Is it possible to increase net-worth, improve profits, and protect adverse MAT implications under Ind AS Regime?
The answer is YES!
For most entities, requirements of Ind AS will be significantly non-identical from those of Existing AS (Previous GAAP). Shift to Ind AS mandates substantial restatement of financial statements. In simple words, it means – accounting policies under Ind AS will substantially differ from accounting policies under previous GAAP.
Ind AS Adoption is a blessing to entities that intend to alter/ improve ‘Net-worth’. Entities can use ‘Fair Value’ of Land & Building as of transition date to be deemed cost. In the asset base of most of the entities, ‘Land’, a non-depreciable asset, is lying for many years at its original cost. Often such lands are purchased way back in early 20th century.
Even if you apply cost inflation index over the value of land that was purchased before 1980 at Rs. 1 Crore, the fair value turns out to be Rs. 11.25 Crore (In the year 2016-17 – note that transition date of Phase II entities is April 1, 2016)
Choosing option under Ind AS to use Fair Value (as a deemed cost) as of transition date inflates the value of the asset base and increases the net-worth.
- For example, in above example, land purchased at Rs.1 Crore can now be deemed to be purchased at Rs.15 Crore as at April 1, 2016. The accounting entry that we will pass as of transition date (April 1, 2016) is – Land A/c… Dr. with Rs.14 Crore and Retained Earning….. Cr. with Rs. 14 Crore)
However, an increased fair value of building would also result in ‘additional depreciation’ charge in a post-transition statement of profit and loss (SOPL).
- In above example, if we replace ‘Land’ wit ‘Building/ Property’ ie. if we replace ‘Non-Depreciable Asset’ with ‘Depreciable Asset’, upward valuation as of transition date (ie. of Rs. 14 Crore) will also result in additional depreciation charge of Rs.1.4 Crore. (See below for detailed commentary)
In a given case, if the entity opts to use fair value of building as a deemed cost under transition into Ind AS:
- It will increase net worth of the entity as of April 1, 2016, by Rs. 14 Crore
- It equally will increase depreciation charge by Rs. 1.4 Crore (ie. Rs.15 Crore/ 10 – Rs.1 Crore/10) for year on year basis.
- This additional depreciation charge of Rs. 1.4 crore:
- Will reduce EPS
- Will not reduce Book Profits for MAT purpose
Let us build a scenario of Phase II entity. Phase II entity has transition date of April 1, 2016, ie. First Ind AS Financial Year is 2017-18 and Comparative Year 2016-17).
Phase II entity has prepared its statutory books of accounts for the year 2016-17 using Existing AS (Previous GAAP). Thus, MAT calculations for the year 2016-17 will be calculated using financial statements prepared using Existing AS (Previous GAAP).
Phase II Company is mandated to prepare first statutory financial statements under Ind AS for the year 2017-18 together with comparative figures of 2016-17.
Please note that – all transition adjustments under Ind AS are made as of April 1, 2016. However, Ind-AS financial statements for the year 2016-17 are not statutory books for the year 2016-17. Hence, Ind AS comparative figures of the year 2016-17 are not used for MAT calculations.
This potentially results in following:
- Transition Adjustments (Such as Fair Value of Land and Building to be treated as Deemed Cost) remain outside of MAT.
- MAT is applicable on ‘Book Profits’ and transition adjustments are directly made in ‘Retained Earnings or any other reserve if appropriate’, thereby not impacting profits.
Inflated Asset base and increased Net-Worth neither get credited in Profit & Loss A/c (under Existing AS/ Previous GAAP) nor get accounted into Statement Of Profit And Loss (under Ind AS). Thus, such increment does not impact ‘Book Profits’.
Finance Bill, 2017 proposed an amendment to Section 115JB by inserting subsection ‘2A’ and ‘2C’ to suggest potential MAT implications as follows:
- Impact in Year of Transition (ie. Year 2016-17 for Phase II entities):
- Increased Net-worth (because of upward valuation of land or building) does not increase book profits and thereby has no adverse impact on Book Profits/ MAT.
- Impact in Subsequent Years:
- Logically, additional depreciation shall not reduce book profits as the previous increment in valuation has not increased profits. Thus, the benefit of additional depreciation in subsequent years is not available to reduce ‘Book Profits’ in those years.
- On the other hand, additional depreciation will reduce accounting profits and thereby plummet EPS in years post-transition.
- Impact in the year of retirement/ disposal of asset:
- The word retirement is used potentially when an asset has reached end of its life cycle or when removal of asset is more beneficial to an entity than to keep it.
- The retirement of an asset may result in some cash inflows. These inflows shall be compared with the book value of an asset (exclusive of remaining ‘revaluation’). Such retirement will either result in profit or loss. In either case, such result is treated as a part of book profit.
- Profit on retirement will increase Book Profits and thereby MAT liability of year of retirement.
- Loss on retirement will decrease Book Profits and thereby MAT liability of year of retirement.
- In case, asset achieves salvage value that is equivalent to remaining book value, no gain or loss is accounted for. Thus, in such situation – retirement remains ‘Book Profit’ neutral.
Disposal of Asset potentially means the asset is sold at a profit (usually at profit) before asset reaches the end of its life cycle. Such profit remains a part of Book Profit and hence, will be subject to MAT.