Accounting and Auditing Update

July 2010

KPMG IN INDIA

Pharmaceutical Industry – An Accountants View

The requisite for biotech and pharmaceutical

companies has been innovation. In this industry

accounting and tax processes are a central part

of managing business. As the industry is purely

research driven, expenses are galore initiating

revenue recognition and business combinations.

Impairment of non financial assets

The study in the form of questions and answers

identifies the floating practical difficulties of the

complex rules within the framework and the

freedom of interpretation provided by IAS 36.

Statement of cash flows – A

discussion overview

As the success of any business depends on a

well managed cash flow predicting the probable

risks and forecasting an approach on the impact

of the changing business factors. The ED has

brought about limited changes to the current

standard though it’s a step towards convergence

to IFRS.

Regulatory Updates

The section covers the Amendment to equity

listing agreement of SEBI, a synopsis of RBI

Guidelines, a clear path for corporate governance

and NBFC and finally the EAC opinions.

It is with great pleasure we bring forth the July edition of the Accounting and Auditing update.

Pharmaceutical industry, which is often referred to as the hot bed of innovation, introduces unique

financial reporting challenges. The accounting dilemmas include: (1) upfront revenue recognition

versus deferral of revenues over the performance period; (2) aggregation versus separation of the

individual elements within a multiple element arrangement; (3) charging off versus capitalisation of

research and development costs; (4) assessment of triggers for recognition of impairments, etc.

We have attempted to provide our perspective on these financial reporting challenges in this

publication.

In this turbulent global economic environment, the carrying values of long lived assets are

constantly challenged by their recoverable amounts. Assessment of impairment also gets

influenced by the Generally Accepted Accounting Principles (GAAP) framework a company

operates under. A classical difference between US GAAP and International Financial Reporting

Standards (IFRS) is that, under US GAAP, impairment on a “held for use basis” is required to be

recognised only in situations where the undiscounted cash flows derived from the asset falls short

of the carrying amount, while, under IFRS, there is no such concept of undiscounted cash flow

comparison. We have attempted to highlight our perspective on the specific implementation

challenges in a Question & Answer format.

Cash flows from operations are synonymous to “net income” and material misclassification of cash

flows between operating, financing and investing categories could even result in a financial

statement restatement. The Institute of Chartered Accountants of India has issued an Exposure

Draft on the presentation of cash flow statements in line with the corresponding IFRS standard.

We have summarised the key provisions of that Exposure Draft and also discussed certain cash

flow specific implementation issues.

There seems to be all round efforts by various regulators in bringing forth improvements in financial

statement presentation and corporate governance. To name a few: (1) financial statements

prepared under IFRS as issued by the International Accounting Standards Board (IASB) is being

accepted by Securities and Exchange Board of India (SEBI) under certain specific circumstances; (2)

the Reserve Bank of India (RBI) has enhanced disclosure requirements in the accounting standards

for Non Banking Finance Companies (NBFCs) and Banks; (3) the RBI has issued specific corporate

governance norms such as partner rotation, constitution of audit committees for NBFCs meeting

certain specified criteria.

We hope you enjoy reading these articles. We look forward to receiving your valuable feedback on

what you would like us to cover in our future publications at aaupdate@in.kpmg.com

contentseditorial

1

10

19

24

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Pharmaceutical Industry – An Accountants View

The requisite for biotech and pharmaceutical

companies has been innovation. In this industry

accounting and tax processes are a central part

of managing business. As the industry is purely

research driven, expenses are galore initiating

revenue recognition and business combinations.

Impairment of non financial assets

The study in the form of questions and answers

identifies the floating practical difficulties of the

complex rules within the framework and the

freedom of interpretation provided by IAS 36.

Statement of cash flows – A

discussion overview

As the success of any business depends on a

well managed cash flow predicting the probable

risks and forecasting an approach on the impact

of the changing business factors. The ED has

brought about limited changes to the current

standard though it’s a step towards convergence

to IFRS.

Regulatory Updates

The section covers the Amendment to equity

listing agreement of SEBI, a synopsis of RBI

Guidelines, a clear path for corporate governance

and NBFC and finally the EAC opinions.

It is with great pleasure we bring forth the July edition of the Accounting and Auditing update.

Pharmaceutical industry, which is often referred to as the hot bed of innovation, introduces unique

financial reporting challenges. The accounting dilemmas include: (1) upfront revenue recognition

versus deferral of revenues over the performance period; (2) aggregation versus separation of the

individual elements within a multiple element arrangement; (3) charging off versus capitalisation of

research and development costs; (4) assessment of triggers for recognition of impairments, etc.

We have attempted to provide our perspective on these financial reporting challenges in this

publication.

In this turbulent global economic environment, the carrying values of long lived assets are

constantly challenged by their recoverable amounts. Assessment of impairment also gets

influenced by the Generally Accepted Accounting Principles (GAAP) framework a company

operates under. A classical difference between US GAAP and International Financial Reporting

Standards (IFRS) is that, under US GAAP, impairment on a “held for use basis” is required to be

recognised only in situations where the undiscounted cash flows derived from the asset falls short

of the carrying amount, while, under IFRS, there is no such concept of undiscounted cash flow

comparison. We have attempted to highlight our perspective on the specific implementation

challenges in a Question & Answer format.

Cash flows from operations are synonymous to “net income” and material misclassification of cash

flows between operating, financing and investing categories could even result in a financial

statement restatement. The Institute of Chartered Accountants of India has issued an Exposure

Draft on the presentation of cash flow statements in line with the corresponding IFRS standard.

We have summarised the key provisions of that Exposure Draft and also discussed certain cash

flow specific implementation issues.

There seems to be all round efforts by various regulators in bringing forth improvements in financial

statement presentation and corporate governance. To name a few: (1) financial statements

prepared under IFRS as issued by the International Accounting Standards Board (IASB) is being

accepted by Securities and Exchange Board of India (SEBI) under certain specific circumstances; (2)

the Reserve Bank of India (RBI) has enhanced disclosure requirements in the accounting standards

for Non Banking Finance Companies (NBFCs) and Banks; (3) the RBI has issued specific corporate

governance norms such as partner rotation, constitution of audit committees for NBFCs meeting

certain specified criteria.

We hope you enjoy reading these articles. We look forward to receiving your valuable feedback on

what you would like us to cover in our future publications at aaupdate@in.kpmg.com

contentseditorial

1

10

19

24

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Biotech and pharmaceutical companies their business. The Pharmaceutical industry

have been hotbeds for innovation for the is charecterised by significant research and

past few decades. The pharmaceutical development spends, heavy regulations

industry has four major processes in its surrounding research, clinical trials, drug

value chain — discovery, development, manufacture and sales and marketing

manufacturing, and marketing and sales. practices and pricing.

Each of these processes is vital for the

success of a pharmaceutical company. In

some cases, a large, vertically-integrated

pharmaceutical firm carries out a lot of

these functions. Sometimes, however,

certain activities are contracted or

outsourced to other firms. The trend of

outsourcing has grown over the past

decade. Outsourcing of drug development

to contract research organisations (CROs),

or manufacturing to contract manufacturing

organisations (CMOs), is common and has

led to the development of a new industry

known as contract research and

manufacturing services (CRAMS). The

pharmaceutical industry environment is

complex, and requires pharmaceutical

companies to balance various aspects of

ABOUT THE PHARMACEUTICAL

INDUSTRY

In normal times and for most industries, Canada, China, India, Israel, Japan and

accounting, issues tend to hum along in South Korea having plans to adopt IFRS or

the background—a necessary but relatively converge national GAAP with IFRS by 2011.

quiet part of business management. But One notable exception to this list is the US,

for the pharma industry, and in these times where until recently, US Generally

of financial systems turmoil, accounting Accepted Accounting Principles (US GAAP)

and tax processes are a central part of appeared set to continue as the required

managing businesses. Rarely does a day framework for all US public companies.

go by without a regulatory agency Within the pharmaceutical industry, the

commencing dispute proceedings against major global players are predominantly

pharma companies, thereby triggering based either in the Western Europe or in

significant judgmental estimates which the US. Since the adoption of IFRS in

impact financial reporting.Europe, two distinct comparable groups

Following a 2002 mandate by the EU, have been established within the industry:

International Financial Reporting Standards European pharma companies , with

(IFRS) (as endorsed by the EU) became the financial statements prepared under IFRS,

common financial reporting language for and US pharmaceutical companies with 1 financial statements prepared under the European-listed companies from 2005 .

US GAAP. The table on the following page This represented the first major step

shows the current accounting basis of a towards the establishment of a single set

number of the global pharmaceutical of high quality, globally accepted

companies. The recent developments in accounting standards. Over 100 countries

the US indicate that in the future direct worldwide now either require or permit the

comparability between companies use of IFRS (or a national variant, based on 1 throughout the world on one accounting IFRS) for listed companies . Other

platform is a realistic proposition.countries are following suit with Brazil,

FINANCIAL REPORTING IN

THE PHARMACEUTICAL INDUSTRY

Pharmaceutical Industry – AN ACCOUNTANT’S VIEW

“Pharmaceutical industry is heavily

regulated and highly research intensive”

“Regulatory

proceedings against

pharmaceutical

companies are

frequent, and

therefore,

accountants would

need to exercise

dexterity and

diligence in

evaluating

contingencies”

1. www.ec.europa.eu/internal_market/accounting/news/index_en.htm

1 2

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Biotech and pharmaceutical companies their business. The Pharmaceutical industry

have been hotbeds for innovation for the is charecterised by significant research and

past few decades. The pharmaceutical development spends, heavy regulations

industry has four major processes in its surrounding research, clinical trials, drug

value chain — discovery, development, manufacture and sales and marketing

manufacturing, and marketing and sales. practices and pricing.

Each of these processes is vital for the

success of a pharmaceutical company. In

some cases, a large, vertically-integrated

pharmaceutical firm carries out a lot of

these functions. Sometimes, however,

certain activities are contracted or

outsourced to other firms. The trend of

outsourcing has grown over the past

decade. Outsourcing of drug development

to contract research organisations (CROs),

or manufacturing to contract manufacturing

organisations (CMOs), is common and has

led to the development of a new industry

known as contract research and

manufacturing services (CRAMS). The

pharmaceutical industry environment is

complex, and requires pharmaceutical

companies to balance various aspects of

ABOUT THE PHARMACEUTICAL

INDUSTRY

In normal times and for most industries, Canada, China, India, Israel, Japan and

accounting, issues tend to hum along in South Korea having plans to adopt IFRS or

the background—a necessary but relatively converge national GAAP with IFRS by 2011.

quiet part of business management. But One notable exception to this list is the US,

for the pharma industry, and in these times where until recently, US Generally

of financial systems turmoil, accounting Accepted Accounting Principles (US GAAP)

and tax processes are a central part of appeared set to continue as the required

managing businesses. Rarely does a day framework for all US public companies.

go by without a regulatory agency Within the pharmaceutical industry, the

commencing dispute proceedings against major global players are predominantly

pharma companies, thereby triggering based either in the Western Europe or in

significant judgmental estimates which the US. Since the adoption of IFRS in

impact financial reporting.Europe, two distinct comparable groups

Following a 2002 mandate by the EU, have been established within the industry:

International Financial Reporting Standards European pharma companies , with

(IFRS) (as endorsed by the EU) became the financial statements prepared under IFRS,

common financial reporting language for and US pharmaceutical companies with 1 financial statements prepared under the European-listed companies from 2005 .

US GAAP. The table on the following page This represented the first major step

shows the current accounting basis of a towards the establishment of a single set

number of the global pharmaceutical of high quality, globally accepted

companies. The recent developments in accounting standards. Over 100 countries

the US indicate that in the future direct worldwide now either require or permit the

comparability between companies use of IFRS (or a national variant, based on 1 throughout the world on one accounting IFRS) for listed companies . Other

platform is a realistic proposition.countries are following suit with Brazil,

FINANCIAL REPORTING IN

THE PHARMACEUTICAL INDUSTRY

Pharmaceutical Industry – AN ACCOUNTANT’S VIEW

“Pharmaceutical industry is heavily

regulated and highly research intensive”

“Regulatory

proceedings against

pharmaceutical

companies are

frequent, and

therefore,

accountants would

need to exercise

dexterity and

diligence in

evaluating

contingencies”

1. www.ec.europa.eu/internal_market/accounting/news/index_en.htm

1 2

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Some of the key challenges relate to: element where (1) the delivered element

has a stand-alone value to the customer; In the

and (2) the fair value of the deliverable can case of multiple element arrangements it

be measured reliably. This guidance is may be necessary to evaluate whether a

largely consistent with the guidance under multiple element arrangement can be

US GAAP which necessitates standalone segmented into components, with different

value of the delivered element and the revenue allocations for each of the

ability to demonstrate the fair value of the component. Often the challenges relate to

undelivered elements in a multiple element situations where one element of the

arrangement as pre-conditions, to upfront arrangement has been delivered while the

revenue recognition of the delivered other elements are still undelivered. The

element.accounting question is usually whether it is

possible to recognise the revenue for the

delivered elements after deferring the fair

values of the undelivered elements. Or

should the entire arrangement be treated

as a single element and revenue

recognition take place on a systematic

method?

Under Indian GAAP, specific guidance in

this regard is not available, and as a result,

diversity in practice is observed. Generally,

the revenue recognition follows themes

such as the terms of the contract, passage

of risks/rewards and probability of collection

at the point of revenue recognition. Under

IFRS, if more than one separately

identifiable service is identified, paragraph

13 of IAS 18, Revenue requires the fair

value of the total consideration for the

agreement to be allocated to each service

and the recognition criteria of IAS 18 are

then applied to each service. In a contract

where there are both delivered and

undelivered elements, IFRIC 18 Transfers of

Assets from Customers permits upfront

revenue recognition for the delivered

Multiple element arrangements -

When US based pharmaceutical companies make comparisons of financial results with

eventually move to the IFRS regime, they those of their foreign counterparts easier,

can have the benefit of the implementation ease the access to foreign capital markets,

experience of major European-based and eventually reduce the compliance

pharmaceutical firms that are already costs.

reporting under IFRS since 2005. While As noted above there are many things to

some believe that the lack of detailed consider with respect to IFRS beyond a

guidance in IFRS is a shortcoming, others new accounting basis. In this document,

say that the US GAAP’s complex detail has we have sought to analyse the specific

resulted in arrangements structured to accounting application issues that surround

comply with accounting rules. Since a transactions generally entered into by a

number of multinationals then be under a pharmaceutical company, affecting revenue

single set of global accounting policies, the recognition and developmental activities.

move by the US-based pharmaceutical

companies to IFRS, as and when SEC

decides to permit IFRS adoption, should

Company Accounting Basis Company Accounting Basis

Actelion US GAAP Genetech, Inc. US GAAP

Amgen US GAAP GlaxoSmithKline IFRS

AstraZeneca IFRS Roche IFRS

Allergan US GAAP Johnson & Johnson US GAAP

Bristol Myers Squibb US GAAP Merck & Co., Inc. US GAAP

Celgene US GAAP Novartis IFRS

Elan Corp. IFRS Pfizer US GAAP

Eli Lilly US GAAP Sanofi-Aventis IFRS

Current accounting basis of a sample of global pharmaceutical companies

Source: OneSource Information Services Inc.

REVENUE RECOGNITION

Revenue recognition as always will

continue to be a point of contention

especially in the pharmaceutical industry,

both within company management as

well as between company management

and their auditors. Because of the variety

and complexity of business transactions,

revenue recognition is always among the

most important accounting policies, and

when coupled with the latest trend of

novel and incentivised structure of

arrangements, recognition of revenue

remains challenging and the level of

complexity associated /or the lack of

transaction specific guidance with certain

accounting rules may be overwhelming

sometimes.

Multiple-element arrangements are

commonplace in the pharmaceutical

industry with varying licensing

agreements, where companies will

license compounds or products, provide

for clinical support agreements, and

provide for a royalty stream once

approved for commercialisation. Such

arrangements give rise to unique revenue

recognition issues that companies must

address in order to properly recognise of

revenue. In the pharmaceutical industry,

once delivery of goods has occurred or

when a price is fixed and determinable,

it's not so black and white for revenue to

be recognised. Accounting rules continue

to evolve, but the challenges for

pharmaceuticals companies remain.

“It is clear that global convergence of

accounting standards will enable a

comparison between the financial statements

of the US multinationals with those of the

rest of the world”

“Often the challenge

in multiple element

arrangements is

whether it is

possible to and in

what manner to

separate the

delivered elements

from the undelivered

elements”

3 4

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Some of the key challenges relate to: element where (1) the delivered element

has a stand-alone value to the customer; In the

and (2) the fair value of the deliverable can case of multiple element arrangements it

be measured reliably. This guidance is may be necessary to evaluate whether a

largely consistent with the guidance under multiple element arrangement can be

US GAAP which necessitates standalone segmented into components, with different

value of the delivered element and the revenue allocations for each of the

ability to demonstrate the fair value of the component. Often the challenges relate to

undelivered elements in a multiple element situations where one element of the

arrangement as pre-conditions, to upfront arrangement has been delivered while the

revenue recognition of the delivered other elements are still undelivered. The

element.accounting question is usually whether it is

possible to recognise the revenue for the

delivered elements after deferring the fair

values of the undelivered elements. Or

should the entire arrangement be treated

as a single element and revenue

recognition take place on a systematic

method?

Under Indian GAAP, specific guidance in

this regard is not available, and as a result,

diversity in practice is observed. Generally,

the revenue recognition follows themes

such as the terms of the contract, passage

of risks/rewards and probability of collection

at the point of revenue recognition. Under

IFRS, if more than one separately

identifiable service is identified, paragraph

13 of IAS 18, Revenue requires the fair

value of the total consideration for the

agreement to be allocated to each service

and the recognition criteria of IAS 18 are

then applied to each service. In a contract

where there are both delivered and

undelivered elements, IFRIC 18 Transfers of

Assets from Customers permits upfront

revenue recognition for the delivered

Multiple element arrangements -

When US based pharmaceutical companies make comparisons of financial results with

eventually move to the IFRS regime, they those of their foreign counterparts easier,

can have the benefit of the implementation ease the access to foreign capital markets,

experience of major European-based and eventually reduce the compliance

pharmaceutical firms that are already costs.

reporting under IFRS since 2005. While As noted above there are many things to

some believe that the lack of detailed consider with respect to IFRS beyond a

guidance in IFRS is a shortcoming, others new accounting basis. In this document,

say that the US GAAP’s complex detail has we have sought to analyse the specific

resulted in arrangements structured to accounting application issues that surround

comply with accounting rules. Since a transactions generally entered into by a

number of multinationals then be under a pharmaceutical company, affecting revenue

single set of global accounting policies, the recognition and developmental activities.

move by the US-based pharmaceutical

companies to IFRS, as and when SEC

decides to permit IFRS adoption, should

Company Accounting Basis Company Accounting Basis

Actelion US GAAP Genetech, Inc. US GAAP

Amgen US GAAP GlaxoSmithKline IFRS

AstraZeneca IFRS Roche IFRS

Allergan US GAAP Johnson & Johnson US GAAP

Bristol Myers Squibb US GAAP Merck & Co., Inc. US GAAP

Celgene US GAAP Novartis IFRS

Elan Corp. IFRS Pfizer US GAAP

Eli Lilly US GAAP Sanofi-Aventis IFRS

Current accounting basis of a sample of global pharmaceutical companies

Source: OneSource Information Services Inc.

REVENUE RECOGNITION

Revenue recognition as always will

continue to be a point of contention

especially in the pharmaceutical industry,

both within company management as

well as between company management

and their auditors. Because of the variety

and complexity of business transactions,

revenue recognition is always among the

most important accounting policies, and

when coupled with the latest trend of

novel and incentivised structure of

arrangements, recognition of revenue

remains challenging and the level of

complexity associated /or the lack of

transaction specific guidance with certain

accounting rules may be overwhelming

sometimes.

Multiple-element arrangements are

commonplace in the pharmaceutical

industry with varying licensing

agreements, where companies will

license compounds or products, provide

for clinical support agreements, and

provide for a royalty stream once

approved for commercialisation. Such

arrangements give rise to unique revenue

recognition issues that companies must

address in order to properly recognise of

revenue. In the pharmaceutical industry,

once delivery of goods has occurred or

when a price is fixed and determinable,

it's not so black and white for revenue to

be recognised. Accounting rules continue

to evolve, but the challenges for

pharmaceuticals companies remain.

“It is clear that global convergence of

accounting standards will enable a

comparison between the financial statements

of the US multinationals with those of the

rest of the world”

“Often the challenge

in multiple element

arrangements is

whether it is

possible to and in

what manner to

separate the

delivered elements

from the undelivered

elements”

3 4

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Likely changes arising from the Exposure draft on revenue recognition

Under the proposed model outlined in the recent exposure draft on revenue

recognition, unlike the existing provisions of EITF 00-21, Revenue Arrangements with

Multiple Deliverables, an entity will no longer be required to defer all revenue under a

multiple-element arrangement due to a lack of fair value on undelivered items. It is

presumed the entity will be able to estimate the selling price. An entity would need to

use the relative selling price method when allocating consideration to each of the

performance obligations and the currently permissible residual method will not be

acceptable.

Company A licenses, manufactures, and found non-competitive. In such situations, have any standalone value in the hands of

sells pharmaceutical products. Company company B can source from alternative the customer as (1) re-sale, sub-license or

B agrees to pay a non-refundable up-front vendors after obtaining regulatory transfer of the rights is not possible; and

fee to company A for providing access to approvals which by no means can be (2) the move to alternative vendors would

proprietary product information required categorised as perfunctory. Company B not be an automatic process, would

by the regulatory agencies in certain only has access to proprietary involve time and need the regulatory

specified territories. Concurrently, information, but cannot sell, sublease or approval. Accordingly, the upfront

company B also enters into an agreement transfer the rights to proprietary product consideration does not represent a

to purchase products for a four year to any third party. The key accounting separable service and would be required

period at certain prices which provide question is whether or not it is possible to to be deferred and systematically

certain assured recoveries of costs and recognise the non-refundable recognised over the period of company A’s

reasonable margins. The supply consideration for provision of access to supply commitment.

agreement can be terminated only for proprietary products upfront. Provision of

quality issues or where the supplier is access to proprietary products does not

Multiple element arrangement,

an example:

Milestone payments, an example:Milestone payments - Contracts in which

milestone payments are received in return

for performing a service should be

accounted using the percentage of

completion method. Where fees are payable

only after a clinical trial, generally there is a

presumption that the outcome of the trial

cannot be estimated with certainty and

therefore it would be possible to assert that

“collectibility is probable” only once the

milestone event has occurred. Therefore, no

revenue in respect of these milestones

would be recognised until they are

successfully completed and costs would be

expensed as incurred.

Company X has developed a molecule for The upfront payment received should be

the treatment of a specific disease and is in recognised over the term of the

the process of conducting clinical trials. arrangement primarily due to the fact that

Company X has signed a licensing and there is a fair level of continuing

marketing agreement with Company Y, a involvement. Milestone payments, being

large pharmaceutical company, to fund the substantive events, would be recognised

product development and subsequent only when the milestones are met. At the

phases of clinical trials. Company Y has also outset of the agreement, Company X is

acquired a license to sell, market and only guaranteed to receive $3 million of the

distribute the product in a particular total cost of the trial of $5 million. Currently,

geography. The commercial terms in this there exists diversity in practice under

arrangement would involve company Y Indian GAAP for a transaction of the above

paying company X (1) an up-front non- nature.

refundable fee of USD 3 mn, and (2) a

milestone payment of USD 5 mn upon

receipt of approval from the regulators.

Milestone payments coupled with

royalty streams -

Incentives to customers/dealers -

payments will be recognised in customer incentives include cash

Where milestone accordance with the achievement of incentives, delivery of goods and services

payments are coupled with royalty milestones. However, where the royalty without charge, and gifts in the form of

streams, it would be important to payments are subsidised, the allocation products or services from an unrelated

evaluate the arrangement as a multiple of the entire consideration would be entity. Consistent with US GAAP, under

element arrangement and then assess required to be recomputed and re- IFRS, sales incentives offered to

whether it is possible to separate the allocated between the milestone customers including incentives given for

milestone payments from the royalty payments and the royalty streams based early payments are reduced from

streams. If it is possible to assert that on fair values. revenue. However, under Indian GAAP,

milestones have standalone value and early payments are not reduced from

also possible to establish that the revenue. This impacts the revenue Pharmaceutical companies may introduce

milestones and the royalty streams are recognised by companies, who currently incentives for their dealerships for the

set at fair values, royalty streams will be consider cash discount and other sales purchase of products. The incentives and

recognisable on an accrual basis as and incentives as a separate expenditure in the arrangements provided by different

when the underlying sales take place and the income statement.companies vary significantly. Examples of

collection is probable. The milestone

RESEARCH is an original and planned

investigation undertaken with the prospect of

gaining new knowledge and understanding.

DEVELOPMENT is an application of research findings or other knowledge to a plan

or design for the production of new or substantially improved materials, products, processes

etc., before the start of commercial production or use.

RESEARCH AND DEVELOPMENT EXPENSES

Internal research and development

(R&D) costs -

Under IFRS, costs incurred during a

The pharmaceutical sector 'research phase' should be recognised as

is one of the most research-driven an expense through profit and loss

industries. Pharmaceutical companies account, whereas costs incurred during

need to generate new discoveries to be the 'development phase' can be

able to sustain their product pipeline and capitalised as an intangible asset, so long

secure future revenues. As research and as the entity can demonstrate technical

development activities require a skilled feasibility of completing the intangible

workforce, state-of-the-art laboratories as asset, the ability to sell and use it, the

well as need to comply with many future economic benefits arising out of

regulations, R&D costs are one of the the asset under the development,

most significant items in the income intention and availability of adequate

statements of the pharmaceutical technical and financial resources to

companies. R&D costs are among the complete the intangible asset under

largest expenditures incurred by development and measure; the

companies in the pharmaceutical industry expenditure incurred on the development

and are incurred at various stage of a on the asset.

product development cycle.

“Non-refundable upfront payments received for future performance

or for continuing involvement is not recognised immediately and

instead deferred and recognised progressively as the performance

milestones are achieved”

“In multiple element arrangements, it is important to look beyond

the contractual provisions to assess whether there is cross

subsidisation of the pricing for the delivered elements and those of

the undelivered elements. If pricing is not set at fair values, the

consideration should be allocated based on fair values”

“Capitalisation is

permissible only for

development costs

which have reached

the stage of technical

feasibility”

5 6

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Likely changes arising from the Exposure draft on revenue recognition

Under the proposed model outlined in the recent exposure draft on revenue

recognition, unlike the existing provisions of EITF 00-21, Revenue Arrangements with

Multiple Deliverables, an entity will no longer be required to defer all revenue under a

multiple-element arrangement due to a lack of fair value on undelivered items. It is

presumed the entity will be able to estimate the selling price. An entity would need to

use the relative selling price method when allocating consideration to each of the

performance obligations and the currently permissible residual method will not be

acceptable.

Company A licenses, manufactures, and found non-competitive. In such situations, have any standalone value in the hands of

sells pharmaceutical products. Company company B can source from alternative the customer as (1) re-sale, sub-license or

B agrees to pay a non-refundable up-front vendors after obtaining regulatory transfer of the rights is not possible; and

fee to company A for providing access to approvals which by no means can be (2) the move to alternative vendors would

proprietary product information required categorised as perfunctory. Company B not be an automatic process, would

by the regulatory agencies in certain only has access to proprietary involve time and need the regulatory

specified territories. Concurrently, information, but cannot sell, sublease or approval. Accordingly, the upfront

company B also enters into an agreement transfer the rights to proprietary product consideration does not represent a

to purchase products for a four year to any third party. The key accounting separable service and would be required

period at certain prices which provide question is whether or not it is possible to to be deferred and systematically

certain assured recoveries of costs and recognise the non-refundable recognised over the period of company A’s

reasonable margins. The supply consideration for provision of access to supply commitment.

agreement can be terminated only for proprietary products upfront. Provision of

quality issues or where the supplier is access to proprietary products does not

Multiple element arrangement,

an example:

Milestone payments, an example:Milestone payments - Contracts in which

milestone payments are received in return

for performing a service should be

accounted using the percentage of

completion method. Where fees are payable

only after a clinical trial, generally there is a

presumption that the outcome of the trial

cannot be estimated with certainty and

therefore it would be possible to assert that

“collectibility is probable” only once the

milestone event has occurred. Therefore, no

revenue in respect of these milestones

would be recognised until they are

successfully completed and costs would be

expensed as incurred.

Company X has developed a molecule for The upfront payment received should be

the treatment of a specific disease and is in recognised over the term of the

the process of conducting clinical trials. arrangement primarily due to the fact that

Company X has signed a licensing and there is a fair level of continuing

marketing agreement with Company Y, a involvement. Milestone payments, being

large pharmaceutical company, to fund the substantive events, would be recognised

product development and subsequent only when the milestones are met. At the

phases of clinical trials. Company Y has also outset of the agreement, Company X is

acquired a license to sell, market and only guaranteed to receive $3 million of the

distribute the product in a particular total cost of the trial of $5 million. Currently,

geography. The commercial terms in this there exists diversity in practice under

arrangement would involve company Y Indian GAAP for a transaction of the above

paying company X (1) an up-front non- nature.

refundable fee of USD 3 mn, and (2) a

milestone payment of USD 5 mn upon

receipt of approval from the regulators.

Milestone payments coupled with

royalty streams -

Incentives to customers/dealers -

payments will be recognised in customer incentives include cash

Where milestone accordance with the achievement of incentives, delivery of goods and services

payments are coupled with royalty milestones. However, where the royalty without charge, and gifts in the form of

streams, it would be important to payments are subsidised, the allocation products or services from an unrelated

evaluate the arrangement as a multiple of the entire consideration would be entity. Consistent with US GAAP, under

element arrangement and then assess required to be recomputed and re- IFRS, sales incentives offered to

whether it is possible to separate the allocated between the milestone customers including incentives given for

milestone payments from the royalty payments and the royalty streams based early payments are reduced from

streams. If it is possible to assert that on fair values. revenue. However, under Indian GAAP,

milestones have standalone value and early payments are not reduced from

also possible to establish that the revenue. This impacts the revenue Pharmaceutical companies may introduce

milestones and the royalty streams are recognised by companies, who currently incentives for their dealerships for the

set at fair values, royalty streams will be consider cash discount and other sales purchase of products. The incentives and

recognisable on an accrual basis as and incentives as a separate expenditure in the arrangements provided by different

when the underlying sales take place and the income statement.companies vary significantly. Examples of

collection is probable. The milestone

RESEARCH is an original and planned

investigation undertaken with the prospect of

gaining new knowledge and understanding.

DEVELOPMENT is an application of research findings or other knowledge to a plan

or design for the production of new or substantially improved materials, products, processes

etc., before the start of commercial production or use.

RESEARCH AND DEVELOPMENT EXPENSES

Internal research and development

(R&D) costs -

Under IFRS, costs incurred during a

The pharmaceutical sector 'research phase' should be recognised as

is one of the most research-driven an expense through profit and loss

industries. Pharmaceutical companies account, whereas costs incurred during

need to generate new discoveries to be the 'development phase' can be

able to sustain their product pipeline and capitalised as an intangible asset, so long

secure future revenues. As research and as the entity can demonstrate technical

development activities require a skilled feasibility of completing the intangible

workforce, state-of-the-art laboratories as asset, the ability to sell and use it, the

well as need to comply with many future economic benefits arising out of

regulations, R&D costs are one of the the asset under the development,

most significant items in the income intention and availability of adequate

statements of the pharmaceutical technical and financial resources to

companies. R&D costs are among the complete the intangible asset under

largest expenditures incurred by development and measure; the

companies in the pharmaceutical industry expenditure incurred on the development

and are incurred at various stage of a on the asset.

product development cycle.

“Non-refundable upfront payments received for future performance

or for continuing involvement is not recognised immediately and

instead deferred and recognised progressively as the performance

milestones are achieved”

“In multiple element arrangements, it is important to look beyond

the contractual provisions to assess whether there is cross

subsidisation of the pricing for the delivered elements and those of

the undelivered elements. If pricing is not set at fair values, the

consideration should be allocated based on fair values”

“Capitalisation is

permissible only for

development costs

which have reached

the stage of technical

feasibility”

5 6

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

The major challenge faced by the Costs of trial batches for available for use (date of receipt of

pharmaceutical industry is to demonstrate drugs under development which have no regulatory and marketing approval) over the

the technical and commercial feasibility of alternative future use and where the estimated useful life. In a way, paragraph

the drug under development and from technical feasibility is not established 25 of IAS 38 attempts to draw some

what point can a company commence should be reflected as development distinction between cost of in-licensed

capitalisation of the costs incurred on the expenses in the income statement. know-how vis-à-vis the cost of self

development. There is no definitive starting However, trial batches are necessary to developed know-how. In the former, the

point for capitalisation. Management obtain regulatory approval to validate the probability of economic benefits flowing in

should use their judgment, based on the use of machinery (unrelated to the approval is assumed while in the latter it is required

facts and circumstances of each for new drugs), the related costs (other to be demonstrated after careful

development project to evaluation the point than abnormal costs) should be capitalised consideration of facts and circumstances.

where the technical feasibility of the project together with the cost of machinery as

can be established and demonstrate the those that are related to bringing the Pharmaceutical companies pay CROs an

criteria’s set down under IAS 38, Intangible machinery to its working condition.upfront consideration to perform research

Assets been met. and have full rights of access to the

When an entity files its submission to the Pharmaceutical companies research findings for a finite period of time.

regulatory authority for final approval, a frequently in-license (i.e., obtain the right to In such situations, the upfront payment

strong indication exists that an entity has use) know-how to manufacture specific should be deferred as a pre-payment and

met all the criteria for capitalisation of the drugs. These arrangements usually involve should be recognised in the income

development costs. Securing regulatory the payment of an up-front non-refundable statement over the life of the research, in

approval is generally viewed by the consideration. Frequently, it is not possible accordance with the underlying assumption

pharmaceutical entities all over the world to conclude whether or not regulatory of accrual basis of accounting. If the

as the best evidence (e.g., receipt of US approvals will be received for the drugs research terminates early, the remainder of

FDA approval) that all the criteria for under development. Paragraph 25 of IAS 38 the pre-payment should be written off as

capitalisation have been met. Apart from suggests that the price of an entity pays to research and development costs in the

very few companies that capitalise acquire an intangible asset, reflects the income statement.

development costs based on the “probable expectations about the probability that the

future economic benefits criteria” prior to expected future economic benefits from Innovators frequently have issues where

the receipt of regulatory approvals, an the asset will flow to the entity. The effect generic companies copy their drugs and

overwhelming number of pharmaceutical of probability is, therefore, reflected in the threaten their patents. Costs incurred by

multinationals do not capitalise their cost of the asset. The probability innovators to defend their patents are in

development costs incurred prior to the recognition criterion is always considered the nature of maintenance expenses, do

receipt of regulatory approval. to be satisfied for separately acquired not increase the expected future economic

intangible assets. Accordingly, the benefits, and accordingly, do not qualify for

purchased know-how is capitalised and capitalisation.

amortised from the date the know-how is

Trial run costs -

Upfront payments to conduct research -

Upfront payments to in-license know-

how -

Costs incurred to defend patents -

LEGAL CONTINGENCIES

Contingent liabilities are recognised with it infringement contingencies require a

is more likely than not that an obligation careful evaluation, review of facts and

exists. If a range of loss exists and no one consultation with both external and internal

amount is more likely than under IFRS, an legal counsel. Some of the law-suits could

entity would accrue a liability at the best threaten the very existence of the company

estimate after considering all possible and therefore, could also have a going

outcomes weighted based on their concern implication.

probabilities. IFRS also requires disclosing a

roll forward of the loss accrual balance. For

losses that are not more likely than not of

occurring, but a loss is greater than remote,

disclosure is required under IFRS. In

pharmaceutical industries, the assessment

of whether an accrual is required to be

established with respect to patent

INVENTORIES

LIFO method of inventory valuation is of a similar nature throughout the entity. Any

prohibited under IFRS. This further impacts inventory write-downs are required to be

the tax accounting basis, since tax requires reversed in subsequent periods if the value

use of the cost basis used under an entity’s recovers. Further, pharmaceutical companies

generally accepted accounting principles. If need to establish policies for inventory

the IRS does not adjust for this, there will be obsolescence taking into account the dates

a significant tax impact for entities using of expiry, shelf life, etc.

LIFO. Under IFRS, an entity is required to

use the same cost method for all inventories

BUSINESS COMBINATIONS

Consolidation and inorganic growth have book values on a designated date as

become the main stay in the Indian approved by the courts in the case of

pharmaceutical sector with several amalgamations.

acquisitions being made over the last few Several acquisitions also include earn-out

years. Similar to US GAAP, IFRS would payments linked to future performance.

require that irrespective of the legal form of IFRS and US GAAP now require that such

the transaction, such acquisitions must be cash earn-out arrangements should also be

recognised on a fair value basis. Under this fair valued on the acquisition date. Any

approach, all assets and liabilities of the subsequent changes in the fair value of

acquired company would be fair valued on such earn-out arrangements are not

the acquisition date. Similarly, unrecognised capitalised, but recognised through the

intangible assets such as in-process R&D income statement. Under the Indian GAAP,

projects, brand /trademark (including those earn-out payments are generally capitalised

with indefinite useful lives), product-related at the time of the payment.

intangibles (dossiers, marketing

authorisations), customer relationships Further, IFRS and the US GAAP require that would also be recognised during the transaction costs incurred for the acquisition. Only the balance consideration acquisition (finder’s fees, due diligence would be recognised as goodwill. Further, costs, etc) are charged to the income IFRS would require that the results of the statement. This is different from the Indian acquired company be included in the GAAP under which capitalisation of direct financial statements of the acquirer only costs of acquisition is permissible.from the date when control is transferred–

and not from a designated effective date.

Under Indian GAAP, companies consolidate

assets, liabilities and goodwill based on

INTANGIBLE ASSETS

Pharmaceutical companies generally have

significant amounts of intangibles and

goodwill on their balance sheets. The

inherent uncertainties in the business result

in a risk of impairment of these assets. IFRS

allows the use of discounted cash flows to

determine if impairment exists. This is unlike

US GAAP which requires the use of an

undiscounted cash flow method.

Impairment analysis under IFRS is similar to

Indian GAAP, with IFRS containing certain

additional guidance with respect to

impairment testing for a Cash Generaitng

Unit (CGU) which contains minority interest.

Also, under IFRS, goodwill must be

allocated to a CGU or a group of CGU’s.

IFRS does not allow reversal of impairment

charge for goodwill, which is permissible

under Indian GAAP if certain specific criteria

are met.

“Fair valuing the earn outs

on the date of business

combinations would

require significant

judgements and estimates”

7 8

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

The major challenge faced by the Costs of trial batches for available for use (date of receipt of

pharmaceutical industry is to demonstrate drugs under development which have no regulatory and marketing approval) over the

the technical and commercial feasibility of alternative future use and where the estimated useful life. In a way, paragraph

the drug under development and from technical feasibility is not established 25 of IAS 38 attempts to draw some

what point can a company commence should be reflected as development distinction between cost of in-licensed

capitalisation of the costs incurred on the expenses in the income statement. know-how vis-à-vis the cost of self

development. There is no definitive starting However, trial batches are necessary to developed know-how. In the former, the

point for capitalisation. Management obtain regulatory approval to validate the probability of economic benefits flowing in

should use their judgment, based on the use of machinery (unrelated to the approval is assumed while in the latter it is required

facts and circumstances of each for new drugs), the related costs (other to be demonstrated after careful

development project to evaluation the point than abnormal costs) should be capitalised consideration of facts and circumstances.

where the technical feasibility of the project together with the cost of machinery as

can be established and demonstrate the those that are related to bringing the Pharmaceutical companies pay CROs an

criteria’s set down under IAS 38, Intangible machinery to its working condition.upfront consideration to perform research

Assets been met. and have full rights of access to the

When an entity files its submission to the Pharmaceutical companies research findings for a finite period of time.

regulatory authority for final approval, a frequently in-license (i.e., obtain the right to In such situations, the upfront payment

strong indication exists that an entity has use) know-how to manufacture specific should be deferred as a pre-payment and

met all the criteria for capitalisation of the drugs. These arrangements usually involve should be recognised in the income

development costs. Securing regulatory the payment of an up-front non-refundable statement over the life of the research, in

approval is generally viewed by the consideration. Frequently, it is not possible accordance with the underlying assumption

pharmaceutical entities all over the world to conclude whether or not regulatory of accrual basis of accounting. If the

as the best evidence (e.g., receipt of US approvals will be received for the drugs research terminates early, the remainder of

FDA approval) that all the criteria for under development. Paragraph 25 of IAS 38 the pre-payment should be written off as

capitalisation have been met. Apart from suggests that the price of an entity pays to research and development costs in the

very few companies that capitalise acquire an intangible asset, reflects the income statement.

development costs based on the “probable expectations about the probability that the

future economic benefits criteria” prior to expected future economic benefits from Innovators frequently have issues where

the receipt of regulatory approvals, an the asset will flow to the entity. The effect generic companies copy their drugs and

overwhelming number of pharmaceutical of probability is, therefore, reflected in the threaten their patents. Costs incurred by

multinationals do not capitalise their cost of the asset. The probability innovators to defend their patents are in

development costs incurred prior to the recognition criterion is always considered the nature of maintenance expenses, do

receipt of regulatory approval. to be satisfied for separately acquired not increase the expected future economic

intangible assets. Accordingly, the benefits, and accordingly, do not qualify for

purchased know-how is capitalised and capitalisation.

amortised from the date the know-how is

Trial run costs -

Upfront payments to conduct research -

Upfront payments to in-license know-

how -

Costs incurred to defend patents -

LEGAL CONTINGENCIES

Contingent liabilities are recognised with it infringement contingencies require a

is more likely than not that an obligation careful evaluation, review of facts and

exists. If a range of loss exists and no one consultation with both external and internal

amount is more likely than under IFRS, an legal counsel. Some of the law-suits could

entity would accrue a liability at the best threaten the very existence of the company

estimate after considering all possible and therefore, could also have a going

outcomes weighted based on their concern implication.

probabilities. IFRS also requires disclosing a

roll forward of the loss accrual balance. For

losses that are not more likely than not of

occurring, but a loss is greater than remote,

disclosure is required under IFRS. In

pharmaceutical industries, the assessment

of whether an accrual is required to be

established with respect to patent

INVENTORIES

LIFO method of inventory valuation is of a similar nature throughout the entity. Any

prohibited under IFRS. This further impacts inventory write-downs are required to be

the tax accounting basis, since tax requires reversed in subsequent periods if the value

use of the cost basis used under an entity’s recovers. Further, pharmaceutical companies

generally accepted accounting principles. If need to establish policies for inventory

the IRS does not adjust for this, there will be obsolescence taking into account the dates

a significant tax impact for entities using of expiry, shelf life, etc.

LIFO. Under IFRS, an entity is required to

use the same cost method for all inventories

BUSINESS COMBINATIONS

Consolidation and inorganic growth have book values on a designated date as

become the main stay in the Indian approved by the courts in the case of

pharmaceutical sector with several amalgamations.

acquisitions being made over the last few Several acquisitions also include earn-out

years. Similar to US GAAP, IFRS would payments linked to future performance.

require that irrespective of the legal form of IFRS and US GAAP now require that such

the transaction, such acquisitions must be cash earn-out arrangements should also be

recognised on a fair value basis. Under this fair valued on the acquisition date. Any

approach, all assets and liabilities of the subsequent changes in the fair value of

acquired company would be fair valued on such earn-out arrangements are not

the acquisition date. Similarly, unrecognised capitalised, but recognised through the

intangible assets such as in-process R&D income statement. Under the Indian GAAP,

projects, brand /trademark (including those earn-out payments are generally capitalised

with indefinite useful lives), product-related at the time of the payment.

intangibles (dossiers, marketing

authorisations), customer relationships Further, IFRS and the US GAAP require that would also be recognised during the transaction costs incurred for the acquisition. Only the balance consideration acquisition (finder’s fees, due diligence would be recognised as goodwill. Further, costs, etc) are charged to the income IFRS would require that the results of the statement. This is different from the Indian acquired company be included in the GAAP under which capitalisation of direct financial statements of the acquirer only costs of acquisition is permissible.from the date when control is transferred–

and not from a designated effective date.

Under Indian GAAP, companies consolidate

assets, liabilities and goodwill based on

INTANGIBLE ASSETS

Pharmaceutical companies generally have

significant amounts of intangibles and

goodwill on their balance sheets. The

inherent uncertainties in the business result

in a risk of impairment of these assets. IFRS

allows the use of discounted cash flows to

determine if impairment exists. This is unlike

US GAAP which requires the use of an

undiscounted cash flow method.

Impairment analysis under IFRS is similar to

Indian GAAP, with IFRS containing certain

additional guidance with respect to

impairment testing for a Cash Generaitng

Unit (CGU) which contains minority interest.

Also, under IFRS, goodwill must be

allocated to a CGU or a group of CGU’s.

IFRS does not allow reversal of impairment

charge for goodwill, which is permissible

under Indian GAAP if certain specific criteria

are met.

“Fair valuing the earn outs

on the date of business

combinations would

require significant

judgements and estimates”

7 8

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Useful life -

Reversal of impairment -

Impairment -

Under IFRS, the depreciable (1) expiry of patents or changes in

amount of an intangible asset should be legislation covering patents; (2)

amortised on a systematic basis over the consolidation of purchasing power in the

best estimate of its useful life. Useful life is hands of large insurance companies

defined as the period of time over which an resulting in a move to a tender based

asset is expected to be used by the entity. regime (as in the case of Germany); (3)

Companies should assess the useful lives development of a drug by a competitor

initially and on an annual basis. Some of with a superior potential; (4) general

the pharmaceutical industry specific factors advances in the manner of treating

which should be considered include: (1) particular diseases; (4) national health care

Duration of the patent right or license and reforms impacting reimbursement policies

any recent regulatory decisions impacting of insurance companies, etc.

patent rights; (2) expected sales and any Impairment

anticipated fall in the sales beyond a period losses recognised may also be reversed

of time; (3) development of new drugs with where there has been a change in the

superior efficacy; (3) move to a tender estimates used to determined the asset’s

based regime with concentration of recoverable amount since the last

purchasing power in the hands of state run impairment loss was recognised. The

insurance agencies, etc.carrying amount of the asset is increased

Pharmaceutical companies to its recoverable amount, but shall not

generally have significant amounts of exceed its carrying amount adjusted for

intangibles and goodwill on their balance amortisation or depreciation had no

sheets. The inherent uncertainties in the impairment loss been recognised for the

business result in a risk of impairment of asset in the prior years. These situations

these assets. Under IFRS, an entity should could occur in a pharmaceutical industry

assess whether there are any triggers where an impairment loss was initially

which indicate that an asset is impaired at recognised and subsequently, there is a

each reporting date. While IFRS provides significant anticipated increase in the

certain general indicators of impairment, income arising from a favourable court

some of the pharmaceutical industry decision which was not considered

specific impairment indicators include: probable or a competitor’s product being

removed from the market.

In summary, the accounting challenges in a pharmaceutical industry continue

to be centered around revenue recognition (upfront vs. deferral), accounting

for research and development (capitalise vs. expense) and intangible assets

(amortise and carry forward vs. impair). Adoption of IFRS around the world

is expected to introduce homogeneity in accounting practices and permit

international comparability and thereby accelerate cross border transactions.

CONCLUSION

Impairment of non-financial assets

Paradigm shift in accounting convention from

‘Historical cost’ to ‘Fair value’

“All that glitters is not gold”,

uttered The Prince of Morocco

as he read the message revealed

when he lifted the lid of a gold

casket, as required of him to win

the hand of a princess. The

message was a lesson taught

from beyond the grave by the

father of the princess Portia in

Shakespeare’s, The Merchant of

Venice. The same sentiment can

be applied to balance sheets in

the midst of the current global

economic crisis. In this case, the

glittering substances are the

carrying values of non-current

assets, particularly goodwill and

intangible assets.

CONTRACT MANUFACTURING/

TOLL MANUFACTURING

A common practice amongst

Pharmaceutical companies, particularly

those with highly diversified product

portfolios, is to enter into exclusive ‘contract

manufacturing’ arrangements, whereby an

identified manufacturing company would

procure assets (tangible/intangible) that

should be exclusively used by them to

produce an identified set of products for and

on behalf of the contracting pharmaceutical

company. Companies entering into such

arrangements should be mindful of the

requirements in IFRIC 4, Determining

whether an Arrangement contains a Lease,

that provides for identification of any

embedded lease component included as

part of the underlying product supply

transaction, in cases where a ‘right to use’

on identified assets is conveyed amongst

the parties thereby.

9 10

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Useful life -

Reversal of impairment -

Impairment -

Under IFRS, the depreciable (1) expiry of patents or changes in

amount of an intangible asset should be legislation covering patents; (2)

amortised on a systematic basis over the consolidation of purchasing power in the

best estimate of its useful life. Useful life is hands of large insurance companies

defined as the period of time over which an resulting in a move to a tender based

asset is expected to be used by the entity. regime (as in the case of Germany); (3)

Companies should assess the useful lives development of a drug by a competitor

initially and on an annual basis. Some of with a superior potential; (4) general

the pharmaceutical industry specific factors advances in the manner of treating

which should be considered include: (1) particular diseases; (4) national health care

Duration of the patent right or license and reforms impacting reimbursement policies

any recent regulatory decisions impacting of insurance companies, etc.

patent rights; (2) expected sales and any Impairment

anticipated fall in the sales beyond a period losses recognised may also be reversed

of time; (3) development of new drugs with where there has been a change in the

superior efficacy; (3) move to a tender estimates used to determined the asset’s

based regime with concentration of recoverable amount since the last

purchasing power in the hands of state run impairment loss was recognised. The

insurance agencies, etc.carrying amount of the asset is increased

Pharmaceutical companies to its recoverable amount, but shall not

generally have significant amounts of exceed its carrying amount adjusted for

intangibles and goodwill on their balance amortisation or depreciation had no

sheets. The inherent uncertainties in the impairment loss been recognised for the

business result in a risk of impairment of asset in the prior years. These situations

these assets. Under IFRS, an entity should could occur in a pharmaceutical industry

assess whether there are any triggers where an impairment loss was initially

which indicate that an asset is impaired at recognised and subsequently, there is a

each reporting date. While IFRS provides significant anticipated increase in the

certain general indicators of impairment, income arising from a favourable court

some of the pharmaceutical industry decision which was not considered

specific impairment indicators include: probable or a competitor’s product being

removed from the market.

In summary, the accounting challenges in a pharmaceutical industry continue

to be centered around revenue recognition (upfront vs. deferral), accounting

for research and development (capitalise vs. expense) and intangible assets

(amortise and carry forward vs. impair). Adoption of IFRS around the world

is expected to introduce homogeneity in accounting practices and permit

international comparability and thereby accelerate cross border transactions.

CONCLUSION

Impairment of non-financial assets

Paradigm shift in accounting convention from

‘Historical cost’ to ‘Fair value’

“All that glitters is not gold”,

uttered The Prince of Morocco

as he read the message revealed

when he lifted the lid of a gold

casket, as required of him to win

the hand of a princess. The

message was a lesson taught

from beyond the grave by the

father of the princess Portia in

Shakespeare’s, The Merchant of

Venice. The same sentiment can

be applied to balance sheets in

the midst of the current global

economic crisis. In this case, the

glittering substances are the

carrying values of non-current

assets, particularly goodwill and

intangible assets.

CONTRACT MANUFACTURING/

TOLL MANUFACTURING

A common practice amongst

Pharmaceutical companies, particularly

those with highly diversified product

portfolios, is to enter into exclusive ‘contract

manufacturing’ arrangements, whereby an

identified manufacturing company would

procure assets (tangible/intangible) that

should be exclusively used by them to

produce an identified set of products for and

on behalf of the contracting pharmaceutical

company. Companies entering into such

arrangements should be mindful of the

requirements in IFRIC 4, Determining

whether an Arrangement contains a Lease,

that provides for identification of any

embedded lease component included as

part of the underlying product supply

transaction, in cases where a ‘right to use’

on identified assets is conveyed amongst

the parties thereby.

9 10

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

At its most basic, the standards that govern other companies in the same industry.

impairment testing for both IFRS and US During this period of macroeconomic

GAAP require companies to assess if their upheaval, it is going to be more difficult to

future cash flows support the carrying justify projections that have not worsened

values of their assets. While there are some since the prior reporting date, which,

differences in the standards, both sets of presumably, would be predicated on

rules require a company to consider the company-specific factors. Of course auditors

impact of ‘triggers’ – indicators of and regulators will also be looking for

impairment – on the carrying value of its companies that want to take a ‘Big Bath.’

assets. Financial crisis is definitely a trigger This is the practice of company

in both sets of standards. Recent earnings management being ‘extremely conservative’

releases indicate that the impairments are and taking excessive write-downs.

making their way into the bottom lines of Companies may do this to improve

companies. Advanced Micro Devices profitability on later years, as well as

reported in January 2009 that it reflected increase the return on assets when the

USD 714 million in impairment charges for economy improves. They may merely be

goodwill and intangibles. Now may be a trying to match the returns that their peers

good time to help ensure that accounting will now get in the light of large impairment

folks familiarise themselves with impairment charges.

triggers. While AS 28, Impairment of Assets, Further massive write-offs may reveal that

IAS 36, Impairment of Assets, SFAS 142, many acquisitions were not as profitable as

Goodwill and Other Intangible Assets, and once thought. Like Portia’s late father, those

SFAS 144, Accounting for the Disposal and with investments in equities and bonds will

Impairment of Long-lived Assets (in addition learn the hard way – all that glitters is not

to several EITF’s and other literature) cite gold. Shiny things can just as well be a fool’s

numerous examples, they all have thread of gold. Impairment test is a complex process

the same basic guidance: adverse changes described in detail in the standards, but

in the company’s earnings prospects are a which nonetheless raises many questions.

trigger to test assets for impairment. What Although there is a lot of common ground in

is notable about these recent impairment the concepts underpinning impairment for

events is that they are not in the banking or assets, cash generating unit (CGU) and

construction industries, those that are at the goodwill, more differences arise when

epicenter of the current economic and looking at their application. The central issue

financial crisis. This lack of connection to the guiding all the analysis is therefore towards

progenitors of the downturn is what makes how the rules are actually implemented in

impairment suddenly very relevant to most the impairment test given the fact that

companies.sometimes formulations are unclear and

With the crisis at hand and in the light of detailed interpretation is frequently needed.

recent accounting scandals (e.g., Satyam’s This article seeks to portray in the form of

chairman’s admission that he perpetrated a question and answers, some of the practical

multi-year, billion dollar fraud), a natural difficulties in application of the intricate

reaction is to wonder if your auditor principles within the framework, which

/regulator will be approaching impairment result from the room for interpretation

differently than in the past. While technically provided by IAS 36.

no, the practical outcome is yes, they will.

These difficulties are increased by the lack

of visibility on business plans in a very

uncertain economic and financial

environment. What this means to

accounting staffs is that the assumptions

used in calculating the fair value of assets

will be heavily scrutinised and would be

subjected to an increased level of

skepticism than ever done before. Another

aspect to the process that was not such a

factor in good times is the overall

comparison of impairment testing results to

How should a company

consider ‘corporate assets’ that

are a part of more than one

CGU in the impairment

assessment process?

The distinctive characteristics of corporate

assets are that they do not generate cash

inflows independently of other assets or

groups of assets and their carrying amount

cannot be fully attributed to one specific

CGU under review (head office building,

computer centre, research centre, etc.). As a

consequence, allocation of corporate assets

to various CGUs, on a reasonable and

consistent basis, is required. This allocation

helps ensure that the impairment review

checks whether the CGU’s net cash flows

will recover not only the carrying values of

the CGU, but also the allocated portion of

the corporate assets.

Under IFRS, when it is not possible to

allocate the entire corporate assets to CGUs

on a reasonable and consistent basis, a two

stage approach is followed:

STAGE 1:

STAGE 2:

To the extent Corporate assets

can be allocated to CGUs, the recoverable

amounts should be compared with the

carrying values of the CGU including the

allocated portion of the corporate assets and

the resultant impairment loss is recognised,

Perform an impairment test at

an overall level by grouping the carrying

values of the CGUs and also the corporate

assets which cannot be allocated on a

reasonable basis and compare them with

the recoverable amount of the larger group.

Any further impairment loss arising from

this comparison is recognised. Assuming

that there are two CGUs A and B with

carrying values of 100 and 200

respectively, and there are two corporate

assets building and research centre carrying

values of 120 and 60 respectively.

Assuming further that the building can be

allocated while the research centre cannot

be allocated on a reasonable basis and that

the recoverable amounts of CGUs A and B

are 180 and 220 respectively, the results of

the two stage impairment test is

summarised below. The impairment losses

arising from these tests should be allocated

pro rata to the assets of the CGU and the

corporate assets.

CGU-A CGU-B

Carrying value of assets 100 200

Allocation of Building 40 80

Total carrying value 140 280

Recoverable amount 180 220

First stage impairment loss - 60

Stage 1 impairment test

CGU-A CGU-B Total

Adjusted carrying values post Stage 1 impairment

140 220360

Research centre - - 60

Total carrying value 140 220 420

Recoverable amount 180 220 400

Stage 2 impairment loss - - 20

Stage 2 impairment test

11 12

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

At its most basic, the standards that govern other companies in the same industry.

impairment testing for both IFRS and US During this period of macroeconomic

GAAP require companies to assess if their upheaval, it is going to be more difficult to

future cash flows support the carrying justify projections that have not worsened

values of their assets. While there are some since the prior reporting date, which,

differences in the standards, both sets of presumably, would be predicated on

rules require a company to consider the company-specific factors. Of course auditors

impact of ‘triggers’ – indicators of and regulators will also be looking for

impairment – on the carrying value of its companies that want to take a ‘Big Bath.’

assets. Financial crisis is definitely a trigger This is the practice of company

in both sets of standards. Recent earnings management being ‘extremely conservative’

releases indicate that the impairments are and taking excessive write-downs.

making their way into the bottom lines of Companies may do this to improve

companies. Advanced Micro Devices profitability on later years, as well as

reported in January 2009 that it reflected increase the return on assets when the

USD 714 million in impairment charges for economy improves. They may merely be

goodwill and intangibles. Now may be a trying to match the returns that their peers

good time to help ensure that accounting will now get in the light of large impairment

folks familiarise themselves with impairment charges.

triggers. While AS 28, Impairment of Assets, Further massive write-offs may reveal that

IAS 36, Impairment of Assets, SFAS 142, many acquisitions were not as profitable as

Goodwill and Other Intangible Assets, and once thought. Like Portia’s late father, those

SFAS 144, Accounting for the Disposal and with investments in equities and bonds will

Impairment of Long-lived Assets (in addition learn the hard way – all that glitters is not

to several EITF’s and other literature) cite gold. Shiny things can just as well be a fool’s

numerous examples, they all have thread of gold. Impairment test is a complex process

the same basic guidance: adverse changes described in detail in the standards, but

in the company’s earnings prospects are a which nonetheless raises many questions.

trigger to test assets for impairment. What Although there is a lot of common ground in

is notable about these recent impairment the concepts underpinning impairment for

events is that they are not in the banking or assets, cash generating unit (CGU) and

construction industries, those that are at the goodwill, more differences arise when

epicenter of the current economic and looking at their application. The central issue

financial crisis. This lack of connection to the guiding all the analysis is therefore towards

progenitors of the downturn is what makes how the rules are actually implemented in

impairment suddenly very relevant to most the impairment test given the fact that

companies.sometimes formulations are unclear and

With the crisis at hand and in the light of detailed interpretation is frequently needed.

recent accounting scandals (e.g., Satyam’s This article seeks to portray in the form of

chairman’s admission that he perpetrated a question and answers, some of the practical

multi-year, billion dollar fraud), a natural difficulties in application of the intricate

reaction is to wonder if your auditor principles within the framework, which

/regulator will be approaching impairment result from the room for interpretation

differently than in the past. While technically provided by IAS 36.

no, the practical outcome is yes, they will.

These difficulties are increased by the lack

of visibility on business plans in a very

uncertain economic and financial

environment. What this means to

accounting staffs is that the assumptions

used in calculating the fair value of assets

will be heavily scrutinised and would be

subjected to an increased level of

skepticism than ever done before. Another

aspect to the process that was not such a

factor in good times is the overall

comparison of impairment testing results to

How should a company

consider ‘corporate assets’ that

are a part of more than one

CGU in the impairment

assessment process?

The distinctive characteristics of corporate

assets are that they do not generate cash

inflows independently of other assets or

groups of assets and their carrying amount

cannot be fully attributed to one specific

CGU under review (head office building,

computer centre, research centre, etc.). As a

consequence, allocation of corporate assets

to various CGUs, on a reasonable and

consistent basis, is required. This allocation

helps ensure that the impairment review

checks whether the CGU’s net cash flows

will recover not only the carrying values of

the CGU, but also the allocated portion of

the corporate assets.

Under IFRS, when it is not possible to

allocate the entire corporate assets to CGUs

on a reasonable and consistent basis, a two

stage approach is followed:

STAGE 1:

STAGE 2:

To the extent Corporate assets

can be allocated to CGUs, the recoverable

amounts should be compared with the

carrying values of the CGU including the

allocated portion of the corporate assets and

the resultant impairment loss is recognised,

Perform an impairment test at

an overall level by grouping the carrying

values of the CGUs and also the corporate

assets which cannot be allocated on a

reasonable basis and compare them with

the recoverable amount of the larger group.

Any further impairment loss arising from

this comparison is recognised. Assuming

that there are two CGUs A and B with

carrying values of 100 and 200

respectively, and there are two corporate

assets building and research centre carrying

values of 120 and 60 respectively.

Assuming further that the building can be

allocated while the research centre cannot

be allocated on a reasonable basis and that

the recoverable amounts of CGUs A and B

are 180 and 220 respectively, the results of

the two stage impairment test is

summarised below. The impairment losses

arising from these tests should be allocated

pro rata to the assets of the CGU and the

corporate assets.

CGU-A CGU-B

Carrying value of assets 100 200

Allocation of Building 40 80

Total carrying value 140 280

Recoverable amount 180 220

First stage impairment loss - 60

Stage 1 impairment test

CGU-A CGU-B Total

Adjusted carrying values post Stage 1 impairment

140 220360

Research centre - - 60

Total carrying value 140 220 420

Recoverable amount 180 220 400

Stage 2 impairment loss - - 20

Stage 2 impairment test

11 12

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

When does a group of assets

held for disposal qualify for

being considered as a

discontinued operation?

As per IFRS 5, Non-current Assets Held for

Sale and Discontinued Operations, the

presentation of operation as a discontinued

operation is limited to a component of

entity that either has been disposed of , or is

classified as held for sale, and: (1)

represents a separate major line of business

or geographical area of operation, (2) is

part of a co-ordinated single plan to dispose

a separate major line of business or

geographical area of operation, or (3) is a

subsidiary acquired exclusively with a view

to resale. The group of assets held for sale

should meet the definition as prescribed in

IFRS 5 /ED of AS 24 ‘component’ of the

entity to be able to be considered for

discontinued operations presentation. A

component of an entity comprises

operations and cash flows that can be

distinguished clearly, both operationally

and for financial reporting purposes, from

the rest of the entity. In other words, a

component of an entity would have been a

cash-generating unit or a group of cash-

generating units while being held for use.

When long-lived assets are

impaired and relate to a foreign

operation, is there a requirement

to reclassify the entire or an

appropriate portion of the

foreign currency translation

reserve to the profit or loss?

Can an entity reuse the calculation

of the recoverable amount of a

CGU that was estimated in the

previous reporting period?

What are the rules governing the allocation of goodwill to

CGUs and annual impairment under IFRS?

Only on the actual disposal of a foreign

operation, the cumulative amount of the

exchange differences relating to that

foreign operation, recognised in other

comprehensive income and accumulated in

the separate component of equity, is

required to be reclassified from equity to

profit or loss. In any other partial disposal

of a foreign operation, the entity shall

reclassify to profit or loss and only the

proportionate share of the cumulative

amount of the exchange differences

recognised in other comprehensive income.

However, a write-down of the carrying

amount of a foreign operation, either

because of its own losses or because of an

impairment recognised by the investor,

does not constitute a partial disposal.

Accordingly, no part of the foreign

exchange gain or loss recognised in other

comprehensive income is reclassified to

profit or loss at the time of recognition of

an impairment loss.

The most recent computation of the

recoverable amount of a CGU may be re-

used in the current year provided the

following criteria are met:

• the assets and liabilities making up the

unit have not changed significantly

since the most recent recoverable

amount calculation

• the most recent recoverable amount

calculation resulted in an amount that

substantially exceeded the carrying

amount of the unit

based on an analysis of events that have

occurred since the previous impairment

analysis, the likelihood that the recoverable

amount would be less than the current

carrying amount of the unit is remote.

The goodwill acquired in a business generating unit to which goodwill has

combination may or may not be directly been allocated, there may be an indication

attributable to a specific CGU. Where of an impairment of an asset within the

goodwill is identified with a CGU, the unit containing the goodwill. In such

impairment test would involve the circumstances, the entity tests the asset for

comparison of the carrying value of the impairment first, and recognises any

CGU with the recoverable amount and the impairment loss for that asset before

usual steps follow. There is limited testing for impairment of the cash-

guidance on how to allocate goodwill to generating unit containing the goodwill.

individual CGUs and this allocation Similarly, there may be an indication of an

should be done on a reasonable basis after impairment of a cash-generating unit

taking into account how the individual within a group of units containing the

CGUs are benefited from the synergies of goodwill. In such circumstances, the entity

the acquisition. Often goodwill is tests the cash-generating unit for

managed on a broader basis and allocated impairment first, and recognises any

to multiple CGUs as it cannot be allocated impairment loss for that unit, before

to a single CGU on a reasonable basis. At testing for impairment the group of units

the time of impairment testing a cash- to which the goodwill is allocated.

13 14

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

When does a group of assets

held for disposal qualify for

being considered as a

discontinued operation?

As per IFRS 5, Non-current Assets Held for

Sale and Discontinued Operations, the

presentation of operation as a discontinued

operation is limited to a component of

entity that either has been disposed of , or is

classified as held for sale, and: (1)

represents a separate major line of business

or geographical area of operation, (2) is

part of a co-ordinated single plan to dispose

a separate major line of business or

geographical area of operation, or (3) is a

subsidiary acquired exclusively with a view

to resale. The group of assets held for sale

should meet the definition as prescribed in

IFRS 5 /ED of AS 24 ‘component’ of the

entity to be able to be considered for

discontinued operations presentation. A

component of an entity comprises

operations and cash flows that can be

distinguished clearly, both operationally

and for financial reporting purposes, from

the rest of the entity. In other words, a

component of an entity would have been a

cash-generating unit or a group of cash-

generating units while being held for use.

When long-lived assets are

impaired and relate to a foreign

operation, is there a requirement

to reclassify the entire or an

appropriate portion of the

foreign currency translation

reserve to the profit or loss?

Can an entity reuse the calculation

of the recoverable amount of a

CGU that was estimated in the

previous reporting period?

What are the rules governing the allocation of goodwill to

CGUs and annual impairment under IFRS?

Only on the actual disposal of a foreign

operation, the cumulative amount of the

exchange differences relating to that

foreign operation, recognised in other

comprehensive income and accumulated in

the separate component of equity, is

required to be reclassified from equity to

profit or loss. In any other partial disposal

of a foreign operation, the entity shall

reclassify to profit or loss and only the

proportionate share of the cumulative

amount of the exchange differences

recognised in other comprehensive income.

However, a write-down of the carrying

amount of a foreign operation, either

because of its own losses or because of an

impairment recognised by the investor,

does not constitute a partial disposal.

Accordingly, no part of the foreign

exchange gain or loss recognised in other

comprehensive income is reclassified to

profit or loss at the time of recognition of

an impairment loss.

The most recent computation of the

recoverable amount of a CGU may be re-

used in the current year provided the

following criteria are met:

• the assets and liabilities making up the

unit have not changed significantly

since the most recent recoverable

amount calculation

• the most recent recoverable amount

calculation resulted in an amount that

substantially exceeded the carrying

amount of the unit

based on an analysis of events that have

occurred since the previous impairment

analysis, the likelihood that the recoverable

amount would be less than the current

carrying amount of the unit is remote.

The goodwill acquired in a business generating unit to which goodwill has

combination may or may not be directly been allocated, there may be an indication

attributable to a specific CGU. Where of an impairment of an asset within the

goodwill is identified with a CGU, the unit containing the goodwill. In such

impairment test would involve the circumstances, the entity tests the asset for

comparison of the carrying value of the impairment first, and recognises any

CGU with the recoverable amount and the impairment loss for that asset before

usual steps follow. There is limited testing for impairment of the cash-

guidance on how to allocate goodwill to generating unit containing the goodwill.

individual CGUs and this allocation Similarly, there may be an indication of an

should be done on a reasonable basis after impairment of a cash-generating unit

taking into account how the individual within a group of units containing the

CGUs are benefited from the synergies of goodwill. In such circumstances, the entity

the acquisition. Often goodwill is tests the cash-generating unit for

managed on a broader basis and allocated impairment first, and recognises any

to multiple CGUs as it cannot be allocated impairment loss for that unit, before

to a single CGU on a reasonable basis. At testing for impairment the group of units

the time of impairment testing a cash- to which the goodwill is allocated.

13 14

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

How should goodwill be tested for the

impairment in the event of existence of a non-

controlling interest in a subsidiary? Is there a

requirement to allocate the impairment loss to

non-controlling interest?

If there are indefinite lived intangibles like say

brand, goodwill and other long lived assets within

a single CGU being evaluated for impairment, on

what order should the impairment loss be

recognised? Within other long lived assets, how

should the impairment loss get allocated?

What are the instances that allow management to

change the allocation of goodwill amongst

various CGUs? is that an acceptable practice?

In the case of a partial acquisition, IFRS 3 (revised), Business

Combinations provides an accounting policy choice on a

transaction-by-transaction basis of whether to measure non-

controlling interest assets at fair value or at the non-controlling

interest’s proportionate share of the acquiree’s identifiable net

assets on the date of acquisition. If an entity measures non-

controlling interests at their proportionate share of the acquiree's

identifiable net assets on the date of acquisition, it can lead to the

recognition of goodwill calculated on the acquirer’s proportionate

share in the acquiree (as opposed to the “full goodwill” method).

The non-controlling interest's share in the goodwill is not

recognised in the acquirer's consolidated financial statements.

However, IAS 36 states that, by convention, the goodwill must be

tested for impairment based on the full goodwill including the

non-controlling interest's share. As a consequence, the goodwill

attributable to the non-controlling interest must be added to the

carrying amount of goodwill (“gross-up”). This adjusted carrying

amount is then compared to the recoverable amount.

However, if an entity measures non-controlling interests at fair

value at the date of acquisition, then the entity will not gross up

the carrying amount of goodwill allocated to a cash-generating

unit since it already includes a portion attributable to the non-

controlling interests. Example: acquisition of 80 percent of a

subsidiary (“partial goodwill” method):

- acquisition price: EUR110 mn;

- fair value of the identifiable net assets of the acquiree:

EUR100mn;

- goodwill recognised: EUR110mn - 80%* EUR100mn =

EUR30mn;

- calculation of “full goodwill” (gross-up):

EUR30mn / 80 % = EUR37.5mn, or

EUR110mn * 100 % / 80 % - EUR100mn = EUR37.5mn

Where impairment losses are estimated at the CGU level and not

at an individual asset level, an important challenge to contend is to

which asset the impairment loss is required to be allocated. If a

CGU comprises goodwill, indefinite lived intangible assets such

as a brand and other long lived assets and if it is determined that

the overall recoverable amount is lower than the aggregate

carrying value, intuitively companies tend to conclude that the

impairment loss should be first allocated to the brand and

thereafter to the remaining assets. However, IAS 36 mandates that

impairment loss should be first allocated to goodwill and

thereafter to the other assets on a pro rata basis based on the

carrying amount of each asset in the CGU. However, no asset is

written down to below its known recoverable amount or zero;

therefore an entity should determine the recoverable amount of

any of the individual assets or lower level CGU in the CGU being

tested, if possible. Any excess impairment loss in respect of an

asset is allocated pro rata to the other assets in the CGU to the

extent possible. A liability should be recognised for any

unallocated impairment loss only if it is required by another

standard.

If an entity reorganises its reporting structure in a way that

changes the composition of one or more cash-generating units to

which goodwill has been allocated, the goodwill shall be

reallocated to the units affected. This reallocation shall be

performed using a relative value approach similar to that used

when an entity disposes of an operation within a cash-generating

unit, unless the entity can demonstrate that some other method

better reflects the goodwill associated with the reorganised units.

Example

Goodwill had previously been allocated to cash-generating unit A.

The goodwill allocated to A cannot be identified or associated

with an asset group at a level lower than A, except arbitrarily. A is

to be divided and integrated into three other cash-generating

units, B, C and D. Because the goodwill allocated to A cannot be

non-arbitrarily identified or associated with an asset group at a

level lower than A, it is reallocated to units B, C and D on the

basis of the relative values of the three portions of A before those

portions are integrated with B, C and D.

What should be done in the

event of disposal of all or part of

a CGU to which goodwill has

been assigned? What would

happen if the CGU is merged

with another CGU within the

consolidated group?

In the event of disposal of all or part of a

CGU to which goodwill has been allocated,

the goodwill must be taken into account

when determining the gain or loss on

disposal. If the disposal only relates to a

part of a CGU to which the goodwill has

been allocated, the proportion of the

goodwill to be derecognised is measured on

the basis of the relative values of the

operation disposed of and the portion of the

CGU retained unless the entity can

demonstrate that some other method is

more appropriate. Merging of the CGU into

another unit within the consolidated group

would be treated as reorganising the

reporting structure which requires

reallocation of goodwill using a relative

value approach. Considering goodwill

when determining the gain or loss on

disposal of a CGU depicts a strong

indication that goodwill is monitored

internally at the organisational level of the

CGU which has been disposed of.

Consistency with the level of goodwill

allocation should then be checked.

Is it always required to

determine both the fair value

less cost to sell (FVLCS) and

value in use (VIU) when

conducting an impairment test,

or will one suffice?

impossibility to take into account capacity

investments, explicit forecast period

generally not exceeding five years, limited

perpetuity growth rate, etc. It may thus, be

that a CGU with strong growth outlook will

have a VIU lower than its carrying amount,

while the FVLCS, as determined based on

market data, is greater than its carrying

amount. Market participants and the entity's

management may assess differently the

assets use, growth and business

profitability. Generally, market cash flows

may not take into account a growth in sales

revenue or a level of profitability greater

than those prevailing in the sector, unless

these levels are anticipated and shared by

market participants. The fact that the entity

must calculate FVLCS on the basis of cash

flows anticipated by the market raises the

problem in periods of economic crisis. IAS

36 provides a hierarchy of methods of

determining fair value: (first level

hierarchy) based on an arms length binding

sale agreement; or (second level hierarchy)

based on the value at which the asset is

traded in the active market; or (third level

hierarchy) based on best information

available to reflect the amount an entity

could obtain from the disposal of the asset

at an arm’s length transaction. Best

available information could be derived

from multiples from recent transactions or

even discounted cash flows method taking

account of the market data at the date of

impairment testing. If discounted cash

flows from a market participant perspective

are used for determining fair values, those

would take into account the effects of

implementation of strategic plans and

anticipated future restructuring initiatives

and thus differ from cash flow projections

used for the calculation of VIU.

Under Indian GAAP, a 'net selling price' is

to be determined in the place of a FVLCS.

The amount thus calculated under Indian

GAAP would be that obtainable from sale

of an asset in an arm's length transaction

and is not akin to a discounted cash flow

derived based on a 'market participant'

approach. Due to the fact that certain forms

of fair value less cost to sell would not be

acceptable alternatives under Indian GAAP

as clarified by an Expert Advisory

Committee consensus, in theory and in

practice, there could be differences in the

recoverable amounts between the two

GAAPs and further the impairment losses

recognised could be different.

It is not always necessary to determine both

an asset’s FVLCS and its VIU. If either of

these amounts exceeds the asset’s carrying

amount, the asset is not impaired and it is

not necessary to estimate the other amount.

Thus, it is possible to use the FVLCS as the

recoverable amount even if the entity has no

intention to dispose of the asset. According

to IAS 36.21, the value in use of an asset

does not need to be determined if there is no

reason to believe that its value in use

materially exceeds its fair value less costs to

sell. In this instance, the recoverable amount

corresponds to the FVLCS.

Yes. Recoverable amount is defined as the

higher of an asset’s FVLCS and its VIU. In

the event that VIU < Net carrying amount

< FVLCS, it is actually forbidden to use

value in use as the recoverable amount and

thus to recognise an impairment loss. This

approach may seem paradoxical when the

entity has no intention to dispose of the

CGU. The paradox may partly be explained

by the fact that the calculation of value in

use under IAS 36 is very restricted:

Is the use of FVLCS permitted

when there is no intention to

dispose of the CGU? Should fair

value be always determined

based on the evidence of a recent

transaction or is it possible to

estimate the cash flows from a

market participant perspective?

Are there any circumstances for

cash flow projections to be based

on market assumptions that differ

from cash flows determined

based on entity’s assumptions?

Would there be a potential GAAP

difference in this regard between

Indian GAAP and IFRS?

“Reallocation of goodwill

occurs when there is a change

in composition of cash

generating units to which it is

previously allocated”

15 16

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

How should goodwill be tested for the

impairment in the event of existence of a non-

controlling interest in a subsidiary? Is there a

requirement to allocate the impairment loss to

non-controlling interest?

If there are indefinite lived intangibles like say

brand, goodwill and other long lived assets within

a single CGU being evaluated for impairment, on

what order should the impairment loss be

recognised? Within other long lived assets, how

should the impairment loss get allocated?

What are the instances that allow management to

change the allocation of goodwill amongst

various CGUs? is that an acceptable practice?

In the case of a partial acquisition, IFRS 3 (revised), Business

Combinations provides an accounting policy choice on a

transaction-by-transaction basis of whether to measure non-

controlling interest assets at fair value or at the non-controlling

interest’s proportionate share of the acquiree’s identifiable net

assets on the date of acquisition. If an entity measures non-

controlling interests at their proportionate share of the acquiree's

identifiable net assets on the date of acquisition, it can lead to the

recognition of goodwill calculated on the acquirer’s proportionate

share in the acquiree (as opposed to the “full goodwill” method).

The non-controlling interest's share in the goodwill is not

recognised in the acquirer's consolidated financial statements.

However, IAS 36 states that, by convention, the goodwill must be

tested for impairment based on the full goodwill including the

non-controlling interest's share. As a consequence, the goodwill

attributable to the non-controlling interest must be added to the

carrying amount of goodwill (“gross-up”). This adjusted carrying

amount is then compared to the recoverable amount.

However, if an entity measures non-controlling interests at fair

value at the date of acquisition, then the entity will not gross up

the carrying amount of goodwill allocated to a cash-generating

unit since it already includes a portion attributable to the non-

controlling interests. Example: acquisition of 80 percent of a

subsidiary (“partial goodwill” method):

- acquisition price: EUR110 mn;

- fair value of the identifiable net assets of the acquiree:

EUR100mn;

- goodwill recognised: EUR110mn - 80%* EUR100mn =

EUR30mn;

- calculation of “full goodwill” (gross-up):

EUR30mn / 80 % = EUR37.5mn, or

EUR110mn * 100 % / 80 % - EUR100mn = EUR37.5mn

Where impairment losses are estimated at the CGU level and not

at an individual asset level, an important challenge to contend is to

which asset the impairment loss is required to be allocated. If a

CGU comprises goodwill, indefinite lived intangible assets such

as a brand and other long lived assets and if it is determined that

the overall recoverable amount is lower than the aggregate

carrying value, intuitively companies tend to conclude that the

impairment loss should be first allocated to the brand and

thereafter to the remaining assets. However, IAS 36 mandates that

impairment loss should be first allocated to goodwill and

thereafter to the other assets on a pro rata basis based on the

carrying amount of each asset in the CGU. However, no asset is

written down to below its known recoverable amount or zero;

therefore an entity should determine the recoverable amount of

any of the individual assets or lower level CGU in the CGU being

tested, if possible. Any excess impairment loss in respect of an

asset is allocated pro rata to the other assets in the CGU to the

extent possible. A liability should be recognised for any

unallocated impairment loss only if it is required by another

standard.

If an entity reorganises its reporting structure in a way that

changes the composition of one or more cash-generating units to

which goodwill has been allocated, the goodwill shall be

reallocated to the units affected. This reallocation shall be

performed using a relative value approach similar to that used

when an entity disposes of an operation within a cash-generating

unit, unless the entity can demonstrate that some other method

better reflects the goodwill associated with the reorganised units.

Example

Goodwill had previously been allocated to cash-generating unit A.

The goodwill allocated to A cannot be identified or associated

with an asset group at a level lower than A, except arbitrarily. A is

to be divided and integrated into three other cash-generating

units, B, C and D. Because the goodwill allocated to A cannot be

non-arbitrarily identified or associated with an asset group at a

level lower than A, it is reallocated to units B, C and D on the

basis of the relative values of the three portions of A before those

portions are integrated with B, C and D.

What should be done in the

event of disposal of all or part of

a CGU to which goodwill has

been assigned? What would

happen if the CGU is merged

with another CGU within the

consolidated group?

In the event of disposal of all or part of a

CGU to which goodwill has been allocated,

the goodwill must be taken into account

when determining the gain or loss on

disposal. If the disposal only relates to a

part of a CGU to which the goodwill has

been allocated, the proportion of the

goodwill to be derecognised is measured on

the basis of the relative values of the

operation disposed of and the portion of the

CGU retained unless the entity can

demonstrate that some other method is

more appropriate. Merging of the CGU into

another unit within the consolidated group

would be treated as reorganising the

reporting structure which requires

reallocation of goodwill using a relative

value approach. Considering goodwill

when determining the gain or loss on

disposal of a CGU depicts a strong

indication that goodwill is monitored

internally at the organisational level of the

CGU which has been disposed of.

Consistency with the level of goodwill

allocation should then be checked.

Is it always required to

determine both the fair value

less cost to sell (FVLCS) and

value in use (VIU) when

conducting an impairment test,

or will one suffice?

impossibility to take into account capacity

investments, explicit forecast period

generally not exceeding five years, limited

perpetuity growth rate, etc. It may thus, be

that a CGU with strong growth outlook will

have a VIU lower than its carrying amount,

while the FVLCS, as determined based on

market data, is greater than its carrying

amount. Market participants and the entity's

management may assess differently the

assets use, growth and business

profitability. Generally, market cash flows

may not take into account a growth in sales

revenue or a level of profitability greater

than those prevailing in the sector, unless

these levels are anticipated and shared by

market participants. The fact that the entity

must calculate FVLCS on the basis of cash

flows anticipated by the market raises the

problem in periods of economic crisis. IAS

36 provides a hierarchy of methods of

determining fair value: (first level

hierarchy) based on an arms length binding

sale agreement; or (second level hierarchy)

based on the value at which the asset is

traded in the active market; or (third level

hierarchy) based on best information

available to reflect the amount an entity

could obtain from the disposal of the asset

at an arm’s length transaction. Best

available information could be derived

from multiples from recent transactions or

even discounted cash flows method taking

account of the market data at the date of

impairment testing. If discounted cash

flows from a market participant perspective

are used for determining fair values, those

would take into account the effects of

implementation of strategic plans and

anticipated future restructuring initiatives

and thus differ from cash flow projections

used for the calculation of VIU.

Under Indian GAAP, a 'net selling price' is

to be determined in the place of a FVLCS.

The amount thus calculated under Indian

GAAP would be that obtainable from sale

of an asset in an arm's length transaction

and is not akin to a discounted cash flow

derived based on a 'market participant'

approach. Due to the fact that certain forms

of fair value less cost to sell would not be

acceptable alternatives under Indian GAAP

as clarified by an Expert Advisory

Committee consensus, in theory and in

practice, there could be differences in the

recoverable amounts between the two

GAAPs and further the impairment losses

recognised could be different.

It is not always necessary to determine both

an asset’s FVLCS and its VIU. If either of

these amounts exceeds the asset’s carrying

amount, the asset is not impaired and it is

not necessary to estimate the other amount.

Thus, it is possible to use the FVLCS as the

recoverable amount even if the entity has no

intention to dispose of the asset. According

to IAS 36.21, the value in use of an asset

does not need to be determined if there is no

reason to believe that its value in use

materially exceeds its fair value less costs to

sell. In this instance, the recoverable amount

corresponds to the FVLCS.

Yes. Recoverable amount is defined as the

higher of an asset’s FVLCS and its VIU. In

the event that VIU < Net carrying amount

< FVLCS, it is actually forbidden to use

value in use as the recoverable amount and

thus to recognise an impairment loss. This

approach may seem paradoxical when the

entity has no intention to dispose of the

CGU. The paradox may partly be explained

by the fact that the calculation of value in

use under IAS 36 is very restricted:

Is the use of FVLCS permitted

when there is no intention to

dispose of the CGU? Should fair

value be always determined

based on the evidence of a recent

transaction or is it possible to

estimate the cash flows from a

market participant perspective?

Are there any circumstances for

cash flow projections to be based

on market assumptions that differ

from cash flows determined

based on entity’s assumptions?

Would there be a potential GAAP

difference in this regard between

Indian GAAP and IFRS?

“Reallocation of goodwill

occurs when there is a change

in composition of cash

generating units to which it is

previously allocated”

15 16

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

In the determination of the

expected future cash flows, can

a future restructuring, planned

future capital expenditure

/expansion be factored in to

arriving at the VIU or FVLCS?

For the purpose of discounting

the expected cash flows, is the

use of pre-tax /post-tax rate

appropriate? How is the pre-tax

discount rate determined?

What are the various ‘cross-

checks’ that are applied in

determining the reasonableness

of the VIU when a substantial

portion of the entity is tested for

impairment?

The recoverable amount must be estimated

based on the asset or group of assets’

current condition at the end of the reporting

period. For the purpose of calculating the

VIU, the entity must base cash the flow

projections on the most recent financial

forecasts approved by the management,

excluding any elements such as:

- external growth investments;

- capacity and performance investments;

however, cash flows include renewal

investments whose objective is to

maintain assets in their current

condition, net of disposals;

- the impact of a future restructuring to

which an enterprise is not yet

committed (neutralisation of future cash

outflows, related to cost savings and

expected advantages).

However, for the purpose of valuing

FVLCS when there is no binding sale

agreement and no active market, fair value

should be determined based on the best

information available to reflect the amount

that an entity could obtain at the reporting

date from the disposal of the asset in an

arm's length transaction between

knowledgeable, willing parties. The fair

value also reflects the market assessment of

expected net benefits to be derived from

restructuring the unit or from future capital

expenditure. Accordingly, the FVLCS

would generally consider including the cost

and the associated benefit on future

restructuring /planned capital expansions.

However, it is to be noted that Indian

GAAP as interpreted by an Expert Advisory

Committee does not support a market

participant based discounted cash flow

approach to determine FVLCS and

therefore, the effects of future restructuring

initiatives cannot be anticipated.

Future cash flows estimates should not

include inflows and outflows associated

with income tax. Consequently, IAS 36

requires that the entity uses a pre-tax

discount rate. When only the post-tax

discount rate is available, it must be

adjusted. Determination of a pre-tax

discount rate is generally not as simple as

grossing up the post-tax discount rate by a

standard tax rate, even in a situation where

the effective tax rate is identical to the

statutory tax rate. This can be linked to

factors such as a variable effective cash tax

rate over the forecast period because of, for

example, the utilisation of future tax losses

or taxable temporary differences relating to

the asset or CGU concerned. Therefore, the

standard indicates that, if the calculation is

carried out after tax, it is necessary to

determine, by an iterative process, the

inferred pre-tax rate. In practice, the

determination of a pre-tax rate is generally

difficult, and the rate used is a post-tax rate

which is permitted as long as this method

gives the same results as with a pre-tax rate.

In most cases, entities use a post-tax rate

applied to post-tax cash flows. The iterative

process, would involve first identifying the

discounted cash flow calculations using

post-tax cash flows and a post-tax discount

rate, and then by iteration determining what

the pre-tax discount rate would need to be

to cause the VIU determined using the pre-

tax cash flows and a pre-tax discount rate to

equal the VIU determined by the post-tax

discounted cash flow calculation.

In addition to performing sensitivity

analysis on key cash flow assumptions,

terminal value growth rates and the

discount rate generally, there are additional

cross-checks that are performed in testing

the reasonableness of a VIU calculation,

especially when a substantial portion of the

entity is tested for impairment, some of

these checks include:

- Comparison to market capitalisation

- Consideration of any recent offers made

to acquire the CGU or an asset

- Comparison to other recent valuations

performed for other purposes (i.e., for

tax reasons)

- Consideration on what analysts are

saying in their articles, reports and

briefings

- Comparison of the overall movement in

value in use and discount rates since the

last impairment test, to identify if it

makes sense

- Consideration as to how comparable a

company’s share prices have moved?

For example, if the CGU was acquired

close to the high points in equity

markets and there has been a large fall

in comparable companies’ share prices,

one might expect that the value in use

would show a lower value than the

acquisition price

- Reconciliation of the total fair value of

CGUs to total market capitalisation,

particularly if the market comparables

are used to value CGUs.

What are the circumstances for

reversal of a previously

recognised impairment loss?

Can impairment loss also be

reversed under the Indian and

US GAAP?

The standard (i.e., IAS 36) requires that at increase in carrying the value of assets

each reporting date an entity should assess shall not exceed the carrying amount that

whether there is an indication that a would have been determined (net of

previously recognised impairment loss has amortisation and depreciation) had no

reversed. If there is such an indication and impairment loss been recognised in prior

the recoverable amount of the impaired years.

asset or CGU subsequently increases, then The below approach is also contemplated

the impairment loss generally is reversed, under Indian GAAP. The difference relates

except those caused only by the unwinding to a reversal of impairment loss on

of the discount used in calculating the goodwill, which is permitted under limited

value in use. Reversal of the impairment circumstances, such as impairment loss

loss for goodwill is prohibited. Therefore, that arose because of a specific event of an

impairment loss shall be reversed if, and exceptional nature which is not expected

only if, there has been a change in the to recur and subsequent external events

estimates used to determine the assets have occurred that reverse the effect of

recoverable amounts since the last that event. Under US GAAP, reversal of all

impairment loss that was recognised. The impairment losses is prohibited.

Reversal of impairment

Individual asset – is recognised in the

income statement unless the asset is carried

at a revalued amount

CGU – is allocated to assets of CGU, follows

the same principles as for the allocation of an

impairment loss

Goodwill – No reversal of previous impairment

Internal Indicators

External Indicators

• Changes in the way the asset is used or expected

to be used

• Evidence from internal reporting indicates that

the economic performance of the asset will be

better than expected

• Significant increase in the market value

• Changes in technological, market, economic or

legal environment

• Changes in the interest rates

Given the economic turmoil and lack of concrete predictability on future business

prospects, more companies would re-evaluate goodwill and long-lived assets and

recognise that impairment losses are a very real prospect. While on the surface, it would

appear that there is a degree of similarity between US GAAP and IFRS in impairment

testing, the practical application of the underlying rules and substance coupled with

possibilities for a vast array of interpretations make this topic sensitive and challenging.

Testing for impairment is not to be considered as an ‘eye wash’ and should result in

depiction of the true business potential, in order to fairly reflect the operational reality

that underpin the commerce.

CONCLUSION

17 18

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

In the determination of the

expected future cash flows, can

a future restructuring, planned

future capital expenditure

/expansion be factored in to

arriving at the VIU or FVLCS?

For the purpose of discounting

the expected cash flows, is the

use of pre-tax /post-tax rate

appropriate? How is the pre-tax

discount rate determined?

What are the various ‘cross-

checks’ that are applied in

determining the reasonableness

of the VIU when a substantial

portion of the entity is tested for

impairment?

The recoverable amount must be estimated

based on the asset or group of assets’

current condition at the end of the reporting

period. For the purpose of calculating the

VIU, the entity must base cash the flow

projections on the most recent financial

forecasts approved by the management,

excluding any elements such as:

- external growth investments;

- capacity and performance investments;

however, cash flows include renewal

investments whose objective is to

maintain assets in their current

condition, net of disposals;

- the impact of a future restructuring to

which an enterprise is not yet

committed (neutralisation of future cash

outflows, related to cost savings and

expected advantages).

However, for the purpose of valuing

FVLCS when there is no binding sale

agreement and no active market, fair value

should be determined based on the best

information available to reflect the amount

that an entity could obtain at the reporting

date from the disposal of the asset in an

arm's length transaction between

knowledgeable, willing parties. The fair

value also reflects the market assessment of

expected net benefits to be derived from

restructuring the unit or from future capital

expenditure. Accordingly, the FVLCS

would generally consider including the cost

and the associated benefit on future

restructuring /planned capital expansions.

However, it is to be noted that Indian

GAAP as interpreted by an Expert Advisory

Committee does not support a market

participant based discounted cash flow

approach to determine FVLCS and

therefore, the effects of future restructuring

initiatives cannot be anticipated.

Future cash flows estimates should not

include inflows and outflows associated

with income tax. Consequently, IAS 36

requires that the entity uses a pre-tax

discount rate. When only the post-tax

discount rate is available, it must be

adjusted. Determination of a pre-tax

discount rate is generally not as simple as

grossing up the post-tax discount rate by a

standard tax rate, even in a situation where

the effective tax rate is identical to the

statutory tax rate. This can be linked to

factors such as a variable effective cash tax

rate over the forecast period because of, for

example, the utilisation of future tax losses

or taxable temporary differences relating to

the asset or CGU concerned. Therefore, the

standard indicates that, if the calculation is

carried out after tax, it is necessary to

determine, by an iterative process, the

inferred pre-tax rate. In practice, the

determination of a pre-tax rate is generally

difficult, and the rate used is a post-tax rate

which is permitted as long as this method

gives the same results as with a pre-tax rate.

In most cases, entities use a post-tax rate

applied to post-tax cash flows. The iterative

process, would involve first identifying the

discounted cash flow calculations using

post-tax cash flows and a post-tax discount

rate, and then by iteration determining what

the pre-tax discount rate would need to be

to cause the VIU determined using the pre-

tax cash flows and a pre-tax discount rate to

equal the VIU determined by the post-tax

discounted cash flow calculation.

In addition to performing sensitivity

analysis on key cash flow assumptions,

terminal value growth rates and the

discount rate generally, there are additional

cross-checks that are performed in testing

the reasonableness of a VIU calculation,

especially when a substantial portion of the

entity is tested for impairment, some of

these checks include:

- Comparison to market capitalisation

- Consideration of any recent offers made

to acquire the CGU or an asset

- Comparison to other recent valuations

performed for other purposes (i.e., for

tax reasons)

- Consideration on what analysts are

saying in their articles, reports and

briefings

- Comparison of the overall movement in

value in use and discount rates since the

last impairment test, to identify if it

makes sense

- Consideration as to how comparable a

company’s share prices have moved?

For example, if the CGU was acquired

close to the high points in equity

markets and there has been a large fall

in comparable companies’ share prices,

one might expect that the value in use

would show a lower value than the

acquisition price

- Reconciliation of the total fair value of

CGUs to total market capitalisation,

particularly if the market comparables

are used to value CGUs.

What are the circumstances for

reversal of a previously

recognised impairment loss?

Can impairment loss also be

reversed under the Indian and

US GAAP?

The standard (i.e., IAS 36) requires that at increase in carrying the value of assets

each reporting date an entity should assess shall not exceed the carrying amount that

whether there is an indication that a would have been determined (net of

previously recognised impairment loss has amortisation and depreciation) had no

reversed. If there is such an indication and impairment loss been recognised in prior

the recoverable amount of the impaired years.

asset or CGU subsequently increases, then The below approach is also contemplated

the impairment loss generally is reversed, under Indian GAAP. The difference relates

except those caused only by the unwinding to a reversal of impairment loss on

of the discount used in calculating the goodwill, which is permitted under limited

value in use. Reversal of the impairment circumstances, such as impairment loss

loss for goodwill is prohibited. Therefore, that arose because of a specific event of an

impairment loss shall be reversed if, and exceptional nature which is not expected

only if, there has been a change in the to recur and subsequent external events

estimates used to determine the assets have occurred that reverse the effect of

recoverable amounts since the last that event. Under US GAAP, reversal of all

impairment loss that was recognised. The impairment losses is prohibited.

Reversal of impairment

Individual asset – is recognised in the

income statement unless the asset is carried

at a revalued amount

CGU – is allocated to assets of CGU, follows

the same principles as for the allocation of an

impairment loss

Goodwill – No reversal of previous impairment

Internal Indicators

External Indicators

• Changes in the way the asset is used or expected

to be used

• Evidence from internal reporting indicates that

the economic performance of the asset will be

better than expected

• Significant increase in the market value

• Changes in technological, market, economic or

legal environment

• Changes in the interest rates

Given the economic turmoil and lack of concrete predictability on future business

prospects, more companies would re-evaluate goodwill and long-lived assets and

recognise that impairment losses are a very real prospect. While on the surface, it would

appear that there is a degree of similarity between US GAAP and IFRS in impairment

testing, the practical application of the underlying rules and substance coupled with

possibilities for a vast array of interpretations make this topic sensitive and challenging.

Testing for impairment is not to be considered as an ‘eye wash’ and should result in

depiction of the true business potential, in order to fairly reflect the operational reality

that underpin the commerce.

CONCLUSION

17 18

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Exposure Draft on AccountingStandard (AS) 3 (revised)

A discussion overview

Statement of cash flows

Managing the cash flow is indispensable for a successful

running and survival of any business. Every business is exposed

to a certain inherent risks. These risks typically include, but are

not limited to: credit risk, liquidity risk, market risk and

operational risk. All risks ultimately affect the profitability,

liquidity and cash flow position of the company.

Forecasting of cash flows thus becomes exceptionally essential

for assessing and sustaining the solvency of any company. It

enables the companies to understand and investigate the impact

of the changing business factors. It summarises expected

inflows and outflows of cash during a given period and it

counters the risk that the company is likely to face difficulty in

meeting the obligations associated with its financial liabilities

that are to be settled by delivering cash.

Statement of cash flows is a tool which To achieve convergence with International Flows as issued by the International

explains the actual year on year Financial Reporting Standards (IFRS), the Accounting Standards Board (IASB). We

performance of the Company, in terms of Institute of Chartered Accountants of India will also brief upon challenges faced by the

availability of cash at the beginning and at (ICAI) has issued Exposure Draft (ED) on companies who currently present

the end of each year. It helps in evaluating AS 3 (revised), Statement of Cash Flows. In information, say, for group reporting, etc.

the movement of cash within the this article, we aim to present an overview as per the US GAAP principles, as issued

organisation during a given period. It of the ED and to bring out the finer points by the Financial Accounting Standards

classifies the cash flows into operating, of difference between the current AS 3, Board (FASB), and wish to converge to

investing and financing activities. Cash Flow Statements, the ED as issued IFRS.

by the ICAI, and IAS 7, Statement of Cash

The position on the applicability of the ED on AS 3 should be clarified by

the regulatory authorities taking into consideration the roadmap and the

definition of SMC.

OUR COMMENTS

ScopeThe Central Government of India had vide The ED, however does not mention any for achieving convergence with IFRS by

notification no. G.S.R. 739(E) dated 7 such exemption from the applicability of companies on 22 January 2010. The

December 2006, issued the Companies the Standard. Para 3 of the ED specifically roadmap to convergence lays down a

(Accounting Standards) Rules, 2006 (‘the mentions that this Standard requires all phased approach to convergence by

Rules’) notifying the accounting standards entities to present a statement of cash companies, based on the listing and net

which became effective for accounting flows. IAS 7 also does not give any worth criteria. It further mentions, inter-alia,

periods commencing on or after 7 exemption to any company based on their that the existing Indian Accounting

December 2006. The current AS 3 as turnover, borrowing or net worth. This Standards would be applicable to

notified by the NACAS states that it is not raises a doubt whether, the ED will be companies, which do not get covered in

mandatory for Small and Medium Sized applicable to all companies including SMC either of the phases to convergence and to

Companies (SMC) as defined in the as defined. Small and Medium Companies. The

notification. notification has ,however, not revisited the In this regard, the Ministry of Corporate

definition of SMC.Affairs (MCA) has announced the roadmap

A statement of cash flows is presented by the cash receipts and payments with

classifying the cash flows into operating, attributes of more than one class of cash

investing and financing activities. As per IAS flows are classified based on the activity

7 the separate components of a single that is likely to be the predominant source

transaction are classified as operating, of the cash flows.

investing or financing. This is also the same

under the existing AS 3 and also the ED on

AS 3. However, the US GAAP provides that

Presentation of a statement of cash flow

“Cash flows are important key performance indicators and are

tracked by investors and creditors for making important decisions”

19 20

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Exposure Draft on AccountingStandard (AS) 3 (revised)

A discussion overview

Statement of cash flows

Managing the cash flow is indispensable for a successful

running and survival of any business. Every business is exposed

to a certain inherent risks. These risks typically include, but are

not limited to: credit risk, liquidity risk, market risk and

operational risk. All risks ultimately affect the profitability,

liquidity and cash flow position of the company.

Forecasting of cash flows thus becomes exceptionally essential

for assessing and sustaining the solvency of any company. It

enables the companies to understand and investigate the impact

of the changing business factors. It summarises expected

inflows and outflows of cash during a given period and it

counters the risk that the company is likely to face difficulty in

meeting the obligations associated with its financial liabilities

that are to be settled by delivering cash.

Statement of cash flows is a tool which To achieve convergence with International Flows as issued by the International

explains the actual year on year Financial Reporting Standards (IFRS), the Accounting Standards Board (IASB). We

performance of the Company, in terms of Institute of Chartered Accountants of India will also brief upon challenges faced by the

availability of cash at the beginning and at (ICAI) has issued Exposure Draft (ED) on companies who currently present

the end of each year. It helps in evaluating AS 3 (revised), Statement of Cash Flows. In information, say, for group reporting, etc.

the movement of cash within the this article, we aim to present an overview as per the US GAAP principles, as issued

organisation during a given period. It of the ED and to bring out the finer points by the Financial Accounting Standards

classifies the cash flows into operating, of difference between the current AS 3, Board (FASB), and wish to converge to

investing and financing activities. Cash Flow Statements, the ED as issued IFRS.

by the ICAI, and IAS 7, Statement of Cash

The position on the applicability of the ED on AS 3 should be clarified by

the regulatory authorities taking into consideration the roadmap and the

definition of SMC.

OUR COMMENTS

ScopeThe Central Government of India had vide The ED, however does not mention any for achieving convergence with IFRS by

notification no. G.S.R. 739(E) dated 7 such exemption from the applicability of companies on 22 January 2010. The

December 2006, issued the Companies the Standard. Para 3 of the ED specifically roadmap to convergence lays down a

(Accounting Standards) Rules, 2006 (‘the mentions that this Standard requires all phased approach to convergence by

Rules’) notifying the accounting standards entities to present a statement of cash companies, based on the listing and net

which became effective for accounting flows. IAS 7 also does not give any worth criteria. It further mentions, inter-alia,

periods commencing on or after 7 exemption to any company based on their that the existing Indian Accounting

December 2006. The current AS 3 as turnover, borrowing or net worth. This Standards would be applicable to

notified by the NACAS states that it is not raises a doubt whether, the ED will be companies, which do not get covered in

mandatory for Small and Medium Sized applicable to all companies including SMC either of the phases to convergence and to

Companies (SMC) as defined in the as defined. Small and Medium Companies. The

notification. notification has ,however, not revisited the In this regard, the Ministry of Corporate

definition of SMC.Affairs (MCA) has announced the roadmap

A statement of cash flows is presented by the cash receipts and payments with

classifying the cash flows into operating, attributes of more than one class of cash

investing and financing activities. As per IAS flows are classified based on the activity

7 the separate components of a single that is likely to be the predominant source

transaction are classified as operating, of the cash flows.

investing or financing. This is also the same

under the existing AS 3 and also the ED on

AS 3. However, the US GAAP provides that

Presentation of a statement of cash flow

“Cash flows are important key performance indicators and are

tracked by investors and creditors for making important decisions”

19 20

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Cash flows from operating

activities

financing. Typical examples of cash flows from operating activities may be presented

from the operating activities include: cash either by the direct or by the indirect

receipts from sale of goods or rendering of method, although the entities are

services, cash payments to suppliers of encouraged to follow a direct method.Cash flows from the operating activities are

material and services, cash receipts from primarily derived from the principal revenue Further, as per IAS 7 when using the

commission, etc. generating activities of the company. It also indirect method, the reconciliation begins

includes any activities which are not Like the existing AS 3, and the ED gives a with profit or loss, although practice varies

investing or financing. These signify the choice to the entities to report cash flows as to whether this is net profit or loss or,

extent to which the operations of the from operating activities using either the for example, profit or loss (i.e., before tax).

company have generated sufficient cash direct method or the indirect method. However, under the US GAAP, unlike IFRSs,

flows to repay loans, maintain the However, the ED specifically encourages when using the indirect method. It is

operating capability of the company, pay entities to use the direct method. This is in required that the reconciliation begin with

dividends and make new investments line with principles stated in IAS 7. Similarly, net income (net profit or loss).

without recourse to external sources of as per the US GAAP, like IFRSs, cash flows

Under IFRS, net cash flow information interest paid (net of capitalised interest)

attributable to operating, investing and from undistributed earnings, must be Interest and dividend received

financing activities of discontinued classified as operating activities.In this regard, there arises a question that operations also is required to be disclosed, whether interest and dividend received

Capitalised interesteither on the face of the statement of cash should be classified as operating or Another significant difference, in this regard flows or in the notes to the financial investing activities. The ED on AS 3 is the treatment of capitalised interest. statements. Whatever method of (revised) states that a financial institution IFRS do not contain specific guidance on presentation is chosen, the total cash flows should classify these as operating cash the classification of capitalised interest. In from each of operating, investing and flows. But for a non-financial company, our view, to the extent that borrowing financing activities, including both interest and dividends received should be costs are capitalised in respect of qualifying continuing and discontinued operations, classified as cash flows from investing assets, the costs of acquiring those assets must be disclosed on the face of the activities. IAS 7, however, does not make should be split in the statement of cash statement of cash flows. any such distinction and the entities can flows. Depending on the entity's

make an accounting policy choice of Unlike IFRSs, cash flow information for accounting policy on presenting the classifying interest and the dividend discontinued operations is not required to interest paid on the statement of cash received as cash flows from operating or be disclosed. Unlike IFRSs, when cash flow flows, the capitalised interest should be investing activities. US GAAP, however, information is reported for discontinued classified as operating or financing specifically states that interest and the operations, for the SEC registrants there activities. However, unlike IFRS, the US dividend received must be classified as are three alternatives: GAAP provides that the capitalised interest operating activities. must be classified as investing activities. • combine cash flows from discontinued

operations with cash flows from Bank overdrafts

continuing operations within each of IAS 7 and the ED has specifically

the operating, investing and financing mentioned, that bank overdrafts which are

categories;repayable on demand and which form an

• separately identify cash flows from integral part of an company’s cash The ED defines financing activities as, discontinued operations as a line item management, are included as part of cash activities that result in changes in the size within each category; or and cash equivalents. The existing AS 3 and composition of the contributed equity

was silent on this issue. Thus, till now by • present cash flows from discontinued and borrowings of the company. Cash

implication, bank overdrafts are in most operations separately with disclosure of flows from the financing activities typically

cases a part of the cash flows attributable operating, investing and financing include any additional funds raised by the

to financing activities since in India bank activities.company, say through issue of shares or

overdrafts are similar to cash-The existing Indian Accounting Standard borrowing from banks. It also includes cash

credits/advances against inventories/books 24, Discontinuing Operations, there does outflow in the form of repayment of debt,

debts. Unlike IAS 7 bank overdrafts under not deal with the concept of discontinued cash payments to owners to acquire or

the US GAAP are always included in operations. Rather, it defines discontinuing redeem the company’s shares, etc.

financing activities.operation as a major line of business or

geographical area of operations and can be

distinguished operationally and for financial

reporting purposes. However, the Exposure Interest and dividend paidDraft on AS 24 (revised), is in line with IFRS Similar to interest and dividend received as 5. mentioned above, IAS 7 allows an entity to

classify interest and dividend paid as

operating or financing activities by any

company, whether financial institution or

not. However, ED on AS 3 (revised)

mentions that a financial institution should

classify these as operating cash flows. But Investing activities relate to the acquisition for a non-financial company, interest and and disposal of long-term assets and other dividends paid should be classified as cash investments not included in cash flows from financing activities. The ED equivalents. Analysis of cash flows from explains that this is so because the interest investing activities is essential for and dividend paid are the costs of obtaining understanding the use of cash for capital financial resources. Similar to the ED, expenditure. This disclosure helps ensure under the US GAAP, the dividends paid proper maintenance of and additions to, a must be classified as financing activities. company’s physical assets to support its However, the US GAAP provides that the efficient operation and competitiveness.

Cash flows from financing

activities

Cash flows from investing

activities

Specific classification issues

Specific classification issues

Specific classification issues on the classification of tax benefits of cash flows associated with extraordinary

associated with share-based payments, items. This is in line with the issuance of Cash payments for assets held for rental and practice varies. However, unlike IFRS, ED on AS 5 (revised), Accounting Policies, to others the US GAAP provides that all income Changes in Accounting Estimates and The ED has explained that although the taxes, with the exception of excess tax Errors, and ED on AS 1, Presentation of cash proceeds from one sale of items like benefits recognised in paid-in capital Financial Statements, which prohibit property, plant and equipment and cash related to share-based payments, should presentation of extraordinary items of payment for acquisition of items of plant be classified as operating activities. Cash income or expense in the statement of are classified as investing activities, all cash flows related to the excess tax benefits comprehensive income. Under the US payments to manufacture or acquire assets recognised in the paid-in capital for share- GAAP though, unlike IFRS, the are held for rental to others and based payments are classified as financing presentation of certain items as subsequently held for sale in the ordinary activities, which may differ from practice "extraordinary items" is required. An course of business are cash flows from under IFRS. extraordinary item is one that is both operating activities. Similarly, the cash unusual in nature and infrequent in

Extraordinary itemsreceipts from rents and subsequent sales occurrence.Further, the existing AS 3 deals with the of such assets are also cash flows from

presentation of extraordinary items and Discontinued operationsoperating activities. The existing AS 3 does

states that the cash flows associated with As per IFRS 5, Non-current assets held for not deliberate this issue. The US GAAP

extraordinary items should be classified as sale and discontinued operations, a provides, that unlike IAS 7 only cash flows

arising from operating, investing or discontinued operation is limited to those from the sale or disposal of equipment that

financing activities as appropriate and operations that are a separate major line of was rented to others for a short period of

separately disclosed. The existing AS 5, Net business or geographical area, and time prior to the sale or disposal are

Profit or Loss for the Period, Prior Period subsidiaries acquired exclusively with a classified as operating activities, as are the

Items and Changes in Accounting Policies, view to resale. The results of discontinued cash flows related to the manufacture or

defines extraordinary items as income or operations are presented separately in the acquisition of such assets.

expenses that arise from events or statement of comprehensive income, and Income taxes transactions that are clearly distinct from cash flow information is disclosed. The Under IFRS, income taxes are classified as the ordinary activities of the enterprise and, comparative statement of comprehensive operating activities, unless it is practicable therefore, are not expected to recur income and cash flow information is re-to identify with them, and therefore, frequently or regularly. The ED on AS 3 presented for discontinued operations.classify them as, financing or investing (revised), however, prohibits presentation activities. IFRS does not contain guidance

In India, the listed companies are required by the Securities and Exchange Board of India (SEBI) guidelines to present

the statement of cash flows only under an indirect method. As required by the Insurance Regulatory and Development

Authority (IRDA) guidelines, insurance companies are required to use the direct method. Thus, to this extent there is a

requirement to align the various statutes governing a company.

OUR COMMENTS

21 22

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Cash flows from operating

activities

financing. Typical examples of cash flows from operating activities may be presented

from the operating activities include: cash either by the direct or by the indirect

receipts from sale of goods or rendering of method, although the entities are

services, cash payments to suppliers of encouraged to follow a direct method.Cash flows from the operating activities are

material and services, cash receipts from primarily derived from the principal revenue Further, as per IAS 7 when using the

commission, etc. generating activities of the company. It also indirect method, the reconciliation begins

includes any activities which are not Like the existing AS 3, and the ED gives a with profit or loss, although practice varies

investing or financing. These signify the choice to the entities to report cash flows as to whether this is net profit or loss or,

extent to which the operations of the from operating activities using either the for example, profit or loss (i.e., before tax).

company have generated sufficient cash direct method or the indirect method. However, under the US GAAP, unlike IFRSs,

flows to repay loans, maintain the However, the ED specifically encourages when using the indirect method. It is

operating capability of the company, pay entities to use the direct method. This is in required that the reconciliation begin with

dividends and make new investments line with principles stated in IAS 7. Similarly, net income (net profit or loss).

without recourse to external sources of as per the US GAAP, like IFRSs, cash flows

Under IFRS, net cash flow information interest paid (net of capitalised interest)

attributable to operating, investing and from undistributed earnings, must be Interest and dividend received

financing activities of discontinued classified as operating activities.In this regard, there arises a question that operations also is required to be disclosed, whether interest and dividend received

Capitalised interesteither on the face of the statement of cash should be classified as operating or Another significant difference, in this regard flows or in the notes to the financial investing activities. The ED on AS 3 is the treatment of capitalised interest. statements. Whatever method of (revised) states that a financial institution IFRS do not contain specific guidance on presentation is chosen, the total cash flows should classify these as operating cash the classification of capitalised interest. In from each of operating, investing and flows. But for a non-financial company, our view, to the extent that borrowing financing activities, including both interest and dividends received should be costs are capitalised in respect of qualifying continuing and discontinued operations, classified as cash flows from investing assets, the costs of acquiring those assets must be disclosed on the face of the activities. IAS 7, however, does not make should be split in the statement of cash statement of cash flows. any such distinction and the entities can flows. Depending on the entity's

make an accounting policy choice of Unlike IFRSs, cash flow information for accounting policy on presenting the classifying interest and the dividend discontinued operations is not required to interest paid on the statement of cash received as cash flows from operating or be disclosed. Unlike IFRSs, when cash flow flows, the capitalised interest should be investing activities. US GAAP, however, information is reported for discontinued classified as operating or financing specifically states that interest and the operations, for the SEC registrants there activities. However, unlike IFRS, the US dividend received must be classified as are three alternatives: GAAP provides that the capitalised interest operating activities. must be classified as investing activities. • combine cash flows from discontinued

operations with cash flows from Bank overdrafts

continuing operations within each of IAS 7 and the ED has specifically

the operating, investing and financing mentioned, that bank overdrafts which are

categories;repayable on demand and which form an

• separately identify cash flows from integral part of an company’s cash The ED defines financing activities as, discontinued operations as a line item management, are included as part of cash activities that result in changes in the size within each category; or and cash equivalents. The existing AS 3 and composition of the contributed equity

was silent on this issue. Thus, till now by • present cash flows from discontinued and borrowings of the company. Cash

implication, bank overdrafts are in most operations separately with disclosure of flows from the financing activities typically

cases a part of the cash flows attributable operating, investing and financing include any additional funds raised by the

to financing activities since in India bank activities.company, say through issue of shares or

overdrafts are similar to cash-The existing Indian Accounting Standard borrowing from banks. It also includes cash

credits/advances against inventories/books 24, Discontinuing Operations, there does outflow in the form of repayment of debt,

debts. Unlike IAS 7 bank overdrafts under not deal with the concept of discontinued cash payments to owners to acquire or

the US GAAP are always included in operations. Rather, it defines discontinuing redeem the company’s shares, etc.

financing activities.operation as a major line of business or

geographical area of operations and can be

distinguished operationally and for financial

reporting purposes. However, the Exposure Interest and dividend paidDraft on AS 24 (revised), is in line with IFRS Similar to interest and dividend received as 5. mentioned above, IAS 7 allows an entity to

classify interest and dividend paid as

operating or financing activities by any

company, whether financial institution or

not. However, ED on AS 3 (revised)

mentions that a financial institution should

classify these as operating cash flows. But Investing activities relate to the acquisition for a non-financial company, interest and and disposal of long-term assets and other dividends paid should be classified as cash investments not included in cash flows from financing activities. The ED equivalents. Analysis of cash flows from explains that this is so because the interest investing activities is essential for and dividend paid are the costs of obtaining understanding the use of cash for capital financial resources. Similar to the ED, expenditure. This disclosure helps ensure under the US GAAP, the dividends paid proper maintenance of and additions to, a must be classified as financing activities. company’s physical assets to support its However, the US GAAP provides that the efficient operation and competitiveness.

Cash flows from financing

activities

Cash flows from investing

activities

Specific classification issues

Specific classification issues

Specific classification issues on the classification of tax benefits of cash flows associated with extraordinary

associated with share-based payments, items. This is in line with the issuance of Cash payments for assets held for rental and practice varies. However, unlike IFRS, ED on AS 5 (revised), Accounting Policies, to others the US GAAP provides that all income Changes in Accounting Estimates and The ED has explained that although the taxes, with the exception of excess tax Errors, and ED on AS 1, Presentation of cash proceeds from one sale of items like benefits recognised in paid-in capital Financial Statements, which prohibit property, plant and equipment and cash related to share-based payments, should presentation of extraordinary items of payment for acquisition of items of plant be classified as operating activities. Cash income or expense in the statement of are classified as investing activities, all cash flows related to the excess tax benefits comprehensive income. Under the US payments to manufacture or acquire assets recognised in the paid-in capital for share- GAAP though, unlike IFRS, the are held for rental to others and based payments are classified as financing presentation of certain items as subsequently held for sale in the ordinary activities, which may differ from practice "extraordinary items" is required. An course of business are cash flows from under IFRS. extraordinary item is one that is both operating activities. Similarly, the cash unusual in nature and infrequent in

Extraordinary itemsreceipts from rents and subsequent sales occurrence.Further, the existing AS 3 deals with the of such assets are also cash flows from

presentation of extraordinary items and Discontinued operationsoperating activities. The existing AS 3 does

states that the cash flows associated with As per IFRS 5, Non-current assets held for not deliberate this issue. The US GAAP

extraordinary items should be classified as sale and discontinued operations, a provides, that unlike IAS 7 only cash flows

arising from operating, investing or discontinued operation is limited to those from the sale or disposal of equipment that

financing activities as appropriate and operations that are a separate major line of was rented to others for a short period of

separately disclosed. The existing AS 5, Net business or geographical area, and time prior to the sale or disposal are

Profit or Loss for the Period, Prior Period subsidiaries acquired exclusively with a classified as operating activities, as are the

Items and Changes in Accounting Policies, view to resale. The results of discontinued cash flows related to the manufacture or

defines extraordinary items as income or operations are presented separately in the acquisition of such assets.

expenses that arise from events or statement of comprehensive income, and Income taxes transactions that are clearly distinct from cash flow information is disclosed. The Under IFRS, income taxes are classified as the ordinary activities of the enterprise and, comparative statement of comprehensive operating activities, unless it is practicable therefore, are not expected to recur income and cash flow information is re-to identify with them, and therefore, frequently or regularly. The ED on AS 3 presented for discontinued operations.classify them as, financing or investing (revised), however, prohibits presentation activities. IFRS does not contain guidance

In India, the listed companies are required by the Securities and Exchange Board of India (SEBI) guidelines to present

the statement of cash flows only under an indirect method. As required by the Insurance Regulatory and Development

Authority (IRDA) guidelines, insurance companies are required to use the direct method. Thus, to this extent there is a

requirement to align the various statutes governing a company.

OUR COMMENTS

21 22

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Summary

The ED is a step towards convergence to IFRS and there

are limited changes brought about by the ED to the

current standard.

The ED has also brought certain changes to align the ED

with exposure drafts on other standards. For example, it

has included additional guidance on classification of cash

flows from changes in ownership interest in subsidiaries,

use of exchange rate between functional currency and

foreign currency at the date of cash flow for translation of

cash flows of a foreign subsidiary.

Also, the ED has certain additional disclosure

requirements. In respect of both obtaining and losing

control of subsidiaries or other businesses during the

period, a company shall also disclose, inter-alia, in

aggregate, the amount of cash and cash equivalents in the

subsidiaries or other businesses over which control is

obtained or lost; and the amount of the assets and

liabilities other than cash or cash equivalents in the

subsidiaries or other businesses over which control is

obtained or lost, summarised by each major category.

Apart from the mandatory disclosures, the ED encourages

the disclosure of certain additional information along with

management commentary. The ED has added disclosure

of amount of the cash flow arising from operating,

investing and financing activities of each reportable

segment in this category. Further the aggregate amounts

of cash flows from each of the operating, investing and

financing activities related to interests in joint ventures

reported using proportionate consolidation is encouraged.

Regulatory Updates

Amendment to Equity Listing Agreement of SEBI-

(An amendment to Clause 41)

Synopsis of the RBI Guidelines on the matters to be

disclosed in the Notes to Accounts – for financial

statements prepared by the Bank

Corporate governance and NBFC (Non-Banking

Financial Companies) – road to a greater

transparency

e. NBFCs shall frame their internal guidelines on corporate

governance, enhancing the scope of the guidelines without

sacrificing the spirit underlying the above guidelines and it shall

As per the Amendment to Equity Listing Agreement the Company be published on the company’s web-site, if any, for the

has the following options with respect to submitting of financials to information of various stakeholders.

the stock exchange:The partner/s of the Chartered Accountant firm conducting the

• Submit audited financial results (standalone and consolidated audit of NBFCs with deposits /public deposits of INR 50 crore and

financials) for the entire financial year within 60 days of the end above should be rotated every three years so that the same partner

of the financial year and intimate the stock exchange in writing does not conduct audit of the company continuously for more than

within 45 days of end of the financial year, the exercise of this a period of three years. However, the partner so rotated will be

option or eligible for conducting the audit of the NBFC after an interval of

three years, if the NBFC, so decides. Companies may incorporate • The company can submit unaudited financial results (standalone

appropriate terms in the letter of appointment of the firm of and consolidated financials) for the last quarter and year within

auditors and ensure its compliance.45 days of end of the financial year. Such un-audited financial

results for the last quarter and year is subject to limited review

by the statutory auditors of the company and a copy of the

limited review report should be furnished to the stock exchange

within 45 days from the end of the year. However, the company

is also required to submit audited financial results for the entire

financial year, as soon as they are approved by the Board.

The guidelines under Section 35A of the Banking Regulation Act,

1949 states that 'Summary of Significant Accounting Policies' and

'Notes to Accounts' may be included under Schedule 17 and

Schedule 18, respectively to maintain uniformity. It also requires

disclosures to be furnished in the “Notes to Accounts” which are

summarised below:

CapitalListed NBFCs which are required to adhere to listing agreement

• Capital – provide details on CRAR (%), CRAR – Tier I Capital (%), and rules framed by the SEBI on Corporate Governance are

CRAR – Tier II Capital (%), Percentage of the shareholding of required to comply with the SEBI prescriptions on Corporate

the Government of India in nationalised banks, amount raised by Governance.

issue of IPDI, amount raised by issue of upper tier II In order to adopt best practices and greater transparency in their instruments.operations, the Board of Directors of all Deposit taking NBFCs with

Investmentsdeposit size of INR 20 crore and above and all non-deposit taking

NBFCs with an asset size of INR 100 crore and above (NBFC-ND-• Disclose the value of investments in India and outside India on

SI), on the date of the last audited balance sheet are proposed to gross value of investments, provision for depreciation and net

considervalue of investments. Also provide a movement of provisions

a. Constitution of audit committee; held towards depreciation on investments

• Repo Transactions (in face value terms) - disclose minimum b. Constitution of nomination committee for appointment of

outstanding during the year, maximum outstanding during the directors;

year, daily average outstanding during the year and outstanding c. Constitution of Risk Management Committee;

as on 31 March for securities sold under repo and securities d. Disclosure and transparency – NBFC must brief to its Board of purchased under reverse repo (disclose separately for

Directors at a regular interval about progress made in putting in government securities and corporate debt securities)place a progressive risk management system and risk

• Non-SLR Investment Portfolio – issuer composition of Non-SLR management policy and strategy followed. Disclosure of

Investment with details of amount, extent of private placement, conformity with corporate governance standards viz. in

extent of ‘Below Investment Grade’ Securities, extent of composition of various committees, their role and functions,

‘Unrated Securities’, Extent of ‘Unlisted Securities’. Discloser for periodicity of the meetings and compliance with coverage and

Non performing Non-SLR investments.review functions, etc.

(Source: RBI Master Circular - RBI / 2010-11/27)

(Source: Circular dated 5 April 2010 issued by Securities and Exchange Board

of India (SEBI))

23 24

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Summary

The ED is a step towards convergence to IFRS and there

are limited changes brought about by the ED to the

current standard.

The ED has also brought certain changes to align the ED

with exposure drafts on other standards. For example, it

has included additional guidance on classification of cash

flows from changes in ownership interest in subsidiaries,

use of exchange rate between functional currency and

foreign currency at the date of cash flow for translation of

cash flows of a foreign subsidiary.

Also, the ED has certain additional disclosure

requirements. In respect of both obtaining and losing

control of subsidiaries or other businesses during the

period, a company shall also disclose, inter-alia, in

aggregate, the amount of cash and cash equivalents in the

subsidiaries or other businesses over which control is

obtained or lost; and the amount of the assets and

liabilities other than cash or cash equivalents in the

subsidiaries or other businesses over which control is

obtained or lost, summarised by each major category.

Apart from the mandatory disclosures, the ED encourages

the disclosure of certain additional information along with

management commentary. The ED has added disclosure

of amount of the cash flow arising from operating,

investing and financing activities of each reportable

segment in this category. Further the aggregate amounts

of cash flows from each of the operating, investing and

financing activities related to interests in joint ventures

reported using proportionate consolidation is encouraged.

Regulatory Updates

Amendment to Equity Listing Agreement of SEBI-

(An amendment to Clause 41)

Synopsis of the RBI Guidelines on the matters to be

disclosed in the Notes to Accounts – for financial

statements prepared by the Bank

Corporate governance and NBFC (Non-Banking

Financial Companies) – road to a greater

transparency

e. NBFCs shall frame their internal guidelines on corporate

governance, enhancing the scope of the guidelines without

sacrificing the spirit underlying the above guidelines and it shall

As per the Amendment to Equity Listing Agreement the Company be published on the company’s web-site, if any, for the

has the following options with respect to submitting of financials to information of various stakeholders.

the stock exchange:The partner/s of the Chartered Accountant firm conducting the

• Submit audited financial results (standalone and consolidated audit of NBFCs with deposits /public deposits of INR 50 crore and

financials) for the entire financial year within 60 days of the end above should be rotated every three years so that the same partner

of the financial year and intimate the stock exchange in writing does not conduct audit of the company continuously for more than

within 45 days of end of the financial year, the exercise of this a period of three years. However, the partner so rotated will be

option or eligible for conducting the audit of the NBFC after an interval of

three years, if the NBFC, so decides. Companies may incorporate • The company can submit unaudited financial results (standalone

appropriate terms in the letter of appointment of the firm of and consolidated financials) for the last quarter and year within

auditors and ensure its compliance.45 days of end of the financial year. Such un-audited financial

results for the last quarter and year is subject to limited review

by the statutory auditors of the company and a copy of the

limited review report should be furnished to the stock exchange

within 45 days from the end of the year. However, the company

is also required to submit audited financial results for the entire

financial year, as soon as they are approved by the Board.

The guidelines under Section 35A of the Banking Regulation Act,

1949 states that 'Summary of Significant Accounting Policies' and

'Notes to Accounts' may be included under Schedule 17 and

Schedule 18, respectively to maintain uniformity. It also requires

disclosures to be furnished in the “Notes to Accounts” which are

summarised below:

CapitalListed NBFCs which are required to adhere to listing agreement

• Capital – provide details on CRAR (%), CRAR – Tier I Capital (%), and rules framed by the SEBI on Corporate Governance are

CRAR – Tier II Capital (%), Percentage of the shareholding of required to comply with the SEBI prescriptions on Corporate

the Government of India in nationalised banks, amount raised by Governance.

issue of IPDI, amount raised by issue of upper tier II In order to adopt best practices and greater transparency in their instruments.operations, the Board of Directors of all Deposit taking NBFCs with

Investmentsdeposit size of INR 20 crore and above and all non-deposit taking

NBFCs with an asset size of INR 100 crore and above (NBFC-ND-• Disclose the value of investments in India and outside India on

SI), on the date of the last audited balance sheet are proposed to gross value of investments, provision for depreciation and net

considervalue of investments. Also provide a movement of provisions

a. Constitution of audit committee; held towards depreciation on investments

• Repo Transactions (in face value terms) - disclose minimum b. Constitution of nomination committee for appointment of

outstanding during the year, maximum outstanding during the directors;

year, daily average outstanding during the year and outstanding c. Constitution of Risk Management Committee;

as on 31 March for securities sold under repo and securities d. Disclosure and transparency – NBFC must brief to its Board of purchased under reverse repo (disclose separately for

Directors at a regular interval about progress made in putting in government securities and corporate debt securities)place a progressive risk management system and risk

• Non-SLR Investment Portfolio – issuer composition of Non-SLR management policy and strategy followed. Disclosure of

Investment with details of amount, extent of private placement, conformity with corporate governance standards viz. in

extent of ‘Below Investment Grade’ Securities, extent of composition of various committees, their role and functions,

‘Unrated Securities’, Extent of ‘Unlisted Securities’. Discloser for periodicity of the meetings and compliance with coverage and

Non performing Non-SLR investments.review functions, etc.

(Source: RBI Master Circular - RBI / 2010-11/27)

(Source: Circular dated 5 April 2010 issued by Securities and Exchange Board

of India (SEBI))

23 24

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Derivatives disclosures, wherever warranted, may be made in the ‘Notes to

Accounts’ to the balance sheet of banks.• Forward Rate Agreement/Interest Rate Swap – disclose the

notional principal of swap agreements, losses which would be Accounting Standard 9 – An enterprise should disclose the

incurred if the counterparties failed to fulfill their obligations circumstances in which revenue recognition have been postponed

under the agreement, collateral required by the bank upon pending the resolution of significant uncertainties.

entering into swaps, concentration of credit risk arising from the Accounting Standard 17 – While complying with the above swaps, the fair value of the swap book. Nature and terms of the Accounting Standard, banks are required to adopt the followingswaps including information on credit and market risk and the

accounting policies adopted for recording the swaps should also • The business segment should ordinarily be considered as the

be disclosed. primary reporting format and geographical segment would be

the secondary reporting format• Exchange Traded Interest Rate Derivatives – give instrument

wise details on notional principal amount undertaken during the • The business segments will be Treasury, Corporate/Wholesale

year, notional principal amount outstanding as on 31 March, Banking, Retail Banking and Other banking operations

notional principal amount outstanding and not ‘highly effective’, • Domestic and International segments will be the geographic mark-to-market value of outstanding and not ‘highly effective’. segments for disclosure.

• Disclosures on risk exposure in derivatives – provide qualitative Accounting Standard 18 – The illustrative disclosure format and quantitative details.recommended by the ICAI as a part of General Clarification (GC)

Asset quality 2/2002 has been suitably modified to suit banks. For illustrative

format refer to the master circular.• Non-Performing Assets – Disclose the opening balance, the

addition made during the year, reduction during the year and Accounting Standard 21 – A parent company, presenting the

closing balance for the movement of NPAs (Gross), movement Consolidated Financial Statements (CFS), should consolidate the

of net NPAs and movement of provisions for NPAs. Also financial statements of all subsidiaries - domestic as well as foreign,

disclose the ratio of net NPAs to Net Advances. except those specifically permitted to be excluded under the AS-21.

The reasons for not consolidating a subsidiary should be disclosed • Particulars of Accounts Restructured – Disclose the no. of in the CFS. The responsibility of determining whether a particular borrowers, amount outstanding and sacrifice (diminution in the entity should be included or not for consolidation would be that of fair value) on standard advance restructured, sub-standard the Management of the parent entity. In case, its Statutory Auditors advances restructured and doubtful advance restructured.are of the opinion that an entity, which ought to have been

• Details of financial assets sold to Securitisation/Reconstruction consolidated, has been omitted, they should incorporate their

Company for Asset Reconstructioncomments in this regard in the Auditors Report.

• Details of non-performing financial assets purchased/sold from Accounting Standard 22 – Deferred tax assets and liabilities may other banksbe created by banks based on the criteria met by banks mentioned

• Provision on Standard Assets - Provisions towards Standard in Master Circular.

Assets need not be netted from gross advances but shown

separately as 'Provisions against Standard Assets', under 'Other Accounting Standard 23 – A bank may acquire more than 20 Liabilities and Provisions - Others' in Schedule No. 5 of the percent of voting power in the borrower entity in satisfaction of its balance sheet. advances and it may be able to demonstrate that it does not have

the power to exercise significant influence since the rights Business ratios – On Interest Income as a percentage to Working

exercised by it are protective in nature and not participative. In such Fund, Non-interest income as a percentage to Working Funds,

a circumstance, such investment may not be treated as investment Operating Profit as a percentage to Working Funds, Return on

in associate under this Accounting Standard. Hence, the test should Assets, Business (Deposits plus advances) per employee, Profit per

not be merely the proportion of investment, but the intention to employee.

acquire the power to exercise significant influence.

Asset liability management – Maturity pattern of assets and Accounting Standard 24 – Merger/closure of branches of banks

liabilities – deposits, advances, investments, borrowings, foreign by transferring the assets/liabilities to the other branches of the

currency assets and foreign currency liabilities.same bank may not be deemed as a discontinuing operation and

hence, this Accounting Standard will not be applicable to Exposures – Provide disclosure on Exposure to Real Estate Sector, merger/closure of branches of banks by transferring the Exposure to Capital Market, Risk Category wise Country Exposure, assets/liabilities to the other branches of the same bank. Details of Single Borrower Limit (SGL)/Group Borrower Limit (GBL) Disclosures would be required under the Standard only when

exceeded by the bank, Unsecured Advances.discontinuing of the operation has resulted in shedding of liability

and realisation of the assets by the bank or the decision to Other disclosures – Amount of Provisions made for Income-tax

discontinue an operation which will have the above effect that has during the year and Disclosure of Penalties imposed by the RBI.

been finalised by the bank and the discontinued operation is The RBI requirements vis-à-vis disclosure Requirements as per substantial in its entirety.Accounting Standards issued by the ICAI

Accounting Standard 25 - The half yearly review prescribed by the Accounting Standard 5 – As per Banking Regulation Act 1949 RBI for public sector banks, in consultation with SEBI, is extended banks follow a format for the profit and loss account, which does to all banks. Banks may adopt the format prescribed by the RBI for not specifically provide for disclosure of the impact of prior period the purpose of half yearly review.

items on the current year’s profit and loss. However such (Source :RBI Master Circular - RBI / 2010-11/41)

EAC opinions project/asset could not be brought to its working condition, such as,

site preparation costs, installation costs, salaries of engineers

Virtual certainty in respect of deferred tax assets (ICAI Journal engaged in construction activities, etc. The Committee is of the May 2010) view that it should be seen that whether the expenses incurred on

Summarised below is the opinion given by the Expert Advisory the activities of the various departments are directly attributable to

Committee of the Institute in response to a query sent by a the construction. Accordingly, if the expenses incurred at the

member in relation to determining virtual certainty in respect of various departments are directly attributable to construction, these

deferred tax assets in situations where unabsorbed depreciation can be capitalised with the cost of the concerned fixed

and losses exist: asset(s)/project(s). As regards basis of allocation of the expenses of

these departments that can be allocated and capitalised to various The Committee is of the view that the orders secured by the

projects or assets under construction, the Committee is of the view company, may be considered while creating deferred tax asset

that the same should be allocated selecting an appropriate basis provided these are binding on the other party and it can be

that reflects the extent of usage of service rendered by the demonstrated that they will result in future taxable income.

department to the construction of the project.However, mere projections made by the company indicating the

earning of profits from future orders, or financial restructuring

proposal under consideration of the Government of India or the fact

that the books of account of the company are prepared on ‘going

concern’ basis, may not be considered as convincing evidence of

virtual certainty as contemplated in the ‘Explanation’ to paragraph

17 of AS 22 reproduced above Further, the mere fact that the items

covered under section 43B of the Income-tax Act, 1961, the

provision for liquidated damages, doubtful advances, guarantee

repairs and other contingencies, and unabsorbed depreciation can

be carried forward for an unlimited number of years, can also not

be a ground for recognising a deferred tax asset, since paragraph 17

of AS 22 read with its ‘Explanation’, requires virtual certainty

supported by convincing evidence at the date of the balance sheet.

The Committee also pointed out that a deferred tax asset can be

created to the extent that the future taxable income will be

available from future reversal of any deferred tax liability recognised

at the balance sheet date. To that extent, it would not be necessary

to consider the level of virtual certainty supported by convincing

evidence.

Capitalisation of expenditures in respect of projects under

construction (ICAI Journal June 2010)

With the withdrawal of “Guidance Note on Treatment of

Expenditure During Construction Period” by the ICAI, the

accounting is to be done as per AS 10, which stipulates that

administration and other general overhead expenses are usually

excluded from the cost of fixed assets since they do not relate to a

specific fixed asset. In some circumstances, such expenses as are

specifically attributable to construction of a project or to the

acquisition of a fixed asset or bringing it to its working condition,

may be included as part of the cost of the construction project or as

a part of the cost of the fixed asset. However, there was confusion

whether allocation of certain expenses which are incurred in

common or at corporate level is allowed under AS 10.

The Committee is of the view that the basic principle to be applied

while capitalising an item of cost to a fixed asset/project under

construction/expansion is that it should be directly attributable to

the construction of the project/fixed asset for bringing it to its

working condition for its intended use. The costs that are directly

attributable to the construction/acquisition of a fixed asset/project

for bringing it to its working condition are those costs that would

have been avoided if the construction/acquisition had not been

made. These are the expenditures without the incurrence of which,

the construction of project/asset could not have taken place and the

25 26

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

Derivatives disclosures, wherever warranted, may be made in the ‘Notes to

Accounts’ to the balance sheet of banks.• Forward Rate Agreement/Interest Rate Swap – disclose the

notional principal of swap agreements, losses which would be Accounting Standard 9 – An enterprise should disclose the

incurred if the counterparties failed to fulfill their obligations circumstances in which revenue recognition have been postponed

under the agreement, collateral required by the bank upon pending the resolution of significant uncertainties.

entering into swaps, concentration of credit risk arising from the Accounting Standard 17 – While complying with the above swaps, the fair value of the swap book. Nature and terms of the Accounting Standard, banks are required to adopt the followingswaps including information on credit and market risk and the

accounting policies adopted for recording the swaps should also • The business segment should ordinarily be considered as the

be disclosed. primary reporting format and geographical segment would be

the secondary reporting format• Exchange Traded Interest Rate Derivatives – give instrument

wise details on notional principal amount undertaken during the • The business segments will be Treasury, Corporate/Wholesale

year, notional principal amount outstanding as on 31 March, Banking, Retail Banking and Other banking operations

notional principal amount outstanding and not ‘highly effective’, • Domestic and International segments will be the geographic mark-to-market value of outstanding and not ‘highly effective’. segments for disclosure.

• Disclosures on risk exposure in derivatives – provide qualitative Accounting Standard 18 – The illustrative disclosure format and quantitative details.recommended by the ICAI as a part of General Clarification (GC)

Asset quality 2/2002 has been suitably modified to suit banks. For illustrative

format refer to the master circular.• Non-Performing Assets – Disclose the opening balance, the

addition made during the year, reduction during the year and Accounting Standard 21 – A parent company, presenting the

closing balance for the movement of NPAs (Gross), movement Consolidated Financial Statements (CFS), should consolidate the

of net NPAs and movement of provisions for NPAs. Also financial statements of all subsidiaries - domestic as well as foreign,

disclose the ratio of net NPAs to Net Advances. except those specifically permitted to be excluded under the AS-21.

The reasons for not consolidating a subsidiary should be disclosed • Particulars of Accounts Restructured – Disclose the no. of in the CFS. The responsibility of determining whether a particular borrowers, amount outstanding and sacrifice (diminution in the entity should be included or not for consolidation would be that of fair value) on standard advance restructured, sub-standard the Management of the parent entity. In case, its Statutory Auditors advances restructured and doubtful advance restructured.are of the opinion that an entity, which ought to have been

• Details of financial assets sold to Securitisation/Reconstruction consolidated, has been omitted, they should incorporate their

Company for Asset Reconstructioncomments in this regard in the Auditors Report.

• Details of non-performing financial assets purchased/sold from Accounting Standard 22 – Deferred tax assets and liabilities may other banksbe created by banks based on the criteria met by banks mentioned

• Provision on Standard Assets - Provisions towards Standard in Master Circular.

Assets need not be netted from gross advances but shown

separately as 'Provisions against Standard Assets', under 'Other Accounting Standard 23 – A bank may acquire more than 20 Liabilities and Provisions - Others' in Schedule No. 5 of the percent of voting power in the borrower entity in satisfaction of its balance sheet. advances and it may be able to demonstrate that it does not have

the power to exercise significant influence since the rights Business ratios – On Interest Income as a percentage to Working

exercised by it are protective in nature and not participative. In such Fund, Non-interest income as a percentage to Working Funds,

a circumstance, such investment may not be treated as investment Operating Profit as a percentage to Working Funds, Return on

in associate under this Accounting Standard. Hence, the test should Assets, Business (Deposits plus advances) per employee, Profit per

not be merely the proportion of investment, but the intention to employee.

acquire the power to exercise significant influence.

Asset liability management – Maturity pattern of assets and Accounting Standard 24 – Merger/closure of branches of banks

liabilities – deposits, advances, investments, borrowings, foreign by transferring the assets/liabilities to the other branches of the

currency assets and foreign currency liabilities.same bank may not be deemed as a discontinuing operation and

hence, this Accounting Standard will not be applicable to Exposures – Provide disclosure on Exposure to Real Estate Sector, merger/closure of branches of banks by transferring the Exposure to Capital Market, Risk Category wise Country Exposure, assets/liabilities to the other branches of the same bank. Details of Single Borrower Limit (SGL)/Group Borrower Limit (GBL) Disclosures would be required under the Standard only when

exceeded by the bank, Unsecured Advances.discontinuing of the operation has resulted in shedding of liability

and realisation of the assets by the bank or the decision to Other disclosures – Amount of Provisions made for Income-tax

discontinue an operation which will have the above effect that has during the year and Disclosure of Penalties imposed by the RBI.

been finalised by the bank and the discontinued operation is The RBI requirements vis-à-vis disclosure Requirements as per substantial in its entirety.Accounting Standards issued by the ICAI

Accounting Standard 25 - The half yearly review prescribed by the Accounting Standard 5 – As per Banking Regulation Act 1949 RBI for public sector banks, in consultation with SEBI, is extended banks follow a format for the profit and loss account, which does to all banks. Banks may adopt the format prescribed by the RBI for not specifically provide for disclosure of the impact of prior period the purpose of half yearly review.

items on the current year’s profit and loss. However such (Source :RBI Master Circular - RBI / 2010-11/41)

EAC opinions project/asset could not be brought to its working condition, such as,

site preparation costs, installation costs, salaries of engineers

Virtual certainty in respect of deferred tax assets (ICAI Journal engaged in construction activities, etc. The Committee is of the May 2010) view that it should be seen that whether the expenses incurred on

Summarised below is the opinion given by the Expert Advisory the activities of the various departments are directly attributable to

Committee of the Institute in response to a query sent by a the construction. Accordingly, if the expenses incurred at the

member in relation to determining virtual certainty in respect of various departments are directly attributable to construction, these

deferred tax assets in situations where unabsorbed depreciation can be capitalised with the cost of the concerned fixed

and losses exist: asset(s)/project(s). As regards basis of allocation of the expenses of

these departments that can be allocated and capitalised to various The Committee is of the view that the orders secured by the

projects or assets under construction, the Committee is of the view company, may be considered while creating deferred tax asset

that the same should be allocated selecting an appropriate basis provided these are binding on the other party and it can be

that reflects the extent of usage of service rendered by the demonstrated that they will result in future taxable income.

department to the construction of the project.However, mere projections made by the company indicating the

earning of profits from future orders, or financial restructuring

proposal under consideration of the Government of India or the fact

that the books of account of the company are prepared on ‘going

concern’ basis, may not be considered as convincing evidence of

virtual certainty as contemplated in the ‘Explanation’ to paragraph

17 of AS 22 reproduced above Further, the mere fact that the items

covered under section 43B of the Income-tax Act, 1961, the

provision for liquidated damages, doubtful advances, guarantee

repairs and other contingencies, and unabsorbed depreciation can

be carried forward for an unlimited number of years, can also not

be a ground for recognising a deferred tax asset, since paragraph 17

of AS 22 read with its ‘Explanation’, requires virtual certainty

supported by convincing evidence at the date of the balance sheet.

The Committee also pointed out that a deferred tax asset can be

created to the extent that the future taxable income will be

available from future reversal of any deferred tax liability recognised

at the balance sheet date. To that extent, it would not be necessary

to consider the level of virtual certainty supported by convincing

evidence.

Capitalisation of expenditures in respect of projects under

construction (ICAI Journal June 2010)

With the withdrawal of “Guidance Note on Treatment of

Expenditure During Construction Period” by the ICAI, the

accounting is to be done as per AS 10, which stipulates that

administration and other general overhead expenses are usually

excluded from the cost of fixed assets since they do not relate to a

specific fixed asset. In some circumstances, such expenses as are

specifically attributable to construction of a project or to the

acquisition of a fixed asset or bringing it to its working condition,

may be included as part of the cost of the construction project or as

a part of the cost of the fixed asset. However, there was confusion

whether allocation of certain expenses which are incurred in

common or at corporate level is allowed under AS 10.

The Committee is of the view that the basic principle to be applied

while capitalising an item of cost to a fixed asset/project under

construction/expansion is that it should be directly attributable to

the construction of the project/fixed asset for bringing it to its

working condition for its intended use. The costs that are directly

attributable to the construction/acquisition of a fixed asset/project

for bringing it to its working condition are those costs that would

have been avoided if the construction/acquisition had not been

made. These are the expenditures without the incurrence of which,

the construction of project/asset could not have taken place and the

25 26

© 2010 KPMG, an Indian 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. © 2010 KPMG, an Indian 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.

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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 endeavor 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 appropriate professional advice after a thorough examination of the particular

situation.

© 2010 KPMG, an Indian 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.

KPMG and the KPMG logo are registered trademarks

of KPMG International Cooperative (“KPMG

International”), a Swiss entity.

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