Switching from Indian GAAP to IFRS

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Background - the need for Indian GAAP to change to IFRS and the global perspective in brief.

The impact of globalization has been immense, with companies facing and following separate financial reporting standards in different countries. This has made it very difficult for multinational companies to consolidate and interpret their financial performance on a global basis, thus giving rise to a wave of implementing the International Financial Reporting Standards (IFRS). The European Union started adopting these standards and many other countries in the Asia Pacific region, including Australia followed suit. Currently, the IFRSs are being followed by over 100 countries around the world. IFRS is already been allowed to be followed by foreign companies listed in the US, and it is expected to be open to domestic companies by 2011. Other countries such as China, Korea and Brazil have also expressed interest in adopting these standards and plan to do so in the near future. Japan too has paved a roadmap to adopting IFRS in a phased manner.

India also has realized the importance of adhering to a common financial platform, but has recognized that there would be significant implications on companies and the economy in India if this transition were to happen. The Institute of Chartered Accountants of India (ICAI) came up with a concept paper for the adoption of the IFRS in India, and realized that India would have to converge to IFRS rather than completely change over to the new standards. The International Accounting Standards Board (IASB), which is the body that has set up the standards for IFRS, has requested for complete unreserved adherence to the IFRS. India currently faces several challenges to completely adapt to the IFRS due to its current legal and regulatory environment, incompatibility of IFRS with accounting standards for all industries and a dearth of certified professionals to play a catalyst's role in the convergence process. Several changes in the laws such as the Companies Act, those set up by SEBI, RBI etc need to be amended for successful convergence. Several sanctions by the parliament would also be required to change to the IFRS.

Convergence would help find a middle and common ground between the Indian GAAP and the IFRS and would result in a smoother transition to the new standards. The Government of India and Ministry of Corporate Affairs (MCA) are in sync with this approach. According to the concept paper designed by ICAI, India would be adopting IFRS from April 1, 2011.

Benefits experienced through converging to IFRS are multifold. Some of them include:

There would be no need for separate reporting for the same company in different countries, resulting in the freeing up of tremendous amount of resources.

The ease of raising capital from international investors would increase due to the ease of assessing the financial health of companies on a common platform.

There would be an increase in consistency in financial reporting worldwide making it easier for all internal and external stakeholders such as shareholders, analysts etc to better understand the financial position of companies and compare them on a common platform. This would make decision making simpler based on authentic evaluation of different financial parameters.

There are currently over 100 companies worldwide who have already adopted these standards and convergence of India to these standards would put India on a global platform of financial reporting.

Current status - What companies (especially banks) are doing to make the transition and meet deadlines

India will follow its own IFRS equivalent accounting standards, which will have no differences between Indian followed IFRS Standards and the IFRSs. Several actions need to be taken by companies to comply with the Indian based IFRS Standards, some of which include:

Changes in the balance sheet due to IFRS should occur in the balance sheet for a period before the applicable date, and the effect of the transition will be adjusted in the general reserve. Hence companies should expect that the balances of equity, assets and liabilities will differ between the first IFRS compliant balance sheet and the last audited balance sheet before the convergence.

IASB requires companies to retrospectively apply IFRS to financial statements for the past years as far as they can possibly go with reasonable efforts. This will be possible for the companies based on the information they have on the past years and whether they can use it to converge their past statements to IFRS. This poses a difficulty for companies within the same industry, as some companies might have enough information to converge for the past 8 years, whereas other might not. Hence issues should be discussed with companies in industry forums.

It is important to come up with a set of new accounting policies which are compliant with the IFRS and whose economic implications can be easily understood. Hence a multidisciplinary team should be set up and should include auditors. In case of government companies, representatives of the Comptroller and Auditor General of India should also be included.

Banks in India are doing their part in converging to the IFRS. The impact of the transition is expected to be felt most on the banking sector due to the multiple financial instruments banks deal with, as well as their exposure to most other industries in the form of loan products. In addition to the actions taken by other industries, banks need to make additional changes due to the complexity involved in the various financial instruments and other regulatory issues. Some of these include:

Apart from following GAAP, banks also have to follow regulations issued by the RBI. Hence significant changes would have to be made to the RBI regulations to fully comply with the IFRS.

The International Accounting Standard 39 (IAS 39) is on financial instruments and is one of the most complex standards. Since this would be applicable to most of the components of the bank's financial statements due to the number of financial instruments that banks deal with.

A lot of the IFRS is based on judgment and fair valuation. India being a developing country does not have highly developed financial markets for all financial instruments, and hence application of the standards becomes difficult. Similarly in areas of loan losses and impairment, banks currently using limited judgment will face difficulty in converging to the IFRS.

Implications on the banking sector

Hence it seems obvious that banks are going to have to make some major changes to converge to the IFRS and the implications of converging are going to be far reaching. Banks will have to:

Create and improvise on their past accounts data collection, information storage in a way that it can be utilized for decision making, such as the calculations of probable losses on a particular loan. This is due to the fact that a lot of the IFRS principles are based on judgment.

Banks in India will have to create fair evaluation methods which are in sync with market conditions at all times.

Create better risk assessment methods for the assessment of the risk exposure of any particular loan.

Make changes in the way calculations are being done, in the light of additional knowledge and past experience, such as the computation of discounted cash flows for accounting for the impairment of a loan.

Associate with a number of specialists in the area of credit risk calculation and a deep understanding of the applications of the IFRS on a bank's existing system to train existing employees and spread the knowledge and awareness about the implications of IFRS on the Indian banking system.

Assess the requirement to consolidate operations within a single entity based on an IFRS principle of consolidation of entities into a single group rather than have separate entities with separate accounting systems for each one.

Several process and system changes will have to be made for various measurements and calculations through processing of existing information and past experience. An example would include the decline in de-recognition of assets under the IFRS norms, resulting in lower returns on assets and a deferral of gains / losses on securitization transactions, as compared to those under the current Indian GAAP.

In order to carry out the necessary actions to converge with the IFRS, banks have started getting external advisors on board to train internal employees as well as facilitate and oversee the changes made to the current accounting practices. Training is an integral part of the convergence project, to understand complex aspects of IFRS and apply them to the different financial instruments and accounts within the bank.

IT systems will have to be re-looked at to ensure correct data collection, analysis and providing the required output in the IFRS formats. Building new formats for reporting and accounting will have to be implemented. Depending on how heterogeneous a bank's IT systems are, there will have to either be enhancements or a major overhaul, and it is necessary to assess this at an early stage, before too much investment is made in setting up a system which might prove to be inappropriate at a later stage.

Making internal and external stakeholders aware of the implementation process and how it will impact the accounts and financial statements is important to clear expectations from the start. This will give analysts a head start into what to expect when they look at financial statements after shifting to the IFRS, and will reduce the shock of the output.

Implications on other industries

Within the insurance industry the IRDA is in the process of setting up a road map for the transition to IFRS Standards. The IASB has designed IFRS 4 which makes limited changes to insurance financial reporting standards. The Phase 2 with more details is expected to be published by the IASB in 2011. According to a study done by ICAI, only two of the Indian accounting standards for insurance are in compliance with the IFRS. All of the others will have to go through transformation, which will have significant implications in terms of the definition of the components of financial statements of insurance companies. Some examples would include the recording of premium income directly into the balance sheet and dividends could be recorded as interest. Dr. R Kannan, member IRDA mentioned that a sudden change to the new accounting standards would not be possible due to several constraints faced by the Insurance industry. The transition is expected to happen in a phased manner.

Companies within most of the other industries too have taken initiative and shown commitment towards converging to IFRS by the set deadline. According to Economic Times, 180 industries attended a 2-day workshop on IFRS in Gujarat in 2008, which was hosted by the ICAI. Some of India's largest companies including Wipro, Infosys, Mahindra and Tata Motors, Bombay Dyeing and pharma major Dr Reddy's Laboratories are now aligning their accounting standards to IFRS.

Implications on infrastructure companies include impact on public private partnerships (a change in the accounting of infrastructure assets and treatment of subsequent income earned on it), leases (differences in the definition of a lease under both accounting standards) and the recording of financial Instruments (changes in accounting of embedded derivatives).

Top accounting implications faced by the IT and BPO Industries include revenue recognition (recognizing and accounting for each component of the software products and services separately by the IFRS as compared to the method of valuation of a complete project by the Indian GAAP), outsourcing contracts (different accounting standards for different types of contracts under the IFRS), share based payments (recorded separately by the two standards) and differences in the derivatives and hedge accounting standards.


India is highly committed towards aligning its accounting standards to IFRS. Owing to the several advantages of the IFRS, a large number of industries with both large and small companies have expressed significant interest in transitioning existing systems. A lot of time and commitment along with high technology expenses will be required for the successful implementation, but this move will catapult India to the global scenario of accounting standards.