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Budget 2014 has given a fresh lease of life on efforts to harmonise India's financial reporting with global standards. In the schedule laid out by Finance Minister Arun Jaitley in his Budget speech, companies here have to mandatorily follow the International Financial Reporting Standards (IFRS)-compliant Indian Accounting System (India AS) from April 1, 2016. They would have the option to do so from the next financial year itself (FY16).
So, over the next two years, 7,000-odd companies (all listed ones and those with a net worth of Rs 500 crore or more) come under the ambit of the new financial reporting regulations, as suggested in March this year by The Institute of Chartered Accountants of India (ICAI). However, the ministry of corporate affairs (MCA) is yet to come out with a final announcement for the companies to which the converged accounting standard would apply.
Not surprising, corporate India appears tentative, adopting a wait-and-watch approach.
This follows a false start in 2011, when the government was forced to postpone the IFRS convergence plan due to user-resistance.
Lessons from the past
There is a key reason why Indian companies resisted a convergence of Indian accounting standards to IFRS, which is followed in around 100 countries. It has also been a long-pending demand of many foreign investors. The reason is their concerns on differences in tax treatment under India AS and IFRS. To avoid confusion in determining taxable corporate income in financial reporting, the government this time has initiated a move to put in place a Tax Accounting Standard (TAS). Officials say TAS would be in place by the time the government comes out with the final accounting rules that business would have to follow from next year.
Teething trouble
Auditor rotation becomes mandatory under the Companies Act, 2013, by 2017. This coincides with the transition to new accounting standards by Indian companies.
This might result in a situation where the first comparative period under Indian AS will be audited by the outgoing entities and the first reporting period by the new auditors. "This is not desirable, considering there are significant judgments and estimates involved, and there are inherent risks of accounting errors in the first year of transition," says Yogesh Sharma, partner, assurance, Grant Thornton India LLP.Further, companies would now have to maintain two sets of books of accounts, as any IFRS-compliant Indian AS would apply to consolidated financial statements, leading to duplication of effort.
On the policy side, the government has to decide which version of IFRS should India follow, as IFRS itself has seen several revisions since 2011.
Impact on profit
Corporate lawyers and accounting experts note that when migrating to a IFRS-compliant financial reporting structure, corporate India has to assess its impact on net profit and net worth, which is likely to take a hit. Companies likely to be impacted the most are those with financial instruments, investments in special purpose entities, joint operations, stock-based compensation plans and those entering into merger and acquisition transactions. Companies in real estate, leasing, infrastructure and banking & financing, and businesses with complex and multiple-entity structures, are likely to be hit the most.
"Companies have to prepare investors, boards and the capital market for the adverse impact on profits," says Jamil Khatri, global head of accounting advisory services at KPMG.
Corporate India would have to make systemic changes in information technology and enterprise resource planning systems to capture data differently, and to train accounts and finance staff for the new financial reporting standards. "The earlier companies become IFRS-compliant, the less would be the teething troubles," says Rahul Chattopadhyay, partner in audit firm PricewaterhouseCoopers India.
10 THINGS INDIA INC SHOULD WATCH OUT FOR
Foreign exchange fluctuation with respect to liability for capital expenditure
* Under Indian Generally Accepted Accounting Principles (Indian GAAP), foreign exchange fluctuation with respect to long-term liabilities relating to capital expenditure is permitted to be capitalised as part of cost of related fixed assets.
* However, under International Financial Reporting Standards (IFRS), the entire gain/loss on foreign exchange fluctuation is required to be recognised in the income statement in the period in which such gain/loss is incurred.
Securitisation of receivables
* Accounting for securitisation of receivables or discounting of receivables under Indian GAAP often involves de-recognising the receivables from the balance sheet of the reporting entity.
* However, the corresponding rules under IFRS are much more stringent and often result in the amount received from the bank/counter-party being separately recognised on the balance sheet as borrowings, with the receivables being reflected separately on the balance sheet
Share-based payments
* Share-based payments under Indian GAAP are often measured by companies in India with reference to the fair values prevailing on the date of the grant (i.e. intrinsic value).
* However, under IFRS, the expenses are recognised with reference to the fair value of the options, rather than the intrinsic value
Preference share capital
* Under Indian GAAP, redeemable preference shares are presented as part of share capital based on the requirements of the Companies Act.
* However, under IFRS, such instruments are classified as liability based on the features of the instrument including obligation to deliver cash
Derivatives
* Under Indian GAAP, most companies account for derivatives (other than forward exchange contracts for recognised assets/liabilities) based on the principles of prudence.
* However, under IFRS, all derivatives are measured at fair value with the changes in fair value being recognised in the income statement.
Identification of subsidiaries
* Subsidiaries are identified under Indian GAAP with reference to control over more than one half of the voting rights of the investee company or control over composition of the board of directors of that company.
* However, under IFRS, determination of whether the control is exercised over another entity also involves an assessment of the rights of the minority interest. Accordingly, in cases where the minority interests have substantive rights over key operating matters, such entities may be classified as a joint venture or an associate (and therefore not apply line-by-line consolidation)
Accounting for joint ventures
* Under Indian GAAP, joint ventures are accounted for with reference to the percentage stake in the joint venture (i.e. line-by-line consolidation to the extent of holding in joint venture).
* However, under IFRS, proportionate line-by-line consolidation is not permitted, and only involves accounting for share of profit based on actual holding
Accounting for expenses through reserves
* Under Indian GAAP, companies are permitted to recognise certain expenses such as redemption premium directly in securities premium based on the requirements of the Companies Act.
* However, under IFRS, all expenses are required to be recognised in the income statement unless specifically stated otherwise.
Accounting for incentives
* Under IFRS, all discounts/incentive under schemes are presented as a reduction from revenue.
Business combinations
* Under IFRS, goodwill on business combinations is determined with reference to the fair values of the identifiable assets and liabilities acquired. Accordingly, unlike Indian GAAP, additional intangibles such as customer relationships, brands are recognised under IFRS and these are either amortised over their useful life, or tested for impairment if useful life is assessed to be indefinite
Source: Analysis by KPMG in India
