CONCEPTUAL FRAMEWORK FOR FINANCIAL

REPORTING UNDER INDIAN ACCOUNTING

As at 31 March 2012, Natasha Ltd. carried trade receivables of Rs 280 crores in its balance sheet.
At that date, Natasha Ltd. entered into a factoring agreement with Samantha Ltd., a financial
institution, according to which it transferred the trade receivables in exchange for an immediate
cash payment of Rs 250 crores. As per the factoring agreement, any shortfall between the
amount collected and Rs 250 crores will be reimbursed by Natasha Ltd. to Samantha Ltd. Once
the trade receivables have been collected, any amounts above Rs 250 crores, less interest on this
amount, will be repaid to Natasha Ltd. The directors of Natasha Ltd. are of the opinion that the
trade receivables should be derecognized.
You are required to explain the appropriate accounting treatment of this transaction in the
financial statements for the year ending 31 March 2012, and also evaluate this transaction in the
context of the Conceptual Framework.

Solution

Accounting Treatment :
Trade Receivables fall within the ambit of financial assets under Ind AS 109, Financial
Instruments. Thus, the issue in question is whether the factoring arrangement entered into with
Samantha Ltd. requires Natasha Ltd. to derecognize the trade receivables from its financial
statements.
As per Ind AS 109, Financial Instruments, an entity shall derecognise a financial asset when, and
only when:
(a) the contractual rights to the cash flows from the financial asset expire, or
(b) it transfers the financial asset or substantially all the risks and rewards of ownership of
the financial asset to another party.
In the given case, since the trade receivables are appearing in the Balance Sheet of Natasha Ltd.
as at 31 March 2012 and are expected to be collected, the contractual rights to the cash flows
have not expired.
As far as the transfer of the risks and rewards of ownership is concerned, the factoring
arrangement needs to be viewed in its substance, rather than its legal form. Natasha Ltd. has
transferred the receivables to Samantha Ltd. for cash of Rs 250 crores, and yet, it remains liable
for making good any shortfall between Rs 250 crores and the amount collected by Samantha Ltd.
Thus, in substance, Natasha Ltd. is effectively liable for the entire Rs 250 crores, although the
shortfall would not be such an amount. Accordingly, Natasha Ltd. retains the credit risk despite
the factoring arrangement entered.
It is also explicitly stated in the agreement that Samantha Ltd. would be liable to pay to Natasha
Ltd. any amount collected more than Rs 250 crores, after retaining an amount towards interest.
Thus, Natasha Ltd. retains the potential rewards of full settlement.
A perusal of the above clearly shows that substantially all the risks and rewards continue to
remain with Natasha Ltd., and hence, the trade receivables should continue to appear in the
Balance Sheet of Natasha Ltd. The immediate payment (i.e. consideration as per the factoring
agreement) of Rs 250 crores by Samantha Ltd. to Natasha Ltd. should be regarded as a financial
liability, and be shown as such by Natasha Ltd. in its Balance Sheet.

Question 2

Explain the criteria in the Conceptual Framework for Financial Reporting for the recognition of
an asset and discuss whether there are inconsistencies with the criteria in Ind AS 38, Intangible
Assets.

Solution

The Conceptual Framework defines an asset as a present economic resource controlled by the
entity as a result of past events. An economic resource is a right that has the potential to produce
economic benefits. Assets should be recognized if they meet the Conceptual Framework
definition of an asset and such recognition provides users of financial statements with
information that is useful (i.e. it is relevant as well as results in faithful representation).
However, the criteria of a cost-benefit analysis always exists i.e. the benefits of the information
must be sufficient to justify the costs of providing such information. The recognition criteria
outlined in the Conceptual Framework allows for flexibility in the application in amending or
developing the standards.
Ind AS 38, Intangible Assets defines an intangible asset as an identifiable non-monetary asset
without physical substance. Further, Ind AS 38 defines an asset as a resource:
(a) controlled by an entity as a result of past events; and
(b) from which future economic benefits are expected to flow to the entity.

Furthermore, Ind AS 38 states that an intangible asset shall be recognised if, and only if:
(a) it is probable that the expected future economic benefits that are attributable to the asset
will flow to the entity; and
(b) the cost of the asset can be measured reliably.
This requirement is applicable both in case of an externally acquired intangible asset or an
internally generated intangible asset. The probability of expected future economic benefits must
be based on reasonable and supportable assumptions that represent management’s best
estimate of the set of economic conditions that will exist over the useful life of the asset. Further,
as per Ind AS 38, the probability recognition criterion is always considered to be satisfied for
intangible assets acquired in business combinations. If the recognition criteria are not satisfied,
Ind AS 38 requires the expenditure to be expensed as and when it is incurred.
It is notable that the Conceptual Framework does not prescribe a ‘probability criterion’. As long
as there is a potential to produce economic benefits, even with a low probability, an item can be
recognized as an asset according to the Conceptual Framework. However, in terms of intangible
assets, it could be argued that recognizing an intangible asset having low probability of
generating economic benefits would not be useful to the users of financial statements given that
the asset has no physical substance.
The recognition criteria and definition of an asset under Ind AS 38 are different as compared to
those outlined in the Conceptual Framework. To put in simple words, the criteria in Ind AS 38
are more specific, but definitely do provide information that is relevant and a faithful
representation. When viewed from the prism of relevance and faithful representation, the
requirements of Ind AS 38 in terms of recognition appear to be consistent with the Conceptual
Framework.

Question 3

The directors of Hind Ltd. are particular about the usefulness of the financial statements. They
have opined that although Ind AS implement a fair value model, Ind AS are failing in reflecting
the usefulness of the financial statements as they do not reflect the financial value of the entity.
Discuss the views of the directors as regards the use of fair value in Ind AS and the fact that the
Ind AS do not reflect the financial value of an entity, making special reference to relevant Ind AS
and the Conceptual Framework.

Solution

Usage of Fair Value in Ind AS :

Treatment under Ind AS :

The statement of the directors regarding Ind AS implementing a fair value model is not entire
accurate. Although Ind AS do use fair value (and present value), it is not a complete fair value
system. Ind AS are often based on the business model of the entity and on the expectations of
realizing the asset- and liability-related cash flows through operations and transfers.
It is notable that what is preferred is a mixed measurement system, with some items being
measured at fair value while others measured at historical cost.

About Fair Value (Ind AS 113)

Ind AS 113 defines fair value as the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at the measurement
date. This price is an exit price.
Ind AS 113 has given consistency to the definition and application of fair value, and this
consistency is applied across other Ind AS, which are generally required to measure fair value
in accordance with Ind AS 113. However, it cannot be implied that Ind AS requires all assets and
liabilities to be measured at fair value. Rather, many entities measure most items at depreciated
historical costs, although the exception being in the case of business combinations, where assets
and liabilities are recorded at fair value on the date of acquisition. In other cases, usage of fair
value is restricted.
Examples of use of fair value in Ind AS:
(a) Ind AS 16 Property, Plant and Equipment permits revaluation through other
comprehensive income, provided it is carried out regularly.
(b) Disclosure of fair value of Investment Property in Ind AS 40, while the companies
account for the same under the cost model.
(c) Ind AS 38 Intangible Assets allows measurement of intangible assets at fair value with
corresponding changes in equity, but only if the assets can be measured reliably by way
of existence of an active market for them.
(d) Ind AS 109 Financial Instruments requires some financial assets and liabilities to be
measured at amortized cost and others at fair value. The measurement basis is largely
determined by the business model for that financial instrument. Where the financial
instruments are carried at fair value, depending on the category and circumstances, the
movement in the fair value (gain or loss) is either recognized in profit or loss or in other
comprehensive income.

Financial value of an entity

Although Ind AS makes use of fair values in the measurement of assets and liabilities, the
financial statements prepared under Ind AS are not intended to reflect the aggregate value of
the entity, as could be the notion among people. The Conceptual Framework specifically states
that general purpose financial statements are not intended to show the value of a reporting
entity. Furthermore, such an attempt would not be fruitful as certain internally generated
intangible assets cannot be recognized under Ind AS. Instead, the objective of general purpose
financial reports is to provide financial information about the reporting entity which would be
useful to existing and potential investors, lenders and other creditors in making decisions about
providing resources to the entity.
It is only in the case of acquisition of an entity by another entity and subsequent consolidation
in group accounts that an entity’s net assets are reported at fair value.

Question 4

Everest Ltd. is a listed company having investments in various subsidiaries. In its annual
financial statements for the year ending 31 March 2012 as well as 31 March 2013, Everest Ltd.
classified Kanchenjunga Ltd. a subsidiary as ‘held-for-sale’ and presented it as a discontinued
operation. On 1 November 2011, the shareholders had authorized the management to sell all of
its holding in Kanchenjunga Ltd. within the year. In the year to 31 March 2012, the management
made a public announcement of its intention to sell the investment but did not actively try to
sell the subsidiary as it was still operational within the Everest group.
Certain organizational changes were made by Everest Ltd. during the year to 31 March 2013,
thereby resulting in additional activities being transferred to Kanchenjunga Ltd. Additionally,
during the year ending 31 March 2013, there had been draft agreements and some
correspondence with investment bankers, which showed in principle only that Kanchenjunga
was still for sale.
Discuss whether the classification of Kanchenjunga Ltd. as held for sale and its presentation as
a discontinued operation is appropriate, by referring to the principles of the relevant Ind AS and
evaluating the treatment in the context of the Conceptual Framework for Financial Reporting.

Solution

Kanchenjunga Ltd. is a disposal group in accordance with Ind AS 105, Non-current Assets Held
for Sale and Discontinued Operations. Disposal group can be defined as a group of assets to be
disposed of, by sale or otherwise, together as a group in a single transaction, and liabilities
directly associated with those assets that will be transferred in the transaction.

Ind AS 105 provides that a disposal group shall be classified as held for sale if its carrying amount
will be recovered principally through a sale transaction rather than through continuing use. Ind
AS 105 is particularly strict as far as the application of held for sale criteria is concerned, and
often the decision to sell an asset or a disposal group is made well before the criteria are met.
Thus, as per Ind AS 105, for the asset (or disposal group) to be classified as held for sale, it must
be available for immediate sale in its present condition subject only to terms that are usual and
customary for sales of such assets (or disposal groups) and its sale must be highly probable.
For the sale to be highly probable:
 The appropriate level of management must be committed to a plan to sell the asset (or
disposal group).
 An active programme to locate a buyer and complete the plan must have been initiated.
 The asset (or disposal group) must be actively marketed for sale at a price that is
reasonable in relation to its current fair value.
 The sale should be expected to qualify for recognition as a completed sale within one
year from the date of classification.
 It is unlikely that significant changes to the plan will be made or that the plan will be
withdrawn.
In the given case, the draft agreements and correspondence with investment bankers are not
specific enough to fit in the points above to prove that the criteria for held for sale was met at
that date. Additional information would be needed to confirm that the subsidiary was available
for immediate sale, and that it was being actively marketed at an appropriate price so as to
satisfy the criteria in the year to 31 March 2012.
Further, the organizational changes made by Everest Ltd. in the year 2012-2013 are a good
indicator that Kanchenjunga Ltd. was not available for immediate sale in its present condition
at the point of classification. The fact that additional activities have been given to Kanchenjunga
Ltd. indicate that the change wasn’t insignificant. The shareholders had authorized for a year
from 1 November 2011. There is no evidence that this authorization extended beyond 1
November 2012.
Conclusion :
Based on the information provided in the given case, it appears that Kanchenjunga Ltd. should
not be classified by Everest Ltd. as a subsidiary held for sale. Instead, the results of the subsidiary
should be reported as a continuing operation in the financial statements for the year ending 31
March 2012 and 31 March 2013.

Evaluation of treatment in context of the Conceptual Framework

The Conceptual Framework states that the users need information to allow them to assess the
amount, timing and uncertainty of the prospects for future net cash inflows. Highlighting the
results of discontinued operations separately equips users with the information that is relevant
to this assessment as the discontinued operation will not contribute to cash flows in the future.

If a company has made a firm decision to sell the subsidiary, it could be argued that the
subsidiary should be classified as discontinued operation, even if the criteria to classify it as ‘held
for sale’ as per Ind AS 105 have not been met, because this information would be more useful to
users. However, Ind AS 105 criteria was developed with high degree of strictness on
classification. Accordingly, this decision could be argued to be in conflict with the Conceptual
Framework.

Question 5

The directors of Jayant Ltd. have received the following email from its majority shareholder:
To : Directors of Jayant Ltd.
Re : Measurement
I recently read an article published in the financial press about the ‘mixed measurement
approach’ that is used by lots of companies. I hope Jayant Ltd. does not follow such an approach
because ‘mixed’ seems to imply ‘inconsistent’. I believe that consistency is of paramount
importance, and hence feel it would be better to measure everything in a uniform manner. It
would be appreciated if you could provide further information at the next annual general
meeting on measurement bases, covering what approach is taken by Jayant Ltd. and why, and
the potential effect such an approach has on the investors trying to analyse the financial
statements.
Prepare notes for the directors of Jayant Ltd. to discuss the issue raised in the shareholders’
email with reference to the Conceptual Framework wherever appropriate.

Solution

‘Mixed measurement’ approach implies that a company selects different measurement bases
(e.g. historical cost or fair value) for its various assets and liabilities, rather than using one single
measurement basis for all items. The measurement basis so selected should reflect the type of
entity and the sector in which it operates and the business model that the entity adopts.
There are criticisms of the mixed measurement approach, particularly under the IFRS regime,
because investors think that if different measurement bases are used for assets and liabilities,
the resulting figures could lack relevance or exhibit little meaning.
It is however important to note that figures of items in the financial statements cannot be
derived by following a one-size-fits-all approach. Such an approach may not provide relevant
information to users. A particular measurement basis may be easier to understand, more
verifiable and less costly to implement. Therefore, to state that ‘mixed measurement’ approach
is ‘inconsistent’ is a poor argument. In reality, a mixed approach may actually provide more
relevant information to the stakeholders.
The Conceptual Framework confirms the allowance of the usage of a mixed measurement
approach in developing standards. The measurement methods included in the standards are
those which the standard-setters believe provide the most relevant information and which most
faithfully represent the underlying transaction or event. Based on the reactions to the
convergence to Ind AS, it feels that most investors feel this approach is consistent with their
analysis of financial statements. Thus, the arguments against a mixed measurement are far
outweighed by the greater relevance achieved by such measurement bases.
Jayant Ltd. prepares its financial statements under Ind AS, and therefore applies the
measurement bases permitted in Ind AS. Ind AS adopt a mixed measurement basis, which
includes current value (fair value, value in use, fulfilment value and current cost) and historical
cost.
Where an Ind AS allows a choice of measurement basis, the directors of Jayant Ltd. must exercise
judgment as to which basis will provide the most useful information for its primary users.
Furthermore, when selecting a measurement basis, measurement uncertainty should also be
considered. The Conceptual Framework states that for some estimates, a high level of
measurement uncertainty may outweigh other factors to such an extent that the resulting
information may be of little relevance.