Tag: Corporate Governance Osmania University b.com Notes

The objective of the Ind AS 107 is to require entities to provide disclosures in their financial statements that enable users to evaluate:

• The significance of financial instruments for the entity’s financial position and performance; and
• the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the end of the  reporting period, and how the entity manages those

The qualitative disclosures describe management’s objectives, policies and processes for managing those risks. The quantitative disclosures provide information about the extent to which the entity is exposed to risk, based on information provided internally to the entity’s key management personnel. Together, these disclosures provide an overview of the entity’s use of financial instruments and the exposures to risks they create

The Ind AS applies to all entities, including entities that have few financial instruments (e.g., a manufacturer whose only financial instruments are accounts receivable and accounts payable) and those that have many financial instruments (e.g., a financial institution most of whose assets and liabilities are financial instruments).

When this Ind AS requires disclosures by class of financial instrument, an entity shall group financial instruments into classes that are appropriate to the nature of the information disclosed and that take into account the characteristics of those financial instruments. An entity shall provide sufficient information to permit reconciliation to the line items presented in the statement of financial position.

Objective

1. The objective of this Indian Accounting Standard is to require entities to provide disclosures in their financial statements that enable users to evaluate:

(a) The significance of financial instruments for the entitys financial position and performance; and

(b) the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the end of the reporting period, and how the entity manages those risks.

The principles in this Indian Accounting Standard complement the principles for recognising, measuring and presenting financial assets and financial liabilities in Ind AS 39 Financial Instruments: Recognition and Measurement and Ind AS 32 Financial Instruments: Presentation.

Scope

This Indian Accounting Standard shall be applied by all entities to all types of financial instruments, except:

(a) Those interests in subsidiaries, associates or joint ventures that are accounted for in accordance with Ind AS 27 Consolidated and Separate Financial Statements, Ind AS 28 Investments in Associates or Ind AS 31 Interests in Joint Ventures. However, in some cases, Ind AS 27, Ind AS 28, and Ind AS 31 permits an entity to account for an interest in a subsidiary, associate or joint venture using Ind AS 39; in those cases, entities shall apply the requirements of this Indian Accounting Standard. Entities shall also apply this Indian Accounting Standard to all derivatives linked to interests in subsidiaries, associates or joint ventures unless the derivative meets the definition of an equity instrument in Ind AS 32.

(b) Employers rights and obligations arising from employee benefit plans, to which Ind AS 19 Employee Benefits applies.

(c) [Refer to Appendix 1]

(d) Insurance contracts as defined in Ind AS 104 Insurance Contracts. However, this Indian Accounting Standard applies to derivatives that are embedded in insurance contracts if Ind AS 39 requires the entity to account for them separately. Moreover, an issuer shall apply this Indian Accounting Standard to financial guarantee contracts if the issuer applies Ind AS 39 in recognising and measuring the contracts, but shall apply Ind AS 104 if the issuer elects, in accordance with paragraph 4(d) of Ind AS 104, to apply Ind AS 104 in recognising and measuring them.

(e) Financial instruments, contracts and obligations under share-based payment transactions to which Ind AS 102 Share-based Payment applies, except that this Indian Accounting Standard applies to contracts within the scope of paragraphs 57 of Ind AS 39.

(f) Instruments that are required to be classified as equity instruments in accordance with paragraphs 16A and 16B or paragraphs 16C and 16D of Ind AS 32.

This Indian Accounting Standard applies to recognised and unrecognised financial instruments. Recognised financial instruments include financial assets and financial liabilities that are within the scope of Ind AS 39. Unrecognised financial instruments include some financial instruments that, although outside the scope of Ind AS 39, are within the scope of this Indian Accounting Standard (such as some loan commitments).

This Indian Accounting Standard applies to contracts to buy or sell a non-financial item that are within the scope of Ind AS 39 (see paragraphs 57 of Ind AS 39).

Classes of Financial Instruments and Level of disclosure

When this Indian Accounting Standard requires disclosures by class of financial instrument, an entity shall group financial instruments into classes that are appropriate to the nature of the information disclosed and that take into account the characteristics of those financial instruments. An entity shall provide sufficient information to permit reconciliation to the line items presented in the balance sheet.

Recognition and Measurement outlines the requirements for the recognition and measurement of financial assets, financial liabilities, and some contracts to buy or sell non-financial items. Financial instruments are initially recognised when an entity becomes a party to the contractual provisions of the instrument, and are classified into various categories depending upon the type of instrument, which then determines the subsequent measurement of the instrument (typically amortised cost or fair value). Special rules apply to embedded derivatives and hedging instruments.

IAS 39 was reissued in December 2003, applies to annual periods beginning on or after 1 January 2005, and will be largely replaced by IFRS 9 Financial Instruments for annual periods beginning on or after 1 January 2018.

Initial Recognition

IAS 39 requires recognition of a financial asset or a financial liability when, and only when, the entity becomes a party to the contractual provisions of the instrument, subject to the following provisions in respect of regular way purchases. [IAS 39.14]

Regular way purchases or sales of a financial asset. A regular way purchase or sale of financial assets is recognised and derecognised using either trade date or settlement date accounting. [IAS 39.38] The method used is to be applied consistently for all purchases and sales of financial assets that belong to the same category of financial asset as defined in IAS 39 (note that for this purpose assets held for trading form a different category from assets designated at fair value through profit or loss). The choice of method is an accounting policy. [IAS 39.38]

IAS 39 requires that all financial assets and all financial liabilities be recognised on the balance sheet. That includes all derivatives. Historically, in many parts of the world, derivatives have not been recognised on company balance sheets. The argument has been that at the time the derivative contract was entered into, there was no amount of cash or other assets paid. Zero cost justified non-recognition, notwithstanding that as time passes and the value of the underlying variable (rate, price, or index) changes, the derivative has a positive (asset) or negative (liability) value.

Initial measurement

Initially, financial assets and liabilities should be measured at fair value (including transaction costs, for assets and liabilities not measured at fair value through profit or loss). [IAS 39.43]

Measurement subsequent to initial recognition

Subsequently, financial assets and liabilities (including derivatives) should be measured at fair value, with the following exceptions: [IAS 39.46-47]

• Loans and receivables, held-to-maturity investments, and non-derivative financial liabilities should be measured at amortised cost using the effective interest method.
• Investments in equity instruments with no reliable fair value measurement (and derivatives indexed to such equity instruments) should be measured at cost.
• Financial assets and liabilities that are designated as a hedged item or hedging instrument are subject to measurement under the hedge accounting requirements of the IAS 39.
• Financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition, or that are accounted for using the continuing-involvement method, are subject to particular measurement requirements.

Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. [IAS 39.9] IAS 39 provides a hierarchy to be used in determining the fair value for a financial instrument: [IAS 39 Appendix A, paragraphs AG69-82]

• Quoted market prices in an active market are the best evidence of fair value and should be used, where they exist, to measure the financial instrument.
• If a market for a financial instrument is not active, an entity establishes fair value by using a valuation technique that makes maximum use of market inputs and includes recent arm’s length market transactions, reference to the current fair value of another instrument that is substantially the same, discounted cash flow analysis, and option pricing models. An acceptable valuation technique incorporates all factors that market participants would consider in setting a price and is consistent with accepted economic methodologies for pricing financial instruments.
• If there is no active market for an equity instrument and the range of reasonable fair values is significant and these estimates cannot be made reliably, then an entity must measure the equity instrument at cost less impairment.

Amortised cost is calculated using the effective interest method. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument to the net carrying amount of the financial asset or liability. Financial assets that are not carried at fair value though profit and loss is subject to impairment test. If expected life cannot be determined reliably, then the contractual life is used.

Recognition and Derecognition

A financial instrument is recognised in the financial statements when the entity becomes a party to the financial instrument contract. An entity removes a financial liability from its statement of financial position when its obligation is extinguished. An entity removes a financial asset from its statement of financial position when its contractual rights to the asset’s cash flows expire; when it has transferred the asset and substantially all the risks and rewards of ownership; or when it has transferred the asset, and has retained some substantial risks and rewards of ownership, but the other party may sell the asset. The risks and rewards retained are recognised as an asset.

Measurement

A financial asset or financial liability is measured initially at fair value. Subsequent measurement depends on the category of financial instrument. Some categories are measured at amortised cost, and some at fair value. In limited circumstances other measurement bases apply, for example, certain financial guarantee contracts.

The following are measured at amortised cost:

• held to maturity investments; non-derivative financial assets that the entity has the positive intention and ability to hold to maturity;
• loans and receivables; non-derivative financial assets with fixed or determinable payments that are not quoted in an active market; and
• Financial liabilities that are not carried at fair value through profit or loss or otherwise required to be measured in accordance with another measurement basis.

The following are measured at fair value:

• Financial assets and financial liabilities held for trading this category includes derivatives not designated as hedging instruments and financial assets and financial liabilities that the entity has designated for measurement at fair value. All changes in fair value are reported in profit or loss.
• Available for sale financial assets: All financial assets that do not fall within one of the other categories. These are measured at fair value. Unrealised changes in fair value are reported in other comprehensive income. Realised changes in fair value (from sale or impairment) are reported in profit or loss at the time of realisation.

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.