At the outset, it is ideal to invest some time to study the different approach unleashed by Ind. AS- on accounting of investments as compared to AS.13 on ‘Accounting for Investments’. Before we understand the distinct approach of Ind.AS on Investments, it is better to have a bird’s eye view of AS.13 on ‘Accounting for investments’.
AS 13 in a Gist:
Under Indian GAP, Accounting Standard 13 regulates Accounting for Investments. Investments are assets held by an enterprise for earning income by way of dividends, interest, and rentals, for capital appreciation, or for other benefits to the investing enterprise. Assets held as stock-in-trade are not ‘investments’. It also covers an investment in property that is an investment in land or buildings that are not intended to be occupied substantially for use by, or in the operations of, the investing enterprise.
Recognition and measurement based on Current and long term investments in AS 13:
These investments are classified primarily as Current and long term investments. A current investment is an investment that is by its nature readily realisable and is intended to be held for not more than one year from the date on which such investment is made. On the other hand, a long term investment is an investment other than a current investment. This classification is the sheet- anchor to measure the value of the investments. The carrying amount for current investments is the lower of cost and fair value. On the other hand, Long-term investments are usually carried at cost. However, when there is a decline, other than temporary, in the value of a long term investment, the carrying amount is reduced to recognise the decline. This conservative approach could be easily appreciated, since loss is recognised in Profit and Loss; as against profit that is not that lucky enough to get recognised in P/L. Why? For simple reason that profit is reckoned when actually realised. Again, is it not a conservative traditional approach?
What a contrast in Ind. AS?
While As 13 has within its ambit
a. assets that have no physical existence and are represented merely by certificates or similar documents (e.g., shares)
b. as well assets that exist in a physical form (e.g., buildings),
Ind.AS 40 is only dealing on investment Property, leaving the investments in financial instruments to the better cares of Ind. ASs 109/1o7/113 relating to recognition, measurement, disclosures and fair value measurements.
As a result, Ind. AS sails, why? Rather flies on a different fast tract to catch up with IFRS regime. That is the scenario changing totally from a mere conservative approach under AS 13, to a pulsating fair value / amortised cost approach as the case may be for measurement of financial assets. If we have to move with the time and catch up with global trend, there is no run away route but to follow suit especially when investors more so stakeholders are spread across worldwide. India is, in fact, in the list of a few countries in the word that has to catch up with the global phenomenon.
Investments in Financial Assets could be either in equity or debt instruments and are valued based on the following Business models.
Equity instruments are those that meet the definition of equity from the perspective of the issuer as defined in Ind. AS 32.
i. Equity instruments that are held for trading are necessarily required to be classified as FVTPL.
ii. For all other equities, management has an option to make an irrevocable election on initial recognition, on an instrument-by-instrument basis, to present changes in fair value in OCI rather than profit or loss. Therefore, it is not accounting policy. If this election is made, all fair value changes, excluding dividends that are a return on investment, will be included in OCI. There is no recycling of amounts from OCI to profit and loss (for example, on sale of an equity investment), nor are there any impairment requirements. However, the entity might transfer the cumulative gain or loss within equity.
Investments in Debt instruments:
i. Financial assets held: a)to collect contractual cash flows and (b) they represent the financial asset of cash flows that are solely payments of principal and interest on the principal amount outstanding(SPPI), is initially measured at fair value and subsequently at amortised cost.
ii. To achieve by both collecting contractual cash flows and selling financial assets and (b) the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount initially and subsequently measured at fair value through Other Comprehensive income (FVTPL). Financial assets included within the FVTOCI category are initially recognized and subsequently measured at fair value. Movements in the carrying amount are recorded through OCI, except for the recognition of impairment gains or losses, interest revenue as well as foreign exchange gains and losses which are recognized in profit and loss. Where the financial asset is derecognized, the cumulative gain or loss previously recognized in OCI is reclassified from equity to profit or loss.
iii. In the case of a residual category in the sense they do not meet the criteria of FVTOCI or amortized cost. at fair value through profit or loss(FVTPL)
Further, the following factors are to be properly stitched into the measurement of financial assets.
i. Transaction costs depending on Business Model
ii. Impairment of financial assets as per Ind. As 109 to be applied retrospectively subject to certain exemptions
iii. Reclassification of financial assets under the aegis of the Ind. AS 109
iv. Hedge accounting as stipulated by the said Ind. As.
For detail the said Ind. AS may be consulted. The author’s earlier article may also be referred. For brevity, the details are not reproduced.
Accounting policies are to be in place as prescribed in the various Business models as enunciated above.
Fair Value Measurement:
Ind. As 113 on Fair Value Measurement does not deal with the issue as to what should be measured at fair value and at what point of time, that is within the domain of the respective Ind. ASs. But, Ind. AS 113 dwells on the multiple valuation models to decide as to which is to be followed on a particular situation.
Computation of fair value is reasonably easy for quoted investments.
Computation of fair value may not be a cake walk for unquoted investments. At times, it will turn out to be a herculean task depending on value adjustment required to arrive at the fair value.
In the separate (non-consolidated) financial statements of the investor, the investments in subsidiaries associates or joint ventures are carried at cost or as financial assets in accordance with Ind. AS 109, unless they meet the criteria to be classified as ‘held for sale’ under Ind. AS 105, ‘Non-current assets held for sale and discontinued operations
Investment Property under Ind. AS 40:
Reverting back to Ind. As. 40 on ‘Investment Property’ that is an investment in land or buildings that are not intended to be occupied substantially for use by, or in the operations of, the investing enterprise. This category includes also such property under construction or development. Any other properties are accounted for as property, plant and equipment (PPE) or inventory as the case may be.
Initial measurement of an investment property will be at cost. But, subsequent measurement of investment properties are to be carried at cost less accumulated depreciation and any accumulated impairment losses.
Policy and Disclosure:
An entity shall adopt as its accounting policy the cost model prescribed in paragraph 56 to all of its investment property and disclose. The next logical question that crops up and hence to be addressed is whether fair valuation is permitted. The Ind. AS 40 does not permit fair value for subsequent measurement, though IFRS allows discretionary option. However, the Ind.AS mandates that it is to be measured for its fair value under the guidance of Ind. AS 113 on fair value measurement for the limited purpose of disclosure. If there has been no such valuation, that fact shall be disclosed. Disclosure required under Para 79 of the said Ind.AS on depreciation methods, Gross Carrying amount and at the close with reconciliations as suggested in Para 79.
The amounts recognised in profit or loss for:(i) rental income from investment property;(ii) direct operating expenses (including repairs and maintenance) arising from investment property that generated / did not generate as the case may be rental income during the period are also to be disclosed.
Ind. AS 1 specifies that the following items, as a minimum, are presented on the face of the balance sheet:
Assets: Property, plant and equipment; investment property; intangible assets; financial assets; investments accounted using the equity method; biological assets; deferred tax assets; current tax assets; inventories; trade and other receivables; and cash and cash equivalents.
Part to be played by Exposure Draft of Ind- As compliant Schedule III:
Based on the above, the Exposure Draft of Ind. As compliant Schedule III to the Companies Act 2013 on Part 1 dealing with Balance Sheet under item II (i) (h) on Non-current Assets deals with Financial assets in (h) and as a sub item(i) to the Financial assets, Noncurrent investments are presented. In the General Instruction for the preparation of Balance Sheet, it distinctly spells out the classification of noncurrent investments, the basis of valuation and the required disclosures. Similarly, item II (2) (b) (i) of the Balance Sheet deals with Current Investments but, shown as sub item of Financial assets. In the General Instruction for the preparation of Balance Sheet, here again it distinctly spells out the classification of current investments, the basis of valuation and the required disclosures.
Adverting to Investment Property, it should be presented as per item II I (c) to be read with Ind. AS 40.
In IFRS Balance Sheets, these are presented directly under Financial Assets. But, taking cognisance of the Indian trendy of presentation, the Exposure Draft of Ind- As compliant Schedule III to the Companies Act 2013 has been so designed as stated above to suit the ‘up –to- the minute’ presentation style and also in consonance with Ind.AS. In other words, the Exposure Draft is attuned to Indian ethos/ Diaspora without anyway compromising Ind. AS compliance.
First – time Adoption:
i. Ind. AS- 1 gives the same voluntary exemptions for Investment Property as available for PPE. Nonetheless, it is not necessary to adopt the same exemption as adopted for PPE. But, within Investment Property, the same voluntary exemption is to be followed suo-moto. There is a choice to consider previous GAAP carrying values prior to the transition as ‘Deemed Cost”.
ii. Appendix B on Exceptions to the retrospective application of other Ind. ASs and Appendix D on Exemptions from other Ind. Ass may be referred to for first adoption particularly for areas connected with financial assets including for investments in subsidiaries, joint ventures and associates.
Since the above deals with various situations where judgement may be a call, the above Appendixes may be studied with all the attention it deserves along with the requirements of the respective Ind. ASs---in particular on Ind. AS on Investment Propert and on financial instruments.
iii. In the preparation SFS, a first time adopter is to account its investments in subsidiaries associates or joint ventures at cost or as financial assets in accordance with Ind. AS 109.-Cost determined as per Ind. AS 27or deemed cost- FV as per Ind. As 109 on the date of transition or previous GAAP carrying amount on that date.
It goes without saying that the impact of fair valuation of financial assets will at times be highly disturbing especially for financial assets valued at FVTPL, particularly when share markets behave funny on 30th March. Equity investments valued at FVTOCI may not impact Profit and loss per- say; but there is no recycling of amounts from OCI to profit and loss (for example, on sale of an equity investment. For Debt Instruments valued at amortised cost, the Profit and Loss will be influenced by the Effective rate of Interest. The consequential workloads on the preparation of IT Returns need to be envisaged. The valuation of unquoted investments is going to be like chasing the shadow at times, if not more often than not. Judgment has to play its role judicially. For Investment companies, it may be a real labour pain since the value of investments on closing day matters for financial results. The transition year is going to be a tough one especially when Indian physic has yet to experience that. Electing the appropriate policies and consequential disclosure requirements will be a quite big challenge waiting in the horizon that the auditing community has to reach out.