Insolvency and Bankruptcy Code: Accounting and Disclosure issues

Introduction

One of the most radical reforms of recent times had been the enactment of Insolvency and Bankruptcy Code,2016, (The Code or IBC). Though the Code had been in the making for many years; the actual enactment was triggered by huge pile-up of NPAs of PSU banks and need to clean up the balance sheet of banks.

NPAs of banks have zoomed to exceptionally high levels of almost Rs. 8.77 lakh crores at December 31, 2017(representing 10% percent of advances by banks). Various measures taken by RBI in the past including restructuring of debts had not achieved the desired results. Hence, the need for an effective mechanism to quickly resolve the mess and unlock the value of assets of defaulting companies which are either not being utilized or are underutilized.

Corporate Insolvency Resolution Process (CIRP or RP) Summary

The Code envisages a time-bound resolution process (which is summarised below) to have a better understanding of accounting and disclosure which may arise during the course of CIRP.

• Filing of the application by lenders/operational creditors to National Company Law Tribunal (NCLT or the Tribunal) upon the occurrence of the default.
• Resolution process commences upon admission by the Tribunal (time period-14 days).
• Declaration of a moratorium prohibiting any suits/proceedings against the company, execution of any judgment of court/authorities for recovery of loan/dues during the resolution period.
• Suspension of the powers of the Board of Directors.
• Appointment of Resolution professional (RP) to manage affairs of the Company, who is empowered to exercise powers of Board and take all actions necessary to manage the Company as a going concern during the resolution period.
• Formation of Committee of Creditors (CoC) consisting of lenders to consider and approve the resolution plan.
• Collating claims from lenders and operational creditors and reconciliation of balances as appearing in books of borrowers.
• Valuation of assets or business of the defaulting company both on Fair Value and liquidation value basis to be done by two registered valuers.
• RP to invite bids from prospective buyers for resolution plans.
• Finalisation of bidder and approval of resolution plan by CoC.
• Approved plan to be referred to NCLT for its final approval within 180 days of admission, subject to extension of 90 days
• Initiation of liquidation proceedings In case resolution plan could not be finalized/approved (or there are no bidders) within the said period of 270 days

Current status of IBC

IBC took a big leap forward when in June 2017, RBI referred 12 large accounts, amounting to Rs.2.8 lakh crores

to NCLT which included big corporates such as Essar Steel, Bushan Steel, Bushan Power and Steel, Alok Industries, Jaypee Infratech, Lanco Infra etc. In the second phase, 25 accounts of the value of Rs.1.30 lakh crores were referred to NCLT. These cases represent 46%of of NPAs as at December 31,2017.

These case are currently at various stages of resolution and will be a crucial test for the effective working of IBC. As of now, Bushan Steel matter is nearing completion with Tata Steel being declared as the selected Buyer and only one case of Electrosteel Steels is approved by NCLT.

Potential accounting and disclosures issues

These companies will be finalizing its financial statements for the year ended March 31, 2018. In

the background of conditions faced by companies in IBC, following common potential accounting and disclosure issues will need to be addressed and taken into consideration while finalizing financial statements of these companies.

Going Concern Basis

Applicable standards

Under AS-1, one of the fundamental assumption underlying the preparation of financial statements(FS) is that the entity is a going concern and will be able to continue its operations for the foreseeable future (generally one year) and realize it’s assets and discharge its liabilities in the normal course of business.

IND AS-1 requires that while making financial statements, the management of the company shall make an assessment of the entity’s ability to continue as a going concern. IND AS-10 also states that an entity shall not prepare its FS on a going concern basis if management determines after the reporting period date either that it intends to liquidate the entity or cease trading, or that it has no realistic alternative but to do. This implies that while making such an assessment, events occurring after the year-end but before the approval of FS should also be considered.

Why going concern issue

The companies under resolution process will generally have one or more combination of following indicators/conditions:

• Huge accumulated losses and continuing current loses
• Significant debts on balance sheets (over-leveraged balance sheets)
• Current liabilities exceeding current assets
• Low capacity utilization or closed plants resulting in operational losses
• Negative cash flows resulting from losses, significant financial cost of debts
• Defaults in repayments of debts including interests
• Inability to carry on its normal operations for lack of funding
• Lenders having classified its debts as non-performing assets triggering insolvency proceedings

What needs to be done

Above indicators and condition creates a material uncertainty and management should make an assessment as to the ability of the company to continue as a going concern, which would depend upon the future outcome of these proceedings.

FS of these companies should make adequate disclosure of the details and status of the resolution process, the existence of above events and conditions and consequent material uncertainty as to its ability to continue as going concern, which depends on the outcome of the resolution proceedings.

In a case where based on above assessment, going concern assumption is considered appropriate by the management, FS would be prepared by applying normal accounting principles of recognition and measurement. The use of going concern assumption is not appropriate, where based on the progress of resolution proceedings, there is no likelihood of any resolution and the company is likely to be referred for liquidation or has already been referred.

Above standards, however, does not provide any details of an alternative basis in case FS is prepared on the basis other than going concern. The management of companies should based on specific facts and circumstances of each case should choose accounting policies that will result in the most relevant and reliable information.

FS in such case should normally be prepared on Liquidation basis (which means assets would be stated at values estimated to be realized and liabilities at values expected to be paid on liquidation) with adequate disclosure of basis of preparation and judgments made in selecting accounting policies.

(Issues involved in preparation of FS on basis other than going concern is a separate subject in itself and an is not covered in this article)

Recognition of Impairment in the value of assets

Applicable Standards

As per requirement of IND AS- 36 and AS-28 on impairment of assets, an entity is required to test impairment in carrying value of assets (fixed assets, intangibles and other non-current assets) in situations where there are certain indicators such as assets are either not being utilised or utilisation is significantly lower than its capacity and recognise impairment in value, if any.

The impairment testing may have to be done at each asset level or at the cash generating unit level(CGU) depending upon facts of each case. The resultant impairment loss if any, will be charged as an expense in profit or loss account. In case impaired asset is revalued as permitted by IND AS-16 on Property, Plant and Equipment and IND-AS 38 on intangible assets, the loss is first adjusted against previously recognized revaluation gains in other comprehensive income in respect of that asset.

(Impairment in value is the shortfall in carrying a value of assets in FS as compared to its recoverable amounts. The recoverable amount is higher of 1) Fair value of assets less cost of disposable or 2) assets value in use (i.e. estimated discounted future cash flows from use of assets in the business of the company), whichever is higher)

What needs to be done

Many of companies in resolution process would have already recognized some impairment based on an assessment made in the previous years as there were already indicators of impairment even before the commencement of resolution proceedings (as mentioned in above para on going concern-negative cash flows, losses from operations due to lower capacity utilization etc). Accordingly, provisions already recognized (or not recognized) will have to be tested for further impairment if any, based on current conditions.

The status of resolutions proceedings will provide additional evidence of impairment in values including fair value and liquidation value determined by Registered valuers and estimates of future cash flows.

FS should adequately disclose amounts recognized as an impairment loss and basis thereof and reasons for not recognising impairment if, any.

Recognition of deferred tax assets (DTA)

Applicable Standards

IND-AS -12 permits recognition of deferred tax assets on such benefits to the extent it is reasonably probable supported by convincing evidence that the company will be able to adjust these carry forward losses and depreciation against future taxable profits.(As-22 prescribe more stringent criteria of virtual certainty). Such recognition need to be reviewed at the end of every accounting period based on revised estimates of profitability and consequent adjustment if, any required in deferred tax balances would be made in FS.

What needs to be done

Companies under IBC would be having significant amounts of carrying forward tax losses and unabsorbed depreciation of past years which would be available for set-off against future taxable profits within a period of 8 years from the year in which such losses were incurred. (unlimited period in case of unabsorbed depreciation).

Based on the status of resolution process at the time of closing of accounts, the management will need to review and update estimates of future realizability of benefits from unabsorbed losses and depreciation and consequent recognition or otherwise of deferred tax assets. The details of the of the plan to the extent finalized including write backs of liabilities dues to haircuts taken by lenders (refer para below) will, for example, accelerate the realization of benefits.

The accounting treatment of Deferred tax assets (recognition or non-recognition or partial recognition) and basis/justification thereof would need to be disclosed by way of notes to FS along with quantification of amounts involved and impact on FS. In case it is not possible to quantify amounts due to uncertainties of the outcome of the resolution process, the same should be stated in notes.

Claims made by lenders and creditors under reconciliation

As required by the Code,RP would receive, collate and admit all claims submitted by the lenders and creditors during the resolution process. At the closure of financial statements, such exercise may be in progress and balance in FS may not agree with claims submitted and may require adjustment upon completion of this process.

Depending upon the stage of completion of the process, financial impact thereof may or may not have been ascertained or partially ascertained and recognized in FS. The companies will need to make appropriate disclosure of this matter in FS and made adequate provisions to the extent of differences already identified.

Provision for impairment in value of investment/ Expected credit loss(ECL) on advances to Company in IBC-in FS of investor/Lending company.

Carrying value of Investments made by Investors/promoters companies (Holding company, associates or otherwise) of companies under IRP would be significantly eroded, which would need to be recognized in FS.

Similarly, there would be impairment in carrying the value of loans and advances given to such companies which would require provision for expected credit loss under IND AS 109.

These companies may have also given guarantees to lenders/creditors of companies under IBC, which would have been invoked by these parties. Under IND AS-109, provision for ECL would need to be assessed and made in FS of these companies. Under AS also these amounts earlier disclosed as contingent liabilities, would now require provisioning as actual liabilities.

The extent of impairment/ ECL may or may not have been ascertained depending upon facts of each case and stage of the resolution process. In a situation where valuer appointed under IRP has completed valuation or bids are submitted by potential buyers, such values will provide an indication of potential impairment/lECL. The same will, however finally crystallize upon approval of plans by NCLT.

The companies may recognize an impairment loss in value of investments/ECL on advance/guarantees taking into consideration the above values, subject to adjustment upon final approval of the plan. It is also likely that some companies may choose not to recognize any impairment/ECL till final values are determined, which treatment may not be appropriate. In either case, appropriate disclosure of facts would be required in FS including the basis for provision or reasons for non-provisioning.

Accounting for reductions in liabilities on account of haircuts taken by lenders

Approved resolution plans are likely to result in significant haircuts to be taken by lenders and creditors and consequent reduction in liabilities of the companies as appearing in books of account.

These liabilities would require to write back in FS which may include principal and interest portion of the loan. Under IND AS and AS, these write backs would be credited to the profit and loss statement.

Accounting of other aspects of the Scheme

Accounting to give effect to final resolution plans in the books of acquirer and acquired company depends on contour of the final plan which my envisage acquisition of full or part of business ongoing concern basis/Infusion of funds by way of equity/loans/acquisition of investment of existing promotors/acquisition of assets of stressed company without the acquisition of company/mergers or demergers etc. Depending on the nature of the transaction, accounting will be governed by IND AS-103 on Business Combinations or AS-14 on Amalgamations, relevant standards on fixed assets accounting etc. The accounting requirements for consolidated financial statements are dealt with by IND AS-110 and AS-21.

Year of accounting to give effect to the Resolution Plan

As per IBB, the plan agreed by CoC will be final upon approval by NCLT. Hence, the effect of the same in FS will be given in the year of approval, when it becomes binding on all the parties. The most likely scenario as at the year ending March 31, 2018 would be that the Plan is under various stages of resolution and pending the approval of NCLT.

It is also likely that the Plan may be approved by the time financial statements are approved and issued. As per IND AS -103 on Business Combinations, the effect of the same will be given in the year of approval of the plan. Appropriate disclosures about details of plans, its estimated impact on FS, to the extent ascertained are made in FS as required by IND AS- 10 on Events occurring after the balance sheet date. The same treatment will apply under AS. (Refer para below on IND AS-10).

Events occurring after Balance Sheet Date

Applicable IND AS-10 and AS-4, classify events occurring after balance sheet date but before approval of accounts into adjusting events (those which provide evidence of conditions existing at the balance sheet date) and non-adjusting events (those which that are indicative of conditions arising after the balance sheet date). The impact of adjusting events need to be recognized in FS and non- adjusting events requires only disclosures.

Accordingly, the information relating to resolution plan which is available at the time of approval of FS would be required to be considered, for validating going concern assumption, determining impairment in values of assets, recognition of deferred tax assets, provisioning for doubtful balances etc, as it provides further evidence of conditions existing at the balance sheet date.

Signing and approval of FI

Under the provision of Section 238 the IBC, upon initiation of the CIRP, the powers of the Board of Directors of the Company are suspended and are to be exercised by RP. This implies that the financial statements of companies under resolution process would have to be approved and signed by RP.

Financial statements would also include the period before initiation of resolution process during which RP was not in charge of affairs of the Company. Hence, the practical difficulty will arise as to how RP takes responsibility for transactions for the said period.

MCA should issue an appropriate clarification as to the process for approval of financial statements of companies under resolution process to avoid any confusion in this regard.

Institute of Chartered Account of India should also provide guidance to its members regarding the position to be taken by auditors while discharging their responsibilities as an auditor under the Company Act and manner of audit reporting.

Non- current assets held for sale and Discontinued operations-applicability of IND AS-105 and AS-24

Under IND AS-105, Non-current assets are to be classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. The resolution plan may involve disposal of investments by the Holding company and resultant loss of control. Applicability of the said Standard to presentation and classification of assets and liabilities of the company in resolution process in the consolidated FS of its Holding company would need to be considered. These assets would be measured at lower of its carrying amount and fair value less cost to sell.

There is no similar standard under AS, except that AS-10 requires fixed assets held for sale to be measured at lower of book value and net realizable value.

The results of operations of such company would be presented as a single item on the face of the statement of profit and loss as being from discontinued operations in the manner prescribed in the standard, which also prescribes additional disclosure requirements.

AS-24 also prescribe presentation and disclosure requirements for discontinued operations which are substantially similar to IND AS-105.

Conclusion

The purpose of this article is to identify some of the potential accounting and disclosure issues which may arise in the course of finalizing standalone FS of companies under resolution process and to a limited extent, FS of its Holding Company. Accounting and disclosure issues which may arise in FS of bidding company are not covered in this article.

I have attempted to give my personal views on these issues. IBC is a law under evolution and currently in most of cases resolution plans are under various stages of finalization. Each of these plans would have its own peculiarities and practical application and treatment of above issues would depend upon the careful evaluation of facts and circumstance of each case.