Tag: Logistic & Supply Chain Management

A parent shall present consolidated financial statements in which it consolidates its investments in subsidiaries in accordance with this Standard. Where a parent is a company, the consolidated financial statements shall be in the form set out in Appendix C to this Standard or as near thereto as circumstances admit.

A parent presents separate financial statements in compliance with paragraphs 3843.

Scope of Consolidated Financial Statements

Consolidated financial statements shall include all subsidiaries of the parent.

Control is presumed to exist when the parent owns, directly or indirectly through subsidiaries, more than half of the voting power of an entity unless, in exceptional circumstances, it can be clearly demonstrated that such ownership does not constitute control. Control also exists when the parent owns half or less of the voting power of an entity when there is:

Footnotes:

If on acquisition a subsidiary meets the criteria to be classified as held for sale in accordance with Ind AS 105 Non-current Assets Held for Sale and Discontinued Operations, it shall be accounted for in accordance with that Indian Accounting Standard.

See also Appendix A Consolidation Special Purpose Entities.

(a) power over more than half of the voting rights by virtue of an agreement with other investors;

(b) power to govern the financial and operating policies of the entity under a statute or an agreement;

(c) power to appoint or remove the majority of the members of the board of directors or equivalent governing body and control of the entity is by that board or body; or

(d) power to cast the majority of votes at meetings of the board of directors or equivalent governing body and control of the entity is by that board or body.

An entity may own share warrants, share call options, debt or equity instruments that are convertible into ordinary shares3, or other similar instruments that have the potential, if exercised or converted, to give the entity voting power or reduce another partys voting power over the financial and operating policies of another entity (potential voting rights). The existence and effect of potential voting rights that are currently exercisable or convertible, including potential voting rights held by another entity, are considered when assessing whether an entity has the power to govern the financial and operating policies of another entity. Potential voting rights are not currently exercisable or convertible when, for example, they cannot be exercised or converted until a future date or until the occurrence of a future event.

In assessing whether potential voting rights contribute to control, the entity examines all facts and circumstances (including the terms of exercise of the potential voting rights and any other contractual arrangements whether considered individually or in combination) that affect potential voting rights, except the intention of management and the financial ability to exercise or convert such rights.

A subsidiary is not excluded from consolidation simply because the investor is a venture capital organisation, mutual fund, unit trust or similar entity.

A subsidiary is not excluded from consolidation because its business activities are dissimilar from those of the other entities within the group. Relevant information is provided by consolidating such subsidiaries and disclosing additional information in the consolidated financial statements about the different business activities of subsidiaries. For example, the disclosures required by Ind AS 108 Operating Segments help to explain the significance of different business activities within the group.

A parent company that presents its consolidated financial statements must consolidate all of its subsidiaries, foreign as well as domestic.

Where a company doesn’t have any subsidiary, however, has associates and/or joint ventures such company also needs to prepare consolidated financial statements as per Accounting Standard 23 – Accounting for Associates in Consolidated Financial Statements and Accounting Standard 27 – Financial Reporting of Interests in JVs respectively.

Scope

• This Standard shall be applied in the preparation and presentation of consolidated financial statements for a group of entities under the control of a parent.
• This Standard does not deal with methods of accounting for business combinations and their effects on consolidation, including goodwill arising on a business combination (see Ind AS 103 Business Combinations).
• This Standard shall also be applied in accounting for investments in subsidiaries, jointly controlled entities and associates when an entity elects, or is required by law, to present separate financial statements.

Derecognition refers to the removal of an asset or liability (or a portion thereof) from an entity’s balance sheet. Derecognition questions can arise with respect to all types of assets and liabilities. This project focuses on financial instruments. Questions regarding derecognition of assets and liabilities often arise in the context of certain special purpose entities and whether those entities should be included in a set of consolidated financial statements.

Derecognition is the removal of a previously recognized financial asset or financial liability from an entity’s balance sheet. A financial asset should be derecognized if either the entity’s contractual rights to the asset’s cash flows have expired or the asset has been transferred to a third party (along with the risks and rewards of ownership). If the risks and rewards of ownership have not passed to the buyer, then the selling entity must still recognize the entire financial asset and treat any consideration received as a liability.

The IASB agreed to consider both a comprehensive project on derecognition or all types of assets and liabilities and also a separate, narrower scope project that would explore the need to revise guidance in IAS 39 Financial Instruments: Recognition and Measurement in the area of derecognition of financial instruments. This limited scope project would address questions that have arisen with regard to the application of conflicting aspects of IAS 39’s guidance on derecognition. The project would result in an amendment to IAS 39 possibly through issuance of a separate standard on derecognition that supersedes that section of IAS 39.

Standard IAS 39 provides extensive guidance on derecognition of a financial asset. Before deciding on derecognition, an entity must determine whether derecognition is related to:

1. A financial asset (or a group of similar financial assets) in its entirety, or
2. A part of a financial asset (or a part of a group of similar financial assets). The part must fulfil the following conditions (if not, then asset is derecognized in its entirety):

• The part comprises only specifically defined cash flows from a financial asset (or group)
• the part comprises only a fully proportionate (pro rata) share of the cash flows from a financial asset (or group)
• the part comprises only a fully proportionate (pro rata) share of specifically identified cash flows from a financial asset (or group)

An entity shall derecognize the financial asset when:

• The contractual rights to the cash flows from the financial asset expire, or
• an entity transfers the financial asset and the transfer qualifies for the derecognition

Transfers of financial assets are discussed in more details. First of all, an entity must decide whether the asset was transferred or not. Then, if the financial asset was transferred, the entity must determine whether also risks and rewards from the financial asset were transferred.

Derecognition of a financial liability

A financial liability should be removed from the balance sheet when, and only when, it is extinguished, that is, when the obligation specified in the contract is either discharged or cancelled or expires. [IAS 39.39] Where there has been an exchange between an existing borrower and lender of debt instruments with substantially different terms, or there has been a substantial modification of the terms of an existing financial liability, this transaction is accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. A gain or loss from extinguishment of the original financial liability is recognised in profit or loss. [IAS 39.40-41]

Financial instrument: a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.

Financial Assets

Any asset that is:

• Cash
• An equity instrument of another entity
• A contractual right

1. to receive cash or another financial asset from another entity; or
2. to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or

• a contract that will or may be settled in the entity’s own equity instruments and is:
• a non-derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments
• a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. For this purpose the entity’s own equity instruments do not include instruments that are themselves contracts for the future receipt or delivery of the entity’s own equity instruments
• puttable instruments classified as equity or certain liabilities arising on liquidation classified by IAS 32 as equity instruments

Financial Liabilities

Any liability that is:

1. a contractual obligation:

• To deliver cash or another financial asset to another entity;
• To exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; or

2. a contract that will or may be settled in the entity’s own equity instruments and is

• a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments or
• a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. For this purpose the entity’s own equity instruments do not include: instruments that are themselves contracts for the future receipt or delivery of the entity’s own equity instruments; puttable instruments classified as equity or certain liabilities arising on liquidation classified by IAS 32 as equity instruments

Equity instrument: Any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

Fair value: The amount for which an asset could be exchanged or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.

The definition of financial instrument used in IAS 32 is the same as that in IAS 39.

Puttable instrument: a financial instrument that gives the holder the right to put the instrument back to the issuer for cash or another financial asset or is automatically put back to the issuer on occurrence of an uncertain future event or the death or retirement of the instrument holder.

Classification as liability or equity

The fundamental principle of IAS 32 is that a financial instrument should be classified as either a financial liability or an equity instrument according to the substance of the contract, not its legal form, and the definitions of financial liability and equity instrument. Two exceptions from this principle are certain puttable instruments meeting specific criteria and certain obligations arising on liquidation. The entity must make the decision at the time the instrument is initially recognised. The classification is not subsequently changed based on changed circumstances. [IAS 32.15]

A financial instrument is an equity instrument only if (a) the instrument includes no contractual obligation to deliver cash or another financial asset to another entity and (b) if the instrument will or may be settled in the issuer’s own equity instruments, it is either:

• A non-derivative that includes no contractual obligation for the issuer to deliver a variable number of its own equity instruments; or
• A derivative that will be settled only by the issuer exchanging a fixed amount of cash or another financial asset for a fixed number of its own equity instruments. [ias 32.16]

Objective of IAS 32

The stated objective of IAS 32 is to establish principles for presenting financial instruments as liabilities or equity and for offsetting financial assets and liabilities. [IAS 32.1]

IAS 32 addresses this in a number of ways:

• Clarifying the classification of a financial instrument issued by an entity as a liability or as equity
• Prescribing the accounting for treasury shares (an entity’s own repurchased shares)
• Prescribing strict conditions under which assets and liabilities may be offset in the balance sheet.

Parties to Financial Instruments: In case of Financial Instruments, the two parties are called:

• Issuer of an Instrument who presents it on the Liability side of the Balance Sheet as per Schedule III- Division II.
• Holder of an Instrument who presents it on the Asset side of the Balance Sheet as per Schedule III- Division II.

An analysis of Schedule III- Division II gives us an insight as under:

1. Asset segregated into non-current and current; further segregated in terms on non-financial and financial in nature.
2. Liability is segregated into Equity and Liability; liabilities are split in terms of non-current and current and further segregated in terms of non-financial and financial in nature.

IAS 32 applies in presenting and disclosing information about all types of financial instruments with the following exceptions: [IAS 32.4]

• Interests in subsidiaries, associates and joint ventures that are accounted for under IAS 27 Consolidated and Separate Financial Statements, IAS 28 Investments in Associates or IAS 31 Interests in Joint Ventures (or, for annual periods beginning on or after 1 January 2013, IFRS 10 Consolidated Financial Statements, IAS 27 Separate Financial Statements and IAS 28 Investments in Associates and Joint Ventures). However, IAS 32 applies to all derivatives on interests in subsidiaries, associates, or joint ventures.
• Employers’ rights and obligations under employee benefit plans (see IAS 19 Employee Benefits)
• Insurance contracts (see IFRS 4 Insurance Contracts). However, IAS 32 applies to derivatives that are embedded in insurance contracts if they are required to be accounted separately by IAS 39
• Financial instruments that are within the scope of IFRS 4 because they contain a discretionary participation feature are only exempt from applying paragraphs 15-32 and AG25-35 (analysing debt and equity components) but are subject to all other IAS 32 requirements
• Contracts and obligations under share-based payment transactions (see IFRS 2 Share-based Payment) with the following exceptions:
• This standard applies to contracts within the scope of IAS 32.8-10 (see below)
• Paragraphs 33-34 apply when accounting for treasury shares purchased, sold, issued or cancelled by employee share option plans or similar arrangements

A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership. All other leases are classified as operating leases. Classification is made at the inception of the lease. [IAS 17.4]

Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form. Situations that would normally lead to a lease being classified as a finance lease include the following: [IAS 17.10]

• The lease transfers ownership of the asset to the lessee by the end of the lease term
• The lessee has the option to purchase the asset at a price which is expected to be sufficiently
• Lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain that the option will be exercised
• The lease term is for the major part of the economic life of the asset, even if title is not transferred
• At the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset
• The lease assets are of a specialised nature such that only the lessee can use them without major modifications being made

Other situations that might also lead to classification as a finance lease are: [IAS 17.11]

• If the lessee is entitled to cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee.
• Gains or losses from fluctuations in the fair value of the residual fall to the lessee (for example, by means of a rebate of lease payments).
• The lessee has the ability to continue to lease for a secondary period at a rent that is substantially lower than market rent

When a lease includes land and buildings elements, an entity assesses the classification of each element as finance or an operating lease separately. In determining whether the land element is an operating or a finance lease, an important consideration is that land normally has an indefinite economic life [IAS 17.15A]. Whenever necessary in order to classify and account for a lease of land and buildings, the minimum lease payments (including any lump-sum upfront payments) are allocated between the land and the buildings elements in proportion to the relative fair values of the leasehold interests in the land element and buildings element of the lease at the inception of the lease. [IAS 17.16] For a lease of land and buildings in which the amount that would initially be recognised for the land element is immaterial, the land and buildings may be treated as a single unit for the purpose of lease classification and classified as a finance or operating lease. [IAS 17.17] However, separate measurement of the land and buildings elements is not required if the lessee’s interest in both land and buildings is classified as an investment property in accordance with IAS 40 and the fair value model is adopted. [IAS 17.18]

Finance lease indicators

There are many risks and rewards outlined within the standard, but for the purpose of the Paper F7 exam there are several important areas. The main reward is where the lessee has the right to use the asset for most of, or all of, its useful economic life. The primary risks are where the lessee pays to insure, maintain and repair the asset.

When the risks and rewards remain with the lessee, the substance is such that even though the lessee is not the legal owner of the asset, the commercial reality is that they have acquired an asset with finance from the leasing company and, therefore, an asset and liability should be recognised.

Other indicators that a lease is a finance lease include:

• At the inception of the lease the present value of the minimum lease payments amounts to substantially all of the fair value of the asset
• The lease agreement transfers ownership of the asset to the lessee by the end of the lease
• The leased asset is of a specialised nature
• The lessee has the option to purchase the asset at a price expected to be substantially lower than the fair value at the date the option becomes exercisable

Finance lease accounting

Initial accounting

The initial accounting is that the lessee should capitalise the finance leased asset and set up a lease liability for the value of the asset recognised. The accounting for this will be:

Dr Non-current assets

Cr Finance lease liability

(This should be done by using the lower of the fair value of the asset or the present value of the minimum lease payments*.)

*Note: The present value of the minimum lease payments is essentially the lease payments over the life of the lease discounted to present value you will either be given this figure in the Paper F7 exam or, if not, use the fair value of the asset. You will not be expected to calculate the minimum lease payments.

All other leases are classified as operating leases.

1. Substance over form: Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form.
2. Indicators to classify finance Lease: Indicators of situations that individually or in combination could also lead to a lease being classified as a finance lease are:

• If the lessee is entitled to cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee
• Gains or losses from fluctuations in the fair value of the residual accrue to the lessee (for example, by means of a rebate of lease payments)
• The lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.

At the commencement of the lease term, lessees recognise finance leases as assets and liabilities in their statements of financial position at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, each determined at the inception of the lease.

Any initial direct costs of the lessee are added to the amount recognised as an asset. Minimum lease payments are apportioned between the finance charge and the reduction of the outstanding liability. The finance charge is allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. Contingent rents are charged as expenses in the periods in which they are incurred. A finance lease gives rise to depreciation expense for the recognised lease assets as well as finance expense for each accounting period.

“At the inception of the Lease, the present value of Minimum Lease Payment amounts to at least substantially (i.e. at least 90%) all of the fair value of the leasehold land”.

In case the above condition is fulfilled, the lessee should present the leasehold land under “Property Plant and Equipment”.

Further, if there is reasonable certainty that the lessee will obtain ownership at the end of the lease term then the land shall not be depreciated else shall be depreciated over the lease term or useful life whichever is lower.

For the purpose of classification of Land and Building separately, following methods are followed:

• The Minimum Lease Payments (including lumpsum upfront payments) are allocated between the land and buildings in proportion to the relative fair values of the leasehold interest in the land and building at the inception of lease.
• If the lease payments cannot be allocated reliably, the entire lease is classified as a finance lease unless it is clear that both elements are operating lease, in which the entire lease is classified as an operating lease.
• If the land value is immaterial, the land and building may be treated as a single unit for the purpose of lease classification. In such case the economic life of the building is regarded as the economic life of the entire leased asset.

Finance lease accounting

Initial accounting

The initial accounting is that the lessee should capitalise the finance leased asset and set up a lease liability for the value of the asset recognised. The accounting for this will be:

Dr Non-current assets

Cr Finance lease liability

(This should be done by using the lower of the fair value of the asset or the present value of the minimum lease payments.)

Note: The present value of the minimum lease payments is essentially the lease payments over the life of the lease discounted to present value you will either be given this figure in the Paper F7 exam or, if not, use the fair value of the asset. You will not be expected to calculate the minimum lease payments.

Subsequent accounting

Depreciation

Following the initial capitalisation of the leased asset, depreciation should be charged on the asset over the shorter of the lease term or the useful economic life of the asset. The accounting for this will be:

Dr Depreciation expense

Cr Accumulated depreciation

When a company pays a rental, in effect it is making a capital repayment (ie against the lease obligation) and an interest payment. The impact of this will need to be shown within the financial statements in the form of a finance cost in the statement of profit or loss and a reduction of the outstanding liability in the statement of financial position. In reality there are several ways that this can be done, but the Paper F7 examiner has stated that he will examine the actuarial method only.

The actuarial method of accounting for a finance lease allocates the interest to the period it actually relates to, ie the finance cost is higher when the capital outstanding is greatest, but as the capital gets repaid, interest payments become lower (similar to a repayment mortgage that you may have on your property). To allocate the interest to a specific period you will require the interest rate implicit within the lease agreement again this will be provided in the exam and you are not required to calculate it.

One of the easiest ways to apply the actuarial method in the exam is to use a leasing table. Please take note of when the rental payment is actually due, is it in advance (ie rental made at beginning of the lease year) or is it in arrears (ie rental made at the end of the lease year)? This will affect the completion of the lease table as highlighted below:

Finance lease:

At commencement of the lease term, leases should be recorded as an asset and a liability at the lower of the fair value of the asset and the present value of the minimum lease payments (discounted at the interest rate implicit in the lease, if practicable, or else at the entity’s incremental borrowing rate).

Minimum lease payments shall be apportioned between the finance charge and the reduction of the outstanding liability. The finance charge to be allocated so as to produce a constant periodic rate of interest on the remaining balance of the liability.

The depreciation policy for depreciable leased assets should be consistent with that for owned assets.

If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset should be fully depreciated over the shorter of the lease term and its useful life.

Operating leases:

The lease payments should be recognised as an expense over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user’s benefit.

The following principles should be applied in the financial statements of lessees:

• At commencement of the lease term, finance leases should be recorded as an asset and a liability at the lower of the fair value of the asset and the present value of the minimum lease payments (discounted at the interest rate implicit in the lease, if practicable, or else at the entity’s incremental borrowing rate) [IAS 17.20].
• Finance lease payments should be apportioned between the finance charge and the reduction of the outstanding liability (the finance charge to be allocated so as to produce a constant periodic rate of interest on the remaining balance of the liability) [IAS 17.25].
• The depreciation policy for assets held under finance leases should be consistent with that for owned assets. If there is no reasonable certainty that the lessee will obtain ownership at the end of the lease the asset should be depreciated over the shorter of the lease term or the life of the asset [IAS 17.27].
• For operating leases, the lease payments should be recognised as an expense in the income statement over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user’s benefit [IAS 17.33]