AS 30 - Financial Instruments and Recognition : An Overview.
In view of converging with International Accounting Standards (IASs) and as a matter of prudence, the ICAI has asked all the companies to follow AS-30: Financial Instruments and Recognition with effect from the financial year ended 31st March 2008. The Standard was proposed to be recommendatory from April 1, 2009 and mandatory from April 1, 2011. The Companies will now have to provide for any losses or future gains on outstanding forex derivative products. However, as per AS-1, companies would have to report only the losses on derivative contracts on the principle of prudence.
The objective of the Standard is to establish principles for recognizing and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items. The significance of AS-30 is that the standard is fair value based and requires recognition of losses and gains from outstanding derivative contracts on the balance sheet date at fair value. Companies will now have to mark-to-market* their derivative contracts. Company auditors have been advised that in case a company do not provide for such unrealized losses in their books, they should make appropriate disclosures in their report to the shareholders.
Full article available in Eure CAtalyst : June '08 issue.
AS 32 - Financial Instruments - Disclosures : A Glimpse.
The Central Council of the ICAI has given its nod to AS-32, “Financial Instruments: Disclosures”. The Standard is recommendatory from April 1, 2009 and mandatory from April 1, 2011. The AS requires entities to disclose exposures to the risks involved in financial instruments. AS-32 follows accounting standards (AS-30 and 31), wherein the ICAI has laid down rules pertaining to recognition & measurement and presentation of financial instruments by companies. The objective of this standard is to require entities to provide disclosures in their financial statements to enable users to evaluate the following :
(a) the significance of financial instruments for the entity’s financial position and performance; and
(b) the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the end of the reporting period, and how the entity manages those risks.
Accounting Standard (AS) 32 requires the entity to provide disclosures about financial assets and financial liabilities it has revalued at fair value through a charge to profit or loss account. However, some financial instruments are out of the purview of the Standard like employers’ rights and obligations arising from employee benefit plans, to which AS 15 applies, contracts for contingent consideration in a business combination (this exemption applies only to the acquirer).
Full article available in Eure CAtalyst : June '08 issue.
AS-32 : ICAI clears disclosure norms for derivatives.
Companies will soon need to disclose the nature and extent of risks arising from the financial instruments they hold and the steps taken to manage such risks.
In a step which is likely to give shareholders a clearer picture of the health of the company they own, accounting regulator ICAI on Friday approved a new accounting standard on disclosure of all sorts of financial instruments. It would also keep investors abreast of the steps taken by the companies to guard against potential financial losses.
The new norms come in the backdrop of various companies filing cases against their banks for the losses they suffered on exotic derivative products in the wake of the US sub prime crisis. Many banks, including some of the country's biggest lenders such as SBI, ICICI Bank and Axis Bank have in the recent past announced making provisions to cover mark-to-market losses.
The new accounting standards mandates the companies to reveal various financial instruments such as derivatives, futures and options, mutual funds and loans in their financial statements. Companies are recommended to disclose these details from the beginning of next fiscal. The accounting standard AS-32 pertaining to disclosure of financial information will become mandatory from April 1, 2011.
AS-32 follows two other accounting standards (AS-30 and 31), wherein the regulator had laid down rules pertaining to recognition and measurement and presentation of financial instruments by companies. “AS-32 will bring greater transparency in disclosures related to financial instruments such as derivatives and how the entity manages risks associated with such a portfolio,” ICAI president Ved Jain said.
(Source: The Economic Times)
AS-30 : Strikes sooner than expected.
The ICAI had notified AS-30 in December 2007 which asks companies to provide for mark-to-market losses on all outstanding forex derivative contracts from April 2009 on a voluntary basis. However ICAI has advanced the date of compliance for the year ended 31st March 2008. Also all the outstanding forex derivative contracts should be disclosed at mark-to-market and appropriate disclosures should be made. The significance of AS-30 is that the standard is fair value based and requires recognition of losses and gains from outstanding derivative contracts on the balance sheet date at fair value. It is widely believed that the new rules will bring in more transparency to the accounts but at the same time valuations may take some beating. Companies like Amtek Auto, Hexaware and Larsen & Turbo have already declared huge mark-to-market losses.
ICAI Announcement on Accounting for Derivatives are available in Eure CAtalyst : April '08 issue.
AS - 22 upheld by Supreme Court.
The Supreme Court by its order upheld the order of the Calcutta High Court whereby Accounting Standard (AS) - 22 titled "Accounting for Taxes on Income" prescribing accounting treatment for taxes on income, issued by ICAI and also notified by the Central Government, was held to be intra vires the provisions of the Companies Act, 1956 and 'valid'.
The ICAI, in April 2001, issued AS - 22 which was challenged by a number of companies by way of 'Writ Petitions' before different High Courts and Calcutta High Court on the grounds stated above that it overrides the statutory provisions contained in Sections 209, 210, 211 and Schedule VI to the Companies Act, 1956, which states that deferred tax being notional and / or contingent in nature, para 33 of AS - 22 being retrospective in operation etc. The said Writ Petitions in different High Courts were transferred by Supreme Court to Calcutta High Court. The Central Government in consultation with National Advisory Committee on Accounting Standards (NACAS), issued Companies (Accounting Standards) Rules, 2006 whereby AS - 22 amongst other Accounting Standards were prescribed. The said Rules were also challenged by said companies by amending the said writ petitions before Calcutta High Court. The Calcutta High Court held that AS -22 and the said Rules are valid and dismissed the said Writ petitions. Appeals were filed before Supreme Court challenging the aforesaid order of Calcutta High Court.
Should ‘deferred’ items be presented in the balance sheet ?
Accounting Standard-22 (AS-22) is an important standard for presentation of true and fair view of accounts on any particular date, as it provides guidance for accounting of various aspects of taxation in a unified manner. AS-22 specifically lays down the principles that ensure that accounting for taxation is made correctly and more importantly, in the period when the income arose.
If a company, in its income-tax returns, seeks to avail of higher depreciation allowance in a particular year and lower in subsequent year, the standard ensures that the difference in timing between the depreciations is provided for in the books and incidence of tax on higher depreciation claimed captured as liability in the books. This liability is subsequently reversed when the depreciation claimed in the returns is less than what is provided in the books, he added. Similar treatment is mandated for other timing differences between book income and income as per income-tax returns.
Such accounting ensures that the reported profit after tax is indicative of the performance of the company for its earnings during the reported period. Similarly, in the case of a loss-making company, if it is virtually certain that the company will earn profits in future years, AS-22 allows for recognition of deferred tax assets as well.
This deferred tax asset will be offset against the liability whenever the enterprise starts earning taxable income.
In India, we are still following the income approach to compute deferred tax liability/asset on a particular date, while worldwide the balance sheet approach is followed for such purposes.
Under the balance sheet approach, a separate tax balance sheet is prepared and differences in each line item are designated as permanent or temporary differences. Temporary differences that will reverse are captured as assets or liabilities. Creation of deferred tax assets and deferred tax liability is essential to reflect the “true and fair view” of profit after tax.
How is cost of acquisition of an investment to be determined ?
A Company had incurred certain expenses like travelling, legal, due-diligence and other expenses in relation to acquisition of an investment through shares up to the date of Investment. Are these expenses in the nature of Capital Expenditure and be capitalised or revenue expenditure and charged to P/L?
Acquisition of Investments and Valuation of the same is governed by AS-13. It is important to note that Para 9 of the Standard states that “cost of an investment includes acquisition charges such as brokerage, fees and duties.” Keeping in view of the nature of the items of the acquisition charges, it is opined that only such direct charges should be capitalised which are incurred ‘on’ investment i.e. without the incurrence of which the transaction could not have taken place such as share transfer fees, stamp duties etc. In the given case the expenses incurred ‘before’ the acquisition of investment, even though directly attributable to the investment, should not form part of the investments since they do not represent the true worth of the shares acquired.
Thus keeping in view the above principles, the said expenses incurred in respect of acquisition of an investment should not be capitalised. Instead they should be written off to the P/L Account in the year in which they are incurred. However the legal costs should be capitalised only if and to the extent they meet the considerations for inclusion in the cost of investments as stated in the above Para.
Whether MAT credit can be considered as an “asset” ?
Although MAT credit is not considered as asset under AS-22, yet it gives rise to expected economic future benefit in the form of adjustment of future income tax liability. A question therefore arises whether it can be considered as an asset and if so should it be recognized in the financial statements.
The Framework for the Preparation and Presentation of Financial Statements, issued by the Institute of Chartered Accountants of India defines the term “asset” as follows
“An asset is a resource controlled by the enterprise as a result of the past events from which future economic benefits are expected to flow to the enterprise.”
MAT paid in a year in respect of which credit is allowed during the specified period under the Act is a resource controlled by the company as a result of a past event namely the payment of MAT. It is also expected to give rise to future economic benefit in the form of adjustment against discharge of normal tax liability during the specified period. Hence MAT is an “asset”.
AS-2 vs. AS-16 : Valuation of stock vs. Borrowing costs
A study of AS-2 and AS-16 together makes interesting reading. Paragraph 12 of AS-2 states interests and other borrowing costs are not to be related for bringing the inventories to their present location and condition and, therefore, are usually excluded from the cost of inventories. AS-16, on borrowing costs, requires such costs to be capitalised in the case of qualifying assets. In paragraph 5 of AS-16, inventories that require a substantial period of time to bringing them to a saleable condition has been included in examples of qualifying assets. These two provisions do not seem to be in sync with each other.
A question arises whether a builder enjoying credit facilities can include the interest on borrowings as a part of the cost of the flat. Apartment blocks, being stock-in-trade, qualify to be inventories for the builder. It takes a long time for him to bring the inventories to a saleable condition. Based on this, the inventories become a qualifying asset as per AS-16.
But AS-2 (paragraph 12) gives a different version and prohibits inclusion of interests in the cost of inventories. As on the balance-sheet date, if a few of the flats in an apartment block remain unsold, whether to include the interest in the value of the flat or not becomes an interesting situation. Top up the situation with the pronouncements in AS-7, and the circle is complete. Valuation of stock of a trading concern is a lesser problem compared to that of a manufacturing concern.
Rupee appreciation and AS-11
The rupee has appreciated 11-12 per cent against the dollar in recent times. Accounting Standard (AS-11) of the Institute of Chartered Accountants of India (ICAI) governs accounting of foreign currency transactions and translations. Those who have long-term loans in dollar such as external commercial borrowings (ECBs) have to book huge gains on account of this fluctuation, when re-stating the balance-sheet. Is this correct?
The rupee appreciation in the past few months was very fast and it is difficult to assume that the appreciation will sustain in the long run. How do we proceed to simultaneously comply with the standard and recognize the currency volatility? We have to be prudent while recognizing income and booking losses. The gain on account of the appreciation may not be sustainable, and hence is it prudent to recognise the same in the profit and loss (P&L) account? Can it be a good practice, not to recognise the income and pass it on to an exchange risk administration reserve to meet future liabilities? Is AS-11 equipped to meet this scenario?
Prudence is no longer an objective of most accounting framework. Fair presentation is. Therefore, it is important that assets and liabilities are represented at fair values. In the case of forex loan, fair presentation would be to account for the loan at the exchange rate prevailing on the balance-sheet date. As a corollary, the corresponding gain/loss is recognised in the `profit and loss' account (where else can it go?).
It would be incorrect not to recognise the gain, since it would tantamount to creating a secret reserve. It is also not appropriate to suggest that the gain is not being recognised, since exchange rates can cause the reverse moment in the future. What if they do not? Accounting cannot be based on prediction.
Just another point, if the loan was used for financing a fixed asset, then the exchange difference may very well be termed as a borrowing cost under AS-16 and to that extent the same may be capitalised or de-capitalised.
