CA Anuj Agrawal
As India moves towards International Financial Reporting Standards (Ind-AS/ IFRS) requirements gradually, there are some fundamental changes which are imperative in nature while defining group structure of any entity and/ or requirement to present it on the face of financial statements differently comparing to the present practices in India.
A. CHANGE IN ASSOCIATE DEFINITION
Let’s talk about the definition of Associate as defined by sec 2 (6) of Companies act 2013 –
(6) “associate company”, in relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company.
Explanation.—For the purposes of this clause, “significant influence” means control of at least twenty per cent. of total share capital, or of business decisions under an agreement;
However current Indian accounting standard AS-23 “Accounting for Investments in Associates in Consolidated Financial Statements” states that
An Associate is “is an enterprise in which the investor has significant influence and which is neither a subsidiary nor a joint venture of the investor”
Significant influence is the power to participate in the financial and/ or operating policy decisions of the investee but not control over those policies.
Now let’s first refer the definition of Associate as per the new accounting standards applicable (refer MCA circular for its applicability) i.e. Ind-As/ IFRS -28 “Investments in Associates and Joint Ventures” which says –
An associate is an entity over which the investor has significant influence,
Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies.
B. POTENTIAL VOTING RIGHTS
Ind-As 28 para 7 states that “An entity may own share warrants, share call options, debt or equity instruments that are convertible into ordinary shares, or other similar instruments that have the potential, if exercised or converted, to give the entity additional voting power or to reduce another party’s voting power over the financial and operating policies of another entity (ie potential voting rights). The existence and effect of potential voting rights that are currently exercisable or convertible, including potential voting rights held by other entities, are considered when assessing whether an entity has significant influence………”
C. INVESTMENT IN ASSOCIATE BY VENTURE CAPITAL FUNDS, MUTUAL FUNDS, ULIP ETC
As per Ind-As -28 “Investment in Associates & Joint Ventures” para -18 states that “ When an investment in an associate or a joint venture is held by, or is held indirectly through, an entity that is a venture capital organisation, or a mutual fund, unit trust and similar entities including investment-linked insurance funds, the entity may elect to measure investments in those associates and joint ventures at fair value through profit or loss in accordance with Ind AS 109”
Summary NOTES :
1) While reading the above definition carefully, one can clearly note that there is some notable gaps between the definition about “Significant influence” which is more stringent while evaluating financial and operating policies in case of new reporting standard (IND-AS 28) as it says BOTH the conditions should be fulfilled, however current accounting version allows “and/or” while evaluating financial and operating policies decisions. Conversely, it can be argued that as per the companies act definition as mentioned above, there is a specific mention about the percentage holding which can make an entity to be eligible as an associate even the other condition does not satisfies;
2) There could be a situations, where an associate has been identified by the entity based on merely on percentage holding (as per companies act) which could be outside the scope while evaluating under Ind-As/ IFRS as one has to look at the significant influence criteria in substance even the percentage holding does not reach to 20% (as mentioned by Companies act which is currently being followed in general in India)
3) Representation on board could be an area where an entity needs to look at it while making any conclusion over the significant influence. There are many situations, where representation on board was one of the contractually available option but the entity has not exercised the same, then also it can lead towards significant influence subject to other significant clauses,
4) Ind-As- 28 states “It is presumed that an entity will have significant influence if it holds 20% shares in an entity unless it can be demonstrated that this is not the case” which essentially means that an auditor or management needs to evaluate about the situation where there is no participation on the board and no significant influence can be established then it can be considered to treat as investment (either through profit or loss or FVOCI) only,
5) There is no potential voting rights concept in current accounting practices which means that if an entity currently holds some call options which are substantive/ currently exercisable (should not be restricted) then these also to be taken into account while deciding about associate percentage holdings,
6) There are some situations currently where an entity does not need to prepare consolidated financial statement if it does not has any subsidiary and holds associates only, but after the introduction of Ind-As/ IFRS no such exemption is allowed/ available and all entities who only has associate also needs to prepare consolidate financial statements (even there in no subsidiary),
7) In the current accounting practices, there is nothing mentioned about the maximum difference in reporting dates that could be allowed between parent financial statement and associate, however as per Ind-As/IFRS this difference could be maximum upto 3 months,
8) In separate financial statement of parent these associates are being shown at cost less impairment under current accounting system, however as per Ind-As -27 “Separate financial statements” these investment in associate can either be shown at cost or as per Ind-As 109 “Financial Instruments” subject to certain conditions,
9) Venture capital funds, Mutual funds etc can elect to account investment in associate at fair through profit and loss instead of equity accounting. This exemption was not available in current accounting practices and every entity has to use equity accounted method only.
The above discussion provides an overall idea about the changes that could affect certain associates’ classification/ measurement as the entity move towards Ind-As/ IFRS gradually. These basis should not be treated any kind of advise and should be read together with the relevant accounting standards available.
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