Auditing & Attestation

For a new project, monies may be brought in by promoters and raised by way of loans. An interesting issue, which arises for determination is whether the interest payable on the loans received would be deductible under section 57 of the Act against the interest earned on the temporary parking of surplus funds.

In CIT v Karnataka Power Corporation (247 ITR 268), it was held by the apex Court that interest receipts/hire charges received during pre-production period is on a capital account. In Tuticorin Alkali Chemicals and Fertilizers Ltd v CIT (227 ITR 172), the Supreme Court considered the investment of borrowed funds prior to commencement of business and held that the interest earnable was taxable.

In CIT v Bokaro Steel Ltd (236 ITR 315), a government company, which during the period of construction of the plant had advanced monies to contractors on which it was earning interest, received rent from quarters let out to employees. It also received hire charges on plant let out to contractors and received royalty on stones removed from its land.

The Supreme Court considered all these activities to be intricately connected with the construction activity and accordingly held that interest received, rent received, hire charges and royalty, etc, would be reduced from the cost of the assets. Such receipts would not be treated as income. A similar view was expressed by the Supreme Court in CIT v Kamal Co-operative Sugar Mills Ltd (243 ITR 2). An identical view was also taken by the Supreme Court in Bongaigaon Refinery and Petrochemicals Ltd v CIT (251 ITR 329) and CIT v Karnataka Power Corporation (247 ITR 268).

This point was considered by the Madras High Court in CIT v VGR Foundations (298 ITR 132). The facts in this case were that the assessee was a partnership firm engaged in the real estate business. For assessment years 1997-98 and 1998-99, a survey under section 133-A of the Act was conducted and noticeS  under section 148 were issued.

The assessee filed "nil" returns of income and also filed letters stating that the returns filed vide acknowledgment No 8869, dated February 14, 2000, for the assessment year 1997-98 and acknowledgment No 8871, dated February 14, 2000, for the assessment year 1998-99, have to be treated as the returns in response to the notices issued under section 148 of the Act. Further, notices under section 143(2) were issued on November 20, 2001. The assessing officer noticed that the statements filed along with the returns of income revealed that the assessee had incurred expenses prior to commencement of business and the assessee had also earned interest income on fixed deposits with the bank. Such income had been set off against the expenses.

The assessing officer was of the view that the interest received on short-term deposits in the bank during the pre-production stage was assessable as income from other sources. Aggrieved by the orders, the assessee filed appeals to the commissioner of income tax (appeals). The commissioner dismissed the appeals and confirmed the orders of the assessing officer. Aggrieved, the assessee filed appeals to the income tax appellate tribunal. The tribunal allowed the assessee's appeals and set aside the orders of the commissioner of income tax (appeals).

Counsel appearing for the revenue submitted before the Madras High Court that the assessee had set off interest earned, prior to the commencement of the business operation, against the expenses. The assessee was wrong in setting off the interest prior to the commencement of the business operation, against the expenses. The interest income earned prior to the commencement of the business has to be assessed under the head "income from other sources". Hence, the assessing officer was right in assessing the interest income under the head "income from other sources" and not allowing expenses as a deduction.

Real estate developers enter into agreements to sell the real estate before they have completed or, at times, even begun construction. Each buyer enters into an agreement to acquire a specified unit when it is ready for occupation.

Typically, the buyer pays a deposit and makes progressive payments as the real estate is being constructed. Real estate sale may take various forms. For example, they may relate to commercial/industrial development, a flat in a building, or a villa that is being exclusive constructed to the specification of the buyer.

The accounting of real estate sales is a contentious issue not only in India but also globally.
AS-7 or AS-9

The question often faced by developers is whether the development is a construction contract and hence percentage of completion method under AS-7 should be applied or whether the sale of the real estate is a product sale to which the requirements of AS-9 relating to sale of product should be applied.

If AS-9 is applied then the sale is recognised on delivery of the product at which time the risk and rewards are also transferred to the buyer.

This question has been addressed in the "Guidance Note on Recognition of Revenue by Real Estate Developers", issued by the ICAI. It may be noted that the interpretation contained in the Guidance Note is different from a recently issued proposed interpretation under IFRS.
Different interpretation

As per the Guidance Note, in the case of real estate sales, all significant risks and rewards of ownership are normally transferred when legal title passes to the buyer (for example, at the time of the registration in the name of the buyer) or if there is a legally enforceable agreement for sale and (a) the significant risks (price risk, for instance) have been transferred to the buyer (b) the buyer has a legal right to sell or transfer his interest in the property, without any material impediment.

Once the seller has transferred all the significant risks and rewards of ownership to the buyer, any further acts on the real estate performed by the seller are, in substance, performed on behalf of the buyer in the manner similar to a contractor.

Accordingly, in case the seller is obliged to perform any substantial acts after the transfer of all significant risks and rewards of ownership, revenue is recognised by applying the percentage of completion method in the manner explained in AS 7, Construction Contracts.

Under the IFRS framework, the International Financial Reporting Interpretations Committee (IFRIC) has prepared a draft IFRIC interpretation "D-21 Real Estate Sales" in the light of divergent revenue recognition practices for sales of units by real estate developers.

The draft IFRIC interpretation concluded that a construction contract is `a contract specifically negotiated for the construction of an asset or a combination of assets ...' A sale agreement meets this definition if it is an agreement for the seller to provide construction services to the buyer's specifications.

Features that, individually or in combination, may indicate that an agreement is for the seller to provide construction services to the buyer's specifications, include:

the buyer being able to specify the major structural elements of the design of the real estate before construction begins and/or specify major structural changes once construction is in progress (whether it exercises that ability or not); and

the seller transferring to the buyer control and the significant risks and rewards of ownership of the work-in-progress in its current state as construction progresses.

Indications that the seller transfers control of the work-in-progress this way may include, for example:

the construction taking place on land that is owned or leased by the buyer;

the buyer having a right to take over the work-in-progress (albeit with a penalty) during construction -- for example, to engage a different contractor to complete the construction;

in the event of the agreement being terminated before construction is complete, the buyer retaining the work-in-progress and the seller having the right to be paid for work performed (subject to buyer acceptance).
Sale of goods

Conversely, features that, individually or in combination, may indicate that an agreement is for the sale of goods (completed real estate) include:

the negotiation between the buyer and seller primarily concerning the amount and timing of payments, with the buyer having only limited ability to specify the design of the real estate, for example, to select a design from a range of options or specify minor variations to the basic design;

the agreement giving the buyer only a right to acquire the completed real estate at a later date, with the seller retaining control and the significant risks and rewards of ownership of the underlying work-in-progress until that date.

If a sale agreement is for the sale of goods, revenue shall be recognised if the entity has transferred to the buyer the significant risks and rewards of ownership of, and effective control over, the goods sold.

These conditions shall be applied to the underlying real estate in its current state, not to the buyer's right to acquire the fully constructed real estate at a later date. This effectively means that revenue on real estate sales is recognised when the real estate is constructed and delivered to the buyer.

Stage of completion

The rationale for applying the stage of completion method to construction contracts is not just that it recognises the value of the entity's activity in the period. Rather it also recognises the economic benefits that the entity has delivered (via continuous transfer of control and risks and rewards of ownership) to the buyer as construction progresses.

This continuous transfer is often not a feature of agreements for the sale of real estate units -- control of the unit tends to pass from seller to buyer at a single point in time, usually when the unit is ready for occupation.

Going by D-21, if the real estate developer is constructing a villa for a purchaser, with the purchaser having control over that construction and the villa is to the specification of the purchaser, then the construction of the villa would be a construction contract and the same would be accounted using the percentage of completion method.

If the real estate developer is constructing a multi-storey building and a purchaser is buying a flat in the building, with little control over the technical specification of the flat and no control over the construction, the sale of the flat would be accounted for as a product sale. In other words, the sale would be recognised by the real estate developer when the purchaser is given the possession of the flat.

Clarity to interpretation

To make the above interpretation clear, the IFRIC has included the proposed new guidance on applying IAS 18 within D-21 and has proposed the withdrawal of Example 9 from the appendix to IAS 18, which was creating some confusion, relating to accounting for real estate sales.

The IFRIC noted that a binding agreement for the sale of real estate -- like other forms of binding customer order -- gives the buyer an asset in the form of a right to acquire, use and sell the completed real estate at a later date. The buyer controls this right and obtains risks and rewards associated with it, such as movements in the market value of the completed real estate.

However, an agreement for the sale of a real estate unit typically does not give the buyer control of the underlying real estate in its existing partially-constructed state. The seller typically retains significant risks of ownership, such as construction risk and risk of damage or default. The seller also typically retains the right to use -- that is, continue development of the work-in-progress. The seller is likely to retain these rights until the buyer obtains possession, usually at contractual completion.

The IFRIC notes that it is necessary to distinguish a right to acquire goods from the underlying goods themselves -- for recognising the sale the entity should have transferred to the buyer the significant risks and rewards of ownership of, and effective control over, the goods sold, not the right to acquire the goods. Hence, a binding agreement for the sale of a real estate unit is usually insufficient to satisfy the conditions for revenue recognition.

As can be seen from the discussion, the revenue recognition criterion under the "Guidance Note on Recognition of Revenue by Real Estate Developers", and D-21 are different. The interpretation in D-21 as to what is a product and what is a construction contract, and the time when risks and rewards are transferred, are far more acceptable considering the core principles of the standards on revenue recognition and contract accounting.

The Indian Guidance Note is fundamentally flawed and may lead to totally unintended conclusions if applied as a general principle, for example, revenue recognition under the Guidance Note would commence on entering into non-cancellable purchase orders, rather than at the time of delivery of goods. Consequently, the Indian Guidance note is ripe for a revision.

Apart from the usual pressures of not being able to meet the financial budgets that a firm has set up for itself (whether by means of a well-defined budget and business plan or through a hazy and unfocussed set of targets), there are also by the very nature of the profession risks that one has to be alive to.

High risk profile

Add to this melange of variables, the recent phenomenon of employee-attrition and the high levels of salary expectations, we now have a very difficult set of circumstances within which the profession has to function. Further, costs having risen at a pace faster than revenues and due to the dearth of manpower, it is not always possible to get the best of resources required.

The profession has a high risk profile. Often the sins of the clients visit the CAs for no fault of their own except that the CA happened to be at the wrong place at the wrong time. It therefore becomes essential for a CA to evaluate the client list periodically in order to mitigate the risks and to maximise the income. This should be done in a systematic manner. Such an evaluation will enable the CA to pinpoint the areas where he/she needs to concentrate. An illustrative template is provided (see Table), which is self-explanatory. This will also help in the peer-review process.

Three qualitative criteria have been used in the template. The greater the number of the qualitative criteria that is employed, the greater will be the options and choices available, apart from making them better and more narrowly defined. Therefore, one can tailor-make the template based on one's experience to make it more relevant for personal needs rather than have a generic model.
Defined Values

It is possible that each CA has his/her own answers to the various situations thrown up by the template. While the comments are only examples, each CA can modify according to own perceptions. Therefore, the comments are not to be taken as answers but as suggestions.

What the template does is help one focus on client rating and articulate what has been hitherto unarticulated. It is absolutely imperative that the CA has a list of defined values and categories into which each client is placed and that the CA examines each client periodically and move the client up and down in the category list on the basis of experience. Once a client is placed in "to watch list" or some equivalent category (according to the internal practices), the client should be monitored carefully.

As one's practice grows larger, one acquires the power to say no and walk away from a deal, if the situation so warrants, which is a sign of maturity. In matters such as this, instinct is a great judge although giving up a client purely because the fees is not adequate may not always be the right decision, since the particular client may refer other clients or may present other opportunities.

Choose with care

However, there is a point at which it may not be worth retaining even such clients since more work at low fee will not help a CA. Pruning down a client list will definitely affect the gross revenues although at the net income level it may not have much impact. This is worth bearing in mind. Being aware of the fact that a new entrant is not always in a position to pick and choose the `right' client, it must be understood that new clients are like investment opportunities and therefore must be chosen with great care.

Q1: Give your views on the

   following:

a) After conducting the audit of a branch of a nationalised bank, the branch auditor purchases shares of this bank from the secondary market soon after releasing his audit report. (5 marks)

b) A company was producing chewing tobacco, which is banned by the Government. The company starts manufacturing energy drinks, but holds the machinery used for producing chewing tobacco and charges depreciation on this machinery. (4)

c) It is the practice of the company to price its issue of stores for production on LIFO basis. The company claims that the provisions of Accounting Standard 2 apply only to closing stock but has no applicability to pricing the issues to production. (5)

d) A company files papers with the Ministry of Company Affairs for change of its name and starts using the new name immediately thereafter. (4)

Q2: Examine if the following situations constitute professional misconduct:

a) During the course of audit of a couple of branches of a nationalised bank, an auditor finds that the NPA classification was not properly made. He writes to the Reserve Bank of India on this matter stating it is his responsibility to bring it to the regulatory authority. (5)

b) A member in practice joins a listed company as an independent professional director and also continues his practice. (4)

c) A member is the Director (Finance) for some of the private limited companies and he is appointed as auditor for other private limited companies having the same composition of shareholders and directors. (5)

d) A member signs a contract with a corporate educational institution to visit the institution for 15 days at a stretch and cover the auditing syllabus of CA examinations in 100 hours. (4)

Q3: (a) What are the requirements of tax audit in respect of deduction of tax at source? (6)

b) What is the list of books required to be maintained by stock brokers? (10)

Q4: (a) What are the possible situations (regarding attitudes of the management and workers) the auditor is likely to encounter in a management audit. (8)

b) What are the different types of reinsurance possible? (8)

Q5: (a) When is a computerised information systems environment said to exist? How does it impact the work of an auditor? (10)

b) What are the powers of the Comptroller and Auditor General (C&AG) in the audit of public sector undertakings. (6)

Q6: (a) What various points do you look in to while carrying out environment audit? (8)

b) What aspects are covered in a due diligence audit? (8)

Q7: How do concurrent audit, internal audit and operations audit differ from each other? (16)

The work of formulating down accounting standards for the companies operating in India was initiated when the Institute of Chartered Accountants of India (ICAI), a statutory body regulating the accounting profession in the country, first took up this task in 1977. However, the accounting standards prepared and issued by the ICAI were mandatory only for its members, who, while discharging their audit function, were required to examine whether the said standards of accounting were complied with. With the amendment of the Companies Act, 1956 through the Companies (Amendment) Act, 1999, accounting standards as well as the manner in which they were to be prescribed, were provided a statutory backing.

Today, in pursuance of the statutory mandate provided under the Companies Act, 1956, the Central Government prescribes accounting standards in consultation with the National Advisory Committee on Accounting Standards (NACAS), also established under the Companies Act, 1956. NACAS, a body of experts including representatives of various regulatory bodies and Government agencies, has been engaged in the exercise of examining Accounting Standards prepared by ICAI for use by Indian corporate entities, since its constitution in 2001. In this exercise, it has adapted the international norms established by the International Financial Reporting Standards issued by the International Accounting Standards Board.

The Central Government notified 28 Accounting Standards (AS 1 to 7 and AS 9 to 29) in December 2006 in the form of Companies (Accounting Standard) Rules, 2006, after receiving recommendations of NACAS. These Accounting Standards are to be applied with effect from company financial year 2007-08, the accounts with respect to which are to be finalised during 2008-09. In notifying the Accounting Standards, the Government has adopted a policy of enabling disclosure of company accounts in a transparent manner at par with widely accepted international practices, through a process of convergence with the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). In doing so, the requirements of the companies functioning in the country are being kept in view. The initiative for harmonization of the Indian accounting standards with IFRS, taken up by NACAS in 2001 and implemented through notification of accounting standards by the Central Government in 2006, would be continued by the Government with the intention of achieving convergence with IFRS by 2011.

Consistent with international practices, the accounting standards are prepared in India in context of the issues concerning large publicly held and listed corporate entities so as to enable the widest possible coverage of financial issues concerning a corporate entity. Consequently, some of the requirements of accounting standards may prove to be onerous for Small and Medium Companies (SMCs), who may not have the necessary resources to apply these requirements and incur associated compliance costs. Also, users of financial statements of the SMCs and their information requirements may also have limited requirements. Keeping this in view, necessary exemptions and relaxations to SMCs have been incorporated in the accounting standards on the recommendation of NACAS to enable them to apply the broad framework of the Accounting Standards in a simple manner.

The accounting and financial reporting practices need to change and evolve with the changing business and economic situation. Accounting practices prevailing in the country would also need to develop likewise. The institutional arrangements under the Companies Act, 1956 enable such developments through the efforts of NACAS and with inputs from ICAI and other quarters to meet the requirements of a changing economy. In this context, ICAI would continue to prepare and hold public consultation on standards of accounting for general application to various entities. It may also issue advice and guidance to its members to consider following certain practices approved by it in pursuance of prudence. The Government would examine further accounting standards to be followed by companies, on the basis of the standards proposed by ICAI, subject to the recommendations of NACAS thereon, for notification in accordance with the procedure laid down under the Companies Act, 1956. In the process, the approach of convergence with International Financial Reporting Standards issued by the International Accounting Standards Board (IASB), being increasingly accepted as a common standard internationally, would be continued so that the financial information disclosed by Indian companies compares well with that disclosed by non-Indian companies in compliance with IFRS. This would not only provide reliable financial information to investors globally but also lower compliance costs since the need for restatement of accounts would be obviated for Indian companies seeking to tap international financial markets.

The Ministry of Corporate Affairs would, through the reform of accounting standards, continue to strengthen the corporate financial systems, at par in the best international practices, in the interest of all stakeholders to meet the requirements of India's changing economy.

The Indian arm of the global consultancy firm Ernst & Young, however, denied any wrong doing saying it had adhered to all the guidelines.

Amid the controversy after selection of Lanco Globeleq consortium as the successful bidder for the 4,000 Mw power project in Madhya Pradesh, the Central Vigilance Commission (CVC) had asked the power ministry to get into the act. The project was later awarded to Anil Ambani group's Reliance Power.

Acting on a direction from ministry in november last year, the PFC's vigilance wing had probed the issue pertaining to "professional conduct of E&Y and alleged omissions and commissions" of various committees involved in evaluation of the bids for the project.

Pointing to "major lapse" on part of E&Y and the bid evaluation committee, the Chief Vigilance Officer of PFC said in his report: "

It is suggested that PFC/ministry of power may initiate a process for debarring M/s E&Y from bidding for projects under the purview of ministry of power."

When contacted, PFC Chairman V K Garg and director Shyam Wadhera, who was also the chairman of the Board of Sasan Power Ltd declined to comment on the vigilance report.

A spokesperson for E&Y told PTI in an emailed statement "E&Y is not aware of the said report. We maintain that E&Y has adhered to all the guidelines with regard to the selection process."

Demerger does not find a specific reference in Section 49 with the result it is a mystery whether the original cost of acquisition for capital assets in the hands of the demerged company can be deemed to be the cost of acquisition for the resulting company.  

Pharma companies have recently embarked on hiving off R&D arms. In other sectors too, such as real estate, power and infrastructure, demerger has led to creation of two companies from a larger but single entity. But does the value or wealth creation (depends on which side you are) come at a price? "The question which has always been a concern for companies undergoing demergers is whether the process of demerger can be said to be completely tax neutral," says Mr Anil Talreja, Senior Manager M&A Tax, Deloitte Haskins & Sells. While joining up two companies (via the amalgamation route) enjoys tax benefits, the case of demerger does not find a specific reference in Section 49 of the Income-tax Act, 1961, he told Business Line in a Q&A session done over e-mail.

Excerpts from the interview:

Tell us about demerger from the tax perspective.

The concept of `demerger' of companies under the income-tax law was introduced by `The Finance Act, 1999' with effect from assessment year 2000-01.

Simultaneous insertions were made in the I-T Act, and these included provisions relating to definition of `demerger', transfer of capital assets in a demerger, computation of depreciation allowance, written-down value of depreciable assets.

You were talking about an amendment that may have led to confusion.

Yes. One such amendment was to exclude any transfer of a capital asset in a demerger from the purview of `transfer' for the purposes of determining capital gains under the Act to the resulting Indian company. This was enshrined in the law by insertion of clause (vi-b) to Section 47 of the Act, thereby making the transfer of such assets, tax neutral.

What about in the case of an amalgamation?

As is also the case with `amalgamation' of companies, any transfer of capital assets to the amalgamated company being an Indian company is not regarded as a `transfer' for the purposes of the Act.

This is in terms of clause (vi) of Section 47. The question which has always been a concern for companies undergoing demergers is whether the process of demerger can be said to be completely tax neutral.

How does the taxman look at amalgamation?

Companies which undergo restructuring in the form of amalgamation enjoy tax benefits on account of transfer of capital assets made pursuant to the amalgamation.

Further, the cost of acquisition of these assets in the hands of the amalgamated company is deemed to be the original cost of acquisition to the previous owner (amalgamating company).

This is by virtue of Section 49(1)(iii)(e) of the Act. This section allows substitution of the original cost of the capital asset in case the asset is sold by the amalgamated company subsequent to the amalgamation.

Section 49 of the Act enables one to determine the cost of acquisition with reference to certain specified modes of acquisition. The modes of acquisition referred to in this section include a case of transfer by succession, inheritance, devolution, dissolution, distribution of assets or liquidation of a company.

It also includes transfers arising pursuant to an amalgamation, transfers between parent and subsidiary companies.

And demergers, too?

No, the case of demerger does not find a specific reference in Section 49 with the result it is a mystery whether the original cost of acquisition for capital assets in the hands of the demerged company can be deemed to be the cost of acquisition for the resulting company.

The issue then is with absence of mention in the Section 49, right?

Yes. The absence of a clear reference to a case of demerger in Section 49 is now a common concern for companies using this route to restructure themselves. This concern has dual implications.

One is with regard to arriving at the cost of acquisition of the capital assets acquired by way of demerger for computing the capital gains on their subsequent sale as narrated above.

The second implication is in determining the period of holding of these assets on their subsequent sale.

The short- and long-term difference?

Yes. The Act provides for differential tax rates on sale of assets based on their period of holding. Section 2(42A) of the Act, which explains what a `short term capital asset' is, specifies circumstances where the period of holding of the previous owner of the asset has to be reckoned in determining whether a particular asset is a `short-term capital asset' or not. Although Section 49(1) of the Act finds place as one such circumstance, the case of transfer of capital assets pursuant to a demerger is again not clearly specified in Section 2(42A).

What are the implications of the `mystery'?

The specific concern here is that in a case where investments forming part of the capital assets are transferred to the resulting company in a demerger and soon after the demerger these investments are sold, whether the period of holding of these investments by the demerged company need to be considered while determining if these investments are short term or long term in nature.

Considering the variation in the tax rates of short term and long-term capital assets, the above concern could be a deal breaker depending upon the stakes involved. A number of companies are proceeding on the basis of giving themselves the benefit of doubt by considering that a case of demerger would fall within the modes covered by Section 49.

Is a solution in sight?

As the above stands un-clarified even by the recent Finance Bill, 2008, it would be appropriate to retrospectively amend the law clarifying this proposition to avoid any confusion or differences of interpretation.

A revised 2008 Edition of the Guidance Note on Audit of Banks has been released by ICAI .

The 2008 edition of the Guidance note has been divided into four distinct parts.

Part I - Banking Operations

    *

# information about the banking industry
# its legal framework
# accounting and auditing framework.
significant financial statement items-their presentation in the financial statements, relevant RBI guidelines, etc.

Part II - Audit Approach and Procedures

    *

# Basic audit considerations in branch office vis a vis head office
audit procedures for each of the financial statement item discussed in Part I.

Part III - Long Form Audit Reports

    *

# LFAR in branches
LFAR in head office

Part IV - Special Aspects

    *

# Special aspects such as Ghosh Jilani Committee requirements
SLR certification, etc., respectively.

The Guidance Note comes with a CD pasted at the inside of its back cover. This CD contains the text of relevant circulars of the RBI. The CD is not to be sold separately.

How to Get a Copy

The Guidance Note is available for sale at the sales counters of all the ICAI's Regional Councils/ their branches near you.

OR

If however, you are unable to get one from there, you can send a Demand Draft of Rs.400/- plus courier charges as applicable (courier in Delhi - Rs. 15/-, courier outside Delhi - Rs. 50/-). The DD should be in favour of The Secretary, The Institute of Chartered Accountants of India payable at New Delhi. The DD can be sent at the following address:

Assistant Secretary (STORES)

The Institute of Chartered Accountants of India,

ICAI Bhawan
, C-1, Sector-1,

NOIDA - 201 301.

Tel.: 0120 - 3054 802

The step, cleared by ICAI, will be operational from April 2009 and is expected to significantly reduce complexity between individual partners in audit firms and their assigned companies, something that has been a cause behind many of the big corporate frauds to have hit the financial world.

"We have cleared rotation of partners and this would come into force from April 1, 2009 only for listed firms, ICAI president Ved Jain told TOI.

He said the move will bring in more transparency in the corporate sector and will help in increasing confidence in the auditing process.

India is taking the step as part of harmonization of auditing standards with the International Auditing and Assurance Standard Board (IAASB), the international audit standard-setting organization. So far, over 100 countries have moved to adapt global practices of IAASB. Even the Sarbanes-Oxely Act in the US mandates rotation of partners.

Rotation of partners on the assignment has been cleared as part of the Standard on Quality Control (SQC), said Jain.

Currently, there are around 1.45 lakh CAs in India, half of which are estimated to be in independent practice while the other half are employed in firms and companies. However, as many as 72 per cent of the independent professionals are estimated to be single practicing proprietary CAs.

Asked how would the single-proprieter firms work out the issue, director with ICAI Vijay Kapur said they would need to provide for a compulsory peer review. "We have provided this option as rotation here is not possible, he said.

As you aware that the launching of MCA-21, a national mission mode project by the Ministry of Corporate Affairs has positioned the brave India on the global path of e-governance benchmarked with best global practices. The new era of corporate governance has certainly paved the way for a more transparent, stakeholder friendly and accountable corporate regime. The Ministry deserves appreciation for the revolutionary effort for conceiving, planning and successfully implementing the MCA 21 Project. Appreciating the emerging global scenario and aiming at making India globally competitive in attracting investments from abroad, by suggesting systems in the Indian corporate environment which are transparent, simple and globally acceptable, the Government of India had constituted an Expert Committee on Company Law, 2005. In pursuance to the recommendations of this Committee, a new Company Law regime is under formulation.
The Committee in its report admitted the right of shareholders to be informed through simple disclosure which should not be in excessively technical format. This will enhance the credibility of the company and will help the shareholders to take an informed and conscious decision in respect of their investments. The Committee visualizes a regime of stringent disclosure norms in case of companies accessing funds through public offers. The Committee observed that proper and accurate compilation of financial information of a corporate and its disclosures, in a manner that is standardized and understood by stakeholders, is central to the credibility of the corporates and soundness of investment decisions by the investors.
The Committee was also of the view that Small companies need not be subject to the costs of a regime suited to large companies with a wide stakeholder base. Relaxations to small companies with regard to the format of accounts to be prescribed in the Act/Rules may also be considered. If necessary, a separate format for small companies may be devised. Exemptions from certain disclosures may also be considered and relaxations, if any required, in respect of compliance with Accounting Standards may be provided for while notifying the Accounting Standards. If necessary, a separate Accounting Standard may be framed for small companies.
Accordingly, the Ministry of Corporate Affairs had requested the Institute to review its earlier suggestions on Schedule VI to simplify the same appreciating the best global practices as well as the emerging Indian practices. The Institute was also requested to prescribe a SARAL Schedule VI for small and medium sized companies.
To carry out the exercise, the Institute had constituted a Study Group to formulate the suggestions on Schedule VI and for prescribing SARAL Schedule VI for small and medium sized companies.
The VISION CONCEPT PAPER to carry out the exercise was as follows: -
A.    OBJECTIVES
(i)     Simplification of presentation.
(ii)     To evaluate existing format with respect to unwanted and outdated disclosures which have lost relevance over the years.
(iii)     To synchronize & harmonize the disclosure requirements with Accounting Standards by including cross references.
(iv)     To harmonize and converge with global disclosure requirements.
(v)     To minimize disclosure requirements for Small and Micro Companies through the Principle of Abridgement by creating a "Saral" document. All companies to be identified and categorized in to three levels for differential disclosure requirements.
(vi)     To incorporate inherent flexibility in the format (to facilitate time to time amendments).
(vii)     To incorporate the disclosure requirements under other statutes only after strict merit evaluation and where extremely justified.
(viii)     The abstract in form 23AC and 23ACA for e-filing of the financial statements to be reviewed and made more comprehensive.
B.    PRINCIPLES
(ix)     The format should ensure adequacy and sufficiency of disclosures in financial statements to give a true & fair view of:

    * the state of affairs as at the end of the financial year,
    * the profit or loss for the accounting period
    * the cash flows for the accounting period

(x)     Financial statements to have a Balance Sheet and an Income statement. The format should be determined only by a single regulatory agency i.e. Companies Act through Schedule-VI only. Multi-regulatory agencies should not determine the format
(xi)     All additional disclosures of information under the Indian Accounting Standards to be included in a separate statement to be appended to the financial statements and not in the main format of the financial statements.
C.    METHODOLOGY
(i)     To study the requirements under IFRS & US GAAP.
(ii)     To study the other models eg. the Australian Model.
(iii)     To study all disclosure requirements which are mandated under the Indian Accounting Standards to be disclosed on the face of Balance Sheet or Profit & Loss Account.
(iv)     To Study the categorization of companies into different levels as per accounting standards/CARO/any other criteria
While appreciating the best global practices and the industry specific requirements as well as the disclosure requirements under IFRS, the Study Group examined the position across the world and carried out indepth research to formulate the drafts. The study group recommended the drafts of simplified Schedule VI and SARAL Schedule VI for small and medium sized companies. The Corporate Laws Committee of the Institute considered the drafts of both the Schedules and finalized the same. The drafts are being sent to the Ministry of Corporate Affairs and other Specified Bodies for comments.

DRAFT SARAL SCHEDULE VI FOR THE SMALL AND MEDIUM SIZED COMPANIES TO THE COMPANIES ACT, 1956

DRAFT SIMPLIFIED SCHEDULE VI TO THE COMPANIES ACT, 1956

As desired by CA. Vinod Jain, Chairman, Corporate Laws Committee, Members are requested to give their views/comments on both the Schedules at the earliest and latest by 31st March, 2008. Comments may be sent by e-mail with the subject line "VIEWS/SUGGESTIONS ON SCHEDULE VI and SARAL SCHEDULE VI FOR SMEs" to the following: -

Real estate developers enter into agreements to sell the real estate before they have completed or, at times, even begun construction. Each buyer enters into an agreement to acquire a specified unit when it is ready for occupation.

Typically, the buyer pays a deposit and makes progressive payments as the real estate is being constructed. Real estate sale may take various forms. For example, they may relate to commercial/industrial development, a flat in a building, or a villa that is being exclusive constructed to the specification of the buyer.

The accounting of real estate sales is a contentious issue not only in India but also globally.

AS-7 or AS-9

The question often faced by developers is whether the development is a construction contract and hence percentage of completion method under AS-7 should be applied or whether the sale of the real estate is a product sale to which the requirements of AS-9 relating to sale of product should be applied.

If AS-9 is applied then the sale is recognised on delivery of the product at which time the risk and rewards are also transferred to the buyer.

This question has been addressed in the "Guidance Note on Recognition of Revenue by Real Estate Developers", issued by the ICAI. It may be noted that the interpretation contained in the Guidance Note is different from a recently issued proposed interpretation under IFRS.

Different interpretation

As per the Guidance Note, in the case of real estate sales, all significant risks and rewards of ownership are normally transferred when legal title passes to the buyer (for example, at the time of the registration in the name of the buyer) or if there is a legally enforceable agreement for sale and (a) the significant risks (price risk, for instance) have been transferred to the buyer (b) the buyer has a legal right to sell or transfer his interest in the property, without any material impediment.

Once the seller has transferred all the significant risks and rewards of ownership to the buyer, any further acts on the real estate performed by the seller are, in substance, performed on behalf of the buyer in the manner similar to a contractor.

Accordingly, in case the seller is obliged to perform any substantial acts after the transfer of all significant risks and rewards of ownership, revenue is recognised by applying the percentage of completion method in the manner explained in AS 7, Construction Contracts.

Under the IFRS framework, the International Financial Reporting Interpretations Committee (IFRIC) has prepared a draft IFRIC interpretation "D-21 Real Estate Sales" in the light of divergent revenue recognition practices for sales of units by real estate developers.

The draft IFRIC interpretation concluded that a construction contract is `a contract specifically negotiated for the construction of an asset or a combination of assets ...' A sale agreement meets this definition if it is an agreement for the seller to provide construction services to the buyer's specifications.

Features that, individually or in combination, may indicate that an agreement is for the seller to provide construction services to the buyer's specifications, include:

the buyer being able to specify the major structural elements of the design of the real estate before construction begins and/or specify major structural changes once construction is in progress (whether it exercises that ability or not); and

the seller transferring to the buyer control and the significant risks and rewards of ownership of the work-in-progress in its current state as construction progresses.

Indications that the seller transfers control of the work-in-progress this way may include, for example:

the construction taking place on land that is owned or leased by the buyer;

the buyer having a right to take over the work-in-progress (albeit with a penalty) during construction -- for example, to engage a different contractor to complete the construction;

in the event of the agreement being terminated before construction is complete, the buyer retaining the work-in-progress and the seller having the right to be paid for work performed (subject to buyer acceptance).

Sale of goods

Conversely, features that, individually or in combination, may indicate that an agreement is for the sale of goods (completed real estate) include:

the negotiation between the buyer and seller primarily concerning the amount and timing of payments, with the buyer having only limited ability to specify the design of the real estate, for example, to select a design from a range of options or specify minor variations to the basic design;

the agreement giving the buyer only a right to acquire the completed real estate at a later date, with the seller retaining control and the significant risks and rewards of ownership of the underlying work-in-progress until that date.

If a sale agreement is for the sale of goods, revenue shall be recognised if the entity has transferred to the buyer the significant risks and rewards of ownership of, and effective control over, the goods sold.

These conditions shall be applied to the underlying real estate in its current state, not to the buyer's right to acquire the fully constructed real estate at a later date. This effectively means that revenue on real estate sales is recognised when the real estate is constructed and delivered to the buyer.

Stage of completion

The rationale for applying the stage of completion method to construction contracts is not just that it recognises the value of the entity's activity in the period. Rather it also recognises the economic benefits that the entity has delivered (via continuous transfer of control and risks and rewards of ownership) to the buyer as construction progresses.

This continuous transfer is often not a feature of agreements for the sale of real estate units -- control of the unit tends to pass from seller to buyer at a single point in time, usually when the unit is ready for occupation.

Going by D-21, if the real estate developer is constructing a villa for a purchaser, with the purchaser having control over that construction and the villa is to the specification of the purchaser, then the construction of the villa would be a construction contract and the same would be accounted using the percentage of completion method.

If the real estate developer is constructing a multi-storey building and a purchaser is buying a flat in the building, with little control over the technical specification of the flat and no control over the construction, the sale of the flat would be accounted for as a product sale. In other words, the sale would be recognised by the real estate developer when the purchaser is given the possession of the flat.

Clarity to interpretation

To make the above interpretation clear, the IFRIC has included the proposed new guidance on applying IAS 18 within D-21 and has proposed the withdrawal of Example 9 from the appendix to IAS 18, which was creating some confusion, relating to accounting for real estate sales.

The IFRIC noted that a binding agreement for the sale of real estate -- like other forms of binding customer order -- gives the buyer an asset in the form of a right to acquire, use and sell the completed real estate at a later date. The buyer controls this right and obtains risks and rewards associated with it, such as movements in the market value of the completed real estate.

However, an agreement for the sale of a real estate unit typically does not give the buyer control of the underlying real estate in its existing partially-constructed state. The seller typically retains significant risks of ownership, such as construction risk and risk of damage or default. The seller also typically retains the right to use -- that is, continue development of the work-in-progress. The seller is likely to retain these rights until the buyer obtains possession, usually at contractual completion.

The IFRIC notes that it is necessary to distinguish a right to acquire goods from the underlying goods themselves -- for recognising the sale the entity should have transferred to the buyer the significant risks and rewards of ownership of, and effective control over, the goods sold, not the right to acquire the goods. Hence, a binding agreement for the sale of a real estate unit is usually insufficient to satisfy the conditions for revenue recognition.

As can be seen from the discussion, the revenue recognition criterion under the "Guidance Note on Recognition of Revenue by Real Estate Developers", and D-21 are different. The interpretation in D-21 as to what is a product and what is a construction contract, and the time when risks and rewards are transferred, are far more acceptable considering the core principles of the standards on revenue recognition and contract accounting.

The Indian Guidance Note is fundamentally flawed and may lead to totally unintended conclusions if applied as a general principle, for example, revenue recognition under the Guidance Note would commence on entering into non-cancellable purchase orders, rather than at the time of delivery of goods. Consequently, the Indian Guidance note is ripe for a revision.

Critics say the scheme will allow local officials to divert the money into their own pockets and now the Minister for Rural Development Raghuvansh Prasad Singh wants to find out how the scheme has actually performed.

His ministry plans to ask the Comptroller and Auditor General (CAG) to compile a report on the implementation of the scheme. The audit will examine implementation of the scheme in all 330 districts of the country.

An earlier report by the CAG had indicted the programmes' implementation but the ministry had rejected it then saying the report covered only 62 districts, so it did not give the complete picture.

A meeting of rural development officials presided over by the minister decided to ask for a fresh audit.

It was a drop of about Nu.15.5 million or about 13 percent compared with the previous year. The dzongkhags had the highest amount of irregularities with Nu. 51.729 million followed by the ministry of labour and human resources with Nu. 15.413 million and the ministry of home and cultural affairs with Nu. 12.744 million.

Of the inspection reports of 16 dzongkhags incorporated in the report Tsirang dzongkhag had the highest irregularities of Nu. 22.480 million, Bumthang Nu. 5.924 million, Dagana Nu. 4.004 million and Sarpang dzongkhag Nu. 3.941 million. Wangduephodrang dzongkhag had the lowest irregularities amounting to Nu. 0.280 million.

Among the gewogs, Chongshing, Khar and Shumar gewogs in Pemagatshel dzongkhag recorded the highest amount of irregularities according to the report. Shumar gewog had the highest irregularities of Nu. 1.298 million followed by Khar with Nu. 1.272 million and Chongshing Nu. 1.199 million.

According to the report irregularities in advances, procurements, constructions, irregular and inadmissible payments still featured as the most significant and prominent issues which required the government's urgent attention.

Cases highlighted in the report included payments disbursed for activities not carried out, forgery and tampering of documents, payments made for materials not received and misappropriation of cash balance amounting to Nu. 13.559 million as against Nu. 3.715 million reported in 2005.

Among the cases of fraud, corruption and embezzlement the ministry of education topped the list with Nu. 2.755 million followed by agriculture ministry and home and cultural affairs ministry with Nu. 0.631 million and Nu. 0.488 million respectively. Among the dzongkhags, Tsirang had Nu. 4.799 million and Gasa Nu. 0.938 million. Among the gewogs Samar in Haa had Nu. 0.428 million and Shaba gewog in Paro Nu. 0.389 million.

Mismanagement of funds, properties, human resources, revenue and taxes including short and non-collections amounting to Nu. 2.427 million was observed in the ministries of agriculture, finance, health, information and communication, works and human settlement and in the dzongkhags.

Of the total unresolved cases of Nu. 7.593 million due to violation of laws, rules and regulations in the budgetary agencies, violation of procurement norms aggregated to Nu. 6.096 million.

The dzongkhags and gewogs saw the highest amount of Nu. 4.671 followed by the ministry of labour and human resources with Nu. 1.549, agriculture ministry with Nu. 0.596 million and ministry of works and human settlement with Nu. 0.588 million.

Unresolved irregularities in corporations, financial institutions and non-government organizations decreased from Nu. 130.714 million in 2005 to Nu. 80.843 million in 2006. Financial institutions had the highest amounts of unresolved irregularities amounting to Nu. 49.342 million followed by corporations with Nu. 19.846 million and NGOs with Nu. 11.655 million.

This, according to audit report, could be mainly due to improved compliances reported by the agencies after issuing the excerpts of draft annual audit report 2006 to the ministries and agencies concerned.

The report stated that the irregularities occurred due to lack of an effective internal control system.

It stated that the internal audit is confined to ministries only and the present strength of one to three auditors in each ministry is "too restrictive" for the internal auditors to adequately and effectively carry out their functions.

The report also pointed out that RAA had recovered a record Nu. 45.651 million as against Nu. 29.771 million in 2005.