Intermediate Accounting: Analysis of L&T Buyback & Lease Accounting

This report provides a theoretical understanding of accounting issues through two case studies: SEBI's rejection of L&T's share buyback proposal and the IASB/FASB exposure draft on leases. The L&T case examines compliance with Companies Act, 2013 regarding debt-equity ratio, highlighting the importance of protecting debt holders' interests. The lease accounting section discusses proposed changes, including enhanced disclosures and classification of leases, along with contrasting viewpoints from KPMG and FASB comment letters, focusing on the practicality and conceptual basis of the proposed standards. Desklib provides access to similar solved assignments and past papers for students.

Intermediate Management
Accounting
Accounting
Assignment

Assignment on the theoretical
understanding of the Accounting Issues
Prepared By
Student Name:
Date: 21st January 2019
Page 1

Executive Summary
This report is intended to provide the deeper theoretical understanding of the various accounting
issues with the help of the two-different real-world case studies discussed in the following
section. The first is one is based on a news published in the Financial daily the Economic Times
on the decision given by the SEBI on the proposal of the Buy Back of the shares by the L& T
and the second one is based on the exposure draft released by the IASB and FASB on the
Leases.T2604
Page 2

Table of Contents
Executive Summary................................................................................................... 2
Answer to Question No. 1........................................................................................... 3
Answer to Question No.2............................................................................................ 6
References................................................................................................................... 13
Answer to Question No. 1
To seek the requisite assistance with the deeper understanding on a major accounting issue, an
article has been forwarded by the CEO of my company to me so that it may help her to engage in
Page 3

lively discourse in an upcoming conference. The article is published in the Financial daily the
Economic Times dated 19 the Day of January,2019 in which the engineering giant the Larsen &
Turbo Group has to face the denial of the Stock Exchange Board Of India for the request made
by it in relation to the offer to buy back of its equity shares from those shareholders holding its
shares as on October 2015.
The news is itself made public by the Larsen & Turbo Group. The proposal of the Buyback was
of 6.1crore equity shares at a buyback price of Rupees 1475 per shares, hence the total amount to
be paid was supposed to be 9000 crores. The buyback is a common accounting process but is
subject to the fulfilment of the preliminary conditions that is adopted by the Corporate entity to
ensure the most efficient utilization of its free reserve along with the objective of reducing its
liability towards the equity shareholders and in future if it wants then these shares may also be
reissued. A screenshot from the news article has been attached for reference-
In the given case the Larsen & Turbo group said that while making necessary filings with the
SEBI, it has been intimated by it that because of the failure to comply with the requirements of
one of the provisions of the Companies Act,2013, the offer of the L & T group has been
disqualified to proceed further.
Page 4

For which the basic conditions as prescribed by the Companies Act,2013 in relation to the
Buyback of the shares are prescribed hereunder:
The funds to be sourced for the buyback should be procured either from the Securities Premium
account or the free reserves of the Company or the proceeds from the fresh issue of any shares or
other specified securities. But it is to be kept in mind that such funds cannot be procured from
the previous issue of the same kind of shares or the other specified securities (Cayon, et al.,
2017).
Now the preliminary conditions to be satisfied before proceeding for the Buyback are explained
in brief hereunder:
1. The Buyback of the shares should be backed with an adequate authorization of the
articles of association of the Company
2. In the general meeting of the company, a special resolution has been passed for
authorising the buyback, but such special authorisation is not required when
a. The Buyback consists of 10% or less than 10% of the paid-up capital and free reserve
of the company or
b. The buyback has obtained the necessary authorization from the Board of Directors of
the company through the means of a resolution.
3. The maximum amount of the Buyback is restricted to the 25% of the paid-up capital and
free reserve of the company. But when it is the case of the Buyback of the equity shares,
then such percentage of 25% shall be calculated only on the equity share capital and not
on the combined figure of the paid-up capital and the free reserve (Abdullah & Said,
2017).
4. The debt-equity ratio post buyback should be 2:1. The debt for this purpose shall be the
aggregate figure of the secured and the unsecured debt and the equity of the company
shall mean the total sum of its paid-up capital and the free reserve.
5. The shares or the other securities which are to be bought back should be the fully paid up
securities (Charles H, et al., 2015).
6. Further, it is to be checked whether the securities to be bought back are listed with the
Stock Exchange or not and if they are listed then the bought back is subject to the
regulation imposed by SEBI in this behalf.
7. Again, the buyback offer is not being made within a period of one year from the date of
the closure of any of the any of the preceding offer of the buyback (Ruth, 2018).
Applying the above condition, the two major things to be noticed in the case of the Larsen &
Turbo are its shares are listed with the recognized stock exchange, hence it is bound to follow the
regulations prescribed by the SEBI in relation to the Buyback. Again, it is the buyback of the
equity shares of the Larsen and Turbo (Boghossian, 2017).
Page 5

Secondly the reason as provided by the SEBI in the given case for the rejection of the offered
place by the Larsen and Turbo was that post buy back the debt-equity ratio of the Larsen and
turbo shall be more than the prescribed ceiling limit of the 2:1 or in other word the amount of the
Secured and Unsecured debt post buyback shall be more than double the aggregate figure of the
paid-up capital and free reserves of the Larsen and Turbo.
We need to see the logic behind making such provision in the Companies Act, 2013. The logic is
this that there should be the restricted amount of the debt in form of secured and unsecured debt
post the completion of the Buyback. It is because if the amount of the debt goes higher beyond
this ratio, then it shall be considered as a company that has not taken into consideration the
interest of its debt holders rather it is interested to repay the capital invested by its equity
shareholders who are the real owners of the company. Then the question would arise in relation
to its future survival of the company. Because debt fund providers to rely heavily on its equity
shareholders while providing the fund to the company with the expectation of the safety and
security of the principal and the interest to be paid by them (Cundill, et al., 2017). If the owners
are being repaid their investment into the company, then their personal interest in the long-term
operation of the company shall be ended and accountability towards the debt fund holders shall
no more be present. This shall mean that their may be the probability of the exposure to default
risk lying in such company that it may in future fail to honor the repayment of the debt and
interest on such debt to its debt fund holders. Hence it has been incorporated in the Companies
act by keeping in mind the interest of the debt fund holders of the company.
Again, the reason for the denial as given by the SEBI seems to be highly justified and the same
has been clearly expressed by the SEBI too in its intimation to the L & T. Further it shows the
lack of knowledge on the part of the company lie Larsen and Turbo too as before making such
proposal it did not notice or take into consideration such provisions of the Company’s Act,2013.
Hence it is being recommended that before making any such offer of buyback by any of the
companies listed with the stock exchange it needs to satisfy that it is meeting the all the requisite
preconditions of the Buyback (Pamela & Tamara, 2013).
Sources: https://economictimes.indiatimes.com/markets/stocks/news/sebi-
rejects-lt-proposal-for-rs-9000-cr-share-buyback/articleshow/
67599867.cms
Answer to Question No.2
Page 6

The exposure draft on the Leases was published by the IASB and it was kept open for the receipt
of the comments from the various individuals and organizations to provide their comment based
on which future amendments in the same is to be made by the Board.
The major issues as reflected in the Exposure draft in relation to the treatment of the lease
related transactions are given hereunder:
1. The first thing that was proposed is to make the adequate disclosure relation to the
liability relating to the lease in the financial statement itself rather than disclosing the
same in the notes to the accounts. As it is much better means of communication to make
the same as a part of the Financial statement rather than the Notes.
2. A major classification as type A and type B has been made in the exposure draft based on
the real estate property and other tangible assets (Abdullah & Said, 2017).
3. It further suggests that the election of the non-inclusion of the initial direct costs. At the
same time, the exclusion of the indirect costs has been made optional.
4. It talks about the payment relating to the Type A leases as a Financing activity, not the
operating activity.
5. In the exposure draft, a lot of provisions has been introduced in terms of disclosure.
6. It has been stated that the Type b lease is to be amortized on a straight-line basis.
7. For the variable lease payment expenses, the same has been decided to be recorded as an
expense when it is to be incurred.
8. This exposure draft mainly addresses the proposed accounting model for the treatment of
the leases so that it may provide various useful information to the users.
9. The Ed provided the definition of the lease along with the fact that the customers’ ability
to control the use of the asset determines their right to use the asset.
10. The exposure draft for this purpose lays down the general principle of the control.
11. It talks about the conditions when it shall be assumed that the customer does not have the
ability to derive the substantial benefit from the asset when both of the following are
lying present like the asset is incidental to the services and the customer can use the asset
only in conjunction with the other assets or services.
12. It is aimed at providing better accounting, especially of the Type A leases.
13. It focuses on the recognition of the lease on a practical and principled manner in the
statement of the financial information (Vieira, et al., 2017).
Page 7

An outline of the views presented in the comments letters which highlight
the areas of agreement and disagreement with the exposure draft
The first comment letter selected is of KPMG IFRG limited, dated 12th September
2013 which does not agree with the view of the ED that it shall be able to satisfy the
needs of the users of financial statements on the ground that it the proposals of the
ED are implemented, then also the adjustments in the financial statements which
are resorting to nowadays shall still be continued, hence the ED fails to serve its
desired purpose.
The second reason for the disagreement is the complexity and the cost involved in
the implementation of the proposal of the ED.
Third, it has the very little conceptual background or the basis of implementation
(Webster, 2017).
Page 8

The second comment letter has been selected as provided by the financial
accounting standard board, dated17th July 2013, has disagreed with the proposal of
the ED in the following terms
1. It is not agreed with the fact that when should we identify the need or
recognise the lease or in other words though it is accepting the definition of
the lease provided in the Debut considered the same as unnecessary.
2. Secondly, it has completely disagreed with the ED in terms of its classification
made as Type A and type B leases.
3. Though while in terms lease accounting in respect of the type A and Type B
leases it has agreed with the proposal in the ED but has expressed its
concern when it is the accounting for the leases for short term lease.
4. While making the classification of the lease based on the economic and
expected value, it has raised the question as for how it is to be determined
that the value consumed is significant or not (Wellmer, 2018).
5. It has been agreed with the fact that the valuation of the lease shall be
changed if the terms of leas change but have expressed its concern on the
renewals.
Page 9

The third letter chosen is the letter from the CFA institute dated October,14,2014
and has agreed with a lot of things as suggested by the ED which are as follows
1. It has supported the capitalisation of the lease agreement with a view to
ensuring better comparability.
2. It has supported the measurement of the lease obligation as has been
suggested by the Ed.
3. It has expressed the view that recognition of the lease obligation is a
controversial issue between the reliability and relevance of the accounting
standard.
4. It has agreed with the fact that the enhanced disclosure for the lease is
necessary, but it should not be viewed as a substitute for the capitalisation.
5. It has agreed with the proposal of the ED in relation to the capitalisation of
the lease as an acceptable approach
Page 10

The Fourth comment letter is of the Ernst and young, dated 13 the
September,2013and it has too expressed its disagreement as to the ED claiming it
could not see any valuable improvement the ED could suggest. It is also concerned
about the complexity and costs associated with the implementation of the proposal
of the ED.
Page 11

An assessment as to whether the comments letters can be interpreted as
being 'for' or 'against' regulation, which provides relevant examples.
It is to be seen that the letter of the KPMG,FASB and the E&Y all of are in complete
disagreement with most of the suggestions as proved by the Exposure draft as it
has clearly found that the improvements which are of primary concern for laying
down the foundation of the Accounting standards, but only very few provisions of
the exposure draft has proved to be able to meet this criterion. Hence there is no
ground for converting these proposals into the accounting standard.
But the letter from the CFA Institute has positively responded to most of the
improvements suggested by the Exposure draft, though not finally agreed but has
shown its highest remarkable support to the Proposal by appreciating the efforts
taken by the international accounting standard Board.
An application of each of the theories of regulation (public interest,
private interest and capture) to the comments letters and a critical
evaluation of the effectiveness of each theory are at explaining the
comments letters.
Page 12

All the above comment letters have clearly kept in mind the each of the theories of
regulation that are public interest, private interest and capture. This is clear from
the fact that all have pointed out towards the cost and the complexity aspect of the
implementation of the provision of the Exposure Draft.
References
Abdullah, W. & Said, R., 2017. Religious, Educational Background and Corporate
Crime Tolerance by Accounting Professionals. State-of-the-Art Theories and
Empirical Evidence, 3(1), pp. 129-149.
Boghossian, P., 2017. The Socratic method, defeasibility, and doxastic
responsibility. Educational Philosophy and Theory, 50(3), pp. 244-253.
Cayon, E., Thorp, S. & Wu, E., 2017. Immunity and infection: Emerging and
developed market sovereign spreads over the Global Financial Crisis. Emerging
Markets Review.
Charles H, C., Giovanna, M., Dennis M, P. & Robin W, R., 2015. CSR disclosure: the
more things change…?. Accounting, Auditing & Accountability Journal, 28(1), pp. 14-
35.
Page 13

Cundill, G., Smart, P. & Wilson, H., 2017. Non‐financial Shareholder Activism: A
Process Model for Influencing Corporate Environmental and Social Performance.
International Journal of Management Reviews, 20(2), pp. 606-626.
Pamela, K. & Tamara, Z., 2013. Attaining legitimacy by employee information in
annual reports. Accounting, Auditing & Accountability Journal, 26(7), pp. 1072-1106.
Ruth, W., 2018. 'Worrying': Companies' reporting of climate risks goes 'backwards'.
The Sydney Morning hearld, 20 September, pp. 123-128.
Vieira, R., O’Dwyer, B. & Schneider, R., 2017. Aligning Strategy and Performance
Management Systems. SAGE Journals, 30(1), pp. 23-48.
Webster, T., 2017. Successful Ethical Decision-Making Practices from the
Professional Accountants' Perspective. ProQuest Dissertations Publishing, 3(1), pp.
142-156.
Wellmer, A., 2018. The Persistence of Modernity: Aesthetics, Ethics and
Postmodernism. fourth ed. UK: Polity Press.
Page 14

Page 15