital government grant, where the government would contribute funds to the purchase of a specific asset. The entity in this case opts either to reduce the contribution from cost of the asset or treat the cash contribution as a deferred income which is recognised in the statement of profit and loss on a systematic and rational basis over the useful life of the asset.

Cash received for employing a certain number of employees for a specific period of time

This is a revenue grant and thus, the entity will need to assess the probability of meeting the required conditions and account for the revenue grant over the period of the revenue grant as a credit in the statement of profit and loss, either separately or under a general heading such as ‘other income’. Alternatively, they can also be deducted in reporting the related expense.

Government grants in the form of non-monetary assets, such as land or other resources, given at concessional rates

In cases where there are assets given at concessional rates, such assets are accounted for such assets at their acquisition cost. Non-monetary assets given free of cost are recorded at a nominal value.

Sales tax related

a) Sales tax concession

b) Deferred payment

c) Tax exemption

Sales tax concession is a case where an entity collects taxes from its customers at full rates but remits only concessional amounts to the government. The retained amount is treated as a revenue grant as sales tax is based on the turnover which is a revenue item and hence, should be recognised in the statement profit and loss of the relevant year.Sometimes the value of such concession is linked to the investment in capital expenditure as well. Such situations need careful evaluation1.

In case a company collects sales tax but is allowed to remit it to the government only after a certain period of time, the sales tax deferral is treated as a deferred liability and recorded at historical cost.

In case, a portion of such deferred liability is subsequently waived off by the government (based on the computation of and settlement at a present value of the liability), such waiver should be treated as ‘other income’ and should be recognised in the statement of profit and loss. However, there could be an income tax implication whether the income would be taxable or not under the Income-tax Act, 1961.

Another form of assistance is the case of a company which is completely exempted from collecting sales tax from its customer. Such assistance is neither in the form of cash nor kind and hence, not be treated as a government grant2.

1. Source: ICAI Expert Advisory Committee’s opinion – Query No. 18 Volume XI 2. Source: ICAI Expert Advisory Committee’s opinion – Query No. 5 Volume XX

In summary, it is very important that the government grants are accounted based on the intent and purpose of receipt of such grants, with appropriate disclosures in the financial statements. Subtle differences exist between different schemes and a careful case by case evaluation is often required to be

compliant with the existing accounting guidance. This careful evaluation and disclosures can enable users of financial statements to determine the impact of such grants on the performance of the entity.

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Nature of the grant Accounting treatment

Investment made specifically for the development of the entity

When funds are invested by the government into an entity for its development and is not for the purchase of specific assets, such investments are considered to be in the form of capital outlay or promoter’s contribution. In cases, where funds are received from the government in the form of a capital outlay or promoter’s contribution and no repayment is ordinarily expected, the grants are treated as capital reserve which can neither be distributed as dividend nor considered as deferred income.

Subsidy received from the government for repayment of loan taken for acquiring fixed assets and capitalised interest

Where an entity has taken a loan to purchase a fixed asset but has subsequently received a subsidy on repayment of the loan and interest, such subsidy should recognised as a subsidy related to specific fixed asset. The reporting entity has an accounting policy choice to either account for such grant as a reduction in cost of the fixed asset or treat it as deferred income which is recognised in the statement of profit and loss on a systematic and rational basis over the useful life of the asset3.

3. Source: ICAI Expert Advisory Committee’s opinion – Query No. 7 Volume XVIII

While International Financial Reporting Standards (IFRS) and United States Generally Accepted Accounting Principles (U.S. GAAP) have specified guidance on the accounting of assets purchased but not intended to be used (such as, a brand purchased to eliminate competition). Indian GAAP (IGAAP) does not have any specific guidance on this area. Thus, lack of specific guidance, as well as the absence of a separate standard relating to business combinations in IGAAP, increases the scope for interpretation and variety of accounting treatments in practice. The key aspects where there are challenges in application include determining the impact on valuation of the intention of the acquirer, treatment of goodwill, identification of impairment and treatment thereof.

This article seeks to highlight the various considerations and accounting challenges that arise in business acquisitions, more specifically focussing on the financial reporting and accounting treatment of brands which have been acquired to either enhance synergies, or increase earnings and market share by eliminating competition. This article aims to further discuss these considerations and highlight the diversity in accounting and reporting in this area.

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Brandsacquisition and accounting



• Highlight the various considerations and accounting challenges that arise on purchase of brands.

• Discuss the diversity in accounting and reporting.

Brand acquisition – acquiring a competitive edge

A brand may be acquired either to eliminate existing competition, or to enhance the value of a business by bringing more brands under its umbrella. Companies may seek to do so by either acquiring a company, a segment or division of another company.

It is important to note here, the concept of a ‘defensive asset’, for which there is prescribed guidance in both IFRS and U.S. GAAP. A defensive asset is an asset that an acquirer does not intend to use, i.e., the sole purpose of the acquisition was to eliminate the competition by effectively ‘killing’ the acquired brand. It essentially represents an intangible asset that may not be actively used, but which is likely to contribute to an increase in the other assets owned by the entity, either directly or indirectly.

As there is no specific guidance available in the Indian accounting framework, the business transfer agreements in such cases are often structured such that the transfer occurs as a ‘slump sale’, for the purpose of tax benefits. ‘Slump sale’ as a concept has been discussed under the Income Tax Act, 1961 (the IT Act) along with detailed provisions on the tax implications. It describes a slump sale as a transaction that involves transfer of one or more ‘undertakings’ as a going concern in return for a lump sum consideration without values being assigned to the individual assets and liabilities. An undertaking could be a division, business unit, product line or a business activity taken as a whole.

Under AS 10, Accounting for Fixed Assets, where several assets are purchased for a consolidated price, the consideration is apportioned to the various assets on a fair basis as determined by competent valuers. Hence, the acquirer will often account for all the assets and liabilities at their respective fair values or relative fair values.

Given this background, there are multiple scenarios that warrant greater deliberation – firstly, the case where a brand is acquired and then continued to be used by the acquirer, secondly, where the brand is acquired with the intention of discontinuing the brand or eliminating competition, and thirdly, where the intention is to continue the brand, but business or other circumstances force discontinuation. What is important to note here, is that the intention of the acquirer has a significant bearing on the accounting treatment.

These different scenarios could have a significant impact on the areas of financial reporting due to the considerations relating to recognition and intangible asset valuation, estimates of useful life, goodwill and impairment considerations – all of which have been discussed in greater detail as follows:

1. Acquisitions of and involving Indian companies have indicated varying treatments. In the event of a brand being acquired, where the intention is to discontinue the brand or eliminate competition, companies typically would recognise the brand as an intangible, and then subsequently, write off the intangible asset. If the intention of the acquirer is to continuing the use of the brand, then the company will continue to recognise the intangible asset on the books while estimating the value and useful life for amortisation.

Another possibility is that the intention is to continue use of the asset, however, for business or other reasons the company believes subsequently that it is not feasible to continue the use of the brand, the company may have already recognised the intangible, and would now need to impair the asset, with suitable impact being given to in the statement of profit and loss. In the event that a slump sale has been recorded on the basis of book values, no separate intangible asset would

be recognised – it would simply be subsumed into goodwill.

2. Identifying and assigning value to the acquired intangible can also pose significant challenges when fair value accounting is followed instead of book value accounting. An entity would need to select appropriate fair valuation approach and technique e.g., market approach, income approach or cost approach. While the approaches may seem simple, estimating the future use of the intangible can be particularly difficult, in cases where the intangible has been acquired to eliminate competition. In the absence of specific guidance in IGAAP, identifying fair values for such intangibles can pose significant challenges.

3. Such acquisitions could also impact goodwill in IGAAP – in the event of a slump sale of a business done on the basis of book values, there would be no separate value attached to the new intangibles (except for intangibles/brands appearing in the acquiree’s books would be recognised at book values) and it would be subsumed into goodwill. However, if fair values are considered, then a separate value would be assigned to the intangible.

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Defensive assets – IFRS and U.S. GAAP considerations

IFRS and U.S. GAAP have clearly specified guidance – IFRS 3, Business Combinations under IFRS and Accounting Standard Codification (ASC) 805 under U.S. GAAP – the guidance for business combinations and assets purchased without the intention of using the acquired asset. The treatment under both IFRS and U.S. GAAP for the various areas related to a defensive asset is largely similar, and has been captured in more detail below.

a. Recognition and valuation of the acquired intangible

In case of an asset acquired in a business combination, both U.S. GAAP and IFRS require the asset to be measured at its fair value, regardless of the intended use of the acquirer. ASC 805 contemplates a scenario where, “to protect its competitive position, or for other reasons, the acquirer may intend not to use an acquired nonfinancial asset actively, or it may not intend to use the asset according to its highest and best use”. It further specifies that regardless of intended use, the asset shall be measured assuming its highest and best use by market participants.

Similarly, IFRS 3 on business combinations uses practically the same language, and states that the acquirer shall measure the fair value of such an asset assuming the highest and best use by market participants, both for the purpose of initial valuation as well as for subsequent impairment testing.

b. Useful life for such acquired intangible assets

Another important consideration under both IFRS and U.S. GAAP, is the estimation of useful life of the acquired intangible, and the subsequent (i.e., post acquisition) accounting related to it. Under U.S. GAAP, this aspect was detailed in the Emerging Issues Task Force (EITF) issue 08-7, Accounting for Defensive Intangible Assets.This EITF has now been codified in ASC 350 which deals with intangible assets. In the context of useful life, the EITF highlights that a defensive intangible asset should be assigned a useful life that reflects the entity’s consumption of the expected benefits relating to that asset. The EITF also states that the benefit received from the defensive asset, is the direct and indirect cash flows resulting from the entity preventing others from realising any value from the intangible asset. The useful life is essentially the period over which the fair value of the defensive asset diminishes.

Under IFRS, considering the principles in both IFRS 3 on business combination and IAS 38, Intangibles Assets, the acquirer’s intentions could affect the estimation of useful life of the asset. The key point while estimating the useful life of such intangible assets, is to ensure that it reflects the period over which the asset is expected to contribute either directly or indirectly to the cash flows of the entity.

c. Impairment

Defensive assets are required to be tested for impairment, should there be factors or circumstances that indicate the acquired intangible may be impaired. In both cases, the fair value to be considered while testing for impairment will be the value based on the market participant assumptions relevant at the time of testing.

It is worth noting though, that while guidance and standards govern the treatment of such acquired intangible assets under IFRS and U.S. GAAP, applying the principles poses multiple challenges. Most critical are those that relate to estimating the useful lives of such assets and also their valuation. Identifying the period over which there may be direct or indirect benefits from the intangible, as well as ascertaining the value based on market participant assumptions can be particularly challenging.

In the Indian scenario, the treatment of such assets requires detailed consideration, in the absence of any guidance. Considering the expected increase in mergers and acquisitions as the global economies travel down the road to economic recovery, the need for specific guidance under IGAAP to help ensure that such assets are identified, accounted for and reported on a consistent basis to ensure comparability of financial statements across companies and sectors, has never been more.

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• Summarise the recently issued FASB guidance on the service concession arrangements.

Service concession arrangements

During our September 2013 issue of the Accounting and Auditing Update, we examined current accounting practices followed for service concession arrangements in India and also accounting guidance for such arrangements under International Financial Reporting Standards (IFRS). This article aims to highlight key developments under the U.S. GAAP with respect to service concession arrangements.

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Service concession arrangements are arrangements under which a public sector entity (grantor) grants a private entity (operating entity), the right to operate and/or maintain the grantor’s infrastructure assets such as airports, roads, bridges, etc. The infrastructure may exist at the date of arrangement or may be constructed and/or upgraded by the operating entity during the period of the service concession arrangement. If infrastructure already exists, operating entity may be required to provide significant upgrades to existing infrastructure. In such arrangements, the grantor controls any residual interest in the assets at the end of the term of the arrangement and these arrangements are commonly referred to as ‘public-to-private’ service concession arrangements.

In a typical service concession arrangement, operating entity operates and maintains the infrastructure that will be used for public services for a period of time. In exchange of services, the operating entity may receive payments from grantor to perform these services and such payments may be paid as the services are performed over the extended period of time. Arrangements also exist where operating entity may be given a right to charge public to use the infrastructure or may contain an unconditional guarantee under which grantor provides for minimum guaranteed payment fees to the operating entity if the fees collected from public do not reach a specified minimum threshold. In these arrangements, grantor generally controls and has the ability to modify or approve the services the operating entity must provide, to whom the services will be provided and the price that will be paid for the services.

Service concession arrangements can take many different forms, some of the common aspects of service concession arrangements include:

• Operating entity constructs the infrastructure for the grantor, provides significant upgrades to existing infrastructure, makes cash payment to the grantor, operates or provides a combination of these kind of features

• Contracted services provided by the operating entity to the public on behalf of the grantor must meet minimum performance standards

• At the end of the arrangement, the grantor controls the residual interest in the infrastructure and may specify the minimum conditions that the infrastructure must be in at the end of the term.

Unlike IFRS, U.S. GAAP had no specific guidance applicable to service concession arrangement and depending on the terms of the arrangement, operating entities may or may not conclude that a service concession arrangement meets the criteria of lease in Topic 840, Leases. In January 2014, Financial Accounting Standards Board issued Accounting Standards Update No. 2014-05 on service concession arrangements with the objective to specify that an operating entity should not account for a service concession arrangement within the scope of this ASU as a lease in accordance with Topic 840, Leases. The update currently limits the scope to arrangement in which grantor is a public-sector entity.

ASU No. 2014-05 applies to operating entity of a service concession arrangement when arrangement meets both the following criteria:

• The grantor controls or has the ability to modify or approve the services that the operating entity must provide with the infrastructure, to whom it must provide them, and at what price

• The grantor controls, through ownership, beneficial entitlement, or otherwise, any residual interest in the infrastructure at the end of the term of the arrangement.

An operating entity should refer to other Topics under Accounting Standards Codification to account for various aspects of service concession arrangement. For example, if service concession arrangement includes construction, upgrade or operation services, then the operating entity is required to refer to Topic 605 on revenue recognition for accounting of revenue for the construction type activity. Further, ASU also clarifies that the infrastructure used in a service concession arrangement should not be recognised as a property, plant and equipment of operating entity.

The amendments in ASU should be applied to service concession arrangements that exist at the beginning of an entity’s fiscal year of adoption on a modified prospective basis i.e., cumulative effect of applying the amendment to arrangements existing on the beginning of an entity’s fiscal year of adoption should be adjusted to the opening retained earnings balance for the annual period of adoption. The ASU is effective for public business entity for annual periods, and interim periods within those annual periods, beginning after 15 December 2014. For an entity other than a public business entity, the amendments are effective for annual periods beginning after 15 December 2014, and interim periods within annual periods beginning after 15 December 2015. Early adoption is permitted.

The amendment as per the ASU and IFRS are consistent in not considering service concession arrangements as leases. IFRIC interpretation No. 12, Service Concession Arrangements, also addresses the accounting by operating entities of service concession arrangements and additional guidance on how to account for service concession arrangements. In contrast to IFRIC 12, the ASU does not provide any specific accounting guidance for various aspects of service arrangements, but rather indicate that an operating entity should refer to other topics to account for various aspects of a service concession arrangement.

1. ASU No. 2014-05- Service Concession Arrangements

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The Companies Act, 2013 Impact on auditors


• Summarise the requirements of the Companies Act, 2013 and the rules in relation to auditors.

The Companies Act, 2013 (2013 Act) has some significant implications for auditors. In our November 2013 issue of the Accounting and Auditing Update, we covered the changes in auditor appointment procedures and reposing responsibilities that

are cast on auditors under the 2013 Act. On 31 March 2014, the Ministry of Corporate Affairs issued the Companies (Audit and Auditors) Rules, 2014 (rules).

In this article, we are focussing on the main requirements of the rules.

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Auditor appointment and removal

Term of appointmentAs per the rules, an individual or a firm would be appointed as an auditor for a five-year term with annual ratification at the annual general meeting by ordinary resolution. If the appointment is not ratified, it appears that the process for change of auditor would have to be followed.

On initial appointment under the 2013 Act, the period of appointment could be less than five years as it depends on the transition requirements and the remaining tenure.

While considering, an auditor appointment, the audit committee/board of directors would have to consider any order or pending proceeding against the auditor/audit firm or any partner of the audit firm relating to matters of professional conduct before the Institute of Chartered Accountants of India, any court or other competent authority.

Mandatory rotation of auditorsCertain specified companies can not appoint or reappoint an audit firm (including an LLP) as auditor for more than two consecutive terms of five years each (in case of an individual there would be one term of five years). The specified companies are as following:

a. listed companies

b. all unlisted companies having paid up share capital of INR100 million or more

c. all private limited companies having paid up share capital of INR200 million or more

d. all other companies having paid up share capital below threshold limit mentioned in (a) and (b) above, but having public borrowings from financial institutions, banks or public deposits of INR500 million or more.

The mandatory rotation of auditors requirement is not applicable to small companies and one person companies.

In determining the period of five consecutive years or ten consecutive years, as the case may be, the tenure of auditors prior to 1 April 2014 would be considered. The rules provide a three years transition period for complying with the provisions of the 2013 Act. For example, if an audit firm has served as the auditor of a company for a period of seven years on 1 April 2014 then the firm would need to rotate out after a maximum period of three years.

Additionally, in determining the tenure of the audit firm prior to 1 April 2014, tenure of the other firms operating under the same network of audit firms would also be considered. The rules clarify that term ‘same network’ includes the firms operating or functioning, hitherto or in future, under the same brand, trade name or common control.

There is a cooling off period of five years for both individual auditors and audit firms within which the auditor can not be re-appointed.

If a partner, who is in charge of an audit firm and also certifies the financial statements of the company, retires from the said firm and joins another firm of chartered accountants, such other firm shall also be ineligible to be appointed for a period of five years for that company.

Rules further clarify that only a tenure break of five years or more to be considered in meeting the rotation criteria.

Disqualifications of auditors An auditor would not be eligible for appointment:

• if he holds any security or interest not only in the company but also in its subsidiary/holding/fellow subsidiary as well as in its associate. Besides, holding of security or interest by relative(s) of the auditor would also result in disqualification except that relatives can hold securities or interest with ‘face value’ not exceeding INR0.1 million). Any acquisition of security or interest by relatives beyond these limits is required to be corrected within 60 days.

• if he, or his relative or partner is indebted in excess of INR0.5 million to the company or its subsidiary/holding/fellow subsidiary as well as in its associate.

• if he or his relative or partner has given a guarantee or provided any security in connection with indebtedness of any third person to the company, or its subsidiary/holding/fellow subsidiary as well as in its associate in excess of INR0.1 million.

• a person or a firm who, whether directly or indirectly, has business relationship with the company, or its subsidiary/holding/fellow subsidiary as well as in its associate except those that are in the ordinary course of business and at an arm’s length like sale of products or services to the auditor, as customer, in the ordinary course of business, by companies engaged in the business of telecommunications, airlines, hospitals, hotels and such other businesses.

• a person whose relative is a director or is in the employment of the company as a director or key managerial personnel

• a person who is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such persons or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies

• a person who has been convicted by a court of an offence involving fraud and a period of ten years has not elapsed from the date of such conviction.

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Auditor reporting responsibilityThe Companies Act, 2013 requires that the auditor has to report:

• Where the company has failed to provide any information and explanations to the auditors, the details of the same and their effect on financial statements.

• Whether the company has adequate internal financial controls in place and the operating effectiveness of such controls.

• Observations or comments on financial transactions or matters which have any adverse effect on the functioning of the company.

• Any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith (this is in addition to the assertion relation to maintenance of proper books of account).

Additionally, the rules now require the auditor’s report should also include their views and comments on the following matters:

• Whether the company has disclosed the impact, if any, of pending litigations on its financial position in its financial statement

• Whether the company has made provision, as required under any law or accounting standards, for material foreseeable losses, if any, on long term contracts including derivative contracts

• Whether there has been any delay in transferring amounts, required to be transferred, to the Investor Education and Protection Fund by the company.

Reporting of frauds by auditorIn case an auditor has sufficient reason to believe that an offence involving fraud, is being or has been committed against the company by officers or employees of the company, he is required to report the matter to the Central Government immediately but not later than 60 days of his knowledge in the following manner:

• He will forward his report to the board or the audit committee, as the case may be, immediately after he comes to knowledge of the fraud in order to seek their reply or observations within 45 days

• On receipt of such reply or observations the auditor is required to forward his report and the reply or observations to the board or the audit committee along with his comments (on such reply or observations of the board or the audit committee) to the Central Government within 15 days of receipt of such reply or observations

• In the auditor fails to get the any reply or observations from the board or audit committee with the stipulated period of 45 days, he should forward his report to the Central Government along with a note containing the details of his report that was earlier forwarded to the board or the audit committee for which he failed to receive any reply or observations within the stipulated time.

• The report is required to be sent to the Secretary, MCA.

Liability of the auditorThe rules clarify that for any criminal liability of any audit firm, liability other than fines would devolve only on the concerned partner or partners, who acted in a fraudulent manner or abetted or colluded in any fraud.

Removal of auditor before expiry of his termApplication for removal of auditor also contains matters such as qualifications in the auditor’s report in last three years, pending civil or criminal proceedings between the company and the concerned officers, pendency of audit and current state of the accounts at the time of removal of auditors, etc. This would enable a more qualitative assessment by the MCA in granting permission for removal of auditors.


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Discussion paper on ‘Annual Information Memorandum’

At the time of making public issue of securities, companies are required to make extensive disclosures in the offer document relating to company’s history, financial performance, etc. Once the securities are listed, companies are required to make periodical disclosures to the stock exchanges such as financial performance of the company, shareholding pattern as well as event based disclosures such as material developments in business, etc. Apart from making such disclosures to stock exchanges companies are also required to submit various reports to the Registrar of Companies, other regulators, etc. based on their respective requirements. In order to integrate the information requirements of various stakeholders at one place the Securities and Exchange Board of India (SEBI) has released a discussion paper on ‘Annual Information Memorandum’ (AIM).

AIM is intended to be a extensive document with relevant information about financial and operating performance of the company, for investors and other stakeholders at one place.

As per the proposed structure, the AIM will include inter-alia, information such as capital structure, market price information, history and corporate matters, business description, promoters or principal shareholders, risk factors, financial statements for past three years, dividend track record, etc. Additionally, it is intended that reports such as corporate governance report (as per clause 49 of the Equity Listing Agreement (ELA)), business responsibility report (as per clause 55 of the ELA), etc. may be included in the AIM, thus eliminating the requirement of providing such details in the company’s annual report.

Key elements of the proposed AIM framework are as under:

• Frequency of preparation would be annually

• Timeline for dissemination: within 135 days from the end of the financial year

• Mode of dissemination: Electronically – on company’s website and filing with stock exchanges

• Approval of AIM by the board of directors

• Implementation timelines:

– Top 200 listed companies based on market capitalisation at BSE or NSE as on 31 March 2014 by financial year beginning on or after 1 April 2014

– All other listed companies by financial year beginning on or after 1 April 2015

– Companies which are planning initial public offerings (IPO), the requirements of AIM will commence with the IPO

• Companies desirous of using AIM as draft offer document for future capital raisings will be required to accompany AIM with an auditor’s examination report.

[Source: SEBI’s Discussion Paper on “Annual Information Memorandum”]

SEBI’s discussion paper on ‘Monitoring Agency Report and Related Disclosures’

With a view to help ensure utilisation of proceeds in accordance with the objects as mentioned in the offer document for public issue of securities, the SEBI strengthened the current norms relating to monitoring of utilisation of such funds raised. In this context, the SEBI has released a discussion paper on ‘Monitoring agency report and related disclosures’ proposing amendments to SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR Regulations).

Proposed amendments to current requirements:

• Monitoring agency should be appointed for all issues irrespective of the size of the issue. Currently monitoring agency is required for issue sizes exceeding INR5 billion.

• The monitoring agency should submit its report quarterly as against the current requirement of half-yearly reporting.

Regulatory updates

28


New requirements proposed:

• The report of the monitoring agency should be submitted to stock exchanges for public dissemination

• Monitoring agency will be required to grade the deviation in utilisation of the funds raised (if any) based on specified criteria

• Audit Committee and the Board/Management should provide their comments for such deviation, if any, pointed out in the report of monitoring agency

• Such report should be submitted to the stock exchanges within 45 days from the end of the quarter

• A committee of the Board of Directors of the company should be constituted before opening of the public issue, to oversee the monitoring of utilisation of issue proceeds. The majority of the members the committee should be independent directors. Further the committee should be headed by an independent director.

Through such amendments the regulators aim to reduce misutilisation of funds raised by companies. Further, dissemination of such information as required by the proposed amendments will enable investors to take informed decisions.

[Source: SEBI’s Discussion Paper on “Monitoring Agency Report and Related

Disclosures”]

RBI’s framework for revitalising distressed assets in the economy for NBFCs

The Reserve Bank of India (RBI) has released a ‘Framework for Revitalising Distressed Assets in the Economy’ on 21 March 2014, which sets out guidelines for the early recognition of financial distress, taking prompt steps for resolution and ensuring fair recovery for NBFCs. The new framework continues to emphasise the RBI’s focus on putting assets to work and incentivising the speedy resolution of NPA or NPA like exposures in the banking system. The set of structural reforms set up earlier for banks such as the Central Repository of Information on Large Credits (CRILC) to facilitate and disseminate information on large credits and co-ordination of lender actions through the establishment of Joint Lenders’ Forums within the lending system, would also encompass NBFCs and would be available to them.

Also, refer to ‘KPMG’s First Notes’ dated 25 March 2014 for an overview of the salient features of the new framework, the potential implications and areas for action.

[Source: RBI/2013-14/528 DNBS (PD) CC.No.371/03.05.02/2013-14 dated 21

March 2014]

Notification for commencement of sections of Companies Act, 2013

On 26 March 2014, the Ministry of Corporate Affairs (MCA) has notified 183 new sections of the Companies Act 2013 and few sub-sections of the 13 sections which were already notified by notification dated 12 September 2013 and the remaining schedules with an effective date of 1 April 2014. Additionally the MCA also notified rules related to certain chapters at a later date.

The MCA has notified key sections (along with the rules)related to incorporation of the company, accounts of companies including

financial statements, directors, related party transactions and auditors have been notified in addition to others.

The sections remaining to be notified are related to National Financial Reporting Authority, Investor and Education Protection Fund, Compromise and arrangement, oppression and mismanagement, winding up, sick companies, special courts, National Company Law Tribunal. It seems that majority of these sections are not notified due to pending cases and considering that as these bodies have not yet been constituted.

The MCA has also issued an amended Schedule II to the Companies Act, 2013 though the date of applicability of the amendments are yet to be notified.

[Source MCA notification dated 26 March 2014 and 29 March 2014]

MCA issues clarification with regard to section 180 of the Companies Act, 2013

Section 180 of the Companies Act, 2013 pertains to ‘restrictions on powers of board’ which requires consent of the company through special resolution for certain powers of the board such as sale/lease of the whole undertaking of the company, borrowings of the company, remittance or giving time for the repayment of any debt due from the director, etc. The corresponding section under the Companies Act, 1956 (section 293) required consent of the company through ordinary resolution.

In this regard, the MCA has clarified that the ordinary resolution passed by the company under the Companies Act, 1956, in relation to the borrowings made by it (subject to the limits prescribed) and creation of security on assets of the company, prior to 12 September 2013 will be regarded as sufficient compliance with the section 180 of the Companies Act, 2013 for a period of one year from the date of notification of section 180 of the Companies Act, 2013 which is 12 September 2013.

[Source: MCA’s General Circular no. 04 /2014 dated 25 March 2014]

MCA and ICAI clarification regarding commencement of certain provisions of the Companies Act, 2013

The MCA has notified that relevant provisions/schedules/rules of the Companies Act 1956, shall continue to apply to the financial statements (and documents required to be attached thereto), auditor’s report and Board’s report in respect of financial years that commenced earlier than 1 April 2014.

In addition to the notification by the MCA as above, the ICAI has re-iterated and clarified further that the auditor’s report of a company pertaining to any financial year commencing on or before 31st march 2014, would be in accordance with the requirements of the Companies Act, 1956 even if that financial year ends after 1 April 2014. For example, where the financial year of a company is 1 January 2014 to 31 December 2014, the statutory auditor’s report signed for that year would be in accordance with the requirements of the Companies Act, 1956

[Source: MCA’s General circular 08/2014 dated 4 April 2014 and ICAI’s

clarification dated 8 April 2014]

Format for auditor’s certificate required under clause 24(i) of the Equity Listing Agreement

As per the Equity Listing Agreement (ELA), the companies need to file the draft scheme of arrangement with the stock exchanges before filing the same with the court for approval. Additionally, under clause 24(i) of the ELA, the companies need to file an auditor’s certificate certifying that the accounting treatment followed in the scheme is in compliance with all the accounting standards specified by the Central Government under section 211(3C) of the Companies Act, 1956. In order to ensure consistency, the Securities and Exchange Board of India (SEBI has released a standardised format for auditor’s certificate which needs to be filed by the companies in this regard.

[Source: SEBI’s circular CIR/CFD/DIL/1/2014 dated 25 March 2014]

Companies 1st (Removal of Difficulties) Order, 2014

The MCA has proposed to issue the Companies 1st (Removal of Difficulties) Order, 2014. The proposal clarifies that a public company in which a director or a manager is a director and holds along with his relatives more than two per cent of its paid up share capital, then such a director shall be regarded as a related party under the Companies Act, 2013.

[Source: MCA has issued a notification dated 28 March 2014]

ICAI proposes a revised IFRS-convergence roadmap to MCA

The Institute of Chartered Accountants of India (ICAI) has proposed a revised roadmap for implementation of Ind AS. The ICAI has submitted the proposed roadmap to the Ministry of Corporate Affairs (MCA) for its consideration.

As per the revised roadmap, listed companies and unlisted companies with a net worth exceeding INR5 billion will be required to prepare consolidated financial statements as per Ind AS from accounting years beginning on or after 1 April 2016. The comparatives for the accounting year 2015-16 will also be as per Ind AS. Further, the ICAI clarified that the stand-alone financial statements will continue to be prepared as per the existing notified Accounting Standards which would be upgraded over a period of time.

[Source: ICAI’s press release: http://www.icai.org/new_post.html?post_

id=10491&c_id=238 dated 24 March 2014]

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Introducing Voices on Reporting

KPMG in India is pleased to introduce Voices on Reporting – a monthly series of knowledge sharing calls to present and discuss current and emerging issues relating to financial reporting.

In our first call, we covered the recently enacted sections of the Companies Act, 2013, and its implications on financial statements preparation for March 2014.

We also covered briefly SEBI corporate governance norms.

Missed an issue of Accountingand Auditing Update or First Notes?

The March 2014 edition of the Accounting and Auditing Update leads with our article on the airport infrastructure sector which focusses on the business models applied in this sector and their implications from an accounting and reporting perspective. This month, we also examine the complexity and challenges associated with carve-out financial statements. Continuing with our series of articles on the Companies Act, 2013, we highlight key measures that relate to investor and stakeholder protection.

As we approach the financial year end for most companies in India, we have also attempted to summarise in one place, key developments under Indian GAAP, IFRS and U.S. GAAP in the past year that may be relevant for preparers of financial statements. Under U.S. GAAP, we have covered a recent development in the area of hedge accounting affecting private companies. Finally, we also cover our regular overview of the key regulatory developments during the recent past, including highlighting a recent EAC opinion on the accounting of a principal only currency swap which has some interesting implications.

Notification of provisions relating to corporate social responsibility under the Companies Act, 2013

The Ministry of Corporate Affairs (MCA) has vide its notification dated 27 February 2014, notified 1 April 2014 as the date on which the provisions of section 135 and Schedule VII of the Companies Act, 2013 shall come into force.

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