Management Notes

Employee Benefits Ind AS 19

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The Indian Accounting Standard (Ind AS) 19 aims to prescribe accounting and disclosure for employee benefits. It requires recognition of the liability by an entity when an employee provides services for employee benefits to be paid in the future, and recognition of expenses when the entity utilises the economic benefit arising from service given by an employee in exchange for employee benefits.

For example, when an employee works for a company, the company derives benefit from the effort put in by the employee. Thus, it can be said that the company consumes the services rendered by the employee, and in this case the company will recognise this as an expenditure. And consequently, a liability arises to the employee that is payable by the company which is equivalent to the benefits that are payable by the company.

The liability can be in the form of salaries which are payable every month, or sometimes the liabilities can be carried forward and be payable on retirement, or after completion of a few years. These depend on the nature of the contract between the employer and employee, and all such benefits that are agreed upon to be paid to the employee need to be accounted for. Under Ind AS 19, even constructive obligations need to be accounted for. For example, this may include a festival bonus (like Eid Bonus or Diwali Bonus) which may not be a legal or contractual requirement, but one which the employer voluntarily provides and is followed based on precedence (ie. The company may have paid the same in the previous year, and the employee would expect it).

Accounting for Short Term Employee Benefits

Short term employee benefits are settled within a period of 12 months from the end of the period in which the services were rendered by the employee. Examples include salaries, paid annual leave, rental accommodation, car benefit etc. They are accounted on a undiscounted basis because the settlement is expected to happen within the short term. Short Term Employee Benefits are recognised as

A liability after deducting the amount paid within the year.

As an asset, if the amount paid exceeds the undiscounted amount of the benefits payable.

As an expense in the profit and loss

Example of accounting for Short Term Employee Benefits

Consider an employee with salary of 10,000 Rs per month and 1 month bonus payable every year. If at the end of the year, 2 months salary along with bonus are unpaid, then these are recognised as a liability. However if 2 months extra salary has been paid to the employee, then it is treated as an asset.

For Short term employee benefits, no specific disclosures are required under Ind AS 19.

Post-Employment Benefits: Defined Contribution Plans

Post-Employee benefit schemes where the obligation of an entity is to only contribute to a plan, and no further obligation arises on the entity is known as a Defined Contribution plan.

Defined Contribution Plans are recognised as

  • A liability after deducting the amount paid within the year.
  • As an asset, if excess amount has been contributed.
  • As an expense in the profit and loss

If the contribution is due within 12 months, then no discounting factor is applied. When the contributions do not fall due within 12 months of the end of the reporting period, then it should be discounted using the discount rate.

Example of Defined Contribution Plan Accounting

Lets say a company contributes 10% of every employee’s salary to a employee benefits plan. In this case, the company takes up no further obligation. The Company should account this contribution, amounting to 10% of its salary to the profit and loss account as an expense.

Post-Employment Benefits: Defined Benefits Plan

While Ind AS 19 prescribes accounting for many types of employee benefits such as long term paid absences, long service benefits, profit sharing / bonus schemes and termination benefits, post-employment benefits of a Defined Benefit Plan are accounted with additional complexity under Ind AS 19. The complexity of accounting for post-employment benefits is high, since it requires the use of actuarial assumptions relating to the demographics of the company/industry and also financial assumptions related to the overall economy.

Accrual of Benefits

Post employment benefit schemes with a Defined Benefit Plan are usually structured in a way that the employees gain the benefit for each year of service they have rendered to the company. This benefit is accrued over time, and when the employee leaves the service, the entire benefit is payable to the employee. This is the accrual system of accounting for employee benefits. Under Ind AS 19, the Projected Unit Credit method of accounting is prescribed for calculation of employee benefits, taking into account the accruing nature of these benefits. The basic premise of the PUC method is that each year of service rendered by an employee will give rise to one unit of benefit entitlement to the employee.

PUC Method

Under the PUC method of accounting, a projected accrued benefit is calculated at the begging of the year, and again at the end of the year for all the employees under the plan. The employee’s benefit will depend on years of service and also considers the future salary increase and the plan’s benefit allocation formula. The Benefit attributable to an employee on a future separation date (date of retirement) is the benefit defined under the plan based on credited service as on the valuation date. The “projected accrued benefit” is based on the Scheme’s accrual formula and upon service as of the beginning or end of the year, but using a member’s final compensation, projected to the age at which the employee is assumed to leave active service. The Scheme Liability is the actuarial present value of the “projected accrued benefits” as of the beginning of the year for active members. An individual’s estimated benefit obligation is the present value of the attributed benefit for valuation purposes at the beginning of the year, and the service cost is the present value of the benefit attributed to the year of service in the plan year.

Important Aspects of Defined Benefit Plan Accounting

The present value of a defined benefit obligation is the present day value of post-employment benefits based on the employee’s future salary, resulting from the employee’s service in the current and past periods. The Plan Assets are measured at fair value as on the balance sheet date. The Net obligation is recognised in the profit and loss account as an expenditure, along with a corresponding liability.

Example: In a funded plan having net obligations as 10 crores, and plan assets as 8 crores. In this case, 2 crores is the expense that the company has to make towards the DBO, and this is treated as an expense in the company’s profit and a corresponding liability is accounted.   

Current Service Cost is the cost incurred to the company due to the employee rendering service in the current year. If the employee renders no service, the current service cost is zero. For a Defined benefit obligation, current service cost can be defined as the increase in the present value of defined benefits obligation due to the employee’s service in the current year.

Interest Cost is the increase in defined benefits obligations that arise due to the passage of time. The present value of the DBO increases in a year, because the benefits are one time period closer to settlement. This is captured in interest cost.

Past Service Cost is the changes in present value of DBO due to plan amendments or curtailment. This may arise due to change in the nature of plan. For example, a company may amend the plan to increase the value of its defined benefit payable to its employees. This would result in recognition of the amounts that were not recognised earlier. In the alternative scenario for a plan curtailment, the company may curtail the bonus that is payable to employees who have completed 10 years of service from 6 month’s salary to 3 month’s salary. Thus, the employees will lose some benefits due to curtailment of the plan. These are captured in past service cost.

Plan Assets include the assets held by the Defined Benefit Plan in an employee benefits fund, or any insurance policy that is designed for employee benefit schemes.

Actuarial Gains/Losses are the changes in the DBO due to changes in actuarial assumptions. When accounting for defined benefit plans and post-employment benefits, certain assumptions have to be made on factors such as salary growth rate, attrition rate etc. Changes in these assumptions results in actuarial gain/loss. For example, salary growth rate of a company may fall from 10% to 3% due to economic slowdown. The gain or loss due to this change is known as actuarial gain/loss. These are treated as unrealised gains or losses, and is not debited to the profit and loss account but is captured in the Other Comprehensive Income (OCI).

Accounting for DBO

In the Profit and Loss account, the following components are recognised:

Under the head Service Cost: the current service cost, past service costs, settlements and curtailments (if any);

Under the head Net Interest Cost: Net Interest expense on DBO, Interest on Plan Assets, and interest on the effect of asset ceiling;

Additionally, any administrative expenses and taxes.

Accounting For Other Long Term Employee Benefits

Employee Benefits that are expected to be settled after 12 months from from the end of the period in which the services are rendered, but are not a post-employment benefits or termination/retrenchment benefit are called Other Long Term Employee Benefits . For example, the employee may be entitled to a loyalty bonus after working for 10 years. This is an Other Long Term Employee Benefit. Other examples include long service award or jubilee awards, long term compensated absences, and long term disability benefits.

Other Long Term Employee Benefits are accounted using the Projected Unit Credit Method in a similar method as that of Defined Benefit Plans, however the actuarial gains and losses arising out of Other Long Term Employee Benefit plans are not considered under the OCI but are considered in the profit and loss account. The components charged to the profit and loss account are service cost, net interest on the net defined benefit liability,

Accounting For Termination Benefits

Termination benefits arise when an employee is terminated by the employer or when an employee accepts the employer’s offer of benefits in exchange of termination of employment. This is different to post-employment benefits. Classic example of termination benefits is retrenchment compensation where the employee has no option to accept the termination. Voluntary Retirement Scheme is also an example of termination benefits where the employees are due a compensation and in return accept early retirement.

Termination Benefits are to be recognised on the earlier date of when the company can no longer withdraw the offer of the termination benefits, or when the company recognises costs for restructuring which involves the payment of termination benefits. For instance, a company may face debt restructuring and accordingly, several employees would have to be laid off, and the termination benefits would be recognised.

Measurement of Termination Benefits

Termination Benefits are measured based on the criteria considering if they are an enhancement to post-employment benefits. If they are an enhancement to post-employment benefits (for instance payable after retirement), then they are accounted as per Defined Contribution Plan or Defined Benefit Plan, as the case maybe. If they are not an enhancement to post-employment benefits, based on whether the termination benefits are expected to be settled within 12months they are accounted as either Short Term Employee Benefits (for cases when the settlement is within 12 months) or Other Long Term Employee Benefits (for other cases).

Management Notes

Post-employment benefits; Defined contribution plans Ind AS 19

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Post-employment benefits are employee benefits (other than termination benefits and short-term employee benefits) that are payable after the completion of employment. Post-employment benefit plans are formal or informal arrangements under which an entity provides post -employment benefits for one or more employees. Post-employment benefit plans are classified as either defined contribution plans or defined benefit plans, depending on the economic substance of the plan as derived from its principal terms and conditions.

Post-employment benefits: Defined contribution plans

Defined contribution plans are post-employment benefit plans under which an entity pays fixed contributions into a separate entity (a fund) and will have no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior periods. Under defined contribution plans the entity’s legal or constructive obligation is limited to the amount that it agrees to contribute to the fund. Thus, the amount of the post-employment benefits received by the employee is determined by the amount of contributions paid by an entity (and perhaps also the employee) to a post-employment benefit plan or to an insurance company, together with investment returns arising from the contributions. In consequence, actuarial risk (that benefits will be less than expected) and investment risk (that assets invested will be insufficient to meet expected benefits) fall, in substance, on the employee.

When an employee has rendered service to an entity during a period, the entity shall recognise the contribution payable to a defined contribution plan in exchange for that service:

  • As a liability (accrued expense), after deducting any contribution already paid. If the contribution already paid exceeds the contribution due for service before the end of the reporting period, an entity shall recognise that excess as an asset (prepaid expense) to the extent that the prepayment will lead to, for example, a reduction in future payments or a cash as an expense, unless another Ind AS requires or permits the inclusion of the contribution in the cost of an asset (see, for example, Ind AS 2 and Ind AS 16).

Post-employment benefits: defined benefit plans

Defined benefit plans are post-employment benefit plans other than defined contribution plans. Under defined benefit plans:

  • The entity’s obligation is to provide the agreed benefits to current and former employees.
  • Actuarial risk (that benefits will cost more than expected) and investment risk fall, in substance, on the entity. If actuarial or investment experience are worse than expected, the entity’s obligation may be increased.

Accounting by an entity for defined benefit plans involves the following steps:

Determining the deficit or This involves:

  • Using an actuarial technique, the projected unit credit method, to make a reliable estimate of the ultimate cost to the entity of the benefit that employees have earned in return for their service in the current and prior periods. This requires an entity to determine how much benefit is attributable to the current and prior periods and to make estimates (actuarial assumptions) about demographic variables (such as employee turnover and mortality) and financial variables (such as future increases in salaries and medical costs) that will affect the cost of the
  • Discounting that benefits in order to determine the present value of the defined benefit obligation and the current service
  • Deducting the fair value of any plan assets from the present value of the defined benefit

Determining the amount of the net defined benefit liability (asset) as   the amount of the deficit or surplus determined in (a), adjusted for any effect of limiting a net defined benefit asset to the asset ceiling. (Asset ceiling is defined as present value of any economic benefit available in the form of refunds from the plan or reduction in future contributions to the plan).

Determining amounts to be recognized in profit or loss:

  • Current service
  • Any past service cost and gain or loss on
  • Net interest on the net defined benefit liability (asset).

Determining the remeasurements of the net defined benefit liability (asset), to be recognised in other comprehensive income, comprising:

  • Actuarial gains and losses;
  • Return on plan assets, excluding amounts included in net interest on the net defined benefit liability (asset).
  • Any change in the effect of the asset ceiling (see paragraph 64), excluding amounts included in net interest on the net defined benefit liability (asset).
  • Where an entity has more than one defined benefit plan, the entity applies these procedures for each material plan separately.
Management Notes

Short-term employee benefits Ind AS 19

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When an employee has rendered service to an entity during an accounting period, the entity shall recognise the undiscounted amount of short-term employee benefits expected to be paid in exchange for that service:

  • As a liability (accrued expense), after deducting any amount already paid. If the amount already paid exceeds the undiscounted amount of the benefits, an entity shall recognise that excess as an asset (prepaid expense) to the extent that the prepayment will lead to, for example, a reduction in future payments or a cash
  • As an expense, unless another ind as requires or permits the inclusion of the benefits in the cost of an asset (see, for example, ind as 2, inventories, and ind as 16, property, plant and equipment).

Different employee benefits under AS 19

Short-term employee benefits: There are those which are expected to be fully paid before 12 months after the end of the accounting period in which the employee rendered service.

Other long-term employee benefits: There are those which are not expected to be fully paid within 12 months after the end of the accounting period.

Termination benefits: These are those which are paid to an employee who is terminated from service due to the employer’s decision.

Post Employment benefits: These are those employee benefits which are paid after the completion of employment.

Short-term employee benefit includes the following:

Recognition & Measurement

Once the employee renders service to an employer, the expected amount of short-term employee benefits to be paid for such service has to be recognized as a liability or as an expense. It is considered a revenue expenditure generally except when any other standard requires it to be capitalized.

Types of short-term benefits

Short-term employee benefits are of two types:

  • Paid absences
  • Profit sharing and bonus plan

Paid Absences

These are compensated absences and can be classified as accumulating paid absences and non-accumulating paid absences. Examples of such absences are holidays, sickness, maternity, etc and their related cost are recognized as follows:

Description Cost Recognition
Accumulating paid absence When services rendered increases the employees right to future paid absence
Non-accumulating paid absences When such absences occur

Profit-Sharing and Bonus Plan

‘Profit sharing’ and ‘Bonus Plan’ are benefits such as employee’s annual incentive, managing director’s commission etc. These costs are recognized when the employer:

  • Has a present obligation to make such payment on account of past events.
  • Has the reliable estimate of expected payment that can be made.
Management Notes

Termination benefits Ind AS 19

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Termination benefits arise when an employee is terminated by the employer or when an employee accepts the employer’s offer of benefits in exchange of termination of employment. This is different to post-employment benefits. Classic example of termination benefits is retrenchment compensation where the employee has no option to accept the termination. Voluntary Retirement Scheme is also an example of termination benefits where the employees are due a compensation and in return accept early retirement.

Termination Benefits are to be recognised on the earlier date of when the company can no longer withdraw the offer of the termination benefits, or when the company recognises costs for restructuring which involves the payment of termination benefits. For instance, a company may face debt restructuring and accordingly, several employees would have to be laid off, and the termination benefits would be recognised.

Termination benefits are employee benefits provided in exchange for the termination of an employee’s employment as a result of either:

  • An entity’s decision to terminate an employee’s employment before the normal retirement date; or
  • An employee’s decision to accept an offer of benefits in exchange for

An entity shall recognize a liability and expense for termination benefits at the earlier of the following dates: The termination of

  • When the entity can no longer withdraw the offer of those benefits; and
  • When the entity recognises costs for a restructuring that is within the scope of Ind AS 37 and involves the payment of termination benefits

It does not cover an employee’s voluntary termination or mandatory retirement. It is generally a lump sum payment and also includes:

  • Enhancement of post-employment benefits (through benefit plan).
  • Salary to be paid until the end of a specified notice period.

Recognition

An employer should recognize termination benefits as a liability and as an expense at the earlier of the following dates:

  • The employer can no longer withdraw the offer for those benefits. The employer recognizes restructuring cost per Ind AS 37 and involves payment of termination benefits

Measurement

Termination Benefits are measured based on the criteria considering if they are an enhancement to post-employment benefits. If they are an enhancement to post-employment benefits (for instance payable after retirement), then they are accounted as per Defined Contribution Plan or Defined Benefit Plan, as the case maybe. If they are not an enhancement to post-employment benefits, based on whether the termination benefits are expected to be settled within 12months they are accounted as either Short Term Employee Benefits (for cases when the settlement is within 12 months) or Other Long Term Employee Benefits (for other cases).

  • Measure the termination benefits on initial recognition and recognize subsequent changes with the nature of employee benefit.
  • Analyze if the benefits are an enhancement of post-employment benefits or short-term employee benefits or long-term employee benefits.
Management Notes

Disclosure of related party Transactions

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Related Party Transactions are an integral part of businesses in today’s world. The transactions between the related parties are generally conducted at negotiated terms and hence they must be disclosed. Additionally, for an investor, knowledge of related parties facilitates a more informed decision to invest in an entity. Also, for every reader of the financial statements accurate disclosure of all the related party relationships, transactions, and outstanding balances presents a correct picture of the risk and opportunities for an entity.

Related party transactions are the transfer of services or obligations, resources between a reporting entity, and related party irrespective of the fact that a price is charged.

The Government refers to government, government agencies, and similar bodies whether local, national, or international.

A government-related entity is an entity that is controlled, jointly controlled, or significantly influenced by the government.

Compensation includes all employment benefits such as short-term employment benefits, post-employment benefits, other long-term employer benefits, termination benefits, and share-based payments.

Related party is a person or entity that is related to the reporting entity that is an entity that prepares financial statements. A person or close family member is related to reporting entity if that individual:

  • Has control or joint control over the reporting entity.
  • Has significant influence over the reporting entity.

Is a member of the key personnel of the reporting entity or of the parent of the reporting entity.

A Close member of the family includes person’s children, spouse or domestic partner, brother, sister, father and mother, children of that person’s spouse or domestic partner and dependants of that person’s or person’s spouse or domestic partner. An entity is related to a reporting entity if the following conditions are met:

  • Both the reporting entity and the entity belonging to the same group.
  • An associate or joint venture of the other entity or of the same third party.
  • The entity is a post-employment benefit plan for the reporting entity or any entity related to the reporting entity.
  • The entity is controlled or jointly controlled by the person mentioned above or the person mentioned has significant influence over the entity.
  • The entity or any member of the group provides key management personnel service to the reporting entity or parent of reporting entity.

The following information should be disclosed where control exists between the parties.

  • Name of its parent and ultimate controlling party (if it is other than its parent); and
  • Nature of the related party relationship.
  • If neither the entity’s parent nor the ultimate controlling party prepares consolidated financial statements available for public use, the name of the next most senior parent (first parent in the group above the immediate parent that produces consolidated financial statements available for public) that does so shall also be disclosed.
  • These two should be disclosed irrespective of whether or not there have been transactions between the related parties. Observe that this requirement is only when control exist between the parties. If there is NO Control, entity needs to disclose the information only when there is a transaction.

Related Party Transactions

If there have been transactions between related parties, disclose the nature of the related party relationship as well as information about the transactions and outstanding balances necessary for an understanding of the potential effect of the relationship on the financial statements. These disclosure would be made separately for each category of related parties and would include: [IAS 24.18-19]

  • The amount of the transactions
  • The amount of outstanding balances, including terms and conditions and guarantees
  • Provisions for doubtful debts related to the amount of outstanding balances
  • Expense recognised during the period in respect of bad or doubtful debts due from related parties.

Examples of the kinds of transactions that are disclosed if they are with a related party

  • Purchases or Sales of Goods
  • Purchases or Sales of Property and Other Assets
  • Rendering or Receiving of Services
  • Leases
  • Transfers of Research and Development
  • Transfers Under Licence Agreements
  • Transfers Under Finance Arrangements (Including Loans and Equity Contributions in Cash or In Kind)
  • Provision Of Guarantees or Collateral
  • Commitments to do Something If a Particular Event Occurs or Does Not Occur in The Future, Including Executory Contracts (Recognised and Unrecognised)
  • Settlement Of Liabilities on Behalf of The Entity or By the Entity on Behalf of Another Party
Management Notes

Government related entity

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A reporting entity is exempt from the disclosure requirements in relation to related party transactions and outstanding balances, including commitments, with:

(a) a government that has control or joint control of, or significant influence over, the reporting entity;

(b) another entity that is a related party because the same government has control or joint control of, or significant influence over, both the reporting entity and the other entity.

If a reporting entity applies the exemption above, it shall disclose the following about the transactions and related outstanding balances referred to the above:

(a) The name of the government and the nature of its relationship with the reporting entity (ie control, joint control or significant influence);

(b) The following information in sufficient detail to enable users of the entity’s financial statements to understand the effect of related party transactions on its financial statements:

(i) The nature and amount of each individually significant transaction;

(ii) for other transactions that are collectively, but not individually, significant, a qualitative or quantitative indication of their extent.

Transaction with the government-related entity

The Reporting entity is exempt from the disclosures requirement with the government who has control or joint control or significant influence over the reporting entity and another entity that is a related party because the same government has control or joint control of or significant influence over both the reporting and other entity. As a result of such exemption, the entity need not disclose related party transactions and outstanding balances including commitments. If the above exemption applies, an entity must disclose the following:

  • Name of the government and nature of its relationship.
  • The nature and amount of each individually significant transaction and for other transactions that are collected, but not individually significant a qualitative or quantitative indication of their extent.

Related party transactions are the transfer of services or obligations, resources between a reporting entity, and related party irrespective of the fact that a price is charged.

The Government refers to government, government agencies, and similar bodies whether local, national, or international.

A government-related entity is an entity that is controlled, jointly controlled, or significantly influenced by the government.

Compensation includes all employment benefits such as short-term employment benefits, post-employment benefits, other long-term employer benefits, termination benefits, and share-based payments.

Management Notes

Key Management Personnel, Significant influence

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Key Managerial Personnel (KMP) or Key Management Personnel refers to the employees of a company who are vested with the most important roles and functionalities. They are the first point of contact between the company and its stakeholders and are responsible for the formulation of strategies and its implementation. The Companies Act mandates certain classes of companies to include such personnel in its ranks. This article looks at this designation which holds a significant place in the Companies Act of 2013.

The definition of Key Managerial Personnel has been made more elaborate in the Companies Act of 2013 as the 1956 Act restricted its scope to a Managing Director, Whole Time Director and Manager. The current definition of the term provides for the inclusion of the Chief Executive Officer (CEO), the Manager, the Managing Director, the Company Secretary, the Whole-Time Director, the Chief Financial Officer (CFO) and such other officers as may be prescribed. For the purpose of this Act, a Key Managerial Personnel (KMP) is considered as an “Officer and an “Officer who is in default”.

It may be noted that companies are prohibited from appointing or employing a Managing Director and a Manager at the same time. Also, no individuals should be appointed or reappointed as the Managing Director, Manager, Whole-Time Director or Chief Executive Officer (CEO) of a Company for a term exceeding five years at a time, and no reappointments are allowed earlier than one year before the expiry of its term (conditions are subject to additional clauses).

Key management personnel are those people having authority and responsibility for planning, directing, and controlling the activities of an entity, either directly or indirectly. This designation typically includes the following positions:

  • Board of directors
  • Chief executive officer, chief operating officer, and chief financial officer
  • Vice presidents

An entity shall disclose key management personnel compensation in total and for each of the following categories

(a) Short-term employee benefits

(b) Post-employment benefits

(c) Other long-term benefits;

(d) Termination benefits

(e) share-based payment.

Compensation includes all employee benefits as defined in Ind AS 19 Employee Benefits including share based payments to employees as per Ind AS 102.  Employee benefits are all forms of consideration paid, payable or provided by the entity, or on behalf of the entity, in exchange for services rendered to the entity. It also includes such consideration paid on behalf of a parent of the entity in respect of the entity.

If an entity obtains key management personnel services from another entity (the ‘management entity’) [See related party definition point (b) (viii)] in such case, the entity should disclose the amount of fees/compensation paid to the management entity.  Generally, the reporting entity pays agreed amount to the management entity and in return management entity pays to its employees i.e., who managed the reporting entity. The details of payment by the management entity to its employees/directors are not required to be disclosed in the reporting entity financial statements.

According to section 203(1) read with Rule 8 of the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014 the following companies are mandated to appoint a Whole-time KMP:

  • Every Listed Company
  • Public Companies having paid-up share capital of 10 Crore rupees or more.
  • Public Companies Having paid-up share of 5 Crore rupees or more.
  • Companies having paid-up share capital of 10 Crore rupees or more are mandated to appoint a Company Secretary.

Roles and Responsibilities of Key Managerial Personnel

The Management function of implementing important decisions comes under the responsibilities of Key Managerial Personnel. Here are some of the main Roles and Responsibilities of KMP:

As per Section 170 of the Act, the details of Securities held by the Key Managerial Personnel in the company or its holding, subsidiary, a subsidiary of the company or associated companies should be disclosed and recorded in the registrar of the Books.

KMP has a right to be heard in the meetings of the Audit Committee while considering the Auditor’s Report; however they do not have the right to vote.

According to Section 189(2), Key Managerial Personnel should disclose to the company, within 30 days of appointment, relating to their concern or interest in the other associations, which are required to be included in the register.

Procedure of Appointment of KMP

  • The appointment of key managerial personnel is prescribed under Section 203 of the Act. Every member of managerial personnel is appointed through a resolution adopted by the Board with terms and conditions of appointment and remuneration.
  • A member of managerial personnel can hold the position in one company at a given time. However a member of managerial personnel of a company can be a member of managerial personnel of its subsidiary company.
  • In case of vacancy the Board has the responsibility of filling up within six months from the date of such vacancy.
  • If the company or its Board tries to violate the provision of appointment of managerial personnel, then the company has to suffer from penalty. The company shall be punishable with fine of rupees one lakh which may extend up to rupees five lakh.
  • Every Director and other key managerial personnel shall also be punishable with a fine of Rs.50, 000. If the contravention is continuing, then they would be charged with Rs. 1000 per day after the first offense.

Officer in default

According to section 2(60) of the Act, an ‘officer who is in default ‘shall be liable for any penalty or punishment by way of imprisonment or fine. The officers may include:

Key Managerial Personnel

Whole-Time director’.

Any person who is responsible for maintenance, filing or distributing records or accounts.

Any Director who is aware of the activities taking place is in contravention of the law or the provisions and yet indulges in or participates in it.

Maintenance of Register:

Every Company falling under this provision is required to maintain a register comprising particulars of its Directors and KMPs, which is to be placed at the registered office of the Company. The documents should include the details of securities held by each of them in the company or its holding, subsidiary, subsidiary of a company’s holding company or associate companies. Further requirements of its contents have been mentioned in Rule 17 of the Companies (Appointment and Qualification of Directors) Rules, 2014.

Significant influence

Significant influence is the power to participate in the financial and operating policy decisions of the investee, but is not control of those policies.

IND-AS 28 defines significant influence as under:

Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies.

Management Notes

Purpose of related party disclosures

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IAS 24 Related Party Disclosures requires disclosures about transactions and outstanding balances with an entity’s related parties. The standard defines various classes of entities and people as related parties and sets out the disclosures required in respect of those parties, including the compensation of key management personnel.

Disclosures to be made

  • Relationships between parent and subsidiaries should be disclosed irrespective of whether there have been any transactions or not. If the entity’s parent or the ultimate controlling party does not produce consolidated financial statements, then the next senior parent must be named in the consolidated financial statements for public use.
  • An entity must report the compensation to the key management personnel in total and each of the categories such as short term employee benefits, post-employment benefits, termination benefits, share-based payment, and other long-term benefits.
  • If key management services are obtained from another entity, then only the amounts incurred for the provision of such services shall be disclosed.
  • If the entity has transactions with the related party during the financial year, then it shall disclose the nature of such transactions, and also all the details such as amount, outstanding balances including commitments, provision for doubtful debts, and the expense recognised in respect of bad and doubtful debts.
  • The above disclosures will be made separately in respect of a parent, subsidiaries, associate, entities with joint control or significant influence over the other entity, joint ventures in which the entity is the venturer, and key management personnel of the entity or parent and other related parties.

In general, any related party transaction should be disclosed that would impact the decision making of the users of a company’s financial statements. This involves the disclosures noted below. Depending on the transactions, it may be acceptable to aggregate some related party information by type of transaction. Also, it may be necessary to disclose the name of a related party, if doing so is required to understand the relationship.

General Disclosures

Disclose all material related party transactions, including the nature of the relationship, the nature of the transactions, the dollar amounts of the transactions, the amounts due to or from related parties and the settlement terms (including tax-related balances), and the method by which any current and deferred tax expense is allocated to the members of a group. Do not include compensation arrangements, expense allowances, or any transactions that are eliminated in the consolidation of financial statements.

Control Relationship Disclosures

Disclose the nature of any control relationship where the company and other entities are under common ownership or management control, and this control could yield results different from what would be the case if the other entities were not under similar control, even if there are no transactions between the businesses.

Receivable Disclosures

Separately disclose any receivables from officers, employees, or affiliated entities.

When disclosing related party information, do not state or imply that the transactions were on an arm’s-length basis, unless you can substantiate the claim.

Management Notes

Related Party Disclosures, Related Party, Related party Transaction

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A related party transaction is a transfer of resources, services or obligations between RE (reported entity) and related party regardless of whether a price is charged or not.

Objective

Related party relationships are a normal feature of commerce and business. Entities frequently carry on their business activities through its subsidiaries, joint ventures, associates and etc.

In general, users presume that the transactions in financial statements are presented on an “arm’s length” basis. However, the presumption may NOT be valid in case of the transactions between the related parties as the terms and conditions of related parties generally different from unrelated parties. Sometimes related parties may not charge anything for their services like interest free loans, free management services etc. Hence the related party relationship will have an effect on the financial position (BS) and operating results (P&L) of the entity.

Operating results and financial position will be affected because of related party relationship even if there is NO transaction between them.  The mere existence of the relationship may be sufficient to affect the transactions of the entity with other parties. For example: a holding company can ask its subsidiary to stop the relationship with a trading partner or it may instruct the subsidiary not to engage in research and development.

Sometimes, transactions would not have taken place if the related party relationship had not existed. For example, a company that sold a large proportion of its production to its holding company at cost might not have found an alternative customer if the holding company had not purchased the goods.

As the related party transactions may not take place at arm’s length, the entity should give sufficient information about the related party relationship and related party transactions so as to make the users understand the financial positions in its perspective. This standard establishes the requirements of such disclosures.

Scope

This standard is applicable to the consolidated & separate financial statements of a parent or investors with joint control/significant influence over an investee – who prepared financial statements under Ind AS 110, Ind AS 27. It is applicable to individual financial statements.

This Standard shall be applied in:

(a) identifying related party relationships and transactions;

(b) identifying outstanding balances, including commitments, between an entity and its related parties;

(c) Identifying the circumstances in which disclosure of the items in (a) and (b) is required; and

(d) Determining the disclosures to be made about those items.

This Standard is NOT applicable in the following circumstances:

  • Entities need not follow the standard if the disclosure under this Ind AS affects the reporting entity’s duties of confidentiality.
  • In case a statute or a regulator or a similar competent authority governing an entity prohibit disclosing certain information which is required to be disclosed as per this Standard disclosure of such information is not required. For example: banks are obliged by law to maintain confidentiality in respect of their customers’ transactions.
  • In case of consolidated financial statements (CFS): Intra group transactions need NOT to be presented as CFS present information about the holding and its subsidiaries as a single reporting entity. This is not applicable for those between an investment entity and its subsidiaries measured at fair value through profit or loss, in the preparation of consolidated financial statements of the group.

This Standard applies only to the below related party relationships.

Disclosures to be made:

  • Relationships between parent and subsidiaries should be disclosed irrespective of whether there have been any transactions or not. If the entity’s parent or the ultimate controlling party does not produce consolidated financial statements, then the next senior parent must be named in the consolidated financial statements for public use.
  • An entity must report the compensation to the key management personnel in total and each of the categories such as short term employee benefits, post-employment benefits, termination benefits, share-based payment, and other long-term benefits.
  • If key management services are obtained from another entity, then only the amounts incurred for the provision of such services shall be disclosed.
  • If the entity has transactions with the related party during the financial year, then it shall disclose the nature of such transactions, and also all the details such as amount, outstanding balances including commitments, provision for doubtful debts, and the expense recognised in respect of bad and doubtful debts.
  • The above disclosures will be made separately in respect of a parent, subsidiaries, associate, entities with joint control or significant influence over the other entity, joint ventures in which the entity is the venturer, and key management personnel of the entity or parent and other related parties.

Related Party

A related party can be a person, an entity, or an unincorporated business.

A related party is a person (individual) or entity that is related to the entity that is preparing its financial statements.

(a) A person or a close member of that person’s family is related to a reporting entity if that person:

(i) Has control or joint control of the reporting entity;

(ii) Has significant influence over the reporting entity; or

(iii) Is a key management personnel (KMP) of the reporting entity or it’s parent entity.

(b) An entity is related to a reporting entity if any of the following conditions applies:

(i) The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others);

(ii) One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member i.e., associate or joint venture of co-subsidiary);

(iii) Both entities are joint ventures of the same third party;

(iv) One entity is a joint venture of a third entity and the other entity is an associate of the third entity;

(v) The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity;

(vi) The entity is controlled or jointly controlled by a person identified in (a);

(vii) A person identified in (a) (i) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity);

(viii) The entity, or any member of a group of which it is a part, provides key management personnel services to the reporting entity or to the parent of the reporting entity.

Control is the power over the investee when it is exposed or has rights to variable returns from its involvement with the investee and has the ability to affect those returns.

Joint Control is the contractually agreed sharing of control of an arrangement which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control.

Significant influence is the power to participate in the financial and operating policy decisions of the investee, but is not control of those policies.

 (a) An INDIVIDUAL becomes related party to the reporting entity, when that individual or his family’s close member

  • Has Control or Joint control or Significant influence over the reporting entity;
  • Is Key managerial personnel in the reporting entity or it’s parent entity; (Not in co-subsidiary entity)

Close Member of the family:

Close members of the family of a person are those family members who may be expected to influence, or be influenced by, that person in their dealings with the entity including:

(a) That person’s children, spouse (married) or domestic partner (a person who is living with another in a close personal and sexual relationship but not married), brother, sister, father and mother.

(b) Children of that person’s spouse or domestic partner.

(c) Dependents of that person or that person’s spouse or domestic partner.

Related Party as per Companies Act, 2013 According to section 2(76) of the Company’s act, 2013 related party with reference to company means:

i) a director or his relative;

) a key managerial personnel or his relative;

i) A firm, in which a director, manager or his relative;

ii) A private company in which a director or manager or his relative is a member or director.

iii) A public company in which a director or manager is a director and holds along with his relatives, more than 2% of its paid-up capital;

iv) Anybody corporate who’s Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager.

v) any person on whose advice, directions or instructions a director or manager is accustomed to act provided that nothing in sub-clauses (vi) and(vii) shall apply to the advice ,directions or instructions given in a professional capacity.

vi) any body corporate which is:

A) A holding, subsidiary or an associate company of such company;

B) A subsidiary of a holding company to which it is also a subsidiary; or,

C) An investing company or the venturer of a company means a body corporate

Related party Transaction

Related Party Transaction can be understood as a deal or arrangement made between two parties or entities that are joined by a pre-existing business relationship or common interest. It is a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged.

All related party transactions require approval of Audit Committee. All contracts that are (1) not in the ordinary course of business but at arm’s length (2) in the ordinary of course of business but not at arm’s length or (3) not in the ordinary course of business and not at arm’s length require prior approval of board of directors or shareholders based on certain thresholds.

Penalties: Any director or any other employee of the company, who had entered into or authorised the contract in violation, as per section 188 of the companies act they are punishable:

a) In case of listed companies, imprisonment upto 1 year or fine from 25,000 to 5 lakhs or both

b) In case of other companies , fine from 25,000 to 5 lakhs.

Main purpose of Related Parties regulation: To regulate transactions between the company, its subsidiaries and its related parties with a view to ensure that such transactions are executed on an arm’s length basis and is transparent and fair manner.

Importance

They provide transparency on how its financial position and financial performance may be affected by transaction with related parties which may or not be conducted on an arm’s length basis.

Under the new law, in relation to every RPT, directors have to necessarily check most importantly the following two criteria:

a) Whether the contracts or arrangements is in the “ordinary course of the business” of the company.

b) Whether the terms and conditions of such contracts or arrangements are on “arms length basis”.

The transaction will be with Related Party in case it is with any of the following:

a) With any Director of Company.

b) With any relative of a Director.

c) With any KMP or relative of a KMP.

d) With any firm in which Director or his relative is a partner.

e) With any private Company in which a Director is a member or Director)

f) With a Public Company in which a Director is a member or Director and additionally holds along with his relative(s) 2% or more paid-up share capital of a Public Company.

g) With a Subsidiary Company h) With an Associate Company in which Company has more than shareholding.

i) With a body corporate which is significantly influenced by a Director of a company.

j) With a person who has control or significant influence over the Company.

Following transactions with above related parties will constitute related party transactions:

a) Sale, Purchase or supply of any goods or material by a Company.

b) Selling or disposing off or buying any property by Company.

c) Leasing of any property by Company.

d) Availing or rendering of any services by Company.

e) Appointment of any agent for purchase or sale of goods, materials, services or property by Company.

f) Any related party’s appointment to any office or place of profit in Company.

g) Company or its subsidiary Company or its associate Company.

h) Underwriting the subscription of any securities or their derivatives of Company To determine a transaction a related party transaction following points to be ensured:

a) The transaction should be entered on an Arm’s length basis.

b) Take prior approval of Audit Committee of the Board in respect of all related party transactions

c) Approval of shareholders through special resolution if the related party transaction during a financial year exceeds 10% annual consolidated turnover of a company.

d) Prior approval of the Board is required in case a related party transaction is not in the ordinary course of business and not on an Arm’s length basis.

Related-party transactions are legitimate activities and serve practical purposes:

They are recognized in corporate and taxation laws.

They have their own standards for accounting treatment.

Systems of checks and balances have been built around them to make sure they are conducted within these boundaries.

Management Notes

Methods of Establishment of cost

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Target Costing Phases: Planning, Development and Production

Target costing is a market driven methodology.

There are the three phases of this methodology as under:

(i) Planning:

The products of all competitors are to be analysed with regard to price, sales, quality, technology, and service etc., and after that target cost is to be determined and then market share of one product is to be finalised.

(ii) Development:

Cost structure of the organisation is to be finalised after examining and studying various cost reductions measures and Activity based costing and then a suitable design has to be developed.

(iii) Production:

Production target are fixed and efforts are made to achieve it at the lowest cost without affecting the quality, technology design and its production techniques etc.

Target Costing Approaches (With Equations)

Target costing system has customer orientation. Under the target costing approach, before a firm launches a product (or a family of products), it determines the ideal selling price, establishes the feasibility of meeting that price, and then control costs to ensure that the price is met.

The target costing approach is radically different from the conventional approach for price fixation and cost management.

  1. Conventional Approach:

The conventional approach is cost plus pricing. The approach is to design a product so that it can be produced at the lowest cost, and then a desired margin is added to the estimated cost to determine the selling price of the new product.

We may present this approach in an equation form as follows:

S = C + P

If the firm feels that the price is too high, it modifies the design to reduce the cost and consequently the required selling price. If the firm could not establish the expected selling price, the product is launched at the originally estimated selling price based on the original design.

The other conventional approach is to design a product so that it can be produced at the lowest cost, and then match the cost to the anticipated selling price.

The profit margin is determined as presented in the following equation:

P = S-C

If the profit margin is below an acceptable level, the product is redesigned, if possible, to reduce the cost until the desired profit margin is achieved.

In both the conventional approaches, the focus is on cost reduction and not on cost management. The cost reduction efforts start after the development stage. Both the approaches induce production efficiencies to apply after the product design stage. Therefore, the potential for cost reduction is limited.

A study estimated that at most 10% cost reduction is attainable. Conventional approaches do not compel managers to estimate how much the customer will pay for each element of functionality and quality. Each product used to be conceived as a package of functionality and quality without much scope for modification.

  1. Target Costing Approach:

Under the target costing approach, firms work backward from customers’ need and willingness to pay. Target costing takes cost as the dependent variable, while conventional approaches take selling price or profit as the dependent variable.

The relationship between the variables can be presented as follows:

C = S-P

The target costing approach recognizes that there is a trade-off between price, cost, functionality, and quality. Managers examine this trade-off at the development stage of the product, and optimize on the product functionality and quality within the parameters of estimated selling price, target cost, target volume and target launch date.

Costing Types:

  1. Job Costing:

Under this method costs are collected and accumulated for each job or work order or project separately. Each job can be identified separately and hence becomes essential to analyze the costs according to each job.

Normally production consists of distinct jobs or lots so that order number can identify costs. A job card is prepared for each job for cost accumulation. This method is suitable for Printers, Machine tool manufacturers, Foundries, and general engineering workshops.

  1. Contract Costing:

Contract costing does not in principle differ from job costing. When the job is big and spread over long period of time, the method of contract costing is used. A separate account is kept for each individual contract. Civil engineering contractors, constructional and mechanical engineering firms, builders, etc use this method.

In contracts, when it is agreed to pay an agreed sum or percentage to cover overheads and profit to the contractors, it will be termed as ‘cost plus costing’. The term cost here refers to the prime cost. Usually government contracts are assigned in this basis.

  1. Batch Costing:

This is an extension of job costing. A batch may represent a number of small orders or group of identical products passed through the factory in batch. Each batch is treated as a cost unit and cost is ascertained separately.

The cost per unit is determined by dividing the cost of the batch by the number of units produced in a batch. The manufacturers of biscuits, garments, spare parts and components mainly use this method.

  1. Process Costing:

A process refers here to a stage of production. If a product passes through different stages, each distinct and well defined, then in order to ascertain the cost at each stage or process, the process costing is used. Under this method, a separate process account is prepared and all costs incurred in that process are charged.

Normally the finished product of one process becomes the raw material of the subsequent process and a final product is obtained in the last process. As the products are manufactured in continuous process, this is also known as continuous costing. Process costing method is generally followed in textile units, chemical industries, refineries, tanneries, paper manufacture, etc.

  1. Operation Costing:

It is a further refinement of process costing. It is suitable to industries where mass or repetitive production is carried out or where the goods have to be stocked in semi-finished stage, to enable the execution of special orders, or for the convenient use in later operations. In this method, the cost unit is an operation. It is used in cycle manufacturing, automobile units, etc.

  1. Unit Costing:

This is also known as single or output costing. This method is suitable for industries where the manufacture is continuous and units are identical. This method is applied in industries like mines, quarries, cement works, brick works, etc.

In all these industries there is natural or standard unit of cost, for example, tonne of coal in collieries, tonne of cement, one thousands of bricks, etc. The object of this method is to ascertain the cost per unit of output and the cost of each element of such cost.

Here the cost account takes the form of cost sheet or statement prepared for a definite period. The cost per unit is determined by dividing the total expenditure incurred during a given period by the number of units produced during that period.

  1. Operating Costing:

This is suitable for industries, which render services as distinct from those, which manufacture goods. This is applied in transport undertakings, power supply companies, gas, water works, municipal services, hospitals, hotels, etc.

It is used to ascertain the cost of services rendered. There is usually a compound unit in such undertakings, for example, tonne-kilometres or passenger-kilometres in transport companies, kilo-watt-hour in power supply, patient-day in hospitals, etc.

  1. Multiple Costing:

It is also called as composite costing. It represents the application of more than one method of costing in respect of the same product. This is suitable for industries where a number of component parts are separately produced and subsequently assembled into a final product. In such industries each component differs from others as to price, materials used, and manufacturing processes.

So it will be necessary to ascertain the cost of each component. For this purpose process costing may be applied. To ascertain the cost of the final product batch costing may be applied. This method is used in factories manufacturing cycles, automobiles, engines, radios, typewriter, aero plane and other complex products.

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