Ind AS Technical Facilitation Group Clarification Bulletin 20
Ind AS Technical Facilitation Group (ITFG) of Ind AS Implementation Group has been
constituted for providing clarifications on timely basis on various issues related to the
applicability and /or implementation of Ind AS under the Companies (Indian Accounting
Standards) Rules, 2015, and other amendments finalised and notified till March 2019, raised
by preparers, users and other stakeholders. Ind AS Technical Facilitation Group (ITFG)
considered some issues received from members and decided to issue following clarifications1
on June 27, 2019:
Issue 1: P Limited, with INR as its functional currency, holds an investment in
debentures denominated in a foreign currency. The investment is not designated as a
hedging instrument in a cash flow hedge of an exposure to changes in foreign currency
rates. The investment is measured at fair value through profit or loss in the financial
statements of P Limited in accordance with Ind AS 109, Financial Instruments. The
change in fair value of the investment during a period measured in terms of INR also
includes the effect of the change in foreign exchange rate during the period (i.e., foreign
exchange difference).
Whether the foreign exchange difference is required to be presented separately from
other fair value changes in statement of profit and loss?
Response:
Paragraph 5.7.1 of Ind AS 109 requires a gain or loss on a financial asset that is measured at
fair value to be recognised in profit or loss though there are some exceptions to this general
requirement, these are not applicable in the case under discussion.
In the case of a financial asset denominated in a foreign currency and measured at fair value
through profit or loss, the fair value is first determined in the relevant foreign currency and it
is then translated into the functional currency in accordance with the requirements of Ind AS
21, The Effects of Changes in Foreign Exchange Rates. Thus, change in fair value of such a
financial asset during a period arises due to two factors: change in fair value expressed in
terms of foreign currency and change in exchange rate.
Ind AS 109 does not contain any requirement for separation of change in fair value of a
foreign-currency denominated financial asset measured at fair value through profit or loss
into the aforesaid two constituent parts.
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Clarifications given or views expressed by the Ind AS Technical Facilitation Group (ITFG) represent the views
of the ITFG and are not necessarily the views of the Ind AS Implementation Group or the Council of the
Institute. The clarifications/views are based on the accounting principles as on the date the Group finalises the
particular clarification. The date of finalisation of this Bulletin is June 26, 2019. The clarification must,
therefore, be read in the light of any amendments and/or other developments subsequent to the issuance of
clarifications by the ITFG. The clarifications given are only for the accounting purpose. The commercial
substance of the transaction and other legal and regulatory aspects has not been considered and may have to be
evaluated on case to case basis.
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As per paragraph 52 of Ind AS 21:
"52 An entity shall disclose:
(a) the amount of exchange differences recognised in profit or loss except for
those arising on financial instruments measured at fair value through profit
or loss in accordance with Ind AS 109; [Emphasis added]
......."
Thus, paragraph 52 of Ind AS 21 specifically excludes financial instruments measured at fair
value through profit or loss from its requirement of disclosure of the amount of exchange
differences recognised in profit or loss.
In view of the above, in the given case, P Limited is not required to present change in fair
value of the investment in debentures on account of change in relevant foreign exchange rate
separately from other changes in the fair value of the investment.
Issue 2: At the beginning of Year 1, A Limited obtains equity funds from several
overseas investors with the express purpose of providing those investor(s) with
investment management services. A Limited uses these funds to acquire controlling
equity stake in several start-up companies (not related parties of A Limited).
A Limited incorporates a wholly-owned subsidiary, S Limited which acquires
infrastructure like office space, office furniture, IT equipment and specialised software
and hires skilled employees to provide investment management services to the investors
as well as to third parties. S Limited is funded by equity contribution from A Limited.
Other than the above, A Limited has no other assets or liabilities or activities.
A Limited concludes that it meets all the conditions for classification as an investment
entity within the meaning of Ind AS 110, Consolidated Financial Statements, including
exit strategies for each of its investments in the start-up companies. A Limited does not
have any exit strategy in place for its investment in S Limited. In its consolidated
financial statements, it values the investments in start-up subsidiaries at fair value
through profit or loss and consolidates S Limited as per Ind AS 110.
The above position continues in Year 2.
At the beginning of Year 3, A Limited transfers investments in start-up companies to a
newly formed wholly-owned subsidiary, B Limited. It also transfers to B Limited its
investment in S Limited. Consideration for the transfer is in the form of issue of equity
shares by B Limited. Except for the above, there is no change, e.g. in the objectives or
activities. Post transfer, A Limited's only asset is its investment in B Limited and it has
no liabilities.
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A Limited does not have any exit strategy in place for its investment in B Limited, but
the exit strategies for each of the investments in start-up companies continue to be in
place.
The following accounting issues arise:
(a) In the post-restructuring scenario, is A Limited still an investment entity?
(b) Whether B Limited qualifies to be an investment entity?
(c) Post-restructuring, is A Limited required to prepare consolidated financial
statements? If yes, will it consolidate its direct investment in B Limited or its
indirect investment in S Limited and the start-up companies and what would be
the valuation basis?
Response:
As per paragraph 27 of Ind AS 110, Consolidated Financial Statements:
"An investment entity is an entity that:
(a) obtains funds from one or more investors for the purpose of providing those
investor(s) with investment management services;
(b) commits to its investor(s) that its business purpose is to invest funds solely for
returns from capital appreciation, investment income, or both; and
(c) measures and evaluates the performance of substantially all of its investments
on a fair value basis."
As per paragraphs 31, 32 and 33 of Ind AS 110, Consolidated Financial Statements:
" 31 Except as described in paragraph 32, an investment entity shall not consolidate its
subsidiaries or apply Ind AS 103 when it obtains control of another entity. Instead, an
investment entity shall measure an investment in a subsidiary at fair value through profit
or loss in accordance with Ind AS 109.
32 Notwithstanding the requirement in paragraph 31, if an investment entity has a
subsidiary that provides services that relate to the investment entity's investment, it shall
consolidate that subsidiary and apply the requirements of Ind AS 103 to the acquisition
of any such subsidiary."
33 A parent of an investment entity shall consolidate all entities that it controls, including
those controlled through an investment entity subsidiary, unless the parent itself is an
investment entity."
Determining whether an entity satisfies the definition of an `investment entity' requires
assessment of specific facts and circumstances. As per the facts of the case, it has been
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evaluated by A Limited prior to the restructuring that it satisfies all the three conditions laid
down in paragraph 27 of Ind AS 110, Consolidated Financial Statements, for classification as
an investment entity (including measurement and evaluation of performance of substantially
all of its investments on a fair value basis). For the purpose of this analysis, it is assumed that
this evaluation is correct. Accordingly, as per paragraphs 31 and 32 of Ind AS 110, prior to
the restructuring, A Limited is required to consolidate S Limited (refer paragraph 32 of Ind
AS 110) and measure the investments in the start-up companies (which qualify as its
subsidiaries) at fair value through profit or loss. As per the facts of the case, prior to the
restructuring, accounting by A Limited is along the above lines.
In the context of the restructuring undertaken by A Limited., the following further
requirements/guidance contained in paragraph B85H of Ind AS 110 may be noted:
"An investment entity may have an investment in another investment entity that is formed
in connection with the entity for legal, regulatory, tax or similar business reasons. In
this case, the investment entity investor need not have an exit strategy for that
investment, provided that the investment entity investee has appropriate exit strategies
for its investments."
In the post-restructuring scenario, A Limited holds the investments in subsidiaries indirectly
through B Limited. As per the facts of the case, the restructuring does not result in any
change in objectives pursued or activities carried out prior to the restructuring. Thus, the
change seems to be merely in form in place of A Limited directly controlling and
evaluating the performance of its subsidiaries (including the start-up companies), it does so
now through B Limited. Assuming that this is indeed so, B Limited satisfies all the three
conditions laid down in paragraph 27 of Ind AS 110 for classification as an investment entity.
While A Limited has no exit strategy in place for its investment in B Limited, exit strategies
for each of the investments in start-up companies are still in place. As per paragraph B85H of
Ind AS 110 quoted above, even if A Limited does not have an exit strategy in respect of B
Limited, it still qualifies as an investment entity since B Limited has exit strategies in place in
respect of start-up companies and satisfies the other conditions for classification as an
investment entity.
In the post-restructuring scenario, in terms of requirements of paragraphs 31 and 32 of Ind
AS 110, B Limited is required to consolidate S Limited and measure the investments in start-
up companies at fair value through profit or loss.
A Limited is an investment entity in the post-restructuring scenario too. The start-up
companies and S Limited are still its subsidiaries (albeit held and controlled indirectly).
Accordingly, A Limited needs to still apply paragraphs 31 and 32 of Ind AS 110. This means
that as in the pre-restructuring scenario, A Limited should consolidate S Limited and measure
investments in start-up companies at fair value through profit or loss. As per the facts of the
case, A Limited does not hold any assets other than its investment in B Limited and also has
no liabilities. Hence, the consolidated financial statements of A Limited would be identical to
the consolidated financial statements of B Limited..
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Accordingly, in the given case:
(a) A Limited is an investment entity in the post-restructuring scenario also.
(b) B Limited qualifies to be an investment entity.
(c) Post-restructuring too, A Limited is required to prepare consolidated financial
statements in which it should consolidate S Limited and measure investments in start-
up companies at fair value through profit or loss.
Issue 3: Company P has been making losses in the past years and hence did not pay
dividend to its cumulative preference shareholders. Prior to transition to Ind ASs, the
Company was showing the accumulated arrears of cumulative preference dividend as
`contingent liability' in the notes to its financial statements. On transition to Ind ASs,
the cumulative preference shares are assessed to meet the requirements for
classification as a financial liability in their entirety under Ind AS 32 Financial
Instruments: Presentation.
(i) Whether the accumulated arrears of preference dividend, earlier shown as
`contingent liability', be recognised in the books of account as interest expense by
applying the effective interest method?
(ii) If yes, then whether the entire amount needs to be amortized or recognised as
interest expense in the first Ind AS reporting period?
Response:
Ind AS 32, Financial Instruments: Presentation, establishes, inter alia, principles for
presentation of financial instruments as liabilities or equity. The application of these
principles may result in a financial instrument being classified as a financial liability in
entirety (e.g. a typical redeemable debenture that carries a periodic coupon rate and is
redeemable at a fixed date for a fixed amount), or as equity in entirety (e.g. a typical equity
share of an entity), or partly as a financial liability and partly as equity (e.g. a typical
optionally convertible debenture that is convertible into a fixed number of equity shares).
As per the facts of the case, the preference shares under reference are assessed to meet the
requirements for classification as a financial liability in entirety. This implies, inter alia, that
the covenants of the terms of issue of preference shares relating to dividends represent a
contractual obligation of the issuer (Company P) to pay such dividends. In this regard, the
following paragraphs AG 25 and AG 26 of Ind AS 32 are noted:
"AG 25 Preference shares may be issued with various rights. In determining whether a
preference share is a financial liability or an equity instrument, an issuer assesses the
particular rights attaching to the share to determine whether it exhibits the fundamental
characteristic of a financial liability. For example, a preference share that provides for
redemption on a specific date or at the option of the holder contains a financial liability
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because the issuer has an obligation to transfer financial assets to the holder of the share.
The potential inability of an issuer to satisfy an obligation to redeem a preference share when
contractually required to do so, whether because of a lack of funds, a statutory restriction or
insufficient profits or reserves, does not negate the obligation. An option of the issuer to
redeem the shares for cash does not satisfy the definition of a financial liability because the
issuer does not have a present obligation to transfer financial assets to the shareholders. In
this case, redemption of the shares is solely at the discretion of the issuer. An obligation may
arise, however, when the issuer of the shares exercises its option, usually by formally
notifying the shareholders of an intention to redeem the shares.
AG26 When preference shares are non-redeemable, the appropriate classification is
determined by the other rights that attach to them. Classification is based on an
assessment of the substance of the contractual arrangements and the definitions of a
financial liability and an equity instrument. When distributions to holders of the
preference shares, whether cumulative or non-cumulative, are at the discretion of the
issuer, the shares are equity instruments. The classification of a preference share as an
equity instrument or a financial liability is not affected by, for example:
(a) a history of making distributions;
(b) an intention to make distributions in the future;
(c) a possible negative impact on the price of ordinary shares of the issuer if
distributions are not made (because of restrictions on paying dividends on the
ordinary shares if dividends are not paid on the preference shares);
(d) the amount of the issuer's reserves;
(e) an issuer's expectation of a profit or loss for a period; or
(f) an ability or inability of the issuer to influence the amount of its profit or loss for
the period."
Preference shares that are classified in entirety as a financial liability are accounted for under
Ind AS 109 in the same manner as a redeemable debenture or a typical loan. This implies,
inter alia, that the dividends on the preference shares are accrued in the same manner as
interest on debentures or loans.
Paragraph 4.2.1 of Ind AS 109, Financial Instruments, provides that an entity shall classify
all financial liabilities as subsequently measured at amortised cost, barring certain specified
exceptions. Therefore, unless any of the specified exceptions given under paragraph 4.2.1(a)
to (e) of Ind AS 109 applies (which, from the tenor of the query, does not appear to be the
case), the preference shares under reference are required to be measured at amortised cost,
using the effective interest method. In determining the amortised cost using the effective
interest method, any dividends that have accrued but have not been paid will be reflected in
the carrying amount of the liability.
Ind AS 101, First-time Adoption of Indian Accounting Standards, contains certain mandatory
exceptions and certain optional exemptions from retrospective application of Ind ASs for an
entity that is preparing its first Ind AS financial statements. None of these exceptions or
exemptions applies in the case under discussion. Accordingly, the entity is required to apply
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the amortised cost method to the preference shares under discussion retrospectively from the
date of their issue and determine their amortised cost in accordance with Ind AS 109 as at the
date of transition to Ind ASs. As indicated earlier, the amortised cost using the effective
interest method as at the date of transition would include any preference dividends accrued
for the period up to the date of transition but remaining unpaid at that date.
As regards the treatment of any difference between such amortised cost and the carrying
amount of the preference shares as per the previous GAAP as at the date of transition,
paragraph 11 of Ind AS 101 notes that:
"The accounting policies that an entity uses in its opening Ind AS balance sheet may differ
from those that it used for the same date using its previous GAAP. The resulting adjustments
arise from events and transactions before the date of transition to Ind ASs. Therefore, an
entity shall recognise those adjustments directly in retained earnings (or, if appropriate,
another category of equity) at the date of transition to Ind ASs."
Dividend for periods after the date of transition to Ind ASs would be accrued in each period
in the same manner as interest and, if unpaid, would get reflected in the amortised cost as at
the end of a period.
Issue 4: A Limited and B Limited, both operating companies are undertaking a
transaction whereby one or more of the business divisions of A Limited (demerged
company) will be demerged and vested in B Limited (resultant company).
All the three companies prepare their financial statements in accordance with Indian
Accounting Standards (Ind ASs).
Both A Limited and B Limited have a common investor, X Limited. Both A Limited
and B Limited are `associates' of X Limited within the meaning of Ind ASs. Company A
and Company B are not entities under common control within the meaning of Ind AS
103, Business Combinations.
X Limited carries its investments in associates at cost in its separate financial
statements.
As part of the proposed transaction, A Limited will demerge an identified business
undertaking (representing one or more of its business divisions) into B Limited.
As a result, A Limited as a legal entity shall continue to survive (with some of its other
business divisions), while fresh shares of B Limited shall be issued to shareholders of A
Limited (including to X Limited) as consideration for the demerger of the identified
business undertaking. The consideration for the demerger would be determined on the
basis of fair value of the underlying businesses.
What is the accounting treatment to be followed by X Limited in its separate financial
statements in relation to the demerger transaction, i.e., accounting treatment for the
receipt of additional shares of B Limited pursuant to the demerger and the potential
reduction in value of shares held by it in A Limited due to the transfer of its business
divisions from A Limited to B Limited?
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Response:
(In the following analysis, it is noted that A Ltd. and B Ltd. are independent, unrelated
parties except to the limited extent of both being associates of X Ltd.)
The query relates to accounting treatment of a demerger in the stand-alone financial
statements of an investor which has opted to measure investments in associates at cost in such
financial statements in accordance with Ind AS 27, Separate Financial Statements. The
following discussion is in this context only.
The term `demerger' is used in the commercial world to refer to a wide range of
arrangements such as the following:
An entity (the `transferor') transfers one (or more) of its business divisions to a
newly-formed entity (the `transferee') which has no economic substance prior to the
demerger. The transferee issues its equity shares to the transferor. Post-demerger, the
transferee is a wholly-owned subsidiary of the transferor.
An entity (the `transferor') transfers one (or more) of its business divisions to a
newly-formed entity (the `transferee') which has no economic substance prior to the
demerger. The transferee issues its equity shares to the equity shareholders of the
transferor in the ratio of their equity shareholding in the transferor.
An entity (the `transferor') transfers one (or more) of its business divisions to an
existing entity (the `transferee') which has economic substance even prior to the
demerger. The transferee issues its equity shares to the equity shareholders of the
transferor in the ratio of their equity shareholding in the transferor.
Each of the above illustrative scenarios has different accounting implications from the
perspective of stand-alone financial statements of an equity shareholder of the transferor. For
example:
In the first scenario, the said shareholder's investment even post-demerger is in
transferor company only. Therefore, the demerger per se does not require any
accounting treatment by a shareholder of the transferor.
In the second and the third scenarios, post-demerger, the shareholder holds
investments in both the transferor and the transferee as against its holding in
transferor only prior to the demerger. Therefore, the shareholder needs to account for
the demerger to reflect the change in its investment. However, the two scenarios may
have different economic effects on the investor which need to be carefully evaluated
to determine the appropriate accounting treatment under each of these scenarios.
As the above discussion highlights, the specific facts of each scheme of demerger need to be
considered to determine the accounting treatment that best reflects the substance and
economic reality of the particular demerger from the perspective of an investor. Accordingly,
the following discussion should not be extended by analogy to other types of demergers.
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The two principal issues to be determined in the present case are: what amount should be
derecognised, and what amount should be recognised, by X Limited to give accounting effect
to transfer of business undertaking from A Limited to B Limited and receipt of additional
shares in B Limited.
Amount to be derecognised
X Limited is not paying any explicit consideration for the shares in B Limited being allotted
to it as part of the demerger scheme. However, prior to the demerger, its investment in A
Limited represents its interest in both the demerged business undertaking as well as other
businesses of A Limited whereas post-demerger, X Limited's investment in A Limited only
represents its interest in businesses retained by A Limited. Thus, to the extent of reduction of
its interest in A Limited, the shares of B Limited received by X Limited under the demerger
scheme have an implicit cost associated with them. Neither Ind AS 27 nor any other standard
under Ind ASs deals specifically with the issue as to how the amount to be derecognised
should be determined in the kind of situation under discussion. However, paragraphs 10-12 of
Ind AS 8, Accounting Policies, Changes in Accounting Estimates and Errors, state as below:
"10 In the absence of an Ind AS that specifically applies to a transaction, other event or
condition, management shall use its judgement in developing and applying an
accounting policy that results in information that is:
(a) relevant to the economic decision-making needs of users; and
(b) reliable, in that the financial statements:
(i) represent faithfully the financial position, financial performance and cash
flows of the entity;
(ii) reflect the economic substance of transactions, other events and conditions,
and not merely the legal form;
(iii) are neutral, ie free from bias;
(iv) are prudent; and
(v) are complete in all material respects.
11 In making the judgement described in paragraph 10, management shall refer to, and
consider the applicability of, the following sources in descending order:
(a) the requirements in Ind ASs dealing with similar and related issues; and
(b) the definitions, recognition criteria and measurement concepts for assets,
liabilities, income and expenses in the Framework.
12 In making the judgement described in paragraph 10, management may also first
consider the most recent pronouncements of International Accounting Standards
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Board and in absence thereof those of the other standard-setting bodies that use a
similar conceptual framework to develop accounting standards, other accounting
literature and accepted industry practices, to the extent that these do not conflict with
the sources in paragraph 11."
In view of the above, analogy may be drawn from the paragraph 2(b) of Ind AS 103, Business
Combinations, which states that-
"This Ind AS applies to a transaction or other event that meets the definition of a business
combination. This Ind AS does not apply to:
(a) .....
(b) the acquisition of an asset or a group of assets that does not constitute a business. In
such cases the acquirer shall identify and recognise the individual identifiable assets
acquired (including those assets that meet the definition of, and recognition criteria for,
intangible assets in Ind AS 38, Intangible Assets) and liabilities assumed. The cost of the
group shall be allocated to the individual identifiable assets and liabilities on the basis
of their relative fair values at the date of purchase. Such a transaction or event does not
give rise to goodwill."
A similar guidance is provided in Ind AS 115, Revenue from Contracts with Customers,
which requires the use of relative stand-alone selling prices in allocating the transaction price
to each performance obligation identified in a customer contract.
In accordance with the above, the carrying amount of X Limited's investment in A Limited
may be split between the demerged business undertaking and businesses retained by A
Limited on the basis of the relative fair values of the two, with the portion of carrying amount
allocated to the former being derecognised.
Amount to be recognised
As per paragraph 10 of Ind AS 27, Separate Financial Statements, when an entity prepares
separate financial statements, it shall account for investments in subsidiaries, joint ventures
and associates either:
(a) at cost, or
(b) in accordance with Ind AS 109
In the present case, X Limited has adopted the accounting policy of recognising investment in
associates at `cost'.
Ind AS 27 does not define what is meant by `cost' except in the specific circumstances of
certain types of group reorganisations (which differ from the nature of the transaction under
discussion).
The issue in the present case is whether the `cost' of the additional shares in B Limited
received by X Limited is represented by
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their fair value, or
by the (allocated) carrying amount of the investment in A Limited, that is
derecognised by X Limited.
The answer to the above issue depends on whether these additional shares represent a new or
different investment acquired in exchange for a part of investment in A Limited or whether
they represent the continuance of the pre-existing investment (though in a different name)
Drawing analogy to paragraphs 24-26 of Ind AS 16, Property, Plant and Equipment, and
paragraphs 45-47 of Ind AS 38, Intangible Assets, regarding determination of cost of an item
of property, plant and equipment or an intangible asset acquired in exchange for a non-
monetary asset, it can be argued that these additional shares in B Limited may be said to
represent a new or different investment acquired in exchange for a part of investment in A
Limited, if the demerger results in a more than insignificant change in -
(a) the risks and rewards associated with the business undertaking transferred from A Ltd. to
B Ltd. or those associated with the other businesses carried on by B Ltd. or A Ltd; and/or
(b) in the extent of X Ltd.'s exposure to aforesaid risks and rewards.
It may be noted that whether the change is `significant' or `insignificant' is a matter of
judgement.
As per guidance provided in paragraphs 24-26 of Ind AS 16 and paragraphs 45-47 of Ind AS
38, if additional shares in B Limited received by X Limited represent a new or different
investment acquired in exchange for a part of investment in A Limited, they would be
measured initially at their fair value, with consequent recognition of gain or loss on
derecognition of part of investment in A Limited.
In the present case, however, there is no `exchange' of investments. X Limited continues to
hold the same number and proportion of equity shares in A Limited after the demerger as it
did before the demerger. Accordingly, in the given facts of the case, it would be an
appropriate view to take that the `cost' of the additional shares is represented by the amount
derecognised by X Limited in respect of its investment in A Limited while accounting for the
demerger.
Issue 5: Entity L applies Ind ASs in preparing its annual financial statements. During
the year, Entity L has purchased investment in an overseas entity, Entity M. Entity M is
associate of Entity L as per Ind ASs.
Entity M prepares its annual financial statements by following local GAAP and laws.
There are following differences between Entity L's accounting policies/estimates as per
Ind ASs and the corresponding accounting policies followed/estimates used by Entity M
in its annual financial statements:
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Particulars Entity L Entity M
(a) Business Common control business Pooling of interests method
combinations combinations pooling of (see Note )
interests method as per Ind
AS 103 Appendix C
Other business combinations
`acquisition method' as per
Ind AS 103
(b) Depreciation Method used shall reflect the Straight-line method for all
method pattern in which the asset's assets to comply with local
future economic benefits are taxation and corporate laws
expected to be consumed by
the entity as per paragraph 60
of Ind AS 16
(c)Useful lives Determined on the basis of Useful life prescribed by
of items of PPE factors (e.g. expected usage, local taxation and corporate
(or their expected physical wear and laws
significant parts) tear etc.) prescribed in
paragraph 56 of Ind AS 16
Note: Entity M has effected two business combinations after acquisition of investment
by Entity L. One of them qualifies as a common control business combination as per
Ind AS 103. However, both business combinations have been accounted for by applying
the pooling of interest methods as ordered by the local corporate regulator. No business
combination was effected by Entity M in the past.
The management of Entity L is of the view that in applying equity method, it cannot
change accounting policies of Entity M for (a) and (b) given above as, it is a well-
established principle that accounting standards do not override local laws. Accounting
policies followed by Entity M in preparing annual financial statements are in
accordance with its local laws and therefore to change them in applying the equity
method by Entity L is against this well-established principle.
Regarding matter (c), the management of Entity L is of the view that the useful lives
used by Entity M are in accordance with local laws and they are accounting estimates
and not accounting policies. Ind AS 28 does not require that accounting estimates
should be uniform in applying the equity method.
How should the specific accounting policies/estimates referred to in the query be dealt
with in application of equity method by Entity L?
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Response:
Ind AS 28, Investments in Associates and Joint Ventures, requires an entity to account for its
investment in an associate using the equity method except when that investment qualifies for
exemption in accordance with paragraphs 1719 of the Standard. It is implicit in the facts of
the case that as per the querist's evaluation, the exemption from application of equity method
is not applicable in the given case. For the purposes of this analysis, it is assumed that the
querist's evaluation is correct.
Paragraphs 35 and 36 of Ind AS 28 state as follows:
"35 The entity's financial statements shall be prepared using uniform accounting policies for
like transactions and events in similar circumstances unless, in case of an associate, it is
impracticable to do so.
36 If an associate or a joint venture uses accounting policies other than those of the entity for
like transactions and events in similar circumstances, adjustments shall be made to make the
associate's or joint venture's accounting policies conform to those of the entity when the
associate's or joint venture's financial statements are used by the entity in applying the
equity method."
In the case of an overseas associate, application of the above requirements means that except
to the extent the exception relating to impracticability applies, for the purpose of applying the
equity method, the associate's financial statements would need to be redrawn on the basis of
Ind ASs. The financial statements so drawn are special-purpose financial statements, meant
for the limited purpose of application of equity method by the investor. These special-purpose
financial statements do not replace general purpose financial statements prepared and
presented by the associate in accordance with its local laws and the preparation of these
special-purpose financial statements by the investor (or by the associate at the investor's
behest) cannot be said to tantamount to breach or non-compliance of the local laws applicable
to the associate.
Except to the extent the exception relating to impracticability applies, the treatment of the
specific items mentioned in the query by Entity L in applying the equity method would be as
follows:
Business combinations
A transaction that meets the definition of a common control business combination from the
perspective of the associate should be accounted for as per Appendix C of Ind AS 103 (i.e., as
per the pooling of interests method).
A transaction that meets the definition of a business combination, but not a common control
business combination, from the perspective of the associate should be accounted for as per
the requirements of Ind AS 103 (i.e., as per the acquisition method).
Depreciation method(s)
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Ind AS 16, Property Plant and Equipment, states the following with regard to selection of
depreciation method:
"60 The depreciation method used shall reflect the pattern in which the asset's future
economic benefits are expected to be consumed by the entity
61 The depreciation method applied to an asset shall be reviewed at least at each
financial year-end and, if there has been a significant change in the expected pattern of
consumption of the future economic benefits embodied in the asset, the method shall be
changed to reflect the changed pattern. Such a change shall be accounted for as a change
in an accounting estimate in accordance with Ind AS 8.
62 A variety of depreciation methods can be used to allocate the depreciable amount of
an asset on a systematic basis over its useful life. These methods include the straight-line
method, the diminishing balance method and the units of production method. Straight-line
depreciation results in a constant charge over the useful life if the asset's residual value
does not change. The diminishing balance method results in a decreasing charge over the
useful life. The units of production method results in a charge based on the expected use or
output. The entity selects the method that most closely reflects the expected pattern of
consumption of the future economic benefits embodied in the asset. That method is applied
consistently from period to period unless there is a change in the expected pattern of
consumption of those future economic benefits."
As per the above, the depreciation method to be applied in respect of an item of property,
plant and equipment (or part of an item of PPE that needs to be depreciated separately as per
paragraphs 43 and 45 of Ind AS 16) is the one that reflects the expected pattern of
consumption of the future economic benefits embodied in the asset. Thus, under Ind AS 16,
depreciation method is a matter of an accounting estimate, and not an accounting policy. In
drawing up the financial statements of the associate as per Ind ASs, the requirements of Ind
AS 16 need to be considered in determining an appropriate depreciation method for each item
of property, plant and equipment (or significant part). The resultant method for an item of
property, plant and equipment (or significant part) may be different from the method applied
by the associate in preparing and presenting its financial statements to comply with its local
laws.
Useful lives
Ind AS 16 defines the term `useful life' as follows:
"Useful life is:
(a) the period over which an asset is expected to be available for use by an entity; or
(b) the number of production or similar units expected to be obtained from the asset by an
entity."
Ind AS 16 contains detailed guidance regarding the factors to be considered in determining
the useful life of an item of property, plant and equipment (or significant part). In drawing up
the financial statements of the associate as per Ind ASs, the useful life of each item of
property, plant and equipment (or significant part) needs to be estimated in line with the
definition of this term and related guidance provided in Ind AS 16. The useful life so
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determined in respect of an item of property, plant and equipment (or significant part) may be
different from the useful life taken by the associate in preparing and presenting its financial
statements to comply with its local laws.
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