Audit Of Financial Statements 2012-13: REVISED REPORTING REQUIREMENTS & OTHER Important Issues

1. Audit Of Financial Statements 2012-13:REVISED REPORTING REQUIREMENTS & OTHER Important Issues Himanshu Kishnadwala 09 Aug 2013

2. Introduction Contractor, Nayak & Kishnadwala • Increased focus on role of auditor in recent times due to some wrong and some‘right’reasons • Audit consists of 3 major activities: • Conduct of the audit (using SAs) • Ensuring compliance of AS • Ensuring adequate disclosure as per statute, AS, etc. • Since last several years, the focus of audit has shifted to (b) and (c) ignoring (a).

3. Contents Contractor, Nayak & Kishnadwala Revised Schedule VI and AS – Some Issues ICAI Announcements Corporate Law Updates - MCA Circulars RBI Circulars Other Developments for FY 2012-13 Standards On auditing – SA 700 series Some issues on CARO

4. Revised Schedule VI and AS Some Issues Contractor, Nayak & Kishnadwala

5. Current vs. Non Current Contractor, Nayak & Kishnadwala A liability is classified as Current if it satisfies any of the following criteria: • it is expected to be settled in the company’s normal operating cycle; • it is held primarily for the purpose of being traded; • it is due to be settled within 12 months after the reporting date; or • the company does not have an unconditional right to defer settlement of the liability for at least 12 months after the reporting date.

6. Current vs. Non Current … Contractor, Nayak & Kishnadwala An asset is classified as Current when it satisfies any of the following criteria: • It is expected to be realized in, or is intended for sale or consumption in the company’s normal operating cycle; • It is held primarily for the purpose of being traded; • It is expected to be realized within 12 months after the reporting date; or • It is cash or cash equivalent unless it is restricted from being exchanged or used to settle a liability for at least 12 months after reporting period date.

7. What is Operating Cycle? • If an OC cannot be identified, it is assumed to have a duration of 12 months • If a company is engaged in multiple businesses, the OC can be different for each line of business An Operating Cycle(OC) is the time between the acquisition of assets for processing and their realization in cash or cash equivalents. Contractor, Nayak & Kishnadwala

8. Operating Cycle – some issues • Different OC for different customers based on different credit terms? say., PSU and non PSU customers • Can OC differ from year to year? • Whether lead time for procuring raw material should be included in OC? • Is credit period allowed by supplier reduced in determination of OC? • To determine OC to consider: • Normal business behaviour • Industry practice • Liquidity position ?? Contractor, Nayak & Kishnadwala

9. Operating Cycle – some issues… • Industry specific OC: • Manufacturing Companies: To determine business-wise • Real Estate Companies: Can be determined project-wise • Finance Companies: Difficult to determine – to be assumed at 12 months • Service companies: To determine business-wise • Relevance of OC for classification of: • Trade receivables / payables – OC relevant • Supplier/Customer advances – OC relevant • Borrowings – OC relevant • Loans – 12 months period • Other assets / liabilities – 12 months period Contractor, Nayak & Kishnadwala

10. Current vs. Non Current … Determining Whether Current or Non-Current? For Assets: To consider expectation of receipt For Liabilities: To consider obligation to pay Whether accounting policy for classification of items into Current / Non Current is to be disclosed? • Neither the RS VI nor the GN on RS VI requires such disclosure • However, disclosure preferable in case of OC > 12 months • In other cases, though not required, maybe given as it lends higher transparency to the FS Classification may have impact on CARO reporting • Whether funds raised on short term basis are used for long term purposes? Contractor, Nayak & Kishnadwala

11. Trade Payables • A payable shall be classified as ‘trade Payables’ if it is in respect of amount due on account of goods purchased or services received in the normal course of business. • Amount under contractual obligations can no longer be included within trade payables. • An argument can be made that any obligation, except statutory obligation, incurred by a Co pertains to goods & services received in normal course. • GN is unclear & subject to interpretations. Contractor Nayak and Kishnadwala

12. Trade Payables… Contractor Nayak and Kishnadwala • Considering the ambiguity only the following may be excluded from trade payables : • Liability towards purchase of Fixed Assets, including finance lease liability. • Statutory dues and all due to government/regulatory bodies. • Contractually reimbursable expenses incurred on behalf of third party which are not charged to Statement of P&L of the Co. • Can the following items be classified as Trade Payable: • Outstanding Audit fees • Amount due to party on account administration expenses

13. Fixed Assets Contractor, Nayak & Kishnadwala Revised Schedule VI requires: “Except in the case of the first financial statements laid before the company (after its incorporation) the corresponding amounts (comparatives) for the immediately preceding reporting period for all items shown in the financial statements including notes shall also be given.” Thus, previous years figures for each class of Fixed Asset has to be given as against the current practice of just mentioning the previous years total of fixed assets. To illustrate (FY 2011 – 12) : Tata Motors give their previous figures under each current year figure in the table for fixed assets Grasim Industries reproduces the entire FA schedule of previous year

14. Investments • Non Current Investments shall be classified as “trade Investment” or “Other Investments”. • The term “trade investments” is defined neither in Revised Schedule VI nor Accounting Standards. • The term “trade investment” is normally understood as an investment made by a company in shares or debentures of another company , to promote the trade or business of the first company. • Whether investment in subsidiary to be classified as “trade investment” or “other investment” ? Contractor Nayak and Kishnadwala

15. Investments… As per Revised Schedule VI: Expected to be realised within 12 months of BS date As per AS 13: • Investment that by its nature is readily realisable and intended to be held for not more than 1 year from the date of investment. • Investment made in December 2011 and expected to be realised in February 2013 (i.e. after 14 months) – whether current or non-current? • Since AS overrides RS VI, investment will be non-current, though expected to be realised within 12 months of next BS date (i.e. 31st March 2012) Contractor Nayak and Kishnadwala

16. Statement of Profit and Loss Whether Revenue should be Gross or Net? • As per GN on terms used in FS, Sales Turnover is defined as: “aggregate amount for which sales are effected or services rendered by an enterprise” • Guide to Company Auditmentions “Total turnover is the aggregate amount for which sales are effected, giving the amount of sales in respect of each class of goods dealt with by the company and indicating quantities separately” • Statement of CARO and Part II of existing Schedule VIdefines turnover as “aggregate amount for which sales are effected by the company. Sales effected would include sale of goods as well as services rendered by the company.” Contractor Nayak and Kishnadwala

17. Statement of Profit and Loss… Whether Revenue should be Gross or Net? … • As per GN on Tax Audit, turnover maybe interpreted to mean “the aggregate amount for which sales are effected or services rendered by an enterprise” • Para 10 of AS 9requires “disclosure of Gross Turnover with separate deduction for Excise Duty”. • GN on VATstates “VAT is collected from customers on behalf of VAT authorities and … should not be recorded as revenue of the enterprise” Contractor Nayak and Kishnadwala

18. Statement of Profit and Loss… Whether Revenue should be Gross or Net? … • Service Tax • For Service Tax, sec 83 of the Finance Act, 1994, provides that the provisions of  certain sections (like sec 9C, 12A, etc.)  of the Central Excise Act, 1944 shall apply, so far as may be, in relation to service tax as they may apply to a duty of excise. • Section 12 A of the Central Excise Act, 1944, which provides that the amount of excise duty shall form part of the price of the goods sold. On a similar analogy, service tax would form part of the price of the services provided. Contractor Nayak and Kishnadwala

19. Statement of Profit and Loss… Whether Revenue should be Gross or Net? … • Excise Duty • Since format of RS VI clearly mentions Excise Duty as a deduction from Sales, the same would be necessary. • Service Tax / VAT • GN On Revised Schedule VI • Such taxes are generally collected from the customer on behalf of government. Depending on whether company is acting as agent or principal, such taxes should be included in Sales (i.e. Gross or excluded (i.e. Net). Contractor Nayak and Kishnadwala

20. Revenue from Operations – Other Operating Revenue vs. Other Income • The term “Other Operating Revenue” is not defined by RS VI. • It would include Revenue arising from a company’s operating activities, i.e., either its principal or ancillary revenue-generating activities, but which is not revenue arising from the sale of products or rendering of services. • Whether a particular income constitutes “other operating revenue” or “other income” is to be decided based on the facts of each case and detailed understanding of the company’s activities. Contractor Nayak and Kishnadwala

21. Revenue from Operations – Other Operating Revenue vs. Other Income… Whether the following is “Other Operating Revenue” or “Other Income”? • A Company engaged in manufacture and sale of industrial and consumer products also has one real estate arm. • A consumer products company owns a 10 storied building. The company currently does not need one floor for its own use and has given the same temporarily on rent. • Sale of Fixed Assets • Sale of Scrap • Interest from customers on delayed payments • Foreign Exchange Gains Contractor Nayak and Kishnadwala

22. Revenue from Operations – Other Operating Revenue vs. Other Income Contractor Nayak and Kishnadwala Whether the following is “Other Operating Revenue” or “Other Income”? • Sale of Carbon credits • Dividend from Joint Venture/Subsidiary • Insurance Claims Received – Kansai Nerolac Paints Limited • Indirect Tax Claims Received – Kansai Nerolac Paints Limited.

23. Disclosure of Accounting Policies Contractor, Nayak & Kishnadwala Are the following statements correct? The company follows the accrual basis of accounting and the AS issued by ICAI. For Fixed Asset schedule previous years’ figures not necessary for each asset Cost for the purpose of calculating Inventory is determined on Moving Average basis. Provision is made for obsolete inventories Trade receivables due for a period exceeding 6 months

24. ICAI Announcements Contractor, Nayak & Kishnadwala

25. Presentation of FCMITDA in BS Para 46 / 46A of AS 11 inserted by MCA in 2009 / 2011 Option available to add / deduct foreign exchange differences arising on long-term foreign currency monetary items insofar as they relate to the acquisition of a depreciable capital asset to the cost of the asset In other cases (i.e. for other than for depreciable assets), to be accumulated in a “ Foreign Currency Monetary Item Translation Difference Account (FCMITDA)” in the balance sheet. The FCMIDTA can be credit or debit Issue is if it is debit, under Revised Schedule VI, where is FCMITDA to be presented in the BS? Contractor, Nayak & Kishnadwala

26. Presentation of FCMITDA in BS… Contractor, Nayak & Kishnadwala As per ICAI FAQs on AS 11 notification issued in May 2009: “ The FCMITDA should be shown as a separate line item in the Balance Sheet, in line with treatment given to Deferred Tax Asset/Liability, i.e. after the head ‘Investments’ or after the head ‘Unsecured Loans’ as the case may be and separately from current assets and current liabilities.” As per Revised Schedule VI, no line item has been specified for the presentation of FCMITDA Companies were therefore following different practices for disclosure of such FCMITDA esp. when the balance was an asset.

27. Presentation of FCMITDA in BS… Contractor, Nayak & Kishnadwala Council of ICAI vide announcement in April 2013 said: “An asset is a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise.” Where the balance in FCMITDA represents foreign currency translation loss, it does not meet the above definition of ‘asset’ as it is neither a resource nor any future economic benefit would flow to the entity therefrom. Accordingly, such balance cannot be reflected as an asset.

28. Presentation of FCMITDA in BS… Contractor, Nayak & Kishnadwala Therefore, the Council decided that debit or credit balance in FCMITDA should be shown on the “Equity and Liabilities” side of the balance sheet under the head ‘Reserves and Surplus’ as a separate line item. This would be a negative reserve.

29. Change in criteria for Level II Entity Contractor, Nayak & Kishnadwala The Council of the Institute at its meeting held on January 2013 considering recent changes in the enhancement of tax audit limit, decided to change the applicability of Accounting Standards for Level II entities from Rs. 40 lakhs to Rs. 1 crore with effect from the accounting year commencing on or after April 01, 2012. This has implications on applicability of ICAI notified AS to non-corporate entities

30. Corporate Law Updates MCA Circulars Contractor, Nayak & Kishnadwala

31. Sec 372A of Companies Act, 1956 Contractor, Nayak & Kishnadwala Sec 372A(3) of The Companies Act, 1956: “No company shall grant a loan to any body corporate at a rate of interest lower than the prevailing bank interest as made public under section 49 by RBI.” Movement of bank rates over the last few years is as under:

32. Sec 372A of Companies Act, 1956 … Contractor, Nayak & Kishnadwala • Section does not apply (among others) to loans: • By companies whose principal business is acquisition of securities • By private companies (unless subsidiary of public company) • Loans or Guarantees to Wholly Owned Subsidiary • Position to be seen at time of giving loan

33. Clarification on Sec 372A(3)… Contractor, Nayak & Kishnadwala Issue: The restriction imposed by Section 372A(3) of The Companies Act, 1956, had resulted in companies not being able to invest in tax free bonds issued by the government which had interest in the range of 6.75% to 7.5%. Clarification: In view of the above difficulty, MCA issued a circular no. 06/2013 dated 14/03/2013 whereby it clarified that in cases where the effective yield (effective rate of return) on tax free bonds is greater than the yield on prevailing bank rate, there is no violation of Section 372A(3) of Companies Act, 1955.

34. Companies (Acceptance of Deposits Amendment) Rules, 2013 Contractor, Nayak & Kishnadwala In the definition of ‘deposits’ in the Companies (Acceptance of Deposits) Rules, 1975,: Rule 2, in clause (b), for sub clause (x), currently excludes “any amount raised by the issue of bonds or debentures secured by the mortgage of any immovable propertyof the Company or with an option to convert them into shares in the Company provided that in the case of such bonds or debentures secured by the mortgage of any immovable property the amount of such bonds or debentures shall not exceed the market value of such immovable property”.

35. Companies (Acceptance of Deposits Amendment) Rules, 2013 … Contractor, Nayak & Kishnadwala This has been substituted as:- “(x) any amount raised by the issue of bonds or debentures secured by the mortgage of any fixed assets referred to in Schedule VI of the Act excluding intangible assets of the Companyor with an option to convert them into shares in the Company: Provided that in the case of such bonds or debentures secured by the mortgage of any fixed assets referred to in Schedule VI of the Act excluding Intangible assets the amount of such bonds or debentures shall not exceed the market value of such fixed assets"

36. Debenture Redemption Reserve Contractor, Nayak & Kishnadwala Clarification by circular no. 04/2013 dated 11/02/2013: Sec 117C of The Companies Act, 1956 requires companies to create a Debenture Redemption Reserve (DRR) to which 'adequate amounts' shall be credited out of its 'profits' every year until such debentures are redeemed, and shall utilize the same exclusively for redemption of a particular set or series of debentures only. The revised requirements with regard to 'adequacy' of debenture redemption reserve (DRR) are as follows:

37. Debenture Redemption Reserve…

38. Debenture Redemption Reserve… Every company required to create/maintain DRR shall before the 30th April of each year, deposit or invest a sum not less than 15% of the amount of its debentures maturing during the year ending on the 31st March next following in any one or more of the following methods: In deposits with any scheduled bank, free from charge or lien In unencumbered securities of the CG or SG; In unencumbered securities mentioned in clauses (a) to (d) and (ee) of section 20 of the Indian Trusts Act, 1882; In unencumbered bonds issued by any other company which is notified under clause (f) of section 20 of the Indian Trusts Act, 1882; Contractor, Nayak & Kishnadwala

39. Debenture Redemption Reserve… The amount deposited or invested above shall not be utilized for any purpose other than for the repaymentof debentures maturing during the year referred to above, provided that the amount remaining deposited or invested, shall not at any time fall below 15 % of the amount of debentures maturing during the 3lst day of March of that year. Contractor, Nayak & Kishnadwala

40. RBI Circulars Contractor, Nayak & Kishnadwala

41. Realisation of Export Proceeds Contractor, Nayak & Kishnadwala Master Circular on Export of Goods and Services dt. 02/07/2012: Para B.3: “It is obligatory for the exporter to realise and repatriate the full value of goods or software to India within a stipulated period as under: Units in SEZs: No specific time period; Status Holder Exporters: Within12 months from the date of export; 100 % EOUs: Within12 months from the date of export w.e.f 1/9/2004; Goods exported to a warehouse established outside India: As soon as it is realised and in any case within 15 months from the date of shipment of goods; In all other cases:W.e.f 3/6/2008, this period has been enhanced to 12 months from the date of export, till 30/9/2012.” The relaxation extended w.e.f. 01/10/2012 to 31/3/2013 vide A.P. (DIR Series) Circular No. 52 dated 20/11/2012 issued by RBI.

42. Write-off of unrealised export bills Contractor, Nayak & Kishnadwala A.P. (DIR Series) Circular No. 88 dated March 12, 2013: The following liberalization in the limits of “write-offs” of unrealized export bills: Self “write-off” by an exporter (Other than Status Holder Exporter): 5%* Self “write-off” by Status Holder Exporters: 10%* “Write-off” by Authorized Dealer bank :10%* *of the total export proceeds realized during the previous calendar year. The above limits will be related to total export proceeds realized during the previous calendar year and will be cumulatively available in a year.

43. Retention of Forex earnings in EEFC account Contractor, Nayak & Kishnadwala Clarification by A. P. (DIR Series) Circular No. 12 dated 31/7/2012 issued by RBI: In terms of Circular No. 124 dated May 10, 2012, it was stipulated that in respect of all future forex earnings, an exchange earner will be eligible to retain only 50% of the export earnings in EEFC accounts and the balance 50% shall be surrendered for conversion to rupee balances. It has now been decided that 100 % credit of forex earnings to the EEFC account have to be converted to Rupees before the last day of succeeding month (after adjusting for utilization of the balances for approved purposes or forward commitments).

44. Retention of Forex earnings in EEFC account Contractor, Nayak & Kishnadwala Accordingly, balances outstanding in an EEFC account as on July 31, 2012 and those balances that would accrue from August 1, 2012 shall get converted to Rupee balances on or before September 30, 2012. Similar procedure may be followed for accruals during the subsequent months.

45. Circulars: NBFC Contractor, Nayak & Kishnadwala Circular DNBS.CC.PD.NO.265/03.10.01/2011-12, Dated 21.03.2012: NBFCs that are predominantly engaged in lending against the collateral of gold jewellery shall: Hereafter maintain a Loan-to-Value(LTV) ratio not exceeding 60% for loans granted against the collateral of gold jewellery and Disclose in their Balance Sheet a % of such loans to their total assets Those NBFCs having such loans comprising 50% or more of their financial assets shall maintain a minimum Tier I Capital of 12% by April 1, 2014. NBFCs should not grant any advance against bullion/primary gold and gold coins.

46. Other Developments in FY 2012-13 Cost Accounting Records Service Tax Deferred Tax Asset / Liability Domestic Transfer Pricing Sec 80 IB / 80 IC Contractor, Nayak & Kishnadwala

47. Coverage of certain sectors under Cost Accounting Records Contractor, Nayak & Kishnadwala The auditor has to report under CARO 2003, clause 4(viii) as under: “where maintenance of cost records has been prescribed by the Central Government under clause (d) of sub-section (1) of section 209 of the Act, whether such accounts and records have been made and maintained;” Every auditor thus needs to verify whether the company is covered by the new Cost Accounting Record Rules, 2011 and if yes whether the prescribed cost records have been maintained.

48. Coverage of certain sectors under Cost Accounting Records… Contractor, Nayak & Kishnadwala • Cost Accounting Record Rules, 2011 issued on June 3, 2012 state that: • These rules apply to every Company including a foreign company which is engaged in the production, processing, manufacturing, or mining activities and wherein: • aggregate value of net worth as on the last date of the immediately preceding financial year exceeds five crores of rupeesor • the aggregate value of the turnover made by the company from sale or supply of all products or activities during the immediately preceding financial year exceeds twenty crores of rupees or • the company’s equity or debt securities are listed or are in the process of listing on any stock exchange, whether in India or outside India.

49. Coverage of certain sectors under Cost Accounting Records … Contractor, Nayak & Kishnadwala The definition of processing activity is very wide. Several industries and sectors now fall in the ambit of these rules. “Processing Activity” includes any act, process, procedure, function, operation, technique, treatment or method employed in relation to altering the condition or properties of inputs for their use, consumption, sale, transport, delivery or disposal; or accessioning, arranging, describing, or storing products; or developing, fixing, and washing exposed photographic or cinematographic film or paper to produce either a negative image or a positive image; or printing, publishing, finishing, perforation, trimming, cutting, or packaging; or

50. Coverage of certain sectors under Cost Accounting Records… Contractor, Nayak & Kishnadwala pumping oil, gas, water, sewage or any other product; or transforming or transmitting, distributing power or electricity; or harboring, berthing, docking, elevating, lading, stripping, stuffing, towing, handling, or warehousing products; or preserving or storing any product in cold storage; or constructing, reconstructing, reconditioning, repairing, servicing, refitting, finishing or demolishing of buildings or structures; or farming, feeding, rearing, treating, nursing, caring, and stocking of living organisms; or telecasting, broadcasting, telecommunicating voice, text, picture, information, data or knowledge through any mode or medium; or obtaining, compiling, recording, maintaining, transmitting, holding or using the information or data or knowledge; or executing instructions in memory to perform some transformation and/or computation on the data in the computer's memory.