IFRS – In Indian Context- PART 2

Objective of IFRS

The objective of IFRS is to develop a single set of high quality, understandable and enforceable global accounting standards which require disclosure of transparent and comparable information in financial statements and other financial reporting to help the users to take informed economic decisions and to  promote the use and rigorous application of those standards taking into  account of the special needs of small and medium-sized entities and emerging economies and thus  bring about convergence of national accounting standards and International Accounting standard.

IFRS Challenges-More than Accounting and financial reporting

Despite several benefits as may be looked out by different people, there will be several challenges that will be faced on the way of IFRS convergence.

·         Human Resources: IFRS will influence hiring, training, compensation and termination practices. Consider hiring: how many of finance staffs are currently versed with IFRS? Assuming a talent shortfall, how will you make up the difference? If you can’t recruit in sufficient numbers, can you train the existing staff? Otherwise learning from mistakes should not be the case.

• Information Systems: Financial accounting and reporting systems must be able to produce consistent data for reporting financial information. The systems must be capable of capturing new information for required disclosures such as fair value of financial instruments. Entities need to enhance their IT security in order to minimize the risk of business interruption- particularly to address potential fraud, data corruption and leakage of information. A trial run must be carried out by the company to ensure that adequate ERP systems are put in place which provides accurate and reliable information.
• Internal Control: Accounting policies and procedures will be refreshed during an IFRS conversion project. Hence better internal control will ensure improved accuracy and better use of resources.
• Amendment to Laws: One of the greatest challenges would be the amendment of laws in time and in imparting effective training regarding the application of these standards to accounting professionals. If not done expediently India can never achieve full convergence (even if ICAI adopts IFRS )  and that entities in India having global stakeholders , would be left with the unfortunate situation of preparing a reconciliation statement between financial statements  prepared under converged IFRS under the Indian framework vis a vis IFRS financial statements that are globally accepted . Example: Prudential norms issued by RBI prescribe recognition and measurement of various financial assets of the banks. However, these norms may not be in agreement with recognition criteria prescribed by concerned IFRS.

·         Audit-ability of fair value measurements; There is no clear guidance for assessing fair value. They largely depend on the judgment and assumptions of the management. The requirement to disclose all such judgments and assumptions does not alter the situation and hence in the absence of good corporate governance practices, such subjective assumptions and judgments can prove dangerous to the investor community. It might be difficult also to audit on the reasonableness of such estimates and judgments. To address this issue ICAI has provided some guidance for audit of fair value accounting estimates in SA 540- Auditing Accounting Estimates, including Fair Value Accounting Estimates, and Related Disclosures.

There is an urgent need to address these challenges and work towards full adoption of IFRS in India. The most significant need is to build a knowledge base among professionals to manage conversion projects for corporates. Leveraging the Knowledge and experience gained from IFRS conversion in other countries and incorporating IFRS in to the curriculum for professionals can help meet these challenges.

Implications on Convergence

Convergence, will change the way financial reporting is done in the country, it will raise our standards and will help us keep pace with the requirements of the quickly changing requirements of business and finance. The existing Indian GAAP has certain significant differences with that of IFRS, resulting in fear and fury among Indian corporates that their bottom line/asset bases may change dramatically on adoption of IFRS.  Let us have a look at some of the major differences of accounting treatment between IFRS and Indian GAAP:

a.      IAS -1:- Presentation of Financial Statements

·         Financial Statement Format: - IFRS prescribes a uniform structure and content for general purpose financial statements for all enterprises. Under Indian GAAP reporting framework prescribed by different regulatory authorities are different. Consequently financial statements of companies functioning under different sectors are not uniform in terms of structure as well as content. For example, all companies have to comply with the reporting format prescribed by Schedule VI of Companies Act; however banking companies have to draw up statements in accordance with Banking Regulation Act.  

·         General purpose financial statement under IFRS includes Balance sheet, Profit and Loss account, statement of cash flows, Notes to accounts and Statement of changes in equity whereas the General purpose financial statement under Indian GAAP does not include the Statement of changes in equity.

·         Extra-ordinary Items: - IAS -1 Prohibits items to be classified as extra-ordinary items while AS-5 Specifically requires disclosure of the same.

b.      IAS – 10:- Events after the balance sheet date

·         Treatment of Proposed dividend: - Not to be shown as a liability when proposed or declared after the Balance sheet date. Instead it only needs to be disclosed.    AS-4 requires creation of provisions for proposed dividend and taxes thereon, even though the same is declared after the balance sheet date

c.       IAS 16-Property , Plant and Equipment

·         Component Accounting: Under IFRS, entities have to follow component accounting method i.e. each significant part of an asset which can be identified separately with a different useful life or depreciation pattern is accounted for and depreciated separately. In Indian GAAP, component accounting is encouraged but it is not mandatory.  E.g.; an aircraft may consist of engine and body which may have different useful lives. Under IFRS both body and engine shall be recognised as separate assets whereas under Indian GAAP recognition of aircraft as a single asset is permitted.

·         Depreciation Charge: Under IFRS, depreciation is based on estimated lives of each component. Under Indian GAAP, by virtue of limitations imposed by Companies Act, 1956, all companies are required to provide a minimum amount of depreciation based on the prescribed rates, that too under SLM and WDV only.

·         Addition to Fixed Asset: Cost of major replacements and inspections which fulfill the recognition criteria are capitalized and the corresponding cost of the replaced part/ previous inspection already capitalized is derecognized. Under Indian GAAP, subsequent cost incurred on fixed asset that has been put to use can be capitalized only if it increases the future economic benefit from the asset.

·         Revaluation: AS 10 allows selective revaluation whereas same is not permitted under IFRS. Besides under Indian GAAP revaluation need not be carried out regularly. Under IFRS, if an item of property, plant and equipment is revalued, the entire class to which that asset belongs has to be revalued. Moreover, regular revaluation shall be done so as to make the carrying amount more or less equal to its fair value at every balance sheet date. Hence, management has to take a conscious decision on revaluation of assets.

·         Change in Method of Depreciation: Change in depreciation method is considered as change in accounting estimate in IFRS whereas; under the Indian GAAP it is considered as change in accounting policy and consequently under IFRS effect of change in method of depreciation is prospective whereas in Indian GAAP change in method of depreciation has a retrospective effect.

d.      IAS – 18 :-Revenue

·         Measurement of Revenue: - Under IAS -18 revenue is to be recognized at the fair value of the consideration received. Where inflow of cash or cash equivalent is deferred, discounting to present value is to be done, while AS -9 requires measurement of revenue at the gross value of consideration received / receivable. Discounting is normally not required. In case of instalment sales, discounting would be required.

·         Revenue from services: - IAS -18 allows only percentage of completion method whereas AS -9 allows completed service contracts or proportionate Completion method.

e.       IAS 37 Provisions, Contingent Liabilities and Contingent Assets

·         Measurement: The amount recognized as provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date. Detailed guidance is available on some specific provision in form of IFRIC. E.g. Waste Management, environmental rehabilitation, whereas in Indian GAAP provision is based on best estimate and no detailed guidance is available.

·         Contingent Assets:  It is disclosed in financial statements where an inflow of economic benefits is probable. In Indian GAAP it is not disclosed in financial statements. However the same can be disclosed in Directors Report.

·         Discounting: Provision should be discounted to present value where the effect of time value of money is material while in Indian GAAP it is not discounted to its present value.

·         Restructuring provision: It should be based on constructive obligation whereas in Indian GAAP it should be based on legal obligation.

f.        IAS – 38 :-Intangible assets

·         Useful life :- Under IAS -38 an intangible asset can have an indefinite useful life and accordingly the same need not be amortized , while under AS -26 there is no concept of indefinite useful life and there is a rebuttable presumption that the useful life of the intangible should not exceed 10 years. E.g.: brand valuation impairment on an annual basis.

·         Amortization: The Depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life. Under Indian GAAP, amortization is done over the useful life but should not exceed 10 years unless there is a persuasive evidence for amortizing over a longer period.

·         Revaluations: - Permitted under IAS -38, the same is prohibited under AS-26.

g.      IFRS -3:-Business Combinations

·         IFRS 3 prescribes accounting treatment regarding all sorts of business combinations including amalgamation and acquisitions. Under Indian GAAP, AS 14 applies to Amalgamations only.  There are other accounting standards such AS 21, 23 and 27 which deal with other type of business combination.

·         Prohibition of Merger Method: - IFRS 3 requires all Business combinations to be accounted as per the purchase method and it prohibits merger method (which is permitted under AS-14).

·         Goodwill- IFRS 3 requires the negative goodwill to be credited to the profit and loss account, while it is to be treated as a capital reserve under the Indian GAAP. Goodwill on business combinations is not amortized. It is tested for impairment annually while in Indian GAAP it should be amortized over a period not exceeding five years.

·         Acquisition date: The date on which acquirer effectively obtains control of the acquiree. Under Indian GAAP, the date of amalgamation is specified in the acquisition/amalgamation scheme. Quite often accounting treatment in respect of amalgamations is specified by court order which sanctions the scheme of amalgamation.