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GAAP FOCUSJuly 2012

© 2012 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Editorial

In this edition, we have discussed how the new consolidation rules under IFRS may have significant financial reporting implications for investment companies (IC) and fund managers, which in turn may require reassessment of previous consolidation conclusions. The article also discusses FASB’s new proposal on accounting by investment property entities (IPE) - being a relatively new concept under US GAAP. Finally, where relevant, the accounting guidance for IC and IPE has been contrasted between US GAAP and IFRS.

Recently, the ICAI issued a Guidance Note on Accounting for Real Estate Transactions. A synopsis of certain key concepts and differences in the accounting for real estate transactions between the Guidance Note under Indian GAAP and IFRS is included in this newsletter. You will note that significant differences in financial reporting would continue to exist when developers/real estate entities prepare their financial statements under Indian GAAP and IFRS.

The US Congress passed the Jumpstart our Business Startups Act (JOBS Act) to encourage raising of public capital in the US by simplifying the registration and filing process and providing certain incentives and exemptions for a new category of public issuers called emerging growth companies. We have highlighted some of the key provisions of the JOBS Act, impacting financial reporting, registration statements and internal control of entities.

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) has issued a proposed update to Internal Control - Integrated Framework (proposed Framework) for public comment. The original Framework issued in 1992 has been one of the most widely accepted frameworks for designing and evaluating systems of internal control - used also by public entities for their evaluation of internal control over financial reporting under SOX. Considering that business has dramatically changed, become increasingly global, complex, technology driven, investors have become more engaged and

Sumit SethPartner and HeadUS GAAP and SEC ServicesKPMG in India

Contents

New consolidation rules under IFRS – Impact on investment companies

Revenue recognition for real estate transactions

JOBS Act

COSO’s proposed update to Internal Control Integrated Framework

Recent accounting updates

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14

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regulatory regimes have expanded, the COSO Board decided to update its original Framework to make it more relevant to investors and other stakeholders. We have explained some of the key changes in the proposed Framework, including action steps that management may have to consider.

Finally, latest update on US GAAP for private company financial statements and proposed IFRS guidance for accounting of put options written on non-controlling interest and levies charged by public authorities are discussed in this newsletter.

We hope you find the information in this newsletter helpful and endeavour to remain connected with you in a meaningful and thought provoking manner.

We look forward to your feedback at [email protected].



New consolidation rules under IFRSImpact on investment companies

The financial crisis gave rise to concerns from investors, regulators and other stakeholders as to whether the existing consolidation rules and disclosures provided sufficient information to the readers about the risks and involvement of an entity with other entities, special purpose entities, vehicles or so called structured entities. Accordingly, one of the more significant joint projects conducted by the IASB and the FASB related to revising the definition of ‘control’ i.e. to determine when an entity is required to be consolidated by another. Though this project was conducted jointly, the timeline of the two Boards for releasing their proposed and final guidance in this area differed.

The IASB released their final suite of standards in May 2011 (IFRS 10

– ‘Consolidated Financial Statements’, IFRS 11 – ‘Joint Arrangements’ and IFRS – 12 ‘Disclosure of Interests in Other Entities’) that provide guidance on accounting for interests in other entities.

However, the second part of the IASB project related to providing a consolidation exemption for investment companies is still in a draft stage and is expected to be finalized in this year and likely to be applicable when IFRS 10 becomes mandatory from 1 January

2013 (this is discussed later in this article).

The FASB has issued its proposals on consolidation requirements in the form of various Proposed Accounting Standard Updates. These updates modify the current guidance on consolidation in a manner similar to the IASB proposals, although some differences will continue to exist.1

In this article we have discussed how the new/proposed guidance on consolidation will affect investment companies and private equity entities that prepare financial statements under IFRS. We have also contrasted the guidance under US GAAP, where relevant.

The following is an illustrative example of a typical private equity fund structure in India

Source: GAAP FOCUS, July 2012

1 Refer FASB’s Proposed Accounting Standards Update on Financial Services – Investment Companies (Topic 946), Proposed Accounting Standards Update on Consolidation : Principal versus Agent Analysis (Topic 810) and Proposed Accounting Standards Update on Real Estate – Investment Property Entities (Topic 973) available on www.fasb.org

GAAP FOCUS - July 2012 | 3


Existing consolidation guidance under IFRSThe existing IFRS guidance on consolidation has two consolidation models – one for general purpose entities and the other for special purpose entities (SPEs). While the concept of control is intended to be the same, the factors that determine whether consolidation is required are different when analysing an SPE vis-a-vis any other entity. An SPE is an entity created to accomplish a narrow and well-defined objective. An investment fund that has a restricted and narrowly defined investment mandate, activities are limited to passive holding of investments rather than active management and has a very limited ability to modify or expand its investment policies may be considered an SPE. This is a subjective assessment and is generally based on

the characteristics and structure of the fund.

The general factors that determine existence of control are the power to govern financial and operating policies of an entity (through power over voting rights/composition of governing body, etc.) combined with a meaningful level of economic benefits. However, consolidation of SPEs is determined mainly by exposure to a majority of residual risks and benefits. The existing guidance has been criticized due to the complexities and judgement involved in applying the two models and also since the outcome of the consolidation analysis may differ depending on the model or approach adopted.

The following is a diagrammatic illustration of the analysis under the two models


In the illustrative example of a fund structure:

• The general partner (GP) or the investment manager (IM) holds management shares with wide ranging decision making powers relating to making and managing investments.

• The external investors or limited partners (LPs) hold units or preference shares in the fund and have limited decision making powers. They have a priority on return of capital and also a right to preferred return (say for example 8 percent) before any performance fee distributions are made to the GP.

• The fund has a board or another governing body that has certain decision making powers within a specified legal mandate. Of the five board members, two are nominated by the GP, two by the LPs and there is one independent director.

• The GP may be removed without cause by a unanimous decision of the board.

• The GP earns an arms’ length investment management fee (base fee) say for example 2 percent. In addition, the GP will earn a performance fee of 2 percent (earned in excess of the preferred return known as ‘catch up’) and a further 20 percent pro rata share of the remaining returns (collectively known as ‘carried interest’).

• The GP also holds a LP interest of say for example 10 percent in the fund.

• The fund expects to generate returns in the range of 15 – 18 percent on the capital invested.

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A fund that is considered to be an SPE would generally be consolidated by the entity that is exposed to a majority of residual risks and benefits. Upon analysing the illustrative fund structure given above, the GP is entitled to some variable returns comprising the preferred return of 8 percent on its 10 percent LP interest and the additional performance fee i.e. the carried interest. However, the GP is not exposed to a majority of residual risks or returns since the GP is not entitled to a majority of the variable returns of the fund. Hence, the GP may not be required to consolidate the fund if it was considered to be a SPE.

However, if the fund was not considered to be a SPE, it would need to be consolidated by an entity that has the power to govern its financial and operating policies and receives ownership benefits that are significant. In the given illustrative fund structure, the GP has wide ranging decision making powers over the investment activities of the fund. Further, the removal rights held by the board are not substantive since the consent of the GP’s nominees on the board would also be required. Accordingly, the GP would be considered to have the power to govern the financial and operating policies of the fund. Further, the GP has an LP interest of 10 percent in the fund. While a ‘meaningful’ level of economic benefits is not defined, an ownership interest of say 10 percent combined with decision making power may be considered meaningful. Therefore, the GP may have been required to consolidate the fund in this scenario.

This demonstrates that significant judgement was involved in making this assessment under IAS 27/SIC 12 leading to diversity in practice and outcomes.

The new consolidation guidance under IFRSThe new consolidation standard replaces the current multiple model guidance with a single uniform consolidation model that can be applied to all entities. IFRS 10 provides an improved concept or definition of control based on a linkage between the power to govern an entity and an exposure to variable returns from the entity. This is expected to have a significant impact for investment companies/funds, especially in determining whether the GP/IM is required to consolidate the investment fund.

This is explained below both from the perspective of consolidation of the investment fund by the GP/IM or the investors and consolidation of the investee companies by the investment fund itself.

Consolidation of an investment fund

IFRS 10 states that control exists when there is power to direct the activities of an entity that significantly affect its returns, there is exposure to variable returns of the entity and there is a linkage between the two.

In a typical investment fund structure, as described earlier, a consolidation assessment would have to be carried out by the GP/IM and any major LP investor. The following factors are relevant to the assessment:

• The GP has the power to direct the relevant activities of the fund, in terms of evaluating potential investments, making investment

decisions and determining exit strategies to realize returns on the investments. Therefore, the GP has the power to direct the activities that significantly affect the returns of the fund.

• The GP receives a base fee of 2 percent of funds managed and additional performance fees or carried interest. The GP has also invested its own funds to acquire a 10 percent LP interest in the fund and therefore receives returns on this investment as well. Accordingly, the GP receives variable returns from the fund.

• The LPs do not have any decision making powers in relation to the activities of the fund but have the right to remove the GP, with or without cause, through their representatives on the board. However, the board has members that are nominated by the GP and is required to act unanimously to remove the GP.

In order to determine if the GP controls the fund, it would be necessary to analyze if there is linkage between the power exercised by the GP and variable returns earned i.e. whether the GP is acting in its capacity as principal (exercising its power to generate returns for itself) or as agent (exercising delegated power to generate returns for others). If the GP is acting as a principal then it would be required to consolidate the fund.

The FASB has recently issued a proposed ASU on ‘Principal-Agent Considerations in Consolidation Evaluations’. While the proposed ASU is directionally consistent with the requirements of IFRS 10 in terms of evaluating whether a decision maker is acting as a principal or an agent, some differences remain. IFRS 10 considers the level of economic interest in aggregate while FASB’s approach requires greater consideration of the GP’s participation in the risks and rewards of the fund. In doing so, the FASB’s approach distinguishes between at market fees providing only positive returns and economic interests providing exposure to both positive and negative returns.


In this regard, the principal-agent analysis requires consideration of several factors as illustrated below:

Accordingly, the following factors would be important in determining whether the GP is acting as principal or agent and will consequently impact the conclusion of consolidation:

• Whether a single party has a unilateral right to remove the manager without cause – this may be the case when there is a significantly large or key investor having this right. Alternatively, if a single investor holds a majority of the units issued by the fund and the GP may be removed by a majority vote of the investors, such an investor may be considered to control the fund. In our illustrative example fund structure, the LP interest is assumed to be held by a fairly large number of investors and therefore no single LP has the right to remove the GP without cause.

• Whether the remuneration paid to the decision maker is ‘at market’ – there is a presumption that the remuneration (i.e. the base fee and performance fees) is at market if it has been agreed between independent parties (the LPs and the GP) in an arms’ length transaction. Accordingly, the fees paid to GP is considered to be ‘at market’ in most cases.

Currently, under existing IFRS guidance, GP/IM would generally consolidate a fund (which is not an SPE), if it had the power to govern the financial and operating policies of the fund (i.e. investors did not have substantive kick-out rights) and it had a significant ownership interest in the fund. Non-ownership interests such as fees and carried interest are not currently considered in the consolidation analysis.





• The principal agent assessment is then based on an analysis of the four indicator groups, which may be broadly assessed on a balance of the following two factors:

– Extent of substantive removal rights held by the investors. The GP generally has a broad scope of decision making authority relating to investment activities. Therefore, rights held by other parties (i.e. removal rights) assume greater significance in this analysis. Removal rights are generally considered substantive if they are capable of being exercised in practice, for example, by a small number of investors, or an independent board/governing body can exercise them without cause. In our illustrative example fund structure, the board has the right to remove the GP by unanimous consent. However, since the GP itself nominates two members to the board, the removal rights may not be considered substantive.

– Variability and magnitude of all economic interests (aggregation of base fees, carried interest, ownership interest, etc.) held by the GP in the fund. This assessment is made relative to the level of expected returns of

the fund. Variability refers to the impact on the GP’s economic interests due to a marginal change in the expected returns of the fund (e.g., a 1 percent change in the expected returns), which may be either positive or negative variability. The magnitude of economic interests held by the GP refers to its share in the expected returns of the fund. In our illustrative example fund structure, since the removal rights held by investors are not substantive, the GP may be required to consolidate the fund if the magnitude and variability of its aggregate economic interest in the fund (10 percent LP interest, 2 percent base fee and carried interest) is also significant. In our example, if the expected level of return for the fund is about 15 percent, the variability of the GP’s return (change in GP’s share for a 1 percent change in expected return of the fund) would be approximately 29 percent2. The magnitude of the GP’s economic interest in the fund at the 15 percent expected level of return would be approximately 39 percent3. Such a significant level of economic interest may require the GP to consolidate the fund.

Further, it is to be noted that any change in the distribution structure or modification of removal rights may lead to a different outcome. For example, if the GP could be removed by the consent of a majority of the board members (the 2 representatives appointed by LPs and 1 independent director), the removal rights would be considered as substantive, and the GP may therefore not have to consolidate the fund even with similar variability and level of economic interest.

In summary, the more substantive the removal rights held by investors and lower the variability and magnitude of economic interest held by the GP/IM, the more likely it is that the GP/IM is acting as an agent and vice-versa. Based on above analysis, if it is concluded that the GP/IM is acting as a principal then it would be required to consolidate the fund.

IFRS 10 does not offer any bright lines to determine whether the magnitude and variability of aggregate economic interest in the fund is significant and therefore judgment will be required to make this assessment. However, there are certain quantitative examples provided in IFRS 10 as well as the ‘Effect Analysis’ published by the IASB in September 2011. These provide indicative thresholds which may be considered to determine if an investment manager is acting as an agent or principal, although there still remains an area between these thresholds where significant judgement will be required.

2 Variability is calculated as the GP’s share of a 1% marginal change in the expected return of the fund calculated as [Base fee (2% * marginal return of 1%) + Performance fee (20% * (1-base fee)) + return on LP interest held by the GP (10% * (1 – (base fee + performance fee)))] / marginal return of 1%

3 Magnitude is the GP’s absolute percentage share in the 15% expected return of the fund calculated as [Base fee (115*2%) + Performance fee (Catch up of 2% + (20% * (15 – base fee – preferred return of 8% - catch up of 2%))) + return on LP interest held by the GP (10% * (15 – (base fee + performance fee)))] / expected return of 15%



Consolidation of investee companies by the investment fund

The existing IFRS guidance does not provide any exemption to an investment company/fund from the requirements to consolidate all entities that are controlled by it i.e. including investee companies. The only exemptions there are available to an investment company (or similar type of entities such as venture capital funds, mutual funds, unit trusts, etc.) are as follows:

• IAS 28 Investments in associates does not apply to investment in associates held by an investment company, if the investments is designated at fair value through profit or loss upon initial recognition or classified as held for trading and measured at fair value through profit or loss.

• IAS 31 Interests in joint ventures does not apply to interests held by an investment company in a jointly controlled entity that are designated at fair value through profit or loss upon initial recognition or classified as held for trading and measured at fair value through profit or loss.

Having said this, the IASB has issued a proposed amendment to IFRS 10 (Exposure draft ‘Investment entities’ in August 2011) that defines/provides criteria to identify an ‘investment entity’. In this proposed amendment to IFRS 10, such an investment entity would be required to measure all its investments in controlled entities at fair value through profit or loss and

would be exempt from consolidation requirements. The comment period of this exposure draft ended on 5 January 2012 and the amendment to IFRS 10 is expected in its final form by the end of 2012. The main criteria for an entity to qualify for the exemption are:

• Its only substantive activity is investing in multiple investments for capital appreciation, investment income or both.

• It makes an explicit commitment to a group of investors that its business purpose is to make investments for capital appreciation or income or both.

• Unit ownership in the entity i.e. units, shares or partnership interests to which proportionate shares of net assets can be attributed.

• The investors’ funds are pooled to benefit from professional investment management. In addition, there is significant ownership by investors unrelated to the parent.

• Substantially all of the investments are managed and evaluated on a fair value basis.

While the above exemption is a positive outcome for the investment funds/private equity industry, the definition of an investment entity and the specified qualifying criteria may pose certain application issues, such as:

• A parent of an investment fund that does not qualify as an investment entity itself would not benefit

from the exemption and would be required to consolidate all controlled investment entities. Accordingly, in a situation where a GP/IM or a key investor controls an investment fund, it would be required to consolidate all investees controlled by the fund even though the fund itself may account and measure those controlled investee companies at fair value. This would effectively negate the benefit of the exemption available to the fund.

• Some investment funds acquire controlling interests in the investee companies as a result of which they may engage in several activities necessary to manage their investee companies, for example, exercising control over the board, strategic decision making, streamlining operations, etc. It is unclear whether the stringent restriction on the nature of activities that an investment fund can undertake would result in such investment fund not qualifying for the proposed exemption from consolidation.

• Certain investment funds may be leveraged and manage their borrowings on a cost or amortized cost basis. Since substantially all of the business of these funds may not be managed on a fair value basis, it is unclear whether they would be disqualified from applying the consolidation exemption.



Proposed guidance under UG GAAPThe FASB has also issued a proposed ASU Financial Services – Investment Companies Consolidation in October 2011 that changes and clarifies the criteria/characteristics to determine whether an entity qualifies for the accounting and financial reporting requirements applicable to investment companies. These include: not having substantive business activities other than its investing activities, an investment exit strategy being an essential characteristic of an entity whose business purpose is to invest for capital appreciation, requirement for pooling of funds by significant external equity investors/partners, investments managed and performance evaluated on a fair value basis, requirement to provide financial information about its investment activities to investors. The proposed guidance under US GAAP is similar to the IFRS proposal on the

consolidation exemption for investment entities, however there are two key areas of differences. Under the FASB proposal:

• An investment company would be required to consolidate other investment companies in which it has a controlling financial interest in a fund – of – funds structure. Investment in other investment companies in a master – feeder or other similar structure which is not a fund – of – funds structure would qualify for the exemption. Recently, the IASB and the FASB held a joint decision making meeting in June 2012, where the Boards jointly reached a tentative decision that an investment entity should be required to measure controlling financial interest in another investment entities at fair value (including in

both master-feeder and fund-of-funds structures). Accordingly, this area of divergence may be resolved when the final standard is issued.

• Consistent with current US GAAP requirements, the proposed ASU would require a non-investment company parent, such as an IM, to retain the fair value accounting for controlled investee companies, whereas, under the IFRS proposal, consolidation exemption will not extend to a parent entity that does not meet the definition of an investment entity. In their recent meeting held in June 2012, the Boards decided to retain their respective views on this issue. Accordingly, this will continue to remain an area of divergence between the IFRS and US GAAP proposals.

The FASB also issued a proposed ASU Real Estate – Investment Property Entities the proposed ASU in October 2011 that will provide accounting guidance for an entity that meets the criteria to be an Investment Property Entity (‘IPE’), which includes amongst others, investing in real estate property for total return as a substantial business activity. The proposed ASU would apply to an IPE and not to individual investment properties (or identifiable parts thereof) within an entity. Under the proposed ASU, an IPE would initially measure acquired investment properties at cost and subsequently measure them at fair value, with all changes in fair value to be recognized in net income. Further, an IPE having controlling financial interest would consolidate another IPE, an investment company (IC) as defined in Topic 946 or an operating entity that provides services to the IPE. Controlling financial interest held by an IPE in other entities would be measured at fair value, with changes recognized in net income. The proposed ASU also specifies guidance on accounting for equity method investments and other investments by IPEs. These proposals under US GAAP would differ from IFRS in the following key areas:

• Under IFRS, all investment properties are initially measured at cost. IAS 40 permits an accounting policy choice for subsequently measuring investment properties at cost or fair value. If the investment properties are carried at fair value, such fair value changes are recognized in net income. The proposed ASU under US GAAP would not provide an option, instead it would require an entity to first determine whether its meets the criteria to be an IPE, in which case all the investment properties held by the IPE would be required to be accounted at fair value.

• Under IFRS, there is currently no specific scope exclusion from consolidating another entity (i.e. entities in respect of which control is exercised are to be consolidated). The proposed ASU under US GAAP provides exemption to an IPE from consolidating controlling financial interests held in certain entities (i.e. other than IPEs, ICs or an operating entity providing services to the IPE) which are to be measured at fair value with changes recognized in net income.

SummaryIn summary, the forthcoming changes in accounting standards on consolidation are expected to have a significant impact on financial reporting of/by investment funds and their fund managers. While the new standards will be more relevant in providing specific guidance related to investment funds, there are likely to be challenges in their interpretation and application in practice. The application of these standards will require significant judgement and depend on a detailed analysis of key factors.

In light of the above, investment funds and fund managers should carefully monitor how accounting guidance and their interpretations continue to evolve in this area.


Revenue recognition for real estate transactions

In recent times, there has been significant growth and activity in the real estate sector and related businesses. This in turn has resulted in real estate development and sale transactions taking different forms, to comply with local laws, tax regulations and prevalent market practices.

Due to the above, there was also widespread divergence in the accounting for real estate transactions by entities prior to the introduction of ‘Guidance Note on Recognition of Revenue by Real Estate Developers’ in 2006 (‘Pre-revised GN’) under Indian GAAP and IFRIC 15 ‘Agreements for the Construction of Real Estate’ in 2008 under IFRS. The crux of the issue was always – whether the real estate developer should record revenue from real estate transaction on transfer of the developed property or during the development phase?

Under Indian GAAP, during the Pre-revised GN era, some developers recorded revenue from real estate transactions under AS 9 - Revenue Recognition i.e. revenue was recognized when the completed real estate was delivered to the buyer, whereas others accounted for such transactions by reference to the stage of completion as construction progressed depending upon whether the significant risks (including price risk) was transferred to the buyer and the buyer had a legal right to sell or transfer

its interest in the property during the construction phase.

The Pre-revised GN sought to bring clarity on recognition and measurement principles related to real estate transactions, by providing additional guidance in respect of the timing of revenue recognition (i.e. establishing superiority of price risk over completion risk, indicators of transfer of title etc.) and method of measurement of revenue i.e. percentage of completion (‘POC’) method per AS 7 – Construction Contracts. However, in absence of comprehensive guidance around the computation of POC, there was still wide spread divergence in how the principles of POC were applied in practice by various entities within the industry. For example:

• Certain developers recognized revenue only when the project reached a reasonable level of development (say stage of development > 20 percent), whereas others did not necessarily follow such a benchmark.

• Certain developers computed the stage of development/completion based on project cost incurred method by including the cost of land as cost incurred upfront in its entirety (thereby resulting in a relatively higher percent of the stage of completion), whereas others excluded the cost of land.

It is to be noted, that the above two differences in computation of POC alone could result in reporting significantly different measures of revenue, costs and profits in the income statement, thereby reducing comparability and relevance of financial reporting.

To reduce such diversity and harmonize into a single uniform practice, particularly in the application of the concept of computing stage of completion in real estate projects, ICAI issued a revised Guidance Note on Accounting for Real Estate Transactions (‘The Guidance Note’) in the first quarter of 2012. The Guidance Note primarily provides guidance on application of POC method and elucidates when it is appropriate to apply this method i.e. where such real estate transactions and activities have the same economic substance as construction contracts. The Guidance Note carries forward the Pre-revised GN accounting literature in respect of the timing of revenue recognition, which may differ from other International GAAPs e.g. IFRS.

This article attempts to explain certain important concepts by identifying certain key differences in the accounting for real estate transactions between the Guidance Note under Indian GAAP and IFRS.



Criteria for recognition of revenue during construction period

Indian GAAP

The primary issue dealt by the Guidance Note is whether the economic substance of a real estate transaction is similar to a construction contract per AS 7 or delivery of goods per AS 9. This classification is dependent on the point of transfer of substantial risks and rewards of ownership pertaining to the underlying real estate transaction. The Guidance Note clarifies that agreement for sale of real estate is also considered to have the effect of transferring all significant risks and rewards of ownership to the buyer. Once the seller has transferred all the significant risks and rewards to the buyer, any acts on the real estate performed by the seller are, in substance, performed on behalf of the buyer in the manner similar to a contractor. Accordingly, revenue in such cases shall be recognized by applying the POC method based on AS 7.

Construction contractSome indicators that may suggest that the substance of a real estate transaction is similar to a construction contract under AS 7 are summarized below:

• The duration of such projects is beyond 12 months and the project commencement date and project completion date fall into different accounting periods.

• Most features of the project are common to construction contracts, i.e. land development, structural engineering, architectural design, construction, etc.

• While individual units of the project may be contracted to be delivered to different buyers these are interdependent upon or interrelated to completion of a number of common activities and/or provision of common amenities.

• The construction or development activities form a significant proportion of the project activity.

Delivery of goodsWhen the substance of a real estate arrangement is similar to delivery of goods, then revenue costs and profits are recognized when the revenue recognition process is completed. Under AS 9, the completion of the revenue recognition process is usually identified when all of the following conditions are fulfilled:

• The seller has transferred to the buyer all significant risks and rewards of ownership and the seller retains no effective control of the real estate to a degree usually associated with ownership

• The seller has effectively handed over possession of the real estate unit to the buyer

• No significant uncertainty exists regarding the amount of consideration that will be derived from the real estate sales; and

• It is not unreasonable to expect ultimate collection of revenue from the buyer.

Where transfer of legal title is a condition precedent to the buyer taking the significant risks and rewards of ownership and accepting significant completion of the seller’s obligation, revenue should not be recognized until such time legal title is validly transferred to the buyer.



Key differencesAs one can see, Indian GAAP and IFRS provide different criteria to assess whether revenue can be recognized during the construction period, which could result in differences in practice. For example, the Guidance Note does not consider the following:

• The ability of the buyer to specify major structural elements of the design of the real estate

• Construction risk borne by the developer during the development phase.

Per the Guidance Note, if an agreement for sale is entered, then the POC method can be applied during the construction period (provided the project achieves reasonable level of development, as discussed later in more detail) even though no major structural elements of the design of the real estate can be influenced by the buyer or the construction risk is borne by the buyer.

As such, the criteria for eligibility for a real estate project to commence revenue recognition during construction period may be less stringent under Indian GAAP as compared to IFRS.

This difference is expected to result in developers preparing their financial statements under Indian GAAP recognizing revenue and costs earlier as compared to those preparing their financial statements under IFRS.

IFRS

An agreement for the construction of real estate meets the definition of a construction contract when the buyer is able to specify the major structural elements of the design of the real estate before construction begins and/or specify major structural changes once construction is in progress (whether or not the buyer exercises that ability). In such cases, the developer recognizes revenue from the real estate transaction as the construction progresses within the scope of IAS 11 – Construction Contracts.

In contrast, an agreement for the construction of real estate in which buyers have only limited ability to influence the design of the real estate, e.g. to select a design from a range of options specified by the entity, or to specify only minor variations to the basic design, is an agreement for the sale of goods within the scope of IAS 18 – Revenue, resulting in recognition of revenue only on completion of the development process and transfer of the title (along with possession) in the favour of the buyer.

In certain cases, the entity may transfer to the buyer control and the significant risks and rewards of ownership of the work-in-progress in its current state as the construction progresses (‘continuous transfer model’- IFRIC 15). For example, the fact that if the agreement is terminated before construction is complete, the buyer retains the work in progress and the entity has the right to be paid for the work performed, might indicate that control is transferred along with ownership. Such cases are considered arrangements to render services within the scope of IAS 18, though not akin to construction contracts, but revenue is recognized similar to construction contracts i.e. as the construction progresses.



Application of the POC method during construction period

Indian GAAP

In case of arrangements whose substance is similar to construction contract, the Guidance Note prescribes certain guidelines for computing the POC achieved in a real estate project. The Guidance Note does not permit recognition of revenue until the project reaches a reasonable level of development and provides a rebuttable presumption that the reasonable level of development is achieved only when all the following conditions are satisfied:

• Stage of construction: Expenditure incurred on construction and development cost (i.e. cost of land to be ignored for this criterion) is not less than 25 percent of the total construction and development costs.

• Agreement to sale of property: Atleast 25 percent of the saleable project area is secured by agreements with buyer.

• Collection of sales proceeds: Atleast 10 percent of the total revenue as per the agreements of sale or other legally enforceable documents are realized at the reporting date in respect of each of the contracts and it is reasonable to expect that the parties to such contracts will comply with the payment terms per the contracts.

Accordingly, the Guidance Note is quite prescriptive in this regard. Though, the Guidance Note states that the three criteria stated above for determining the reasonable level of development can be rebutted, currently no additional guidance is provided on this matter.

IFRS

For arrangements that are in the nature of construction contracts under IAS 11 or where the significant risks of the property are transferred continuously as construction progresses under IAS 18 (based on IFRIC 15), the entity recognizes revenue based on POC method during the construction period beginning from the date of agreement to sale. Further, no specific criteria/bright-lines have been specified to determine reasonable level of development before revenue can be recognized during the construction period.

Key differences In respect of real estate transactions, where revenue is to be recognized using the POC method, revenue may get recognized in the initial stages of the development under IFRS vis-à-vis Indian GAAP, in absence of specific criteria/bright lines to determine reasonable level of development under IFRS.



Method used to determine the percentage/stage of completion

Indian GAAP

The stage of completion may be determined by variety of ways depending upon the nature of the arrangement. The most commonly used method for determining the stage of completion for a real estate project is the ‘project cost incurred’ method, whereby the stage of completion is determined as a percentage of contract costs incurred as of a reporting period in proportion to the total estimated contract costs. Though, this is the preferred method per the Guidance Note, other methods for determining the stage of completion, e.g., surveys of work done, technical estimation, etc. is also permitted, subject to a restriction that the amount of revenue based on such other methods should not exceed the revenue computed based on the ‘project costs incurred’ method.

IFRS

Under IFRS, no specific method is mandated for determining the stage of completion. An entity may use the more appropriate of input measures (consideration of the efforts devoted to a contract), or output measures (consideration of the results achieved), depending upon the nature of the contract. Additionally, there is no restriction on the amount of revenue that can be recognized based on output measures even though it may exceed the amount computed based on input measures – the standard emphasizes on use of the most appropriate method.

To sum-up

The Guidance Note under Indian GAAP is expected to improve transparency and comparability of information that will be reported by real estate entities and developers preparing their financial statements under Indian GAAP. However, due to absence of specific bright lines/rules under IFRS when compared to Indian GAAP, significant differences may exist in the reported financial performance and position of the real estate entities and developers who prepare their financial statements under Indian GAAP and IFRS.

Key differencesThough the Guidance Note under Indian GAAP and IFRIC 15 under IFRS do not prohibit use of any particular method for determining the stage of completion, unlike IFRS, the Guidance Note considers the ‘project cost incurred’ method as a preferred method. The Guidance Note also prescribes a ceiling for recognition of revenue based on any other method, when in excess of amount that would have been recognized based on the ‘project cost incurred’ method.


JOBS Act

The US Congress passed the Jumpstart our Business Startups Act (JOBS Act or Act), which was signed into law on April 5, 2012. The Act intends to encourage raising of public capital in the United States by companies with less than USD 1 billion in revenue. Many companies may not have undertaken initial public offerings as they become subject to various SEC rules and regulations. The Act provides temporary relief and exemptions from certain SEC rules and regulation to a new category of public entity issuers.

The Act includes provisions that require the SEC to undertake various initiatives, including rulemaking and studies touching on capital formation, disclosure and registration requirements. SEC is proactively seeking comments before it begins rulemaking to implement parts of the JOBS Act because many of its provisions require that SEC quickly implement rules changes. The SEC also wants to let constituents make their views known before issuing proposed rules. The Act among other things:

• Creates a new category of public entity issuers called emerging growth companies (EGC) that will be exempt from certain SEC reporting requirements for up to a period of five years.

• Amends SEC Regulation A (or adopt a new similar exemption) to increase the limit for registration exemption for offerings to USD 50 million from current limit of USD 5 million.

• Raises the 1934 Act registration threshold for companies with at least USD 10 million in total assets from 500 to 2,000 shareholders.

• Facilitates crowdfunding where non-reporting issuers may raise up to USD 1 million within a 12-month period with a defined maximum amount to be received from an individual investor depending on income and net worth.

The Staff of the SEC’s Division of Corporation Finance has posted questions and answers (Q&A) on its website about how the Act affects SEC filings and reporting4.

Emerging Growth Companies (EGC)

An EGC is a company that has an initial sale of registered equity securities after December 8, 2011 and has total annual gross revenues less than USD 1 billion for its most recently completed fiscal year. An EGC retains this status until the earliest of:• The last day of its fiscal year in which

it has total annual gross revenues of USD 1 billion or more.

• The last day of its fiscal year following the fifth anniversary of the date of the first sale of common equity securities pursuant to an effective registration statement.

• The date on which the issuer has more than USD 1 billion in nonconvertible debt during the previous three-year period.

• The date on which the issuer is deemed to be a large accelerated filer. A large accelerated filer has a public float of at least USD 700 million and has been a reporting company for one year.

(Given the existing regulatory regime for registered investment companies and the context of the JOBS Act and its definition of EGC, registered investment companies do not qualify as EGCs. However, business development companies who invest in startups may qualify as EGCs).

4 Refer the SEC’s JOBS Act page available at www.sec.gov


Temporary relief and regulatory exemptions available to an EGC

The Act provides scaled disclosure provisions, including temporary relief and exemption from certain SEC rules and regulations for EGCs. Some of these are discussed below:

• An EGC may confidentially submit a draft initial registration statement to the SEC for non-public review. The Act allows an EGC to limit presentation of audited financial statements in the initial registration statement to the two most recent fiscal years. Where there are conflicts between the disclosure standards for an EGC under the JOBS Act and existing form requirements (e.g., Regulation S-X or Regulation S K), an EGC should rely on and comply with the disclosure provisions of the JOBS Act (as it supersedes existing rules and regulations).

• An EGC may comply with the MD&A provisions of Regulation S-K by providing discussion about the same periods for which it presents financial statements in the filing. Executive compensation disclosures are limited to the same content required for smaller reporting companies.

• The Act removes the requirement for an EGC to comply with Sarbanes-Oxley Act Section 404(b) auditor attestation of internal control over financial reporting (ICOFR). Under existing SEC rules and regulations, a new public entity, (other than non-accelerated filers), begins complying with Sarbanes-Oxley Section 404(b) auditor attestation of ICOFR with their second annual report filed with the SEC. However, this does not change the requirement of management’s assessment of ICOFR in the second annual report filed after an IPO.

• The Act provides an EGC with an option, by election, to take advantage of the extended transition period for complying with new or revised accounting standards as applicable to non-public companies. An EGC must notify the SEC of that election in their initial confidential submission.

• The Act exempts an EGC from mandatory audit firm rotation and any supplements to the auditor’s report (e.g. an auditor’s discussion and analysis) should the PCAOB issue these standards in the future. However, an EGC’s financial statements must be audited by a PCAOB registered accounting firm.

• After going public, an EGC will file annual, quarterly, and periodic reports under existing SEC rules and regulations. Filing deadlines are determined by an EGC’s status as an accelerated filer or non-accelerated filer. An EGC filing that includes selected financial data in a filing is not required to provide this information for periods earlier than those presented in the EGC’s initial registration statement.

Threshold of offering exemption raised

The Act raises the cap on the Regulation A exemption from registration of an issuer’s securities offerings to USD 50 million from USD 5 million in a 12-month period. Securities covered by the exemption include equity, debt, debt convertible or exchangeable to equity interests, and guarantees of these securities. The Act requires that an issuer relying on this exemption file audited financial statements with the SEC annually but leaves it up to the SEC to determine what information will be required in an offering statement (such as audited financial statements, description of business operations, financial condition, corporate governance principles, and use of investor funds). The SEC will also need to determine whether periodic reporting might be required for these issuers.



Shareholder threshold for registration

The shareholder threshold to trigger 1934 Act registration and reporting has been raised for unlisted companies with at least USD 10 million in assets to 2,000 persons, if less than 500 of the shareholders are not accredited investors. The Act does not change the thresholds for termination of registration (generally fewer than 300 persons). The definition of a holder of record has been revised to exclude securities held by employees of an issuer that were received under an employee benefit plan in transactions exempt from registration under the 1933 Act.

Crowdfunding

Crowdfunding allows groups of people to contribute relatively small amounts of money to a pool of funds that can be used by a small or start-up company to further its growth or other objectives. The Act introduces an exemption from registration that allows non-public companies to raise up to USD 1 million within a 12-month period with certain limits on amounts sold to individual investors. Provisions in crowdfunding section of the Act are aimed at protecting investors including requiring that these transactions be conducted through a broker or funding portal registered with the SEC and with any applicable self-regulatory organization. Investors must be appraised of the risks associated with the offerings. In connection with an offering, the issuer would need to file with the SEC and provide to investors certain specified information including file reports with the SEC not less than annually that will include results of operations and financial statements of the issuer as the SEC deems appropriate.

Conclusion

The JOBS Act is a welcome change from the plethora of disclosure requirements that public companies are required to comply with currently. The reduced cost of regulatory filing eases compliance norms and allow companies to keep vital data confidential for much long. There could be a few unanswered questions about how the Act applies to a company’s specific facts and circumstances as the Act is still at a very nascent stage. Some of the Act’s provisions may require further rulemaking by SEC to implement changes in its rules and regulations.



“The principles embedded within the original Framework remain relevant in today’s environment, so the proposal would not fundamentally alter those principles e.g. the core definition of internal control and its five components: control environment, risk assessment, control activities, information and communication, and monitoring activities would be retained in the proposed Framework”

COSO’s proposed update to Internal Control Integrated Framework

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) recently issued a proposed update to Internal Control - Integrated Framework (proposed Framework) for public comments5. The original Framework issued in 1992 has been one of the most widely accepted frameworks for designing and evaluating systems of internal control. However, since the inception of the original Framework, business has changed dramatically and has become increasingly global, complex, and driven by technology. Investors have also become more engaged and increasingly seek greater transparency and accountability. Regulatory regimes also have expanded, and additional forms of external reporting have emerged and some are under proposal stages. In line with these developments, the COSO Board also decided to update its original Framework to make it more relevant to investors and other stakeholders. The factors driving the change are:

• Higher expectations for governance oversight from both regulators (such as SEC and PCAOB in the US) and stakeholders, including increased scrutiny to prevent and detect material misstatements, loss of assets, and corruption

• Increasing globalization of markets and operations

• Changes in business models, such as expanded use of shared service centers and outsourced service providers

• The expanded role that technology now plays in improving business performance, business processes, and decision making.

One of the most significant changes would be the codification of internal control concepts introduced in the original Framework into 17 principles and 81 associated attributes to help businesses better manage risk and improve performance. Further, the proposed framework provides separate guidance for internal and external reporting, recognizing that much information is reported externally that goes far beyond what’s contained in published financial statements.

5 For details refer ‘The proposed Framework’ available at www.ic.coso.org.

Key changes to internal control components

Control environment

Specifically, changes in the control environment would:

• Combine into five principles the content on integrity and ethical values, commitment to competence, board of directors or audit committee, management’s philosophy and operating style, organizational structure, assignment of authority and responsibility, and human resource policies and practices.

• Provide more explicit discussion on what is involved in achieving the ideal control environment and explain linkages between the components of internal control to demonstrate a sound foundation.

• Expand the discussion about governance roles, recognizing differences in structures, requirements, and challenges across jurisdictions and industries.

• Clarify that the expectations of integrity and ethical values include lessons learned and developments in ethics and compliance (e.g. codes of conduct, the attestation process, whistle-blower processes, investigation and resolution, training and reinforcement, both internally and with third parties).

• Expand risk oversight and strengthen the linkages between risk and performance to help allocate resources to support internal control and the achievement of business objectives.

• Emphasize the need to consider internal control in light of the complexities of organizational structures that have resulted from using outsourced service providers and other external partners.

• Align roles and responsibilities discussed in organization structure with the roles and responsibility chapter so that the major roles are used consistently within the proposed Framework.

Risk assessment

Specifically, the changes in risk assessment would:

• Broaden the Financial Reporting category of objectives to include other aspects of external reporting and internal reporting.

• Reflect the view that non-financial reporting occurs in relation to an external requirement or standard.

• Clarify that risk assessment includes processes for risk identification, analysis, and response.

• Incorporate risk tolerances into the assessment of acceptable risk levels.

• Expand the discussion on management needing to understand significant changes in the organization’s internal and external factors and how those might affect the overall system of internal control.

• Consider fraud risk relating to material misstatement of reporting, inadequate safeguarding of assets, and corruption as part of the risk assessment process.

Control activities

Specifically, the changes in control activities would:

• Broaden the discussion to reflect technology’s evolution (e.g., replacing data center concepts with a general discussion on the technology infrastructure) and update the discussion on general technology controls to focus on an overall concept about what needs to be controlled.

• Expand the discussion of the relationship between automated control activities and general controls

over technology to reinforce the linkages to business processes.

• Expand the discussion that control activities constitute a range and mix of control techniques, provide a more detailed description, and suggest methods to categorize them. Transaction level controls would be made distinct from controls at other levels of the organization.

• Clarify that control activities are actions established by policies and procedures, but are not by themselves the policies and procedures.

• New expectations on corporate governance

• The globalization of markets, entity’s operations and new business models

• Greater complexity of laws, regulations, standards and rules

• Expanded expectations for competency and accountability

• Increasing reliance on advancing technologies

• New attitudes and expectations on the prevention and detection of corruption.

High level impact of the proposed framework


Expected to assist company’s management in addressing:



Action steps for management

The proposed changes and enhancement to the original Framework would require management to:

• Focus on broad principles representing the fundamental concepts associated with the components of internal control that are implicit in the original Framework.

• Identify objectives as a pre-condition to internal control. The original Framework identified objective-setting as a management process and the proposed Framework emphasizes that objective-setting is not a part of internal control.

• Take into consideration how technology affects all components of internal control while designing and implementing control framework and extent of information technology dependence of processes to identify greater reliance on information technology. The proposed framework considers technology across all internal control components as

against the original framework that addressed technology as a key component of control activities and the information system. The proposed framework increases the importance of technology skills in assessing competence, requires management to consider identification of risks related to technological developments that may impact achievement of objectives, consideration of technological impact on risk of business continuity and entity level considerations of the impact of systems.

• Include more content on governance related to the board of directors and its committees including audit, compensation, nomination, and governance.

• Consider expanded objectives of financial reporting to consider external reporting beyond financial reporting, and expand internal

reporting for both financial and non-financial information.

• Consider enhanced anti-fraud expectations. The proposal contains increased discussions on fraud and would require management to consider the potential for fraud when assessing risks to achieve its objectives.

• Consider different business models and organizational structures while designing and implementing the control framework (companies are increasingly using third parties to provide products or services necessary to their operations. Further, competition, globalization, dynamic industry and technological changes, new business models, competition for talent, cost management, and other factors have required management to look beyond internal operations to obtain necessary services).

Information and communication

Specifically, the changes in information and communication would:

• Emphasize the importance of information quality and expand the discussion about the expectations for verifying to a source when information is used to support external reporting objectives.

• Expand information about the effect of regulatory requirements on reliability and protecting information.

• Expand the content about the volume and sources of information in light of increasingly complex business processes, greater interaction with external parties, and technology advances.

• Add content about the information and communication needs between companies and third parties and emphasize the importance of considering how processes may occur outside the company (e.g., third-party service

providers for payroll, customer relationship management, data center operations, supply chain, manufacturing, etc.). The content would cover how companies should obtain information from counterparties that operate outside their legal and operational boundaries.

Monitoring activities

Specifically, the changes in monitoring activities would:

• Refine the terminology in the two main categories of monitoring activities that are referred to as ongoing evaluations and separate evaluations.

• Add the requirement for a baseline understanding when establishing and evaluating ongoing and separate evaluations.

• Expand the content about using technology and external service providers.



In finale

With its principles-based approach, the proposed Framework would allow users to apply judgment in maintaining and improving internal control. It should offer management and board of directors the flexibility to expand the core framework’s use beyond financial reporting, provides separate guidance on external reporting, and addressing internal control over information not included in published financial statements. The proposed Framework is capable of being applied to a wide range of entities in different industries, across various organizational levels. Use of the proposed Framework should result in management being in a better position to identify and analyze risks and create workable approaches to address those risks. Comment period on the proposed Framework has ended and some of the comments/ observations include:

• COSO to consider establishing transition guidance from the original framework to the proposed framework to allow sufficient time for an organization to review the proposed framework, gain an understanding of the significant changes from the original framework and consider whether changes

are needed to its current system of internal control, and implement those changes.

• Although the fundamental principles underlying the original framework remain the same, however explicit rendering of the principles and attributes might cause some organizations to modify their evaluation of the organization’s internal control.

• The proposed framework indicates that when a principle is determined not to be present or functioning, an internal control deficiency exists resulting in an organization identifying deficiencies where they had not done so in previous assessments under the original framework and therefore organizations may need time to address this possibility.

• The proposed framework addresses the use of, and reliance on, evolving technologies. Currently, selection and development of any tool, including general control activities over technology (technology general controls) is outlined as one of the principles in the proposed framework which could more

appropriately be considered as an aspect of principle implementation rather than a principle in itself. Further, highlighting technology general controls as its own principle in the control activities component of internal control could give the impression that technology is only relevant to that component. In reality, technology may be relevant to all five components of internal control and therefore be considered, along with appropriate general controls, within all five components.

• Further, small public companies may take more time to update and implement the proposed framework in absence of specific implementation guidance for smaller public companies.

The projected publication date of the updated framework is early 2013. The exposure draft of the proposed framework will remain available at www.coso.org and public comments on the exposure draft will remain available at www.ic.coso.org for public viewing until the final updated framework is issued.



Recent accounting updates

US GAAP for private company financial statementsIn an effort to focus on private-company issues and taking into account the differences in the way private company financial statements are used by lenders, investors and others, the FASB is developing a new framework for deciding when and how to modify specific US GAAP guidance for private companies.

In January 2011, the Blue-Ribbon Panel (the Panel) recommended to the Financial Accounting Foundation (FAF), FASB’s parent organization on how accounting standards can best meet the needs of users of U.S. private company financial statements. The Panel concluded that the current system of accounting standard setting lacked an understanding of the information that users of private company financial statements consider ‘decision-useful’ as well as that the needs of such users differ from those of the users of public company financial statements. The panel recommended the creation of a new private-company standards board that would focus on making exceptions and modifications to US GAAP for private companies and creation of a differential standard-setting framework that would

allow FASB to make appropriate and justifiable exceptions and modifications. The Panel report did not recommend development from scratch of a separate set of GAAP for private companies, and therefore FAF decided not to create a new, autonomous standard setting body.

In May 2012, the FAF voted to establish the Private Company Council (PCC) to improve the accounting standard setting process for private companies. The PCC will identify, deliberate and advocate on any proposed changes, which will be subject to endorsement by the FASB and be submitted for public comment before being incorporated into GAAP. In the third quarter of 2012, the FASB plans to issue for comment a discussion paper on a private company decision-making framework. The objective of the project is to develop a framework for making decisions about potential modifications to US GAAP for recognition, measurement, presentation, disclosure, effective dates and transition methods to serve better the needs of users and preparers of private company financial statements. The FASB is expected to work with the PCC to develop and finalize the framework.

Simultaneously, FASB is continuing its project to develop a single definition of a non-public entity to be used in making distinctions for standard setting when considering whether modifications to public company US GAAP should be made for non-public entities. Currently, the master glossary to the Accounting Standards Codification contains five definitions of non-public entities that are relevant when different topics are applied.


In response to comments received during the private company roundtables and other input by non-public entity stakeholders, the FASB added to its agenda a project to assess the potential for reducing or eliminating certain fair value measurement disclosure requirements for non-public entities. The primary objective is to evaluate whether there is a basis to exempt non-public entities from providing the disclosures about Level 3 fair value measurements, and whether there could be cost-effective alternative to the existing requirements to disclose a tabular reconciliation from the opening balances to the closing balances for (1) derivative assets and liabilities (2) pension and post retirement plan assets, and (3) all other assets and liabilities for which Level 3 fair value measurement is being used on a recurring basis. Targeted outreach is being conducted and an exposure draft is expected in the second half of 2012.

The FASB staff will continue to develop a differential framework for the Board’s consideration. During this time, the FASB will continue to solicit input from those using, preparing, and auditing the financial statements of private companies.

While the US is still in the process of developing accounting standards for private companies, the IASB has a robust set of pronouncements paralleling IFRS that smaller entities can apply. Along with simplifying the full IFRS principles, the SME version eliminates irrelevant sections, reduces required disclosures and limits modifications to once every three years.

Proposed guidance by the IFRS Interpretations Committee (IFRIC)Put options written on non-controlling interest (NCI)The accounting for NCI put liabilities has been a contentious issue in a number of countries, with policies adopted by different companies (i.e. profit or loss vs equity) having a significant impact on the comparability of financial statements. IFRIC has published the draft interpretation on accounting for put options written on non-controlling interests, which is open for public comment until October 1, 2012. A put option is a contract that gives the holder of the option, the right to sell a specified asset to the writer of the option at a specified price within a specified time.

The draft interpretation applies, in parent’s consolidated financial statements, to put options that oblige the parent to purchase shares of its subsidiary that are held by a non-controlling interest shareholder for cash or another financial asset (NCI puts). If a parent entity is obliged to purchase the shares of its subsidiary for cash or for another financial asset, the parent must recognize a financial liability in its consolidated financial statements for the present value of the redemption amount (the option exercise price). The Interpretations Committee was asked to consider how to subsequently measure that financial liability, because diversity exists in practice.

IFRIC reached a consensus that in accordance with IAS 32 Financial Instruments: Presentation, an NCI put gives rise to a financial liability that is initially measured at the present value of the redemption amount in the parent’s consolidated financial statements. Subsequently, the financial liability is measured in accordance with IAS 39 Financial instruments: Recognition and Measurement or IFRS 9 Financial Instruments which require that changes in the measurement of such financial liability are recognized in profit or loss. The changes in the measurement of such financial liability do not change the relative interests in the subsidiary that are held by the parent and the non-controlling interest shareholder, and therefore are not equity transactions i.e. not transactions with owners in their capacity as owners per IAS 27 Separate Financial Statements or IFRS 10 Consolidated Financial Statements. The draft interpretation would achieve greater comparability between entities because all changes in the value of NCI puts would be recognized in the profit or loss.


The draft interpretation does not apply to NCI puts that had been issued as part of a business combination that occurred before the application of IFRS 3 Business Combinations (2008) and were accounted for as contingent consideration in accordance with IFRS 3 (2004). Those put options were excluded from the scope of IAS 32 and IAS 39 because the accounting for contingent consideration was set out in IFRS 3 (2004). In accordance with IFRS 3 (2004), changes in the measurement of contingent consideration were treated as an adjustment to the cost of business combination. When the Board revised IFRS 3 in 2008, it did not change the accounting for contingent consideration that arose from a business combination that occurred before the application of IFRS 3 (2008). Consequently, it was decided that this draft interpretation should not the change accounting for those contracts.


Levies charged by public authorities on entities that operate in a specific market

Levies have become more common in recent years with public authorities in a number of jurisdictions introducing levies to raise additional income. This raises the question for those who pay the levy as to when should a liability for levies be recognized in the financial statements. IFRIC has published proposed guidance on the accounting for levies charged by public authorities on entities that operate in a specific market, which is open for public comment until September 5, 2012.

A public authority may impose a levy on entities that operate in a specific market, such as a specific country, a specific region or a specific market in a specific country. The Interpretations Committee was asked to consider how an entity would account for the payment of levies, other than income taxes, in its financial statements; specifically, when the liability to pay a levy should be recognized. The consensus by the committee is as follows:

• The obligating event that gives rise to a liability to pay a levy is the activity that triggers the payment of the levy as identified by the legislation. An entity does not recognize a liability at an earlier date, even if it has no realistic opportunity to avoid the triggering event.

• An entity does not have a constructive obligation to pay a levy that will arise from operating in a future period as a result of being economically compelled to continue in that future period.

• The preparation of financial statements under the going concern principle does not imply that an entity has a present obligation to continue to operate in the future and therefore does not lead to an entity recognizing a liability at a reporting date for levies that will arise from operating in a future period.

For example, if an entity is liable to pay a levy if it generates revenues in a specific market on 1 January 2013, then it does not recognize a liability for the levy at 31 December 2012. This is the case even if the entity is economically compelled to operate in 2013, and prepares its financial statements on a going concern basis.

• The liability to pay a levy is recognized progressively if the obligating event occurs over a period of time.

• The liability to pay a levy that is within the scope of this draft interpretation gives rise to an expense.

• The same recognition principles shall be applied in the interim financial statements as applied in the annual financial statements. As a result, in the interim financial statements, the levy expense should not be anticipated if there is no present obligation to pay the levy at the end of the reporting period (or) deferred if a present obligation to pay the levy exists at the end of the interim period.

For example, if an entity with an annual reporting period ending on 31 December is liable to pay a levy if it operates in a specific market on 31 December 2012, then it does not recognize a liability for the levy or any portion of the levy, in interim financial statements for the six months ending 30 June 2012.

The draft interpretation would achieve greater comparability between entities that operate in the same market. However, the timing of the liability recognition will depend on the precise wording of the relevant legislation, which may be different for different levies.



Missed an issue of GAAP FOCUS?

January 2012

This edition of GAAP FocUS attempts to keep you informed about the advancement on the IASB and FASB convergence goal and the SEC’s work plan on adoption of IFRS into the US Financial Reporting System.

Additionally, we have highlighted key accounting and financial reporting matters under US GAAP/IFRS and areas of regulatory focus (‘Hot Topics’) that preparers should consider as they gear up for this year-end financial reporting.

Finally, this newsletter discusses key themes around audit quality, role of audit committee and current initiatives of the PCAOB, which includes proposed changes in the audit report model, audit firm rotation and other audit independence related matters.

April 2012

This edition of GAAP FOCUS provides a high-level summary of certain significant concepts including presentation differences when financial statements are prepared based on the revised Schedule VI under Indian GAAP, IFRS and US GAAP.

A summary of how volatile market conditions may impact fair value/measurement of various assets and liabilities and consequently the financial position and/or performance of entities and an analysis of how IFRS has been implemented by companies globally based on observations of market regulators such as the SEC in the US and ESMA in the EU is included in this newsletter.

Back issues are available on www.kpmg.com/IN/en/IssuesAndInsights/




The KPMG name, logo and “cutting through complexity“ are registered trademarks or trademarks of KPMG International.

Printed in India.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without a thorough examination of their facts and circumstances followed by an appropriate professional advice. Information on current practices and principles mentioned in this report, may or may not be our view on interpretative issues.

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