AA Update September 2013

September 2013

ACCOUNTINGAND AUDITINGUPDATE

In this issue

The Companies Act, 2013 A snapshot p01

Regulatory Deferral Accounts p03

Accounting for Certified Emission Reductions p08

Service Concession Arrangements p10

Discussion paper on clause 41 of the Equity Listing Agreement p14

Revenue recognition by Real Estate Developers p16

Revised Schedule VI: Differences in practice p21

Regulatory updates p25

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.

V. VenkataramananPartner, KPMG in India

The past month has been a busy one from an accounting and reporting

perspective. The passage of the Companies Bill through the Rajya Sabha

and subsequently the Presidential assent in August has attracted a lot of attention

and interest. Significant changes are imminent and while a lot of related

details need to fleshed out in the rules that will accompany the new Companies

Act, the direction of travel is clear.

We will have a series of articles in our Accounting and Auditing Update on the

key changes and nuances on specific sections in the coming months as the

rules are notified and made public by the Government of India. The Securities

and Exchange Board of India has also recently issued a discussion paper on

proposed changes to the clause 41 of the Equity Listing Agreement; we

examine these changes which can be substantial for some companies in this

issue.

We also examine the accounting for rate regulated activities and how

assets and liabilities that are resulting from such activities are dealt with in

practice in India. This area of accounting and reporting is most relevant to the

power sector. We also consider the accounting and reporting challenges

that are relevant to service concession arrangements under Indian GAAP. This

issue also features an analysis of the reporting issues and judgmental areas

relating to the accounting and reporting of Certified Emission Reduction (CER)

credits; commonly referred to as carbon credits and how these are dealt with in

practice in India.

Carrying on the theme of examining diversity in practice; we also cast a

lens on accounting practices relating to revenue recognition in the real estate

industry and the application of the revised Schedule VI of the Companies

Act. In both of these areas, revised guidance came into force over the

last accounting year and we think it is instructive and meaningful to consider

how this guidance has been applied and where the challenges relating to these

areas have emerged in practice.

We look forward to continuing to hear from you on what you find useful and

what you would like us to cover in future editions of the AAU.

Happy reading!

Editorial

The Companies Act, 1956 to

The Companies Act, 2013

A. Board structure - Increase in permitted number of directors, CSR committee and role of audit committee enhanced

B. Directors - At least one resident director (stayed in India for at least 182 days), At least one woman director (1 year to comply)

C. Maximum number of public company directorships restricted to 10

D. Independent Directors - More clarity on role, independence and liability (detailed responsibilities), Tenure limited to maximum of 2 consecutive terms of 5 years, Stock options prohibited

A. Appointment of Statutory Auditor for a five-year term; every AGM to ratify the appointment

B. Limits the number of companies an auditor can serve to 20 per partner

C. Rotation of Auditors after two consecutive terms of five years each; cooling off period of 5 years

D. Prohibition on rendering specified non-audit services to the company, its holding or subsidiary company

E. Extended reporting responsibilities for auditors

A. Preparation of Consolidated Financial Statements is now mandatory

B. Structural changes in depreciation rates

C. Revised definitions of what is a Subsidiary and an Associate company

D. National Financial Reporting Authority (NFRA) to be formed to recommend accounting/auditing standards and enforce compliance

E. Framework for revision of Financial Statements or Boards report set out

A. CFO recognised as Key Managerial Personnel

B. Internal audit to be mandated for certain class of companies

C. Listed companies mandated to establish a vigil mechanism (whistleblower)

D. Prohibition on insider trading and strict penalties for a director/KMP

E. Serious Fraud Investigation Office (SFIO) empowered and provided statutory status

F. Class action suits introduced to empower investor community

A. Allow objections to compromise or arrangement by only Shareholders holding > 10 % stake and creditors having outstanding debt of > 5 % of total debt

B. Simplified amalgamations between holding and fully owned subsidiary

C. Merger of Indian company with a foreign company permitted subject to RBI approval

A. Mandatory contribution towards CSR at least 2 % of past 3 years average profits

B. Requires constitution of a CSR committee with at least 3 directors (of which one to be an independent)

C. Disclosure of CSR policy required

A. Govt-approval to shareholder-approval regime

B. Definition broader than accounting standards

C. Shareholder approval needed in case the paid-up capital/transaction amount exceeds prescribed limit

D. Disclosure of RPTs in the directors report

7 Schedules | 29 Chapters | 470 Sections

New Act

Accounting related

Auditor related

Board oversight

Related party

transactions (RPT)

Corporate Social

Responsibility (CSR)

Compromise, arrangement,

amalgamation or demerger

Other provisions

The Bill introduced

Passed by the Lok Sabha

Passed by the Rajya Sabha

Received the President of

Indias assent

Published in the Gazette

of India

Detailed rules to be published

2009 2012 2013 2013 2013

30 August 2013

29 August 2013

8 August 2013

18 December 2012

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The International Accounting Standards Board (IASB) on 25 April 2013 issued an Exposure Draft (ED) on Regulatory Deferral Accounts. This would be an interim standard that is expected to provide temporary guidance until the IASB completes its comprehensive project on accounting for rate-regulated activities.

The IASB and the IFRS Interpretations Committee had received several requests for guidance on whether rate-regulated entities can or should recognise, in their IFRS financial statements, a regulatory deferral or variance account debit balance or credit balance as a result of price or rate regulation by regulatory bodies or governments. Although some national accounting bodies e.g., U.S. provide specific guidance on accounting for the effects of rate regulation, IFRS does not contain any equivalent guidance. Therefore, the IASB recognised that while adopting IFRS, the jurisdictions whose local accounting principles permitted or required the recognition of regulatory deferral account balances might place an industry-specific carve out from the application of IFRS. Such jurisdictions may allow rate-regulated entities to continue use of local GAAP and this may create diversity of application in practice.

Therefore, in December 2012, the IASB reactivated its project on rate regulation and decided to:

issue an interim standard to provide temporary guidance and

undertake a comprehensive project a process that is likely to take several years.

The IASB has mentioned in the basis for conclusion that by publishing this ED, it is in no way anticipating the outcome of the comprehensive Rate-regulated Activities project. Therefore, the IASB chose the term regulatory deferral account balances as a neutral descriptor for regulatory assets and regulatory liabilities.

Regulatory Deferral Accounts

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The regulatory deferral account balance as defined in the ED is the balance of any expense (income) deferral or variance account that is included in the setting of the future rate(s) by the rate regulator and that would not otherwise be recognised as an asset or liability in accordance with other standards. The examples of allowable costs that might be recognised are volume or price variances, approved green energy initiatives, non-directly attributable overhead costs, project cancellation costs, storm damage costs and deemed interest.

THIS ARTICLE AIMS TO

SUMMARISE THE GUIDANCE GIVEN IN THE ED

ILLUSTRATE THE PRESENTATION OF THE REGULATORY DEFERRAL ACCOUNT BALANCES IN THE FINANCIAL STATEMENTS


Rate regulationThe interim standard would apply to entities or to activities of an entity that are subject to rate regulation. An entity e.g., electricity distribution utility would be in the scope of the proposals if it meets the following core criteria:

An authorised body sets the price that the entity can charge its customers, and that price is binding on its customers and

The price established is designed to recover the entitys allowable costs of providing regulated goods or services.

The interim standard explains that there should be an identifiable causal effect that links the regulatory account balances to the rate-setting process. The interim standard does not carry a requirement of one-to-one matching of costs but does require that the rate-setting mechanism should be designed to recover the entitys specified costs. Consequently, rate-setting mechanisms that determine rates based on targeted or assumed costs, for example, industry averages, without a link to the actual costs of the entity are not within the scope of this ED.

If the expenses (income) that give rise to a regulatory deferral account balance are not included within the regulated rate, then those expenses (income) are outside the scope of this interim standard. Expenses (income) may be outside the regulated rate because, for example, the amounts are not expected to be accepted as allowable by the rate regulator or because they are not within the scope of the rate regulation. Consequently, such an item is recognised as income or expense as incurred, unless another standard permits or requires it to be included in the carrying amount of another asset e.g., property, plant and equipment or intangible assets.

Scope Under the proposals, the interim standard would be available to first-time adopters of IFRS if they recognised regulatory balances in their financial statements under the reporting requirements applied immediately prior to:

Transition to IFRS and

The initial application of the interim standard.

Recognition and measurementThe interim standard would follow grandfathering approach i.e., it would permit the first-time adopters of IFRS to continue to apply their existing policies and measuring regulatory deferral account balances (recognition and measurement including impairment). A similar approach was previously taken by the IASB for the insurance and extractive industries. The interim standard would therefore allow entities to ease their transition to IFRS, because they would not need to make any significant changes to their accounting policies on rate regulation until the comprehensive project has been finalised. However, specific presentation and disclosure requirements are proposed and these are discussed separately in the article.

Changes in accounting policy after transition

The interim standard proposes that entities that already apply IFRS would not be allowed to change back to their previous local accounting approach and not allowed to reinstate regulatory balances that they eliminated when they adopted IFRS.

An entity that recognises regulatory account balances on transition to IFRS would subsequently be able to change its accounting policy to discontinue recognition of such balances, provided that the entity meets the criteria in IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors i.e., the change would result in information that is reliable and more relevant.

However, if a first-time adopter did not elect to grandfather and subsequently changes the accounting policy to begin recognising regulatory deferral account balances then this change would not be permitted. The IASBs rationale for these restrictions is that starting to recognise such balances would not make the financial statements more reliable under the requirements of IAS 8, given that the policy may need to change again following completion of the IASBs comprehensive project.

PresentationThe interim standard requires that regulatory deferral account balances should be presented separately from assets, liabilities, income and expenses recognised in accordance with other standards. The interim standard does not permit grandfathering of the presentation requirements.

In the statement of financial position Regulatory deferral account balances would be presented without offsetting of debit and credit balances in separate line items, distinguishing them from other assets and liabilities. While discussing current/non-current allocation, the IASB noted that regulatory deferral account balances are expected to be recovered over a period and may require complex and detailed scheduling of the timing of recovery or reversal of each regulatory deferral account debit or credit balance. Consequently, the IASB proposes that regulatory deferral account balances should not be classified as current. This decision of the IASB would have an impact on an entitys working capital ratios and other financial ratios.

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Illustration: Statement of financial position Note 20X2 20X1

Asset

Non-current assets a x y

Current assets b x y

Total assets before regulatory balances c x y

Regulatory deferral account debit balances d x y

Total assets x y

Equity and liabilities

Total equity e x y

Non-current liabilities f x y

Current liabilities g x y

Total liabilities before regulatory balances x y

Regulatory deferral account credit balances d x y

Total liabilities x y

Total equity and liabilities x y

Source: KPMGs New on the Horizon: Accounting for rate-regulated activities, May 2013

In the statement of profit or loss and other comprehensive income (OCI) the net movement in all regulatory deferral account balances would be presented in a separate line item in the statement of profit or loss and OCI.

Illustration: Statement of profit or loss and OCI Note 20X2 20X1

Revenue h x y

Cost of sales i x y

Gross profit x y

Other income j x y

Expenses k x y

Result from operating activities x y

Net finance cost l x y

Share of profit of associates and joint ventures m x y

Profit before tax and regulatory account movements x y

Income tax expense n x y

Net movement in regulatory deferral accounts d x y

Profit for the year x y



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Interaction with other standardsAlthough the interim standard allows grandfathering of existing accounting policies, it does not mean that an entity could necessarily carry forward the regulatory deferral account balances that it has recognised and measured in accordance with its previous GAAP to its first IFRS financial statements without adjustments. Therefore, interim standard mentions that the normal requirements of other IFRS would apply to regulatory deferral account balances; however, there are some exceptions and additional requirements (which are discussed below). In the absence of any specific exemption, exception or additional requirements within the interim standard, if other standards have different measurement requirements

from the existing accounting policy under previous GAAP, then those standards take precedence in recognising and measuring regulatory items.

In short, to determine the amount of regulatory deferral account balances for the statement of financial position at the entitys date of transition, other standards would need to be taken into account, and resulting adjustments made to the amounts carried forward from the previous GAAP.

Standards that might need to be applied include, for example:

IAS 10, Events after the Reporting Period - An entity should apply IAS 10 to identify whether subsequent events should be taken into account

in estimates and assumptions that are used in recognising and measuring regulatory deferral account balances.

IAS 21, The Effects of Changes in Foreign Exchange Rates An entity should apply IAS 21 to translate regulatory deferral account balances that are denominated in a foreign currency.

The interim standard proposes following specific exceptions, exemptions and additional requirements in applying the following standards:

Standard Description of specific exceptions, exemptions and additional requirements

IAS 12, Income Taxes A entity should apply IAS 12 to all of its activities, including its rate-regulated activities, to identify an amount of income tax expense that is to be recognised. However, the amounts recognised would be included with the regulatory line items, instead of within tax line items, with clear disclosure. An entity may either

present the deferred tax amount as a separate item alongside the regulatory deferral account balance or movement in regulatory deferral accounts or

Disclose it as part of analysis of the regulatory line item(s) as required by the interim standard.

IAS 33, Earnings per share An entity would be required to present additional basic and diluted earnings per share excluding the movements in the regulatory deferral account balances, with equal prominence.

IAS 36, Impairment of Assets For an entity that continues to apply its previous GAAP accounting policies for the identification, recognition and measurement of regulatory deferral account balances, IAS 36 would not apply with respect to impairment testing of such balances. However, the interim standard would require an entity to apply the requirements of IAS 36 to a cash-generating unit that includes regulatory deferral account balances.

IFRS 5, Non-current Assets Held for Sale and Discontinued Operations

An entity would not be required to apply the measurement requirements of IFRS 5 to its regulatory deferral account balances if it continues to apply its previous GAAP accounting policies for the identification, recognition and measurement. The entity would present regulatory deferral account balances that relate to the discontinued operation and/or disposal group with the separate line items for regulatory items, rather than reclassifying them into the amounts presented as non-current assets held for sale or profit or losses from discontinued operations in accordance with IFRS 5.

IFRS 12, Disclosure of Interest in Other Entities

An entity would be required to present additional disclosures if an entitys interests in its subsidiaries, associates or joint ventures contain regulatory deferral account balances.



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First-time adoption of IFRSIFRS 1 includes an optional exemption permitting a first-time adopter of IFRS to use the carrying amounts of property, plant and equipment (PPE) or intangible assets that were determined under previous GAAP on an item-by-item basis (deemed cost exemption).

If an entity elected to apply the deemed cost exemption, then the regulatory deferral account balance already recorded within the cost of PPE or intangibles would remain in these accounts. It would be subject to IAS 16, Property, Plant and Equipment or IAS 38, Intangible Assets for subsequent accounting and IAS 36, Impairment of Assets for impairment evaluation.

If an entity recognised regulatory deferral account balance as other assets in accordance with previous GAAP e.g., financial assets then it would not be able to use the deemed cost exemption.

Extensive new disclosures The interim standard would require an entity that recognises regulatory deferral accounts in its financial statements to provide extensive disclosures to enable the users of the financial statements to understand:

the features and nature of, and risks associated with, rate regulation and

the effect of rate regulation on the entitys financial position, performance and cash flows.

The disclosures would, therefore, need to meet the specific needs of users in understanding the rate regulation to which the entity is subject.

In India, the Institute of Chartered Accountants of India has issued a guidance note (GN) on Accounting for rate regulated activities on 11 February 2012. However, the effective date of the guidance note is not yet prescribed. Largely the principles of recognition of regulatory deferral account balances under the IASB ED and Indian GN are on similar lines e.g., the activities that are subject to rate regulation should be those where the regulator determines the price that the entity must charge to its customers. Also the price established by regulation would need to be designed to recover allowable cost i.e., the costs that are specific to the entity and for which the regulated rate is intended to provide recovery. Similarly, both IASB ED and Indian GN require that regulatory deferral account balances should be presented separately from other assets and liabilities. However, Indian GN requires current/non-current classification in the balance sheet for the regulatory deferral account balances, unlike the IASB ED.

Conclusion

The IASB has acknowledges that the proposal permit only a limited population of entities to recognise regulatory deferral account balances and accordingly, will introduce some inconsistency and diversity into IFRS practice for the treatment of regulatory deferral account balances, when it does not currently exist. However, the IASB thinks that the proposed presentation and disclosure accounting requirements in the interim standard will help to minimise the impact of introducing this inconsistency, that the benefits to users and preparers of financial statements outweigh the costs.

The above proposals do not include an effective date. However, it is proposed that early adoption would be permitted, and therefore an entity would be able to adopt the amendments at the same time as it transitions to IFRS.


Background

Climate change poses a significant challenge to governments around the world prompting them to take a slew of measures to promote focus on alternative sources of energy. To deal with the issue of global warming, the United Nations Framework Convention on Climate Change (UNFCCC) was adopted in 1992. Supplementing the convention, the Kyoto Protocol came into force in February 2005 setting limits to the maximum amount of emission of Green House Gases (GHG) by countries. At present, the protocol commits developed countries to reduce their GHG emissions whilst the developing and least developed countries are not bound by the emission release limits. Thus, developed countries with binding emission reduction targets are issued allowances (carbon credits) equal to the amount of emissions determined. Carbon credit represents an allowance to emit one metric tonne of carbon dioxide equivalent. The projects undertaken by the developing/least developed countries which reduce carbon emissions are allotted CERs by the UNFCCC. The process of obtaining these CERs is known as Clean Development Mechanism or CDM.

Scope of the guidance note

Given the lack of accounting guidance in the area of CER internationally, divergent financial reporting practices posed challenges for users of financial statements. In February 2012, the Institute of Chartered Accountant of India (ICAI) issued a guidance note on accounting for self-generated certified emission reductions (GN) which became effective from accounting periods beginning on or after 1 April 2012. Out of the three market-based mechanisms provided by the Kyoto Protocol, the GN provides guidance on accounting for carbon credits, i.e., CERs generated under CDM. Further, the GN does not deal with purchased CERs or with the use of CERs in own business.

In this article, we examine some of the key aspects of the GN and also comment on where application in practice continues to be mixed even after the first annual reporting cycle when the GN was in force.

1. Timing of recognition of CER as an asset

As per the GN, CERs do not arise when the emission reductions are taking place. The GN stipulates that the CER comes into existence and meets the definition of an asset only when the communication of credit of CERs is received by the generating entity. Further, the GN clarifies that it is only at this stage that the CER becomes a resource controlled by the generating

entity and therefore, leads to expected future economic benefits in the form of cash and cash equivalents which would arise on future sale of CERs. As stated above, at other earlier stages of the CDM project activity, there is no resource in existence for the generating entity, and hence the question of resource controlled and expected future economic benefits, therefore, does not arise.

Certain companies have historically recognised CERs on an entitlement basis (using the accounting standard for government grants as a basis to do so) and believe that the certification process is procedural in nature and that the primary act of emission reduction ought to be considered for timing the recognition of asset instead of recognising upon the subsequent act of verification and certification of CERs. With an active market and binding contract for sale in place, such entities prefer recognition of CERs on entitlement basis as and when the emission reduction takes place.

2. Transition adjustment

Paragraph 37 of the GN requires that on the first occasion this GN is applied, the entity should recognise in the financial statements certified emission rights earned as on that date with corresponding credit to revenue reserves.

Accounting for Certified Emission Reductions (CERs)


TELL YOU ABOUT THE KEY ASPECTS OF THE GUIDANCE NOTE ON ACCOUNTING FOR SELF-GENERATED CERTIFIED EMISSION REDUCTIONS

PROVIDE OUR OBSERVATION ON THE DIVERSITY IN PRACTICE REGARDING ACCOUNTING OF CERs

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Conclusion

Whilst the GN is no doubt an important step by the ICAI in an area where there is very little established accounting literature internationally, divergent views/practice on accounting treatment prescribed by the GN continue to exist. A post implementation refresh of the GN may be called for (including covering accounting for RECs), now that Indian industry has been through a full reporting cycle with the new guidance, to enable higher levels of quality and consistency in financial reporting in the area of certified emission reductions/RECs.

Even though the GN does not explicitly discuss about the treatment to be given in case there is a debit adjustment arising upon transition, the principle applied would suggest that an adjustment through revenue reserve would equally be applicable for a debit adjustment arising out of transition to the accounting prescribed by the GN.

3. Measurement of costs

As regards measurement of costs, paragraph 24 of the GN discusses various elements of costs incurred by the generating entity to set up a CDM project activity, operate the CDM project and generate CERs. These costs typically include

research costs arising from exploring alternative ways to reduce emissions

costs incurred in developing the selected alternative as a process/device to reduce emissions

costs incurred to prepare the project design documents

fees paid for validation and verification and to the National Authority for approval

fees of registering with the UNFCCC

costs incurred for monitoring the reductions of emissions

costs incurred for certification of CERs and

operating costs incurred to run the CDM project.

Since the existence of CERs is not recognised by the GN until the UNFCCC certifies and credits the same to the generating entity, many of the costs incurred may not qualify for capitalisation as they cannot be considered as the costs of bringing the CERs to existence. Paragraph 25 of the GN explicitly clarifies that the costs incurred by the generating entity for certification of CERs are the costs of inventories of CERs since all other costs incurred prior to the certification stage do not result in CERs coming into existence.

In this regard, there continue to be divergent practices followed by companies with some entities continuing to view emission reductions as a result of an entire process involving equipments, inputs and production

processes and therefore, not restricting the consideration of costs capable of capitalisation to only certification as costs incurred to bring the CERs to their present location and condition. These entities argue that considering only certification costs would result in a mismatch of revenue and costs in the statement profit and loss in the year in which sale of inventory takes place since such costs are generally negligible.

While there does not appear to be much discretion on this point given the explicit guidance in the GN; we continue to see some variations in practice by reporting entities.

4. Applicability of this guidance note for Renewable Energy Certificates

Pursuant to the Electricity Act, 2003, certain entities were mandated to fulfil renewable purchase obligations (RPOs) which would result in such obligated entities purchasing electricity from renewable energy sources. Renewable energy certificate (REC) is an instrument which represents 1 MW hour of renewable hour generated. REC mechanism is a market based means to promote renewable energy business and facilitate buying renewable energy to meet RPOs. RECs are similar to CERs in that both are instruments meant for promoting environment-friendly activities and require pre-registration, validation and issuance of formal certificate by the agency concerned. In the case of CERs, the parameters are with reference to quantitative measures of emission reduction i.e., the extent to which actual emissions are lower than permissible emissions. In the case of RECs, the entitlement is based on units of output/sale from clean energy sources which can be considered a proxy measure of the extent to which emissions/consumption of non-renewable resources has been avoided. There are also areas of differences which include existence of trade exchanges, floor price, etc. in the case of RECs unlike CERs.

Given that CERs and RECs share certain common attributes, the principles of the GN could be extended to cover the accounting of

RECs. However, diversity exits in the accounting of RECs given that RECs are not explicitly covered in the scope of the current GN.

5. Taxation

The accounting treatment given by way of adjustment to opening balance of revenue reserves may also pose challenges from a tax perspective. Certain companies which previously recognised CERs on an entitlement basis and would have offered this amount for tax previously, would, as per the transition provisions of the GN have to de-recognise the assets previously recognised that do not meet the asset recognition threshold by and adjustment to reserves. Some of these entities are concerned that they may struggle to claim the expenditure resulting from de-recognition pursuant to application of GN and which were adjusted to revenue reserves. Similarly, entities that did not recognise CERs as an asset in the previous years would recognise CERs as an asset on application of the GN and would adjust reserves to recognise such assets and may have potential tax implications.


Introduction

Infrastructure for public servicessuch as roads, bridges, tunnels, prisons, hospitals, airports, water distribution facilities, energy supply and telecommunication networkshas traditionally been constructed, operated and maintained by the public sector and financed through public budget appropriation.

Governments have introduced contractual service arrangements to attract and increase private sector participation in the development, financing, operation and maintenance of such infrastructure. The arrangement between the Government and the private sector that formalises the private sector participation is referred to as a service concession arrangement (SCA). They are also commonly referred to as build-operate-transfer, rehabilitate-operate-transfer or public-to-private service concession arrangements. In such arrangements, the Government or an entity in the public sector which has the primary obligation to provide public services, is referred to as a grantor and the entity in the private sector is referred to as the operator.

The SCAs vary in terms of the infrastructure

whether existing or new, obligations of the operator

whether build-operate-transfer, or only upgrade-maintain-operate-transfer, and the manner of consideration for the operator for taking the obligations under the contract

whether through fixed payments by the Government or through the transfer of a right to charge the users of the infrastructure.

The public-to-private model has gained a lot of popularity in the recent past, specifically in the context of toll roads, bridges, airports and power generation among others. Many large infrastructure company in India are involved in service concession arrangements, making the practical and accounting considerations of such arrangements a significant point of discussion.

Salient features of SCAs

A common feature of these service arrangements is the public service nature of the obligation undertaken by the operator. Public policy relates to the aspect that the services related to the infrastructure are to be provided to the public, irrespective of the identity of the party that operates the services. The service arrangement contractually obliges the operator to provide the services to the public on behalf of the public sector entity. Other common features include:

the party that grants the service arrangement (the grantor) is a public sector entity, including a governmental body, or a private sector entity to which the responsibility for the service has been devolved.

the operator is responsible for at least some of the management of the infrastructure and related services and

does not merely act as an agent on behalf of the grantor.

the contract sets the initial prices to be levied by the operator and regulates price revisions over the period of the service arrangement.

the operator is obliged to hand over the infrastructure to the grantor in a specified condition at the end of the period of the arrangement, for little or no incremental consideration, irrespective of which party initially financed it.

Service Concession Arrangements


TELL YOU ABOUT THE CURRENT ACCOUNTING PRACTICES FOR SERVICE CONCESSION ARRANGEMENTS

EXPLAIN THE INTERNATIONAL ACCOUNTING GUIDANCE FOR SUCH ARRANGEMENTS

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Accounting challenges and questions

From an accounting standpoint, SCAs have certain aspects that require careful consideration especially under the current reporting framework in India. Some of these matters are highlighted below:

In many cases, the operator takes over an existing infrastructure of the grantor for expansion, rehabilitation and/or development. The improved/ expanded infrastructure is operated and maintained by the operator for the term of the concession. From an accounting perspective, a key question is how such infrastructure taken over and the subsequent cost for improvement, rehabilitation, development and expansion should be accounted for in the books of the operator.

The operator needs to transfer the infrastructure whether newly constructed or rehabilitated infrastructure at the end of the concession period to the grantor at no cost. Additionally, the operator is generally not permitted to provide such infrastructure as collateral to obtain finance for satisfying its obligations. Accounting judgement is often required to determine whether the cost incurred by the operator in relation to the infrastructure represents a tangible asset, an intangible asset or whether it would be a leasing type arrangement.

The operator is also obliged to maintain infrastructure at a given level of efficiency, which may involve incurring significant costs at predetermined periodic intervals. The timing of accrual and measurement of such costs over the concession term requires careful assessment.

The consideration to the operator is paid either by the grantor as an annuity or by the users of the infrastructure (i.e., general public) by way of toll collections or service charges. Additionally, the grantor has varying levels of control on the pricing of the services and the recipients of the services in different concessions. The operator incurs concession fees payable to the grantor which is generally determined as a percentage of the revenue collected from the users. These conditions raise questions

as to whether the operator exercises control over the infrastructure for the purpose of recognition of such infrastructure as its own assets.

There is significant variety in the SCAs across the infrastructure industry with different allocation of the responsibilities towards the infrastructure between the grantor and the operator and the manner of compensation to the operator.

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 in the infrastructure industry. 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 under Indian GAAP has not been issued on this topic.

In this article, we will discuss the current accounting practices followed by the Indian companies and the international guidance on this subject.

Current accounting practices for SCAs

In the absence of any authoritative guidance for accounting for such arrangements under the Indian GAAP, multiple interpretations and accounting treatments are currently followed by the Indian companies. Some of the key areas of interpretation/variation that are seen in practice are set out below:

Classification of the asset

The cost incurred on the infrastructure which is the subject matter of the SCA is either capitalised as fixed assets or as intangible assets. There appears to be some amount of consistency in treating the infrastructure as an intangible asset with regard to SCA for construction and maintenance of highways regardless of whether the operator is compensated by an annuity income or collection of charges from the users of the infrastructure. However, in the cases where airports and power generating units are the subject matter of an SCA, the dominant practice appears to classify them as fixed assets.

The upfront fee paid to the grantor is treated as an intangible asset. The existing infrastructure taken over by the operator is not brought into the books of the operator. Further, many reporting entities tend to reduce the income earned out of tolls collected during the period of construction from the cost of the fixed asset or intangible asset, as the case may be.

Amortisation/depreciation of the concession assets

Operators depreciate infrastructure capitalised as fixed assets over the useful life. Guidance on depreciation rates/useful lives is often sought from Schedule XIV of the Companies Act, 1956 or in the case of power generating units, the Central Electricity Regulatory Commission (Terms and Conditions of Tariff) Regulation, 2012.

The upfront fees capitalised as intangible assets, as discussed above, are amortised over the period of the concession on a straight line basis.

In the case of roadways, in many cases, intangible assets are amortised over the concession period based on the proportion of actual traffic volume for a particular period over the total projected traffic volume over the period for which the company is entitled to operate the roads/carriageways. Some reporting entities have adopted the method specified in the notification issued by the Ministry of Corporate Affairs dated 17 April 2012. The notification has inserted guidance in Schedule XIV to the Companies Act, 1956, with regard to amortisation of intangible assets representing toll collection rights in the case of roadway SCAs.

The amortisation amount, as per this notification, would be computed as follows:

Cost of intangible asset

Actual revenue for the year

XProjected revenue

from intangible asset (till the end of the

concession period)


Actual revenue in this case is the toll charges received during the accounting year. The amortisation rate or amount ensures that the whole cost of the intangible asset is amortised over the concession period.

Total revenue is reviewed at the end of each financial year and the projected revenue is adjusted to reflect any changes in the estimate which will lead to the actual collection at the end of the concession period.

For service concession arrangements that are annuity based and have a specified period for the concessionaire agreement, the approach followed by infrastructure companies in India is fairly consistent, with most companies amortising the intangible in such a case over the period of the concessionaire agreement.

The useful lives, for the purpose of depreciating/amortising the infrastructure, do not exceed the concession term.

Revenue recognition

When the operator is granted the right to collect fee/toll from the users of the infrastructure, the operator accounts for such collection as income as and when the service is rendered following the guidance in AS 9, Revenue Recognition. In such arrangements, the operator needs to pay the grantor a concession fee which is computed as a percentage of the revenue. There are varying practice amongst the reporting entities with regard to the presentation

of such concession fee. Some reporting entities show the revenue collected gross of the concession fee with the concession fee presented as a separate expenditure, while others have presented the concession fee as a reduction from the gross revenue.

In the cases, where the operator is compensated with annuity payments by the grantor, the annuity income is typically accounted on a time proportionate basis over the period of the concession.

Provision

Service concession arrangements typically cover a significant period of time, and include obligations for resurfacing, relaying or other significant period maintenance expenditure (most typically found where toll roads and airports are the subject matter of an SCA). Infrastructure companies follow different accounting policies for such obligations, which include:

Adopting the principles of AS 29, Provisions, Contingent liabilities and Contingent assets, and recognising a provision based on the best estimate of expenditure required to settle the obligation as at the balance sheet date.

Capitalising periodic maintenance costs on the date they are incurred and thereafter amortised from the date of incurrence till the date of the next periodic maintenance obligation.

Disclosures

There are varying degrees of disclosures in the financial statements with regard to the terms of the SCAs. While some entities have provided disclosures in the notes to financial statements containing the nature of infrastructure, period of concession agreements, presentation of revenue, etc. The lack of consistency of disclosure and varying levels of detail affect the comparability of the financial statements.

Given the nature and complexity of the arrangement, a reporting entity exercises judgement and makes estimates in the financial statements such as the volume of traffic over the concession period for the purpose of amortisation of intangible asset, the cost of future obligations to maintain the infrastructure like resurfacing/relaying obligations, etc. Discussions in the notes to accounts with regard to these judgements/estimates could be improved to include the specific judgements and estimates that are involved in accounting for SCAs like, the manner of estimation of the volume of traffic, the revenue forecast (in case the amortisation of the intangible asset is based on revenue), the estimation of future costs for maintaining the infrastructure, etc.

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International guidance on service concession accounting

IFRS guidance on service concession accounting (IFRIC 12) has the following salient features:

Scope of the guidance

SCA accounting applies to public-to-private service concession arrangements if:

the grantor controls or regulates what services the operator must provide with the infrastructural facilities, to whom it must provide them, and at what price and

the grantor controls - through ownership, beneficial entitlement or otherwise - any significant residual interest in the infrastructural facilities if remaining at the end of the term of the arrangement.

The operators rights over the infrastructure

The operator should not recognise the public service infrastructure as property, plant and equipment, because the operator is considered to have a right of access rather than a right of use. This requirement applies to the existing infrastructure of the grantor as well as the infrastructure that the operator builds or operates under the arrangement.

Recognition of construction or upgrade revenue

The operator is required to recognise and measure revenue in accordance with existing revenue recognition guidance that is pertinent for construction or upgrade services. Revenue recognised is typically based on the stage of completion of services and is measured with reference to the fair value of the consideration receivable.

Recognition of consideration receivable on construction or upgrade services

The nature of consideration received by the operator determines whether it should be classified and accounted for as a financial asset, an intangible asset or both.

The operator should recognise a financial asset to the extent that it has an unconditional right to receive cash irrespective of the use of the infrastructure or to extent that the grantor bears the demand risk (this refers to annuity based SCAs). If the operator receives a right to charge the users of the asset, it should recognise an intangible asset for such a right.

There could also be more complex cases, wherein the operator recognises both a financial asset and an intangible asset under a single service concession arrangement. Typically in such cases, the financial asset arises from the right to receive a minimum amount of cash, while the intangible asset arises from the right to earn additional amounts above that minimum fixed amount.

Recognition of operation revenue

The operator should recognise and measure revenue that relates to operation services in accordance with normal revenue recognition guidance. The general principle is that revenue is measured at fair value of the consideration received or receivable for services provided.

If the operator recognises a financial asset during the construction phase, then a portion of the payments received during the operation phase is allocated to reduce the financial asset. The operator recognises revenue from the operation services, and the resulting financial asset, as it is earned, and measures the revenue at the fair value of the consideration received or receivable.

If the operator recognises an intangible asset during the construction phase, then it recognises operation revenue as it is earned.

In the cases, where the operator has recognised both a financial and an intangible asset, the fair value of the consideration receivable under the arrangement is allocated between the financial asset and intangible asset. Revenue is recognised as it is earned at the fair value of the consideration received or receivable and a portion of payments collected is allocated to the repayment of the financial asset.

Conclusion

As we have examined in this article, there is considerable divergence in how SCAs are accounted for and disclosed in the financial statements in India. It is imperative that we put in place authoritative guidance that prescribes a consistent accounting practice. This would lead to increased levels of transparency and confidence for stakeholders in a sector that is both critical to Indias development and where perceptions of accounting and reporting transparency are currently muted. We believe that to reflect the economic substance of such arrangements, accounting under Indian GAAP should be along the lines of IFRS.


Overview

The Securities and Exchange Board of India (SEBI) issued a discussion paper on Revision of Clause 41 of the Equity Listing Agreement (Discussion Paper) on 20 August 2013 which proposes several changes to the existing clause 41 of the Equity Listing Agreement (Listing Agreement). The proposals are based on the recommendations of the SEBI Committee on Disclosures and Accounting Standards. Comments are due to the SEBI by 13 September 2013.

Summary of key proposals

Half-yearly consolidated financial results

If a company does not opt to submit quarterly and year to date consolidated financial results then in addition to the existing requirements of disclosing consolidated results annually, the proposals require disclosure of half-yearly consolidated results including statement of assets and liabilities and cash flow statement. Companies would be required to provide these additional disclosures if there is a variation of more than 20 percent in the revenue, total assets, total liabilities or profit/(loss) between the consolidated financial results and the corresponding amounts in the standalone financial results as per the last annual audited financial statements. The consolidated results shall be subjected to limited review or audit, as the case may be, by the auditors of the company.

Observations

Based on the threshold suggested in the discussion paper (20 percent of revenue, total assets, total liabilities or profit/(loss) it is likely that several companies would be covered under its scope especially in sectors such as real estate and infrastructure which tend to have large number of subsidiaries.

Not only companies will have to prepare consolidated financial results but also get them audited or reviewed by the auditors. Several companies might be preparing consolidated financial results for their internal requirements on an ongoing basis, but the new requirements would require additional rigour in the process resulting in companies having to ramp up resources in their finance function and align their systems to publish the financial results on an ongoing basis.

Further, the format for half-yearly submission suggests that comparative information and cash flow statement will be required to be disclosed for the consolidated financial results. These requirements could be onerous and companies might not be geared to disclose such information. The SEBI may consider providing transitional relief by not requiring comparative consolidated financial results and comparative cash flow statement.

Discussion paper on clause 41 of the Equity Listing Agreement


TELL YOU THE KEY PROPOSALS IN THE DISCUSSION PAPER

PROVIDE OUR OBSERVATIONS ON THE KEY PROPOSALS

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Option to prepare consolidated financial results under IFRS discontinued

The extant clause 41 gives an option to submit consolidated financial results as per International Financial Reporting Standards (IFRS). The proposal modifies this requirement and mandates listed companies to publish consolidated financial results prepared under Indian GAAP. Companies may, in addition, publish financial results under IFRS, if they so desire.

Observations

Companies that present consolidated financial results under IFRS would now be required to submit such results under Indian GAAP. The Companies Act, 2013 requires all companies to prepare and present consolidated financial statements in accordance with the Indian GAAP. The proposed modification in the Listing Agreement harmonises the requirements under both the regulations.

The requirement to discontinue IFRS consolidated financial results might apparently seem regressive, it could by contrast, be the SEBIs way of manifesting confidence that transition to Ind-AS is imminent. Additionally, the SEBI may consider providing transition relief to entities that have previously followed IFRS as they would also be required to complie comparative information as per Indian GAAP. This task could be onerous as they might not be geared to disclose such information.

Audit of foreign group companies

In preparing the consolidated financial results, the proposals require the results of Indian subsidiaries and joint ventures to be reviewed or audited. Further, in respect of the foreign subsidiaries or joint ventures, the consolidated results should include reviewed or audited results of such number of foreign subsidiaries which together with the reviewed or audited results of all the Indian subsidiaries or joint ventures, would constitute at least 80 percent of the consolidated turnover, net worth, or profit/(loss).

Observations

The proposals might pose administrative challenges in getting the results of the foreign subsidiaries reviewed or audited by auditors on a timely basis and will entail additional costs.

Change in accounting policy

The proposal clarifies that in the event of a change in accounting policy during the year, the impact of such change should be disclosed as a note in the financial results of the quarter in which the change occurs, without restating the previously published figures.

Observations

The proposal requiring to present the effect of change in accounting policy in the current quarter without having to restate previously published figures addresses inconsistent application by companies currently and appears to align the requirement to the principles of AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies which requires the effect of the change in accounting policy to be made in the year/period in which the change occurs. This, however, conflicts with the requirement in Ind-AS 5, Accounting Policies, Changes in Accounting Estimates and Errors which requires the restatement of the comparative amounts and ED of AS 5 (Revised), Accounting Policies, Changes in Accounting Estimates and Errors, issued by the ICAI.

The proposal is also a change from the current requirement of AS 25, Interim Financial Reporting which requires restatement of prior interim periods of the current financial year.

Other key changes

In order to improve consistency in presentation of exceptional items, the proposal defines exceptional items, in line with AS 5, to be items that are of such, size, nature and incidence that their disclosure is relevant to explain the performance of the entity e.g., write down of inventory, litigation settlement, etc. This can be

a subjective and judgemental area since the list given in AS 5 seems to be illustrative and not comprehensive and using the principles of nature, size and incidence various other items could continue to be disclosed as exceptional items.

The proposal clarifies that the figures for the last quarter are the difference between the audited figures in respect of the full financial year and the published year to date figures upto the quarter preceding the last quarter of the financial year. No separate review or audit required to be conducted for the last quarter unless the company presents audited quarterly financial results. This represents a welcome change since currently the requirement is that audited financial results in respect of the last quarter are to be submitted along with the audited financial results of the entire financial year.

The proposals have also now aligned the reporting formats for banks and finance companies. Currently finance companies are required to follow the same format followed by non-financial services entities.

Conclusion

In summary, by acknowledging the relevance of consolidated financial results, the SEBI is recognising the way the users of financial information analyse performance of companies. They align to international practices and the Companies Act, 2013 and would make transition to Ind-AS simpler. However, in the immediate, companies will have to contemplate upgrades to their financial reporting systems and scale up their finance functions to address the increased reporting obligations.


Accounting in the real estate industry is challenging; the industry is characterised with complex arrangements, e.g., agreement to sell, flat-buyer agreement, joint development agreements, space-sharing agreements, etc. and these agreements take various forms depending on the nature and type of arrangement between parties.

One of the most significant areas of judgement pertains to revenue recognition in the case of projects under development. In these projects, although the legal title in the property and possession are generally transferred to the buyers at the closure of the project, revenue may be recognised on a percentage of completion basis under Indian GAAP provided certain criteria are met. Determining if these criteria are met and to what extent requires significant judgement and involves careful evaluation of agreements to sell entered into between the real estate developers and buyers.

This article aims to analyse some of the requirements under Indian GAAP with regard to revenue recognition by the real estate developers, industry practice and also some of the typical clauses in agreements to sell and their possible impact on revenue recognition.

Background - accounting guidance under Indian GAAP

The Institute of Chartered Accountants of India (ICAI) issued a Guidance Note on Recognition of Revenue by Real Estate Developers, in 2006 which looked to address the timing of recognition of revenue by the real estate developers. As per AS 9, Revenue Recognition, one of the significant condition for recognition of revenue is that the seller of goods has transferred to the buyer the property in the goods for a price or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to a degree usually associated with ownership. The Guidance Note recognised that an agreement for sell (which is normally entered into at initial stages of construction) could be considered to have the effect of transferring all significant risks and rewards of ownership to the buyer, provided the agreement is legally enforceable and subject to the satisfaction of all the following conditions which signify transferring of significant risks and rewards (even though the legal title is not transferred or the possession of the real estate is not given to the buyer):

a. The significant risks related to the real estate have been transferred to the buyer; in case of real estate sales, price risk is generally considered to be one of the most significant risks.

b. The buyer has a legal right to sell or transfer his interest in the property, without any condition or subject to only such conditions which do not materially affect his right to benefits in the property.

It may be noted that even after the issuance of the above guidance note, varying practices were followed by the real estate developers with regard to the timing of recognition of revenue considering the subjectivity involved. In an attempt to address this situation, the ICAI issued a revised Guidance note on Accounting for Real Estate Transactions in 2012. This revised Guidance Note is applicable to all projects in the real estate which commence on or after 1 April 2012 and also to projects which have already commenced but where revenue is being recognised for the first time on or after 1 April 2012. An enterprise could choose to apply the revised Guidance Note from an earlier date provided it applies this Guidance Note to all transactions which commenced or were entered into on or after such earlier date of application. This Guidance note prescribes certain rule-based criteria for recognition of revenue by applying percentage of completion method, subject to fulfillment of certain conditions.

Revenue recognition by Real Estate Developers


TELL YOU THE INDIAN GAAP REQUIREMENTS FOR REAL ESTATE ACCOUNTING

PROVIDE A SUMMARY OF INDUSTRY PRACTICE REGARDING REVENUE RECOGNITION

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The following are examples of change in accounting policies by certain leading real estate companies due to the revised guidance note:

Sl.No.Name of the

companyExtracts from the published financial statements for the year ended 31 March 2013

1. DLF Limited

Revenue from constructed properties is recognised in accordance with the provisions of Accounting Standard (AS) 9 on Revenue Recognition, read with Guidance Note on Recognition of Revenue by Real Estate Developers. Revenue is computed based on the percentage of completion method and on the percentage of actual project costs incurred thereon to total estimated project cost, subject to such actual cost incurred being 30 per cent or more of the total estimated project cost

With effect from April 1, 2012 in accordance with the Revised Guidance Note issued by Institute of Chartered Accountants of India (ICAI) on Accounting for Real Estate Transactions (Revised 2012), the Company revised its Accounting Policy of revenue recognition for all projects commencing on or after April 1, 2012 or project where the revenue is recognised for the first time on or after the above date. As per this Guidance Note, the revenue has been recognised on percentage of completion method provided all of the following conditions are met at the

reporting date.

i. at least 25 percent of estimated construction and development costs (excluding land cost) has been incurred;

ii. at least 25 percent of the saleable project area is secured by the Agreements to sell/ application forms (containing salient terms of the agreement to sell); and

iii. at least 10 percent of the total revenue as per agreement to sell are realised in respect of these agreements.

2. Oberoi Realty Limited

The Group follows the percentage of project completion method for its projects. The revenue recognition policy is as under:

Project for which revenue is recognised for the first time on or after April 1, 2012

The Institute of Chartered Accountants of India has issued Guidance Note on Accounting for Real Estate Transactions (Revised 2012) in connection with the revenue recognition for a real estate project which commences on or after April 1, 2012 and also to real estate projects which have already commenced but where revenue is being recognised for the first time on or after April 1, 2012.

In this scenario, the Company recognises revenue in proportion to the actual project cost incurred (including land cost) as against the total estimated project cost (including land cost), subject to achieving the threshold level of project cost (excluding land cost) as well as area sold, in line with the Guidance Note and depending on the

type of project.

Project for which revenue recognition has commenced prior to April 1, 2012

In this scenario, the Company recognises revenue in proportion to the actual project cost incurred (excluding land cost) as against the total estimated project cost (excluding land cost) subject to completion of construction work to a certain level depending on the type of the project.

3. Godrej Properties

Limited

The Company is following the Percentage of Completion Method of accounting. As per this method, revenue from sale of properties is recognised in Statement of Profit & Loss in proportion to the actual cost incurred as against the total estimated cost of projects under execution with the Company on transfer of significant risk and rewards to the buyer. Up to 31 March 2012 revenue was recognised only if the actual project cost incurred is 20 percent or more of the total estimated project cost.

Effective 1st April 2012, in accordance with the Guidance Note on Accounting for Real Estate Transactions (Revised 2012) (Guidance Note), all projects commencing on or after the said date or projects which have already commenced, but where the revenue is recognised for the first time on or after the above date, Construction revenue on such projects have been recognised on percentage of completion method provided the following thresholds have been met:

a. All critical approvals necessary for the commencement have been obtained;

b. The expenditure incurred on construction and development costs is not less than 25 percent of the total estimated construction and development costs;

c. At least 25 percent of the saleable project area is secured by contracts or agreements with buyers; and

d. At least 10 percent of the agreement value is realised at the reporting date in respect of such contracts and it is reasonable to expect that the parties to such contracts will comply with the payment terms as defined in the contracts.


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Source: Published financial statements for the year ended 31 March 2013

Sl.No.Name of the

companyExtracts from the published financial statements for the year ended 31 March 2013

4. Sobha Developer

Limited

For projects commenced and period where revenue recognised before April 1, 2012

Revenue from real estate development/sale of developed property is recognised upon transfer of all significant risk and rewards of ownership of such real estate/property, as per the terms of the contracts entered into with buyers, which generally coincides with the firming of the sale contracts/agreements, except the contracts where the Group still has obligations to perform substantial acts even after the transfer of all significant risks and rewards. In such cases, the revenue is recognised on percentage of completion method, when the stage of completion of each project reaches a reasonable level of progress. Revenue is recognised in proportion that the contract costs incurred for work performed up to the reporting date bear to the estimated total contract costs. Land costs are not included for the purpose of computing the percentage of completion.

For projects commenced on or after April 1, 2012 and also to projects which have already commenced but

where revenue is being recognised for the first time on or after April 1, 2012.

Revenue from real estate projects including revenue from sale of undivided share of land (group housing) is recognised upon transfer of all significant risks and rewards of ownership of such real estate/property, as per the terms of the contracts entered into with buyers, which generally coincides with the firming of the sales contracts/agreements. Where the group still has obligations to perform substantial acts even after the transfer of all significant risks and rewards, revenue in such cases is recognised by applying the percentage of completion method only if the following thresholds have been met:

a. All critical approvals necessary for the commencement of the project have been obtained;

b. The expenditure incurred on construction and development costs (excluding land cost) is not less than 25 percent of the total estimated construction and development costs;

c. At least 25 percent of the saleable project area is secured by contracts/agreements with buyers; and

d. At least 10 percent of the contracts/agreements value are realised at the reporting date in respect of such contracts/agreements.

When the outcome of a real estate project can be estimated reliably and the conditions above are satisfied, project revenue (including from sale of undivided share of land) and project costs associated with the real estate project should be recognised as revenue and expenses by reference to the stage of completion of the project activity at the reporting date arrived at with reference to the entire project costs incurred (including land costs).

5. Brigade enterprises

Income from contractual Real Estate projects is determined and recognised, based on the percentage of completion method, as the aggregate of the profits earned on the projects completed/under completion and the value of construction work done during the period.

Profit so recognised in respect of individual projects is adjusted to ensure that it does not exceed the estimated overall profit margin. Loss on projects, if any, is fully provided for.

Stage of completion of projects in progress is determined on the basis of the proportion of the contract costs incurred, in respect of individual projects for work performed up to the period of the financial statements, bear to the estimated total project cost.

Income recognised as contract revenue during the period is based on the lower of stage of completion as determined above and actual amount received on sale (pursuant to agreements entered into by the Company). Project revenues on new projects are recognised when the cost incurred for stage of completion of each

project reaches a significant level (excluding land cost), which is estimated to be at least 25 percent.

As may be noted from the above, currently most companies are following two policies at the same time, since the revised guidance note is applicable to all projects in real estate which are commenced on or after 1 April 2012 and also to projects which have already commenced but where revenue is being recognised for the first time on or after 1 April 2012. In

respect of all other projects, the earlier guidance note continues to apply. It may be noted that while applying earlier guidance note, the companies were and continue to follow varying practices in respect of timing of recognition of revenue; for instance, some use a 20 percent cost threshold to commence recognising revenue whilst some others

have used a 30 percent threshold for this purpose. It may be noted that after the issuance of the revised Guidance Note, there appears to be consistency with regard to timing of recognition of revenue due to prescription of certain rule-based thresholds.


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Sl.No. Sample clause in the agreement to sale Possible impact on the transfer of risk and rewards

1. Right of buyer to transfer the interest in the property under development

The transfer or substitution of the name of the buyer in the agreement shall be allowed on such terms and conditions as the developer may deem fit including payments of administrative charges, etc. Such transfer shall not be unreasonably withheld.

The buyer should have a legal right to sell or transfer his interest in the property without any condition or subject to only such conditions which do not materially affect his right to benefits in the property. Accordingly, it needs to evaluated whether the relevant clause in the agreement to sell has the effect of giving unconditional right to allow or not allow a buyer to transfer his rights under the agreement to a third party. It would be difficult to demonstrate that the significant risk and rewards are transferred to the buyer in case the developer has the unconditional right to restrict the transfer by the buyer. On the contrary, in case this clause provides that the transfer is allowed subject to payment of certain nominal administrative charges, it could be demonstrated that the risk and rewards are transferred and the developers permission is only an administrative process.

2. Provisional allotment and subsequent change in area of the flat

The allotment of this flat is provisional. Both buyer and the developer understand that the area of the said flat given in this agreement is subject to change as per the direction of the sanctioning authority or architect/engineer of the developer which may result in a change (decrease/increase) in the area of the said flat, change in its dimensions, size, number, etc. In case of such a change, the price of the flat shall be subject to adjustment at the booking rate based on the change in area.

With regard to this clause, it needs to be evaluated whether there will be a limited adjustment in the price based on the final area delivered by the developer or the agreement to sell is executed even without detailed plan and/or approval from necessary authorities. In the latter case, there can be a significant adjustment in the area and the price of the flat. In case, all the approvals are in place and only a limited change in the area is expected due to certain changes necessitated as a part of construction process, the recognition of revenue may commence and an adjustment due to change in estimate at the time of delivery of the flat be recognised. However, in case the relevant approvals are not in place and significant changes are expected, there is likelihood that the transfer of risk and rewards analysis will be impacted till this contingency is resolved.

Transfer of risk and rewards

While both the pre-revised and revised Guidance notes recognise percentage of completion method for the purposes of revenue recognition, it may be noted that the same can be applied only if it is determined that there is a transfer of risk and rewards. For this, the terms and conditions contained in the agreement to sell have to be carefully evaluated to assess if they have the effect of transferring the underlying risk and rewards of the property under construction.

This assessment is fundamental to the revenue recognition process for the real estate developers and in the absence of transfer of risk and reward may result in no revenue being recognised till the legal title is transferred/possession is given. This assessment is often judgemental and involves a comprehensive evaluation of various terms and conditions of the agreement to sell.

The following table illustrates certain typical clauses in the agreement to sell and their impact of the assessment whether risk and rewards can be considered as transferred:


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Sl.No. Sample clause in the agreement to sale Possible impact on the transfer of risk and rewards

3. Implications of cancellation of booking

As per the payment schedule, the buyer is required to pay 10 percent of the price of the flat at the time of booking, which would be considered as earnest money. In the event of failure of the buyer to perform his obligations or to fulfil all the terms and conditions set out in the Agreement to sell, the developer has the right to forfeit the earnest money out of the amounts paid by the buyer and the allotment of the said Flat shall stand cancelled. In such a case, the rest of amount would be refunded by the developer. In case any of the installments indicated in the payment schedule is not paid when it become due and there is a continuing defaults in making payment of the outstanding amount for three consecutive months, the allotment shall automatically stand cancelled and the developer shall refund the amount paid over and above the earnest money.

It may appear that the effect of such a clause is that in case the buyer fails or neglects to perform any of his obligations under the agreement, the developers remedy is limited to forfeiting the earnest money (10 percent). In such a case, it could be viewed that the downward price risk is not transferred by the developer since in case of fall in prices, the buyer may exit by having the earnest money of 10 percent forfeited and the rest of the amount would be refunded to him.

This clause requires careful consideration which may involve evaluation of respective rights and obligations of the developer and the buyer in case there is a cancellation.

4. Ability of the developer/buyer to raise finance on the property

The developer is entitled to raise finance/loan from any bank by way of mortgage of the property under construction and the buyer will have no objection in this regard, However, such mortgage, if created, will be vacated before execution of conveyance deed and handing over the possession of the said Flat to the buyer. Further, in case the buyer wants to avail loan facility from banks to purchase the flat, the developer will not have any objection provided that the terms of the bank shall be exclusively binding and applicable upon the buyer only.

This clause also needs to be evaluated as the buyer and the developer would be mortgaging the same property. An important question to analyse is whether the developers ability to mortgage the property is an indicator that the buyer would obtain complete ownership interest in the property only on execution of conveyance deed. Additionally, in case the buyer intends to raise finance against the property, one needs to assess what would be the position of the mortgage created by the developer.

There may be other clauses in typical agreements which may also warrant careful evaluation to conclude whether the agreement to sell has the effect of transferring the risk and rewards.

Carve-out from IND-ASs

Considering the peculiar nature of the industry, while the ICAI has already issued Guidance Notes to deal with the subject, the international experience is no different. The International Accounting Standards Board (IASB) has issued an Interpretation (IFRIC 15), Agreement for Construction of Real Estate, to deal with the subject. In general, the criteria laid down in IFRIC 15 are such which makes it difficult to recognise revenue based on an agreement to sell. IFRIC 15 provides guidance on determining whether revenue from the construction of real estate should be accounted for in accordance with IAS 11, Contraction Contracts or IAS 18, Revenue and the timing of revenue recognition. If the agreement does not meet the definition of a construction contract, then

Conclusion

Revenue recognition for real estate developers is driven by a mix of principles and rules. The rules are somewhat arbitrary but relatively easy to apply. It is often the application of the principles that is tricky and judgemental. As we have illustrated in this article, considering the significant judgement involved and its implication on revenue recognition, many companies are finding it to be beneficial to do this assessment/evaluation while drafting the agreement to sell itself rather than conducting this assessment on already executed documents where amendments/clarifications may not be possible.

it is in the scope of IAS 18. In making this assessment, an entity should consider the nature of the buyers rights - e.g. whether they are substantive the surrounding facts and circumstances and the legal requirements of the relevant jurisdiction. Therefore, there is a potentially significant GAAP difference between the Guidance Note and IFRIC 15. It may also be noted that this GAAP difference would continue even after notification of Ind-ASs since while issuing Ind-ASs, IFRIC 15 has not been included in Ind AS 18, Revenue. Such agreements have been scoped out from Ind AS 18 and have been included in Ind AS 11, Construction Contracts.


Introduction The Ministry of Corporate Affairs (MCA) had issued a revised Schedule VI which sets out a new format for preparation and presentation of financial statements by the Indian companies for the financial years commencing on or after 1 April 2011. The revised Schedule VI introduced some significant conceptual changes such as current/non-current distinction, primacy to the requirements of the accounting standards, etc. While the revised Schedule did not adopt the international standard on disclosures in the financial statements fully, it intended to bring corporate disclosures closer to international practices.

It has been more than two years since the revised Schedule VI has come into force and we thought it would be meaningful to assess practical implementation issues and differences in practice. The application of the revised schedule has thrown up a number of questions, the answers to which are not often straight forward or which require additional guidance from the MCA or the Institute of Chartered Accountant of India (ICAI).

Some of the significant aspects of the revised Schedule included:

The revised Schedule applies to all companies following Indian GAAP until such companies are required to follow International Financial Reporting

Standards (IFRS) converged Indian accounting standards (Ind AS).

Accounting standards and requirements of the Companies Act (Act) override the requirements of the revised Schedule, wherever the two are inconsistent.

Information to be mandatorily presented on the face of the financial statements limited to only broad and significant items details by way of notes.

Revised Schedule VI has eliminated the concept of Schedules. Such information is now provided in the Notes to the accounts.

Part IV of the pre-revised Schedule (containing balance sheet abstract and general business profile) has been dispensed with.

Format of cash flow statement not prescribed hence companies which are required to present this statement (i.e., other than small and medium sized companies) to continue to prepare it as per AS 3, Cash Flow Statements.

The nomenclature for the Profit and Loss account is now changed to Statement of Profit and Loss. Also, only the vertical format is prescribed for both Balance Sheet and the Statement of Profit and Loss.

The classification in the Statement of Profit and Loss is by nature of expenses.

Disclosure requirements of various accounting standards also need to be complied with.

We examine a number of areas in this article where we have encountered either practical implementation issues or areas where we see differences in application by companies. Often, in the absence of specific guidance, more than one treatment may be possible.

Revised Schedule VI: Differences in practice


HIGHLIGHT PRACTICAL IMPLEMENTATION ISSUES WHILE PRESENTING FINANCIAL STATEMENTS AS PER SCHEDULE VI

SHOWCASE AREAS WHERE WE SEE MORE THAN ONE WAY OF PRESENTATION

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Classification of provision for disputed tax dues Under the revised Schedule, a liability is classified as current when it satisfies

AA Update September 2013

Documents

Transcript of AA Update September 2013