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A. Facts of the Case
1. A company is engaged, through its subsidiaries, joint ventures and associates, in generation of power, development of expressways, airport infrastructure facilities and special economic zones. As per the concession agreements with grantors, the company is required to carry out each of its infrastructure projects through a separately designated Special Purpose Vehicle (SPV) which is either a subsidiary, associate or a joint venture. These SPVs exclusively undertake the project for which these are respectively incorporated and they are not permitted to undertake any other activity. The company is a public company and is listed on the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). The consolidated gross annual turnover of the company for the year ended March 31, 2009 was Rs. 4,476 crore and the networth was Rs. 6,471 crore.
2. As stated above, the company is engaged in the infrastructure business and its present activities are spread across various verticals, such as, Power, Roads, Airports, Engineering, Procurement & Construction (EPC) and other infrastructure projects. The querist has provided the following pictorial representation that depicts the company’s structure:
SPVs incorporated for each project are classified/grouped under distinct business sectors and each of these sectors is headed by a Business Chairman assisted by a Chief Executive Officer (CEO) and Chief Financial Officer (CFO). These businesses are reviewed and monitored by the respective business chairmen who are on the boards of the respective SPVs and also on the board of the company (holding company).
3. At present, the company has about 100 subsidiaries/associates/JVs. It prepares its standalone financial statements and also consolidated financial statements. The consolidated financial statements (CFS) include the accounts of the company (standalone) and its subsidiaries, associates and joint ventures. According to the querist, the CFS are prepared in accordance with historical cost convention and comply in all material respects with the applicable accounting principles in India, the accounting standards notified under section 211(3C) of the Companies Act, 1956 (hereinafter referred to as ‘the Act’) and other relevant provisions of the Act.
4. The querist has stated that under CFS, segment report of the company and its subsidiaries, associates and joint ventures is prepared considering business segment as the primary segment and geographic segment as the secondary segment. The company has identified the business segments as Power, Roads, Airport, Engineering, Procurement & Construction (EPC) and others. Others include the operations, like, real estate development, investment companies which do not qualify for separate disclosure as segments as per the threshold limits prescribed under Accounting Standard (AS) 17, ‘Segment Reporting’. As explained above, each sector has many SPVs which are independently incorporated companies. The company merely holds all these companies by virtue of the equity holding/ownership control. However, each of these SPVs under respective sectors are separate and distinct legal entities.
5. The querist has further stated that each of the SPVs prepares its stand alone annual accounts and has specifically identifiable timing differences for the computation of deferred taxes and specific allowances and disallowances for the computation of current tax. Also, each of the SPVs is individually discharging its tax liability and the books of account of each of these entities also carries the tax assets/provisions (net) distinctly. Hence, for the preparation of consolidated financial statements, the company is of the view that the tax assets/expenses are part of the respective segments only, as the same are distinctly identifiable and directly attributable to those respective sectors/segments. The company has prepared the consolidated segment report accordingly by classifying the tax assets/expenses under each of the respective segments. However, the same is not acceptable to the auditors, who are of the view that the same should be disclosed as an unallocated item in the segment report included in the consolidated accounts.
6. Extending the above arguments, auditors are also of the opinion that interest expense relating to loans borrowed by the SPVs for their projects, overdrafts and other operating liabilities including loans identified with a particular segment should not be included in the segment expense of the consolidated financial statements since the operations of the company are primarily not of a financial nature.
Viewpoint of the Querist
7. The querist has stated that AS 17, as notified under the Companies (Accounting Standards) Rules, 2006 states the objective of the Standard as follows:
“The objective of this Standard is to establish principles for reporting financial information, about the different types of products and services an enterprise produces and the different geographical areas in which it operates. Such information helps users of financial statements:
(a) better understand the performance of the enterprise;
(b) better assess the risks and returns of the enterprise; and
(c) make more informed judgements about the enterprise as a whole.”
The querist has further reproduced paragraphs 11 and 13 of AS 17 as follows:
“11. Determining the composition of a business or geographical segment involves a certain amount of judgement. In making that judgement, enterprise management takes into account the objective of reporting financial information by segment as set forth in this Standard and the qualitative characteristics of financial statements as identified in the Framework for the Preparation and Presentation of Financial Statements issued by the Institute of Chartered Accountants of India. The qualitative characteristics include the relevance, reliability, and comparability over time of financial information that is reported about the different groups of products and services of an enterprise and about its operations in particular geographical areas, and the usefulness of that information for assessing the risks and returns of the enterprise as a whole.”
“13. The definitions of segment revenue, segment expense, segment assets and segment liabilities include amounts of such items that are directly attributable to a segment and amounts of such items that can be allocated to a segment on a reasonable basis. An enterprise looks to its internal financial reporting system as the starting point for identifying those items that can be directly attributed, or reasonably allocated, to segments. There is thus a presumption that amounts that have been identified with segments for internal financial reporting purposes are directly attributable or reasonably allocable to segments for the purpose of measuring the segment revenue, segment expense, segment assets, and segment liabilities of reportable segment.” (Emphasis supplied by the querist.)
8. The querist further states that paragraph 5.6 of AS 17 defines that segment expense does not include, among others, ‘income tax expense’, ‘interest expense’, etc. Paragraph 5.8 of the Standard specifies that “segment assets do not include income tax assets”. Paragraph 5.8 also states that “If the segment result of a segment includes interest or dividend income, its segment assets include the related receivables, loans, investments, or other interest or dividend generating assets”. However, the definition of the term “segment expense” also states as follows:
“5.6 Segment expense is the aggregate of
(i) the expense resulting from the operating activities of a segment that is directly attributable to the segment, and
(ii) the relevant portion of enterprise expense that can be allocated on a reasonable basis to the segment, including expense relating to transactions with other segments of the enterprise.
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9. The querist has analysed the company’s case as follows:
(i) As mentioned in the foregoing paragraphs, the underlying business of each segment is carried through several SPVs which are separate legal entities.
(ii) The performance of each of these segments and the performance of the companies comprised in the segment are internally monitored distinctly by a separate Business Chairman, CEO and CFO who are responsible to the respective Boards of the companies. In accordance with paragraph 13 of AS 17, segment reporting of the company is based on the internal reporting and monitoring framework.
(iii) Each of these companies underlying the segments enjoy different and distinct tax benefits applicable and specific to each such sector/company. Further, interest cost of each segment is directly attributable to the borrowings or operating liabilities of the SPVs falling under the specific sectors/segments. In CFS, the performance evaluation of a segment (which is a sum total of the performance of individual project SPVs) and analysis of segment risks and rewards would be incomplete without considering the tax expense / benefit, interest cost incurred distinct to such segment.
(iv) The tax exposure of each segment is significantly different and unique to the respective segment.
(v) Paragraph 13 of AS 17 states that segment expense/assets/liabilities include “such items that are directly attributable to a segment and amounts of such items that can be allocated to a segment on a reasonable basis”. As per the querist, the structure of the company is such that the SPVs under each sector are independently assessed as a legal entity under law and these SPVs carry on one single activity leaving no uncertainty in identifying the segment expenses/assets/liabilities. Accordingly, in the case of the company’s consolidated financials, the tax expense/interest cost/asset/liability, can be directly linked/allocated to a segment and the exclusions stipulated under paragraph 5 of AS 17 are not relevant.
(vi) As these are separate legal entities, the tax expenses are clearly distinguishable to each company/sectors and do not have/involve any presumptions or do not require any allocation/appropriation.
(vii) The essence of disclosing interest cost and tax expense under unallocated segment stems from the rationale that such expenses are common for various segments of a standalone company and cannot be attributable to individual segments at actuals and hence, the same may not be shown as part of any segment. However, this is not the case of a consolidated entity. In the case of a consolidated entity, these expenses are specific to individual SPVs and in the case of the company, such individual SPVs carry on one specified activity only and thus, such expenses are required to be shown under the specific segment to enable the user of the financial statements to assess the performance of the segment.
(viii) Reliance is to be placed on the objective of the Standard and its disclosure requirements for reporting purposes.
(ix) The company also considers the characteristics of relevance, reliability and comparability in presenting the segment report. Tax assets/expenses and interest cost being more directly attributable, are more relevant if the same are disclosed as part of the respective sectors. The same will also be consistent and comparable with the practice followed by the company in the past and makes the financial data more reliable to assess the risks and rewards of each business segment.
(x) Therefore, in order to present more realistic results of the respective segments, it is appropriate to include the interest and tax expense of each of the SPVs under their respective segments itself in case of consolidated accounts.
(xi) The related loans or borrowings corresponding to the interest expenses disclosed under respective segments, as argued by the company, should also be disclosed under the respective segments and the same will be in compliance with the requirements of paragraph 5.8 of AS 17.
In view of the above, the company is of the view that the tax assets/expenses and interest cost & related borrowings thereon should be considered under respective segments for the purposes of disclosure for consolidation purposes.
B. Query
10. The querist has sought the opinion of the Expert Advisory Committee as to:
(i) Whether the tax assets/expenses need to be disclosed under respective segments or to be disclosed as ‘unallocated’ in the segment report of consolidated financial statements.
(ii) Whether interest expense incurred by SPVs coming under individual sectors (which are treated as segments under CFS) needs to be disclosed under respective segments itself or to be disclosed under unallocated/corporate column.
(iii) What would be the position of borrowings/loans taken in each segment while preparing CFS.
C. Points considered by the Committee
11. The Committee, while expressing its opinion, has considered only the issues raised in paragraph 10 above and has not examined any other issue that may arise from the Facts of the Case.
12. The Committee notes paragraph 4 and definitions of the terms ‘segment expense’, ‘segment result’, ‘segment assets’ and ‘segment liabilities’ as stated in paragraph 5 of AS 17, notified under the Companies (Accounting Standards) Rules, 2006, as follows:
“4. If a single financial report contains both consolidated financial statements and the separate financial statements of the parent, segment information need be presented only on the basis of the consolidated financial statements. In the context of reporting of segment information in consolidated financial statements, the references in this Standard to any financial statement items should construed to be the relevant item as appearing in the consolidated financial statements.”
“5.6 Segment expense is the aggregate of
(i) the expense resulting from the operating activities of a segment that is directly attributable to the segment, and
(ii) the relevant portion of enterprise expense that can be allocated on a reasonable basis to the segment, including expense relating to transactions with other segments of the enterprise.
Segment expense does not include:
(a) extraordinary items as defined in AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies;
(b) interest expense, including interest incurred on advances or loans from other segments, unless the operations of the segment are primarily of a financial nature;
Explanation:
The interest expense relating to overdrafts and other operating liabilities identified to a particular segment are not included as a part of the segment expense unless the operations of the segment are primarily of a financial nature or unless the interest is included as a part of the cost of inventories. In case interest is included as a part of the cost of inventories where it is so required as per AS 16, Borrowing Costs, read with AS 2, Valuation of Inventories, and those inventories are part of segment assets of a particular segment, such interest is considered as a segment expense. In this case, the amount of such interest and the fact that the segment result has been arrived at after considering such interest is disclosed by way of a note to the segment result.
(c) losses on sales of investments or losses on extinguishment of debt unless the operations of the segment are primarily of a financial nature;
(d) income tax expense; and
(e) general administrative expenses, head-office expenses, and other expenses that arise at the enterprise level and relate to the enterprise as a whole. However, costs are sometimes incurred at the enterprise level on behalf of a segment. Such costs are part of segment expense if they relate to the operating activities of the segment and if they can be directly attributed or allocated to the segment on a reasonable basis.
5.7 Segment result is segment revenue less segment expense.
5.8 Segment assets are those operating assets that are employed by a segment in its operating activities and that either are directly attributable to the segment or can be allocated to the segment on a reasonable basis.
If the segment result of a segment includes interest or dividend income, its segment assets include the related receivables, loans, investments, or other interest or dividend generating assets.
Segment assets do not include income tax assets.
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5.9 Segment liabilities are those operating liabilities that result from the operating activities of a segment and that either are directly attributable to the segment or can be allocated to the segment on a reasonable basis.
If the segment result of a segment includes interest expense, its segment liabilities include the related interest-bearing liabilities.
Segment liabilities do not include income tax liabilities.”
The Committee notes from the above that interest and income tax expense are explicitly excluded from the definition of ‘segment expense’. In view of the definition of ‘segment result’, interest and income tax expense are also excluded from the segment result. Similarly, the Standard specifically excludes income tax assets/liabilities from the segment assets/liabilities. Accordingly, the Committee is of the view that interest and income tax expense in the present case, though being specifically identifiable and related to particular segments cannot be included in the segment expense and accordingly, in the calculation of segment result. Similarly, income tax asset/liability also cannot be included in the segment assets/liabilities in the segment report of the consolidated financial statements.
13. As far as the reporting of borrowings/loans specifically related to a segment in the consolidated segment report is concerned, the Committee notes from the definition of the term ‘segment liabilities’, as reproduced in paragraph 12 above, that if the segment result of a segment includes interest expense, its segment liabilities would include the related interest-bearing liabilities. Conversely, the Committee is of the view that if the interest expense is not included in the segment result, segment liabilities would also not include the related interest-bearing liabilities. Accordingly, the Committee is of the view that borrowings/loans, even though, specifically raised by each segment, cannot be included in the calculation of segment liabilities.
14. The Committee further notes paragraphs 41 and 42 of AS 17 which provide as follows:
“41. Paragraph 40(b) requires an enterprise to report segment result. If an enterprise can compute segment net profit or loss or some other measure of segment profitability other than segment result, without arbitrary allocations, reporting of such amount(s) in addition to segment result is encouraged. If that measure is prepared on a basis other than the accounting policies adopted for the financial statements of the enterprise, the enterprise will include in its financial statements a clear description of the basis of measurement.
42. An example of a measure of segment performance above segment result in the statement of profit and loss is gross margin on sales. Examples of measures of segment performance below segment result in the statement of profit and loss are profit or loss from ordinary activities (either before or after income taxes) and net profit or loss.”
From the above, the Committee is of the view that the Standard itself encourages, in addition to disclosure of the segment result as discussed above, disclosure of other items relating to the performance of each segment. However, that disclosure should not affect the calculation of segment result. Thus, while the company in the extant case is required to disclose segment expense and segment result without including the interest and income tax expense as stated above, the company, if it so desires, may disclose the performance of each segment after interest and income tax expense. On the same analogy, the Committee is of the view that income tax asset/liability and loans/borrowings related to the afore-mentioned interest specifically related to a segment, may be provided as additional information apart from segment assets and segment liabilities as per the provisions of AS 17 by way of separate disclosure.
D. Opinion
15. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 10 above:
(i) The tax assets/expense cannot be included in the segment assets and segment expenses, respectively. However, if the company so desires, it may disclose the performance of each segment after income tax expense and income tax asset as additional information relating to these segments separately, as discussed in paragraph 14 above.
(ii) The interest expense incurred by SPVs coming under individual sectors (which are treated as segments under CFS) cannot be included in the segment expense. However, if the company so desires, it may disclose the performance of each segment after interest expense relating to these segments separately, as discussed in paragraph 14 above, without affecting the ‘segment result’.
(iii) The borrowings/loans, even though, specifically raised by each segment, cannot be included in the calculation of segment liabilities, as discussed in paragraph 13 above. However, these may be shown by way of additional information separate from segment liabilities as discussed in paragraph 14 above.
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