Big Story. What’s new in Ind AS

“The financial results of the company for the quarter ended June 30, 2018 are prepared in accordance with Ind AS 115. The information presented for the quarter ended June 30, 2017 (as per Ind AS 18) has not been restated, hence the results are not comparable to that extent.” Were you confused by such disclosures in the results update for the quarter ended June 30, 2018? Be prepared. You are going to see this disclosure for the remaining three quarters, too.

Companies that are listed or those with a net worth of over ₹250 crore already use Indian Accounting Standards (Ind AS) to prepare their financial statements. So, what is this new disclosure all about?

On March 28, 2018 the Ministry of Corporate Affairs notified the new revenue recognition standard — Ind AS 115 - Revenue from Contracts with Customers. It mandated that all companies which comply with Ind AS must follow the latest standard from April 1, 2018. This replaced the earlier revenue standards — Ind AS 18 - Revenue, and Ind AS 11 - Construction Contracts. This move made the corresponding figures uncomparable.

Revenue — which reflects an entity’s growth and financial performance — is one of the most important components in a financial statement. Ind AS 115 directs companies to follow the most conservative approach while recognising revenue. It also prescribes more extensive qualitative and quantitative disclosures than the earlier revenue standards. These new disclosures can add value to your investment decisions.

Though the financials of almost all companies have been impacted by the new accounting standard, there is a more notable change in the reporting done by entities in real estate, IT and hospitality.

Here, we discuss in detail, the impact Ind AS 115 has had on key sectors, and how investors can deal with the ‘lack-of-comparability’ disclosures in the financial statements.

Before taking a look at how this new standard has affected key sectors, it is important to understand the options available and the provisions applicable in the move from Ind AS 18/11 to Ind AS 115.

Once a company begins applying Ind AS 115, it can either restate the financial statements of the prior accounting year (2017-18) as per the new standard, or adjust the opening reserves — as of April 1, 2018 — as regards incomplete projects for which revenue was partially recognised in the previous period (as per Ind AS 18/11). Most of the companies have chosen the latter option by adjusting the retained earnings at the beginning of the year without restating the previous financial statements. This makes the reporting in this financial year uncomparable with the corresponding figures in the previous year.

Remember, not just revenue, key metrics such as earnings per share (EPS) and debt-equity ratio also cannot be compared. Therefore, investors have to pay keen attention to the notes to the financial statements, where the effect of Ind AS 115 is disclosed.

Ind AS 115 has had a striking impact on the real estate sector. The new accounting standard directs companies to recognise the revenue in a more conservative manner — only when the collections from customers become ‘probable’.

Ind AS 115 allows using the percentage of completion method (POCM) to recognise revenue, albeit with explicit and specific requirements. POCM implies that until certainty is achieved, at every stage of a project, revenue is to be recognised only to the extent of cost, and the margins gets deferred to the period in which the project phase attains certainty.

Certainty essentially implies the ability of the company to gauge the progress of each stage in a project.

Under the earlier Ind AS 11, as long as there was certainty attached to the entire project — not necessarily to each stage — companies could recognise revenue as cost plus margin.

Aside from POCM, companies can also report revenues under the project completion method. Here, the revenue is completely deferred, and recognised only in the quarter in which the project is completed. Till then, even payments received from customers have to be shown under loans or advances from customers.

Here’s a closer look at how various real-estate companies reported their revenues during the quarter ended June 30, 2018.

Retaining POCM

With the transition to Ind AS 115, most of the companies that earlier used POCM continue to follow the same method to recognise revenues. The rest of the real-estate players have shifted to the project completion method. For example, Oberoi Realty’s earnings call shows that the firm still follows the POCM. But given that it reported revenues, including margins, for two of its projects as per the earlier regime, there has been an adjustment in its opening reserves as of April 1. The two projects were Sky City, and Eternia and Enigma. In the June quarter, revenue (including profit) was recognised for Sky City as it had crossed certainty. But for the other project — progress on which was not certain then — revenue was reported only to the extent of cost.

Application of Ind AS 115 reduced Brigade Enterprises’consolidated retained earnings as of April 1, 2018 by ₹406 crore. However, Ind AS 115 helped raise its revenue and net profit for the quarter ended June 30 by ₹123 crore and ₹36 crore, respectively. A significant impact is also evident in the firm’s EPS — ₹4.63 (as per Ind AS 115), compared with ₹1.96, had it followed Ind AS 11.

Deferring revenue

Sobha Developers shifted to the project completion method beginning this financial year. The transition brought about considerable changes in how the company recognised revenue. The company’s retained earnings as of April 1, 2018 were reduced by a whopping ₹757 crore due to postponing of revenue from unfinished projects.

As the firm adjusted the opening reserves and did not restate the financial statements, revenue for the first quarter of FY 2019 cannot be compared with the figures for the corresponding period in the previous financial year. Therefore, revenue for the June quarter was down ₹203 crore compared with the same quarter last year. Had it followed the earlier accounting method, the revenue would have increased 18 per cent y-o-y.

Takeaway

As the new standard lacks clarity, realty firms have come up with their own interpretations. Under Ind AS 115, the profits may not reflect the actual performance of the company in that particular period. Therefore, if you track real-estate companies, bear in mind that, given the changes in accounting methods, you should not consider merely the quarterly profits. Instead, take a close look at projects in pipeline to get a better picture of the likely revenue over the coming quarters.

IT

‘Remaining performance obligations’ and ‘disaggregated revenue’ — two new disclosures under Ind AS 115 — provide more transparency. These disclosures are applicable to all companies across sectors. However, disclosures made by services companies in the information technology and construction sectors are more meaningful due the continuing nature of their contracts.

The ‘remaining performance obligation’ disclosure reveals the aggregate amount of revenue yet to be recognised as of the end of the reporting period. It also discloses when the company expects to recognise these revenues. For example, Infosys, in its June quarter report, stated that “the aggregate value of performance obligations that are completely or partially unsatisfied as of June 30, 2018 is ₹40,936 crore (with some exclusions). Of this, the firm expects to recognise revenue of around 50 per cent within the next year and the remaining thereafter.” Such disclosures help investors assess the near-future revenue inflow from existing projects.

Auto

The payment that auto companies receive when transferring vehicles to dealers for sale was earlier recognised as revenue. The costs associated with that process were presented under ‘other expenses’ in the statement of profit and loss. Under Ind AS 115, such revenue is to be presented net of cost. This change significantly contributed to the dip in Tata Motors’ revenue and expenses — down ₹929 crore — in the quarter ended June 30. So, even though the company’s profitability wasn’t affected, revenue has become uncomparable.

Hospitality

The non-refundable admission fee collected for vacation ownership contracts is one of the key revenue segments in the hospitality sector.

A significant portion of this revenue was earlier recognised in the year of sale. According to the new standard, income from such contracts has to be recognised over the tenure of the membership; and the associated costs (except incremental) are to be charged to the profit-and-loss account for the period. Due to this change, the profit of Mahindra Holidays and Resorts was down by ₹23 crore, compared with the profits computed using Ind AS 18.

Telecommunication

Under Ind AS 115, revenue from certain items has to be recognised over the life of a contract, unlike earlier, when it was recognised — fully or substantially — in the year of sale. Tata Communication has had to bear the brunt of this alteration. Ind AS 115 is also one of the prime reasons for the decline in the company’s Q1 FY19 revenue by 12.6 per cent y-o-y and 6.2 per cent q-o-q.

In the upcoming quarters of FY 2019, investors would do well to be a bit more cautious while analysing the results of these sectors. However, keep in mind that Ind AS 115 has not caused a ripple in the revenue recognition process of all companies in these segments.

Some revenue recognition rules were altered when the transition from Indian GAAP to Ind AS revenue standards (Ind AS 18/11) happened in April 2016. These changes continue to be effective under the Ind AS 115 as well.

Under Indian GAAP, the gross revenue and the tax paid (on sales) were shown separately in the financial statement. Ind AS requires companies to show just the post-tax revenue in the statement of profit and loss.

The Ind AS revenue standards focus on recognising the revenue on a fair-value basis, that is, after considering the time value of money.

Fair value comes into the picture when there is an in-built financing element (explicit or implicit) in the price consideration. For example, fair value is considered when the time provided for payment to a particular customer is beyond the normal credit period.

In such cases, the revenue is to be recognised at the discounted value of future cash flows, while the difference is to be recognised as interest over the tenure of the contract. As per Ind AS, a company has to recognise its interest income from investments — other than operational investments — according to the effective interest rate method, while Indian GAAP suggested the proportionate basis method.

The effective interest method takes into consideration the time value of money while calculating the interest income. Ind AS mandates considering the fair value while reporting income, in line with global reporting standards.

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