Accounting and Auditing Update, Issue 5 - Technology

68 Pages·2016·1.7 MB·English

Accounting and
Auditing Update
Issue no. 5/2016 | Technology
IN THIS EDITION
Impact of the new revenue standard on the technology
sector p1
Conversation with Mr. Sanjay Puria p11
Key elements of business combinations – contingent
consideration, intangible assets and goodwill p19
Share-based payments - key accounting developments p27
Financial Instruments p31
Operating segment p35
Enhanced responsibilities of the audit committee p37
The dilemma of tax exemption for SEZ p41
Base Erosion and Proft Shifting p45
Will GST address the expectations of technology service
exporters? p51
Regulatory updates p53
www.kpmg.com/in
© 2016 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Editorial
Jamil Khatri Sai Venkateshwaran
Partner and Head Partner and Head
Assurance Accounting Advisory Services
KPMG in India KPMG in India
In continuance with our revamped series The publication also carries an interview it is coherent and consistent amongst
of the Accounting and Auditing Update, section where we speak to a CFO/ countries. Our article summarises the
this edition focusses on the technology fnance director of a leading company impact of this guidance with a specifc
services sector. from the sector and explore some key reference drawn to the technology
accounting and reporting, as well as services sector. Additionally, we
The Ind AS (Indian Accounting
topical matters relevant to the industry. summarise the expected impact of the
Standards) are bringing about a paradigm
This month’s issue features an interview Goods and Services Tax requirements on
shift in fnancial reporting which is going
with Mr. Sanjay Puria, Group Chief the sector.
to potentially affect many key metrics of
Financial Offcer, WNS.
performance. This publication seeks to Finally, apart from our regular round up
highlight the expected impact of Ind AS Certain entities in the technology of regulatory updates, this edition of
on various topics including how revenue services sector enjoy certain tax the Accounting and Auditing Update
recognition would be impacted for a exemptions when they set-up their provides a summary of the concept
typical technology services contract facilities in the special economic zones release by the U.S. Securities and
on adoption of Ind AS 115, Revenue in India. These tax exemptions affect Exchange Commission on enhanced
From Contracts with Customers. Under the computation of current and deferred responsibilities of the Audit Committee
business combinations accounting, taxes under Indian GAAP and Ind AS. along with the Indian Exposure Draft on
the publication highlights the impact of Our article on this topic highlights the Auditing Standard 260, Communication
accounting of contingent consideration, potential impact of such tax exemptions with those charged with governance.
types of intangibles recognised in under the new reporting framework.
As always we would be delighted to
the technology services sector and
The sector is also affected by a number receive any kind of feedback or inputs on
differences in the approach of goodwill
of global developments in the areas of the topics that we have covered.
impairment under the current Indian
direct and indirect tax. For example, the
GAAP, Ind AS and the U.S. GAAP. The
Organisation for Economic Co-operation
Accounting and Auditing update also
and Development issued guidance on
discusses accounting of share-based
15 key areas for identifying and curbing
payments, fnancial instruments and
aggressive tax planning practices (Base
segment reporting under Ind AS and
Erosion and Proft Sharing) and altering
their likely impact on the fnancial
the international tax system in a way that
statements of companies in this sector.
© 2016 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
© 2016 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Overview
The importance of the technology sector as a critical driver of growth for the Indian
economy cannot be overemphasised. The revenue generated from this sector is
expected to exceed USD150 billion in in Financial Year (FY) 2015-161, making it one
of the largest contributors to the Indian GDP and to employment. The explosive
growth witnessed in the e-commerce industry in India over the past couple of years
and the emphasis laid on e-governance, ‘Make in India’ as well as the ‘Start-up
India’, are aiding the technology sector in India to assume a leading position, even
within the domestic industry.
Historically, companies that operate in the technology services sector in India have
been better aligned in terms of adoption of leading practices in accounting and
reporting, governance, etc. Since this sector led the clutch of Indian companies
that went public in developed markets such as the U.S., it necessitates compliance
with higher accounting, reporting and governance norms. Additionally, many of the
global multinational companies (MNCs) in the technology and consultancy sector
have made India their second home, employing a huge workforce in their captive
centers here, and bringing to the country some of the well-known practices from
around the world.
The changes introduced by the Companies Act, 2013 and the adoption of Ind AS
are developments that are expected to assist companies in the sector to align even
more closely with leading practices in the accounting, reporting and governance
arena.
Recent developments such as the proposed introduction of the Goods and Services
Tax and the recently introduced Base Erosion and Proft Shifting Rules, Advance
Pricing Agreement, etc. also seem to be in line with global practices in taxation
that require companies to carefully review the impact of such legislation on their
operations and prepare for a smooth transition/adoption.
1. NASSCOM publication ‘The Information Technology- Business Process Management sector in
India – Strategic Review 2015’
© 2016 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
1
Impact of the new
revenue standard on the
technology sector
This article aims to:
– Highlight key impact areas of the new revenue standard
– Highlight key differences between the new standard and the existing IFRS and
U.S. GAAP guidance
© 2016 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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What is this about? Recognition and the Technical Guide has recommended to the Ministry of
on Revenue Recognition for Software Corporate Affairs (MCA) that Ind AS
In May 2014, the International
provide guidance on revenue recognition. 115 be deferred in line with IFRS 15.
Accounting Standards Board (IASB) and
In India, Ind AS 115, Revenue from Consequently, on 24 September 2015,
Financial Accounting Standards Board
Contracts with Customers, is the the Institute of Chartered Accountants
(FASB) published their new joint standard
standard on revenue recognition that is of India has issued two exposure drafts
on revenue recognition - IFRS 15 and
converged with IFRS 15. on Ind AS 11, Construction Contracts and
FASB Topic 606 Revenue from Contracts
Ind AS 18, Revenue, which will form part
with Customers, replacing the existing Internationally, under the road map for
of the suite of Ind AS standard available
revenue guidance in both U.S. GAAP and implementation, the new standard is
for adoption.
IFRS. effective for annual periods beginning
on or after 1 January 2018 for entities
The new standard moves away from Five-step model
applying IFRS and for annual periods
the industry and transaction specifc
beginning on or after 15 December 2017 The core principle of the new standard
requirements under U.S. GAAP (which
for public business entities and certain is that revenue should be recognised
are also used by some IFRS preparers in
not-for-proft entities applying U.S. GAAP. when (or as) an entity transfers control
the absence of specifc IFRS guidance),
Early adoption is permitted only under of goods or services to a customer at the
and contains a single model that will be
IFRS. amount to which the entity expects to
applied while accounting for contracts
be entitled. To achieve the core principle,
with customers across all industries, Ind AS 115 is currently applicable for
the new standard establishes a fve
including real estate. Under current periods beginning on or after 1 April
step model that entities would need to
Indian GAAP, AS 7, Construction 2016. The National Advisory Committee
apply to determine when to recognise
Contracts and AS 9, Revenue on Accounting Standards (NACAS)
revenue, and at what amount.
Step 1 Step 2 Step 3 Step 4 Step 5
Identify the Identify Determine the Allocate the Recognise
contract performance transaction transaction revenue
obligations price price
Five step model Key requirements
Step 1 Contract is considered in scope if it is legally enforceable and certain other criteria such as
collectability, commercial substance, rights and obligations are met.
Step 2 Performance obligation represents goods or services that are capable of being distinct and are
distinct within the context of the contract.
Step 3 Transaction price is the consideration the company expects to receive under the contract. This
should include an assessment of variable consideration, non-cash consideration, deferred
payment terms and amounts payable to the customers.
Step 4 Allocate the transaction price to identifed performance obligations in proportion to stand-alone
selling prices computed based on observable prices or management estimates.
Step 5 Recognise revenue either at a point or over a period of time depending on when the customer
obtains control of the transferred goods or services.
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3
How does this impact you? Example: Accounting for contract Transformation – involves activities
revenue and costs under the new pertaining to upgrading the customer’s
While the overall principles remain the
standard
legacy application platforms to the latest
same, the new standard is expected to
industry standards. This would entail
have signifcant impact on the accounting Company X enters into a multi-year
of revenue by entities in the technology IT services contract with a customer implementation services, migration,
sector, specifcally in view of the detailed developing interfaces and testing the
to render transition, transformation,
guidance in steps 2 and on identifying end solution.
development and support services.
separate components and allocating the
The broad scope of the services are as
Development - involves building certain
transaction price.
below:
computer software (IP which would
be owned by customer) to assist
What is in this for you? Transition – includes activities to
the customer in automating service
transfer maintenance of all in-scope
This article analyses some of the
desk functionalities and other manual
applications to company X’s governance
frequent service offerings by companies
processes.
in the technology sector and the impact and delivery model. Deliverables include
of Ind AS 115 on accounting for such documentation of existing processes
Support – involves maintenance
transactions. and defning the new process that will
activities (including bug fxes) for all
be followed for service delivery during a
in-scope applications over the contract
steady state.
period of three years and adherence to
prescribed Service Level Agreements
(SLAs).
The charges under the contract for the services are as below:
Service Amount in INR Service Amount in INR
Transition Nil Development 15,000,000
Transformation 10,000,000 Support 40,000,000
Under the terms of the contract, pertains to costs which would have been Accounting for contract
company X is also required to set up a incurred irrespective of whether or not modifcations
near shore facility from which services the contract was obtained.
A contract modifcation may either be
would be rendered to the customer.
for a change in scope of services or
In addition to the above mentioned Step 1
price or both. Under the new standard, a
payments, the customer is also required
contract modifcation is accounted for as
to pay an upfront fee of INR2,000,000, Identifcation of the contract with
a separate contract if distinct goods and
intended to compensate company X for the customer
services are added to the arrangement,
the initial set up costs incurred by it to
A contract exists if it is considered to and if those goods and services are
set up the near shore facility.
be legally enforceable and certain other priced at their stand-alone selling
Company X has incurred costs criteria discussed earlier are met. Legal prices. Else, contract modifcations are
amounting to INR800,000 to obtain the enforceability may be either through oral accounted for either prospectively or
contract. Of this, INR500,000 pertains to or written arrangements, depending on by a cumulative catch-up adjustment.
sale commissions paid by the company the customary practice. In this example, No such guidance is provided explicitly
to its sales personnel who were company X has signed a contract for in the existing standard on revenue
instrumental in securing the contract. services which demonstrates legal recognition.
Company X believes that these costs enforceability. Hence, a contract is
are capable of being recovered under deemed to be in existence for the
the contract. The balance (INR300,000) purposes of this standard.
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Step 2
Identifcation of performance obligations
The new standard requires an entity to identify the performance obligations, i.e. the unit of account for revenue recognition. A
promised good or service would qualify to be a performance obligation if both the below mentioned criteria are met:
Criteria Indicators
Capable of being • Sold by the entity separately to other customers
distinct
• Capable of being used by the customer independently in a manner that generates economic
benefts
• Capable of being used in conjunction with other goods or services sold separately by the entity
or other vendors
Distinct within • The entity is not using the services as an input to deliver the output promised under the
the context of the contract
contract
• The services do not signifcantly modify or customise other services promised under the
contract
• The customer has the ability to procure each service independently without signifcantly
affecting the utility of other services promised under the contract
If a promised service under the bundled arrangement qualifes to be a of the promised goods and services
contract does not qualify to be a performance obligation. under the contract (including implied and
separate performance obligation, the customary promises). Please see below
Identifcation of a performance obligation
entity would need to combine such for an indicative evaluation that company
requires signifcant management
services with other services until the X could perform to identify performance
judgement and entails an assessment
obligations:
Performance obligation Points for evaluation
Transition services • Are the transition deliverables owned by the customer?
• Are they robust enough to enable a new service provider to gain an in-depth
understanding of the customer’s IT environment?
Transformation services • What is the customer’s objective of availing such services? These could include
reduction in capital assets, shift of operational responsibility. Are these objectives
capable of being met even if other services are not rendered?
Transition, transformation, • Does company X in the normal course of business render similar services on a
development and support standalone basis to customers?
services
• Is rendering of the service independent of the other services to be rendered under
the scope of the contract?
• Is the customer capable of consuming the associated benefts of the service
independent of other services under the contract?
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Comparison with current IFRS current U.S. GAAP. The evaluation no resolved (a downward adjustment).
longer depends entirely on whether Under this example, the transaction price
Currently, limited guidance is available
the entity or another entity sells an is determined to be INR67 million (INR10
under IFRS to account for multiple
identical or largely interchangeable million + INR15 million + INR40 million +
deliverable contracts and these are
good or service separately, or whether INR2 million).
accounted for by analogy to the test in
the delivered item can be resold by the
IFRS Interpretations Committee (IFRIC) Under the new standard, consideration
customer, to support a conclusion that
18, Transfer of Assets from Customers. is measured at the amount to which the
a good or service is distinct. Therefore,
The interpretation provides two entity expects to be entitled, rather than
potentially more goods can qualify as
indicators (not exhaustive): at fair value.
distinct under criterion one than under
• the service has stand-alone value to current U.S. GAAP. However, an entity
the customer also has to evaluate criterion two.
Step 4
• the fair value of the service can be
Step 3
measured reliably.
Allocation of transaction price
In contrast, Ind AS 115 provides
Determine the transaction price
The standard requires that company X
comprehensive guidance on identifying
Transaction price is the consideration allocate the transaction price to each
performance obligations. In practice, this
company X expects to receive under the performance obligation in proportion
could result in goods or services being
contract. This includes an estimate of to its stand-alone selling prices, i.e.
unbundled or bundled more frequently
the variable consideration and evaluation the price at which company X would
than under current practice.
of embedded fnancing components, sell the promised service separately
if any. Variable pricing is included in to a customer. See table below for an
Comparison with current U.S.
the transaction price only if it is highly illustration of the methods used to
GAAP
probable that a signifcant reversal in determine the stand-alone selling prices.
Criterion one (capable of being distinct) is the amount of cumulative revenue
similar, but not identical, to the stand- recognised will not occur when the
alone value criterion required under associated uncertainty is subsequently
Is an observation price available
Yes No
Use the observable price Estimate price
Adjusted market Expected cost plus a Residual approach
assessment approach margin approach (only in limited
circumstances)
Source: KPMG’s publication Issues in Depth – Revenue from Contracts with Customers September 2014
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