IFRS - The Road Ahead

IFRS – THE ROAD AHEAD

By Jameskutty Antony FCA, DISA, CISA

Introduction

The financial reporting in India is formulated based on the accounting standards issued by the Institute of Chartered Accountants of India. The Institute of Chartered Accountants of India (ICAI) being a member body of the IASC, constituted the Accounting Standards Board (ASB) on 21st April, 1977, with a view to harmonize the diverse accounting policies and practices in use in India. After the much debated adoption of liberalization and globalization as the corner stone‘s of Indian economic policies in early 90’s and the growing concern about the need of effective corporate governance of late, the Accounting Standards have increasingly assumed importance.

While formulating accounting standards, the ASB takes into consideration the applicable laws, customs, usages and business environment prevailing in the country. The ASB has also given due consideration, while formulating the Accounting Standards, to the International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS), to the extent possible, considering the conditions and practices prevailing in India.

ICAI has issued 32 Accounting Standards so far. These Standards are mandatory in nature and has also been recognized by Section 211 (3C) of the Companies Act, 1956. The mandatory status forces the business entities to adhere to these standards vis-à-vis the accounting and disclosure of financial information. The auditors are also required to give adequate disclosure in their audit report, if there is any deviation from standards by the auditee.

Why IFRS?

With globalisaiton and the foreign direct investment in India and foreign investments by Indians abroad, the concept of ‘open economy’ has come into being. Movement of capital and investment from one country to another has become a common phenomenon. So the question of ‘readability’ or compatibility across two financial statements prepared two different countries has become more significant, in the recent days. Thus arose the need for a financial reporting language which can be universally read and understood.

The use of international financial reporting standards (IFRS) as a universal financial reporting language is gaining momentum across the globe. Over a 100 countries in the European Union, Africa, West Asia and Asia-Pacific regions either require or permit the use of IFRS.

Most of the Europe adopted IFRS in 2005. India and Canada plan to converge in 2011, Brazil in 2010 and USA in 2014

IFRS – A bane or a boon?

Adopting IFRS by Indian corporates is going to be very challenging but at the same time could also be rewarding. There are different opinions on whether Indian corporates are likely to reap significant benefits from adopting IFRS. The European Union’s experience highlights many perceived benefits as a result of adopting IFRS.

The areas such as corporate governance, revenue recognition, use of financial statements, budgeting, management reporting etc. is going to witness a sea-change, on the adoption of IFRS.

IFRS assists in cross border transactions and with business spread across geographies as consistency can be achieved in financial statements.

Following are some of the benefits perceived for companies converging to IFRS, in the Indian context:

For multinational companies, it will be easier to prepare accounts according to IFRS especially if subsidiaries or branches are located in countries which have adopted IFRS.

Companies can obtain easy and cheap finance from the international markets if they have prepared their accounts based on IFRS as IFRS are now accepted as a financial reporting framework for companies seeking to raise funds from most capital markets across the globe. US Securities and Exchange Commission (SEC) recently permitted foreign companies listed in the US to present financial statements in accordance with IFRS. This means that such companies will not be required to prepare separate financial statements under Generally Accepted Accounting Principles in the US (US GAAP). Therefore, Indian companies who are listed in the US or who are planning to tap the investment market in US would benefit from having to prepare only a single set of IFRS compliant financial statements, and the consequent saving in financial and compliance costs

The financial statements of all the companies in countries adopting IFRS will be comparable. This will result in more transparent financial reporting of a company’s activities which will benefit investors, customers and other key stakeholders in India and overseas.

The adoption of IFRS is expected to result in better quality of financial reporting due to consistent application of accounting principles and improvement in reliability of financial statements. This, in turn, will lead to increased trust and reliance placed by investors, analysts and other stakeholders in a company’s financial statements.

However, there may be a few drawbacks; some companies may face certain setbacks such as disruption in the day to day business, shortage of accounting professionals who are trained in IFRS etc. In addition, IFRS will probably affect tax accounting and reporting in terms of deferred taxation, tax filing etc.

So, what is different in IFRS?

One of the major differences between IFRS and Indian GAAP is that the IFRS lays more emphasis on the balance-sheet disclosures than the profit & loss account.

IFRS is a new concept that in many cases is vastly different from the manner in which it treats the accounting of items in a company’s profit and loss account and the balance sheet. Since some of these reporting standards are market sensitive, they sometimes have material impact on reported results which could lead to stock price volatility. The impact is also on the tax and operating structures, which could alter once IFRS comes into place.

IFRS carries a “Global Approach” compared to the “Indian Approach” of Indian GAAP. It is based on ‘Fair Value Accounting’ rather than ‘Historical Cost’ Accounting’. It is more concerned about the ‘Group of Entities’ rather than the ‘Individual or stand alone entities’.

It follows the concepts of Substance Over Form, Principles Over Rules And The Entity Over Company.

Convergence to IFRS – Major Issues

It will be a grave mistake to presume convergence as a mere technical accounting exercise.

But the biggest challenge in convergence with IFRS is that our chartered accountants and finance professionals will have to unlearn all that they have spent the past 20-30 years practicing. This puts a big emphasis on training.

Surprisingly, the stakeholders have given the tax impact of conversion of Indian GAAP financial statements to IFRS financial statements little or no importance. Conversion to IFRS could have a significant impact on all aspects of the tax lifecycle - tax planning, provisioning, tax compliance and litigation. It could also have a combined impact on various accounting policies and change the way accounting income is determined. This, in turn, would alter the face of the balance sheet.

The most important area where corporates would be locking horns with the taxmen will be the fair value accounting is that it gives rise to the recognition of unrealised profits and losses. The difficulty for companies would arise when unrealised profits & losses on account of fair value accounting are brought to tax without the company having the cash to pay for it.

For instance, real estate companies would have to take a re-look at their construction agreements for the purposes of revenue recognition. Under IFRS, a company would be able to recognise revenue with reference to stage of completion, if and only if, the agreement transfers control to the buyer, as well as the significant risks and rewards of the ownership of the work.

The Roadmap to Convergence

The Institute of Chartered Accountants of India (ICAI) has recently a concept paper on Convergence with IFRS in India, detailing the strategy for adoption of IFRS in India with effect from April 1, 2011. The Ministry of Corporate Affairs (MCA) issued a press release on 22nd January 2010, detailing the roadmap and the plan of convergence of Indian GAAP to IFRS, confirming the agenda for convergence with IFRS in India by 2011. It is known that there will be two sets of accounting standards under Section 211 (3C) of the Companies Act, 1956.

The agenda for convergence is made in a phased manner as below:

Applicable to entities	Form
§ NIFTY Companies § SENSEX Companies § Companies whose securities are listed outside India § Entities with Net Worth is more than Rs.1000 Crores [Companies (private or public) or other entities – whether listed or not]	Opening Balance Sheet as at 1st-April-2011 [Financial Year 2011-12]
§ Entities with Net Worth is more than Rs.1000 Crores [Companies (private or public) or other entities – whether listed or not]	Opening Balance Sheet as at 1st-April-2013 [Financial Year 2013-124]
§ All listed companies § Specified SME’s*	Opening Balance Sheet as at 1st-April-2014 [Financial Year 2014-15]

* There will be a separate set of IFRS for SME’s.

Separate road map will be notified for Banks and Insurance Companies. However, there is no clarity yet as to the applicability of IFRS to NBFC’s.

Applicable IFRS’s

There are 8 International Financial Reporting Standards (IFRS) and 29 International Accounting Standards (IAS) which are collectively called the IFRS in common parlance.

The list of IFRS is as follows:

1. IFRS 1: First time adoption of IFRS

2. IFRS 2: Share based Payment

3. IFRS 3: Business Combinations

4. IFRS 4: Insurance Contracts

5. IFRS 5: Non-current Assets held for Sale and Discontinued Operations

6. IFRS 6: Exploration for and Evaluation of Mineral Resources

7. IFRS 7: Financial Instruments: Disclosures

8. IFRS 8: Operating Segments

The 29 IAS are:

1. IAS 1: Presentation of Financial Statements.

2. IAS 2: Inventories

3. IAS 7: Cash Flow Statements

4. IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors

5. IAS 10: Events after the Balance Sheet Date

6. IAS 11: Construction Contracts

7. IAS 12: Income Taxes

8. IAS 14: Segment Reporting

9. IAS 16: Property, Plant and Equipment

10. IAS 17: Leases

11. IAS 18: Revenue

12. IAS 19: Employee Benefits

13. IAS 20: Accounting for Government Grants and Disclosure of Government Assistance

14. IAS 21: The Effects of Changes in Foreign Exchange Rates

15. IAS 23: Borrowing Costs

16. IAS 24: Related Party Disclosures

17. IAS 26: Accounting and Reporting by Retirement Benefit Plans

18. IAS 27: Consolidated Financial Statements

19. IAS 28: Investments in Associates

20. IAS 29: Financial Reporting in Hyperinflationary Economies

21. IAS 31: Interests in Joint Ventures

22. IAS 33: Earnings per Share

23. IAS 34: Interim Financial Reporting

24. IAS 36: Impairment of Assets]

25. IAS 37: Provisions, Contingent Liabilities and Contingent Assets

26. IAS 38: Intangible Assets

27. IAS 39: Financial Instruments: Recognition and Measurement

28. IAS 40: Investment Property

29. IAS 41: Agriculture

Impact of Convergence

The age-old nomenclature of Balance Sheet will give way to “Statement of Financial Position” (SOFP) and the Profit and Loss Account will give way to “Statement of Comprehensive Income” (SOCI).

The ‘Rule Driven’ Indian GAAP and US GAAP will change to the ‘Principle Driven’ IFRS.

As per the Indian GAAP, the concept is of ‘True and Fair’ presentation of the financial statements. But in IFRS the concept is whether the accounts are ‘IFRS compliant’. Henceforth there will not be any qualified audit report or disclaimer of opinion. Audit report has to state that whether the accounts are IFRS complaint or not. The gimmicks

However, major impacts are expected in processes and systems, operations, taxation planning, treasury and forex operations, debt covenants, compensation plans, revenue contracts, joint ventures and alliances and investor communications.

Conclusion

The roll over to IFRS is time and cost consuming and needs extensive planning and detailing. Conversion is much more than a technical accounting issue. IFRS adoption may significantly affect company’s day-to-day operations and may even impact the reported profitability of the business itself. Conversion brings a one-time opportunity to comprehensively reassess financial reporting and take “a clean sheet of paper” approach to financial policies and processes.

In the tax planning front, companies need to start identifying the differences that will arise and consider what the potential tax implications maybe. With the deadline fast approaching , IFRS conversion should be taken as an opportunity to align the tax provisioning and reporting processes.

Correct implementation will ensure that IFRS convergence results in tangible benefits, whereby financial statements prepared using the converged Indian framework are useful to meet all relevant purposes within and outside India.

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