Measuring credit losses

During the global financial crisis, delayed recognition of credit losses on loans and other financial instruments was identified as a weakness in the International Financial Reporting Standards. To address this, the International Accounting Standards Board released a new exposure draft titled Financial Instruments: Expected Credit Losses, on March 7, 2013. It proposes that an entity should recognise and measure credit loss provision based on expected credit loss model, rather than the incurred loss model followed currently. It suggests measuring the 12-month expected credit losses or, if the credit risk has increased significantly since initial recognition, as the lifetime expected credit losses. The proposals may raise the credit loss provision recorded by many financial institutions. However, the increase will vary by entity, and those with shorter term and higher-quality financial instruments are less likely to be affected. The comment period for the draft ends July 5, 2013.

New revenue recognition standard

The IASB and the Financial Accounting Standards Board are working on new revenue recognition standards for all entities following either IFRS or US GAAP (generally accepted accounting practices). The boards recently concluded deliberations on the new standard. However, some issues remain unaddressed, including the treatment of intellectual property licences. The boards are also evaluating how much guidance should be provided in the final standard, which is expected to be issued in the coming months. To give entities time to implement systems, gather data and resolve issues, the IASB has set January 1, 2017, as the effective date for the new standard.

Loans to directors and subsidiaries

Clause 185 to Companies Bill states that unless otherwise provided, no company will, directly or indirectly, advance any loan to its directors or any other person in whom the director is interested or give any guarantee or provide any security in connection with the loan taken. The expression “other person in whom director is interested” includes “anybody corporate, the board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the board, or of any director or directors, of the lending company”. Unlike the existing Act, the Bill does not contain any exemption for a loan given by a holding company to its subsidiary or for guarantee or security provided for loan made to subsidiary. Apparently, the clarification may cover subsidiary companies. Hence, one interpretation is that a holding company cannot give any loan to its subsidiary. However, this may not be the intention, as Clause 186 allows provision of loans to other companies. The Ministry of Corporate Affairs should clarify.

Keeping forex out of free reserves

Under Clause 2(43) of the Companies Bill, the term ‘free reserves’ refers to those that are, according to the latest audited balance sheet of a company, available for distribution as dividend. However, free reserves do not include

any amount representing unrealised gains, notional gains or revaluation of assets, whether shown as a reserve or otherwise; or

any change in carrying amount of an asset or a liability recognised in equity, including surplus in profit-and-loss account on measurement of the asset or the liability at fair value.

This provision does not clarify whether a company should also exclude from free reserves any unrealised gains on derivative instruments and foreign currency monetary items, recognised in profit-and-loss. The Ministry of Corporate Affairs should clarify.

— Ernst & Young

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