EMBRACING IFRS IN INDIAN ECONOMY

A STUDY ON INDIA INCS PREPAREDNESS TO EMBRACE IFRS.

SUBMITTED FOR:

KRISTU JAYANTI COLLEGE INTERNATIONAL CONFERENCE

SUBMITTED BY:

ABHAY PANDIT KUSHAL SINGHANIA SHARAN GABA

INDEX

Sl. No. 1 2 3 4 5 6 7 8 9 10
.

Topic/s Abstract The Study Adopting or Converging? Common Pitfalls Comparison with GAAP Treatment of Depreciation Recent Developments The Indian Scenario Conclusion References

Page No. 3 4 5 6 7-10 11 12-13 14-15 16 17

ABSTRACT

The purpose of the study is to analyze the benefits of IFRS in the global financial perspective and how it would affect the companys accounting standards and bring out transparency. It also makes a comparison with the existing system of accounting standards like the US-GAAP and Indian Accounting Standards. The study would also find out the deficiencies in the existing system and also bring out the benefits of IFRS. The study would also cover the causes & effects of different items on Indian companies.

A STUDY ON INDIA INCs PREPAREDNESS TO EMBRACE IFRS

International Financial Reporting Standards (IFRS) is a principal based rather than rule based standard, which is internationally accepted accounting standard and would help international investors to understand geographically and politically separated companies and make analysis and draw conclusions about the companys financial position. Principal based standard means, that the accounting system is designed in such a manner that it does not allow the companies for manipulation and makes it adhere to the principals and not deflate or inflate their numerical figures. In contrast, rule based standard means that the companies in a way can make modifications and manipulates data in a way they desire, without complying with the standard practices already mentioned by the Accounting and Auditing Body for e.g. In India; it is the Institute of Chartered Accountants of India. The principal based accounting in case of IFRS, is still a debatable issue as it challenges a company to follow certain principal which are not laid down in form of rules like the ones laid down by Indian-GAAP and US-GAAP. Principal based accounting is challenging enough to be accepted. The inherent characteristic of a principles-based framework is the potential of different interpretations for similar transactions. This situation implies secondguessing and creates uncertainty and requires extensive disclosures in the financial statements. However, IFRS include positions and guidance that can easily be considered as sets of rules instead of sets of principles. Now that there has been relatively clear definition of IFRS and what exactly would be its convergence to the Accounting Standards (AS) in India, let us make a comparative analysis of the IFRS with the AS.

ADOPTING OR CONVERGING?

While the terms adoption and convergence are often used interchangeably, there is a subtle but important difference between them. Adoption refers to the process of adopting IFRS as issued by the IASB with or without modifications; the modifications generally being in the nature of additional disclosure requirements or elimination of the alternative treatments. Adoption, therefore, generally involves a legislative or regulatory endorsement of IFRS coupled with minor modifications that are done by the national standard setting body.

Convergence, on the other hand, means harmonization of national GAAP with IFRS through the design and maintenance of national accounting standards in a way that financial statements prepared in accordance with national accounting standards draw unreserved statement of compliance with IFRS.

WHO IS COVERED?

Keeping in view the complex nature of IFRS and the extent of and reason for differences between the existing Indian Accounting Standards and the corresponding IFRS, the ICAI is of the view that IFRS should be adopted for public interest entities. These have been defined to include: All listed companies All banking companies All insurance companies All enterprises with a turnover in excess of Rs 100 crore (US$ 23 million) All enterprises with borrowings in excess of Rs 25 crore (US$ 5.8 million)

COMMON PITFALLS

The most common issues faced by companies adopting IFRS are:

Lack of an adoption plan and starting late Viewed as a technical accounting exercise resulting in under estimation of efforts involved Lack of senior management commitment Under-estimating modifications to IT systems Lack of communication with stakeholders and users of financial reports Difficulties in estimating fair values Complexities in the presentation of financial statements

COMPARISON WITH US-GAAP AND INDIAN-GAAP

1. In IFRS, the revenue recognition concept is applied only when all the significant risk and rewards of ownerships are transferred, unlike Indian-GAAP where industry guidelines are not followed and revenue is recognized even on partly recognized basis, and in USGAAP it is an industry specific guideline that needs to be followed for revenue recognition.

This would mean that the industries like real estate cannot recognize their revenue till the time they have sold off all their condominium. Thus, avoiding exaggerated figures in the balance sheet, by way of valuating prices according to market price as soon as the apartments are ready and saving huge taxes. Thus, revenue recognition concept has in a way helped a few companies.

2. In IFRS, the statements are presented in the form of inverse order i.e. the company has to present the illiquid items first and then the liquid items, and also it requires disclosure of changes in equity other than those arising from capital transactions. In Indian-GAAP it is a format where Equity and capital is presented first and then debt, fixed assets, investments, Net current assets, net current liabilities, deferred tax liabilities, etc. In USGAAP, it is exactly opposite to IFRS, liquid items are shown first and then illiquid items.

This would mean that the companies would be able to focus more on their illiquid items and not their liquid items, illiquid items would be their fixed assets, etc and liquid items would be their current assets. Short term liquidity ratio would not act important in this matter, but turnover ratios of the company and the sales generated through the use of the illiquid items would play a major role.

3. In IFRS, cash flow statements are mandatory for all the entities i.e. whether listed or not and whether they meet the turnover criteria or not they should disclose their cash flows. In Indian-GAAP, it is mandatory of only the listed companies and companies meeting a certain turnover criteria. In US-GAAP, it is same as IFRS.

Cash flow statements reflect the soul of the company and are prepared through use of balance sheet and profit and loss account. Cash flow showcases how much cash is generated from the operating, financing and investing activities.

4. In IFRS, the historical cost concept is followed i.e. the accrual concept of accounting and that plant, property and equipment are revalued for the entire class of assets, In IndianGAAP it is the same as IFRS, although sometimes certain class of assets are only selected for revaluation. In US-GAAP, revaluation is not at all permitted, but only testing is done for impairment, whenever changes in circumstances indicate carrying cost amount may not be recoverable.

Accrual concept of accounting helps to identify and realize revenue as soon as it is made, even though cash is received or not or paid or not, it is still presented in the final accounts.

5. In IFRS, there is no need to mention share issue expenses. In Indian-GAAP, it is usually accounted for as deferred expenses and amortized accordingly. In US-GAAP, the expenses are written-off when incurred against proceeds of capital.

This would create a problem since the very purpose of IFRSs principal based accounting would be challenged, as not so ethical companies may have very less share issue expenses but it could result in modification in the share capital of the company.

6. In IFRS, dividends are classified as financial liability and reported in the Income statement as expense. Also if dividends are declared after the balance sheet date, it is not recognized as a liability. In Indian-GAAP, dividends are reported for the financial year to which they relate to even if it is declared later on. In US-GAAP, dividends are not considered as a subsequent event so as to adjust the financial, even if they are declared after the financial year end.

Dividends are paid to shareholders of the company, and it is treated as a liability.

7. In IFRS, in case of accounting for the foreign currency transactions, all the exchange differences are included in determining net income for the period in which differences arise. In Indian-GAAP, exchange differences are accounted for in the Income statement. In US-GAAP it is the same as IFRS.

8. In IFRS, in presentation of financial statements, the following are the components:

a. Statement of financial position b. Statement of comprehensive income statement c. Statement of cash flows d. Statement of changes in equity e. Notes including summary of accounting policies and explanatory notes. In Indian-GAAP the financial statements consist of

a. Balance Sheet b. Profit and loss account c. Cash flow Statements (not mandatory for small scale industries) d. Explanatory notes and summary of accounting policies.

9. In IFRS, there is no prescribed balance sheet format, but a separate presentation of assets and liabilities is required. Use of judgement by the management is permitted. In IndianGAAP, Accounting Standards do not prescribe format but Companies Act do like in the way of Sources of Funds and Application of Funds.

This would result in better clarity in understanding of the accounts and increase efficiency during interpretation and analysis as well as during preparation of accounts.

Thus, it clearly indicates how IASB (International Accounting Standards Board) has worked out to make IFRS more transparent and easy to understand through various accounting standards. There are presently 35 Accounting Standards adopted by ICAI (Institute of Chartered Accountants of India). The basic motive of IFRS is to simplify the financial statements and making it transparent as far as possible.

TREATMENT OF DEPRECIATION

In present times, the treatment of depreciation in preparation of accounting statements, has always been showing ambiguous results through the use of straight line method or the written down value method. In IFRS context, ICAI should take a leading stance in the treatment of depreciation through use of market price mechanism and not other methods which gives a blurry image of the companys management of assets and treatment of depreciation. As, ICAI employs valuators, a system should be implemented to cover all the market price of the fixed assets of every company, although this would take a long time, it would surely help analyst and companies to present the correct data.

RECENT DEVELOPMENTS

The ICAI has put down 35 accounting standards of IFRS, and some of the few accounting standards are not able to be compatible with local companies in India as it is giving way for parallel valuations, thus forcing these companies to prepare dual financial statements thereby defeating the purpose of IFRS which proposes uniform accounting standard across the globe to ease investment hurdles. The Indian version of IFRS has many fundamental difference in handling of forex gains or losses and which are accounted for a major part for software firms and a few manufacturing firms. And also that, unlike in IFRS, Indian companies don't need to provide for any mark-to-market (MTM) losses arising out of FCCBs in the profit and loss account. Likewise, they don't need to write-off exchange-rate losses from foreign borrowings against profits. In a foreign currency loan, depreciation of the rupee increases a company's liability. In Indian-IFRS, the amortization of forex losses would confuse the Indian investors when the earnings per share and valuation would get distorted. And even, companies can be at an advantage because, they can now add the expenses related to the building of the plant to the cost of the plant. Under the global IFRS norms, the expenses are to be charged on the date of the migration, to the net worth of the company, which would have brought down valuations.

Indian companies converting its accounting system to IFRS would take a long time to transition as most of the CFOs of the companies have not yet realized the importance of going the IFRS way. It is a long process because, companies going for IFRS need not only have to exert load on the auditors of the company but within its internal finance team as well as the other departments, and achieving success in the first time is not a guarantee because transition means changes in all the departments of the company be it IT, legal, manufacturing,

purchase, operations, HR etc. Thus, transition should be in a phased manner and not sudden. IFRS is brought with the idea of making accounting system transparent and for the ease of all the investors- global or local. In IFRS, the banks would not be able to find much leeway for cheap loans which are usually given for political reasons. Once IFRS comes in place, these banks would need to transparently reflect the impact of such loans on their bottom line and also do provisioning where defaults are anticipated. Managing migration to IFRS would constitute a major governance responsibility with significant spillover effects on their business.

THE INDIAN SCENARIO

Indias blue-chip companies have begun to align their accounting standards to the International Financial Reporting Standards (IFRS), three years ahead of the mandatory time for the switchover. The list of companies includes IT firms like Wipro, Infosys Technologies and NIIT, automakers like Mahindra & Mahindra and Tata Motors; textile companies like Bombay Dyeing and pharma firm Dr Reddys Laboratories. The companies are moving on despite being compliant with the US GAAP standards, the current global accounting norms. This is because the IFRS has become mandatory for listing in the European markets after 2007. The other reason is that the new norms provide for stiffer provisioning for mark-to-market losses, also known as AS-30 standards. For companies with exposure in European markets through equity or debt, such transparency is essential to raise capital cheap and hence, the proactive approach. The Indian accounting standards body, the Institute of Chartered Accountants of India (ICAI), has set a time line of 2011 for compulsory switchover to the new standard. IFRS is the accounting benchmark developed by the International Accounting Standards Board. Suresh Senapaty, CFO and executive director, Wipro Ltd, said, We welcome the initiative of ICAI in driving convergence with international financial reporting standards by 2011. We have adopted AS-30 from April this year, much ahead of its scheduled implementation. We are also actively considering early adoption of AS-31, which is the next standard. Ved Jain, president, ICAI, said, Many companies have already started following the new accounting standards because these ensure transparency and uniformity. The implementation would strengthen the confidence of stakeholders in the companies financial statements, which, in turn, will bring value to the corporate.

The ICAIs accounting standard 30 mandates companies to provide for mark-to-market losses as well as profits from April 2009 on a voluntary basis. All complexities regarding derivatives have been addressed in AS-30, which is in line with the IFRS norms. If an entity does not opt for either AS-30 or AS-1, the auditors will need to make a suitable disclosure. Analysts note that the total mark-to-market losses of Indian companies from forex derivative exposures could be about $5 billion. The company auditors would need to disclose the figures separately if the company balance sheet does not bring them out. Companies with international presence are not willing to take this risk. Says Rajendra S Pawar, chairman, NIIT Technologies: AS-30 was started from January 2008, and by 2012, it is expected that we would start following AS-31 as well as AS-32 as they both happen to be a continuation of AS-30, which we have already started off with. A large number of Indian firms are currently battling how to write in huge losses on their exposure to forex derivatives, when their currency bets went wrong.

CONCLUSION

It seems from the Indian scenario that the companies are taking efforts to migrate to IFRS and bring out more transparency. But, ambiguities still exist as there is not much clarity on how to bring about the transition in a phased manner. And also that, the companies are still in the process of understanding IFRS and its implication to their business and accounting system. Time period of total transition depends on the size of the company and the nature of their business. The Ministry of Corporate Affairs and the ICAI should publish literature on the exact implication on all categories of companies and also should work out the transition in a phased manner so as to bring out clarity for migration process. Although 35 accounting standards have been laid down on February 25, 2011, there is still lobbying going around between the companies, ICAI and MoCA.

REFERENCES