Index to extracts of consolidated financial statements America Movil. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91, 190 Anheuser-Busch InBev SA/NV. . . . . . . . . . . . . . . . . . . . . . . . 92, 107, 111, 121, 200, 201, 215, 217, 249, 302 Arcelor Mittal. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124, 183, 185, 187, 338 BHP Billiton. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99, 105, 149, 232, 233, 235, 240 BP plc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100, 127, 133, 175, 225, 228 Euronav NV. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125 Honda Motor Co. Ltd.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 327 Itau Unibanco Holding S.A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283 Korea Electric Power Corporation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197, 218 Sanofi . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136, 318 Tata Motors Limited. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93, 256, 261, 275, 279, 283, 286, 289 Unilever NV. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127, 291, 314, 344 Vodafone Group Public Limited Co.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130, 151, 305, 334
xiii
Contents at a glance Acknowledgements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii About the author. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi Index to extracts of consolidated financial statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii Table of contents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xvii Chapter 1
Framework for Preparation and Presentation of Financial Statements. . . . . . . . . . . . 1
Chapter 2
Accounting Frameworks and Consolidation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Chapter 3
Accounting policies and Profit or Loss under Companies (Accounting Standards) Rules, 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
Chapter 4
Financial statements under Companies (Accounting Standards) Rules, 2006. . . . . 47
Chapter 5
Accounting policies, accounting estimates and errors under Ind AS . . . . . . . . . . . . 89
Chapter 6
Financial statements under Companies (Indian Accounting Standards) Rules, 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139
Chapter 7
Exposure Draft of Schedule III for NBFCs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 359
Annexure 1
Ind AS Rules Notification. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 363
Annexure 2
Press Release NBFCs, Scheduled Commercial Banks (excluding RRBs) and Insurers/Insurance Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369
Annexure 3
Notification for NBFCs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 373
Annexure 4
Framework for the Preparation and Presentation of Financial Statements in accordance with Indian Accounting Standards. . . . . . . . . . . . . . . . . 377
Annexure 5
Schedule III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 403
Annexure 6
Form AOC-I. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 447
Annexure 7
Exposure Draft of Ind AS compliant Schedule III to Companies Act, 2013, for Non-Banking Financial Companies (NBFCs). . . . . . . . . . . . . . . . . . . . . 449
Annexure 8
Exposure Draft of Amendments to Ind AS 101, First-time Adoption of Indian Accounting Standards. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 483
Annexure 9
Exposure Draft of Guidance Note on Division II - Ind AS Schedule III to the Companies Act, 2013. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487
Annexure 10 Exposure Draft Transfers of Investment Property Amendments to Ind AS 40, Investment Property. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 623 Annexure 11
Exposure Draft Recognition of Deferred Tax Assets for Unrealised Losses Amendments to Ind AS 12, Income Taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . 627 xv
Preparing Financial Statements under Schedule III
Annexure 12 Exposure Draft Appendix B of Ind ASÂ 21, Foreign Currency Transactions and Advance Consideration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 633 Annexure 13 Exposure Draft Annual Improvements to Ind AS - Amendments in Ind AS 112 and 28 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 639 Annexure 14 Exposure Draft Clarifications to Ind AS 115, Revenue from Contracts with Customers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 643
xvi
Table of Contents Acknowledgements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii About the author. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi Index to extracts of consolidated financial statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii Contents at a glance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xv Chapter 1 Framework for Preparation and Presentation of Financial Statements . . . . 1.1 Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2 Financial Statements for purposes of Framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.1 Objective of general purpose financial reporting . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2.2 Access to economic resources and changes therein. . . . . . . . . . . . . . . . . . . . . . . . . 1.2.3 Underlying assumptions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.3 Qualitative characteristics of financial statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.3.1 Understandability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.3.2 Relevance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.3.3 Reliability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.3.4 Comparability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.4 True and fair view. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.5 The elements of financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.5.1 Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.5.2 Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.5.3 Equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.5.4 Income and expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.5.5 Capital Maintenance Adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.6 Recognition of financial statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.7 Measurement of financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.8 Concepts of capital and capital maintenance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 2 Accounting Frameworks and Consolidation. . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 Introduction of Ind AS Roadmap. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2.1 “Convergence” with IFRS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3 Applicability of the notifications. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4 Consolidation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4.1 ASB’s FAQs on consolidated financial statements. . . . . . . . . . . . . . . . . . . . . . . . . 2.4.2 Matters to be included in Board’s report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4.3 Exemption from section 129 for a class of companies. . . . . . . . . . . . . . . . . . . . . . 2.5 Ind AS Transition Facilitation Group (ITFG) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1 1 2 2 2 3 4 4 4 4 5 5 6 6 7 7 7 8 8 8 9
11 11 11 13 13 14 16 17 18 19
xvii
Preparing Financial Statements under Schedule III
2.6 2.7
2.5.1 Extracts from ITFGs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Ind AS (IFRS) implementation committee. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 Exposure draft of Ind AS compliant Schedule III to the Companies Act, 2013 for NBFCs. . 39
Chapter 3
Accounting policies and Profit or Loss under Companies (Accounting Standards) Rules, 2006. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Fundamental accounting assumptions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 Accounting policies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.1 Selection of accounting policies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.2 Changes in accounting policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4 Accounting estimates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.5 Prior period items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.6 Extraordinary items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.7 Profit or loss from ordinary activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
41 41 41 42 42 43 44 44 45 45
Chapter 4
Financial statements under Companies (Accounting Standards) Rules, 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 4.1 Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Chapter 5 Accounting policies, accounting estimates and errors under Ind AS . . . . . 89 5.1 Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 5.2 Ind AS Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 5.2.1 What comprises a complete set of financial statements. . . . . . . . . . . . . . . . . . . . . 89 5.2.2 Frequency of reporting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 5.2.3 Identification of financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 5.2.4 Statement of compliance with Ind AS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 5.2.5 Presentation and Functional currency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92 5.2.6 General principles of preparation of financial statements . . . . . . . . . . . . . . . . . . 100 5.2.7 Accounting policies, estimates and errors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 5.2.8 Comparatives and when their restatement is needed. . . . . . . . . . . . . . . . . . . . . . 117 5.2.9 Disclosures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 Chapter 6
Financial statements under Companies (Indian Accounting Standards) Rules, 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139 6.1 Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139 Chapter 7 Exposure Draft of Schedule III for NBFCs. . . . . . . . . . . . . . . . . . . . . . . . . . . 359 7.1 Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 359 7.2 Main Differences from Division II of Schedule III for Non NFBC Companies. . . . . . . . . . 359 Annexure 1
Ind AS Rules Notification. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 363
Annexure 2
Press Release - NBFCs, Scheduled Commercial Banks (excluding RRBs) and Insurers/Insurance Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369
xviii
Table of contents
Annexure 3
Notification for NBFCs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 373
Annexure 4
Framework for the Preparation and Presentation of Financial Statements in accordance with Indian Accounting Standards. . . . . . . . . . . . . . . . . 377
Annexure 5
Schedule III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 403
Annexure 6
Form AOC-I. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 447
Annexure 7
Exposure Draft of Ind AS compliant Schedule III to Companies Act, 2013, for Non-Banking Financial Companies (NBFCs) . . . . . . . . . . . . . . . . . 449
Annexure 8
Exposure Draft of Amendments to Ind AS 101, First-time Adoption of Indian Accounting Standards. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 483
Annexure 9
Exposure Draft of Guidance Note on Division II - Ind AS Schedule III to the Companies Act, 2013. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487
Annexure 10 Exposure Draft Transfers of Investment Property Amendments to Ind AS 40, Investment Property. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 623 Annexure 11
Exposure Draft Recognition of Deferred Tax Assets for Unrealised Losses Amendments to Ind AS 12, Income Taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . 627
Annexure 12 Exposure Draft Appendix B of Ind ASÂ 21, Foreign Currency Transactions and Advance Consideration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 633 Annexure 13 Exposure Draft Annual Improvements to Ind AS - Amendments in Ind AS 112 and 28 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 639 Annexure 14 Exposure Draft Clarifications to Ind AS 115, Revenue from Contracts with Customers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 643
xix
Chapter 1
Framework for Preparation and Presentation of Financial Statements 1.1 BACKGROUND The Accounting Standards Board (‘ASB’) of the Institute of Chartered Accountants of India (‘ICAI’) has issued a Framework for Preparation and Presentation of Financial Statements (‘Framework’) in July 2000 that sets out the concepts that underlie the preparation and presentation of general purpose financial statements. The Framework is not an Accounting Standard and does not define or override any specific Accounting Standard. It rather assists preparers of financial statements in applying Accounting Standards and in dealing with topics that have yet to form the subject of an Accounting Standard. It helps the preparers to develop consistent accounting policies when no accounting standard applies to a particular transaction or event, or when a standard allows a choice of accounting policy. The Framework is crucial for bodies like the proposed National Financial Reporting Authority (‘NFRA’) and in the meantime till its set up, by National Advisory Committee on Accounting Standards (‘NACAS’) and ICAI to develop new accounting standards which will keep pace with the changing economic reality. It assists an auditor in opining on whether the financial statements are prepared in accordance with the accounting standards. Lastly the users of the financial statements are able to interpret the financial information presented to them. The Framework has immense appeal to all stakeholders as it sheds light on situations where a standard does not provide specific guidance. The Accounting Gods use it as a looking glass for envisioning the future accounting landscape. Recently the ASB issued a Framework for Preparation and Presentation of Financial Statements in accordance with Indian Accounting Standards (‘Ind AS Framework’). This is similar to the Framework issued in July 2000 but has a few differences. In the case of a conflict between the Framework and an Accounting Standard, the requirements of the Accounting Standard prevail over those of the Framework [Para 3 of the Framework/Ind AS Framework]. Over time as the ASB works on defining new standards, revising existing standards or revising the Framework itself based on its experience of working with it, the friction between the Framework and the Accounting Standards will diminish through time. The scope of Framework is: •
the objective of financial statements; 1
Preparing Financial Statements under Schedule III
Chapter 1
•
the qualitative characteristics that determine the usefulness of information provided in financial statements;
•
definition, recognition and measurement of the elements from which financial statements are constructed and;
•
concepts of capital and capital maintenance.
1.2
FINANCIAL STATEMENTS FOR PURPOSES OF FRAMEWORK
Financial Statements form part of the financial reporting. They are presented at least annually and are directed towards a wide range of users. Nevertheless, the Framework may be applied in the preparation of special purpose reports where their requirements permit. A complete set of financial statements normally includes a balance sheet, a statement of profit and loss (also known as ‘income statement’), a cash flow statement and explanatory notes that are an integral part of the financial statements. They may also include supplementary schedules and information derived from, and expected to be read with, such statements, eg. segment information. The Financial Statements however do not include the Management Discussion and Analysis that may be included in a financial or annual report. A reporting enterprise is an enterprise for which there are users who rely on the financial statements as their major source of financial information about the enterprise. The Framework covers all reporting enterprises engaged in all commercial, industrial business activities whether in the private or public sector. The users of financial statements include present and potential investors, employees, creditors, customers, governments and the public. The Framework identifies providers if risk capital as the main users of the financial statements and financial statements that meet their needs would meet the needs of all other users [Para 10 of the Framework/Ind AS Framework].
1.2.1
Objective of general purpose financial reporting
The objective of financial statements is to provide information about the financial position, performance and cash flows of an enterprise that is useful to a wide range of users in making economic decisions [Para 12 of the Framework]. The Framework acknowledges that financial statements cannot provide all the information to users as they largely portray the effects of past events and do not necessarily provide non-financial information. Further, financial statements do not represent the valuation of an entity but are to be used as a starting point for users to be able to estimate it for themselves.
1.2.2
Access to economic resources and changes therein
The balance sheet, the profit and loss statement and the cash flow statement make the financial statement angular. Each statement is a reflection of different aspects of the same transactions or
2
Chapter 1
Framework for Preparation and Presentation of Financial Statements
events and make the financial statements more comprehensive, though not necessarily providing all the information needed by the users. The supplementary information that is relevant to the needs of users about the items in the balance sheet and statement of profit and loss are also part of the financial statements. Users analyse the entity’s liquidity, solvency, financial structure and past performance to predict the entity’s capacity to alter economic resources controlled by it. They can also predict the valuation of the entity and the entity’s future borrowing needs and profit distribution patterns. The profitability of an enterprise allows a user to predict the return the entity will effectively generate from its existing resource base. The cash flows statement depicts the pattern of investing, financing and operating activities and provides information about cash generated by an entity and its cash needs. The reasons for changes in economic resources impacts the user’s economic decisions. An increase in economic resources as a result of credit borrowing has a different impact on an investor than an increase in net cash flows from operations would have brought.
1.2.3
Underlying assumptions
The underlying assumptions on which a set of financial statements are prepared are: •
Accrual basis- The effects of transactions and other events are recognised when they occur (and not as cash or a cash equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.
•
Going concern- The financial statements are prepared on the assumption that the entity will continue its operations for the foreseeable future and is not expected to liquidate or curtail materially the scale of its operations.
•
Consistency- In order to achieve comparability of the financial statements of an enterprise through time, the accounting policies are followed consistently from one period to another. A change in accounting policy is made in exceptional circumstance.
The accrual assumption helps the user in analysing the future cash obligations of an entity that relate to its past events. The going concern assumption helps the user in extrapolating t the future performance of the company based on its current resource base. The consistency principle helps the user compare different reporting periods and compare the company with its peers. Just o give you a flavour, the underlying assumption of consistency spells more work for a new auditor of an entity, who has to perform additional procedures to report on consistency of accounting policies, for instance. Under the Ind AS Framework, consistency has been addressed under ‘comparability’.
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Preparing Financial Statements under Schedule III
1.3
Chapter 1
QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS
Qualitative characteristics are those attributes that make the financial statements useful to the users. There are four principal qualitative characteristics- understandability, relevance, reliability and comparability.
1.3.1 Understandability It is extremely important that the financial statements be understandable to the user. That said it is also assumed that users are knowledgeable about the business and accounting and study the information with reasonable diligence. Complex information relevant to the economic decision-making needs of users should not be excluded merely on the ground of difficulty as the financial statements would be incomplete without them and therefore potentially misleading. The users may use specialist advice where they need to enhance their understanding of the transactions entered into by an entity and the relevant complex information about the transaction would be needed to make that assessment.
1.3.2 Relevance To be useful, the financial statements should include information that is relevant to the users. The three pillar stones of relevance of a set of financial statements are its predictive value, confirmatory value and having a materiality threshold specific to the users of the financial statements, which are usually providers of risk capital to the entity. The predictive and confirmatory roles of an information feed are interrelated. When a user reads about a segment growth of a business, they confirm what they had predicted earlier and also make their own prediction of the future of the segment. An information is materiality if its error or omission could influence the economic decisions of users. Since providers of risk capital are the primary users of the financial statements, materiality needs to be seen through the lens of the parent or say the shareholders of the parent company. If margins of an entity are more material to the providers of capital, then materiality thresholds should also be based thereon and if revenue is material to the parent then likewise materiality thresholds should mimic the same. Under the Ind AS Framework the nature of information alone is sufficient to determine its relevance. For example, the reporting of a new segment may affect the assessment of the risks and opportunities facing the entity irrespective of the materiality of the results achieved by the new segment in the reporting period. In other cases, both the nature and materiality are important, for example, the amounts of inventories held in each of the main categories that are appropriate to the business. [Para 29 of the Ind AS Framework]
1.3.3 Reliability Information should also be reliable. The information should faithfully represent the transactions and other events it either purports to represent or could reasonably be expected to represent. In the process, management should prepare financial statements that are complete, neutral (no bias) and free from material error. 4
Chapter 1
Framework for Preparation and Presentation of Financial Statements
The financials should be complete so that they are not misleading. They should include all the information and descriptions of factors that are relevant to the understanding of the economic event, keeping in mind the factors of materiality and cost. The financials need not necessarily be accurate but management should not make errors or omissions in the process of providing complete relevant information about the transaction or event. Management should make a calculated judgement on whether it can reliably make a measurement of the financial effect of an item and may for relevance purposes disclose the risk of error surrounding their recognition and/or measurement. The financial statements should be neutral and not have any bias in the selection and presentation of financial information. The management should not be selective about information that may have a pre-determined effect on the user’s decisions or judgement. Information should definitely be relevant but not have an agenda of influence. To faithfully represent a transaction or other event the accounting should give precedence to substance over the legal form and reflect the economic reality of the situation. Prudence, which is a degree of caution, should be exercised in making the judgements which impact estimates required under conditions of uncertainty, about the carrying amount of assets and liabilities and the recognition of income and expenses. Assets or income should not be overstated and liabilities or expenses should not be understated. However, prudence does not allow creation of excessive reserves as that would not be neutral and therefore not a reliable p resentation.
1.3.4 Comparability Another qualitative characteristic of financial statements is its comparability over different time periods for an entity or in a reporting period across different enterprises. To compare financials over time, the management should present corresponding information for the preceding period(s). The user should be able to able to identify the trends in the financial position, performance and cash flows of an entity over time. The user should be able to see the relativity of financial effects of like transactions and other events with performance between different entities. Comparability should not be confused with ‘uniformity’. There is consistency of accounting policies required throughout an enterprise over time and within different enterprises. Changes in accounting policies and the effects of such changes should be highlighted in the financials. Compliance with Accounting Standards and their disclosure helps meet the objective of comparability. However, an accounting policy should be changed when the change leads to more reliable and relevant recording of a transaction and that would bring about comparability.
1.4
TRUE AND FAIR VIEW
Para 46 of the Framework states “Financial statements are frequently described as showing a true and fair view of the financial position, performance and cash flows of an enterprise. Although this Framework does not deal directly with such concepts, the application of the principal qualitative characteristics and of appropriate accounting standards normally results in financial statements that convey what is generally understood as a true and fair view of such information.” 5
Preparing Financial Statements under Schedule III
1.5
Chapter 1
THE ELEMENTS OF FINANCIAL STATEMENTS
The financial effects of transactions entered into by and entity are grouped into classes based on their economic characteristics. The elements related to the measurement of financial position are assets, liabilities and equity. The elements related to the measurement of performance in statement of profit and loss are income and expenses. There are no additional elements identified for the cash flow statement as it reflects the changes in balance sheet elements and usually reflects the elements of the statement of profit and loss. A process of sub-classification is followed for these elements, for eg. presentation of assets by nature or function with an enterprise makes it more useful to the user for the purposes of making economic decisions. The overarching principle of determining whether an item meets the definition of an asset, liability or equity is that attention needs to be given to its substance over form and to the economic reality of the situation. Under the Ind AS Framework, Balance sheets drawn up in accordance with current Indian Accounting Standards may include items that do not satisfy the definitions of an asset or liability and are not shown as part of equity. The definitions set out in paragraph 49 will, however, underlie future reviews of existing Indian Accounting Standards and the formulation of further Standards [Para 52 of the Ind AS Framework]. The existing Framework is silent on this point.
1.5.1 Assets An asset is a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise [Para 49 of the Framework/Ind AS Framework]. The definition mentions the essential features of the asset but not the conditions that must be met before the asset may be recognised. This definition has one significant practical implication- for eg. goodwill falls out of the definition of an asset as per the definition as it is not a resource ‘controlled’ by an enterprise- although goodwill is well recognised as an asset by the ASB. The question mark over whether future economic benefits will arise from a resource gives birth to the second question, “what is future economic benefits?” However, the phrase ‘future economic benefits’ has not been defined in the Framework but examples added for demonstrate how they may arise. Para 54 of the Framework states, “The future economic benefits embodied in an asset may flow to the enterprise in a number of ways. For example, an asset may be:
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(a)
used singly or in combination with other assets in the production of goods or services to be sold by the enterprise;
(b)
exchanged for other assets;
(c)
used to settle a liability; or
(d)
distributed to the owners of the enterprise.”
Chapter 1
Framework for Preparation and Presentation of Financial Statements
Hence, it appears an asset is a resource controlled by an enterprise from which future assets may be gained or liabilities settled.
1.5.2 Liabilities A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits [Para 49 of the Framework/Ind AS Framework]. A distinction is drawn between a present obligation and a future commitment. A decision of management to acquire assets in the future does not give rise to a present obligation, unless the decision to acquire is irrevocable. Some liabilities require significant degree of estimation and are called ‘provisions’.
1.5.3 Equity Equity is the residual interest in the assets of the enterprise after deducting all its liabilities [Para 49 of the Framework]. The amount at which equity is shown in the balance sheet is therefore dependent on the amount of assets and liabilities. It may be sub-classified as funds obtained from owners, retained earnings and reserves etc. the classifications should be relevant to the decision-making needs of the users. It is rarely a measure of the valuation of the enterprise or the market capitalisation of its shares or the sum that could be raised by disposing the net assets either on a piecemeal basis or the whole enterprise as a going concern.
1.5.4
Income and expenses
Income is increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants [Para 69(a) of the Framework/Para 70(a) Ind AS Framework]. The definition encompasses both revenue and gains. Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants [Para 69(b) of the Framework/Para 70(b) Ind AS Framework]. The above definitions of income and expense only mention the essential characteristics of the elements and do not specify the criteria for their recognition. The Framework allows a depiction of income and expenses arising from ordinary course of business and those that do not. Unlike the existing Framework, the Ind AS Framework allows netting of gains and related losses [Para 80 of the Ind AS Framework].
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Preparing Financial Statements under Schedule III
1.5.5
Chapter 1
Capital Maintenance Adjustments
The Framework acknowledges that assets and liabilities may be revalued or restated and that would give rise to increases or decreases in equity. While these increases or decreases meet the definition of income and expenses, they should not be included in statement of profit and loss under certain concepts of capital maintenance. Instead, these items are included in equity as capital maintenance adjustments or revaluation reserves. These concepts of capital maintenance are discussed in section 1.8 below.
1.6
RECOGNITION OF FINANCIAL STATEMENTS
“An item that meets the definition of an element should be recognised if: (a)
it is probable that any future economic benefit associated with the item will flow to or from the enterprise; and
(b)
the item has a cost or value that can be measured with reliability” [Para 82 of the Framework/Para 83 of the Ind AS Framework].
Materiality is applied for recognition in financial statements. A degree of certainty of the flow of economic benefits needs to be established and the same requires judgement. The interrelationship between the elements implies that when one element is recognized then automatically an effect is also recognized in another element. Recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities and recognition of expenses occurs simultaneously with the recognition of an increase of liabilities or a decrease in assets. Many expenses are recognised due to a direct association between the costs incurred and the earnings emanation from certain items of income. This concept of matching the costs with revenues from the same transaction or other events is called the matching concept. However, the matching concept is built on the foundation of recording of an ‘asset’ and ‘liability’ which qualifies for the definition under the Framework. The expenses may be allocated over accounting periods in order to match them with the pattern of consumption of the economic benefits associated with them. An expense is recognised immediately in the statement of profit and loss when an expenditure produces no future economic benefits. When a reasonable estimate cannot be made, the item is not recognised in the financial statements but if relevant, it may require disclosure in the notes, explanatory material or supplementary schedules.
1.7
MEASUREMENT OF FINANCIAL STATEMENTS
“Measurement is the process of determining the monetary amounts at which the elements of financial statements are to be recognised and carried in the balance sheet and statement of profit and loss. This involves the selection of the particular basis of measurement.” [Para 98 of the Framework/Para 99 of the Ind AS Framework]. 8
Chapter 1
Framework for Preparation and Presentation of Financial Statements
A number of measurement bases are prescribed and are used in various permutations and combinations:
1.8
•
Historical cost – Assets and liabilities are recorded using the amount of cash or cash equivalents paid/ received or at the fair value of the other consideration paid or received, respectively. This is the most common measurement base.
•
Current cost – Assets are recognised at the amount of cash or cash equivalents that would need to be paid currently to acquire them and liabilities are recorded at the amount of undiscounted cash or cash equivalents needed to settle the obligation currently.
•
Realisable (settlement) value – Assets are recognised at the amount of cash or cash equivalents that would currently be obtained in an orderly disposal and liabilities carried at the amount of undiscounted cash or cash equivalents needed to settle the obligation in the normal course of business.
•
Present value – Assets and liabilities are carried at the present value of the future net cash inflows/ outflows that the item is expected to generate/ required to settle in the normal course of business, respectively.
CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE
The concept of capital is concerned about how the enterprise defines its capital that it seeks to maintain. The concept of capital is closely linked to the concept of profit making it essential to distinguish between a return of capital and a return on capital. Inflows of assets that maintain capital are a return of capital and only the inflows of assets in excess of amounts needed to maintain capital can be regarded as profit and therefore as a return on capital. Profit is the residual amount that remains after expenses (including capital maintenance adjustments, where appropriate) have been deducted from income. If expenses exceed income, the residual amount is a net loss. The Framework talks about two concepts of capital maintenance- Financial capital maintenance and Physical capital maintenance. Choice of an appropriate concept of capital should be based on the needs of users of the financial statements. The choice depicts the goal to be attained in determining profit. The principal difference between the two concepts is treatment of the effects of changes in the prices of assets and liabilities of the enterprise, which are entirely attributed to equity under the physical capital maintenance model and party to profit and partly to equity under the financial capital maintenance model. Financial capital maintenance – Under the financial concept of capital where capital is defined in nominal monetary terms, profit represents the increase in nominal money capital over the period. The entire profit may not be realised as such however until the assets are sold. This concept does not require a particular measurement basis and the choice depends on the type of financial capital that is to be maintained. When the concept of financial capital maintenance is defined in terms of constant purchasing power units, say under the revaluation model, profit 9
Preparing Financial Statements under Schedule III
Chapter 1
represents the increase in invested purchasing power over the period. Thus, only that part of the increase in the prices of assets that exceeds the increase in the general level of prices is regarded as profit. The rest of the increase is treated as a capital maintenance adjustment and, hence, as part of equity. (Refer section 1.5.5. above). Under this concept, a profit is earned only if the financial (or money) amount of the net assets at the end of the period exceeds the financial (or money) amount of net assets at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period. Physical capital maintenance – Under the physical concept of capital, capital stands for the productive capacity of an enterprise, eg. units of output per day. Profit represents the increase in that capital over the period. This concept requires a current cost basis. All price changes affecting the assets and liabilities of the enterprise are viewed as changes in the measurement of the physical productive capacity of the enterprise; hence, they are treated as capital maintenance adjustments that are part of equity and not as profit. A profit is earned only if the physical productive capacity (or operating capability) of the enterprise at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period. The selection of the measurement bases and concept of capital maintenance will determine the accounting model used in the preparation of the financial statements. Different accounting models exhibit different degrees of relevance and reliability and, as in other areas, management must seek a balance between relevance and reliability. [Para 109 of the Framework/Para 110 of the Ind AS Framework]
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