Accountancy, more-often-than-not, is erroneously sighted as a static science. It is a common belief that the principles of accountancy do not change, sans their operating environment, or the circumstances which confront them. You always debit the receiver and credit the giver, whether you are on Earth or Mars. Know the basics well, and you can master the profession, is what our astute predecessors said. MCA, thankfully, thinks otherwise!
We breathe in a world where change in the only constant and uncertainty is the only certainty. The corporate and regulatory environment happens to be no exception. Accountancy too reflects dynamism, and the traditional methods must stand the passage of time to continue uninterrupted. At a time when the global accounting practices are funneling to arrive at common end points, the challenge is to keep the local flavors alive. Accountancy is not an invincible one-size-fits-all cloak, and some cultural differences are bound to occur. It is for this very reason that striking a correct balance between convergence and adoption assumes paramount importance.
The last five years have catapulted the way in which the average Indian corporate reports. There has been a sea change in the corporate affairs segment. The dream of Indian integration with the global best practices isn’t a dream anymore. It is slowly but surely crystallizing into reality. The onset of the Companies Act, 2013, the grand arrival of the Ind-AS, the entry of the Income Computation and Disclosure Standards, the POEM and BEPS framework, the advanced Listing Obligations and Disclosure Requirements have had their own share in making the Indian corporate more robust, fair and transparent to stakeholders.
The Ministry of Corporate Affairs has played a lion’s role in bringing about the requisite changes. It is up to the corporates and the professionals assisting them to ensure that these are implemented not just in letter, but also in spirit.
Key takeaways from Ind-AS 16: Property, Plant and Equipment (‘PPE’)
The cost of an item of PPE will now be the cash price equivalent at the recognition date. The difference between the cash price equivalent and the total payment (if payment is deferred beyond normal credit terms) is recognized as interest over the period of credit, unless it is a qualifying asset as per AS-16.
Illustration: Lohar Limited purchased a machinery on a credit period of 7 years. The company paid Rs. 32 lakhs for the said machinery. However, had the company opted for the ‘spot payment’ scheme, the machinery would have costed Rs. 25 lakhs. Here, in this case, the excess payment of Rs.7 lakhs is attributable to the financing activity of the fixed asset rather than acquisition cost. Had the historic cost convention (before the revised AS-10 came into being) been followed, entire amount of Rs. 32 lakhs would have been capitalized. However, Ind-AS 16 mandates a different treatment with capitalization of only Rs. 25 lakhs and treating the remnant Rs. 7 lakhs as interest cost to be spread over the period of 7 years. Thus, substance over form prevails.
Furthermore, the concept of component depreciation finds more weight in Ind-AS 16, though the erstwhile AS-10 (before revision) contained a short paragraph on component depreciation. The erstwhile AS-10 did not require the assets to be componentised and depreciated separately, although it stated that such an approach may improve the accounting for fixed assets. Component depreciation is likely to affect the quantum of depreciation and will require the corporates to be more particular with regards to record-keeping in relation to PPE.
Under Ind-AS 16, major inspections/replacement costs will be capitalized if recognition criteria are fulfilled and any remaining carrying amount of the cost of previous inspection/replacement will be derecognized. Derecognition of the carrying amount occurs regardless of whether the cost of the previous part/inspection was identified in the transaction in which the item was acquired or constructed. If it is not practicable for an enterprise to determine the carrying amount of the replaced part/inspection, the entity may use the cost of replacement or the estimated cost of the future inspection as an indication of what the cost of replaced part/inspection component was when the item was acquired or constructed.
Illustration: Udaan Limited purchased an aircraft for private use on April 1, 2016 and useful life of the aircraft is 12 years. One of the important aspects of the aircraft is that it requires major inspection after every year of operation. Included in the purchase cost of the aircraft was Rs. 6 lakhs, the inspection cost for first three years. The contract for first three years was entered with Disappointers Ltd. However, if the contract is cancelled in the year 2018-19 (in the third year) due to poor services, and the contract is entered for three years with Hopeful Ltd for a sum of Rs. 9 lakhs, a sum of Rs. 2 lakhs (6lakhs/3) should be derecognized and a sum of Rs. 9 lakhs should be capitalized. In the third year, Rs. 3 lakhs (9 lakhs/3) will be expensed off.
The depreciation method will also require a review at least at every financial year-end. Change in method of depreciation is treated as a change in accounting estimate rather than an accounting policy change, and therefore will require only a prospective effect. The residual value and useful life, too are reassessed at each balance sheet date.
Furthermore, spare parts, servicing equipment and standby equipment which meet the definition criteria of PPE will be treated as PPE and will be accounted accordingly, and not as inventory.
There are certain assets which must adhere to decommissioning obligations. In scenarios like these, Ind-AS 16 gives reference to Ind-AS 37 on Provisions, Contingent Assets and Contingent Liabilities. The discounted value of such liabilities will be added to the cost of PPE on a discounted basis. The unwinding of the discounted value will be recognized as an interest expense every year. In the IFRS terminology, decommissioning liabilities usually take the connotation ‘Asset Retirement Obligations’.
Illustration: On April 1, 2016, Sandesh Telecommunications Limited got an order from a mobile network operator to construct and lease 15 telecom towers in Bangalore. The land required for the construction of the towers was to be arranged by the operator. At the end of the 10-year period term, Sandesh Telecommunications Limited is required to dismantle the tower and restore the site on which the towers are constructed. The towers were constructed at a total cost of Rs. 200,00,000/- The estimated cost of dismantling and restoration is Rs. 10,00,000/- and yield on government bonds is 10% for a 10- year period.
The opening present value of Rs. 385,543/- as at the beginning of year 1 will be added to the cost of the telecom towers and will be correspondingly treated as a liability. The unwinding of the discounted value will be treated as a finance cost every year. Unwinding of the discounted value will eventually cause the liability to increase to Rs. 10 lakhs at the end of year 10, and will be settled.
Additionally, Ind-AS 16 provides much more guidance on the revaluation model, and states that if revaluation model is adopted, revaluation is to be done with sufficient regularity to ensure that the carrying amount does not differ materially from the fair value at the end of the reporting period. The erstwhile AS-10 (before revision) did not prescribe the frequency of revaluation. The frequency of revaluation as per Ind-AS 16 is dependent on the significance and volatility of changes in fair value of the asset.
PPE acquired in exchange for a non-monetary asset will now be measured at fair value subject to certain exceptions such as the lack of commercial substance or when neither the fair value of the asset received nor the fair value of the asset given up is reliably measurable.
Illustration: Badlav Limited exchanges land having book value of Rs. 12 lakhs with a machinery having fair value of Rs.30 lakhs. If there is commercial substance in the transaction the machinery will be recorded at Rs. 30 lakhs with appropriate impact in the profit and loss account.
Badlav Limited exchanges land having book value of Rs. 12 lakhs (fair value of Rs. 18 lakhs) with a machinery having fair value of Rs. 18 lakhs with the configuration of the cash flows not expected to change; then the machinery will be recorded at Rs.12 lakhs as the transaction lacks commercial substance.
Badlav Limited would have recorded the machinery at Rs. 12 lakhs in either of the above cases per old AS 10 (before revision).
Furthermore, the disclosure requirements of Ind-AS 16 are more comprehensive, detailed and robust as compared to the erstwhile AS-10.
Thus, Ind-AS-16 makes accounting for PPE much more comprehensive, besides adding some more columns to the Fixed Asset Register!
Transitional provisions under Ind-AS 16:
Understanding Ind-AS 16 is a futile exercise if we fail to read the transitional provisions in the same breath as that of reading the technicalities of the standard. The concept of ‘deemed cost’ as advocated in Ind-AS 101 (First time adoption of Ind-AS), which forms the very substratum of migrating to Ind-AS framework from the AS framework. While transitioning to Ind-AS, the company can elect to choose either the fair value of PPE or its net carrying value as on the opening balance sheet date as the deemed cost of PPE. The latter option will help the Indian corporates to a very large extent by easing and simplifying the enabling process.
Ind-AS 16, at a glance, can be illustrated figuratively as follows:
Revised AS-10 in sync with Ind-AS 16:
The Indian Accounting Standards (‘Ind-AS’) will never be applicable to unlisted companies which do not breach the 250 Crore net worth threshold. However, the Companies (Accounting Standards) Amendment Rules, 2016, replaced 7 erstwhile accounting standards. The replacements meant that the distance between existing AS and Ind-AS (and in turn IFRS) was bridged by a large extent. Particularly, the Standard on Property, Plant and Equipment introduced hitherto unexploited concepts, which changed the manner in which the corporates look at fixed assets. Revised AS-10, in all material aspects, is aligned with Ind-AS 16.
Differences between Ind-AS 16 and ICDS V (Tangible Fixed Assets)
Differences arising from exchange rate fluctuations are charged to Statement of profit and loss (if not treated as borrowing cost) as per Ind-AS 16; whereas the ICDS on Tangible Fixed Assets mandates capitalization of the same. Furthermore, in case of abnormal costs being incurred for self-constructed assets, Ind-AS 16 mandates such costs to be expensed off, whereas the ICDS on the subject matter does not explicitly provide any such guidance.
All said and done, such conceptual differences are bound to exist between Ind-AS and ICDS, since the underpinning objectives of both the frameworks do not lie on the same plane.
The Indian accounting environment is currently amidst a sunshine era, with many progressive amendments making their presence felt. The current accounting framework represents not only a future- centric outlook, but an ever-strengthening commitment and resolve to provide transparency and fairness to the stakeholders concerned. Achieving harmony with global standards is one of the underpinned objectives, and its successful achievement depends largely on the spirited response of the corporate citizens. Two MCA’s will play a centrifugal role in creating an environment conducive to the stakeholders – the Ministry of Corporate Affairs and Mindful Chartered Accountants!
(Author Urvish Mehta is a Chartered Accountant working in the Business Advisory vertical at KNAV and can be reached as firstname.lastname@example.org)