Dcode Classes for Professional Excellence

The Ministry of Corporate Affairs (MCA) has notified Ind-AS, but the implementation roadmap is yet to be announced. The newly drafted standards extensively talk about fair value measurement. The International Accounting Standards Board (IASB) has issued "IFRS 13 - Fair Value Measurement" which provides detailed guidance on measurement principles and valuation techniques w.r.t. fair valuation of assets and liabilities. The valuation techniques and measurement principles given in this standard can be applied in a consistent manner while determining the fair value in various situations under the Indian regulatory scenario.

The method adopted by the assessee, therefore,cannot be regarded to comply with the ownership so as to get an enforceable right to receive the balance of sale consideration, the question of applying Section 53A of the Transfer of Property Act would not arise so as to recognise the revenue before actual registration. Recognition/identification of income under the Income-tax Act 1961 is attainable by several methods of accounting. Project completion method [PCM] is one such method.

AS-7 deals with accounting for treatment of revenue and costs associated with construction contracts in the financial statements of contractors. The revised AS-7 recognises only the percentage completion method and is to be applicable only to the construction contractors’ financial accounting.AS-7, Construction Contracts, wherever percentage completion method is appropriate (as most of the real estate transactions and activities have the same economic substance as construction contracts), whereas, in respect of transactions of real estate which are in substance similar to delivery of goods, principles enunciated in accounting standard (AS) 9, Revenue Recognition, are applied.

Pre-amendment, taxpayers were allowed to compute their income in accordance with any method, provided they regularly employed the method and their income could be properly deduced from it. Section 145 was thereafter amended. And so, from the assessment year 1997-98, income chargeable under the head ‘profits and gains from business or profession’ or ‘income from other sources’can be computed by following either the cash or mercantile system of accounting– a mixture or ‘hybrid’ method of accounting is not permitted for the reasons as explained by the CBDT.

The advancement of loans at zero/concessional rate of interest are made to the eligible employees as per the terms of service, the implied benefit is on the basis of the services rendered by the employee. Para 7 of Indian Accounting Standard (Ind-AS) 19 ‘Employee Benefits’ defines employee benefits as all forms of consideration given by an entity in exchange for service rendered by employees. Accordingly, the implied benefit has to be recognised as employee benefit expense.

Valuation of Assets and liabilities AS–14 requires valuation at carrying value in the case of pooling method. In the case of purchase method either carrying value or fair value may be used. Contingent liabilities are not fair valued. Under AS–21, AS–23, and AS–28, goodwill is determined based on book values rather than fair values. Ind AS 103 requires the acquired identifiable assets, liabilities and non-controlling interest to be recognised at fair value under acquisition method.Even contingent liabilities are fair valued.

With reference to this convergence, this article provides an insight on the treatment of goodwill and its impairment, bargain purchase, non-controlling interests, reverse acquisitions and identifiable net assets & liabilities at fair value through various examples. Also, Ind AS 103 is more stringent about the accounting method to be used. This article also shows the major difference between IND AS 103 and As 14 Amalgamation with the help of different case studies as well as carves outs of Ind AS 103 from IFRS 3 and its reasons.

Reversal of revenue AS-7 provides for reversal of revenue on account of uncertainty arising on realisability of contract revenue which was already recognised as income. Where contract revenue already recognised as income is subsequently written off in the books of accounts as uncollectible, the same shall be recognised as an expense and not as an adjustment of the amount of contract revenue.

Companies whose equity or debt securities are listed or are in the process of listing on any stock exchange in India or outside India (listed companies) and having net worth of R500 crore or more.Unlisted companies having a net worth of R500 crore or more.holding, subsidiary, joint venture or associate companies of the listed and unlisted companies covered above.

Scope The scope of the existing AS 14 is confined only to amalgamation. It stays silent for the issues of common control transactions. Ind AS 103 has a wider scope ie it also includes common control transactions and additional guidance (APPENDIX C) provides that business combination transactions for such entities should be accounted for using the “pooling of interest” method.

Reversal of revenue AS-7 provides for reversal of revenue on account of uncertainty arising on realisability of contract revenue which was already recognised as income.Where contract revenue already recognised as income is subsequently written off in the books of accounts as uncollectible, the same shall be recognised as an expense and not as an adjustment of the amount of contract revenue.

The method adopted by the assessee, therefore,cannot be regarded to comply with the ownership so as to get an enforceable right to receive the balance of sale consideration, the question of applying Section 53A of the Transfer of Property Act would not arise so as to recognise the revenue before actual registration.Recognition/identification of income under the Income-tax Act 1961 is attainable by several methods of accounting. Project completion method [PCM] is one such method.

Accounting Treatment under Indian GAAP The staff loans are recognised in the financial statements equivalent to the amount disbursed. The interest income for the period is recognised at the contracted rate (the subsidised rate) in the statement of profit and loss by the company. There is no specific guidance under Indian GAAP to recognise such loans at fair value.

With reference to this convergence, this article provides an insight on the treatment of goodwill and its impairment, bargain purchase, non-controlling interests, reverse acquisitions and identifiable net assets & liabilities at fair value through various examples. Also, Ind AS 103 is more stringent about the accounting method to be used. This article also shows the major difference between IND AS 103 and As 14 Amalgamation with the help of different case studies as well as carves outs of Ind AS 103 from IFRS 3 and its reasons.

The Standard defines the business as an integrated set of activities and assets from which economic benefit sare gained by the investor or other owners. It also explains that, for determining whether a group of assets and liabilities is a business, one must examine the three ingredients, viz. Inputs, Process and Outputs. In other words a business consists of inputs and processes applied to those inputs that have the ability to create outputs.

Reasons for such treatment of bargain purchase in IND AS 103 IND AS 103 recognises it in OCI or as capital reserve because recognition of such gains in profit or loss would result into recognition of unrealised gains as the value of net assets is determined on the basis of fair value of net assets acquired.Ind AS 103 will require disclosure of information to assist the users of the financial statements with the understanding of the nature and financial effect of a business combination.

IND AS 103 is associated to the measurement of many other standards like Ind AS 37, 39, 19 individually so, the understanding and applicability in India will require lots of deliberation which need to be weighed in view of facts and circumstances.It adopts a business fair value” measurement approach as opposed to the traditional “cost-based” approach.The concept of fair value is debatable and its implementation will question the financial statements results.

The acquirer shall, at the acquisition date, allocate the cost of a business combination by recognising the acquiree’s identifiable assets, liabilities and contingent liabilities that satisfy the recognition criteria, at their fair values at that date, except for noncurrent assets (or disposal groups) that are classified as held for sale in accordance with IND AS105, Non-current Assets Held for Sale and Discontinued Operations, which shall be recognised at fair value less costs to sell.

Pre-amendment, taxpayers were allowed to compute their income in accordance with any method, provided they regularly employed the method and their income could be properly deduced from it. Section 145 was thereafter amended. And so, from the assessment year 1997-98, income chargeable under the head ‘profits and gains from business or profession’ or ‘income from other sources’can be computed by following either the cash or mercantile system of accounting– a mixture or ‘hybrid’ method of accounting is not permitted for the reasons as explained by the CBDT.

The advancement of loans at zero/concessional rate of interest are made to the eligible employees as per the terms of service, the implied benefit is on the basis of the services rendered by the employee. Para 7 of Indian Accounting Standard (Ind-AS) 19 ‘Employee Benefits’ defines employee benefits as all forms of consideration given by an entity in exchange for service rendered by employees. Accordingly, the implied benefit has to be recognised as employee benefit expense.

Companies whose equity or debt securities are listed or are in the process of listing on any stock exchange in India or outside India (listed companies) and having net worth of R500 crore or more.Unlisted companies having a net worth of R500 crore or more.holding, subsidiary, joint venture or associate companies of the listed and unlisted companies covered above.

Ind-AS 109 provides that “interest revenue shall be calculated by using the effective interest method.” The effective interest method uses the financial instrument’s carrying amount in the books of accounts as the principal value for the calculation of interest.Accordingly, the interest income is recognised in the books of accounts as per the market rate and not the interest rate as per the concessional terms. However, the principal for the purpose of calculation of interest shall be the amortised cost and not the principal amount outstanding.

Goodwill Any excess of the amount of the consideration over the value of the net assets of the transferor company acquired by the transferee company is recognised in the financial statements as goodwill arising on amalgamation. Measured as the difference between the aggregate of (a) the acquisition date fair value of the consideration transferred (b) the amount of any non-controlling interest and (c) in a business combination achieved in stages, the acquisition date fair value of the acquirers previously held equity interest in the acquirer and,The net of the acquisition-date fair values of the identifiable assets acquired and the liabilities assumed.

Over and above the findings in Table 2, the following apparent conclusions can be made from the above converged standard Ind AS 103: Ind AS 103 will require disclosure of information to assist the users of the financial statements with the understanding of the nature and financial effect of a business combination.Even though IND AS 101 provides exemptions regarding retrospective application of IND AS 103 for the first time adopter, the standard will pose many challenges for the Chartered Accountants.

It is pertinent to note that the Ministry of Corporate Affairs has carved out the treatment of bargain purchase, while converging Indian Standards towards IFRS 3. It will create a GAAP difference in which Converged Indian AS 103 will recognise the bargain purchase in other comprehensive income (OCI) and accumulated in equity as capital reserve if there is a clear evidence of the underlying reason for classification of the business combination as a bargain purchase; otherwise, the resulting gain is recognised directly in equity as capital reserve.

Measurement of assets, liabilities, intangible assets, non-controlling interest, recognition of goodwill etc. in case of business combination is acquisition-date sensitive. Hence, it is very critical to determine the acquisition date. Acquisition date is the date on which the acquirer obtains effective control of the acquiree. Usually,the date on which the acquirer legally transfers the consideration, acquires the assets, and assumes the liabilities of the acquiree - the “closing date”.

A business combination is a transaction or other event in which an acquirer obtains control of one or more businesses Identifying a Business Combination: If the assets acquired are not a business, the reporting entity shall account for the transaction or other event as an asset acquisition. For example, acquisition of a “shell” or “shelf” company is not a business combination because no business is being acquired.

The objective of the Indian Accounting Standard 103 is to improve the relevance, eliability and comparability of the information that a reporting entity provides in its financial statements about a business combination and its effects. To accomplish that, this Indian Accounting Standard establishes principles and requirements for how the acquirer:recognises and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree recognises and measures the goodwill acquired in the business combination or a gain from a bargain purchase.

Valuation of Assets and liabilities AS–14 requires valuation at carrying value in the case of pooling method. In the case of purchase method either carrying value or fair value may be used. Contingent liabilities are not fair valued. Under AS–21, AS–23, and AS–28, goodwill is determined based on book values rather than fair values. Ind AS 103 requires the acquired identifiable assets, liabilities and non-controlling interest to be recognised at fair value under acquisition method.Even contingent liabilities are fair valued.

The necessity of a standard on Business Combinations in India assumes importance considering the fact that Indian companies are increasingly stretching their business in foreign countries for best-fit business combinations. At present in India, though the AS 14 lays out specific treatment for Amalgamation, it is not matching the global reporting standards requirements. So ICAI has converged the present standard AS 14 to Ind AS 103 Business combination which is in line with IFRS 3. The transition to Ind AS, as and when it happens, is likely to have impact on the accounts of companies involved in such acquisitions and mergers.

The income arising to the assessee during a particular period has to be brought to tax for that period, and that period alone; each year being an independent unit of assessment. It is trite law that profit is to be understood in the commercial sense and, subject to the provisions of the Act, computed accordingly. The issue is not as to which of the two methods, i.e., the percentage completion or the project completion, is the correct method in-asmuch as each could be valid in a particular set of facts. What is relevant is which of the two methods results in the correct reporting of the operating profit and the state of affairs of a business entity in the facts and circumst AS-7 the case.

AS-7 deals with accounting for treatment of revenue and costs associated with construction contracts in the financial statements of contractors. The revised AS-7 recognises only the percentage completion method and is to be applicable only to the construction contractors’ financial accounting.AS-7, Construction Contracts, wherever percentage completion method is appropriate (as most of the real estate transactions and activities have the same economic substance as construction contracts), whereas, in respect of transactions of real estate which are in substance similar to delivery of goods, principles enunciated in accounting standard (AS) 9, Revenue Recognition, are applied.

accounting standard (AS) 7 [Construction Contracts] and accounting standard (AS) 9 [Revenue Recognition] issued by the ICAI acquire significance. [The Income-tax Act does not prescribe any method of accounting for construction contracts under Section 145. Even accounting standards prescribed under Section 145 does not include any standard on construction contracts. However, as held by the courts from time to time, views of the ICAI as the premier regulatory body for the profession of the accountancy had to be accorded respect.

Accordingly, the guidance in this respect is very clear under Ind-AS that loans advanced at zero or concessional rates of interest are to be measured at fair value which is to be calculated using effective interest method.Accordingly, the interest income is recognised in the books of accounts as per the market rate and not the interest rate as per the concessional terms. However, the principal for the purpose of calculation of interest shall be the amortised cost and not the principal amount outstanding.

Under Ind-AS is going to get more complex. Just like in the instant case of accounting for staff loans, even though the effective impact on the bottom line over the years shall be the same under both Indian GAAP and Ind-AS, the presentation of the transaction differs in Ind-AS, since Ind-AS tend to portray the effective substance of a transaction. With a roadmap clearly visible for the implementation of Ind-AS in the country, the need of the hour is to understand the practical differences between the existing Indian GAAP and the converged Ind-AS and plan to implement it smoothly.

The fair value of a financial instrument at initial recognition is normally the transaction price (i.e.the fair value of the consideration given or received.However, if part of the consideration given or received is for something other than the financial instrument, an entity shall measure the fair value of the financial instrument. For example, the fair value of a long term loan or receivable that carries no interest can be measured as the present value of all future cash receipts discounted using the prevailing market.

Bargain purchase occurs if the fair value of the identifiable net assets of the acquiree exceeds the aggregate . of the consideration transferred . the non-controlling interests and . the fair value of any previously held equity interest. . Gain on bargain purchase or simply bargain purchase may arise because of:   Forced sale . Recognition or measurement exceptions for particular items discussed under IFRS 3 . Error in the valuation of identifiable assets, noncontrolling interest and/or equity   interest

Consideration is the sum of the acquisition-date fair values of: the assets transferred the liabilities incurred by the acquirer the equity interests issued.Acquisition-related costs Consideration should be measured at fair value. Acquisition-related costs are costs the acquirer incurs to effect a business combination. They are as under Finder’s fees Advisory, legal, accounting, valuation and other professional or consulting fees General administrative costs, including the costs of maintaining an internal acquisitions department Costs of registering and issuing debt and equity securities.

Under Ind AS 103 only acquisition method is used for business combination. The Standard eliminates the now-optional pooling-of-interests method and mandates the Purchase Method in accounting for a Business Combination.Purchase method requires the Acquiring Company to fair value all the identified Assets and Liabilities and also recognise additional liabilities if any, at fair values on balance sheet. It requires allocating the Purchase Price to all the items on the balance sheet and also off the balance sheet contingent liabilities.

Reverse acquisition takes place when a private entity wants to become a public entity but does not want to register its equity shares. In such case,private entity approaches a public entity,the one which is listed, to acquire its (private entity’s) equity interests in exchange for the equity interests of the public entity In a reverse acquisition, the entity issuing equity interests is legally the acquirer, but for accounting purposes is considered the acquiree. Accounting for business combination is done from the perspective of accounting acquirer and not legal acquirer.

Measuring the goodwill The existing AS 14 requires that the goodwill arising on amalgamation in the nature of purchase is amortised to the statement of profit or loss over a period not exceeding five years and in case of amalgamation in the nature of merger excess consideration over net assets taken over, is adjusted against the revenue reserves. Under Ind AS 103, the goodwill is not amortised but tested for impairment on annual basis in accordance with Ind AS 36.

Non-controlling interest The existing AS 14 states that the minority interest is the amount of equity attributable to minorities at the date on which investment in a subsidiary is made and it is shown as outside shareholders’ equity. Ind AS 103 requires that for each business combination, the acquirer shall measure any noncontrolling interest in the acquiree company either at fair value or at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets.

Need of converged IND AS 103 Business Combination The necessity of a standard on Business Combinations in India assumes importance considering the fact that Indian companies are increasingly stretching their business in foreign countries for best-fit business combinations. When Vodafone took over Hutchison Essar, there were a number of tax related issues in India. Despite that, it triggered the interest of small and medium sized companies for such acquisitions. With the cross border mergers and acquisitions, the compatibility of Indian accounting standards with the IFRS is challenging but necessary for a true and fair view of the financial statements worldwide.

Impact of ICDS on settled judicial principles: Till date, due to non recognition of ICAI Accounting Standards formally by the Income-Tax Act or CBDT,courts were applying the principles enumerated in AS for tax purposes, having regard to the facts and circumstances of each case, using their own discretion. However, due to advent of mandatory ICDS notified by CBDT, many of the settled judicial precedents (delivered on the basis of ICAI-AS) may not hold good with effect from A.Y. 2016-17.

AS-9 of the ICAI - Method of accounting - uncertainty in ultimate collectability of revenue justifies change of method of accounting by property developer from percentage of completion to recognition of income based on registration of agreements for sale or completion of possession and consequential reversal of revenue on cancellations/legal cases. This change in method of recognition of income, as adopted by assessee was in terms of relevant accounting standard laying down prudential norms of revenue recognition, and the same was legally correct.

Revenue is to be recognised when all of the following conditions are satisfied: (Completed contract method)The seller has transferred all significant risks and rewards of ownership and retains no effective control of the real estate (including ownership),The seller has handed over the possession of the real estate unit to the buyer, The amount of sale consideration can be reasonably measured, It is not unreasonable to expect ultimate collection of revenue from buyer,  Where the transfer of legal title is a condition before the buyer taking over significant risks and rewards of ownership, revenue should be recognised when the legal title is transferred.

Recognition of claims Only when (i) negotiations have reached an advanced stage such that it is probable that the customer will accept the claim; and (ii) The amount that will be accepted by the customer can be measured reliably. If the claims are capable of being reliably measured, same are to be recognised as per POCM.it is not matching the global reporting standards requirements. So ICAI has converged the present standard AS 14 to Ind AS 103 Business combination which is in line with IFRS 3. The transition to Ind AS, as and when it happens, is likely to have impact on the accounts of companies involved in such acquisitions and mergers.

The case of builders, undertaking construction on own account, is more appropriately covered by AS-9. The question, therefore, reduces to as to which of the two methods is, on facts of the case,in consonance with AS-9. The said standard stipulates the basic conditions that should obtain if the income can be said to have accrued. The first is the transfer of all significant risks and rewards of ownership. Income arises on exchange. Risk and reward are incidents of ownership, income, thus, can be said to have accrued when there has been i.e., given the binding legal contract, transfer of these incidents, wholly or substantially so.

Under AS-7, this is not a recognised method of recognising the revenue. This method is neither project completion method nor percentage of completion method. Registration of the sale deed represents only the transfer of the title in favour of the buyer from the assessee. It has nothing to do with the method of accounting followed by the assessee.Under the percentage of completion method,revenue is recognised in the profit and loss account in the accounting period, to the extent the work is completed. In case the revenue has to be recognised on the basis of receipt of the payment from the plot-holders, that will also not be regarded to be percentage of completion method.

It is important to note that the income for purposes of taxation cannot be different from what is computed in accordance with the general principles of commercial accounting. Where substantial risks and reward in respect of a property sold are passed on to the buyer at pre-completion stage, revenue will have to be recognised immediately by adopting Percentage of completion method [POCM] even for tax purposes. Thus, when for example, the guidance note requires recognition of revenue by applying POCM, the same method should also be applied for the purpose of computation of taxable income.

Incentive payments Only when (i) contract is sufficiently advanced that it is probable that specified performance standards shall be met or exceeded; and (ii) amount of incentive payment can be measured reliably.If the incentive payments are capable of being reliably measured, same are to be recognised as per POCM.