IFRS: Is India Ready?
The use of IFRS as a universal financial reporting language, is fast gaining ground across the globe. Adopting of IFRS is going to be very challenging and rewarding for India Inc.
The era of globalization has thrown open both opportunities and challenges to India Inc. The opportunity of gaining access to global markets has been accompanied by the need to adhere to internationally acclaimed standards. Besides this, as businesses became transnational, they realized the importance of maintaining a single set of accounting standards across the globe rather than having separate, country-specific Generally Accepted Accounting Principles (GAAP). In recent times, International Financial Reporting Standards (IFRS) have emerged to serve this very purpose. IFRS is being increasingly used as a universal financial reporting language across the globe.
IFRS hogged the limelight ever since the European Union (EU) decided to adopt it for all of its member states from 2005. Since then, more than 8,000 EU-listed firms have adopted the IFRS. After the EU, many more countries began to adopt the IFRS. As of now, more than 100 countries, either allow or require, their firms to use the IFRS, while preparing financial statements. Some of these countries include, Australia, New Zealand, China, Singapore, Japan, Middle East, Africa and members of the EU.
The US capital markets are no exception to this trend. The US capital markets have been losing their sheen as a result of excessive regulations imposed by the existing US GAAP. As an alternative, many companies prefer those capital markets where IFRS is accepted. More than 1,100 Chinese companies have recently switched over to new accounting standards, bringing their books in line with international norms.
Back home, India follows the Indian GAAP, which is inspired by the International Accounting Standards (IAS). The Institute of Chartered Accountants of India (ICAI) and the Government of India have affirmed that the country will converge with the IFRS by April 1, 2011. This means that, within the next two years, there would be a transition from the Indian GAAP into the IFRS and the IFRS will be the GAAP of India. Accordingly, the ICAI has released a Concept Paper on `Convergence with IFRS in India'. The concept paper includes the strategy and roadmap for convergence of the accounting norms of all the listed companies to the IFRS by April 1, 2011. Further, besides India, Canada, Japan and Korea have announced that they would be IFRS compliant by 2011, China and Israel envisaged doing so by 2008, and Brazil by 2010. Thus, about 150 countries across the world would be adopting the IFRS norms by 2011. It would be both challenging and rewarding for the Indian corporates to adopt the IFRS.
Road to IFRS
"The need for converge with IFRS has not only become an option or an alternative but a requirement" , says Rajesh Arora, Partner BSR & Co. The developments in the Indian economy in the recent years have transformed it from a rule-based one to a principle-based one. The adoption of the IFRS will require a deep understanding of its procedures and policies. For that matter, the goal of any accounting standard would be to generate transparent and comparable financial statements useful to its investors, organizations and customers.
According to Sanjay Hegde, Executive Director, PricewaterhouseCoop ers, "The ICAI's roadmap to convergence with IFRS would, not only save companies undertaking significant reconciliation procedures, which otherwise results in additional costs and the risk of being exposed to errors in reporting under the different accounting frameworks, but also significantly enhances the quality of financial reporting."
Those entities looking for the smooth transition to IFRS will have to abide by a few procedures set for the first time adopters of IFRS. Accordingly, an entity will be called as a first time adopter, when it has explicitly stated the adoption of IFRS in its financial statements. To comply with IFRS and to file the financial returns as per the IFRS, companies have to prepare at least one year of comparatives. Thus, companies, which are adopting the IFRS for the first time in 2011 will have to prepare the comparative financial statement for the year ended march 31, 2011. For this, the opening balance sheet of the financial year 2011, i.e., the balance sheet for the year ended March 31, 2010, should also be IFRS compliant. So the companies that are filing the returns for the financial year ending March 31, 2012 will have to file three balance sheets and two Profits &Loss accounts.
Some of the accountants feel that the Indian GAAP draws some of its basics from the IFRS and that significant differences do not persist between the two standards. Despite the fact that the ICAI has made many revisions to the Indian GAAP to bring it on par with the global standards, significant differences still exist between the two. India still needs to update its accounting standards, which fall far behind the new standards. Indian GAAP was initially based on the IFRS, but later acquired its own identity when it was updated according to the changing needs. The IFRS and the Indian GAAP mainly differ in areas of managing business combinations, group accounts, fixed asset accounting, presentation of financial statements and accounting for foreign exchange transactions. These differences exist due to the deviations of the Indian GAAP from the IFRS.
A major conceptual difference persists between the Indian GAAP and the IFRS. While the IFRS relies on the fair value concept for valuing most of the transactions of the companies, the Indian GAAP follows the cost-carrying approach for the same. Application of IFRS concepts would also make the accounting process more complex, thus increasing volatility in the income and other financial statements. Determining the fair value of their debts and assets will be a major challenge for the Indian companies.
Another significant difference is that the IFRS requires depreciation of all assets over their estimated useful lives, i.e., indefinite, whereas Indian GAAP mandates that the depreciation rates cannot be lower than the rates prescribed under the law. Further, the concept of deferred taxes under the IFRS is based on the balance-sheet approach, while the current Indian standard prescribes the income-statement approach for accounting deferred taxes. The latter approach is easier to understand and implement. Companies must also be careful about the operational changes in the standards under the IFRS. They have to reconsider the already valued contracts, debt agreements, employee benefits, treasury policies, education and training programs, and communications.
The first-time adopters must also consider the differences between the IFRS and the Companies Act, 1956. The statutory calculation of depreciation, definition of subsidiary as given by IFRS, treatment of expenses, such as the preliminary expenses, underwriting commission paid or discount allowed on issue of debentures, premium payable on redemption of debentures etc., in the IFRS is not consistent with that given in the Companies Act.
Most importantly, in the treatment of final accounts, the Companies Act restricts the opening up of final accounts once they are submitted to AGM, while IFRS needs to compare the financial statements to reaffirm the effect of adjustment in accounting policies and preceding period items. The Companies Act also stipulates the format for balance sheet and its disclosure in Schedule VI, which is almost incompatible with that of IFRS.
The above discussion indicates that the Indian companies have to make major changes in their accounting practices to adopt the new standards. The most revolutionary change would be to adopt the fair value principles. Thus, elimination of these differences and adopting the IFRS will considerably change the functioning of the Indian corporates in the future.
| Interview |
| The use of International Financial Reporting Standards (IFRS) as a universal financial reporting language is gaining momentum across the globe. What is the reason for this growing momentum? How different is IFRS from GAAP? Dolphy D'Souza, Partner, Ernst & Young Pvt. Ltd.: Businesses have become truly global over the periods and an increased number of companies are making cross-border acquisitions and investments. Also, there are large number of companies which are accessing international capital market to raise funds. This requires establishment of an accounting framework, which is globally accepted and understood. In India, the ICAI formulates Accounting Standards (AS), based on IFRS. However, there are significant differences between the two because Indian AS remain sensitive to local conditions, including the legal and economic environment, and Indian AS have not kept pace with changes in IFRS. Significant differences exist between the two in areas, such as accounting for financial instruments, business combinations, property, plant and equipment and investment property. Jamil Khatri, Head, IFRS Conversion Services, KPMG in India: The convergence with IFRS is largely driven by the need for a single-set of high quality global standards, as opposed to varied national standards. The support of the US Securities and Exchange Commission (SEC) is an important contributor to the growing momentum. For example, the SEC now permits foreign companies to use IFRS and has proposed a roadmap and milestones for American companies to adopt IFRS. Under this roadmap, the US may undergo a transition to IFRS between 2014 and 2016, with early adoption permitted for some very large US companies. There are several areas of differences between the currently used Indian GAAP and IFRS. Key areas of differences include: Accounting for business acquisition and consolidation, accounting for financial instruments – including derivatives, accounting for share-based payments and option plans and overall presentation and disclosure of the financial statements. India is poised to converge with IFRS by the year 2011. On its road to convergence with IFRS, what are the potential benefits and probable challenges that India Inc., is likely to experience? Dolphy D'Souza: Convergence with IFRS will offer multiple benefits to India Inc in terms of improved access to international capital markets, benchmarking with global peers, improvement in brand value, escape from multiple reporting under various GAAPs, reflecting true value of acquisitions, etc. It will also open up a host of opportunities in the services sector for accountants, valuers and actuaries, etc. India has the potential to become a global hub for these services. Changing from Indian GAAP to IFRS is not merely an accounting exercise but it also has significant business consequences. In the process of convergence, India Inc is expected to face challenges in the terms of shortage of qualified resources, training of staff, changes to information system, tax planning strategies, management compensation, communication of potential impacts with stakeholders, etc. Jamil Khatri: The benefits of convergence include – comparability with global peers, access to global capital markets and ability to reduce risk premium with global investors, impetus to crossborder acquisitions, eliminating multiple-reporting for companies with global operations and multiple-listings in India and abroad and additional opportunities for Indian professionals and chartered accountants to play a role in global financial reporting. Challenges include – need to make faster regulatory progress, lack of trained and experienced resources, need to change the mindset in the organization, educating boards and investors, increased complexity and volatility in the financial statement reporting process, and one-time costs of transition. What could be the possible impact of convergence on the financial sector? Dolphy D'Souza: The financial sector would be one of the highest impacted sectors from convergence with IFRS. Presently, entities in the financial sector are complying with the RBI Guidelines, as well as accounting standards issued by the ICAI, to the extent relevant. The requirements of these pronouncements differ significantly from those of IFRS on Financial
Instruments. Key areas where requirements differ include: Accounting for financial guarantees, loan commitments, derivatives and embedded derivatives, hedge accounting, accounting for priority sector loans, identification and provision on impaired/ non-performing loans, etc. Jamil Khatri: On a broader level, the convergence with IFRS may reduce reported earnings and net worth and thereby may impact valuation metrics that are used by investors and analysts to value companies. Additionally, due to the extensive use of fair values (especially for financial instruments
such as derivatives) , the convergence may result in additional volatility in reported income and net worth. Specifically, IFRS convergence will have a relatively higher impact on the Indian banking and financial services sector. How prepared is India Inc for the convergence and do you feel that India can handle IFRS related issues effectively? Dolphy D'Souza: A few Indian companies have already published their first financial statements prepared in accordance with IFRS. There are also some other Indian companies that have started crunching their numbers in accordance with IFRS to produce the opening balance sheet for their conversion from Indian GAAP. Majority of the companies, however, have not started this process till date. These companies need to start preparing for IFRS convergence at an early date. The experience shows that significant time and efforts may be required to achieve convergence. If companies start
preparing for IFRS at the right time (which is now) with the right kind of resources, they should be able to handle most IFRS related issues effectively. Jamil Khatri: While KPMG is in the process of rolling-out a formal survey to evaluate the preparedness for the convergence, our current interactions with the regulators, standard-setters and several companies, indicate that we are largely unprepared. A part of this lack of progress may be attributable to lack of sufficient regulatory clarity (e.g., regarding the manner of the first time transition – will this transition be in accordance with IFRS 1). The current depressed economic environment may also have resulted in deferral of IFRS implementation due to the lack of available budgets for the upfront one-time costs of preparedness. Having said that, sectors that will be most impacted, e.g., banking, have made relatively higher progress, as compared to other sectors. We believe that each company will need to develop its own time-bound plan, based on its specific circumstances. This plan needs to be developed immediately, even if a significant portion of the actual conversion activity is planned to be performed at a later stage. Against this backdrop, how do you see the future of accounting standards? Dolphy D'Souza: Presently, there are more than 100 countries across the world where IFRS is either required or permitted. Historically, besides IFRS, US GAAP was considered to be the most acceptable financial reporting framework. However, with the Securities and Exchange Commission (SEC) acceptance of IFRS for foreign private issuers without reconciliation to US GAAP, and a proposed 'Roadmap' for the local US companies, it is clear that IFRS is the standard of the FUTURE. Jamil Khatri: We believe that the movement towards IFRS is generally irreversible with all key stakeholders in India and across the world being committed to the convergence plan. Thus, in the future, accounting standard setting will most probably be centralized with the International Accounting Standards Board (IASB). However, unlike the past, key stakeholders from across the world – including the US and India, are likely to play a much more involved role in the functioning and governance of the IASB. For example, recently, Prabhakar Kalavacherla, an Indian Chartered Accountant and a US CPA has been appointed as an IASB Board member effective January 1, 2009. Prabhakar has previously worked in India and is currently a partner with KPMG LLP in Silicon Valley, US. Any other comments? Dolphy D'Souza: Conversion to IFRS entails a business-wide change management exercise and should be approached using a structured methodology encompassing the best practices of project management. As with any major finance transformation project, full support of the board and
senior management will be critical to the success of the conversion effort. Boards should pay close attention to the details of management's proposed approach to the IFRS conversion and satisfy themselves that it covers all appropriate areas and is based on sound project management principles. Involvement of IFRS and valuation experts in the conversion project is most essential. Jamil Khatri: We believe that it is extremely important that key stakeholders from India Inc and industry associations get more fully involved with the convergence plan and process. This will ensure that the benefits envisaged by the convergence are fully realized. For example, unless the convergence and transition to IFRS is made using the first-time adoption rules of IFRS 1, the financial statements, prepared in accordance with the converged Indian GAAP (say for 2011-12) will not be in accordance with the IFRS issued by the IASB, which require that all transition be consistent with IFRS 1. Accordingly, Indian companies that raise capital in overseas markets may need to perform additional reconciliations to deal with this issue. This would be a permanent reconciliation item for years to come. Our interactions indicate that this issue has not been completely analyzed and understood by most stakeholders in India. There are similar other implementation issues where India Inc needs to get more fully involved. |
Benefits and Challenges
The convergence to IFRS, not only provides access to global laws, but also includes key benefits such as reduction in the risk premium and the cost of capital while giving an opportunity to anticipate challenges, set global targets, manage outcomes and implement the best solutions in the global environment. Those companies, which could not get listed on the international stock exchanges because of their non-compliance with the IFRS, will now have an opportunity to be listed. This access to international bourses will enable the companies to earn foreign investments. The international investor community will have access to financial information that is more reliable and is based on international standards to mitigate risk. With this, there would also be more cross-border transactions enabling the companies to acquire, merge and form alliances with the international entities.
While this would be a welcome step, there are many challenges that the companies would face on their way to convergence. Many are still skeptical about the convergence and implementation process. There are a few teething problems that would hinder the early adoption of the IFRS in India. For instance, the regulatory requirements in many countries are not compliant with IFRS, the accounting staff is not trained enough to implement IFRS, some of the entities do not have the required data to implement IFRS and certain IFRS requirements are highly complex. Above all, lack of guidance, communication and time may hinder the entire process of implementing the IFRS.
The success of shifting to IFRS in India largely depends on how well the regulators cooperate. There are fairly high chances that if a conflict arises between laws and accounting standards, the law would override the accounting standards. Hence, laws stipulated by the SEBI, RBI, and Income tax department need to be amended before adopting the IFRS. A CII release regarding the implementation of IFRS is as follows "Challenge in view of the conflicting legal and regulatory requirements related to financial statements, the technical preparedness of the industry and accounting professionals and economic environment prevailing in the country would pose challenges to convergence. "
Despite making all the amendments and complying with all regulatory and legal issues, shortage of resources could be a challenging factor for convergence. A recent report reveals that there are almost 1,45,000 CAs in the country _ the second largest pool of CAs in the world. But this figure still needs to be strengthened in order to cater to the growing requirement. More importantly, the need of the hour is to amend the curriculum of the CA course, accredited by the ICAI, in line with the new standards.
Impact of Convergence
The adoption of IFRS in India from 2011, will have a far-reaching impact on India Inc. Therefore, before implementing the IFRS, companies have to assess the possible threats and opportunities. The impact of implementing the IFRS would be different on different companies depending on the size, industry and the degree of complexity of operations of the company. To reduce the impact, many global companies are attempting to amend their traditional accounting laws in accordance with the new system. Rather than just amending the strategies of financial reporting, there is also a need to change the mindset of the people towards this comprehensive accounting language.
Further, the impact of IFRS would be huge on accounting for group accounts, business combinations, share-based payments, presentation of financial statements, fixed assets and investment property, and financial instruments. Adopting IFRS, also calls for rising obligation to additional reporting requirements in areas, such as taxes, financial instruments and fixed assets.
It is no wonder that, given the relatively less-developed debt and asset markets in India, their fair value determination will be a major challenge for the Indian companies. Managing the volatility that arises out of applying fair value concepts to financial instruments is all the more unfamiliar to Indian companies. Hence, audit committees are required to devise and implement appropriate hedge accounting principles and policies. Importantly, it would be a shift from local accounting standards to global accounting standards that reaches out to large groups of businesses all over the world. Hence, Indian companies have to take utmost care in the process of adoption.
How Prepared is India?
Keeping in view the differences between the IFRS and the Indian GAAP, the Indian Accounting Standards Board has decided to set up a task force for the enforcement of the IFRS principles. The assigned task force shall formulate strategies and lay down a road map to converge the Indian GAAP with the IFRS by April 1, 2011.
ICAI, with an objective of a smooth transition to IFRS, has taken up the matter with, The National Advisory Committee on Accounting Standards established under the Ministry of Corporate Affairs, Government of India, along with other regulators, like the RBI, IRDA and SEBI. The ICAI, along with all the other regulatory bodies, will decide on the convergence, implementation and formulation of IFRS compliant policies and procedures suitable to the Indian conditions.
Prior to the implementation of IFRS, Indian companies will have to assess the eventual benefits to the country. With almost two years in hand, the IFRS adopters have to effectively employ and appreciate the benefits of the new standards. Industry analysts opine that it would be better to adopt the IFRS in a phased manner. The listed companies should be allowed to adopt the IFRS first, followed by the non-listed ones.
As of now, it is not yet clear how India would deal with the IFRS. There are several questions cropping up in this regard: Will there be a convergence or adoption of IFRS, or will the Companies Act be amended, or will there be a few exceptions allowed in the IFRS to meet specific issues in the Indian context, or will the IFRS standards be notified in the Companies Act, and finally, will these standards be applicable to small and medium-sized enterprises or will a separate set of guidelines be laid down for them, etc. In this regard, the Ministry of Corporate Affairs has notified that India will adopt the IFRS which will give it a distinct advantage in the global environment as the Indian companies will be able to claim themselves as being IFRS compliant. According to the Ministry, "if we converge and don't adopt the IFRS, Indian entities would not be able to claim that they are IFRS compliant, which will defeat the very purpose of embracing IFRS."
Accordingly, the ICAI has planned to initiate measures to build awareness about the new accounting language among the corporate Indians. It has planned to conduct a survey to assess the preparedness and knowledge about the new standards. However, Indian corporates opine that amendments should be made to the existing laws and the doubts involved in IFRS implementation should be cleared by the ICAI. This would set the ball rolling and enable the companies to start adopting the IFRS.
Companies have sufficient time in hand to plan for a smooth transition. They should utilize this time wisely to avoid last minute rush. Some of the provisions are very complex. Applying them in time crunch situations carries the risk of misapplication of the requirements. It has to be recognized that adoption of IFRS is more than a mere technical exercise.
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