Changes to the Indian Accounting Standards (Ind AS) will allow companies to show the benefit in their profit and loss (P&L) account. The move comes as a huge relief for airlines or retail chains that have many assets or properties on hire.
Until now, if any terms and conditions of an existing lease contract changed, then it would have to be treated as a new lease contract. This meant that if a company got a rental concession for one year in a ten-year contract, the benefit would have to be reworked to reflect its present value, which would be lower than the current value.
The latest amendment does away with the need for such recalculations, and the benefit can be taken into the P&L for the current period, simplifying the accounting to a great extent.
The relaxation on rental concession accounting is especially beneficial to companies that have many assets or properties on hire, such as airlines or retail chains, insurance companies and banks, according to Shalu Kedia, partner at Nangia and Co.
“This would also improve the profitability of a company,” Kedia added.
The changes, which went through the Institute of Chartered Accountants of India (ICAI) and the National Financial Reporting Authority (NFRA) before being notified, were part of annual refinements made to align Ind AS with the International Financial Reporting Standards (IFRS).
The ministry of corporate affairs (MCA) has also amended the definition of business combinations and material items to remove ambiguities, while exempting hedges from being classified as ineffective on the basis of interest rate benchmark reform.
Interest rate benchmark reform
The exemption in hedge accounting will mostly benefit multinational companies that take foreign currency loans from their parent companies. To protect against losses arising from exchange rate differences, these companies hedge their loan repayments using forward contracts.
The interest on these contracts are based on interest rate benchmarks such as the interbank offered rate (IBOR). The decreasing usage and risk incorporated in these benchmarks have made them unreliable, which essentially weakens the basis of hedge contracts, and calls for a change in the benchmark itself.
In terms of hedge accounting, this would render a hedge ineffective. “When a cash flow hedge is determined to be ineffective, the entire loss has to be carried to the P&L account immediately, which would have a significant impact on financial statements,” said Abuali Darukhanawala, partner at ZADN and Associates.
The amendment allows for the use of existing benchmarks until a new one is released, preventing the booking of unrealised exchange losses.
A material item was earlier defined as any information that would have a significant impact on a company’s financial statement. The amendments have enhanced this definition to include any information which if omitted, misstated or obscured, “could reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements.”
This has resulted in another change that requires companies to disclose in their financial statements, any material event or transaction that occurred from the last date of FY20, till the signing of the balance sheet. This even though it does not affect company finances for the accounting year ending on March 31, 2020.
“This has been done to include any material event arising from the Covid-19 impact such as the downfall in revenue, any force majeure clauses affecting the company or the termination of a key customer agreement. Apart from a qualitative disclosure, it has to be quantitative also,” Kedia said.
Although this will not affect FY20 numbers of a company, it would ensure that companies were aware of the Covid-19 impact, which would be material for the users of the financial statement.