International Financial Reporting Standards Implementation In India

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What is IFRS

IFRS (International Financial Reporting Standards) is a set of accounting standards developed by an independent, not-for-profit organization called the International Accounting Standards Board (IASB). The goal of IFRS is to provide a global framework for how public companies prepare and disclose their financial statements.

IFRS provides general guidance for the preparation of financial statements rather than setting rules for industry-specific reporting. Currently, over 100 countries permit or require IFRS for public companies, with more countries expected to transition to IFRS by 2015.

International Financial Reporting Standards comprise:

International Financial Reporting Standards (IFRS)-standards issued after 2001

International Accounting Standards (IAS)-standards issued before 2001

Interpretations originated from the International Financial Reporting Interpretations Committee (IFRIC)-issued after 2001

Standing Interpretations Committee (SIC)-issued before 2001

Framework for the Preparation and Presentation of Financial Statements (1989)

Does India need IFRS

Come 2011 and India Inc will experience drastic changes in the way financial statements are reported. India is among the 150-odd countries that have decided to adopt the International Financial Reporting Standards (IFRS) in 2011.

Need for IFRS:

Indian Companies are listed on overseas stock exchange and have to prepare accounts with respect to GAAP followed in respective countries. Foreign companies having subsidiary in India have to prepare their accounts in order to meet overseas reporting.

FDI and FII's are more comfortable with one global accounting language which can be understood globally.

The key benefit will be a common accounting system that is perceived as stable, transparent and fair to investors across the world.

It will eliminate barriers to cross border listings and will be beneficial for investors who generally ascribe a risk premium if the underlying financial information is not prepared in accordance with international standards.

Cross border Mergers and Acquisitions will get a boost by making it easier for parties involved in as far as redrawing the financial statements is concerned.

Applicability of IFRS in India

Over nearly 150 countries have implemented or have announced the decision to migrate and implement IFRS. The ICAI has also been trying to get convergence in accounting standards with IFRS. The uniformity in accounting standards should help in a smoother functioning and enable a better comparison across different sectors in different countries.

Most respondents have indicated that they would like IFRS to be implemented in India for their financial statements. This indicates that people have realized the importance of such a standard in the world. Having such a uniform system of accounting has several advantages.

It is expected that such an accounting standard will enable a more transparent, stable system across the world and would also attract a lot of foreign inflow in the economy.

Adopting this International standard, will be helpful for people who live outside India to compare their own companies with Indian companies, and at the same time it will also be helpful for Indians to get more investment from foreign investor.

When asked about India's current stand on IFRS and why it deferred this decision to 2011, most of the respondents felt that this was due to the lack of preparation of Indian companies to adapt to these changes.

Most respondents also believed that lack of proper understanding and training with respect to IFRS is also a major reason for India to have deferred the decision to implement IFRS.

There is a great amount of conflict between the legislation and the accounting standards. As a result of this, there can be several interpretations for the same transactions. Differences between the current Indian GAAP and the proposed IFRS may impact businesses owing to the use of fair value concept instead of historical cost accounting.

The changes that will be brought out by the implementation of IFRS in India may impact ratings, financial performance metrics and also the design of financial product. Training in the corporate is essential to incorporate IFRS, but more importantly there is also a need to understand the modification processes. Companies should devote time and resources in educating and training employees and other stakeholders. More efforts are required to bring awareness on the conceptual framework and timeline to prepare companies, particularly small and medium enterprises (SMEs), to make the switch to IFRS more efficiently. The preparedness of industry also depends on the readiness of professionals in carrying out tasks related to preparation and audit of financial statements in accordance with the IFRS-converged accounting standards.

Challenges faced in the implementation of IFRS

Changeover to IFRS in India is definitely a complicated process. The ICAI has already laid down the broad outline for this changeover.

While a broad direction is available from the ICAI, it needs to gather a lot of momentum to put the complex machinery in India to work to achieve some of the intended results within the aggressive timelines currently proposed. IFRS implementation is likely to have a significant impact for most banks company and the non-banking companies too.

Based on the survey, having only limited number of questions, we have summarized our thoughts and perspectives on some important questions that organization may wish to consider while developing a plan for IFRS implementation. As part of the survey, we covered three questions which focuses on the challeges these companies have to face in implementing these.

Not easy for the regualatory and standard setters body to work in tandem towards a common goal. Accounting and regulatory body will also bring in other changes in 2011.

Most respondents do feel that the working of RBI, ICAI, IRDA and SEBI will cause interruptions in implementing the process.

To achieve the end objective of comparability in financial reporting, all of these complex accounting standards need to be understood and applied in a consistent manner by a wide group of accountants, both within the industry and the profession.

To achieve the end objective of comparability in financial reporting, all of these requirements need to be understood and applied in a consistent manner by a wide group of accountants, both within the industry and the profession.

It is said that India is moving towards a moving target and IFRS is ready to undergo a major change in this month. What is the level of preparedness for the same in such a case?

For this question, the vote is divided between the respondents. Some feel that internal teams should be apprised and be well informed but some feel otherwise.

Advantages and Disadvantages of IFRS

The move to IFRS has its advantages and disadvantages. These are the mostly quoted ones.

Pros

IFRS is easier to use and will result in better reporting

Institutional Investors prefer IFRS

IFRS is a "global" approach; comparability to financial statements from other countries that have already adopted IFRS

Cons

IFRS fails the cost/benefit analysis

Transition periods will cause disconcerting results

This is a conversion that will shake the whole basis of reporting for many corporations, affecting not just their external communication of performance, but also their internal management reporting and data collection systems. For example a European company that recently prepared its first financial statement according to IFRS. Management was shocked to see that its return on investment under the new requirements fell from 16 percent to 3 percent. Add to this the potential for the new "fair value" provisions, which would increase substantially the volatility of reported financial numbers in certain situations, and it is clear that IFRS conversion will challenge preparers and readers alike. Within the organization, the perceived contribution of any given product or team to total corporate profitability could be transformed overnight. The potential financial, structural and cultural implications of this transition are pervasive. Amidst the many changes that conversion to IFRS might entail, one challenge dominates the agenda of investors and directors alike: how to evaluate corporate performance. How, in a world of greater earnings volatility, can a good management be differentiated from bad. Fair-value accounting provides a way to measure assets and liabilities that appear on a company's balance sheet and income statement and seeks consistent reporting among comparable institutions. Measuring companies' assets and liabilities at fair value may affect their income, both negatively and positively.

Accounting Differences in IFRS

Implementation of IFRS will require many changes to the way items are treated in the books of account for organizations. The complexity associated with the same is the main reason why a lot of survey respondents feel that their organization is ill-equipped to effectively implement IFRS owing to a lack of appropriate knowledge and training for employees. This is also the reason we have received a diverse set of responses to the question pertaining to accounting differences in the survey as most respondents probably don't know all the key differences in the way certain items are treated under IFRS in comparison to current accounting standards. As such, no specific trend was observed in the response to this question as the responses varied significantly.

The key accounting changes proposed under IFRS include the following:

Financial assets to be classified on initial recognition and measured at amortized cost or fair value. Eliminates the existing IAS 39 categories of held to maturity, available for sale and loans and receivables.

Embedded derivates are no longer separated from hybrid contracts that have a financial asset as the host. Instead, the entire hybrid contract is assessed for classification using certain principles.

Establishes that rights to acquire a fixed number of the entity's own equity instruments for a fixed amount in any currency are equity instruments if the entity offers the rights pro rata to all of its existing owners.

Equity instruments issued to settle financial liabilities to be measured at fair value and the difference between the carrying amount of the liability and the fair value to be included in the entity's profit and loss account.

Introduced related party disclosure exemption for government-related entities and improved the definition of a related party. The revised standard has also expanded the list of transactions that require disclosure.

Provides a simplified and slimmed-down version of full IFRS, tailored for the needs and capabilities of SME.

IFRS for Banking

In addition to the general accounting standards and practices that constitute Indian GAAP, banking companies are currently required to adhere to accounting policies and principles that are prescribed by the Reserve Bank of India (RBI). For example, financial reporting policies for provision for loan losses and investments are specified by the RBI. Hence, as found in survey, the adoption of IFRS requires a significant change to such existing policies and could have a material impact on the financial statements of banking companies.

The following are the challenges and differences identified through the survey and articles/reports on the internet:

• IFRS prescribes an impairment model that requires a case by case (for significant exposures) assessment of the facts and circumstances surrounding the recoverability and timing of future cash flows relating to a credit exposure. Should there be an expectation that all contractual cash flows would not be recovered (or recovered without full future interest applications), an account would be classified as impaired and impairment be measured on present value basis using the effective interest rate of the exposure as the discount rate. For groups of loans that share homogenous characteristics (such as mortgage and credit card receivables), impairment can be assessed on a collective basis. The aim of an individual or collective assessment is to capture the incurred loss for a specified portfolio. General provisions are permissible only to extent that they relate to a specified risk that can be measured reliably and for incurred losses. No provisions are permitted for future or expected losses. For investments, a similar analysis is conducted, the key difference being that the fair value of the investment is also considered as an input in addition to the financial / credit standing of the issuer.

The assessment assumes a system that considers all the facts and circumstances and requires the use of informed judgment. This aspect represents the most significant difference from Indian GAAP for banks in India. Current Indian GAAP / RBI guidelines require a limited use of judgment and are mechanistic in nature with prescribed provisioning rates.

• Fair value measurement is infrequently used under Indian GAAP and in most cases where it is, the aim is primarily to capture a lower of cost or fair value measurement base. Under IFRS, there may be a significant increase in the extent that fair value measurement needs to be used. For instance all financial assets and liabilities will need to be initially measured at fair value. While in a number of instances, fair values may be represented by transaction prices, the onus on banks will be to prove that transaction prices represent fair value. In addition, there will be a number of instances where unrealized gains can / should be recognized; for example, trading instruments and those where the bank elects the fair value option. Further, due to the stringent criteria prescribed under IFRS, a Held to Maturity (HTM) classification, (which currently results in an amortized cost valuation basis for a significant part of most Indian banks' investment portfolio), is unlikely to be available leading to fair value measurement for a substantial part of the portfolio. Again, this is a significant shift from current accounting treatment under Indian GAAP.

• Under IFRS, all derivatives are recognized on the balance sheet at fair values with changes in fair values being recognized generally in the income. In addition, embedded derivative contracts (such as equity conversion options embedded in a convertible debenture - the most common situation found in India) require to be separated from their host contracts and be accounted for separately. In contrast, current Indian GAAP does not specifically address the more 'difficult to apply' provisions of fair value and hedge accounting.

• Under IFRS, de-recognition of financial assets is a complex, multi-layered area with the de-recognition decision dependent largely on whether there has been a transfer of risks and rewards. If the assessment of the transfer of risks and rewards is not conclusive, an assessment of control and the extent of continuing involvement are required to be performed. In many cases, this cannot be restricted to qualitative assessments and needs to be necessarily a quantitative assessment. A major area impacted would be securitization activity - most Indian securitization vehicles are currently structured to meet Indian GAAP de-recognition norms. Substantially all those securitization vehicles would collapse into the transferor's balance sheet and assets would fail the de-recognition test under IFRS. For example, securitization transactions where credit collaterals are provided /guarantee is provided to cover credit losses in excess of the losses inherent in the portfolio of assets securitized, may not meet the de-recognition principles enunciated in IAS 39.

The new norms would lead to more instances of transfers failing the de-recognition criteria thereby resulting in large balance sheets and capital adequacy requirements, lower return on assets and deferral of gains / losses on such securitization transactions.

• Under IFRS, consolidation is not driven purely by the ownership structure of an entity. Instead the focus is more on the power to control an entity to obtain economic benefits - this power to control could be expressed as ownership of equity securities but is not limited to it. For instance, this will include a consideration of currently exercisable potential voting rights / shares; management and other agreements, de facto control and other arrangements that provide the power to control an entity. IFRS also provides guidance on how consolidation decisions for special purpose entities should be arrived at. In a number of ways, IFRS provides more rigorous consolidation tests and in practice can result in the consolidation of a larger number of entities as compared to Indian GAAP which focuses on a narrower set of tests (majority of ownership and control over a majority of the composition of the board of directors or similar body).

Sectoral Comments on IFRS

When companies prepare their first financial statements compliant with the International Financial Reporting Standard (IFRS), they will have to use IFRS-1-First-time Adoption of International Financial Reporting Standards. IFRS-1 prescribes procedures that a company has to follow while preparing its opening IFRS balance sheet at the beginning of the so-called comparative (comparing with the previous corresponding period) period. Thus, Indian companies preparing IFRS financial statements for the period beginning 1 April 2011 with one year comparatives would need to prepare the opening IFRS balance sheet as on 1 April 2010.

It is only obvious that each sector gets affected in a different manner once the IFRS standards are adopted. Thus through this section of the report, we focus on some of the sectors - namely REALTY AND INFRASTRUCTURE, IT and MEDIA with special focus towards the REALTY sector since that has been mentioned as being affected the most by our survey.

MEDIA

A common practice amongst media owners is the bundling of space across various products/ programs/ channels/ publications/ portals. The accounting of revenues or costs becomes challenging where such space is marketed for a consolidated amount. There is no specific guidance under Indian GAAP or IFRS. However, under IFRS, the practice is to use the relative fair value method to allocate the revenue amongst the various components and recognize them as the components are delivered. Under Indian GAAP, there are disparate practices, including recognizing full revenue upfront with a provision for cost made for the unrecognized components.

Media companies often enter into barter transactions, for example, broadcasters exchange rights to place advertisements on each other's channels. Under IFRS, revenue from barter transactions is recognized at the fair value only when the exchange involves dissimilar goods/services. Under Indian GAAP, there is no guidance other than for dotcom companies; therefore, disparate practices exist, including not recording the barter transaction.

Under IFRS, the revenue from the sale of broadcast, film or exhibition rights may be recognized in full upon commencement of the license period. It is not appropriate to recognize revenue prior to the date of commencement of the license period since it is only from this date that the licensee is able to freely exploit the rights of the license and hence has the rewards of ownership.

IT

Just as technology is constantly evolving, so is IFRS. Here we will examine a few areas that will majorly impact information technology companies. First and foremost, IFRS may have a significant impact on the revenue top-line being reported by technology companies. Technology companies enter into lump sum contracts for sale of licenses, implementation fees, warranty, maintenance and free upgrade services, etc., over a period of time.

Under IFRS, a key issue will be to determine whether the components of a single transaction can be separated from an obligations performance standpoint i.e. from a technical and commercial perspective. In such instances, bundled contracts and multiple offerings under a package will require fair valuation of different components and revenues would be recognized accordingly. Indian GAAP does not provide any specific guidance on this and, therefore, inconsistent practices are presently being followed by various companies. Some companies defer the revenue recognition till the entire project is completed. Other companies recognize revenues and provide for costs associated with pending post-sale contractual obligations. Very recently, the research committee of the ICAI has come out with a technical guide on revenue recognition for software companies, which is very similar to SOP 97-2 followed in US GAAP.

Large outsourcing contracts are quite common in the IT sector. Often a significant part of the capacity is being utilized by a specific customer or facilities may be specifically earmarked to cater to the needs of a particular client. Usually in such cases, the pricing of the contract is also agreed on special terms, keeping in mind the costs incurred by the IT company in providing such services. In such scenarios, one will have to evaluate whether provision/receipt of services constitutes or contains a lease arrangement under IFRIC 4. Financial statements would change quite significantly if it is determined that such transactions contain an element of lease, particularly if they satisfy the criteria for a finance lease. Under Indian GAAP, such arrangements are normally considered as those for providing services and not a leasing activity.

IFRS entails discounting of future receivables and payables to their current values using expected interest rates. The application of 'time value of money' concept will have impact on the amounts recorded for long-term security deposits, payables falling due after one year and revenues earned in advance for long-term contracts/ arrangements. Imputed interest amounts will also have an impact on profits reported by IT companies.

REALTY AND INFRASTRUCTURE

The advent of International Financial Reporting Standards (IFRS) in India will have far-reaching implications for real estate, construction and infrastructure companies. It will impact the basis for recognizing revenues, take cognizance of multiple-element contracts and barter transactions, and allow the use of fair value for measurement of assets.

Under Indian generally accepted accounting principles (GAAP), there is no specific definition of investment property; hence, there are varying practices of classifying such properties held for rentals or capital appreciation. They are either shown under investments or as part of fixed assets at cost of acquisition or construction. If the property is classified as part of fixed assets, it is possible to undertake revaluation, but such gain is taken directly to reserves and the property needs to be depreciated over its economic useful life.

IFRS will allow real estate companies to adopt fair value for measuring and reporting their investment properties.

The fair-value gains as well as losses arising from adoption of this method will be routed through the profit and loss account. If the fair-value model is adopted, investment property is not depreciated; hence there will be no amortization cost. IFRS recognizes the fact that usually landed properties only appreciate in market values over the long term; therefore, they need not be depreciated (have a certain value written off every year, which is how most assets are currently

Being substance-driven, IFRS will have a significant impact on recognition of real estate sales. Usually, agreements for sale with buyers are made as soon as the projects are launched; typically well before completion of construction and handing over of possession. The IFRS provision on "agreements for the construction of real estate" requires developers to determine whether the contract is a construction contract, services contract or a sales contract, and revenue recognition will follow this substance. The agreement will be a construction contract if the buyer has control over the design and specification of the property till it gets completed. It will qualify as an agreement for services, if the materials are being provided by the buyer, which normally is not the case, but this may apply in certain joint development contracts. In all other cases, IFRS will treat sales of residential flats or properties as sale of goods on completion basis. Indian GAAP allows it to be done by the proportionate completion method once the agreement for sale has been entered into. However, in the case of IFRS, this will be possible only if the contract is a construction contract, wherein the buyer has control over the specifications. IFRS will allow recognition of multiple elements in the real estate contract. So, if there are two separate arrangements, one for sale of land and another for construction services, then it may be possible to recognize revenue from sale of land separately.

For infrastructure companies, the IFRS provision on "service concession arrangements" will have far-reaching consequences, since concession arrangements would need to be accounted for differently. Under Indian GAAP, expenditure incurred by the infrastructure provider is capitalized as fixed or intangible asset, depreciated usually over the term of the service concession agreement. Under IFRS, this will have two elements. First, it will be treated as rendering of construction services where revenues will get recorded at the fair value of such services, that is, with appropriate mark-up over cost. Second, the provider will recognize an intangible asset in extinguishment of the receivables on completion of construction. The results of the service provider will be thus significantly different, since it will recognize revenues during the construction period under IFRS.

Another important aspect will be discounting of long-term payables and receivables, including retention money, in line with market interest rates to reflect the current fair value.

Appendix

The survey was done using an online questionnaire at the link http://spreadsheets.google.com/a/fms.edu/viewform?formkey=dE1CVG1PQkpTM2FCV21vWklNUmh6cUE6MQ

The questionnaire was sent to 17 people for their responses. The respondents were mainly CAs and a few people from the finance department of companies. Please find below the list of people surveyed.

Survey Results:

Do you think India needs to implement IFRS for its financial statements?

If yes, which of the following could be the possible reasons

Biggest hurdles that companies could face on IFRS?

People may select more than one checkbox, so percentages may add up to more than 100%.

Unclear regulation on IFRS adoption

Unclear tax laws

Unavailability of IFRS skills

Timelines are not detailed for proper planning

Some of the investments may be recorded under IFRS at fair value with the movement of fair values between different periods reported in equity or the income statement. Currently, such investments may be reported at cost. While the underlying business situations continue to be the same, the fact that the movement in fair values is recorded through the income statement in the future may affect the profitability of the company. This might be of disadvantage to investors.

A core panel constituted by the government on IFRS decided to exempt SMEs from the first phase of IFRS convergence falling due in 2011. The reason given is convergence to IFRS is a costly exercise that includes an overhaul of operational and IT processes apart from training costs. The SMEs cannot bear such huge costs. Do you feel that these are justifiable causes?

The advantages of IFRS like improvement in comparability of financial information and financial performance with global peers and industry standards resulting in better quality of financial reporting and low cost of raising funds in abroad outweighs its disadvantages like high training cost, huge cost of enhancement of IT systems and managing market expectations and investor relationships

The current level of IFRS knowledge within the company is adequate for IFRS implementation purposes

Which sector do you think will be affected by IFRS the most?

People may select more than one checkbox, so percentages may add up to more than 100%.

Realty and infrastructure

IT

Media

FMCG

Food and Beverages

Other

Do you think implementation of IFRS would cause significant changes to the banking sector?

IFRS prescribes an impairment model that requires a case by case (for significant exposures) assessment of the facts and circumstances surrounding the recoverability and timing of future cash flows relating to a credit exposure. Do you think IFRS is too judgmental and hence presents great difficulty?

IFRS requires a significant increase in use of fair value measurement. Do you think it is challenge for banks to use and prove transaction prices as representing fair value?

Given that the IFRS position is significantly different from that followed under Indian GAAP, Do you think application of the new norms would in general lead to more instances of transfers failing the de-recognition criteria thereby resulting in large balance sheets and capital adequacy requirements, lower return on assets and deferral of gains/losses on such securitization transactions?

Large outsourcing contracts are quite common in the IT sector. Due to IFRS implementation, the financial statements detailing these would be significantly affected.

IFRS implementation will impact the infrastructure sector because it will impact the basis for recognizing revenues, take cognizance of multiple-element contracts and barter transactions, and allow the use of fair value for measurement of assets

A common practice amongst media owners is the bundling of space across various products, programs, channels, publications and portals. This makes the accounting of revenues or costs challenging. IFRS will change all that.

'In spite of efforts by the core group set up by the ministry of corporate affairs to bring convergence of Indian Accounting Standards with IFRS, a lot of ground is yet to be covered to align and harmonise legislative changes with various enactments. The challenge for industry comes from differences in the underlying conceptual framework and lack of trained people'. Do you agree with this opinion?

Accounting framework in India has multiple influencers and accounting standard-setters, such as the ICAI, SEBI, Companies Act, NACAS, income-tax authorities, and industry regulators such as the RBI, IRDA, etc. Hence these bodies need to work in tandem to set regulations that are consistent with each other. This is going to be a difficult task considering the Indian Environment?

India is working towards a moving target - IFRS is expected to undergo change between now and 2011. This puts countries like India, at a comparative disadvantage, as they still don't know what would be the IFRS requirements to apply in 2011.

Internal teams and sponsors fully should be apprised of project progress by newsletters, email alerts and intranet site within the organization.

Kindly provide your opinion on the extent of difference in the treatment of following items under IFRS and current accounting standards. 0 (No difference) 5 (Vastly different) - Classification of financial assets and measurement at amortized cost or fair value

1

22%

2

56%

3

17%

4

0%

5

0%

Kindly provide your opinion on the extent of difference in the treatment of following items under IFRS and current accounting standards. 0 (No difference) 5 (Vastly different) - Embedded Derivatives

1

1

6%

2

9

50%

3

7

39%

4

0

0%

5

0

0%

Kindly provide your opinion on the extent of difference in the treatment of following items under IFRS and current accounting standards. 0 (No difference) 5 (Vastly different) - Accounting for rights issues

1

11%

2

50%

3

33%

4

0%

5

0%

Kindly provide your opinion on the extent of difference in the treatment of following items under IFRS and current accounting standards. 0 (No difference) 5 (Vastly different) - Related Party Transactions

1

11%

2

44%

3

33%

4

6%

5

0%

Kindly provide your opinion on the extent of difference in the treatment of following items under IFRS and current accounting standards. 0 (No difference) 5 (Vastly different) - Standards for SME

1

33%

2

22%

3

28%

4

11%

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