Financial Reporting Quality Review Report (FRQRR) in respect of ISGEC Heavy Engineering Limited for the FY 2019-20.
Company: ISGEC Heavy Engineering Limited
CIN: L23423HR1933PLC000097
Financial Reporting for the Financial Year: 2019-20
Financial Reporting Framework: Indian Accounting Standards (Ind AS)
Report No: NF- 20011/12/2021
Date of Report – 20.07.2022
National Financial Reporting Authority
7th Floor, Hindustan Times House
18-20, Kasturba Gandhi Marg, New Delhi 110001
https://nfra.gov.in
A. Executive Summary
1.1. The Legal Framework of Financial Reporting Quality Review (FRQR)
As mandated under Section 132(2)(b) of the Companies Act, 2013, the National Financial Reporting Authority (NFRA) shall inter alia, monitor and enforce compliance with accounting standards in such manner as may be prescribed. Rule 7 of the NFRA Rules, 2018, provides that for monitoring and enforcing compliance with accounting standards under the Act, NFRA may–
(a) review the financial statements of the company;
(b) direct such company or its auditor by written notice to provide further information or explanation or any relevant documents relating to such company; and
(c) require the personal presence of the officers of the company and its auditor for seeking additional information or explanation in connection with the review of financial statements of such company.
This FRQR focuses on the role of preparers, i.e., those responsible for the preparation of Financial Statements and Annual Reports. The primary goal of the FRQR is to assess and evaluate how well the information needs of users of the Financial Statements and the Annual Report have been met. The FRQR also has the objective of assessing the Financial Reporting Quality Control System of the Company and the extent to which the same has been complied with in the preparation and presentation of the Financial Statements.
Accordingly, NFRA has made this Financial Reporting Quality Review Report (FRQRR) of the M/s ISGEC Heavy Engineering Ltd. (ISGEC/the Company) for the Financial Year 2019-20. ISGEC is a Company listed on the Bombay Stock Exchange (BSE) and is engaged in manufacturing project businesses & Engineering Procurement & Construction (EPC) activities.
1.2 Review Approach
Under the above mandate, NFRA has reviewed the said financial statements of ISGEC Heavy Engineering Ltd., which was selected for review on the basis of NFRA’s statistical sampling approach. The review is made according to the Companies Act, 2013, and the NFRA Rules, 2018. The observations in this FRQRR are based on an examination of the Annual report of the Company and additional information sought from the Company from time to time, an examination of the financial statements, and the responses submitted by the Company to NFRA’s Questionnaire and during the in-person presentation made by the Company on 5th July 2022.
The observations in this FRQRR are divided into three parts categorised as High Impact, Moderate Impact and Low Impact. Each category has two kinds of observations – observations in the Annual Financial Statements and observations in the other parts of the Annual Report. These divisions detail the observations, and conclusions made during the FRQR process. The final observations and conclusions were made after the in-person presentation by the Company. Wherever the Company has provided satisfactory responses to the questions of the questionnaires or has pointed out inaccuracies, those issues have been removed from the respective sections.
The FRQRRs of NFRA are designed to identify and highlight non-compliance with the requirements of the applicable Accounting Standards and the Companies Act 2013, and to bring out insufficiencies in the Quality Control System of the companies with regard to the preparation and presentation of financial statements and Annual Reports. The observations in the FRQRR are made based on a high-level review of the annual reports and the replies to queries furnished by the company. The queries are limited to the specific areas selected from the annual reports, and do not cover the entire gamut of financial reporting by the company. The FRQRR is, therefore, not to be treated as an overall rating tool. The observations in this FRQR set out NFRA’s view of the specific reporting issues discussed in this report. Though there are areas of good quality reporting, many of the NFRA queries were a result of apparent inconsistencies in the information reported in the financial statements and the annual report, viewed from a user’s perspective.
The Chronology of the events regarding this FRQRR
NFRA’s FRQR started with seeking documents from the Company ISGEC, vide NFRA letter dated 15th April 2021, information/certified copies of documents from the Company pertaining to the financial statements. The Company provided the required information vide its email dated 14th July 2021 (attaching letter dated 13th July 2021). After a preliminary examination of the financial statements of the Company for the financial year 2019-20, NFRA sent a questionnaire dated 14th October 2021, containing the prima facie observations on the financial statements. The Company vide its email dated 29th November 2021 and 21st December 2021 provided its response to the questionnaire. The Company made an in-person presentation on the 5th of July 2022 and then submitted a written reply on 8th of July 2022 to certain additional queries made by NFRA. This FRQRR has been finalised based on all such responses by the Company.
1.3 Executive Summary of Observations in the FRQR
1.3.1 Key observations categorized as ‘High’ Impact.:
(a) NFRA observes deficiencies in implementing the provisions of Ind AS 109 Financial Instruments relating to impairment loss allowance (provisioning) for some of the financial assets viz. Trade Receivables and other financial assets. (Para 2.1)
(b) The company did not evaluate impairment loss allowance on ‘Unbilled Revenue1’ (under Other Current Asset) despite it being a contract asset2 for which the company was required to evaluate impairment loss in accordance with the requirements of Ind AS 109. (Para 2.2)
(c) The Company did not make the required disclosure for Employee Benefits-Pensions in accordance with Para 135 of Ind AS 193 regarding defined contribution plans. The note provided by the Company lacks clarity on whether the employee benefit of Pension is a defined benefit plan or a defined contribution plan. Such disclosure is important to enable the users of financial statements to understand the characteristics of the benefit plans, the consequential liabilities of the Company and the risks associated with them. (Para 2.3)
(d) ISGEC has given corporate guarantees to the banks to secure the credit facilities granted by the banks to three of its subsidiaries. These corporate guarantees should have been accounted for as financial guarantees in accordance with Para 4.2.1 of Ind AS 1094. But the Company has not done the same, resulting in non-compliance with the requirements of Ind AS 109. (Para 2.4)
(e) ISGEC acquired another overseas company through one of its wholly owned subsidiaries during the year but did not disclose this transaction in the consolidated financial statements of ISGEC in accordance with the requirements5 of Ind AS 103 Business Combinations. The Company has not made adequate disclosures in this regard. (Para 2.5)
(f) The overseas company so acquired was in distress due to financial difficulties, but ISGEC did not evaluate impairment loss on its investment value in its subsidiary in accordance with Ind AS 1096. Though the amount involved is not material, this shows weakness in the internal controls with respect to impairment evaluation by the company. Also, ISGEC has earlier provided a loan to the same wholly owned subsidiary but did not evaluate the increase in credit risk on this loan as per the requirements of Ind AS 1097. (Para 2.6)
(g) ISGEC has given loans to two of its foreign subsidiaries namely, ISGEC Investments Pte Ltd., Singapore and Eagle Press & Equipment Co. Ltd, Canada but did not disclose the purpose of giving loans to its foreign subsidiaries in its Board Report in accordance with the provisions of section 1868 of the Companies Act, 2013. (Para 2.7)
1.3.2 Key observations categorized as ‘Moderate’ Impact.:
(a) NFRA has observed that certain information regarding ‘significant payment terms’ (e.g. when a payment is due) as required9 by Ind AS 115 Revenue from contracts with customers is not disclosed in the notes to the financial statement of the Company. Also, disclosure regarding ‘obligations for returns, refunds, and other similar obligations’10 has not been made by the Company. This disclosure is mandatory as per Ind AS 115. (Para 3.1)
(b) According to Ind AS 115 Revenue from contracts with customers, an entity is required to disclose its method used to recognise revenue and why this method provides a faithful depiction of transfer of goods and services. The company’s disclosures fall short of the above requirement insofar as the explanations why the method used provides a faithful depiction of the transfer of goods and services11 is concerned. (Detailed observation in Para 3.2)
(c) The Company has not clarified in the financial statements regarding the bifurcation of leave encashments into long-term and short-term. Ind AS 112 specifically requires the companies to inform the users of financial statements of the measurement basis used while categorising a line item as short term or long term. (Detailed observation in Para 3.3)
(e) The Company has not disclosed the nature of the balance sheet item “Others” under Other Non-Current Assets as required by Schedule III of the Companies Act. (Para 3.5)
(g) The Company has taken a loan under a government scheme in which a part of the interest shall be borne by the government in the form of interest subvention. Ind AS 20 Government Grants specifically requires certain disclosures13 but ISGEC has not complied with these disclosures (Para 3.7)
1.3.3. The Company in its submissions to NFRA has stated that it has taken measures to rectify the deficiencies and other issues observed by NFRA. The Company also submitted that it has taken measures to implement these recommendations for the subsequent financial years and also taken measures to ensure no such errors/omissions occur in future financial statements.
Notes:-
1 Unbilled Revenue: these refer to the costs already incurred for execution of contracts for customers but not yet billed to them because specified milestones as per contract agreements have not been achieved yet.
2 Para 107 of Ind AS 115 Revenue from contracts with customers refers to contract assets as : “A contract asset is an entity’s right to consideration in exchange for goods or services that the entity has transferred to a customer. An entity shall assess a contract asset for impairment in accordance with Ind AS 109.”
3 Para 135 of Ind AS 19 Employee Benefits states “An entity shall disclose information that:
(a) explains the characteristics of its defined benefit plans and risks associated with them. (b) identifies and explains the amounts in its financial Ind AS 19, Employee Benefits statements arising from its defined benefit plans; and (c) describes how its defined benefit plans may affect the amount, timing and uncertainty of the entity’s future cash flows.
4 As per Para 4.2.1 of Ind AS 109 – An entity shall classify all financial liabilities as subsequently measured at amortised cost, except for:
c) financial guarantee contracts. After initial recognition, an issuer of such a contract shall (unless paragraph 4.2.1(a) or (b) applies) subsequently measure it at the higher of:
(i) the amount of the loss allowance determined in accordance with Section 5.5 and
(ii) the amount initially recognised (see paragraph 5.1.1) less, when appropriate, the cumulative amount of income recognised in accordance with the principles of Ind AS 115
5 Para B64 of Ind AS 103 Clauses (c), (d), (f), (g), (h), (j), (n), (p) and (q)and Para B67 Clause (a)(i) and (ii)
6 Para B5.2.3 of Ind AS 109
7 Para B 5.2.5 of Ind AS 109
8 Sec. 186(4): “The company shall disclose to the members in the financial statement the full particulars of the loans given, investment made or guarantee given or security provided and the purpose for which the loan or guarantee or security is proposed to be utilised by the recipient of the loan or guarantee or security”
9 Para 119 of Ind AS 115
10 Para 119 of Ind AS 115
11 Para 124 of Ind AS 115
12 Para 65 of Ind AS 1 that “the information on the expected date of recovery of non-monetary assets such as inventories and expected date of settlement for liabilities such as provisions is also useful, whether assets and liabilities are classified as current or as noncurrent.”
13 Para 39 of Ind AS 20
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