Published On - Jul 25, 2023
Key Amendments to Indian Accounting Standards – An Overview
The Ministry of Corporate Affairs (MCA) on 31st March 2023 notified the Companies (Indian Accounting Standards) Amendment Rules, 2023, whereby certain important changes have been made to Indian Accounting Standards (Ind AS). All these changes are applicable from annual reporting periods beginning on or after 1 April 2023. We expect that some of these changes will require companies to re-evaluate the accounting currently followed and incorporate consequential impact carefully. In this article, we provide an overview of key changes and their likely impact.
Amendments to Ind AS 12 Income Taxes
Ind AS 12 Income Taxes prescribes accounting treatment for income taxes. It requires an entity to recognize a deferred tax liability or (subject to specified conditions) a deferred tax asset for all temporary differences between carrying amount of an asset or liability and its tax base, with very few exceptions.
One such exception from recognition of deferred tax asset or liability relates to temporary differences arising on the initial recognition of an asset or a liability in a transaction which is not a business combination. The exception is generally referred to as the ‘initial recognition exception’, sometimes abbreviated to ‘IRE’. The example below explains the rationale for the IRE.
Example: Rationale for initial recognition exception
An entity acquires an asset for INR1,000 which it intends to use for five years and then scrap (i.e., the residual value is nil). The tax rate is 40%. Depreciation of the asset is not deductible for tax purposes. On disposal, any capital gain would not be taxable, and any capital loss would not be deductible.
Although the asset is non-deductible, its recovery has tax consequences, since it will be recovered out of taxable income of INR1,000 on which tax of INR400 will be paid. The tax base of the asset is therefore zero, and a temporary difference of INR1,000 arises on initial recognition of the asset.
Absent the IRE, the entity would recognize a deferred tax liability of INR400 on initial recognition of the asset. A debit entry would then be required to balance the credit for the liability.
One possibility might be to recognize tax expense of INR400 immediately in the statement of profit and loss. One may argue that this is meaningless since the entity has clearly not suffered a loss simply by purchasing a non–deductible asset in an arm’s length transaction for a price that (economically) must reflect the asset’s non– deductibility.
A second possibility will be to gross up the asset amount to appropriately reflect the deferred tax amount using a mathematical formula. Therefore, the cost of an equivalent fully deductible asset would, all else being equal, be INR1,667. On this analysis, the entity would gross up the asset to INR1,667 and recognize deferred tax liability of INR667 (INR1,667 @ 40%).
To avoid such anomalies, Ind AS 12 does not allow the entity to recognize resulting deferred tax liability or asset, either on initial recognition or subsequent changes therein.
In practice, there was a divergence in the treatment of deferred tax balances relating to transactions which – at the time of the transaction – gave rise to equal and offsetting temporary differences (e.g., leases). To illustrate, consider that an entity has entered into a leasing transaction. Under Ind AS 116 Leases, it recognizes a right-of-use asset (lease asset) and a lease liability at the commencement date of a lease. Under the Income-tax Act, the entity will- be eligible for tax deductions only when it makes lease payments. In such cases, apparently, the following two views were prevalent:
a) Apply the IRE separately to both the asset and liability. Thus, no deferred tax asset or liability is recognized, and tax impacts get recognized in P&L in the period they are incurred.
b) Consider the asset and liability together – as part of an “integrally-linked” transaction for deferred tax purposes. The consequence is that no IRE applies, and deferred taxes are recognized.
A similar situation can arise in many other cases also, for example:
a) Decommissioning/ restoration obligations are recognized upfront and capitalised as the cost of the asset. Under the Income-tax Act, the entity will be allowed to deduction only on payment basis.
b) The parent has given an interest-free loan to its subsidiary. In accordance with Ind AS 109 Financial Instruments, it recognizes loan on day 1 at fair value, i.e., discounted amount. The difference between the fair value of the loan and the amount paid is treated as an additional investment in the subsidiary. However, the Income-tax Act does not recognize such fair value and additional investment accounting.
The amendments narrow the scope of the IRE such that it no longer applies to transactions that give rise to equal taxable and deductible temporary differences. The amendments also clarify that where payments that settle a liability are deductible for tax purposes, it is a matter of judgement (having considered the applicable tax law) whether such deductions are attributable for tax purposes to the liability recognized in the financial statements (and interest expense) or to the related asset component (and interest expense). This judgement is important in determining whether any temporary differences exist on initial recognition of the asset and liability.
The amendment, however, does not change the fact that the IRE applies only to temporary differences arising on initial recognition of an asset or liability. It does not apply to new temporary differences that arise on the same asset or liability after initial recognition. When the exception has been applied to the temporary difference arising on initial recognition of an asset or liability, and there is a different temporary difference associated with that asset or liability at a subsequent date, it is necessary to analyse the temporary difference at that date between:
- Any amount relating to the original temporary difference (on which no deferred tax is recognized, and
- The remainder, which has implicitly arisen after the initial recognition of the asset or liability (on which deferred tax is recognized)
When the deferred tax asset and deferred tax liability are not equal
The amendment requires entities to recognize a separate deferred tax asset (DTA) and deferred tax liability (DTL) when the temporary differences arising on the initial recognition of an asset and liability are equal. Nevertheless, it is possible that those DTAs and DTLs are not equal, for example, because:
- An entity may recognize a deferred tax liability, but is unable to recognize an equal and offsetting deferred tax asset if it is unable to benefit from the tax deductions, or
- Different tax rates may apply to the taxable and deductible temporary differences
In the above scenarios, which are expected to occur infrequently, an entity would need to account for the difference between the deferred tax asset and liability in the statement of profit and loss immediately.
Transition and effective date
An entity should apply the amendments for annual reporting periods beginning on or after 1 April 2023. An entity should apply the amendments to transactions that occur on or after the beginning of the earliest comparative period presented. In addition, at the beginning of the earliest comparative period presented, it should also:
- Recognize a deferred tax asset (to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised) and deferred tax liability for all deductible and taxable temporary differences associated with:
- Right-of-use assets and lease liabilities,
- Decommissioning, restoration and similar liabilities and the corresponding amounts recognized as part of the cost of the related asset, and
- Recognize the cumulative effect of initially applying the amendments as an adjustment to the opening balance of retained earnings (or other component of equity, as appropriate) at that date.
The amendment limits the use of the initial recognition exemption. This is likely to improve comparability and provide more relevant information to the users of financial statements about the tax consequences of relevant transactions. The amendments could, in a few cases, lead to the recognition of unequal amounts of deferred tax assets and liabilities, despite the gross deductible and taxable temporary differences being equal. In such cases, an entity would need to account for the difference between the deferred tax asset and liability in profit or loss.
Amendments to Ind AS 1 Presentation of Financial Statements
The amendment replaces the requirement for entities to disclose their “significant” accounting policies with a requirement to disclose their “material” accounting policies. It also provides guidance on how entities apply the concept of materiality in making decisions about accounting policy disclosures.
Whilst there was no definition of the term ‘significant’ in Ind AS, ‘material’ is a defined term in Ind AS and is widely understood by the users of financial statements. Material accounting policy information is defined as follows in Ind AS 1 “Accounting policy information is material if, when considered together with other information included in an entity’s financial statements, it can reasonably be expected to influence decisions that the primary users of general-purpose financial statements make on the basis of those financial statements.”
The amendments also clarify that accounting policy information is expected to be material if, without it, the users of the financial statements would be unable to understand other material information in the financial statements. Given below are some examples of circumstances in which an entity is likely to consider accounting policy information to be material.
| Circumstance | Example |
|---|---|
| A change of accounting policy results in a material change to the information in the financial statements | The application of Ind As 116 Leases, in the initial year of application, results in the recognition of ROU asset and a lease liability for material amounts vis-à-vis operating lease accounting under the earlier Ind AS. |
| A choice of accounting policy is permitted by Ind ASs | Ind AS 27 Separate Financial Statements gives the entities an option to account for investments in subsidiaries, joint ventures, and associates either at cost or in accordance with Ind AS 109 Financial Instruments. |
| An entity develops an accounting policy in accordance with Ind AS 8 Accounting Policies, Changes in Accounting Estimates and Errors in the absence of an Ind AS that specifically applies. | Transactions involving contingent consideration are often very complex and payment is dependent on a number of factors. In the absence of specific guidance in Ind AS 38 Intangible Assets, entities should develop an appropriate accounting treatment based on other accounting principles and requirements. |
| Application of accounting policy requires significant judgements or assumptions. | Significant judgement is involved in determining the lease term of contracts with renewal and termination options. |
| It is difficult to understand material transactions, other events, or conditions because they require complex accounting, e.g., when more than one Ind AS is applied. | Accounting for complex financial instruments like compound financial instruments involving equity component and derivative. |
Immaterial accounting policies
The amendments to Ind AS 1 also clarify that immaterial accounting policy information need not be disclosed. However, if it is disclosed, it should not obscure material accounting policy information, for example, by giving the immaterial accounting policy information more prominence.
Under the amendments, it may be argued that, although a transaction, other events, or condition to which the accounting policy information relates may be material, it does not necessarily mean that the corresponding accounting policy information is material to the entity’s financial statements. On the other hand, the amended Ind AS 1 highlights that other disclosures required by Ind AS may be material despite the corresponding accounting policy information being immaterial. For example, if an entity determines that accounting policy information for income taxes is immaterial to its financial statements, other disclosures required by Ind AS 12 Income Taxes may still be material.
How we see it
The replacement of ‘significant’ with ‘material’ accounting policy information in Ind AS 1 and the corresponding new guidance in Ind AS 1 may impact the accounting policy disclosures of entities. Determining whether accounting policies are material or not requires greater use of judgement. Therefore, entities are encouraged to revisit their accounting policy information disclosures to ensure consistency with the amended standard.
The use of boilerplate disclosures for accounting policy information has been observed in practice. Entities should carefully consider whether “standardized information, or information that only duplicates or summarizes the requirements of the Ind AS” is material information and, if not, whether it should be removed from the accounting policies disclosures or given lower prominence to enhance the usefulness of the financial statements.
Amendments to Ind AS 8 Accounting Policies, Changes in Accounting Estimates and Errors
The current version of Ind AS 8 does not provide a definition of accounting estimates. Accounting policies, however, are defined. Furthermore, the standard defines the concept of a “change in accounting estimates”. A mixture of a definition of one item with a definition of changes in another has resulted in difficulty in drawing the distinction between accounting policies and accounting estimates in many instances. In the amended standard, accounting estimates are now defined as, “monetary amounts in financial statements that are subject to measurement uncertainty”.
To clarify the interaction between an accounting policy and an accounting estimate, paragraph 32 of Ind AS 8 has been amended to state that: “An accounting policy may require items in financial statements to be measured in a way that involves measurement uncertainty - that is, the accounting policy may require such items to be measured at monetary amounts that cannot be observed directly and must instead be estimated. In such cases, an entity develops an accounting estimate to achieve the objective set out by the accounting policy”. Accounting estimates typically involve the use of judgements or assumptions based on the latest available reliable information.
We expect that these amendments should provide preparers of financial statements with greater clarity as to the definition of accounting estimates, particularly in terms of the differentiation between accounting estimates and accounting policies. We would not expect the amendments to have a material impact on entities’ financial statements. However, we expect that the amendments will provide helpful guidance for entities in determining whether changes are to be treated as changes in estimates, changes in policies, or errors.
