The lengthy road to accounting compliance

Come 1 April 2016, India would join a group of 110 countries following a similar accounting standard - International Financial Reporting Standard (IFRS).

But the transition to a new accounting standard, Indian Accounting Standard (Ind-AS) - the Indian version of IFRS - has to begin from the current financial year.

According to the Ministry of Company Affairs road map released in February this year, the new accounting standard is mandatory for all listed companies with a net worth of more than Rs 250 crore.

In the first phase, the government has kept banks, insurance companies and non-banking financial companies (NBFCs) outside Ind-AS's ambit. The FY 2017 financial numbers have to be comparative for the previous financial year. Companies also have the option to voluntarily adopt Ind-AS this financial year. This would mean that corporate India would have to prepare two sets of financial numbers in the transition year - one following existing Indian GAAP and the other based on Ind-AS. (WHERE THE SHOE PINCHES)

Accounting experts claim Ind-AS would make financial statements comparable internationally, providing comfort to investors. "It will lead to greater transparency, more disclosures and standardised accounting norms comparable across global markets," said Mohandas Pai, chairman, Manipal Global Education.

Sai Venkateshwaran, head, accounting advisory services, KPMG, India, said the use of internationally accepted standards could potentially improve valuations and reduce cost of capital.

Also, companies will be able to access newer markets for fund raising and conducting businesses. "The standard is comprehensive enough, capturing various aspects of revenue recognition. It emphasises more on substance than form, and has superior disclosure requirements, reflecting how the management is evaluating the business," said Suresh Senapaty, the former chief financial officer of Wipro. However, adoption of Ind-AS could have a significant impact on revenue recognition for Indian IT companies, including those reporting under IFRS/US GAAP, he added. "Ind-AS will have a significant impact on financial results and book value. However, if there is no change in the economic model under which a company operates, there should not be a significant impact to valuation."

Experts claim though Ind-AS is a step forward, it is still not fully IFRS-compliant. The ministry has issued some carve-outs in keeping with Indian business practices. For instance, while dealing with foreign currency convertible bonds, there is a difference in the treatment of conversion option. Ind-AS recognises any embedded foreign currency conversion option as "equity". Under IFRS, any conversion option is treated as derivative, and carried at fair value. In another departure from IFRS, Ind-AS gives the option to companies to defer exchange rate fluctuations on long-term foreign currency monetary items. IFRS requires any such fluctuation to be captured in the profit and loss statements. The carve-outs reduce transparency, and should be made optional, said Pai.

The extensive use of the concept of fair value in the preparation of financial statements, especially when it comes to financial assets and liabilities, could lead to some volatility in profit and loss statements, says experts.

"A company would need to educate its investors and analysts upfront if its financials are going to be impacted by the volatility caused due to fair valuation. This would have to be communicated much in advance so that they don't lose their confidence," said Charanjit Attra, an IFRS expert, and the executive director of 3i Infotech. Companies would have to assess the impact of the new accounting standard on its valuation, revenue recognition, additional disclosure, on group structures, and on acquisition and fund-raising strategies.

KPMG's Venkateshwaran said sectors where valuations are linked to multiples based on earnings, revenue, assets, could see movements based on how these metrics change. Ind-AS would bring a single model for revenue recognition covering all types of arrangements including sale of goods, services, construction contracts, licensing arrangements, among others. "This would impact timing and quantum of revenue recognition, as well as its presentation," said Venkateshwaran.

Companies have to pay more attention to treatment of contracts, especially those with multiple elements or with long-term arrangements. Given the extensive of disclosure requirements under the new accounting standard, financial statements will become more comprehensive, presenting a lot of useful information, both qualitative and quantitative. "With numerous disclosure requirements in Ind-AS, there would be a manifold increase in the extent of notes to accounts, albeit with a risk of boilerplate disclosures finding their way into these reports" said Venkateshwaran.

As per new principles of control under Ind AS, majority equity ownership may not necessarily translate into "control". Control can also be established even with minority, or at times with no ownership, through new concepts like de-facto control. In such a situation, veto rights, protective and kick-out rights also become relevant in defining "control". "Joint ventures, which were proportionately consolidated, would now move to one-line consolidation through equity accounting" says Venkateshwaran. When it comes to acquisitions and fund-raising, structure of acquisition arrangements would gain more significance, say experts. With acquisition accounting using fair value method, amounts attributed to goodwill could shrink with a corresponding increase in intangible and other assets, potentially impacting earnings.

On the technology side, companies would have to maintain two sets of financials, and suitably upgrade their IT and ERP systems to support dual reporting. Organisations would have to re-orient their internal operations vis-à-vis Ind AS on a holistic basis - be it economic decision-making, business planning or decision support systems, and not treat IFRS reporting as a mere compliance activity, said Senapaty. "Top management should be involved in overseeing the transition."