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Globalization of financial markets has meant an increased focus on international standards in accounting and has intensified efforts towards a single set of high quality, globally acceptable set of accounting standards. Financial statements prepared in different countries according to different set of rules, mean numerous national sets of standards, each with its own set of interpretation about a similar transaction, making it difficult to compare, analyse and interpret financial statements across nations. A financial reporting system supported by strong governance, high quality standards, and firm regulatory framework is the key to economic development. Indeed, sound financial reporting standards underline the trust that investors place in financial reporting information and thus play an important role in contributing to the economic development of a country. Needless to mention, internationally accepted accounting standards play a major role in this entire process.
An upcoming economy on world economic map, India, too, decided to converge to International Financial Reporting Standards (IFRS). With the adoption of IFRS by Indian firms, the comparison of two financial statements becomes easier and also expects to result in better quality of financial reporting due to consistent application of accounting principles and improvement in reliability of financial statements. Again, one of the major pre-requisites of getting listed on European markets is preparation of accounts as per IFRS requirements. Meanwhile, the proposed convergence with IFRS is likely to create significant challenges to the accounting practices in industrial and financial sectors. While regulators, standard setters and law makers sit together to rollout the road map for implementation of International Financial Reporting Standards (IFRS) in India, a wide section of the industry is already debating the impact and the implementation challenges of transitioning into IFRS.
A remarkable and important element of smooth transition into IFRS is the convergence of RBI guidelines with the principles laid down in IFRS. In other words, the successful adoption of IFRS is based on flexibility and acceptability of IFRS by RBI. Banks will have to soon adjust to accounting changes that are enforced by IFRS. It is generally expected that IFRS adoption worldwide will be beneficial to investors and other users of financial statements, by reducing the costs of comparing alternative investments and increasing the quality of information Companies are also expected to benefit, as investors will be more willing to provide financing. Companies that have high levels of international activities are among the group that would benefit from a switch to IFRS. Companies that are involved in foreign activities and investing benefit from the switch due to the increased comparability of a set accounting standard.
Comparability in financial statements is vital for investors to draw reasonable conclusions about the relative performance of entities. However for a variety of reasons an entities financial statements may not be as comparable to its competitors as preparers or users would prefer in the near term. Another way to enhance comparability is to consider treating the financial statements not only as an accounting exercise but also an exercise in communicating important elements that in fact affect the year-to-year comparability of financial statement data. Adoption of IFRS, the new global reporting standards, would improve comparability, transparency and credibility of financial statements and in a globalised world, would lead to greater economic efficiencies.
Research suggests that cultural differences cause accountants in different countries to interpret and apply accounting standards differently. Translation of IFRS into various languages poses another threat to comparability. It will be important for multinational corporations and global audit firms to strengthen cultural awareness training. This could benefit multinational corporations and their auditors by making them aware of potential biases held by their international staff and by colleagues in their international offices, and by helping professionals recognize their own country's cultural accounting tendencies and better understand how these values affect their own interpretations and judgments.
Most importantly, the initial and ongoing IFRS convergence will affect reported net worth, available capital and capital adequacy for Indian banks. Further, the finalised roadmap for the convergence of Indian Accounting Standards with IFRS, with respect to banking companies, requires all scheduled commercial banks to convert their opening balance sheets as of April 1, 2013. RBI has also emphasised to banks that they need to gear up to adopt the new standards. Thus, there is always a need to have an assessment of the possible opportunities and challenges for banks in India while converging to IFRS. Subsequent to the announcement of the proposal by the Institute of Chartered Accountants of India (ICAI) to converge the Indian accounting standards (Indian GAAP) with IFRS effective April 1, 2011, there has been significant debate among the standard setters, regulators, corporate India and professional accounting firms, on the roadmap to convergence and its implications.
2. Review of Literature
Since European Union was the first to adopt IFRS across the globe, most of the researches have been carried out on IFRS analyzing the data from member countries of EU. Researchers have given various opinions on the utility of adoption of IFRSs across the globe as a single set of reporting standards. Existing literature supports this view of researchers that adoption of IFRS as single set of reporting standards improves the quality of financial information and also ensures timely loss recognition. Summarily, adopting single set of financial reporting standards bring many benefits to reporting entities, Investors, bankers and other interested parties as in this period of international boundaries getting eliminated, they will not have to refer to reporting statements prepared on the basis of different reporting standards.
According to Epstein & Jermakowicz, (2010) IASBâ€Ÿs Framework for the Preparation and Presentation of Financial Statements states that the objective use of financial statements is to present the wide range of users of these financial statements with information about the entityâ€Ÿs financial position, performance and the changes in financial position. This helps in better equipping the users with more suitable economic decision making. Elliott B. & Elliott J., (2002) explains that initially, regulated financial statements were needed on country level in order to ensure that all the companies present their financial statements in a similar and consistent fashion.
But the pace with which globalization is taking place, the need for internationally comparable financial reports were brought forward. Thus, in order to decrease the national differences and the differences in financial reporting, the international setters and regulators, for example, Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) have issued accounting standards such as Generally Accepted Accounting Standards (GAAP) and International Financial Reporting Standards (IFRS), respectively. Chorafas D.(2006) says that IFRS is considered by management think-tanks as a phase shift in the general accounting, balance sheet position valuations and financial reporting techniques.
According to Drury and Tayles (1997) there is a need for more in-depth case study to explore the linkage between external financial reporting and management accounting. This study regards the IFRS' adoption as an opportunity to develop the overall planning systems of a company rather than a narrow reporting system. Financial accounting and management accounting are seen as systems complimentary to each other. Gordon (2008) notes that the harmonization of financial reporting, which has led to comparable accounting and financial information across countries and companies, continues to support and advance the business itself. According to Soderstrom and Sun (2007) the voluntary adoption of high-quality accounting standards -IFRS included- is found to have a positive impact on accounting quality.
El-Gazzar et al. (1999) state that firms adopt international standards in order to expand their sales to foreign markets, to attain more customers and to reduce political costs when expanding activities into foreign markets. These companies see the benefits of applying the IFRS exceeding the costs of implementation and in-usage. Meek and Thomas (2004) state that the reporting environment of a company also affects the relevance of financial reporting, not the accounting standards alone, i.e. the country in which the company operates may have an impact on the relevance of the information. It is argued, that even when applying the International Financial Reporting Standards, the financial statement information may not be comparable among different countries due to cultural differences (Scott 2009). According to Ball (2006) companies may even face a competitive disadvantage from an inefficient financial reporting model. Especially, firms competing in global markets face growing pressure to apply globally accepted financial reporting standards.
Cai and Wong (2010) in their study of global capital markets summarized that the capital markets of the countries that have adopted IFRS have higher degree of integration among them after their IFRS adoption as compared to the period before the adoption. Paananen and Lin (2009) gave a contrary view to prior research that IFRS adoption ensures better quality of accounting information. Their analysis of German companies reporting showed that accounting information quality has worsened with the adoption of IFRS over time. They also suggested that this development is less likely to be driven by new adopters of IFRS but is driven by the changes of standards. The study carried out by Callao and others (2007) on financial data of Spanish firms revealed that local comparability is adversely affected if both IFRS and local Accounting Standards are applied in the same country at the same time. The study, therefore calls for an urgent convergence of local Accounting Standards with that of IFRS.
Thus, based on the review it can be deduced that IFRS on financial instruments as being very complex, convergence with IFRS contributes to different sections in the economy viz. the investors, accounting professionals and the industry as a whole. As IFRS is in the infant stage there is need for more specific studies using scientific methodology so that the pros and cons of IFRS could be understood in a larger context.
The present study is analytical in nature based on secondary data collected from books, periodicals, committee reports and the Internet.
For banks in India, convergence to IFRS is likely to pose significant challenges, as shown by global experience. Certain large Indian banks, which have the benefit of going through the process of international GAAP such as US GAAP in the past, have recognised the challenges of convergence and have already started planning their detailed roadmap to achieve a smooth convergence. It is time for other banks to take the cue and follow suit. Critical to the successful implementation of IFRS in the Indian context would be the level of regulatory sponsorship, the appropriate level of investment in systems and processes and consistency in market practices for areas where judgment is critical.
A move to IFRS can be compared to the mountain peak which can certainly be scaled if well planned and appropriately executed. This is likely to have a significant impact on the financial position and financial performance, directly affecting key parameters such as capital adequacy ratios and the outcomes of valuation metrics that analysts use to measure and evaluate performance. In addition to the financial accounting impact, the convergence process is likely to entail several changes to financial reporting systems and processes adopted by banks in India. These changes would need to be planned, managed, tested and executed in advance of the implementation date. Despite the various impediments to the proposed transition, until the time IFRS is implemented, it would be worthwhile to assess its challenges and opportunities for the primary financial institutional setup in India, called banks.
Opportunities for Banks in India
Indian Banks as an early adopter to IFRS enables to better manage the expectations of internal stakeholders such as Board of Directors and senior management, regulators and internal investors and analysts relating to the impact on earnings and equity. Banking companies are required to produce better quality information in the notes to financial statements and are obliged to reveal information not required previously. Publicly posted financial information allows for open and transparent discussion with clients and suppliers, employees understand better the financial health and direction of the banking company and better financial notes allow stakeholders to make more in depth analysis of the financial statement.
The provisions of IAS 39-Financial instruments, recognition and measurement- issued by the International Accounting Standards Board (IASB), establishes the principles for recognizing and measuring financial assets and financial liabilities. This standard is of particular importance to the Indian banking sector and NBFCs which deal primarily in financial instruments. The same is being replaced as IFRS 9 in the convergence process. In Indian banking industry, the convergence of IFRS 9 is in three phases which will help in reducing complexities. The first phase was completed with the issue of the portion of IFRS 9 which deals with the classification and measurement of financial assets and financial liabilities. The second and third phases are in the area of hedge accounting and impairment, where currently work is underway.
At present, as per RBI's prudential norms, banks have to invest in government securities and account such investments at 'amortised cost'. Under IFRS 9, these securities may have to be accounted for on a 'fair value' basis, with the fair value changes taken to the income statement. This will help Indian banks to exhibit the income statement on a 'fair value 'basis. Under RBI norms, investments in equity instruments (other than subsidiaries, joint ventures) are recorded at market value. Net losses are recognized but net gains are ignored. Under IFRS 9, investments in equity instruments are fair valued. The gains or losses are either recognized in the income statement or in a reserve account. This makes the statement more accurate. That choice is required to be made at the inception, on an instrument by instrument basis, and is irrevocable.
Training is a key element of a successful convergence in the Indian banking sector. A workshop-based training need to be provided to internal staff as well as high officials for more complex and specific aspects of IFRS such as financial instruments or share based compensation on income taxes, or different media such as web-enabled training to reach a broader audience. Using an external advisor to all difficult assessments which are underestimated by internal staff will provide a great support during the actual conversion process, making the execution more successful. As the markets expand globally the need for convergence increases. The convergence benefits the economy by increasing growth of its International business. It facilitates maintenance of orderly and efficient capital markets and also helps to increase the capital formation and thereby economic growth. It encourages international investing and thereby leads to more foreign capital flows to the country. Indian banking sector also contributes to the economic growth through the convergence.
Investors want the information that is more relevant, reliable, timely and comparable across the jurisdictions. Financial statements prepared using a common set of accounting standards help investors better understand investment opportunities as opposed to financial statements prepared using a different set of national accounting standards. For better understanding of financial statements, global investors have to incur more cost in terms of the time and efforts to convert the financial statements so that they can confidently compare opportunities. Convergence with IFRS contributes to investors' understanding and confidence in high quality financial statements. The Indian banking industry is able to raise capital from foreign markets at lower cost if it can create confidence in the minds of foreign investors that their financial statements comply with globally accepted accounting standards. With the diversity in accounting standards from country to country, enterprises which operate in different countries face a multitude of accounting requirements prevailing in the countries.
Convergence of accounting standards simplifies the process of preparing the individual and group financial statements and thereby reduces the costs of preparing the financial statements using different sets of accounting standards. Convergence with IFRS also benefits the accounting professionals in Indian banking sector in a way that they are able to sell their services as experts in different parts of the world. The thrust of the movement towards convergence has come mainly from accountants in public practice. It offers them more opportunities in any part of the world if same accounting practices prevail throughout the world. They are able to quote IFRS to clients to give them backing for recommending certain ways of reporting.
Challenges for Banks in India
The first challenge in implementation of IFRS in banking sector in India is integrity of data and information. Most scheduled commercial banks in India have either already migrated or are in the process of migrating to Core Banking Solutions (CBS). In this context, data integrity and data validity would be of critical importance especially due to data intensive requirements of IFRS converged standards. Preparatory work in this regard would enable banks to counter a basic challenge in their effort towards IFRS convergence. Maintaining 'Ethical Standards' and values is a key part of financial reporting. Without a strong code of ethics and adherence to those ethics, financial reporting would fail to inspire and ensure public and investor confidence in entities. Thus, along with high levels of technical competence, accounting professionals also need to have unquestionable and impeccable professional integrity. Maintaining ethical standards will be a great challenge for Indian banks.
The adaptability and compatibility of existing IT solutions used by Indian banks to the new requirements imposed by IFRS convergence is also a major challenge. Software which has been written keeping in mind Indian GAAP requirements may have to be modified substantially to incorporate features of IFRS requirements. Similarly, compatibility between software and hardware would have to be addressed to take care of the new requirement. The most important factor which differentiates the successful and less successful conversion projects is the presence and absence of project management arena. A comprehensive training strategy and program to human resource is a complex area and needs to be carefully considered. Failure to spend sufficient time and energy on impact assessment makes the conversion more complex for Indian banks.
In addition to the general accounting standards, Indian banking companies are currently required to adhere to the accounting policies and principles prescribed by RBI, making the conversion a tedious process. The replacement of IAS 39 by IFRS 9, will pose significant complexity and application challenges which will result in significant volatility in income statement of Indian banks. Indian Banking companies are subject to regulatory reviews and inspection and are also subject to minimum capital requirements. But IFRS requires increased use of judgement and extensive use of unobservable valuation inputs and assumptions which makes the regulatory review process more explanatory and complex.
IFRS prescribes an impairment model that requires a case to case assessment of facts surrounding the recoverability and timing of cash flows relating to credit exposure. The bedrock of this impairment assessment is the current guidelines of Indian banks, which requires a limited use of judgment and are mechanistic in nature. Significantly different IFRS and GAAP in general lead banks in India to more instances of transfers failing the derecognition criteria, thereby resulting in large balance sheets, capital adequacy requirements, lower return on assets, and deferral of gains/losses on securitisation transactions.
To conclude, as an early adopter to IFRS it is expected that Indian banks enable to better manage the expectations of all its stake holders in many ways. The replacement of IAS 39 as IFRS 9 in the convergence process, implementation of IFRS 9 in a phased manner, valuation of investments in equity instruments on fair value basis, workshop-based training to internal staff for various aspects of IFRS, etc will undeniably help to meet their expectations. Again, financial statements prepared using globally accepted standards enable Indian banking industry to raise capital from foreign markets at lower cost and also help investors better understand investment opportunities globally. Though convergence with IFRS results some challenges viz. integrity of data and information, high level of technical competency and ethical standards, amortization accounting, frequent changes in the policies of RBI etc, the challenges cannot subside its opportunities.