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KPMG IN INDIA

IFRS Monitor
January 2010

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Editorial

Welcome to the inaugural edition of the IFRS Monitor, a quarterly newsletter brought to you by KPMG in India. The purpose of this newsletter is to keep our clients and other friends updated on regulatory developments relating to IFRS convergence in India; changes in IFRS; and potentially significant implementation issues that can often arise on convergence with IFRS. We will also use this newsletter to share our perspectives on other matters arising due to the planned convergence with IFRS. The current edition of the newsletter discusses the announcement by the

Jamil Khatri
Head of Accounting Advisory Services KPMG in India

Ministry of Corporate Affairs dated 22 January 2010 which confirms the manner in which IFRS convergence will be achieved in India. This landmark announcement is an important trigger in the path of achieving IFRS convergence in India. We believe that the phased approach to IFRS convergence (which is consistent with the current proposal in the United States of America) will greatly smoothen the IFRS convergence journey for medium-sized and smaller listed companies. We expect several implementation issues in relation to this announcement and believe that the regulators will provide further guidance on several of these issues. The newsletter also summarizes the key provisions of some recent updates to IFRS; including IFRS 9 on Financial Instruments, which is likely to significantly change current accounting practices relating to accounting for financial instruments. We also discuss the concept of embedded leases a concept that does not exist under current Indian accounting standards. KPMG in India and NIIT have recently launched an IFRS Certification program. This program has received an overwhelming response. Details of this program are also provided within. We hope that you find the contents of this newsletter useful as you prepare for IFRS convergence. We look forward to your comments and feedback, which can be sent to us on in-fmifrsnewsletter@kpmg.com.

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Contents

Regulatory update

Recent key amendments to IFRS

IFRS implementation issues

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KPMG NIIT IFRS Certification Program

19

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Regulatory update

Announcement by the Ministry of Corporate Affairs (MCA) dated 22 January 2010

The Announcement states that a separate roadmap for banking and insurance companies will be prepared and submitted to the government for consideration after consultation with the concerned regulators by 28 February 2010.

Background
Based on the recommendations of the Core Group set up to facilitate IFRS convergence in India, the MCA has announced the approach and timelines for achieving convergence with IFRS. This landmark announcement eliminates the uncertainty around IFRS convergence in India.

Timelines for convergence


The Announcement lays down a phased approach to convergence. This is similar to the proposed approach of other countries such as Japan and the United States. Convergence with IFRS is planned in three phases as set out below: Phase 1 Companies covered in this phase will prepare an opening balance sheet in accordance with IFRS converged standards as of 1 April 2011 and will follow the IFRS converged standards from this date. The following companies will be covered in Phase 1: Companies included in the Nifty 50; Companies included in the Sensex 30; Companies which have shares or other securities listed on stock exchanges outside India; and Companies (whether listed or not) which have a net worth in excess of Rs 1,000 crores. Phase 2 Companies covered in this phase will prepare an opening balance sheet in accordance with IFRS converged standards as of 1 April 2013 and will follow the IFRS converged standards from this date. All companies (whether listed or not) with a net worth in excess of Rs 500 crores but less than Rs 1,000 crores, will be covered in Phase 2; Phase 3 Companies covered in this phase will prepare an opening balance sheet in accordance with IFRS converged standards as of 1 April 2014 and will follow the IFRS converged standards from this date. All listed companies with net worth less than Rs 500 crores will be covered in Phase 3.

Manner of achieving convergence


There will be two separate sets of Accounting Standards under Section 211(3C) of the Companies Act, 1956. The first set would comprise the Indian Accounting Standards, which are converged with the IFRS (IFRS converged standards) and which shall be applicable to the specified class of companies in a phased manner. The second set would comprise the existing Indian Accounting Standards (existing accounting standards) and would be applicable to other companies, including Small and Medium Companies (SMC). In relation to the IFRS converged standards, the Chairman of the Accounting Standards Board of the Institute of Chartered Accountants of India (ICAI) will submit the converged version of individual Accounting Standards to the National Advisory Committee on Accounting Standards (NACAS) from time to time for recommendations and onward submission to the MCA. Convergence of all the accounting standards is required be completed by the ICAI by 31 March 2010. NACAS will submit its recommendations to the MCA by 30 April 2010. Other amendments to the Companies Act (including, for example, Schedule VI and Schedule XIV) will be undertaken in a time bound manner to facilitate the process of convergence. For example, it is anticipated that certain amendments to the Companies Act will be undertaken as early as February 2010.

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For companies with an accounting year end other than 31 March, the above requirements will apply in relation to the first balance sheet, which is made on a date after 31 March. For example, for a company with a net worth in excess of Rs 1,000 crores with a 1 July to 30 June accounting year, the opening balance sheet will be prepared as of 1 July 2011. The following categories of companies will not be required to follow the IFRS converged standards: Non-listed companies which have a net worth less than Rs. 500 crores and whose shares or other securities are not listed on stock exchanges outside India; and Other defined Small and Medium Companies (SMC). Such companies will need to follow the existing accounting standards. However, such entities may also voluntarily opt to follow the IFRS converged standards.

Applicability to group entities The IFRS converged standards would require preparation of consolidated financial statements by covered companies. Many of these covered companies would have holding companies, subsidiaries, joint ventures and associates (group entities). It is possible that while the reporting company may be covered in a particular phase (for example, Phase 1), other group entities are covered only in subsequent phases or are not required to follow the IFRS converged standards. The regulators would need to determine if it is appropriate for consolidated financial statements to be prepared by the reporting company in a manner that the reporting company follows the IFRS converged standards, while other group entities follow the existing accounting standards. This approach, if permitted or required, would result in lack of consistency. However, if the regulators believe that IFRS converged standards should be followed by all group entities; the question of standards to be followed in the standalone financial statements of such group entities would need to be considered. We believe that it is important to align accounting standards used for the standalone financial statements and the consolidated financial statements. Applicability to non-banking finance companies The Announcement states that the current convergence

Matters for consideration


We believe that the Announcement effectively addresses the previous uncertainty regarding the manner and timelines for IFRS convergence in India. This would enable affected companies to finalize their approach to the transition. For companies covered by Phase 1 and which are yet to substantially commence their IFRS convergence projects; the time to start is Now. Further, the phased approach to IFRS convergence would greatly smoothen the path to convergence for medium-sized and small listed companies. The convergence experience of the large companies covered in Phase 1 would provide other companies with a better understanding of the technical changes due to convergence; provide examples of best practices to manage convergence projects and also provide access to a larger resource pool with experience in IFRS. As inevitable with such large policy announcements, several implementation issues would arise as affected companies consider the impact of the Announcement. Significant issues for consideration are summarized below:

plan does not apply to banking companies. Non-banking finance companies (NBFC) are also regulated by the Reserve Bank of India (RBI) and follow norms prescribed by the RBI in areas such as provision for non-performing assets and capital adequacy. Applicability of the IFRS converged standards for NBFC needs to be evaluated in the context of non-applicability for banking companies. It may be useful to consider if entities governed by similar regulatory requirements should be treated similarly for the purposes of the convergence plan.

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Applicability based on shares/other securities listed on stock exchanges outside India criteria In addition to entities that have issued American Depository Receipts (ADR) and Global Depository Receipts (GDR) listed outside India; issuers of other instruments such as Foreign Currency Convertible Bonds (FCCB) would need to evaluate whether such securities are listed on stock exchanges outside India. In the case that such instruments are listed; the entities would be covered in Phase 1. Comparatives and first-time transition exemptions The Announcement seems to suggest that comparative periods are not required to be revised in the initial period of transition. For example, consider an entity covered in Phase 1. While this entity would prepare an opening balance sheet per the IFRS converged standards on 1 April 2011 and would Applicability based on the net worth criteria While the Announcement does not elaborate on how net worth would be determined, one approach would be that the net worth be based on the last annual audited standalone financial statements of the company. For example, a company would need to evaluate its net worth per the standalone audited financial statements as of 31 March 2011 (prepared per the existing accounting standards) to determine if such net worth is more than Rs1,000 crores. If the net worth exceeds Rs1,000 crore, the company would be covered by Phase 1 and would prepare an IFRS converged opening balance sheet as of 1 April 2011. Other alternative approaches may also be possible to determine applicability. MCA should clarify this for consistent application. Applicability to entities other than companies Since the Announcement only covers convergence by companies, individual regulators governing other types of entities (for example, Mutual Fund entities organized as Trusts) would need to determine the manner of convergence for such entities. While this may be consistent with the intention of the regulators and would smoothen the transition in the initial year, several important points need consideration. For example, financial statements for the year ending 31 March 2012 prepared in accordance with the IFRS converged standards would still not be compliant with IFRS issued by the International Accounting Standards Board (IASB), which require comparatives. Thus, such companies will be able to fully comply with IFRS as issued by the IASB only on preparation of the financial statements for the year ending 31 March 2013. Similarly, investors may get confused if the profit and loss account prepared under the IFRS converged standards for 2011-12 is materially different from the profit and loss account for 2010-11. Individual companies would need to plan their communication strategies to identify changes caused due to changes in accounting policies/practices as compared to changes due to core business operations. follow the IFRS converged standards for the year ending 31 March 2012; comparative financial statements for the year ending 31 March 2011 would not be revised on a comparable basis.

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Further, it needs to be determined whether any one-time transition exemptions are available, while preparing the opening balance sheet as of 1 April 2011. Such exemptions are available under IFRS issued by the IASB through a standard titled IFRS 1, First Time Adoption. For example, assume that a company had done a material acquisition in the year 2008-09. Under the IFRS 1 transition exemptions, the company could avoid restating this past acquisition under the IFRS standards, while preparing the opening balance sheet as of 1 April 2011. It is unclear on whether similar exemptions will be available for companies that prepare their opening balance sheet under the IFRS converged standards. Lastly, there are several companies that currently prepare IFRS compliant financial statements either because they are listed in overseas markets or because they are subsidiaries of global companies that have adopted IFRS. These companies may have availed certain first-time transition exemptions available under IFRS 1, while preparing their opening IFRS balance sheets. It would need to be determined whether such existing IFRS balance sheets can be used for the purpose of transition to the IFRS converged standards in India. In the event that this is not permitted, differences would arise between the IFRS financial statements used for international purposes and IFRS converged financial statements prepared for Indian regulatory requirements. This is not desirable. Early adoption of IFRS converged standards While the Announcement does not specify if the IFRS converged standards can be early adopted by companies covered in Phases 2 and 3, it does permit companies not covered by the convergence (for example, non-listed companies with net worth less than Rs500 crores) to voluntarily adopt the IFRS converged standards. This seems to indicate that companies covered by Phases 2 and 3 may early adopt the IFRS converged standards. However, it is unclear on whether companies (including companies covered by Phase 1) may early adopt the IFRS converged standards for accounting periods prior to 1 April 2011 (for example, financial year ending 31 March 2011).

Change in status Consider a company that is not covered in Phase 1 because its net worth as of 31 March 2011 is less than Rs1,000 crores and it does not meet the other criteria for Phase 1. Such a company may follow the existing accounting standards, while preparing the financial statements for the year ending 31 March 2012. Further assume that the net worth as of 31 March 2012 exceeds Rs1,000 crores. While the Announcement does not directly address such situations involving change in status, it would be logical for such a company to follow the IFRS converged standards commencing 1 April 2012 as it would now meet the criteria for a Phase 1 company.

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Taxation
The Central Board of Direct taxes and the ICAI have jointly constituted a study group to identify direct tax issues arising from the convergence. On 7 January 2010, this group has invited suggestions, queries/comments relating to tax issues arising from IFRS convergence. The recommendations of this group and operationalization of the recommendations in a time bound manner will provide affected companies with clarity on the potential tax implications of the various choices and policies available due to convergence.

Conclusion
The announcement by the MCA is a very important first step in operationalizing IFRS convergence in India. Adherence to the prescribed timelines for further regulatory changes; and clarification on the above implementation and taxation issues, would play a decisive role in successful implementation of IFRS convergence in India. The real work for Corporate India starts now.

Regulatory update
Convergence with IFRS in a phased manner starting 1 April 2011 Criteria for companies covered in each phase defined Two separate sets of Accounting Standards under Section 211(3C) of

the Companies Act, 1956 IFRS converged standards and existing accounting standards
Companies not covered will follow existing accounting standards; but

may voluntarily converge


Separate notification for Banks and Insurance companies to be issued

by 28 February 2010

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Recent key amendments to IFRS

A) IFRS 9 Financial Instruments


Background
The IASB issued this standard as part of its comprehensive review of financial instruments accounting. The IASB aims to reduce the complexity of the current requirements and to replace IAS 39, Financial Instruments: Recognition and Measurement in phases. IFRS 9 is intended to replace IAS 39 once the remaining stages of the project are completed by the end of 2010. IFRS 9 (as published) deals with classification and measurement of all financial assets only. The requirements for financial liabilities will be issued in 2010. The guidance in IAS 39 on impairment of financial assets and on hedge accounting continues to apply.

All other financial assets are measured at fair value. The standard eliminates the existing IAS 39 categories of held to maturity, available for sale and loans and receivables.

Entitys business model for managing financial assets


The business model approach is a fundamental building block of the new standard and aligns the accounting with the way that management deploys assets in its business while also considering the characteristics of assets. The business model is determined by the entitys key management personnel and does not depend on managements intentions for an individual asset. It is instead determined at a higher level. An entity could have more than one business model for managing financial assets and may manage different portfolios of assets with different objectives.

Summary of the standard


Classification - The standard requires financial assets to be classified on initial recognition as measured at: amortised cost; or fair value A financial asset is measured at amortised cost if: the objective of the business model is to hold assets in order to collect contractual cash flows; and the contractual terms give rise, on specified dates, to cash flows that are solely payments of principal and interest on the principal outstanding (Interest is defined as consideration for the time value of money and credit risk).

Embedded derivatives
Embedded derivatives are no longer separated from hybrid contracts that have a financial asset as the host. Instead, the entire hybrid contract is assessed for classification using the principles above. IAS 39 continues to apply to embedded derivatives where the host is not within the scope of IFRS 9.

Fair value option


The standard allows an entity to designate a financial instrument on initial recognition as measured at fair value through profit or loss regardless of it meeting the criteria to be measured at amortised cost. This election is available only if it eliminates or significantly reduces a measurement or recognition inconsistency (accounting mismatch). This election is retained from IAS 39.

IFRS 9 Financial Instruments


Issued in November 2009 Requires financial assets to be classified on initial recognition and measured at amortised cost or fair value Eliminates the existing IAS 39 categories of held to maturity, available for sale and loans and receivables Intended to replace IAS 39 and at present deals with the classification and measurement of financial assets only. Effective retrospectively for annual periods beginning on or after 1 January 2013.
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investment in other comprehensive income (OCI). No amount recognised in OCI is ever reclassified to profit or loss at a later date. Dividends on such investments are recognised in profit or loss, in accordance with IAS 18, Revenue unless they clearly represent a recovery of the cost of the investment.

Measurement
TIFRS 9 eliminates the exception in IAS 39 that allows investments in unquoted equity instruments, and related derivatives, for which a fair value can not be determined reliably, to be measured at cost. These instruments are now measured at fair value although the standard notes that in some limited circumstances cost may be an appropriate estimate of fair value. As under existing IAS 39 requirements, financial assets are initially measured at fair value plus, in the case of a financial asset not at fair value through profit or loss, transaction costs. The guidance in IAS 39 on impairments of financial assets and on hedge accounting continues to apply. However, as a result of the simplified classification requirements, the numerous impairment methods in IAS 39 have been reduced to a single impairment method. All changes in the fair value of financial assets that are

Reclassification
Reclassification of financial assets is required if the objective of an entitys business model changes in a manner that is both significant to the entitys operations and demonstrable to external parties. Such changes are expected to be very infrequent .

measured at fair value are recognised in profit or loss, with the exception of equity investments for which the OCI option has been elected, and assets that are part of a hedge relationship. Gains or losses on assets measured at amortised cost are recognised in profit or loss upon derecognition, impairment or reclassification of the asset, and through applying the effective interest method.

Investments in equity instruments


Investments in equity instruments are measured at fair value and, except as described below, gains and losses on remeasurement are recognised in profit or loss. For an investment in an equity instrument that is not held for trading, IFRS 9 allows an entity on initial recognition to elect irrevocably to present all fair value changes from the

Effective date
The standard is effective retrospectively for annual periods beginning on or after 1 January 2013.

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B) Amendments to IAS 32 (Financial Instruments Presentation) Classification of Rights Issues


Background and reasons for the amendment
IAS 32 states that a derivative instrument relating to an entitys own equity instruments is classified as equity only if it results in the exchange of a fixed number of equity instruments for a fixed amount of cash or another financial asset. In 2005, the IFRIC concluded that if an equity conversion option in a convertible bond was denominated in a foreign currency, the amount of cash receivable in the functional currency on conversion would be variable. Consequently, the conversion option was a derivative liability that should be measured at its fair value with changes in fair value included in profit or loss. Many entities undertaking right issue to raise additional capital fix the exercise price of the rights in currencies other than their functional currency because they are listed in more than one jurisdiction and might be required to do so by law or regulation. However, there was no guidance on whether rights issues entitling the holder to receive a fixed number of the issuing entitys own equity instruments for a fixed amount of a foreign currency should be accounted for as a derivative liability.

Summary of the amendment


The amendment addresses the accounting for rights issues (rights, options, warrants) that are denominated in a currency other than the functional currency of the issuer. As per the amendment, a pro rata issue of rights to all existing shareholders to acquire additional shares is a transaction with an entitys owners in their capacity as owners and consequently the transaction should be recognised in equity, not comprehensive income. Accordingly the definition of a financial liability has been amended.

Effective date
The amendment is applicable for annual periods beginning on or after 1 February 2010. Earlier application is permitted.

Amendments to IAS 32 (Financial Instruments Presentation) Classification of Rights Issues:


Addresses the accounting for rights issues (rights, options, warrants) that are denominated in a currency other than the functional currency of the issuer Establishes that rights to acquire a fixed number of the entitys own equity instruments for a fixed amount in any currency are equity instruments if the entity offers the rights pro rata to all of its existing owners Applicable for annual periods beginning on or after 1 February 2010. Earlier application permitted.

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C) IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments


Background
IFRIC has issued an interpretation (IFRIC 19) that provides guidance on how to account for the extinguishment of a financial liability by the issue of equity instruments. These transactions are often referred to as debt for equity swaps. IFRIC 19 clarifies the requirements of IFRS when an entity renegotiates the terms of the financial liability with its creditor and the creditor agrees to accept the entitys shares or other equity instruments to settle the financial liability fully or partially.

the equity instruments issued are measured at their fair value. If their fair value cannot be reliably measured, the equity instruments should be measured to reflect the fair value of the financial liability extinguished. the difference between the carrying amount of the financial liability extinguished and the initial measurement amount of the equity instruments issued is included in the entitys profit or loss for the period.

Effective date
This interpretation is effective for annual periods beginning on or after 1 July 2010 with earlier application permitted.

Summary of the amendment


IFRIC 19 clarifies that: the entitys equity instruments issued to a creditor are part of the consideration paid to extinguish the financial liability.

IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments:


Equity instruments issued to settle financial liabilities to be measured at fair value and the difference between the carrying amount of the liability and the fair value to be included in the entitys profit and loss account Effective for annual periods beginning on or after 1 July 2010 with earlier application permitted.

D) Amendments to IAS 24 Related Party Transactions (revised 2009)


IAS 24 (Revised 2009) establishes new disclosure requirements for government-related entities and makes limited amendments to the definition of a related party. Prior to IAS 24 (2009), the disclosure requirements in relation to outstanding balances and certain transactions were extensive, particularly for government-related entities. While the disclosure requirements for related party transactions

have not been lessened, the amendments provide an exemption from some of the detailed requirements for entities meeting the definition of a government-related entity.

Background and reasons for the amendment


The currently effective requirement of IAS 24 (2003) to disclose transactions between government-related entities has raised concerns amongst users; in particular in countries in which government control was pervasive.

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Amendments to IAS 24 Related Party Transactions (revised 2009):


IAS 24 amended in November 2009 to introduce related party disclosure exemption for government-related entities and improve the definition of a related party. The revised standard has also expanded the list of transactions that require disclosure. Applicable retrospectively for annual periods beginning on or after 1 January 2011 with the option to early adopt in full or only the part in respect of the disclosure exemption for government-related entities. If the revised standard is applied earlier, then this fact should be disclosed.

In addition, there are justified concerns about the cost and potential benefit of voluminous information regarding transactions that had not been impacted by a related party relationship but are required only because of ownership by the government. However, this issue is not isolated to such countries. During the global financial crisis, many private sector financial institutions in Europe and the US have become governmentrelated entities, broadening considerably the range of entities to which those financial institutions would now be regarded as related. Also the definition of a related party in IAS 24 (2003), was considered too complex, lacked symmetry and included some inconsistencies. The IASB issued two Exposure Draft (ED) in February 2007 and December 2008 and then issued the final amendments to the standard in November 2009.

However, if the reporting entity takes advantage of the exemption, certain disclosures to enable users of the entitys financial statements to understand the effect of the transactions on its financial statements would still be required. Amendments to the definition of a related party Related party relationships have been made symmetrical. New relationships have been included and certain previous relationships have been excluded in the definition of a related party. Clarification that references to associates and joint ventures include the subsidiaries of those associates and joint ventures. The reference to significant voting power was removed from the definition. Other minor changes The revised standard expanded the list of transactions that require disclosure.

Summary of the amendment


Disclosure exemption for the government-related entities A government-related entity is exempt from the disclosure requirements in relation to related party transactions and outstanding balances, including commitments, with (a) a government that has control, joint control or significant influence over the reporting entity; and (b) another entity that is a related party because the same government has control, joint control or significant influence over both the reporting entity and the other entity.

It has also been clarified that the standard applies to individual, separate and consolidated financial statements.

Effective date
The amendment is applicable retrospectively for annual periods beginning on or after 1 January 2011 with the option to early adopt in full or only the part in respect of the disclosure exemption for government-related entities. If the revised standard is applied earlier, then this fact should be disclosed.

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E) IFRS for Small and Medium sized entities


Background
In July 2009, the IASB published the IFRS for Small and Medium-Sized Entities (SME). The IFRS for SME is intended to facilitate financial reporting by small and medium-sized entities that want to use international standards by providing an accounting standard suitable for them. It is a simplified and slimmed-down version of full IFRS, tailored for the needs and capabilities of SME.

Some of the key requirements of the IFRS for SME are mentioned below: Financial statement presentation Like full IFRS, a set of financial statements prepared in accounting with the IFRS for SME comprises: A statement of financial position; A statement of comprehensive income (or a separate income statement and statement of comprehensive income);

Summary of the standard


The IFRS for SME is intended for those entities that do not have public accountability and do not publish general purpose financial statements for external users, i.e., financial statements directed towards the common information needs of a wide range of users. The IFRS for SME: provides significantly less guidance than full IFRS; simplifies the recognition and measurement requirements compared to full IFRS in some areas and excluding topics not considered relevant for SME; and removes the more complex option in certain areas in which full IFRS allow more than one accounting option.

A statement of changes in equity; A statement of cash flows Notes, comprising a summary of significant accounting policies and other explanatory information. An SME is permitted to present a combined statement of comprehensive income and retained earnings in place of separate statements of comprehensive income and changes in equity, if the only changes to equity during the period arise from profit or loss, the payment of dividends, the correction of prior period errors, and / or changes in accounting policy. If an entity has other equity transactions with owners, then a statement of changes in equity is required.

IFRS for Small and Medium-sized entities


Simplified and slimmed-down version of full IFRS, tailored for the needs and capabilities of SME Simplifies the recognition and measurement requirements compared to full IFRS in some areas, excludes topics not considered relevant for SME and removes the more complex option in certain areas in which full IFRS allow more than one accounting option Does not contain an effective date and instead will take effect from a date determined by the national regulator in each jurisdiction.

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A statement of financial position as at the beginning of the earliest comparative period is not required when the entity applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements. The expenses can be presented in the statement of comprehensive income either by nature or by function; if presented by function, then further disclosure by nature in the notes is not required. Financial instruments A SME has an accounting policy choice for all of its financial instruments to apply either the provisions of the IFRS for SME, or the recognition and measurement provisions of IAS 39 Financial Instruments: Recognition and Measurement and the disclosure requirements of the IFRS for SME.

The IFRS for SME provides guidance on accounting for financial instruments in two sections. Section 11 provides guidance on basic financial instruments and Section 12 provides guidance on more complex financial instruments. The IFRS for SME has two classification categories for financial instruments: amortised cost and fair value through profit or loss. Tangible and intangible assets Only the cost model is permitted under IFRS for SME for accounting tangible and intangible assets. The revaluation option permitted under full IFRS is removed under IFRS for SME. Under IFRS for SME all intangibles (including goodwill subject to a maximum of ten years) are considered to have finite lives and hence are amortised.

Effective date
The IFRS for SME does not contain an effective date; instead, it will take effect from a date determined by the national regulator in each jurisdiction.

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IFRS implementation issues

Determination of whether an arrangement contains a lease (IFRIC 4)


The purpose of IFRIC 4, determining whether an arrangement contains a lease, is to identify an arrangement which, in substance, is or contains a lease (even if the contract does not use the term lease). The assessment of the substance of the agreement should be analysed at inception. A lease arrangement conveys rights to use an asset for agreed periods of time in return for a payment or series of payments. The situations where the interpretation may apply include outsourcing arrangements, for example information technology management; and take or pay contracts (purchasers to make specified payments whether or not they take delivery of the contracted products). The following example illustrates take or pay contracts: A Company has a contract with its supplier (job worker) whereby the Company is contractually bound to get 10,000 units of goods manufactured by the supplier. The supplier has installed a machinery to manufacture and supply the goods for the contract. The supplier has no other machinery that can manufacture these goods Price terms are as under: For first 10,000 units - Rs 22 per unit 10,001 onwards - Rs 10 per unit; In case of any shortfall as compared to 10,000 units, a penalty of Rs 12 per unit of shortfall shall be levied.

IFRIC 4 helps the Company to assess if the above specified contract is a mere plain-vanilla supply contract or whether in substance there is actually a lease embedded in this contract. The assessment whether the above arrangement is or contains a lease is based on whether: fulfillment of the arrangement is dependent on the use of a specific asset or assets; and the arrangement conveys a right to use the asset(s). In the above example, it needs to be assessed whether the goods are being manufactured from a specific asset of the supplier or if the supplier has the ability to manufacture the goods from any of the assets he owns. An arrangement conveys the right to use the asset where the purchaser (lessee) obtains the ability or right to control the use of a specific asset. IFRIC 4 clarifies that the right to use an asset is transferred, if any of the following conditions are met: The purchaser has the ability or right to control the asset including to direct how others should operate the asset, and at the same time obtaining or controlling more than an insignificant amount of the asset's output The purchaser has the ability or right to control physical access to the asset, while obtaining or controlling more than an insignificant amount of the asset's output The possibility that another party will take more than an insignificant amount of the asset's output during the term of the arrangement is remote, and the price paid by the purchaser for the output is neither a contractually fixed price per unit of output nor the market price per unit of output.

Conditions of IFRIC 4:
Determining whether an arrangement is, or contains, a lease shall be based on the substance of the arrangement and requires an assessment of whether: fulfilment of the arrangement is dependent on the use of a specific asset or assets; and the arrangement conveys a right to use the asset.

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In the above example assuming that the goods are being manufactured from a specific asset of the supplier then the arrangement would contain a lease. Up to the initial 10,000 units, the Company is required to pay Rs 120,000 (10,000 * Rs 12) to the contract manufacturer (as there is a penalty of Rs 12 per unit for any shortfall in off take by the Company up to 10,000 units). This payment pertains to the capital costs of the asset and would be considered as a lease rent for the asset being used. The balance amount of Rs 10 (22 12) per unit would be job work charges for the manufacture of goods.

The asset under the arrangement may be identified explicitly in the arrangement or it may be specified implicitly; for example, if the supplier owns or leases only one asset with which to fulfill the obligation, and it is not economically feasible or practicable for the supplier to use alternative assets to fulfill the arrangement. The following decision tree provides an overview of when an IFRIC 4 case exists:

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Impact of IFRIC 4
If the arrangement is within the scope of IFRIC 4, it is necessary to determine whether it is an operating lease or a finance lease. The guidance to make this determination is available in IAS 17 Leases. If the lease is recognised as an , operating lease then an entity is would provide operating lease commitments disclosure along with recognition of operating lease expense on a straight line basis. If the lease is classified as finance lease then there would be significant changes in the financial statements which include recognition of both an asset and the associated financing obligation. In practice, obtaining information to make this determination as operating and finance lease is a significant challenge.

or leases only one asset with which to fulfil the obligation and it is not economically feasible or practicable for the supplier to perform its obligation through the use of alternative assets, then it will be an impliedly specified asset. Assessing whether the use of alternative asset is economically feasible and practical will not always be straightforward.

The arrangement conveys a right to use the asset


If the arrangement is based upon a specific asset, the entity must determine whether the arrangement conveys a right to use the asset based on the steps in the above decision tree. It is often a challenge to determine whether a right to use the item has been conveyed. Consider the terms fixed price per unit of output or current market price per unit of output at the time of delivery In practice, interpretations of . these terms widely vary. Some entities interpret the term fixed price as absolutely fixed with no variance per unit based on costs or volumes. However, other entities accept certain adjusted prices as fixed such as fixed price per unit adjusted for inflation or a fixed percentage increase etc. If the price per unit is not fixed, or at a market price per unit of output, the substance of the arrangement may be to pass on the economic risks associated with producing the output.

Practical challenges arising on implementation of IFRIC 4


Specific asset or assets
In practice, identification of an asset that is impliedly specified in an arrangement is a significant challenge. An asset shall be impliedly specified in an arrangement only if the same asset / assets shall be used to fulfil the contractual arrangement. For instance if the supplier owns

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18 | IFRS MONITOR

This would effectively mean that the purchaser is using the asset and therefore it would qualify as a lease. Arriving at these conclusions is judgmental and would require an entity to disclose such key judgments.

First time adoption


The first time adopters of IFRS has the option to apply the transitional provisions given in IFRIC 4 and determine whether an arrangement existing at the date of transition to IFRS is, or contains, a lease based on the facts and circumstances at that date.

Splitting of lease components


In practice, the lease is not the only question that has to be considered. The reality of many agreements / arrangements are such that an important judgment need to be made on how to treat the cash flow under the arrangements and how to divide them into the individual components. For instance, a contract for warehouse management services, whereby the vendor shall manage a warehouse on a dedicated basis for a single customer against a fixed monthly fees. The inputs of the vendor includes warehouse premises, assets deployed therein and warehouse labour. Thus, the arrangement contains a lease of warehouse and warehouse assets. The overall consideration shall be separated into lease rentals for warehouse, lease rentals for warehouse assets and consideration for warehouse management (labour). In practice separation of individual components pose significant challenges to entities.

Conclusion
An entity can expect significant changes to its balance sheet and income statement due to arrangements covered under the scope of IFRIC 4 and the related IAS 17 It is essential . for an entity to carefully evaluate such arrangements (both at the time of entering into for the first time and at the time of first time adoption of IFRS) and assess the impact on its financial statements.

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KPMG NIIT IFRS Certification Program

Advanced Certificate Program on IFRS: Implementation and Compliance


The aim of this program is to focus on training finance professionals in issues that they would face during IFRS implementation within their organizations. The program provides an in-depth analysis of the accounting and disclosure requirements under IFRS. Additionally the program shares value knowledge on how finance professionals can navigate complex issues surrounding the recognition and measurement of items under IFRS. The program also places the Indian financial reporting requirements (Indian GAAP) in perspective and explains the differences between Indian GAAP and IFRS. Learning through the program is tested through class-room type tests. The program is spread over six weeks to enable better retention of the learning objectives. Participants can attend this program at any designated NIIT learning center across India. https://www.niitimperia.com

KPMG IFRS Institute

KPMG in India launched the IFRS Institute in February 2009 to assist various stakeholders in the planned convergence from Indian GAAP to IFRS. The IFRS Institute is a web-based platform which seeks to act as a one-stop site for all information updates and views on IFRS implementation in India. Membership to the Institute is free and the registered members are also entitled to receive invitation for KPMG sponsored IFRS events and IFRS web casts. https://www.in.kpmg.com/IFRSInstitute

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in.kpmg.com
KPMG in India
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KPMG Contacts
Jamil Khatri Head - Accounting Advisory Services Tel: +91 22 3090 1660 e-Mail: jkhatri@kpmg.com

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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