Accounting and Auditing Update - November 2013

November 2013

ACCOUNTINGAND AUDITINGUPDATE

In this issue

PCC proposes alternative accounting methods under US GAAP for private companies p08

Post-implementation review findings – IFRS 8, Operating Segments p12

Corporate Social Responsibility in India A new phase p14

The Companies Act, 2013 – Impact on auditors p16

SEBI permits pre-emptive rights in the shareholders’ agreements p19

Cash Flow Statement presentation – Financing Activities p20

Regulatory updates p22

Healthcare Challenging times ahead

p01

Healthcare is an industry and sector that has witnessed significant growth over the past few years and with large amounts of investments, both public and private flowing into this sector, poised for even greater heights for the forseeable future. This month we cast our lens on this sector and examine in our lead feature, some of the industry dynamics and the impact it has both on controls and accounting and reporting matters.

We also kick start a series of articles in this issue that will highlight areas impacted by the Companies Act, 2013 that have been subject to much discussion and debate. In this issue, we focus on Corporate Social Responsibility ‘CSR’ and auditor appointment and reporting requirements.

In our coverage of US GAAP developments, we focus this month on proposals of the Private Company Council relating to the area of business combinations, goodwill and on the accounting of certain derivative swap contracts. This area of development

should be of interest to many in India as it provides an insight on how a differentiated accounting standards model for public and non public companies may be applied. Given some of the proposed transition plans to Ind-AS in India, this is an area that may be useful to consider for Indian standard setters also.

Finally, in our sections on emerging trends and application issues, we look at recent developments relating to the SEBI guidance on acceptability of certain pre-emptive rights in shareholder agreements and we also consider certain aspects of the application of the cash flow accounting standard AS 3 by financial sector entities.

Happy reading and best wishes for the festive season from the AAU team!

Editorial

V. VenkataramananPartner, KPMG in India

© 2013 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.

Healthcare Challenging times ahead

India’s need for health services and infrastructure have been significantly unmet. According to World Health Statistics 2013, India’s physician to population ratio is 6.5 per 10,000, the beds density is 9 per 10,000 and nursing/midwifery personnel to population is 10 per 10,000. This is extremely low compared to the guidelines recommended by the World Health Organisation (WHO).

Given the pace at which India is emerging as a healthcare destination, it is imperative that public expenditure and policy is supportive of the sector. Central Government healthcare expenditure of 28.2 percent (2010) is extremely low contribution for a large diversified country like India. Total expenditure on health as a percentage of India’s GDP is only 3.7 percent (2010). A large portion, almost 72 percent (2010), of the healthcare expenditure in India is, therefore, private expenditure. According to the Association of Healthcare Providers (India) it is believed that India needs 2.4 million more doctors and 2 million more hospital beds to be comparable to the United States.

A closer look at the ecosystem reveals that while the demand for high quality medical services and a dependable infrastructure is ever increasing, the disparity in healthcare services between rural and urban India is also concerning.

The healthcare sector in India is experiencing rapid transformation. Healthcare services which are critical to the growth in economy have seen vast improvements over the past few years in India. However, it lags behind the global average in terms of healthcare infrastructure and manpower.1 The question is: are healthcare providers really prepared for the monumental challenges posed and opportunities emerging? Healthcare providers are often faced with the healthcare ‘dilemma’ of social vs. commercial purpose. The constant challenge is whether to contain spiraling costs or to provide high value delivery services. For most players the gap seems to be increasingly widening. How do the healthcare providers then address this problem? The solution is not easy especially because the recipient of these services is a ‘patient’ for whom the experience and satisfaction is as important as the costs incurred on medical procedures required.

This article aims to:

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highlight the challenges and emerging issues faced by the healthcare providers in India

explain an accountant’s perspective to these challenges and emerging issues

highlight the internal control considerations that are relevant to this sector

[Source: World Health Statistics 2013 by the World Health Organisation (WHO)]

1 KPMG’s publication: The Emerging Role of PPP in Indian Healthcare Sector


Striking the right balance between costs and delivery is easier said than done. The sector is highly capital intensive. As the payback period is long, working capital funding is crucial. Debt levels need to be controlled to ensure sustainability. Funding challenges are further compounded as liquidity is strained due to lack of government funding. For hospitals that rely on private finance, financial health is a key ingredient in raising further capital for growth or expansion. Given the generally poor infrastructure, lack of physicians and trained workforce, a high cost structure is inevitable to maintain assets, provide high value medical services and also generate surplus. These commercial compulsions sometimes tend to override the need to excel operationally in the medical field. There is a very thin line between maintaining ethical standards and meeting budgets. For-profit hospitals encounter this dilemma more often than not. As these hospitals cater to all classes of patients, in addition to the provision of right medical practices, a clearly articulated strategy and a strong governance model is critical to ensure long term sustainability.

Success is no longer about only making profits. Increased accountability and transparency through governance is expected to drive value.

With the increasing regulatory scrutiny, hospitals should look at broadening their board and management committee to increase governance. Building capabilities and making continuous improvements is essential as sustainability is the real challenge. A lean, patient focussed integrated delivery system with complete accountability and transparency should be the new goal.

Revisit traditional physician focused strategy as a fresh perspective is required.

As hospitals get prepared for the immense transformation some of the key aspects

to be considered are:

• Revisiting the strategy to make it a value based governance model that can attract patients

• Harnessing the relationship between patients and doctors

• Increasing patient awareness

• Strengthening the relationship between hospitals and doctors

• Increasing transparency of the medical procedures and making information available to ‘all’ stakeholders

• Making changes to the internal process so as to align them with the overall strategy

• Separate strategic management from operations management team to reduce conflicts

• Identifying and mapping key risks

• Investing in the right information technology systems to increase efficiency.

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Source: Accounting and Auditing Update, November 2013

SpecialistPatientGeneral

practitioner

Payers

Support services

Patient groups

Patient

General practitioner

Other specialist

SpecialistCommunity care

Hospital

Source: KPMG International, 2012


As costs of delivery increase, a right balance is required between quantitative and qualitative goals

A comprehensive risk mapping will seek to reduce the constraints and funnel growth by instituting required mitigating controls.

Hospitals cater to a large spectrum of medical delivery including emergency and trauma conditions. The governance model needs to identify, incorporate strategic and process level controls that respond to and manage these risks. An effective risk mapping can ensure clarity in processes which can then be embedded in the operational and monitoring activities.

Use of IT should be pervasive, fundamental and not need based.

Hospitals typically use IT as a need based tool rather than making it a fundamental platform for all operational aspects. With the advent of the internet and mobile technology it is imperative to have the backend and frontend architecture fully automated. Being a regulated industry, the stakeholders need to ensure that the data gathering, analysis and reporting is accurate. It is now important to have a comprehensive IT system that can play a critical role in monitoring and supporting the strategic initiatives of the hospitals. With the world moving towards a digital future, it is imperative that hospitals provide management, patients, doctors, nurses, paramedical and other staff with the right technology platform that can not only increase effectiveness but also bring transparency and be an interactive media for service delivery.

Emerging issues

The healthcare sector has been undergoing significant changes across the globe with respect to new laws, IT, revenue models, regulatory partnerships and India is no different. These changes bring new challenges to the management from an operational and accounting framework. Companies will require an integrated patient delivery system with standardised policies and procedures, effective internal control mechanism, pervasive IT system, value based delivery model to overcome these emerging challenges.

Emerging issues

• New value driven revenue models

• Cost optimisation strategies

• Next generation healthcare information technology integrated with patient delivery system

• Consolidation

• Public-private partnership.

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Following is an illustrative list of risks:

• Highly capital intensive sector, availability of capital is strained on account of poor government funding

• Lack of a larger health insurance benefit in India leading to a high incidence of healthcare payments by consumers in the nature of private out of pocket spends

• High level of cash component of the billing and collections. Managing cash is, therefore, critical and requires tight controls

• Mismatch in costs incurred and reimbursements approved

• Incorrect billing, processing, maintenance of patient health records could result in disputes and claims

• Lack of infrastructure, physicians, trained workforce around the clock

• Lack of patient awareness

• Lack of inter departmental cohesiveness

• Lack of a supportive public policy

• Concern on data integrity and security.

Some of the risks are inherent business risks while others emanate from the way the processes are structured.

Each of these risks has to be analysed from the point of view of the relevant stakeholder and the constraints that they pose in day to day operations.


Emerging issue – understanding partnerships, alliances and arrangements for visiting doctor services

An integrated patient delivery model will not be successful without the right partnerships and alliances as it involves bringing together different skill sets to deliver healthcare services to a patient. For instance, a patient suffering from diabetes could have developed several other complications which need specialised treatment and all of them may need to be provided at the same time depending on the condition. These partnerships and alliances could be formed locally or internationally. With the globalisation of healthcare industry, the markets have begun witnessing various alliances or partnerships between healthcare providers and local market players providing end to end services or with international market players to provide services to the patients under a collaborative arrangement in different geographies. The concept is at a nascent stage and many accounting challenges could arise such as accounting for profit sharing, revenue sharing, gross versus net presentation of revenue.

It is common for hospitals to engage specialists as visiting doctors to provide patient services particularly for performing surgeries. Fees paid to the visiting doctors could be fixed or variable depending on the arrangement. In case a portion of the revenue is shared with the doctor, this could create accounting challenges in determining whether revenue is to be recognised gross or net.

Accountant’s perspective of the emerging issue

Partnering and collaborative arrangements create unique accounting challenges for recognition of the collaborative arrangement on the balance sheet and accounting for revenues and profit sharing that are earned through these arrangements. Accounting for such arrangements should be based on the substance of the arrangement and the expected benefits that accrue over a period of time. Some of these benefits could be linked to revenue/cost sharing which could make it even more complex and significant estimations could be involved depending on when the obligations of each partner has been completed.

Accounting for fees paid to visiting doctors requires judgement depending on the facts and substance of the arrangement i.e., whether revenue should be presented gross or net.

In such a situation, the substance of the arrangement could be either: (1) the hospital providing the necessary infrastructure for the visiting doctor in order to perform a specialised medical therapy or (2) the hospital engaging with the patient in the capacity of a principal and make available the services of a visiting doctor. In these situations, a substantial portion of the patient revenue collected would be reimbursed to the visiting doctor. Accounting for such transactions as either gross or on a net basis is expected to be challenging and would depend on the specific facts and circumstances taking into consideration factors such as: (1) who is the primary obligor, (2) who has latitude in determining prices (3) who has the credit risk on billings, etc. Some of the performance indicators which are directly or indirectly linked to the revenue cycle such as occupancy rate, revenue per patient, etc. are also used as key performance indicators.

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Emerging issue – multiple elements arrangement

Packaging or bundling of medical services contain various elements including provision of support services such as diagnostic services, nursing services, emergency and trauma related services, surgical services, ambulance, other ancillary services and post operative care. Additionally, use of internet and mobile technology platforms to increase awareness and widen ‘reach’ to patients directly is emerging as a revenue driver. Healthcare services are typically billed at a standard listed rate or published rate. However, the billing process could be complex given the class of the patient, ultimate payer and the multiple elements of services provided. Billing and charges may not be complete or may be made for procedures that have not been performed that would result in a greater degree of manual intervention between the provision of services, entering the data onto the patient’s medical chart and coding the services to enable an invoice to be generated. Several financial and regulatory issues could arise if the data is incorrectly captured and recorded.


Revenue recognition has become a complex area as the delivery models are complex. While multiple elements are required to be packaged or bundled together to increase patient satisfaction these have to separated in order to allocate consideration to individual services.

Each of the service provided under a bundled arrangement (e.g., diagnostic services, surgical services, ambulances, etc.) needs careful consideration based on the value they deliver to the patients and consideration is assigned on the basis of fair value of each individual service being performed or on the basis of fair value of the undelivered components. Considering there are various services provided under a single package, hospitals as at the period end may need to measure the revenues yet to billed for the completed and in progress activities and estimate unbilled revenue/revenue in case of advance billings to be recognised. On the other hand, hospitals also need estimate the discounts that they generally offer and reduce it from the revenue accrued.


In this section, we have made an attempt to point out certain accounting considerations under Indian GAAP and internal control related matters relating to these emerging challenges.

Hospitals are beginning to realise that technology has far reaching implications on its delivery model and, therefore, the traditional revenue model driven by physicians is now challenged. New value driven revenue models are, therefore emerging which threaten to shift revenue to hospitals that provide an integrated patient delivery model.

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Emerging issue - leases

Hospitals typically enter into long term leases for buildings and equipments. Assets taken on lease could be either in the form of operating or finance lease depending on the nature of the arrangement.

Sometimes long term leases include annual fixed rate inflators and lease incentives. These payments are required to be considered while accounting for the total lease rentals over the lease term. Recognising straight line rent over the period of time results in recognition of higher expense in the initial lease period.

Healthcare companies, in addition to lease expense incur certain cost towards initial improvement which include installations, temporary partitions and fittings. These costs are generally capitalised as leasehold improvements. Leasehold improvement are depreciated over its useful life or lease term, whichever is lower.


A ‘finance lease’ is a lease that transfers substantially all of the risks and rewards incidental to ownership of the leased asset from the lessor to the lessee; title to the asset may or may not transfer under such a lease. An ‘operating lease’ is a lease other than a finance lease.

For example, a medical equipment lease may qualify as a finance lease, if it meets any of the following criteria

1. Transfer of ownership at the end of lease term

2. Where lessee has purchased the option at very reduced rates and lessee is certain to opt for this purchase option at the inception

3. Where lease term covers substantial period of economic life of the asset

4. Where amount paid as lease rentals in terms of present value is equal to the fair value of the asset

5. Where asset is of specialised nature and can not be used by a person other than lessee without making major modifications.

Else it may be a mere operating lease with lease rentals being recognised as an expense to the profit and loss account. The analysis is extremely important as the asset and the corresponding lease liability will be reflected on the balance sheet. This could in turn impact the debt-equity ratio and the overall leveraging capability of the hospital.

Many hospitals try and enter into arrangements that qualify as operating leases in practice.

If the lease meets the definition of operating leases, a lessee does not recognise the leased asset in its balance sheet, nor does it recognise a liability for rentals in respect of future periods. Lease payments (excluding costs for services such as insurance and maintenance) are recognised as an expense on a straight-line basis unless another systematic basis is representative of the time pattern of the user’s benefit, even if the payments are not on that basis. If the timing of lease payments does not represent the time pattern of the lessee’s benefits under the lease agreement, then prepaid rent or accrued liabilities for rental payments are recognised.

In our experience, the use of another systematic basis is rare. In addition the accounting guidance on leases does not incorporate adjustments to reflect the time value of money; therefore, in our view recognising income or expense from annual fixed rate inflators [e.g. fixed rental step-ups intended to reflect inflation increases] as they arise to rental expense would not be consistent with the time pattern of the user’s benefit.

Sometimes lessors provide incentives for the lessee to enter into a lease agreement; such incentives may include the reimbursement of relocation costs or costs associated with exiting lease agreements, or initial periods that are rent-free or at a reduced rate. These incentives are an integral part of the net consideration agreed for the use of the asset. Incentives granted to the lessee to enter into an operating lease are spread over the lease term using the same recognition basis as the rental payments - i.e., on a straight-line basis unless another systematic basis is representative of the time pattern over which the benefit of the leased asset is diminished.

It is common for healthcare providers to utilise a sale/leaseback arrangement for a medical office building. In these transactions, the healthcare provider forms a separate entity that owns and finances the building, and then leases the office space back to the healthcare provider. This type of lease has typically been structured to qualify as an operating lease with off-balance sheet treatment.

Emerging issue - IT systems

Next generation IT systems are expected to be expensive and will need to be integrated with the patient delivery system to be effective.

India is yet to develop a national electronic health record management system, and the healthcare sector could utilise the Cloud to set up a common Cloud based database for health records for the healthcare sector to utilise.

The Cloud is a paradigm shift in the use of Healthcare Information Technology (HIT), which enables stakeholders to focus more on their core competencies. In the case of the healthcare industry, it would provide for the seamless management and access to the Electronic Health Records (EHRs) of patients.


IT revolution brings several challenges including cloud computing which require changes to the internal IT platforms. Healthcare companies can enter into two kinds of contracts to acquire such services:

• Term based license - where the cost of acquiring the license would be expensed ratably over the period of time.

• Purchase of license (perpetual) - where the cost of purchase of software can be capitalised based on evaluation of economic benefits accruing on purchase of the software. The accounting for investment made in such cloud computing models has to be further scrutinised if it would eligible for capitalisation as an intangible. This will depend on whether the healthcare entity is able to demonstrate future economic benefits associated with the applications developed which could require careful consideration.


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Emerging issue – new models

There are other emerging delivery models such as internet, social media and mobile systems which are emerging in the market which enable easy connectivity to the patients. Sometimes these arrangements would in addition to an initial license acquisition fee also involve usage based fee payable by the hospitals and healthcare entities to the service provider.


There are divergent practices today with respect to accounting for usage based fee. The determination of cost is more complicated when the consideration paid in exchange for receiving an intangible asset is wholly or partly variable. These arrangements have to be carefully evaluated to determine the accounting treatment. When variable payments are based on future usage of the asset, it would be more appropriate to account for the cost of the intangible asset on the basis of the agreed minimum payments. This is so because the revenue-based payments are not a present obligation and therefore, the view that they form part of the cost of the license is not free from doubt. Instead, in general expensing any additional payments would be preferable.

Private-Public Partnerships (PPP) hold the key to improve healthcare delivery in India. New PPP models could have accounting implications depending on the how the arrangement is entered into.

India is focused on developing the PPP model to cover the demand-supply gap prevalent in the healthcare sector. Private sector expertise coupled with efficiencies in operation and maintenance would lead to improved healthcare service delivery to the masses. A PPP model can act as a catalyst in the creation of new capacity and improvement of efficiency in the existing infrastructure established if followed in letter and spirit. A PPP could be in the nature of any of the following:

• Management contract where private companies operate the management of the company

• Joint venture where specific special purpose vehile’s are formed with participation by both the parties

• Leasing where short to medium term leases are provided to the companies

• Build Own Operate Transfer(BOOT)/Build Operate Transfer (BOT) - where the capital is raised by public sector and private sector is assigned all the aspects of the project.

Hospitals need to evaluate whether the particular model is a joint venture, service concession arrangement or any other type of PPP arrangement to determine specific accounting. For instance, if it is a joint venture, the consolidation standard for joint venture accounting may need to applied and if it is a BOOT/BOT arrangement the accounting for service concession arrangements may need to be applied. Indian GAAP did not traditionally provide any guidance on the accounting for SCAs by the operator or the grantor. Therefore, this has resulted in the adoption of different accounting policies for such arrangements across the various reporting entities. The Institute of Chartered Accountants of India (ICAI) proposed an Exposure Draft (ED) on Guidance Note on Accounting for Service Concession Arrangements in 2008. The ED replicates the principles set out in the IFRS. As yet, a final Guidance Note or accounting standard has not been issued on this topic.

Internal Control Considerations

Considering the volume of the transactions and services being offered by the hospitals, it is important to have a control environment to ensure all the information is appropriately recorded and presented in the financial statements and their internal reporting through which the financial performance of the hospitals are measured. Key controls which ensure appropriate record keeping and to address the risk of inaccurate reporting are as follows:

• Access controls and segregation of duties need to be incorporated in the billing the patients record system

• Adequate supervisory checks on the manual billings and day register of utilisation of services by patients

• Adequate review of patient case sheets

• Review of collectability by management keeping in view the contractual obligations

• A review of collection pattern and assumption used to arrive at estimates for determining bad debt expense


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• Ensure adequate review of complex arrangements and ensure appropriate revenues are recognised for the services provided before the ‘cut off’ period

• Adequate approval mechanisms for the discounts provided to the patients

• Compliance review to identify potential violations of policies and procedures including regulatory requirements.

• Legal review of medico legal claims and litigations

• The use of the Cloud could possibly result in significant changes to business model, automation of processes, streamlining of workflows, and a consolidation of IT assets for healthcare service providers. A detailed evaluation prior to embarking on making changes to the IT systems is very important

• Appropriate integration of IT controls over the data and patient records with the financial reporting model is critical

• Appropriate records need to be maintained to ensure compliance with the terms of the arrangement with government agencies and third party vendors

• Periodic review of the expenses incurred and review generated to ensure compliance to regulations

• Appropriate internal control systems that can facilitate accurate reporting to withstand further scrutiny by the regulators

• A company that has a large number of equipment leases (e.g., computers, copiers, medical equipment, and other office equipment) shall ensure to have appropriate records and resources required to track, evaluate, and monitor lease arrangements and assets taken on leases

• Assumptions used to value the leases will need to be monitored and reassessed at least annually

• Review of government funded arrangements to ensure that appropriate records are available and approvals obtained for the grants and utilisation of government subsidies.

Consolidation a way forward?

While the hospital sector reorganises itself to become an integrated value based patient delivery model, growth by acquisition of specialised teams and consolidation is expected. Inorganic growth could bring synergies, make them more competitive and also help in building capabilities if the right acquisition strategy is adopted. Business combinations could be complex depending on the manner in which the combination is carried out. Depending on the underlying assets or business that is acquired, transactions may involve complex valuation issues for which the entity may consider a valuation specialist. Consolidation will also involve complex tax issues which may arise while giving effect to the combination. Accounting for business combinations could be extremely challenging, especially if it involves human capital and premium resources.


PCC proposes alternative accounting methods under US GAAP for private companies

In May 2012, the Financial Accounting Foundation (FAF), the parent organisation of FASB1 established the Private Company Council (PCC) to improve the accounting standard-setting process for private companies by identifying potential modifications to the US GAAP to address the needs of users of private company financial statements. The PCC will also advise the FASB on private company matters related to areas under consideration by the FASB.

Recently, the FASB and PCC approved for public comment three proposals that would establish accounting alternatives for private companies that issue US GAAP financial statements, which if finalised, would permit private companies to select any or all of the alternatives to account for:

• Identifiable intangible assets acquired in a business combination

• Goodwill

• Certain receive-variable, pay-fixed interest rate swaps.

The scope of these proposals uses the term ‘publicly traded company’ from an existing definition in the Master Glossary under US GAAP. Concurrent with the FAF’s creation of the PCC, the FASB is working on a separate project about the definition of a nonpublic entity i.e., it is deliberating

which types of business entities would be considered public and would not be included within the scope of the Private Company Decision-making Framework. The FASB and PCC expect that the final definition of a public business entity resulting from that project would be added to the Master Glossary and would amend the scope of these proposals.

As proposed, these alternatives would not be available to public companies. However, the FASB may consider whether the alternatives would be appropriate for public companies during the redeliberation process.

The PCC added the above mentioned issues to its agenda in response to feedback received from private company stakeholders through various channels indicating that the benefits of the current accounting treatment for goodwill as well as intangible assets acquired in a business combination do not justify the related costs.

The summary of the proposed ASU alongwith the key highlights have been summarised in this article.


explain relief expected to be provided for intangible assets acquired in a business combination, goodwill and receive-variable, pay-fixed interest rate swaps under the US GAAP for private companies

provide our observations on the proposals

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1Financial Accounting Standards Board


Accounting for identifiable intangible assets acquired in a business combination

Who would be affected by the amendments in this proposed ASU?

All entities that is required to apply acquisition method under Topic 805, Business combinations , except for a publicly traded company or a not-for-profit entity.

Current US GAAP requirements

Topic 805 requires an acquirer to recognise assets acquired and liabilities assumed in a business combination at their acquisition-date fair values, including all intangible assets that are identifiable. An intangible asset is identifiable if it meets any one of the criteria – (1) it arises from contractual or other legal rights, regardless of whether those rights are transferrable or separable from the entity or from other rights and obligations (2) it is separable, that is, capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset, or liability, regardless of whether the entity intends to do so.

What are the main provisions of the proposed ASU?

Provides guidance about an accounting alternative for the recognition, measurement and disclosure of identifiable intangible assets acquired in a business combination.

If an entity elects the accounting alternative, it would recognise separately from goodwill only those identifiable intangible assets that arise from contractual rights with noncancellable contractual terms, or that arise from other legal rights, whether or not those intangible assets are transferrable and separable.

An entity would be required to disclose qualitatively the nature of identifiable intangible assets acquired but not recognised as a result of applying this accounting alternative.

Identifiable intangible assets that arise from contractual rights would be measured using the fair value measurement principles of Topic 820, Fair Value measurement. The measurement

would consider market participant assumptions about the remaining noncancellable term and, therefore, would not consider any potential contractual renewals or cancellations that ordinarily would be considered in determining fair value of that contract.

Identifiable intangible assets that arise from other legal rights but that are contractual would continue to be measured at fair value in accordance with Topic 820 incorporating all market participant expectations.

Benefits of the proposed ASU

Recognition of fewer intangible assets in a business combination because not all identifiable intangible assets would be recognised separately.

PCC believes that the proposed ASU, when elected would continue to provide decision-useful information to the users of private company financial statements, while providing a reduction in the cost and complexity associated with the valuation of certain identifiable intangible assets.

When would the amendments be effective?

The effective date will be determined after the PCC considers stakeholder feedback on this proposed update. Early adoption would be permitted.

The accounting alternative for identifiable intangible assets would be effective prospectively for all business combinations entered into during fiscal years, and interim periods within those years, beginning on or after the effective date.

Accounting for goodwill


All entities that is required to apply acquisition method under Topic 805, Business combinations, except for a publicly traded company or a not-for-profit entity.


The US GAAP currently prohibits amortisation of goodwill and only requires companies to test it annually for impairment or more frequently if certain conditions exist.

Further, US GAAP requires impairment testing for goodwill to be carried out at the reporting unit level, which is generally at or one level below the operating segment level. This necessitates allocation of goodwill in certain situations to various reporting units involving significant complexity.

Goodwill impairment process under US GAAP is carried out using a 2 step process – (1) wherein the carrying value of the reporting unit (including goodwill) is compared to the fair value of reporting unit and (2) if there is a deficit in step 1, proceed to step 2 wherein a purchase price allocation is done based on the fair value of the reporting unit and implied fair value of goodwill is computed. The difference between the implied fair value of the goodwill and the carrying value of the goodwill is the impairment that is recorded by the entity.

The US GAAP, was amended for annual and interim goodwill impairment tests performed for fiscal years beginning after 15 December 2011 to also allow an entity to first perform a qualitative assessment to determine if it is more likely than not that a reporting unit’s fair value is less than its carrying value.

Alternatively, it can bypass the qualitative assessment and proceed directly to quantitative assessment as noted above.

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Provides guidance about an accounting alternative for the subsequent measurement of goodwill.

If an entity elects the accounting alternative, it would amortise goodwill on a straight-line basis over the useful life of the primary asset acquired in a business combination, not to exceed 10 years. (A primary asset is the long-lived asset that is the most significant asset of the acquired entity.)

Goodwill will be tested for impairment at the entity-wide level rather than at the reporting unit level.

The goodwill impairment loss, if any, would represent the excess of an entity’s carrying amount over its fair value. The goodwill impairment loss would not exceed the carrying amount of goodwill.


PCC received input indicating that most users of private company financial statements disregard goodwill and goodwill impairment losses in their analysis of the company’s financial condition and operating performance. Hence, the PCC believes that the proposed amendment would result in minimal loss of relevant information for users of the private company financial statements.

PCC believes that the proposed ASU, when elected would continue to provide decision-useful information to the users of private company financial statements, while providing a reduction in the cost and complexity associated with the current goodwill impairment test.


The effective date will be determined after the PCC considers stakeholder feedback on this proposed update.

The accounting alternative for goodwill would be applied prospectively for all existing goodwill and for all new goodwill generated in business combinations after the effective date.

Accounting for certain receive-variable, pay-fixed interest rate swaps


All entities except publicly traded -companies, not-for profit entities, employee benefit plans and financial institutions.


Under current US GAAP requirements, a swap is a derivative instrument. Topic 815, Derivatives and Hedging, requires that an entity recognise all of its derivative instruments on its balance sheet as either assets or liabilities and measure them at fair value. To mitigate the income statement volatility of recording a swap at fair value, Topic 815 permits an entity to elect, ‘cash flow hedge’ accounting if certain requirements under that topic are met.

The requirement of hedge accounting is complex and involves contemporaneous documentation to be maintained by the entity to support its estimates.


Provide two simpler approaches, the combined instruments approach and the simplified hedge accounting approach to account for swaps that are entered into for the purposes of economically converting variable-rate borrowing to fixed-rate borrowing.

Under both the approaches, the periodic income statement charge for the interest expense would be similar to the amount that would result if the entity had directly entered into fixed-rate borrowing, instead of variable-rate borrowing and a swap. Alternatively, that entity could continue to follow the current guidance in Topic 815.

The combined instruments approach would provide entities within the scope of this proposed update with an entity-wide accounting policy election to apply a scope exception from the current guidance in Topic 815. This will allow the swap and the borrowing are accounted for as one combined financial instrument, i.e., the swap would not be recorded in the entity’s financial statements (except for the period-end accrual relating to the next

swap settlement). This approach can be applied if all the following criteria are met:

• Both the variable rate on the swap and the borrowing are based on the same index and interest rate

• The terms of the swap, are typical, and there is no floor or cap on the variable interest rate of the swap unless the borrowing has a comparable floor or cap

• The repricing and the settlement dates for the swap and the borrowing match or differ by no more than a few days

• The swap’s fair value at inception is at or near zero

• The swap is not a forward starting swap

• The notional amount of the swap is equal to, or less than, the principal amount of the borrowing

• The term of the swap approximates the term of the borrowing

• The swap is effective at the same time as the borrowing or within a few days.

The simplified hedge accounting approach would provide entities within the scope of this proposed update with a practical expedient to qualify for hedge accounting under Topic 815. Under this approach, the swap and the related borrowing would continue to be accounted for as two separate financial instruments, however, no ineffectiveness would be assumed for qualifying swaps designated in a hedging relationship under Topic 815. The designated swap may be recorded at settlement value in the entity’s financial statements, instead of fair value.

The criteria to qualify for simplified hedge accounting are similar to the criteria proposed under the combined instruments approach, however, the term of the swap could be less than the term of the borrowing and the swap does not have to be effective at the same time as the borrowing.

The simplified hedge accounting approach would allow for the hedge documentation under para 815-20-25-3 to be completed within ‘a few weeks’ of the hedge designation instead of requiring that documentation to be completed concurrently at the inception of the hedge.


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Conclusion

The proposed ASU’s, if approved will have far reaching implications for nonpublic entities. Currently, accounting for business combinations and derivatives are two of the most complex accounting topics and the above exemptions would go a long way in reducing complexity for smaller private companies. However, one also needs to see if it will have the impact of increasing challenges about comparability of financial statements. However, for smaller private companies without any listing plans, this will be a very welcome move, having faced significant challenges in accounting for complex areas like business combinations and derivatives.

Also Topic 815 permits election of hedge accounting on a swap-by-swap basis, an entity within the scope of the proposed update could elect to apply the simplified hedge accounting to any swaps, whether existing at the date of adoption or entered into after that date, provided the requirements of applying this approach otherwise are met.


The two alternative approaches are simpler in comparison to Topic 815, in accounting for swaps.

The fair value disclosures of Section 825-10-50, Financial instruments-Overall-Disclosure, would not apply to swaps accounted for under combined instruments approach. Also for the purpose of applying scope exception in paragraph 825-10-50-3, a swap accounted for under the combined instruments approach would not be considered to be an instrument accounted for as a derivative instrument under Topic 815. However, the settlement value of the swap would be disclosed.


Entities within the scope of this proposed update would be provided with an option to apply the amendments in this proposed ASU using either (1) modified retrospective approach in which the opening balances of the current period presented would be adjusted to reflect application of the proposed amendments or (2) a full retrospective approach in which financial statements for each individual period presented and the opening balances of the earliest period presented would be adjusted to reflect period-specific effects of applying the proposed amendments. Early adoption would be permitted.


Post-implementation review findings – IFRS 8, Operating Segments

The requirement to carry put a post-implementation review was added to the IASB’s due process by the Trustees in 2007. The IASB1 would review major new standards, or significant amendments to existing standards, two years after the standard has been applied internationally. The post-implementation review is an important tool in maintenance of IFRS. IFRS 8 is the first standard that was subject to a post-implementation review by the IASB.

Background to IFRS 8

The project to develop IFRS 8 was added to the IASB’s agenda in September 2002 as a short-term convergence project, conducted jointly with the FASB2. The objective of the project was to reduce the differences between IFRS and US GAAP that were capable of resolution in a relatively short time and that could be addressed outside of the major projects.

While discussing IFRS 8’s project, the IASB discussed the expected benefits and disadvantages of applying IFRS 8 at the time it was issued which are shown in the table below:

Benefits Disadvantages

Achieves convergence with US GAAP Inconsistent segments may be reported between entities, because the internal organisation of each entity might differ

‘Management eyes’ perspective would improve users’ ability to predict future results and cash flows

Frequent internal reorganisations would result in a loss of trend data

Highlights risks that management think are important

Geographical analyses would not be available because IFRS 8 does not require that a separate geographical analysis is presented

Use of management reporting would result in increased interim reporting, because the information would be readily available.

IFRS 8 requires that the segment information disclosed is measured on the basis used for management reporting. Non-IFRS measures used by management may not be understood.


highlight the benefits and disadvantages of IFRS 8

bring a snapshot of post-implementation review findings

explain the IASB conclusion and next steps

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1 International Accounting Standards Board2 Financial Accounting Standards Board


Areas for potential improvement and amendment

Issues raised Participants’ suggestions

Requests for implementation guidance

The concept of an identifiable chief operating decision maker (CODM) is confusing and outdated. Identification of the CODM is difficult in practice.

Participants suggest that IFRS 8 should provide more guidance or replace ‘CODM’ with a more common term, such as ‘key management personnel’ (KMP) as defined by IAS 24, Related Party Disclosures or ‘governing board’ as used in the Conceptual Framework. The IASB noted that KPM includes non-executive directors, which is at odds with an ‘operating decision making’ function.

Some preparers are uncertain how the reconciliation should be presented and how reconciling amounts should be disclosed. Some investors find the items included in the reconciliations difficult to understand.

Some regulators and preparers suggest that the IASB should provide application guidance that includes examples of such a reconciliation.

Requests for improved disclosures

Any change in the basis of segmentation from one year to the next benefits in the loss for investors of valuable trend information for that entity.

In the event of a reorganisation, investors suggest that 3-5 years’ comparative information for segment information should be presented.

Many entities present different definitions of ‘operating result’ or ‘operating cash flow’, making comparison difficult between entities. Investors report that important line items needed to derive these sub-totals are often not separately reported.

Investors would like the IASB to require disclosure of some defined line items in order that investors can calculate their own sub-totals for operating result or cash flow. Some investors think that non-IFRS defined sub-totals should be labeled ‘adjusted’.

Many investors think that operating segments are aggregated inappropriately, reducing the value of the information presented. Some preparers find the aggregation guidance difficult to apply in practice.

It has been suggested that the IASB should provide guidance on the nature of ‘similar economic characteristics’ and reconsider the use of quantitative thresholds in order to help preparers apply the aggregation guidance more consistently and aggregate operating segments only when appropriate.

Some investors cannot understand how reconciling amounts relate to an individual segment.

Many investors would like reconciliations prepared segment-by-segment, but others warn about allocating costs to individual segments when this cannot be done on a systematic basis.

Post-implementation review -summary of findings about IFRS 8

• The use of the management perspective did make communication by management with investors easier and the incremental costs of implementation of IFRS 8 were low. In addition, the standard achieved convergence with standards issued by the FASB, and at low cost.

• Preparers generally think that the standard works well. Auditors, accounting firms, standard-setters and regulators generally support the standard, but have made some suggestions to improve its application. Views on IFRS 8 received from investors were mixed.

Some investors prefer to have information about how management views the business, as IFRS 8 requires. When all aspects of an entity’s reporting align so that operating segment information in the financial statements, management commentary and presentations to analysts all agree, this provides more detailed, integrated information to them. In addition, the fact that the IFRS 8 information is audited increases the value that investors attribute to the other sources of consistent segment information.

Other investors, however, were wary of a segmentation process that is based on the management perspective. Those investors mistrust management’s intentions and sometimes think that segments are reported in such a way as to obscure the entity’s true management structure (often as a result of concerns about commercial sensitivity) or to mask loss-making activities within individual segments.

• Internal reporting had been modeled on the previous standard, reported segments in some jurisdictions did not change. The IASB’s review of academic research confirmed that although the number of reported segments did not change in many jurisdictions, when the number of reported segments did change, the number generally increased.

These issues will be researched by the staff and their findings and recommendations presented to a future meeting of the IASB.

The Financial Accounting Foundation (FAF) has also carried out a post-implementation review on the FASB’s standard on operating segments. That report, Post-Implementation Review Report on FASB statement No. 131, Disclosures about Segments of an Enterprise and Related Information, was published earlier this year.

As IFRS 8 is a standard that is substantially converged with standard issued by the FASB. In its April 2013 meeting, the IASB concluded that the development of any proposed amendment to an IFRS that is converged with the equivalent guidance in the US GAAP principles, proposed as a result of the post implementation review, should include active liaison with the FASB.

IASB’s conclusion and next steps

• The benefits of applying the standard were largely as expected and overall the standard achieved its objectives and improved financial reporting. It is clear, however, that some investors have concerns about the information provided when segment information is disclosed in accordance with IFRS 8.

• These concerns warrant a revision of the principles on which the standard is based, because the evidence provided to us does not suggest that there are any significant failings in the standard.

• There are some issues that could be considered for improvement by the IASB. As a result of the information provided to us, we have identified some areas that we think warrant further investigation.

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Corporate Social Responsibility in India A new phase


summarise the CSR requirements of the Companies Act, 2013 and the draft rules

provide our observations on the above requirement i.e., challenges

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The draft rules define net profit as net profit before tax as per books of accounts and shall not include profit arising from branches outside India. Also for the first CSR reporting the net profit would mean average of the annual net profit of the preceding three financial years ending on or before 31 March 2014.

The draft rules specify that CSR policy should

• Specify the projects and programmes to be undertaken and also a list of CSR projects/programmes which the company plans to undertake during the implementation year, modalities of execution in the areas/sectors chosen along with implementation schedules

• The surplus arising out of the CSR activity will not be part of business profits of a company

• The corpus to include following:

– 2 percent of average profits

– any income arising therefrom

– surplus arising out of CSR activities.

Appointment of the committee

A committee is required to be formed consisting of three or more directors of the company, out of which at least one director should be an independent director. Following is the role of the CSR committee:

• Formulate strategy and activities

• Recommended expenditure amount to execute the strategy

• Regularly monitor CSR policy.

Applicability

Companies meeting any one or more of the following criteria during any financial year are required to contribute towards CSR:

• Net worth ≥ INR 5,000 million

• Turnover ≥ INR 10,000 million

• Net profit ≥ INR 50 million.

We believe that the net profit threshold limit in the applicability criteria would bring many companies within the ambit of CSR as defined under the 2013 Act. The 2013 Act specifies that net profits would the average net profits of the company made during the three immediately preceding financial years.

In India, most Corporate Social Responsibility (CSR) activities have traditionally been in a voluntary form. The Companies Act, 2013 (2013 Act) prescribes a framework for all companies meeting the prescribed criteria to contribute two percent of their profits for a CSR purpose. The 2013 Act puts greater responsibility on companies to set out a clear framework and process to ensure strict compliance.

In this article, we are summarising the CSR requirements given in the 2013 Act and the draft rules.


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If a company sets up a trust or section 8 company (companies set up for charitable purposes), society, foundation or any other form of entity operating within India to facilitate implementation of its CSR activities in accordance with its stated CSR policy then the company should

• Specify the projects/programmes to be undertaken by such an organisation, for utilising funds provided by it

• Establish a monitoring mechanism to ensure that the allocation is spent for the intended purpose only.

The draft rules also allow a company to conduct/implement its CSR programmes through trusts, societies or section 8 companies operating in India which are not set up by the company itself. Such spends may be included as part of its prescribed CSR spend only if such organisations have an established track record of at least three years in carrying on activities in related areas.

The draft rules also allow companies to collaborate or pool resources with other companies to undertake CSR activities and any expenditure incurred on such collaborative efforts would qualify for computing the CSR spending.

CSR activities shall not include activities exclusively for the benefit of employees and their family members.

The draft rules provide the format in which all qualifying companies shall report the details of their CSR initiatives in the Director’s report and on the company’s website.

What constitutes eligible CSR spend

Activities which may be considered as eligible CSR spend are provided in the Schedule VII of the 2013 Act. The specified activities are as under:

• Environment sustainability

• Empowering women and promoting gender equality

• Education

• Poverty reduction and eradicating hunger

• Social business projects

• Reducing child mortaility and improving maternal health

• Improvement of health

• Imparting of vocational skills

• Contribution towards Central and State Government funds for socio-economic development and relief including contribution to the Prime Minister’s National Relief Fund

• Such other matters as may be prescribed.

The companies should give preference to the local area and the area around it where it operates for spending the amounts earmarked for CSR activities.

Board responsibility

The 2013 Act puts responsibility of the CSR on the board of directors and they are required to

• To approve the CSR policy (recommended by the CSR committee) and disclose the contents of the policy in its report and place it on the company’s website

• Ensure that the CSR activities are undertaken by the company

• Ensure 2 percent spending on CSR activities

• Report CSR activities in the Board of Director’s report and disclose non-compliance (if any) with the CSR provisions and reasons for not spending the amount.

Our observations - challenges

We believe that some of the issues that are still not clarified/need further clarity are as under:

• While the draft CSR rules specify that CSR activities shall not be exclusively for the benefit of employees/their families, it does not provide any objective critieria of certain benefits (not exclusive) given to employees/their families that could be regarded as CSR activities.

• Whether the list of activities specified under Schedule VII of the Act is exhaustive?

• While the draft CSR rules suggest that tax treatment of CSR spend will be in accordance with the Income-tax Act, 1961 as may be notified by the Central Board of Direct Taxes (CBDT), one will have to wait and watch for notification from the CBDT and whether the same provides adequate certainty on tax treatment of CSR spend.


The Companies Act, 2013 Impact on auditors

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Our observations

The introduction of a fixed tenure for audit appointment is a welcome move. Viewed in conjunction with other provisions of the 2013 Act, it provides a certain level of balance to the role and responsibilities of auditors. Also, while it may now be difficult to remove an auditor prior to the expiry of their term, the conditions of a special resolution and the Central Government approval, if applied in the spirit that they have been drafted, could be supportive of greater auditor independence and objectivity.

The Rules require the appointment of the auditor to be ratified at every AGM. If the appointment is not ratified, it appears that the process for change of auditor would have to be followed.


highlight the challenges and emerging issues faced by auditors

explain our observations regarding these challenges and emerging issues

The Companies Act, 2013 (2013 Act) has some significant implications for auditors. These implications range from how they are appointed, the tenure that an auditor will be appointed for, conditions around their qualification and disqualification to be an auditor, their reporting responsibilities and how auditor performance will be evaluated and in cases of misconduct acted upon. In this article, we are focussing on changes in appointment procedures and reporting responsibilities that are cast on auditors under the 2013 Act.

Auditor appointment and removal

Term of appointment

As per the 2013 Act, an individual or a firm would be appointed as an auditor for a five-year term; this is in contrast to the previous provisions of appointments that were valid from one AGM to the next AGM. Changes of auditors before the five year term would require special resolution after obtaining the previous approval of the Central Government. Further the auditor concerned would have to be given a reasonable opportunity of being heard.


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Companies need to be compliant with the provisions relating to rotation within three years from the date of the commencement of the 2013 Act. The Central Government may, by Rules, prescribe the manner of rotation. The draft Rules state that the period for which the auditor has held office prior to commencement of the 2013 Act shall be taken into account in calculating the period of five consecutive years or ten consecutive years, as the case may be. Also the incoming auditor shall not be eligible, if such auditor is associated with the outgoing auditor or audit firm under the same network of audit firms or is operating under the same trademark or brand. As per the draft Rules, this requirement has been extended to all companies except small companies and one person companies.

Our observations

Auditor rotation (and in certain situations where resolved by the members, audit partner/team rotation) is one of the significant areas that the 2013 Act points towards. The requirement for past tenure to be considered while applying transition provisions would require a large number of companies to gear up towards mandatory auditor change in the next few years. Further, neither the 2013 Act nor the draft Rules define the term ‘network’. The term should be defined in the final Rules to ensure compliance as well as consistent application. The ICAI does not allow the use of trademark or brand, therefore, this restriction seems irrelevant.

These Rules could have some impact of movement of audits and audit professionals between audit firms also especially when viewed with the expanded definition of ‘relatives’ that also require to be independent for an auditor appointment to be effective.

The draft Rules require these rotation provisions to be applied not only to listed/public interest entities but also to non public/private companies except certain small companies and one man companies. In certain other jurisdictions where auditor rotation applies, the requirement for auditor rotation tends to be applied only to listed/ public interest entities.

Rotation of auditorsListed companies or companies belonging to such class of companies as may be prescribed 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).

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. Audit firms having a common partner or partners to the outgoing audit firm or operating under the same trademark or brand will also not be eligible for appointment till the cooling off period of the outgoing firm has expired. Further, the members of a company may resolve that the audit firm appointed by it, the auditing partner and his team should be rotated at such intervals as may be resolved by members.

Non-audit servicesThe 2013 Act prohibits an auditor from rendering specified non-audit services to the auditee company/ its subsidiary/holding company e.g., accounting and book keeping services, internal audit, design and implementation of any financial information system, investment advisory services, investment banking services, management services, etc.

Existing companies get a transition period till the end of the financial year to comply with the new requirements.

Our observations

The intent to set some bright lines from an auditor independence perspective is a constructive theme in the 2013 Act. However, some further clarification may be required to ensure effective application. For instance, the scope of the term ‘management services’ should be clarified, as there is a concern that in the absence of more specific rule, there would be confusion and potential litigation on whether or not a service is permitted to be rendered by an auditor. Auditors have traditionally provided to their audit clients a range of non-audit services that are consistent with their skills and expertise. While some non – audit services may create threat to the independence of the auditor, the non-audit services in general may also benefit the Company. Driven by the intent to address the perception of independence threats, the list of prohibited services has been significantly extended from what is practice currently in India.

The prohibition applies whether services are provided directly or indirectly, i.e. either by the audit firm or through its partners or through its parent or subsidiary or associate entity or through any other entity in which the firm or any partner has significant influence or control or whose name/trademark/brand is used by the firm or its partners.

Even permitted non-audit services can be rendered only with the approval of the Board or Audit Committee; which while increasing the administrative burden on companies, is a welcome move as it re-emphasises the importance of the Audit Committee in auditor related matters.


Other changes - National Financial Reporting Authority

An independent authority, viz. National Financial Reporting Authority (NFRA) is to the be constituted to make recommendations to the Central Government on formulation and laying down of accounting and auditing policies and standards, monitor and enforce compliance therewith and oversee the quality of service of relevant professions. NFRA has been vested with quasi judicial powers to investigate matters of professional or other misconduct (as defined in the Chartered Acoountants Act, 1949) by chartered accountants ‘for such class of bodies corporate or persons‘ as may be prescribed. At present matters relating to professional or other misconduct are handled by the Institute of Chartered Accountants of India.

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Auditor reporting responsibilities

Auditors’ report The reporting requirements have been extended from what was required under the 1956 Act. Further, the Central Government, in consultation with National Financial Reporting Authority, has the power to direct the inclusion of specified matters into the auditors’ reports for specified classes/description of companies. As per the 2013 Act, 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).

• Such other matters as may be prescribed.

The draft Rules require the auditor to comment on the disclosure by the company of effect of pending litigations on financial position, making of provision for foreseeable losses on long-term contracts including derivative contracts, and whether there has been any delay in making deposits in Investor Education and Protection Fund.

not specifically commented upon by an auditor. Unless the responsibilities are specifically defined, it is very likely that a lot of diversity would exist in application such that the very purpose of the provision would be defeated. It may be appropriate if the scope of the expression ‘financial transactions and matters’ is limited to items having significant impact on financial statements. Also the 2013 Act or the draft Rules do not define the scope of the term ‘internal financial controls’. To facilitate a consistent application, a clarification that the scope of the term is limited to internal controls over financial reporting should be incorporated in the final Rules/relevant auditing standards.

Another instance would be to consider that under accounting standards the provision for foreseeable losses is required only in case of long term construction contracts under AS 7; perhaps the word ‘construction’ should be added to provide more specific boundaries to the reporting responsibilities for auditors.

Our observations

Similar to our earlier observations, there are a number of areas that require further amplification in the Rules to enable consistent application. For instance, the scope of the expression ‘financial transactions or matters’ which have any ‘adverse effect on the functioning of the company’ is extremely wide. It may also be seen as requiring the auditor to comment on propriety matters which in the auditor’s view could potentially have an adverse impact of the functioning of the company. Hitherto such matters were

Our observations

The increase of reporting requirements is well intentioned to ensure that such matters are brought to the attention of the Government/regulatory authorities. However, the construct of the Rules make these reporting requirements very challenging. For instance the auditor is required to comment not only on confirmed frauds but also suspected frauds in addition to the application of the quantitative thresholds for reporting. In many instances where fraud or suspected fraud exists, the auditor may struggle to have adequate or timely information to comply with these reporting requirements. Additionally, the current construct of the Rules may push auditors to report earlier than what may be prudent/appropriate mainly to avoid the risk that the auditor is non compliant and subject to penalty provisions under the 2013 Act. In the case of entities with large and widespread customer base (e.g., electricity supply companies) petty thefts by customers with connivance of lower-level company employees are quite common and the experience has been that despite best efforts, these instances can not be totally avoided. Such situations would lead to repetitive reports being sent to the Central Government which does not seem to the intention. Accordingly, the draft Rules may limit the reporting only to material frauds – mere recurrence of a fraud does not make it material.

Reporting on fraud

Under the 2013 Act, if in the course of performance of his duties as auditor, the auditor has reason to believe that an offence involving certain fraud is being or has been committed against the company by officers or employees, the matter needs be reported to the Central Government within the prescribed time and manner.

The relevant draft Rules state that the matter has to be reported immediately but not later than thirty days of his knowledge or information with a copy to the Audit Committee or in case the company has not constituted an audit committee, to the Board. As per the draft Rules the aforesaid reporting is required in case of (a) fraud(s) that is/are happening frequently or (b) fraud(s) where amount involved or likely to be involved is not less than 5 percent of net profit or 2 percent of the turnover of the company for the preceding financial year.

In case of frauds other than the above, the draft Rules require the statutory auditor to report the matter to the Audit Committee/Board of Directors. In case the Audit Committee or the Board, as the case may be, is not taking action or the auditor is not satisfied with the action taken, he may report to the Central Government even if the fraud is not material in nature.

[Source: SEBI’s PR No. 98/2013 dated 3 October 2013; SEBI’s notification dated 3 October 2013]

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SEBI permits pre- emptive rights in the shareholders’ agreements


summarise the key matters regarding the amendment issued by the SEBI for pre-emptive rights

Pre-emptive rights are rights such as right of first offer, right of first refusal (ROFR), tag-along, drag-along and call-put options. Such rights are common in shareholders’ agreement between investors in joint ventures, private equity investors and venture capital investors.

So far there was uncertainty on the enforceability of such pre-emptive rights as the Securities and Exchange Board of India (SEBI) held the view that the same do not conform to the requirements of a spot delivery contract nor with that of permissible derivative contracts as provided under relevant provisions of the Securities Contracts Regulation Act, 1956 (SCRA).

On 3 October 2013, the SEBI relaxed certain provisions of the SCRA by allowing investors to include in the shareholder’s agreement, the articles of association of a company or other body corporate, clauses relating to rights of pre-emption.

Both (a) the spot delivery contract and (b) contract for sale and purchase of securities or contracts in derivatives through recognised stock exchange were permissible earlier, the SEBI has now permitted the following contracts to be entered without obtaining its approval

• Contracts for pre-emption including ROFR, tag-along or drag-along rights contained in shareholders’ agreements/articles of association of companies or other body corporate

• Contracts in shareholders’ agreements/articles of association of companies or other body corporate, for purchase or

sale of securities pursuant to exercise of an option contained therein to buy or sell the securities (call/put option) provided:

a. the title and ownership of the underlying securities is held continuously by the selling party for a minimum period of one year from the date of entering into the contract

b. the price or consideration payable for the sale or purchase of the underlying securities is in compliance with all applicable laws

c. the contract is settled by way of actual delivery of the underlying securities.

The SEBI requires that above mentioned contracts should be in compliance with the Foreign Exchange Management Act, 1999 and the notification is to be applied prospectively from 3 October 2013 i.e., this notification does not validate any contract entered into before the said date.

This notification is also in line with the proviso to section 58(2) of the Companies Act, 2013 which states that “any contract or arrangement between two or more persons in respect of transfer of securities shall be enforceable as a contract”.

This notification is a welcome relief especially for private equity investors or companies seeking private equity participation. This is so because agreements with a private equity investor generally provide the private equity investor with an exit route by including such clauses.


Cash Flow Statement presentation Financing Activities

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summarise the EAC opinion on ‘Disclosure in the cash flow statement of borrowings and loan disbursements and related payments in the case of a financial institution’

highlight the divergence in practice within the banking sector

Under Indian GAAP, the objective of preparing cash flow statements under AS 3, Cash Flow Statements is that users of an enterprise’s financial statements are interested in how the enterprise generates and uses cash and cash equivalents. This is the case regardless of the nature of the enterprise’s activities and irrespective of whether cash can be viewed as the product of the enterprise, for example for a financial enterprise. Enterprises need cash for essentially the same reasons, however different their principal revenue-producing activities might be. They need cash to conduct their operations, to pay their obligations, and to provide returns to their investors.

It is interesting to note that in the case of operating activities as well as investing activities the standard distinguishes between financial enterprises and other enterprises. However, such distinction is not made while explaining the financing activities. This has resulted in divergent practices among the financial enterprises with respect to disclosure of activities relating to borrowings of a financial enterprise.

Expert Advisory Committee Opinion

In December 2009, the Expert Advisory Committee (EAC or the Committee) of the Institute of Chartered Accountants of India (ICAI) issued an opinion on ‘Disclosure in the cash flow statement of borrowings and loan disbursements and related payments in case of a financial institution’. In the case of a financial institution, the EAC opined that the amounts of loans raised from and the repayments made to the lenders should be classified under the head ‘cash flows from financing activities’ and the amounts of loan disbursed to and the payments received from the borrowers under the head ‘cash flows from operating activities’, as per the indirect method of preparation of cash flow statement as per AS 3. The opinion further clarified that the aforesaid amounts would be arrived as increase/decrease in the borrowings and loans and advances outstanding in the two balance sheets relevant for cash flow.


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While taking this view, the Committee noted that the standard explicitly states that the cash flows arising from loans advanced by a financial enterprise should be classified as an operating activity as these relate to main revenue producing activities of the enterprise. The Committee was of the view that the basic objective of financing activities is to finance the business of the enterprise irrespective of its nature of operations. An activity can be classified as financing activity only if it meets its definition. Since the loans disbursed and the repayments received do not result in changes in the size and composition of the owner’s capital and borrowings of the company, these should not be classified as financing activities.

The Committee further elucidated that cash flows arising from loans raised and repayments made to the lenders by the financial institution should be classified under financing activities as the definition of financing activities as per paragraph 17 of AS 3 does not make any distinction between financial and non financial enterprise or between funds raised for operating activities or investing activities.

AS 3 para 17

“The separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of funds (both capital and borrowings) to the enterprise. Examples of cash flows arising from financing activities are:

a. cash proceeds from issuing shares or other similar instruments

b. cash proceeds from issuing debentures, loans, notes, bonds and other short or long-term borrowings and

c. cash repayments of amounts borrowed.”

Accordingly, in the case of a financial enterprise, even though ‘loans raised and repayments made’ and ‘loan disbursements and repayments received’ are interdependent, the former can not be classified as an ‘operating activity’ for the purpose of AS 3.

Industry practice

The illustrative cash flow statement for financial enterprises given in the AS 3 discloses changes in borrowings of a financial enterprise under financing activities.

It appears that the EAC opinion reiterates the disclosure given in the above illustrative cash flow statement.

Currently there is a mixed practice in the financial sector regarding presentation of ‘loans raised and repayments made’ and ‘loan disbursements and repayments received’. Certain nationalised and public sector banks classify both ‘loans raised and repayments made’ and ‘loan disbursements and repayments received’ under operating activities. Private sector banks, however, typically disclose the loans raised and repayments made under financing activities and ‘loan disbursements and repayments received’ under the operating activities.


Regulatory updates

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Pilot scheme to allow unlisted Indian companies to list and raise capital abroad

Currently, unlisted Indian companies are not allowed to list on an overseas stock exchange directly without prior or simultaneous listing in Indian markets. Now, with the approval of the Ministry of Finance (MOF)an unlisted company may be allowed to list and raise capital abroad without the requirement of prior or simultaneous listing in India. The scheme will be implemented on a pilot basis for a period of two years from the date of its notification and impact of this arrangement would be reviewed.

The approval from MOF to list abroad under the scheme is subject to the following conditions:

• Listing abroad is allowed only on exchanges in the IOSCO (International Organisation of Securities Commissions)/FATF (Financial Action Task Force) compliant jurisdictions or those jurisdictions with which SEBI (Securities and Exchange Board of India) has signed bilateral agreements

• The return submitted to the proposed exchange/regulators should also be submitted to the SEBI for the purpose of Prevention of Money Laundering Act (PMLA)

• In addition to the requirements of the primary exchange, SEBI’s disclosure requirements will also need to be complied with prior to listing abroad

• The company should be fully compliant with the prevailing Foreign Direct Investment (FDI) policy while raising funds abroad

• The capital raised abroad may be utilised for retiring overseas debt or for operations abroad including for acquisitions

• In case the funds raised are not utilised as mentioned above, the companies will be required to remit the money back to India within 15 days and deposit with Reserve Bank of India (RBI) recognised AD category banks.

The MOF, Department of Industrial Policy and Promotion (DIPP) and the Reserve Bank of India (RBI) would be issuing the necessary notifications in due course in order to implement the required changes to the existing rules.

[Source - http://pib.nic.in/newsite/erelease.aspx?relid=99712 – Press Information Bureau, dated 27 September 2013]


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Amendment to bye-laws of recognised stock exchanges with respect to non-compliance of certain listing conditions and adopting standard operating procedure for suspension and revocation of trading of shares

For non-compliance of the Equity Listing Agreement, the stock exchanges have been suspending the trading of the shares of the listed companies. This procedure has affected the interest of non-promoters as the exit route is closed due to suspension of trading. Therefore, the SEBI has decided that in the case of non-compliant companies it would resort to several other measures such as imposition of fines, freezing of shares of the promoter and promoter group, transferring the trading in the shares of the company to separate category, etc. before suspending the trading of the shares of the company.

Accordingly, the SEBI has prescribed procedures for imposition of fines on the non-compliant listed entities and has also laid down Standard Operating Procedure (SOP) for suspension and revocation of suspension of trading in the shares of such listed entities. This will bring consistency and uniformity of approach undertaken by the stock exchanges for taking action against the listed entities for non-compliance with certain important listing conditions, such as Clause 31, Filing of Annual Report, Clause 35, Disclosure of Shareholding Pattern, Clause 41, Preparation and submission of financial results, Clause 49, Corporate Governance of the Equity Listing Agreement.

The key aspects of the new procedures are as under:

Imposition of fines

• Fines have been imposed on a per day basis during the period of default, for non-compliance or delay in compliance with a listing condition such as filing of annual report, submission of shareholding pattern, financial results, corporate governance, etc.

• Such fines collected will be credited to the ‘Investor Protection Fund’ of the respective stock exchange

• Names of the non-compliant listed entities will be displayed on the website of the respective stock exchange

• Appropriate enforcement action including prosecution will be initiated if the non-compliant listed entities fail to pay the fine despite receiving notice from the stock exchange in this regard

• Further, if a listed entity commits non-compliance of the Equity Listing Agreement conditions for two consecutive quarters, the shares of the non-compliant entity will be moved to ‘Z’ category, where the trades would be settled on ‘trade to trade’ basis.

Suspension of trading

• Following are the criteria for suspension of trading of shares of the non-compliant listed entity:

– Failure to comply with clause 31 for two consecutive financial years

– Failure to comply with clauses 35, 41, 49 for two consecutive quarters

– Failure to submit information on the reconciliation of shares and capital audit report for two consecutive quarters or

– On receipt of notice of suspension of trading of that listed entity from any other stock exchange.

• In case the non-compliance continues, before the suspension of shares from trading, the stock exchange will direct depositories to freeze the entire shareholding of the promoter group of the non-compliant entity. Simultaneously, the stock exchange will give 21 days public notice on its website proposing suspension of shares of the non-compliant listed entity.

• In case of failure to comply with the listing conditions as mentioned above, the shares of the non-compliant listed entity will be suspended.

• In order to provide exit window for the non-promoters, after 15 days of suspension, trading in the shares of non-compliant entity will be available on the ‘trade for trade’ basis, on the first trading day of every week for 6 months.

Revocation of suspension of trading of shares

• Detailed steps for revocation of suspension of trading of shares have been prescribed by the SEBI. This is subject to compliance by the non-compliant listed entity with the aforementioned conditions and payment of the requisite fine.

[Source: SEBI circular CIR/MRD/DSA/31/2013 dated 30 September 2013; and SEBI’s PR No. 96/2013]


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The October 2013 edition of the Accounting and Auditing Update discusses the key areas of focus when conducting impairment testing under Indian GAAP. We also examine some considerations from an accounting perspective of Corporate Debt Restructuring. We also cast our lens on the IASB’s proposals on Insurance accounting. In this issue we also explain the accounting for employee share based payments under Indian GAAP. In addition, we have covered an overview of the key changes being proposed to the format and content of the auditors’ report internationally.

The issue also highlights the accounting practices by entities in India relating to transaction costs associated with lending/financing and provides an overview of the key regulatory developments including a snap shot view of the key regulatory developments relating to the Companies Act, 2013.

The September 2013 edition of the Accounting and Auditing Update discusses the proposals of the SEBI with regard to clause 41 of the Equity Listing Agreement. We also cast our lens on the IASB’s proposals on Regulatory Deferral Accounts providing temporary guidance on accounting for rate-regulated activities. We have examined the accounting and reporting challenges that are relevant to Service Concession Arrangements and Certified Emission Reduction credits under Indian GAAP. The issue also highlights the accounting practices relating to revenue recognition in the real estate industry. Finally, this issue covers key application challenges of the revised Schedule VI of the Companies Act, provides an overview of the key regulatory developments and updates including a snap shot view of the key requirements of the Companies Act, 2013.


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