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Common errors in Ind AS financial statements – Observations by FRRB

The Financial Reporting Review Board (FRRB) of the Institute of Chartered Accountants of India (ICAI) is established as a proactive tool to enhance financial reporting processes.

The FRRB examines general purpose financial statements of various businesses to ensure that they comply with generally accepted accounting principles, the auditor’s reporting obligations, and the disclosure requirements imposed by regulatory bodies, statutes, and rules and regulations that apply to the business.

After reviewing multiple enterprises and their financials, the FRRB published a Study on Compliance of Financial Reporting Requirements (Ind AS Framework) in February 2021, which comprises examples of common non-compliances or inaccuracies found in Ind AS financial statements. It offers relevant insights on the compliance aspects of financial reporting with the goal of improving the quality of financial statement reporting.

In this blog, we strive to throw light on some instances of the key non-compliances and errors observed by the FRRB.

Observation 1 – Non-amortization of leasehold land

The matter contained in the Financial Statements

FRRB observed that Leasehold land was shown with the same quantities in the reporting year and the comparative periods in the note to a company’s financial statements on Tangible Assets.

Relevant principle

According to Paragraph 43 of Ind AS 16, Property, Plant, and Equipment, any component of a piece of property, plant, or equipment that has a significant cost in comparison to the entire cost of the item must be depreciated separately.

In addition, according to Paragraph 50 of Ind AS 16, Property, Plant, and Equipment, the depreciable value of an asset must be distributed in a systematic manner during the asset’s useful life.

Observations by FRRB

It was discovered that leasehold land was not amortized. A depreciable asset should essentially have a limited useful life, according to the requirements of Ind AS 16. Leasehold land has a limited useful life by definition, and as such, it should be amortized in accordance with paragraphs 43 and 50 of Ind AS 16.

It was highlighted that the company in this situation has leasehold land, but the cost has not been amortized. Non-amortization of leasehold land was seen to be in violation of Ind AS 16.

As a result, it was determined that the requirements of Ind AS 16 had not been met.

Observation 2 – Wrong capitalization of borrowing costs

The matter contained in the Financial Statements

The abstract of accounting policy of a company on Borrowing Cost read as follows:

Borrowing costs directly associated with the purchase of fixed assets are capitalized as part of the asset’s cost until it is put to use. Other borrowing costs are recorded on the income statement in the year in which they occur.

Relevant principle

According to Paragraph 8 of Ind AS 23, Borrowing Costs, borrowing costs that are directly linked to the acquisition, building, or production of a qualified asset must be capitalized as part of the asset’s cost.

Further, according to Paragraph 22 of Ind AS 23, Borrowing Costs, when practically all of the operations required to prepare the qualifying asset for its intended use or sale have been completed, the business must stop capitalizing borrowing expenses.

Observations by FRRB

It was observed that according to the company’s stated accounting policy, borrowing costs directly related to the acquisition of fixed assets are capitalized. But borrowing costs that are directly linked to the acquisition, building, or production of only a qualified asset are capitalized (not all fixed assets), according to paragraph 8 of Ind AS 23.

Furthermore, the borrowing costs that were incurred until the date the asset was put to use were capitalized. But borrowing expenses should be capitalized until the asset is ready for its intended use or sale, according to Ind AS 23 – paragraph 22. As a result, capitalization of expenses incurred until the asset is put to use does not comply with Ind AS 23.

Accordingly, it was determined that the requirements of paragraphs 8 & 22 of Ind AS 23 had not been met.

Observation 3 – Wrong treatment of tangible assets

The matter contained in the Financial Statements

FRRB found that in the note to its financial statements on intangible assets, a corporation categorized “Toll Equipment” as an intangible asset. Furthermore, depreciation on Toll Equipment is determined on a WDV basis over a useful life of 7 years, according to the accounting policy on property, plant, and equipment.

Relevant principle

As per Paragraph 6 of Ind AS 16, Property, Plant and Equipment,

Property, plant, and equipment are those tangible assets that:

(a) are retained for use in the manufacture or provision of goods or services, for renting to others, or for administrative purposes; and

(b) are expected to be used over a long length of time, i.e., during more than one period.

Observations by FRRB

According to the note on Intangible Assets, the asset “Toll Equipment” has been classified as an Intangible Asset. However, according to the note on accounting policy on property, plant, and equipment, it was seen that the depreciation on Toll Equipment is calculated on a WDV basis over a useful life of 7 years.

Given the stated accounting policy on Property, Plant, and Equipment, as well as the fact that Toll Equipment is a tangible asset, it was determined that classifying Toll Equipment as an intangible asset was incorrect.

As a result, it was determined that the treatment provided by the company did not meet the above-mentioned standard of Ind AS 16.

Observation 4 – Non-disclosure of significant accounting policies

The matter contained in the Financial Statements

In the note on Capital Work in Progress (CWIP) of a company, various expenses were recorded, which were capitalized as CWIP and all of them were assigned to “Intangible assets under development”.

Additionally, the company had shown leasehold land under tangible assets.

Relevant principle

According to Paragraph 117 of Ind AS 1, Presentation of Financial Statements, all significant accounting policies concerning the measurement basis (or bases) used in compiling the financial statements, as well as any other accounting policies that are relevant to an understanding of the financial statements, must be disclosed by a company.

Observations by FRRB

It was noted that the corporation did have leasehold land, but the accounting policy linked to the leasehold land was not revealed by the company.

The total CWIP was also represented as “Total intangible assets under development,” according to a note to the company’s financial statements on Capital Work in Progress (CWIP). However, no policy on capitalization of such internally generated intangible assets was published, and no explanation was provided for that.

Accordingly, it was viewed that the requirements of Ind AS 1 pertaining to the disclosure of accounting policies have not been complied with.

Observation 5 – Non-recognition of a joint operation

The matter contained in the Financial Statements

An excerpt of a footnote in the note to the financial statements of a company on Non-Current Financial Assets read as follows:

Expenses under Joint operation agreement – A “Production Sharing Contract” has been signed by the Company and another company with the Ministry of the Government of India. They signed a “Joint Operation Agreement” outlining each party’s rights and obligations under the previously specified “Production Sharing Contract.” The corporation has also disclosed the terms of the arrangements and the share of assets in the footnote.

Relevant principle

According to Paragraph 20 of Ind AS 111, Joint Arrangements, a joint operator needs to recognize the following in relation to its interest in a joint operation:

a) assets, comprising its share of assets that are held jointly;

b) liabilities, comprising its share of liabilities that are paid jointly;

c) revenue arising from the sale of its share of any output arising from joint operation;

d) share of the revenue arising from the sale of any output by the joint operation; and

e) expenses, comprising its share of any expenses that are incurred jointly

Observations by FRRB

The company had gone into a joint operation with another company and had declared the terms of the arrangements and share of assets, according to the footnote given under the note to the financial statements on Non-Current Financial Assets. The corporation, on the other hand, did not recognize the liability for obligations, expenses, or revenue details related to its joint operations.

As a result, it was determined that the standards of Ind AS 111 had not been met.

Observation 6 – Non-disclosure of previous years’ data

The matter contained in the Financial Statements

It was noted that the previous years’ data for all of the items were not supplied in the note to the financial statements of a company on Property, Plant, and Equipment.

Relevant principle

As per Paragraph 6 of General Instructions for the Preparation of Financial Statement of a Company required to comply with Ind AS, except in the case of the first Financial Statements laid before the company after its incorporation, Financial Statements must include the corresponding amounts (or comparatives) for the immediately preceding reporting period in respect of all items shown in the Financial Statements, including Notes thereof.

Observations by FRRB

It was discovered that the previous years’ figures for all of the items of Property, Plant, and Equipment had not been provided, which was in violation of the above-mentioned requirements of Schedule III to the Companies Act, 2013.

Accordingly, it was known that the above-mentioned requirements of Schedule III to the Companies Act, 2013 had not been met.

Observation 7 – Non-classification of loans

The matter contained in the Financial Statements

In the notes to the financial statements of a company on Financial Assets (Loans), certain loans were disclosed and some were not.

Relevant principle

As per Paragraph 6A (VIII) of General Instructions for preparation of Balance Sheet given under Part I, Division II – Ind AS Schedule III to the Companies Act, 2013, Loans must be classified as follows:

Loans:

(i) Loans shall be classified as:

1. Security deposits;
2. Loans to related parties (along with giving any details thereof); and
3. Others (specify nature).

(ii) The above categories will also be sub-classified as-

1. Secured, considered good;
2. Unsecured; considered good; and
3. Doubtful

Observations by FRRB

The note to the financial statements on Financial Assets (Loans) revealed that the loans were not classified in accordance with the above-mentioned requirement, which did not specify whether these loans were secured, unsecured, or doubtful. Furthermore, the nature of other advances was also not specified, despite the fact that the amount shown under this heading was significant, accounting for 86 percent of the total loans and advances.

As a result, it was considered that the above-stated requirements of General Instructions for preparation of Balance Sheet given under Part I, Division II – Ind AS Schedule III to the Companies Act, 2013 had not been complied with.

Observation 8 – Balances subject to confirmation

The matter contained in the Financial Statements

The abstract of a note to the financial statements of a company read as follows:

Certain balances of trade receivables, loans and advances, trade payables, and other liabilities are subjected to confirmation and/or reconciliation.

Relevant principle

Paragraph 7 of SA 705, Modification to the Opinion in the Independent Auditor’s Report provides that the auditor shall express a qualified opinion when:

• After gathering sufficient and appropriate audit evidence, the auditor decides that individual or aggregate misstatements are material, but not pervasive, to the financial statements; or
• The auditor is unable to gather sufficient and acceptable audit evidence on which to base his assessment, but he assesses that the undiscovered misstatements could have material but not pervasive consequences on the financial statements.

Observations by FRRB

It was observed by FRRB that certain balances of trade receivables, loans and advances, trade payables, and other liabilities were reported as being subject to confirmation and reconciliation in the above-mentioned note to the financial statements.

The above-mentioned information was deemed ambiguous. If the confirmations/ reconciliations of balances are not important and do not alter the accurate and fair picture of the company’s financial statements, they should not be published in the financial statements, since doing so may cause the readers of the financial statements to have concerns or doubts. However, if such balances are important and have an impact on the entity’s true and fair assessment of its financial statements, the auditor should have effectively incorporated these facts into his report by way of a modified opinion.

Furthermore, according to paragraphs 7, 8, and 9 of SA 505, External Confirmation, the auditor must maintain control over external confirmation requests, and if management refuses to send a confirmation request, the auditor must perform alternative audit procedures to obtain relevant and reliable audit evidence, among other things.

Therefore, it was considered that the requirements of SA 705 and SA 505 have not been complied with.

Observation 9 – Disclosure of Receivables from Related Parties

The matter contained in the Financial Statements

“Interest receivable from a related party” and “advances to related party” were mentioned in the notes to the financial statements on Other Non-Current Financial Assets and Other Current Assets, respectively.

Relevant principle

As per Paragraph 4(ii) of General Instructions for preparation of Financial Statements of a Company required to comply with Ind AS Division II – Ind AS Schedule III to the Companies Act 2013, it is provided that each line item in the Balance Sheet, Statement of Changes in Equity, and Statement of Profit and Loss must be cross-referenced to any relevant information in the Notes. When compiling the Financial Statements, including the Notes, a balance must be struck between providing excessive detail that may not be beneficial to users of the Financial Statements and omitting vital information because of too much aggregation.

Observations by FRRB

It was noted that ‘interest receivable from related party’ was disclosed in the notes to the financial statements on Other Non-Current Financial Assets. Similarly, ‘advances to related party’ were disclosed in the notes to the financial statements on Other Current Assets. However, it was discovered from the disclosure of related party transactions made in another note to the financial statements that the company did not cross-reference the interest receivable and advances to related parties disclosed in respective notes.

The cross-referencing of the items of assets and liabilities with the relevant note for the related party disclosures was deemed necessary for the ease of understanding of the users and better presentation of the financial statements.

Observation 10 – Statement of changes in equity

The matter contained in the Financial Statements

The company’s financial statements included a Balance Sheet, a Statement of Profit and Loss, a Statement of Cash Flow, and Notes to Accounts, but the Statement of Changes in Equity was not there. Furthermore, the auditor’s report said that the statement of changes in equity had been audited by them, despite the fact that it was not included in the annual report.

Relevant principle

Section 2(40) of the Companies Act, 2013 provides that financial statements in relation to a company consist of a balance sheet, a profit and loss account/ an income and expenditure account, a cash flow statement, a statement of changes in equity, and any explanatory note annexed thereto.

Observations by FRRB

The firm that is preparing financial statements in accordance with Ind AS, among other things, is required to create and present the Statement of Changes in Equity.

However, in the above-mentioned situation, the Statement of Changes in Equity, which is a legal obligation, was not prepared. Furthermore, the auditor’s report said that the statement of changes in equity had been audited by them, despite the fact that it was not included in the annual report.

As a result, it was determined that failure to prepare a Statement of Changes in Equity is a violation of Section 2(40) of the Companies Act, 2013.

Conclusion

The above were only a few instances of common non-compliances observations by FRRB in the financial statements of companies. It reviews the compliance of reporting requirements of various applicable Statues, Ind AS, Standards on Auditing, Companies (Auditor’s Report) Order (CARO), Schedule III to Companies Act, 2013^[1], and other applicable sections. The aim of FRRB is to educate all the preparers of financial statements, across the globe, about uniform standards of accounting disclosure so as to ensure consistency in financials.

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