Revision of criteria of non-company entities on which AS shall be applicable

CS Aisha Begum Ansari and Harsh Juneja ( )


For the purpose of applicability of Accounting Standards (“AS”), The Institute of Chartered Accountants of India (“ICAI”) has classified the entities into two segments – company entities and non-company entities. Non-company entities such as sole proprietors, partnership firms, trusts, Hindu Undivided Families, association of persons and co-operative societies are further classified into various levels. Currently, the ICAI has categorized non-company entities into 3 levels.

With increasing number of non-company entities, the ICAI has, now, further classified them into 4 levels. The amendments have been brought to reduce stringency on non-company entities which were earlier required to comply with all AS in pursuance of being level I entities as the norms for the same have been revised.

Since most of the Special Purpose Vehicle(s) (“SPV”s) are in the form of non-company entities, they were required to comply with all accounting standards as most of these were covered under level I category. However, with the proposed changes, the burden of strict adherence to AS will be reduced for SPVs falling under level I category.

This Article is an attempt to cover the proposed revision criteria for application of AS on non-company entities.

Proposed applicability

It is proposed that this scheme be made effective in respect of accounting periods commencing on or after April 1, 2020. However, the same shall be effective once the required changes are incorporated in the AS while publishing the updated Compendium of AS.

Non-company entities[1] on which Ind AS is not applicable. It should be noted that such entities have been classified in 4 levels basis different criteria including turnover and borrowing and classified as large – medium – small and micro entities- last three referred to as MSMEs.

Entities belonging to level II, III, IV have been granted certain exemption. It is to be noted that the applicability of AS has been made milder as one goes down the four level of entities i.e to say, maximum relaxations / exemptions are given to level IV entities.


All non-company entities which are covered under this Proposal, are required to make following disclosures:

  1. That the AS has been complied by the entity;
  2. The level to which the entity belongs and whether it has availed exemptions granted to such level;
  3. Availing of partial exemption – It is to be noted that the entities are allowed to cherry-pick the exemptions they intend to avail. However, such partial availing of exemption should not be misleading. That the entity has cherry-picked the exemptions and not availed all the exemptions granted to such level should be disclosed as to which all exemptions it has availed;


The Proposal also talks about disclosure / rules of transition from one level to another, which are as follows:

  1. From transition from a higher level to a lower level – relaxations / exemptions of the lower level may be availed only on staying at such level for two consecutive years.
  2. From transition from a lower level to higher level – while the disclosures pertaining to the higher level becomes applicable, however no change / revision is required to be made in the previous year [where the entity was classified as a lower level, and had availed exemptions / relaxation as such] is required to be made. However, disclosure of such fact is required to be made in the notes to financial statement.
Levels Existing criteria for classification [2019][2] New criteria for classification Applicability


1.      Equity / Debt Listed / to be listed entity

a)     Entities listed on overseas exchanges also included

2.      Banks (including co-operative banks), FIs, Insurance entities

3.      Entities having [3]turnover in the (excluding other income) > 50 crores

4.      Borrowings (including public deposit) > 10 crores

5.      Holding and subsidiary entities of the above

1.     Listed / to be listed entity

a)     Entities listed on overseas exchanges also included

2.      Banks (including co-operative banks), FIs, Insurance entities

3.      Entities having turnover in the (excluding other income) > 250 crores

4.      Borrowings (including public deposit) > 50 crores

5.      Holding and subsidiary entities of the above

All 29 AS applicable in full.
II [Medium] 1.      Entities having turnover in the (excluding other income) > 40 lakhs ≤ 50 crores

2.      Borrowings (including public deposit) > 1 crores ≤ 5 crores

For turnover / borrowing criteria – only such entities shall be regarded which  are engaged in commercial, industrial or business activities

Holding and subsidiary entities of the above

1.      Entities having turnover in the (excluding other income) > 50 crores ≤ 250 crores

2.      Borrowings (including public deposit) > 10 crores ≤ 50 crores

For turnover / borrowing criteria – only such entities shall be regarded which  are engaged in commercial, industrial or business activities

3.      Holding and subsidiary entities of the above

A.      Accounting Standard(s) not applicable:

AS 3   – Cash Flow Statements

AS 17 – Segment Reporting

AS 20 – Earnings Per Share


B.      Accounting Standard(s) applicable with disclosure exemption:

AS 19 – Leases

AS 28 – Impairment of Assets

AS 29 – Provisions, Contingent Liabilities and Contingent Assets


C.      Accounting Standard(s) applicable with exemptions:

AS 15 – Employee Benefits


D.     Accounting Standard(s) applicable with Note: [following AS, being related to CFS, the same is not applicable to Level II, III, IV entities unless they voluntary decide to consolidate the financial statements]

AS 21 – Consolidated Financial Statements

AS 23 – Accounting for Investments in Associates in Consolidated Financial Statements

AS 25 – Interim Financial Reporting

AS 27 – Financial Reporting of Interests in Joint Ventures (to the extent of requirements relating to Consolidated Financial Statements)




Remaining non corporate entities 1.      Entities having turnover in the (excluding other income) > 10 crores ≤ 50 crores

2.      Borrowings (including public deposit) > 2 crores ≤ 10 crores

For turnover / borrowing criteria – only such entities shall be regarded which are engaged in commercial, industrial or business activities

3.      Holding and subsidiary entities of the above

All exemptions provided to Level II shall be applicable. Further exemptions:


A.      In addition to full exemptions as given in Level II, further Accounting Standard(s) not applicable:


AS 18 – Related Party Disclosures

AS 24 – Discontinuing Operations


B.      In addition to disclosure exemption as given in Level II, further Accounting Standard(s) applicable with disclosure exemption:


AS 10 – Property, Plant and Equipment

AS 11 – The Effects of Changes in Foreign Exchange Rates

IV [Micro] There were only III levels Remaining non corporate entities All exemptions provided to Level III shall be applicable. Further exemptions:


A.      In addition to full exemptions as given in Level III, further Accounting Standard(s) not applicable:


AS 14 – Accounting for Amalgamations

AS 28 – Impairment of Assets

AS 22 is applicable only for current tax related provisions.


B.      In addition to disclosure exemption as given in Level III, further Accounting Standard(s) applicable with disclosure exemption:


AS 13 – Accounting for Investments



As discussed above, the intent to revise the criteria for classification of non-company entities is to provide exemptions/ relaxations from applicability of all AS to certain entities covered under level I as they will now be shifted to descending levels. These proposed amendments will also lessen the difficulties faced by non-company entities falling under the existing levels as they will be provided with partial or full exemptions by getting transferred to descending levels.


[1]This Announcement supersedes the earlier Announcement of the ICAI on ‘Harmonisation of various differences between the Accounting Standards issued by the ICAI and the Accounting Standards notified by the Central Government’ issued in February 2008, to the extent it prescribes the criteria for classification of Non-company entities (Non-corporate entities) and applicability of Accounting Standards to non-company entities, and the Announcement ‘Revision in the criteria for classifying Level II non-corporate entities’ issued in January 2013.


[3] For turnover / borrowing criteria – only such entities shall be regarded which  are engaged in commercial, industrial or business activities


About time to unfreeze NPA classification and reporting

-Siddarth Goel (


The COVID pandemic last year was surely one such rare occurrence that brought unimaginable suffering to all sections of the economy. Various relief measures granted or actions taken by the respective governments, across the globe, may not be adequate compensation against the actual misery suffered by the people. One of the earliest relief that was granted by the Indian government in the financial sector, sensing the urgency and nature of the pandemic, was the moratorium scheme, followed by Emergency Credit Line Guarantee Scheme (ECLGS). Another crucial move was the allowance of restructuring of stressed accounts due to covid related stress. However, every relief provided is not always considered as a blessing and is at times also cursed for its side effects.

Amid the various schemes, one of the controversial matter at the helm of the issue was charging of interest on interest on the accounts which have availed payment deferment under the moratorium scheme. The Supreme Court (SC) in the writ petition No 825/2020 (Gajendra Sharma Vs Union of India & Anr) took up this issue. In this regard, we have also earlier argued that government is in the best position to bear the burden of interest on interest on the accounts granted moratorium under the scheme owing to systemic risk implications.[1] The burden of the same was taken over by the government under its Ex-gratia payment on interest over interest scheme.[2]

However, there were several other issues about the adequacy of actions taken by the government and the RBI, filed through several writ petitions by different stakeholders. One of the most common concern was the reporting of the loan accounts as NPA, in case of non-payment post the moratorium period. The borrowers sought an extended relief in terms of relaxation in reporting the NPA status to the credit bureaus. Looking at the commonality, the SC took the issues collectively under various writ petitions with the petition of Gajendra Sharma Vs Union of India & Anr. While dealing with the writ petitions, the SC granted stay on NPA classification in its order dated September 03, 2020[3]. The said order stated that:

In view of the above, the accounts which were not declared NPA till 31.08.2020 shall not be declared NPA till further orders.”

The intent of granting such a stay was to provide interim relief to the borrowers who have been adversely affected by the pandemic, by not classifying and reporting their accounts as NA and thereby impacting their credit score.

The legal ambiguity

The aforesaid order dated September 03, 2020, has also led to the creation of certain ambiguities amongst banks and NBFCs. One of them being that whether post disposal of WP No. 825/2020 Gajendra Sharma (Supra), the order dated September 03, 2020, should also nullify. While another ambiguity being that whether the stay is only for those accounts that have availed the benefit under moratorium scheme or does it apply to all borrowers.

It is pertinent to note that the SC was dealing with the entire batch of writ petitions while it passed the common order dated September 03, 2020. Hence, the ‘stay on NPA classification’ by the SC was a common order in response to all the writ petitions jointly taken up by the court. Thus, the stay order on NPA classification has to be interpreted broadly and cannot be restricted to only accounts of the petitioners or the accounts that have availed the benefit under the moratorium scheme. As per the order, the SC held that accounts that have not been declared/classified NPA till August 31, 2020, shall not be downgraded further until further orders. This relaxation should not just be restricted to accounts that have availed moratorium benefit and must be applied across the entire borrower segment.

The WP No. 825/2020 Gajendra Sharma (Supra) was disposed of by the SC in its judgment dated November 27, 2020[4], whereby in the petition, the petitioner had prayed for direction like mandamus; to declare moratorium scheme notification dated 27.03.2020 issued by Respondent No.2 (RBI) as ultra vires to the extent it charges interest on the loan amount during the moratorium period and to direct the Respondents (UOI and RBI) to provide relief in repayment of the loan by not charging interest during the moratorium period.

The aforesaid contentions were resolved to the satisfaction of the petitioner vide the Ex-gratia Scheme dated October 23, 2020. However, there has been no express lifting of the stay on NPA classification by the SC in its judgment. Hence, there arose a concern relating to the nullity of the order dated September 03, 2020.

The other writ petitions were listed for hearing on December 02, 2020, by the SC via another order dated November 27, 2020[5]. Since then the case has been heard on dates 02, 03, 08, 09, 14, 16, and 17 of December 2020. The arguments were concluded and the judgment has been reserved by the SC (Order dated Dec 17, 2020[6]).

As per the live media coverage of the hearing by Bar and Bench on the subject matter, at the SC hearing dated December 16, 2020[7], the advocate on behalf of the Indian Bank Association had argued that:

It is undeniable that because of number of times Supreme Court has heard the matter things have progressed. But how far can we go?

I submit this matter must now be closed. Your directions have been followed. People who have no hope of restructuring are benefitting from your ‘ don’t declare NPA’ order.

Therefore, from the foregoing discussion, it could be understood that the final judgment of the SC is still awaited for lifting the stay on NPA classification order dated September 03, 2020.

Interim Dilemma

While the judgment of the SC is awaited, and various issues under the pending writ petitions are yet to be dealt with by the SC in its judgment, it must be reckoned that banking is a sensitive business since it is linked to the wider economic system. The delay in NPA classification of accounts intermittently owing to the SC order would mean less capital provisioning for banks. It may be argued that mere stopping of asset classification downgrade, neither helps a stressed borrower in any manner nor does it helps in presenting the true picture of a bank’s balance sheet. There is a risk of greater future NPA rebound on bank’s balance sheets if the NPA classification is deferred any further. It must be ensured that the cure to be granted by the court while dealing with the respective set of petitions cannot be worse than the disease itself.

The only benefit to the borrower whose account is not classified NPA is the temporary relief from its rating downgrade, while on the contrary, this creates opacity on the actual condition of banking assets. Therefore, it is expected that the SC would do away with the freeze on NPA classification through its pending judgment. Further, it is always open for the government to provide any benefits to the desired sector of the economy either through its upcoming budget or under a separate scheme or arrangement.


[Updated on March 24, 2021]

The SC puts the final nail to almost a ten months long legal tussle that started with the plea on waiver of interest on interest charged by the lenders from the borrowers, during the moratorium period under COVID 19 relief package.  From the misfortunes suffered by the people at the hands of the pandemic to economic strangulation of people- the battle with the pandemic is still ongoing and challenging. Nevertheless, the court realised the economic limitation of any Government, even in a welfare state. The apex court of the country acknowledged in the judgment dated March 23, 2020[8], that the economic and fiscal regulatory measures are fields where judges should encroach upon very warily as judges are not experts in these matters. What is best for the economy, and in what manner and to what extent the financial reliefs/packages be formulated, offered and implemented is ultimately to be decided by the Government and RBI on the aid and advice of the experts.

Thus, in concluding part of the judgment while dismissing all the petitions, the court lifted the interim relief granted earlier- not to declare the accounts of respective borrowers as NPA. The last slice of relief in the judgement came for the large borrowers that had loans outstanding/sanctioned as on 29.02.2020 greater than Rs.2 crores. The court did not find any rationale in the two crore limit imposed by the Government for eligibility of borrowers, while granting relief of interest-on-interest (under ex-gratia scheme) to the borrowers.[9] Thus, the court directed that there shall not be any charge of interest on interest/penal interest for the period during moratorium for any borrower, irrespective of the quantum of loan. Since the NPA stay has been uplifted by the SC, NBFCs/banks shall accordingly start classification and reporting of the defaulted loan accounts as NPA, as per the applicable asset classification norms and guidelines.

Henceforth, the CIC reporting of the defaulted loan accounts (NPA) must also be done. Surely, the said directions of the court would be applicable only to the loan accounts that were eligible and have availed moratorium under the COVID 19 package. [10]

The lenders should give credit/adjustment in the next instalment of the loan account or in case the account has been closed, return any amount already recovered, to the concerned borrowers.

Given that the timelines for filing claims under the ex-gratia scheme have expired, it is expected that the Government would be releasing extended/updated operational guidelines in this regard for adjustment/ refund of the interest in interest charged by the lenders from the borrowers.











[9] Compound interest burden taken over by the Central Government: Lenders required to pass on benefit to borrowers – Vinod Kothari Consultants

[10] Moratorium on loans due to Covid-19 disruption – Vinod Kothari Consultants; also see Moratorium 2.0 on term loans and working capital – Vinod Kothari Consultants



Corporate Restructuring- Corporate Law, Accounting and Tax Perspective

Resolution Division 


Restructuring is the process of redesigning one or more aspects of a company, and is considered as a key driver of corporate existence. Depending upon the ultimate objective, a company may choose to restructure by several modes, viz. mergers, de-mergers, buy-backs and/ or other forms of internal reorganisation, or a combination of two or more such methods.

However, while drafting a restructuring plan, it is important to take into consideration several aspects viz. requirements under the Companies Act, SEBI Regulations, Competition Act, Stamp duty implications, Accounting methods (AS/ Ind-AS), and last but not the least, taxation provisions.

In this presentation, we bring to you a compilation of the various modes of restructuring and the applicable corporate law provisions, accounting standards and taxation provisions.

Bridging the gap between Ind AS 109 and the regulatory framework for NBFCs

-Abhirup Ghosh


The Reserve Bank of India, on 13th March, 2020, issued a notification[1] providing guidance on implementation of Indian Accounting Standards by non-banking financial companies. This guidance comes after almost 2 years from the date of commencement of first phase of implementation of Ind AS for NBFCs.

The intention behind this Notification is to ensure consistency in certain areas like – asset classification, provisioning, regulatory capital treatment etc. The idea of the Notification is not to provide detailed guidelines on Ind AS implementation. For areas which the Notification has not dealt with, notified accounting standards, application guidance, educational material and other clarifications issued by the ICAI should be referred to.

The Notification is addressed to all non-banking financial companies and asset reconstruction companies. Since, housing finance companies are now governed by RBI and primarily a class of NBFCs, this Notification should also apply to them. But for the purpose of this write-up we wish to restrict our scope to NBFCs, which includes HFCs, only.

The Notification becomes applicable for preparation of financial statements from the financial year 2019-20 onwards, therefore, it seems the actions to be taken under the Notification will have to be undertaken before 31st March, 2020, so far as possible.

In this article we wish to discuss the outcome the Notification along with our comments on each issue. This article consists of the following segments:

  1. Things to be done by the Board of Directors (BOD)
  2. Expected Credit Losses (ECL) and prudential norms
  3. Dealing with defaults and significant increase in credit risk
  4. Things to be done by the Audit Committee of the Board (ACB)
  5. Computation of regulatory capital
  6. Securitisation accounting and prudential norms
  7. Matters which skipped attention

1.   Things to be done by the BOD

The Notification starts with a sweeping statement that the responsibility of preparing and ensuring fair presentation of the financial statements lies with the BOD of the company. In addition to this sweeping statement, the Notification also demands the BOD to lay down some crucial policies which will be essential for the implementation of Ind AS among NBFCs and they are: a) Policy for determining business model of the company; and b) Policy on Expected Credit Losses.

(A) Board approved policy on business models: The Company should have a Board approved policy, which should articulate and document the business models and portfolios of the Company. This is an extremely policy as the entire classification of financial assets, depends on the business model of the NBFC. Some key areas which, we think, the Policy should entail are:

There are primarily three business models that Ind AS recognises for subsequent measurement of financial assets:

(a) hold financial assets in order to collect contractual cash flows;

(b) hold financial assets in order to collect contractual cash flows and also to sell financial assets; and

(c) hold financial assets for the purpose of selling them.

The assessment of the business model should not be done at instrument-by-instrument level, but can be done at a higher level of aggregation. But at the same time, the aggregation should be not be done at an entity-level because there could be multiple business models in a company.

Further, with respect the first model, the Ind AS states that the business model of the company can still be to hold the financial assets in order to collect contractual cash flows even if some of the assets are sold are expected to be sold in future. For instance, the business model of the company shall remain unaffected due to the following transactions of sale:

(a) Sale of financial assets due to increase in credit risk, irrespective of the frequency or value of such sale;

(b) Sale of cash flows are made close to the maturity and where the proceeds from the sale approximate the collection of the remaining contractual cash flows; and

(c) Sale of financial assets due to other reasons, namely, to avoid credit concentration, if such sales are insignificant in value (individually or in aggregate) or infrequent.

For the third situation, what constitutes to insignificant or infrequent has not been discussed in the Ind AS. However, reference can be drawn from the Report of the Working Group of RBI on implementation of Ind AS by banks[2], which proposes that there could be a rebuttable presumption that where there are more than 5% of sale, by value, within a specified time period, of the total amortised cost of financial assets held in a particular business model, such a business model may be considered inconsistent with the objective to hold financial assets in order to collect contractual cash flow.

However, we are not inclined to take the same as prescriptive. Business model of an entity is still a question hinging on several relevant factors, primarily the profit recognition, internal reporting of profits, pursuit of securitization/direct assignment strategy, etc. Of course, the volume may be a persuasive factor.

The Notification also requires that the companies should also have a policy on sale of assets held under amortised cost method, and such policy should be disclosed in the financial statements.

(B) Board approved policy on ECL methodology: the Notification requires the companies to lay down Board approved sound methodologies for computation of Expected Credit Losses. For this purpose, the RBI has advised the companies to use the Guidance on Credit Risk and Accounting for Expected Credit Losses issued by Basel Committee on Banking Supervision (BCBS)[3] for reference.

The methodologies laid down should commensurate with the size, complexity and risks specific to the NBFC. The parameters and assumptions for risk assessment should be well documented along with sensitivity of various parameters and assumptions on the ECL output.

Therefore, as per our understanding, the policy on ECL should contain the following –

(a) The assumptions and parameters for risk assessment – which should basically talk about the probabilities of defaults in different situations. Here it is important to note that the assumptions could vary for the different products that the reporting entity offers to its customers. For instance, if a company offers LAP and auto loans at the same time, it cannot apply same set of assumptions for both these products.

Further, the policy should also lay down indicators of significant increase in credit risk, impairment etc. This would allow the reporting entity in determining classifying its assets into Stage 1, Stage 2 and Stage 3.

(b) Backtesting of assumptions – the second aspect of this policy should deal with backtesting of the assumptions. The policy should provide for mechanism of backtesting of assumption on historical data so as to examine the accuracy of the assumptions.

(c) Sensitivity analysis – Another important aspect of this policy is sensitivity analysis. The policy should provide for mechanism of sensitivity analysis, which would predict the outcome based on variations in the assumptions. This will help in identifying how dependant the output is on a particular input.

Further, the Notification states that any change in the ECL model must be well documented along with justifications, and should be approved by the Board. Here it is important to note that there could two types of variations – first, variation in inputs, and second, variation in the model. As per our understanding, only the latter should be placed before the BOD for its approval.

Further, any change in the assumptions or parameters or the ECL model for the purpose of profit smothering shall seriously be frowned upon by the RBI, as it has clearly expressed its opinion against such practices.

2.   Expected Credit Losses (ECL) and prudential norms

The RBI has clarified that whatever be the ECL output, the same should be subject to a regulatory floor which in this case would be the provisions required to be created as the IRAC norms. Let us understand the situation better:

The companies will have to compute two types of provisions or loss estimations going forward – first, the ECL as per Ind AS 109 and its internal ECL model and second, provisions as per the RBI regulations, which has to be computed in parallel, and at asset level.

The difference between the two will have to be dealt with in the following manner:

(A) Impairment Reserve: Where the ECL computed as per the ECL methodology is lower than the provisions computed as per the IRAC norms, then the difference between the two should be transferred to a separate “Impairment Reserve”. This transfer will not be a charge against profit, instead, the Notification states that the difference should be appropriated against the profit or loss after taxes.

Interestingly, no withdrawals against this Impairment Reserve is allowed without RBI’s approval. Ideally, any loss on a financial asset should be first adjusted from the provision created for that particular account.

Further, the continuity of this Impairment Reserve shall be reviewed by the RBI going forward.

A large number of NBFCs have already presented their first financial statements as per Ind AS for the year ended 31st March, 2019. There were two types of practices which were followed with respect to provisioning and loss estimations. First, where the NBFCs charged only the ECL output against its profits and disregarded the regulatory provisioning requirements. Second, where the NBFCs computed provisions as per regulatory requirements as well as ECL and charged the higher amount between the two against the profits.

The questions that arise here are:

(a) For the first situation, should the NBFCs appropriate a higher amount in the current year, so as to compensate for the amount not transferred in the previous year?

(b) For the second situation, should the NBFCs reverse the difference amount, if any, already charged against profit during the current year and appropriate the same against profit or loss?

The answer for both the questions is negative. The provisions of the Notification shall have to be implemented for the preparation of financial statements from the financial year 2019-20 onwards, hence, we don’t see the need for adjustments for what has already been done in the previous year’s financial statements.

(B) Disclosure: The difference between the two will have to be disclosed in the annual financial statements of the company, format of which has been provided in the Notification[4]. Going by the format, the loss allowances created on Stage 1, Stage 2 and Stage 3 cases will have to be shown separately, similarly, the provisions computed on those shall also have to be shown separately.

While Stage 1 and Stage 2 cases have been classified as standard assets in the format, Stage 3 cases cover sub-standard, doubtful and loss assets.

Loss estimations on loan commitments, guarantees etc. which are covered under Ind AS but does not require provisioning under the RBI Directions should also be presented.

3.     Dealing with defaults and significant increase in credit risk

Estimation of expected losses in financial assets as per Ind AS depends primarily on credit risk assessment and identifying situations for impairment. Considering the importance of issue, the RBI has voiced its opinion on identification of “defaults” and “significant increase in credit risk”.

(A)Defaults: The next issue which has been dealt with in the Notification is the meaning of defaults. Currently, there seems to be a departure between the Ind AS and the regulatory definition of “defaults”. While the former allows the company to declare an account as default based on its internal credit risk assessments, the latter requires that all cases with delay of more than 90 days should be treated as default. The RBI expects the accounting classification to be guided by the regulatory definition of “defaults”.

 If a company decides not to impair an account even after a 90 days delay, then the same should be approved by the Audit Committee.

This view is also in line with the definition of “default” proposed by the BASEL framework for IRB framework, which is:

“A default is considered to have occurred with regard to a particular obligor when one or more of the following events has taken place.

 (a) It is determined that the obligor is unlikely to pay its debt obligations (principal, interest, or fees) in full;

 (b) A credit loss event associated with any obligation of the obligor, such as a charge-off, specific provision, or distressed restructuring involving the forgiveness or postponement of principal, interest, or fees;

 (c) The obligor is past due more than 90 days on any credit obligation; or

 (d) The obligor has filed for bankruptcy or similar protection from creditors.”

Further, the number of cases of defaults and the total amount outstanding and overdue should be disclosed in the notes to the financial statements. As per the current regulatory framework, NBFCs have to present the details of sub-standard, doubtful and loss assets in its financial statements. Hence, this disclosure requirement is not new, only the sub-classification of NPAs have now been taken off.

(B) Dealing with significant increase in credit risk: Assessment of credit risk plays an important role in ECL computation under Ind AS 109. Just to recapitulate, credit risk assessments can be lead to three possible situations – first, where there is no significant increase in credit risk, second, where there is significant increase in credit risk, but no default, and third, where there is a default. These three outcomes are known as Stage 1, Stage 2 and Stage 3 cases respectively.

 In case an account is under Stage 1, the loss estimation has to be done based on probabilities of default during next 12 months after the reporting date. However, if an account is under Stage 2 or Stage 3, the loss estimation has to be done based on lifetime probabilities of default.

Technically, both Stage 1 and Stage 2 cases would fall under the definition of standard assets for the purpose of RBI Directions, however, from accounting purposes, these two stages would attract different loss estimation techniques. Hence, the RBI has also voiced its opinion on the methodology of credit risk assessment for Stage 2 cases.

The Notification acknowledges the presence of a rebuttable presumption of significant increase in credit risk of an account, should there be a delay of 30 days or more. However, this presumption is rebuttable if the reporting entity has reasonable and supportable information that demonstrates that the credit risk has not increased significantly since initial recognition, despite a delay of more than 30 days. In a reporting entity opts to rebut the presumption and assume there is no increase in credit risk, then the reasons for such should be properly documented and the same should be placed before the Audit Committee.

However, the Notification also states that under no circumstances the Stage 2 classification be deferred beyond 60 days overdue.

4.   Things to be done by the ACB

The Notification lays down responsibilities for the ACB and they are:

(A) Approval of any subsequent modification in the ECL model: In order to be doubly sure about that any subsequent change made to the ECL model is not frivolous, the same has to be placed before the Audit Committee for their approval. If approved, the rationale and basis of such approval should be properly documented by the company.

(B) Reviewing cases of delays and defaults: As may have been noted above, the following matters will have to be routed through the ACB:

(a) Where the reporting entity decides not to impair an account, even if there is delay in payment of more than 90 days.

(b) Where as per the risk assessment of the reporting entity, with respect to an account involving a delay of more than 30 days, it rebuts that there is no significant increase in credit risk.

In both the cases, if the ACB approves the assumptions made by the management, the approval along with the rationale and justification should be properly documented.

5.   Computation of Regulatory Capital

The Notification provides a bunch of clarifications with respect to calculation of “owned funds”, “net owned funds”, and “regulatory capital”, each of which has been discussed here onwards:

(A) Impact of unrealised gains or losses arising on fair valuation of financial instruments: The concept of fair valuation of financial instruments is one of the highlights of IFRS or Ind AS. Ind AS 109 requires fair valuation of all financial instruments. The obvious question that arises is how these gains or losses on fair valuation will be treated for the purpose of capital computation. RBI’s answer to this question is pretty straight and simple – none of these of gains will be considered for the purpose of regulatory capital computation, however, the losses, if any, should be considered. This view seems to be inspired from the principle of conservatism.

 Here it is important to note that the Notification talks about all unrealised gains arising out of fair valuation of financial assets. Unrealised gain could arise in two situations – first, when the assets are measured on fair value through other comprehensive income (FVOCI), and second, when the assets are measured on fair value through profit or loss (FVTPL).

In case of assets which are fair valued through profit or loss, the gains or losses once booked are taken to the statement of profit or loss. Once taken to the statement of profit or loss, these gains or losses lose their individuality. Further, these gains or losses are not shown separately in the Balance Sheet and are blended with accumulated profits or losses of the company. Monitoring the unrealised gains from individual assets would mean maintenance of parallel accounts, which could have several administrative implications.

Further, when these assets are finally sold and gain is realised, only the difference between the fair value and value of disposal is booked in the profit and loss account. It is to be noted here that the gain on sale of assets shown in the profit and loss account in the year of sale is not exactly the actual gain realised from the financial asset because a part of it has been already booked during previous financial years as unrealised gains. If we were to interpret that by “unrealised gains” RBI meant unrealised gains arising due to FVTPL as well, the apparent question that would arise here is – whether the part which was earlier disregarded for the purpose of regulatory capital will now be treated as a part of capital?

Needless to say, extending the scope of “unrealised gains” to mean unrealised gains from FVTPL can create several ambiguities. However, the Notification, as it stands, does not contain answers for these.

In addition to the above, the Notification states the following in this regard:

  • Even unrealised gains arising on transition to Ind AS will have to be disregarded.
  • For the purpose of computation of Tier I capital, for investments in NBFCs and group companies, the entities must reduce the lower of cost of acquisition or their fair value, since, unrealised gains are anyway deducted from owned funds.
  • For any other category of investments, unrealised gains may be reduced from the value of asset for the purpose of risk-weighting.
  • Netting off of gains and losses from one category of assets is allowed, however, netting off is not allowed among different classes of assets.
  • Fair value gains on revaluation of property, plant and equipment arising from fair valuation on the date of transition, shall be treated as a part of Tier II capital, subject to a discount of 55%.
  • Any unrealised gains or losses recognised in equity due to (a) own credit risk and (b) cash flow hedge reserve shall be derecognised while determining owned funds.

(B) Treatment of ECL: The Notification allows only Stage 1 ECL, that is, 12 months ECL, to be included as a part of Tier II capital as general provisions and loss reserves. Lifetime ECL shall not be reckoned as a part of Tier II capital.

6.   Securitisation accounting and prudential norms

All securitisation transactions undergo a strict test of de-recognition under Ind AS 109. The conditions for de-recognition are such that most of the structures, prevalent in India, fail to qualify for de-recognition due to credit enhancements. Consequently, the transaction does not go off the books.

The RBI has clarified that the cases of securitisation that does not go off the books, will be allowed capital relief from regulatory point of view. That is, the assets will be assigned 0% risk weight, provided the credit enhancement provided for the transaction is knocked off the Tier I (50%) and Tier II (remaining 50%).

There are structures where the level of credit enhancement required is as high as 20-25%, the question here is – should the entire credit support be knocked off from the capital? The answer to this lies in the RBI’s Securitisation Guidelines from 2006[5], which states that the knocking off of credit support should be capped at the amount of capital that the bank would have been required to hold for the full value of the assets, had they not been securitised, that is 15%.

For securitisation transactions which qualify for complete de-recognition, we are assuming the existing practice shall be followed.

But apart from the above two, there can also be cases, where partial de-recognition can be achieved – fate of such transactions is unclear. However, as per our understanding, to the extent of retained risk, by way of credit enhancement, there should be a knock off from the capital. For anything retained by the originator, risk weighting should be done.

Matters which skipped attention

There are however, certain areas, which we think RBI has missed considering and they are:

  1. Booking of gain in case of de-recognition of assets: As per the RBI Directions on Securitisation, any gain on sale of assets should be spread over a period of time, on the other hand, the Ind AS requires upfront recognition of gain on sale of assets. The gap between the two should been bridged through this Notification.
  2. Consideration of OCI as a part of Regulatory Capital: As per Basel III framework, other comprehensive income forms part of Common Equity Tier I [read our article here], however, this Notification states all unrealised gains should be disregarded. This, therefore, is an area of conflict between the Basel framework and the RBI’s stand on this issue.


Read our articles on the topic:

  1. NBFC classification under IFRS financial statements:
  2. Ind AS vs Qualifying Criteria for NBFCs-Accounting requirements resulting in regulatory mismatch?:
  3. Should OCI be included as a part of Tier I capital for financial institutions?:
  4. Servicing Asset and Servicing Liability: A new by-product of securitization under Ind AS 109:
  5. Classification and reclassification of financial instruments under Ind AS:







Lease Accounting under IFRS 16- A leap towards transparency!

Megha Mittal

Our mission is to develop IFRS Standards that bring transparency, accountability and efficiency to financial markets around the world”, the International Accounting Standards Board (IASB) is indeed on a way towards fulfilling its mission. The International Financial Reporting Standards (IFRS) have been worldwide acknowledged and appreciated as a benchmark of transparency, trust and growth. In another specimen of its attempt to increase transparency in financial markets around the world, the IASB, back in 2016, introduced the IFRS 16, to be applicable w.e.f. annual reporting period beginning on or after 01.01.2019.

Introduced with the objective of introducing a single lessee accounting model, the IFRS-16, aims at ensuring faithful representation of lease transactions and pioneers the concept of “Right-to-Use” Assets.

In this article, we intend to delve deeper into what IFRS-16 brings to the table, its objective and most importantly its impact.

Understanding the Concept

In the present financial set-up of our economy and business environment, “Lease” is an indispensable element. With the advantages it carries and the flexibility it has provided to financing, the concept of lease has penetrated to every strata of being. However, from an accounting perspective, the nexus of “lease” with “assets” makes it essential to understand the procedure of incorporating the lease transactions in the books of both the lessor (legal owner of the asset) and the lessee (user of the asset); and, IFRS-16 is the answer.

While it does not modify the accounting treatment in the books of the lessors from that laid down in IAS 17, IFRS-16 introduces a single lessee accounting model and requires a lessee to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value. A lessee is required to recognise a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments.

To understand better, let us now take an illustration:

Illustration 1:

A is the legal owner of a car. B, a small businessman, intends to take the car on lease for a period of 3 years. Here, A becomes the Lessor, and B, steps into the shoes of a Lessee. Now that B has the right to use the car, he must identify this car as a right-to-use asset, more colloquially knows as RTU Asset.

Hence, the Lessee records the car along with other non-financial assets like property, plant and building, and the lease liabilities along with other liabilities. It is pertinent to note that the RTU asset must however, be recorded at its present value, arrived at by discounting at its Internal Rate of Return (IRR). As a result, the lessee also recognises depreciation of the RTU Asset and interest on the lease liability in its Statement of Profit and Loss.

Rationale behind IFRS-16:

By what can be called the “5 Rule Check”, IAS 17, distinguishes leases into two broad classesviz. Operational and Financial Leases. While the leased assets wererecorded in the books of the lessor, in case of both operational and financial leases; as per IAS 17, an operational lease in the books of a lessee was treated as an “off-balance sheet” item. Regards the objective with which the new standard was introduced, IASB Chairman, Mr. Hans Hoogervorst, said that “These new accounting requirements bring lease accounting into the 21st century, ending the guesswork involved when calculating a company’s often-substantial lease obligation. The new standard will provide much-needed transparency on companies’ lease assets and liabilities, meaning that off balance sheet lease financing is no longer lurking in the shadows. It will also improve comparability between companies that lease and those that borrow to buy.

Hence, it is clearly a step towards IASB’s vision of transparency, accountability and efficiency.


Put simply, IFRS 16 eliminates the distinction between operational and financial lease in the books of a lessee. We shall now analyse its impact in the real field and compare the outcome with the expectations.

Overall Impact:

On the surface, the accounting treatment will have a knock-off effect on financial elements; for instance, Earnings before Interest, Tax, Depreciation & Amortization (EBITDA) and Profit After Tax (PAT).

Let us understand this effect with the help of an illustration:

Illustration 2:

A Ltd., an aviation company, has taken on lease, aircrafts worth Rs. 1000 crore, having residual value (RV) 20%, for 36 months, @ 12% p.a., having revenue of Rs. 15,000 crore

On the basis of the above information, we get the following:

  • Lease Rental p.a. : Rs. 342.86 crores
  • Right to Use Asset (RTU) : Rs. 860.22 crores
  • Depreciation on RTU Asset (on SLM Basis) : Rs. 286.74 crores
  • Annual Interest @ 12% p.a. : Rs. 89.59 crores

Now let us compare the impact of the accounting treatment under IAS 17 vs. IFRS 16:

Note: Unlike IFRS-16, under IAS 17, the entire operating lease transaction remains to be an off-balance sheet transaction. Under IFRS 16, the RTU less depreciation is recorded under the assets side vis-à-vis. Lease payables under the liabilities head.

Hence, as evident from the above illustration, sum towards rentals (fixed cost) under IAS 17, have now been substituted with Interest obligation under IFRS 16, and as such the EBIDTA is higher in the initial years. Further, recording the asset at RTU value also gives way for depreciation, and hence, as a result of depreciation along with interest, the PBT reduces in the initial years. From a bird’s eye view, both the assets and liabilities of the lessees adopting IFRS 16 will increase.

Re-negotiation of Loan Covenants:

Further, now that the lease assets are to be recorded, it will typically result in companies appearing to be more debt leveraged; however, since leases are most likely on the operating transaction side vis-à-vis loan transactions, this is not the true picture. This pseudo-presence of huge liabilities is also likely to take a toll on the lessee’s credit rating. Hence, formal communication with the lenders will become a matter of concern, and a sound two-way communication and transparency with the lenders will be the key to managing the transition from IAS 17 to IFRS 16, smooth and efficient.

Industry-wise Impact:

With the first quarter of F.Y. 2019-20 embarking the first quarter of implementation of IFRS 16, the author makes a humble attempt to study the impact, on the basis of financial results declared by several industry-majors.

BPM Industry-

According to a study by Cushman & Wakefield in June 2019, the Indian markets show a strong presence in office space leasing. It has also been observed that the IT-BPM sector, has a higher share in office lease activities, as compared to its contemporaries. Hence, it is evident that the “leasing” is an essential element in the BPM industry.

As the Mumbai-based BPM giant, WNS Global announced its first quarter results; we observe that while the operating profit increased as a result of IFRS 16, the profit for the quarter has decreased. This increase in the operating margins comes to picture as fixed costs reduce with interests of lease payments replace the rentals; the counter result of which is the increase in finance costs due to which the ultimate profit dips.

It is said that the three objectives of any business is Survival, Profit and then Growth. However, as may be seen from above, application of IFRS 16 has led to fall in the profit. It is apprehended that the fall in profit may hold back companies, in the BPM sector from continuing office-space leasing.

Aviation Industry-

Ever imagined that the airplanes we fly in, are most likely not even present on the company’s balance sheet? This non-appearance in the balance sheets was the outcome of accounting standards laid down under IAS 17. However, with IFRS 16 in the picture, the new financial year will be different from previous fiscals, especially for the aviation industry, as they now have to record all lease transactions in their books.

Adopting IAS 116, the Indian counterpart of IFRS 16, the airline industries now have to capitalise operating leases as RTU assets. While recording lease transactions and its by-products like interest, depreciation, the impact will majorly depend on factors like

  • Proportion of operating lease in the overall asset pool;
  • Duration of leases.

With leasing forming an indispensable element of airline companies, even though accounting should not be the key driver in commercial negotiations, market behaviour might change towards shorter lease tenures to minimize lease liabilities.

Owing to the fall in profits in the initial years, it is expected that there might be fall in operating leases, and sale & lease-back arrangements, which will prompt the airlines to purchase more aircrafts. Mr. Wui Jin Woon, Head of Aviation, Asia Pacific, Natixis CIB, also said that “Airline with sufficient access to liquidity may be more incline to purchase now that there is no difference from an accounting perspective between operating and finance leases.

However, adopting IAS 116, the Indian counterpart of IFRS 16, the airline industry major, IndiGo stated that while there might be changes in the future reported profits, which may necessitate a change in current P/E based valuation methodology, it will not impact IndiGo’s cash profits, cash flows and growth strategy.

Hence, while there is broad consensus on how the standard will affect various financial metrics, there is considerably less agreement on how it might influence operating decisions and market sentiments.

Communication Industry:

Most Communications companies enter into lease agreements both as lessors and lessees, as such, leases in the industry are prevalent. The new standard is likely therefore to have a material impact for Communications companies.

Arrangements which may contain leases could include – customer contracts for using identified network or infrastructure equipment, equipment provided to customers through which the operator delivers communication services such as set top boxes and modems, and data centre services etc.

As a consequence of IFRS 16, the potential business impact could include renegotiation of network development and network sharing agreements. Further, companies already having large asset bases, may be prey to the impairment risk with the addition of further assets in the balance sheet.

Automobile Industry

(a) Corporate Car Leasing

Corporate Car Leasing is a very innovative employee benefit scheme that has cropped up off late. Under this scheme, big corporates provide its employees, car taken on operational lease, which the end of tenure is sold to the employee at a nominal value.Hence, while the car is essentially for the benefit of the employees, the company is the actual lessee. As this set up was in the nature of an operating lease, the lessee, as per IAS 17, was not required to record the car in its balance sheet.

However, will the roll in of IFRS 16, the corporates will be required to record these cars at their RTU as assets and a corresponding lease liability in their books; as a result of which, the balance sheet of the corporate shall increase manifold.

(b) Fleet Management

In the Fleet Management market, leasing, especially operating lease has proven to be a smart move to optimise its costs and maintain adequate ratios, as until now, it was not required to be recognized in the balance sheet of the lessee.

Murray Price, managing director of EQSTRA Fleet Management said, “These include the impact on the company’s financial report, key ratios, disclosures, the cost of implementation, the ability to access desired information, the impact of covenants and debt renegotiations and leasing strategies.

This magnification of balance sheet, by virtue of change in accounting policies is anticipated to be detrimental to this industry. It is expected that this will hold back corporates from entering into such arrangements.

Change in the Lessors’ Approach:

Like every action has a reaction, even though IFRS 16 does not essentially alter or modify accounting methodologies adopted by the lessors,  the lessors may be impacted in their business models due to change in lessees’ behaviour. From the foregoing, a common thread that can be observed is that lessees having better liquidity, will now tend to incline towards purchasing the assets rather than leasing, as such, lessors may be required to revaluate the current portfolio of leases and prospective targets to identify lessees that may seek to alter their strategies as a result of IFRS-16.

Global Scenario:

Moving ahead from the industry wise acceptance, we shall now see how the new standard has been welcomed at the global level.While India has come up with IAS 116, drawn on the same lines and principles as IFRS 16, the United stated shall continue to follow ASC 842, dealing with the same subject.

Further, barring variances in implementation due to local regulatory requirements, IFRS 16 has been relatively consistently adopted in most of the Asia-Pacific markets. In Hong Kong, for example, most companies have a December financial year-end and submit financial statements to in around August in the following year. IFRS 16 impacts may become more apparent when listed companies release interim results in July 2019.

In Australia, most year-ends are in June, so some companies will not technically need to grapple with IFRS 16 until the second half of 2019.Similar patterns are evident in Singapore, Malaysia, India and the Philippines, where common accounting periods and reporting practices mean many companies won’t have to address IFRS 16 until later in the year.

The equivalent standards in Thailand and Indonesia are not effective until January 2020. In China, the Ministry of Finance only released the local version of the standard in December 2018, giving non-listed companies up to 2021 to adopt.


Given the gravitas and indispensable presence of leases and the fact that it resides on such a large scale ground, to judge with certainty, the impact of IFRS 16 certainly requires more time. The dust around the same has not settled yet, hence one can say the picture is not yet vivid; however, it surely sets up the pace for what might unveil in days to come.


Link to our other publication on the above subject are provided below:




Ind AS vs Qualifying Criteria for NBFCs-Accounting requirements resulting in regulatory mismatch?

-Financial Services Division and IFRS Division,  (

The transition of accounting policies for the non-banking financial companies (NBFCs) is on the verge of being completed. As was laid down in the implementation guide issued by the Ministry of Corporate Affairs, the Indian Accounting Standard (Ind AS) was to be implemented in the following manner:

Non-Banking Financial Companies (NBFCs)
Phase I


 From 1st April, 2018 (with comparatives for the periods ending on 31st  March, 2018)
·         NBFCs having net worth of rupees five hundred crore or more (whether listed or unlisted)
·         holding, subsidiary, joint venture and associates companies of above NBFC other than those already covered under corporate roadmap shall also apply from said date
Phase II From 1st April, 2019 (with comparatives for the periods ending on 31st March, 2019)
·         NBFCs whose equity and/or debt securities are listed or in the process of listing on any stock exchange in India or outside India and having net worth less than rupees five hundred crore


·         NBFCs that are unlisted companies, having net worth of rupees two-hundred and fifty crore  or more but less than rupees five hundred crore
·         holding, subsidiary, joint venture and associate companies of above other than those already covered under the corporate roadmap
· Unlisted NBFCs having net worth below two-hundred and fifty crore shall not apply Ind AS.

· Voluntary adoption of Ind AS is not allowed (allowed only when required as per roadmap)

· Applicable for both Consolidated and Individual Financial Statements

As may be noted, the NBFCs have been classified into three major categories – a) Large NBFCs (those with net worth of ₹ 500 crores or more), b) Mid-sized NBFCs (those with net worth of ₹ 250 crores – ₹ 500 crores) and c) Small NBFCs (unlisted NBFCs with net worth of less than ₹ 250 crores).

The implementation of Ind AS for Large NBFCs has already been completed, and those for Mid-sized NBFCs is in process; the Small NBFCs are anyways not required implementation.

The NBFCs are facing several implementation challenges, more so because the regulatory framework for NBFCs have not undergone any change, despite the same being closely related to accounting framework. Several compliance requirements under the prudential norms are correlated with the financial statements of the NBFCs, however, several principles in Ind AS are contradictory in nature.

One such issue of contradiction relates to determination of qualifying assets for the purpose of NBFC classification. RBI classifies NBFCs into different classes depending on the nature of the business they carry on like Infrastructure Finance Companies, Factoring Companies, Micro Finance Companies and so on. In addition to the principal business criteria which is applicable to all NBFCs, RBI has also laid down special conditions specific to the business carried on by the different classes of NBFCs. For instance, the additional qualifying criteria for NBFC-IFCs are:

(a) a minimum of 75 per cent of its total assets deployed in “infrastructure loans”;

(b) Net owned funds of Rs.300 crore or above;

(c) minimum credit rating ‘A’ or equivalent of CRISIL, FITCH, CARE, ICRA, Brickwork Rating India Pvt. Ltd. (Brickwork) or equivalent rating by any other credit rating agency accredited by RBI;

(d) CRAR of 15 percent (with a minimum Tier I capital of 10 percent)

Similarly, there are conditions laid down for other classes of NBFCs as well. The theme of this article revolves the impact of the Ind AS implementation of the conditions such as these, especially the ones dealing with sectoral deployment of assets or qualifying assets. But before we examine the specific impact of Ind AS on the compliance, let us first understand the implications of the requirement.

Relevance of sectoral deployment of funds/ qualifying assets for NBFCs

The requirement, such as the one discussed above, that is, of having 75% of the total assets deployed in infrastructure loans by the company happens to be a qualifying criteria. IFCs are registered with the understanding that they will operate predominantly to cater the requirements of the infrastructure sector and therefore, their assets should also be deployed in the infrastructure sector. However, once the thresholds are satisfied, the remaining part of the assets can be deployed elsewhere, as per the discretion of the NBFC.

The above requirement, in its simplest form, means to have intentional and substantial amount of the total assets of the NBFC in question to be deployed in the infrastructure area, both, at the time of registration, as well as a regulatory requirement, which has to be met over time. Breaching the same would result in non-fulfilment of the RBI regulations.

Impact of Ind AS on the qualifying criteria

The above requirement might seem simple, however, with the implementation of Ind AS on NBFC, there can be important issues which might result in the breach of the above requirement.

With the overall slogan of “Substance over Form”, and promoting “Fair Value Accounting” and an aim to make the financial statements more transparent and just, Ind AS have been implemented. However, the same fair value accounting can result in a mismatch of regulatory requirement, to such an extent that the repercussion may have a serious impact on the existence of being an NBFC.

As already stated above, once an NBFC satisfies the qualifying criteria, it can deploy the remaining assets anywhere as per its discretion. Let us assume a case, where the remaining assets are deployed in equity instruments of other companies. All this while, under the Indian GAAP, investments in equity shares were recorded in the books of accounts as per their book value, but with the advent of Ind AS, most of these investments are now required to be recorded on fair values. This logic not only applies in case of equity instruments, but in other classes of financial instruments, other than those eligible for classification as per amortised cost method.

The problem arises when the fair value of the financial instruments, other than the NBFC category specific loans like infrastructure loans, exceed the permitted level of diversification (in case of IFC – 25% of the total assets). Such a situation leads to a question whether this will breach the qualifying criteria for the NBFC. A numeric illustration to understand the situation better has been provided below:

Say, an NBFC-IFC, having a total asset size of Rs. 1,000 crores would be required to have 75% of the total assets deployed in infrastructure loans i.e. Rs. 750 crores. The remaining Rs. 250 crores is free for discretionary deployments. Let us assume that the entire Rs. 250 crores have been deployed in other financial assets.

Now, say, after fair valuation of such other financial assets, the value of such assets increases to ₹ 500 crores, this will lead to the following:

Under Indian GAAP Under Ind AS

(in ₹ crores)

As per a % of total assets Amount

(in ₹ crores)

As per a % of total assets
Infrastructure Loans 750 75% 750 60%
Other financial assets 250 25% 500 40%
Total assets 1000 100% 1250 100%


Therefore, if one goes by the face of the balance sheet of the NBFC, there is a clear breach as per the Ind AS accounting, as the qualifying asset comes down to 60% as against the required level of 75%. However, is it justified to take such a view?

The above interpretation is counter-intuitive.

It may be noted that the stress is on “deployment” of its assets by an IFC. Merely because the value of the equity has appreciated due to fair valuation, it cannot be argued that the IFC has breached its maximum discretionary investment limits. The deployment was only limited to 25% or so to say that even though the fair value of the exposure has gone up but the real exposure of the NBFC is only to the extent of 25%. Under Ind AS, the fair value of an exposure may vary but the real exposure will remain unchanged.

Taking any other interpretation will be counter-intuitive. If the equity in question appreciates in value, and if the fair value is captured as the value of the asset in the balance sheet, the IFC will be required to increase its exposure on infrastructure loans. But the IFC in question may be already fully invested, and may not have any funding capability to extend any further infrastructure loans. Under circumstances, one cannot argue that the IFC must be forced to disinvest its equities to bring down its investment in equities, particularly as the same had nothing to do with “deployment” of funds.

This is further fortified by Para 10. Accounting of Investments, Chapter V- Prudential Regulations of the Master Direction – Non-Banking Financial Company – Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016 about valuation of equities:

“Quoted current investments for each category shall be valued at cost or market value whichever is lower”.

Hence, the RBI Regulations have been framed keeping in view the historical cost accounting. There is no question of taking into consideration any increase in fair value of investments.


Therefore, it is safe to say that while determining the compliance with qualifying criteria, one must consider real exposures and not fair value of exposures as the same is neither in spirit of the regulations nor seems logical. This will however be tested over time as we are sure the regulator will have its own say in this, however, until anything contrary is issued in this regard, the above notion seems logical.

New lease accounting standard kicks off from 1st April, 2019

Financial Services Division


The Ministry of Corporate Affairs (MCA) has put a small announcement on its website that the new lease accounting standard, IndAS 116 will get implemented from 1st April 2019. The new Standard, globally implemented in several countries from 1st Jan 2019, is called IFRS 16. The Standard eliminates the 6-decade old distinction between financial and operating leases, from lessee accounting perspective, thereby putting all leases on the balance sheet. The phenomenon of off-balance sheet lease transactions was one of the burning analyses after bankruptcy of Enron in 2001, and since then, had been erupting off and on, until the global standard setter decides to push the new standard on the rule book in Jan 2016, effective 1st Jan 2019.

After the introduction of IFRS 16, the ICAI came out with an exposure draft on the new standard in 2017 and kept it open for comments for some days. However, nothing further was heard about it thereafter.

The exposure draft and the final published Ind AS 116 are same except for the below mentioned change which has been incorporated in the final published Ind AS 116:

Para 47 dealing with presentation in books of lessee:
In Exposure Draft Text of published Ind AS 116
Para 47 A lessee shall either present in the balance sheet, or disclose in the notes: Para 47: A lessee shall either present in the balance sheet, or disclose in the notes:
(a) right-of-use assets separately from other assets. (a) right-of-use assets separately from other assets. If a lessee does not  present right-of-use assets separately in the balance sheet, the lessee shall:
(i) include right-of-use assets within the same line item as that  within which the corresponding underlying assets would be  presented if they were owned; and
(ii) disclose which line items in the balance sheet include those  right-of-use assets.
(b) lease liabilities separately from other liabilities. (b) lease liabilities separately from other liabilities. If a lessee does not  present lease liabilities separately in the balance sheet, the lessee  shall disclose which line items in the balance sheet include those liabilities.

(above para is same as para 47 IFRS 16, thereby making IFRS 16 and Ind AS 116 exactly same now, except for the fair value option for investment property- ref para 1 of comparison with IFRS 16 )

Giving the above option makes it clear how the lessee is going to show the asset in books.

For example, if A takes Aircraft-1 on lease and owns Aircraft-2, A can either include both of them in PPE or can show Aircraft-1 in PPE and Aircraft-2 just below PPE under the head ROU.

Correspondingly, a lease liability can be disclosed separately, if not disclosed separately, then disclose which line item in BS includes the lease liability.

Globally, several jurisdictions have implemented the Standard with effect from 1st January, 2019. A list of jurisdictions which have already adopted can be viewed here.

Some of the key takeaways from the implementation of this Standard are:

  • Currently, there are two accounting standards for lease transactions, first, Ind AS 17, which is applicable to the Ind AS compliant companies and second, AS 19, which is applicable to the remaining classes of companies. Ind AS 116 proposes to replace Ind AS 17, therefore, the companies which are not covered by Ind AS shall continue to follow old accounting standard. 
  • The applicability of this standard shall have to be examined separately for the lessor and the lessee, that is, if the lessor is Ind AS compliant and lessee is not Ind AS compliant, then lessor will follow Ind AS 116 whereas lessee will follow AS 19. 
  • The new standard changes treatment of operating leases in the books of the lessees significantly. Earlier, operating leases remained completely off the balance sheet of the lessee, however, vide this standard, lessees will have to recognise a right-to-use asset on their balance sheet and correspondingly a lease liability will be created in the liability side. 
  • Lease of low value assets and short tenure leases (up to 12 months) have been carved out from the requirement of recognition of RTU asset in the books of the lessee.
  • No change in the accounting treatment in case of financial leases. 
  • No change in the lessor’s’ accounting.

While leasing has not been greatly popular in India compared to the world, there has been a substantial pick up in interest over recent years. Therefore, a question comes – will the new standard put a death knell to the feeble leasing industry in India? To the extent the demand for leasing comes from off balance sheet perspective for a lessee, the standard may have some impact. However, there are many economic drivers for lease transactions – such as the ease of usage, tax benefits, better residual realisation, etc. Those factors remain unaffected, and in fact, the focus of lease attractiveness will shift to real economic factors rather than balance sheet cosmetics.

The apparent question that arises here is whether the new standard unsettle the taxation framework for lease transactions in India, especially direct taxes – the answer to this question is negative. The tax treatment of lease transaction does not depend on the treatment of the transaction in books of accounts. Instead, it depends on whether the transaction is case a true lease or is merely a disguised financial transaction. There will be no impact on the indirect taxation framework as well.

Indefinite deferral of IFRS for banks: needed reprieve or deferring the pain?

Vinod Kothari (; Abhirup Ghosh (

On 22 March, 2019, just days before the onset of the new financial year, when banks were supposed to be moving into IFRS, the RBI issued a notification[1], giving Indian banks indefinite time for moving into IFRS. Most global banks have moved into IFRS; a survey of implementation for financial institutions shows that there are few countries, especially which are less developed, where banks are still adopting traditional GAAPs. However, whether the Notification of the RBI is giving the banks a break that they badly needed, or is just giving them today’s gain for tomorrow’s pain, remains to be analysed.

The RBI notifications lays it on the legislative changes which, as it says, are required to implement IFRS. It refers to the First Bi-monthly Monetary Policy 2018-19[2], wherein there was reference to legislative changes, and preparedness. There is no mention in the present  notification for preparedness – it merely points to the required legislative changes. The legislative change in the BR Act would have mostly been to the format of financial statements – which is something that may be brought by way of notification. That is how it has been done in case of the Companies Act.

This article analyses the major ways in which IFRS would have affected Indian banks, and what does the notification mean to the banking sector.

Major changes that IFRS would have affected bank accounting:

  • Expected Credit Loss – Currently, financial institutions in India follow an incurred credit loss model for providing for financial assets originated by them. Under the ECL model, financial assets will have to be classified into three different stages depending on credit risk in the asset and they are:
    • Stage 1: Where the credit risk in the asset has not changed significantly as compared to the credit risk at the time of origination of the asset.
    • Stage 2: Where the credit risk in the asset has increased significantly as compared to the credit risk at the time of origination of the asset.
    • Stage 3: Where the asset is credit impaired.

While for stage 1 financial assets, ECL has to be provided for based on 12 months’ expected losses, for the remaining stages, ECL has to be provided for based on lifetime expected losses.

The ECL methodology prescribed is very subjective in nature, this implies that the model will vary based on the management estimates of each entity; this is in sharp contrast to the existing provisioning methodology where regulators prescribed for uniform provisioning requirements.

Also, since the provisioning requirements are pegged with the credit risk in the asset, this could give rise to a situation where the one single borrower can be classified into different stages in books of two different financial institutions. In fact, this could also lead to a situation where two different accounts of one single borrower can be classified into two different stages in the books of one financial entity.

  • De-recognition rules – Like ECL provisioning requirements, another change that will hurt banks dearly is the criteria for derecognition of financial assets.

Currently, a significant amount of NPAs are currently been sold to ARCs. Normally, transactions are executed in a 15:85 structure, where 15% of sale consideration is discharged in cash and the remaining 85% is discharged by issuing SRs. Since, the originators continue to hold 85% of the SRs issued against the receivables even after the sell-off, there is a chance that the trusts floated by the ARCs can be deemed to be under the control of the originator. This will lead to the NPAs coming back on the balance sheet of banks by way of consolidation.

  • Fair value accounting – Fair value accounting of financial assets is yet another change in the accounting treatment of financial assets in the books of the banks. Earlier, the unquoted investments were valued at carrying value, however, as per the new standards, all financial assets will have to be fair valued at the time of transitioning and an on-going basis.

It is expected that the new requirements will lead to capital erosion for most of the banks and for some the hit can be one-half or more, considering the current quality of assets the banks are holding. This deferment allows the banks to clean up their balance sheet before transitioning which will lead to less of an impact on the capital, as it is expected that the majority of the impact will be caused due to ECL provisioning.

World over most of the jurisdictions have already implemented IFRS in the banking sector. In fact, a study[3] shows that major banks in Europe have been able to escape the transitory effects with small impact on their capital. The table below shows the impact of first time adoption of IFRS on some of the leading banking corporations in Europe:

Impact of this deferment on NBFCs

While RBI has been deferring its plan to implement IFRS in the banking sector for quite some time, this deferral was not considered for NBFCs at all, despite the same being admittedly less regulated than banks. The first phase of implementation among NBFCs was already done with effect from 1st April, 2018.

This early implementation of IFRS among NBFCs and deferral for banks leads to another issue especially for the NBFCs which are associates/ subsidiaries of banking companies and are having to follow Ind AS. While these NBFCs will have to prepare their own financials as per Ind AS, however, they will have to maintain separate financials as per IGAAP for the purpose of consolidation by banks.

What does this deferment mean for banks which have global listing?

As already stated, IFRS have been implemented in most of the jurisdictions worldwide, this would create issues for banks which are listed on global stock exchanges. This could lead to these banks maintaining two separate accounts – first, as per IGAAP for regulatory reporting requirements in India and second, as per IFRS for regulatory reporting requirements in the foreign jurisdictions.




Compound financial instruments- A paradigm shift in accounting concepts

By Rahul Maharshi (, 


Financial instruments accounting has been one of the highlighting issues in implementation of Ind AS in India. Several new concepts have been introduced and compound financial instrument (CFI) is one of them.

Explained in para 28 of Ind AS 32, a CFI is a financial instrument which is a non-derivative financial instrument that, from the issuer’s perspective, contains both liability and equity component. Therefore, when characteristics of both, liability and equity are fused into one instrument, it gives rise to a CFI.

It is usually observed, as a way of raising funds, many companies go for issuing debt instruments with a conversion feature in it. A bond which is convertible into fixed number of shares of the issuer would generally be preferred over a plain vanilla bond, since there lies a convertibility feature which would be an incentive for the investor over and above the interest income on such a bond. Additionally, if the issuer company is one which is positively growing, the investor would reap out fair amount of benefits with the help of a convertibility option.

Therefore, this makes CFI an interesting topic to discuss. In this article, we intend to discuss the manner of treatment, recognition, classification and various other intricacies associated with CFIs.

Compound financial instrument from investors perspective

The accounting treatment with respect with CFI prescribed in Ind AS 32 deals with the issuer’s books of accounts only, there is no special treatment required in the books of the investor. A CFI is nothing but a financial asset in the books of an investor.

A CFI is required to be accounted for in the books of an investor as a financial asset till redemption, however, at the time of redemption, if the instrument is converted into equity, the same will require reclassification for subsequent measurement of the financial asset as a whole by the investor.

Compound financial instrument vs. Hybrid financial instrument

Yet another new concept in the Ind AS is that of hybrid financial instrument. Differentiating the same with CFI; a hybrid financial instrument, or a hybrid contract is one which has an embedded derivative sitting on a host contract. From an investor’s point of view, a host contract can be of any kind, such as a financial asset or a non-financial asset.

If the host contract is a non-financial asset, the embedded derivative will be required to be separated from the host contract subject to the requirements given in para 4.3.3 of Ind AS 109. After separation, the host contract shall be required to be accounted for in accordance with the appropriate Ind AS(s).

For example, a lease agreement with variable lease payments adjusted to the change in a benchmark interest rate such as LIBOR would result in a hybrid instrument with the host contract being the lease agreement i.e. a non-financial asset and an embedded derivative being the variability feature of the lease payments being leveraged. The lease agreement should be accounted for as per Ind AS 17- Leases and the derivative feature may be required to be accounted for as per Ind AS 109 subject to para 4.3.3.

A host contract being a financial instrument (viz. being a financial asset) is required to be accounted for by the investor as explained in the earlier section.

However, for the purpose of this article, emphasis is required to be given on the treatment of a CFI being a host contract with an embedded derivative (such as a call option) from an issuer’s point of view. Ind AS 32 provides that the value of the derivative embedded on CFI is required to be included in the liability component of the CFI.

It is to be noted that the equity conversion option in a CFI, on a standalone basis, is not a derivative. The derivative that is required to be included in the liability component are those which qualify to be a derivative as defined under Ind AS 109.

The concept of CFI and a Hybrid contract is diagrammatically explained below:

The above diagram can be seen as an example of deriving concepts from application of two Ind AS(s) viz. Ind AS 109 and Ind AS 32. By interpretation, it exhibits the notion that a CFI is in fact, a type of a hybrid contract, but a hybrid contract is not a type of a CFI. Nevertheless, this notion can be questioned on the ground that both the instruments are required to be looked at from different perspectives.

The distinctions between a hybrid contract and a CFI can be tabulated as below:

Basis of distinction Hybrid contract/ Hybrid financial instrument Compound financial instrument
Governing Ind AS for accounting Ind AS 109 Financial Instruments Ind AS 32 Financial Instruments- Presentation
Nature Derivative Derivative /Non- derivative
Split accounting Based on conditions given in para 4.3.3 of Ind AS 109 Mandatory in all cases
Resultant instruments after splitting Financial assets, non-financial assets, financial liability, non-financial liability  and/or equity Equity and financial liability

Split Accounting in case of a CFI

The incidence or event of testing a financial instrument to be a CFI or not is not only to be done at the issuance or on a periodic basis, rather whenever the terms of the contract of a financial instrument reveal a dual character i.e. of equity as well as liability, the same should be classified and accounted for.

The steps involved in accounting for a CFI from the perspective of an issuer is diagrammatically represented below:

Step 1: Identification of the components of the CFI:

Identifying the components of CFI into equity and liability from the issuer’s perspective is done by checking the terms and conditions provided in the contract of the financial instrument.

For example, an issuer issues 7% Optionally Convertible Debentures, convertible into a fixed number of shares. This would mean that the obligation towards debenture holder can be discharged either by payment of cash or by issuing a fixed number of the equity shares of the issuer. The liability component here being the issuer’s obligation to pay 7% interest and the potential redemption of the debenture in cash at maturity. The equity component here being the holder’s call option for the issuer’s shares.

Step 2:  Determination of fair value of CFI as a whole

The fair value of the CFI as a whole would normally be the transaction price as provided in para B5.1.2A of Ind AS 109. In case the transaction has not taken place under market conditions, then the principles of Ind AS 113 would be applied to derive at the fair value of the financial instrument as a whole.

Step 3: Determination of the fair value of the liability component:

Fair value of the liability component is the present value of the contractually determined stream of future cash flows discounted at the rate of interest applied at that time by the market to instruments of comparable credit status and providing substantially the same cash flows, on the same terms but without the convertibility option.

The act of discounting the cash flows of the instrument as a whole with the discounting rate being the rate of interest prevailing in the market on a debenture without the conversion option is done to derive the value of the liability component.

Now if the instrument as a whole has an embedded derivative, like a call option on the equity shares, the liability component is inclusive of the value of the derivative embedded in the CFI.

Step 4: Determine value of the equity component:

The equity component of a CFI is nothing but the residual amount left after subtracting the liability component as computed in step 3 from the fair value of the CFI as a whole (step 2).

This is fairly evident from the definition of equity as provided in para 11 of Ind AS as below:

“An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.”

Also, once the value of the equity component of a CFI is determined, being the residual amount, it is not re-measured or reclassified till final settlement. In cases of conversion, there can merely be a change within equity. Any kind of cost associated with the issue of the CFI shall be proportionately allocated to the liability and equity components.

Since the liability component of a CFI satisfies the definition of a financial liability as per Ind AS 32, the same is required to be subsequently accounted for in accordance with the principles of subsequent measurement of financial liabilities as provided in para 4.2 of Ind AS 109 viz. at Fair value through profit or loss (FVTPL) or at amortised cost method.


Example 1: 9% Preference shares with partial conversion and partial redemption

Company M has issued 10,000 9% Preference shares having face value Rs. 100 each with mandatory dividends and mandatory conversion of 50% preference shares into equity and balance 50% redemption at the end of 3 years from the date of issue. Market rate for Preference shares with similar credit status and other features except the conversion feature is 12%p.a.

The preference share has two components – (1) Contractual obligation for payment of mandatory dividend and mandatory redemption of 50% Preference shares. (2) Mandatory conversion of 50% Preference shares into equity.

The first component is a financial liability because the same consist of contractual obligation to pay cash and the entity does not have an unconditional right to avoid delivering cash.

The second component is equity since there is mandatory conversion into equity shares, which, in substance, signifies that the amount for the equity is already prepended even before receiving the shares in reality.

The values of equity and liability components are calculated as follows:

Present value of Principal payable at the end of the 3 years (Rs. 5,00,000 discounted at 12% for 3 years)= Rs.3,55,890.

Present value of contractual obligation to pay dividends in arrears for 3 years (Rs. 90,000 discounted at 12% for 3 years) = Rs. 2,16,165

Total financial liability= Rs.5, 72, 055.

Therefore, equity component= fair value of CFI, say Rs. 10,00,000 less financial liability component i.e. Rs. 5,72,055=Rs. 4,27,945.

Subsequent year’s profit and loss account is charged with interest amortisation at 12% on the financial liability component and dividend expense of Rs. 90,000 each.

Example 2: 6% optionally convertible debentures (OCDs)

X ltd (issuer) has issued 6% p.a. debentures to Y Ltd. (holder) for a consideration of Rs. 30 lakhs. The holder has an option to convert these debentures to a fixed number of equity instrument of the issuer anytime up to a period of 3 years. If the option is not exercised by the holder, the debentures are redeemed at the end of 3 years. The prevailing market rate for similar debentures without the conversion feature is 9% p.a.

The instrument has two components – (1) Contractual obligation that is conditional on holder exercising his right to redeem, and (2) conversion option with the holder.

The first component is a financial liability because the entity does not have an unconditional right to avoid delivering cash. The other component, conversion option with the holder, is an equity feature.

The values of liability and equity component are calculated as follows:

Present value of principal payable at the end of 3 years (Rs. 30 Lakhs discounted at 9% for 3 years)= Rs. 23,16,550.

Present value of interest payable in arrears for 3 years (Rs. 1,80,000 discounted at 9% for each of 3 years) = Rs. 4,55,632

Total financial liability= Rs. 27,72,182.

Therefore, equity component= fair value of CFI, say Rs. 30 Lakhs less financial liability component i.e. Rs. 27, 72,182=Rs. 2, 27,818.

In subsequent years the profit is charged with interest of 9% on the debt instrument.

Example 3: Accounting for Compound financial instrument on date of transition

On 1st April, 2015, X Ltd. issued 50,000, 7% convertible debentures of face value of Rs. 100 per debenture at par. The debentures are redeemable on 31st March 2020 or these may be converted into ordinary shares at the option of the holder. The interest rate for equivalent debentures without the conversion rights would have been 10%. The date of transition to Ind AS is 1st April, 2017.

As per previous Indian GAAP, the given instrument has been accounted for as a non-current liability and corresponding interest expense of Rs. 3,50,000 each for 2 years should have been charged directly to profit and loss account.

On the date of transition to Ind AS, i.e. 1st April, 2017, the Company has to account for the instrument as a compound financial instrument as per para 28 of Ind AS 32. Subsequently, the value of debt component and equity component has to be calculated (viz. split accounting).

Therefore, for the remaining 3 years, there will be an interest expense at Rs. 3,50,000 each and at the end of 3rd year the instrument either gets redeemed or gets converted into ordinary shares of the Company.

On 1st April, 2017

Value of Debt:

Present value of interest payable for 17-18, 18-19 & 19-20 = (Rs. 3,50,000 discounted at 10% for each of the 3 years)= Rs. 8,70,398

Present value of Principal at the end of 3rd year i.e. as on 31st March, 2020 = (Rs. 50,00,000 discounted at 10% for 3 years) = Rs. 37,56,574

Value of Debt component= Rs. 37,56,574 + 8, 70,398 =Rs.46,26,972

Value of equity component= Rs. 50,00,000-46,26,972=3,73,028

Therefore, on the date of transition i.e. 1/4/2017 amount of Rs. 50,00,000 being the Fair value of CFI will be split into debt & equity as given above.

For the coming 3 years, the following treatment shall be done by the X Ltd.

Particulars 2017-18 2018-19 2019-20
Opening debt component 46,26,972 47,33,669 48,57,015
(+)Interest amortisation @ 10% 4,62,697 4,73,365 4,85,702
(-)Interest expense at 3.5 lakhs p.a 3,50,000 3,50,000 3,50,000
Closing balance of debt component   47,33,669 48,63,635 50,00,000


The move towards substance over form and fair value accounting is fairly reflected with the introduction of the concept of CFI. There has been a fundamental shift in the understanding when a contract is put to test in light of Ind AS governing financial instruments. The instruments which were erstwhile treated to be debt are currently being treated as equity. This is primarily dependant on the notion that equity capital is the amount of money not repaid, accordingly an instrument convertible into equity capital should also be treated as equity. Therefore, a CCD is shown as a CFI.

However, in the midst of split accounting of a CFI, there are certain issues which are of concern to entities in doing the same. The major challenge to stakeholders lies in treatment of the equity component of the CFI from Income tax perspective, since there arises a MAT implication.

On the date of transition to Ind AS, there arises a tax implication on the already issued instruments which require reclassification as a CFI in the current Ind AS regime. The equity component of the CFI is required to be included in the “transition amount” defined in sub-section 2(C) of section 115JB of the Income Tax Act, 1961.

This results in taxing the one-fifth amount of the equity component for 5 years. The same has been further clarified by the CBDT circular dated 25th July, 2017[1] stating that the equity component of a CFI is to be included in the transition amount and further be taxed for MAT purposes over a period of five years. The same is seen as a burden on companies transitioning from erstwhile Indian GAAP to Ind AS because the equity component is not excluded from the purview of book profits as computed for MAT purposes.

Nevertheless, we feel the concept is relatively new to the Indian context and the same shall be developed over a period of time.