Already a wide rage of debate is raging about the implementation challenges of transitioning into International Financial Reporting Standards (IFRS) and its impact. A major and indispensable element of smooth transition into IFRS is the convergence of Reserve Bank of India (RBI) guidelines with the principles laid down in IFRS. Succinctly, the successful adoption of IFRS is dependent on the flexibility and acceptability of IFRS by RBI. Banks would need to soon adjust to accounting changes that are enforced by IFRS. 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 emphasised to banks that they need to gear up to adopt the new standards. Practical experience from other countries has proved that transition to IFRS can take 18-24 months to fully embed and implement.
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Given this backdrop, RBI has constituted up a working group under the chairmanship of Mr. Ravi Mohan, Chief General Manager, Department of Banking Operations & Development (DBOD), RBI, to address the implementation issues and facilitate formulation of operational guidelines in the context of IFRSs convergence for the Indian banking system. The group is entrusted with the issues such as; (i) Classification and measurement of financial assets (2) Classification and measurement of financial liabilities and hedge accounting (3) Amortised cost and impairment (4) Fair value measurement (5) Presentation, disclosures and balance sheet formats and (6) Derecognition, consolidation and residuary issues.
In pursuit of its objectives, the International Accounting Standards Board (IASB) works in close cooperation with stakeholders around the world, including investors, national standard-setters, regulators, auditors, academics, and others who have an interest in the development of high-quality global standards. Progress toward this goal has been steady. All major economies have established time lines to converge with or adopt IFRSs in the near future and more than hundred countries require or permit the use of IFRSs. Approximately 100 countries have adopted or are in the process of adoption.
Convergence with IFRS has gained momentum in recent years all over the World. 110+ countries including European Union, Australia, China, New Zealand, and Russia currently have permitted the use of IFRS. Apart from India, countries like Japan, Sri Lanka, Canada and Korea have also committed to adopt IFRS from 2011. United States of America has announced its intention to adopt IFRS from 2014 and it also permits foreign private filers in the U.S. Stock Exchanges to file IFRS complied Financial Statement, without requiring the presentation of reconciliation statement. The status of adoption of IFRS in some select countries is furnished in table-1.
Table-1: Status of Adoption of IFRS in some Select Countries
Status of IFRS Implementation
Similar to IFRS (effective for listed entities 2007)
Currently applicable for banks.
2011 (as per action plan released)
Overview of IFRS
The term "IFRSs" currently comprises of: 9 IFRSs (the 9th being in the stage of development, 29 IASs (originally 41), 18 IFRIC and 11 SIC interpretations, plus the Framework. IFRS-1: First time adoption of IFRS; IFRS-2: Share Based Payment; IFRS-3: Business Combinations; IFRS-4: Insurance Contracts; IFRS-5: Non-current assets held for sale and discontinued operations; IFRS-6: Exploration for and evaluation of mineral resources; IFRS-7: Financial Instruments-Disclosures; IFRS-8: Operating Segments; and IFRS-9: Financial Instruments - Assets.
Figure-1: Transition to IFRS
Fair Value Accounting
Historical Value Accounting
Mainly the objectives of IFRS include; principles based high quality global standards and emphasis on relevance and disclosures.
Further, Effective Project Management is also an essential ingredient for a successful and sustainable IFRS implementation process. As illustrated in figure-2, there are issues for Accounting and Reporting, Systems and Processes, People and for the wider Business.
Figure-2: IFRS implementation process 
Why Convergence to IFRS?
The drivers of IFRS convergence are mainly; capital Markets, regulatory requirements, internal controls and performance evaluation. Converging to global accounting standards i.e. IFRS facilitates comparability between enterprises operating in different jurisdictions. Thus, global accounting standards would remove a frictional element to capital flows and lead to wider and deeper investment in markets. Convergence with IFRS is also in the interest of the industry since compliance with them would be able to create greater confidence in the mind of investors and reduce the cost of raising foreign capital. It is also burdensome and costly for enterprises operating across several countries to comply with a multitude of national accounting standards and convert them to a single standard for group reporting purposes. Convergence would thus help reduce both the cost of capital and cost of compliance for industry.
Always on Time
Marked to Standard
Banks in India may face several challenges along the path to convergence. Apart from the regulatory challenges some of the significant technical accounting challenges could be; Loan/Investment impairment Losses, Fair value accounting of financial Instruments, Derivatives and Hedge Accounting, De-recognition of Financial Assets and Consolidation of Entities.
Loan / Investment Impairment Losses
Application of IFRS may result in higher loan losses and impairment charges, thereby impacting available capital and capital adequacy ratios. A case by case assessment of the individual facts and circumstances surrounding the recoverability and timing of future cash flows for all major credit exposures is prescribed under the impairment model suggested under IFRS. Further, loan losses are required to be calculated based on an objective impairment assessment of the specific facts & circumstances of the credit exposures and based on the use of informed judgment. However under the current Indian GAAP / RBI guidelines, loan losses are provided for the non performing assets based on prescribed provisioning rates in a mechanical manner, without any such impairment assessment. As such, banks need to improve and strengthen the loss forecasting mechanisms within the organization in parallel with fine tuning risk adjusted pricing for fresh loans.
Fair value accounting of financial Instruments
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 amortised 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.
Derivatives and Hedge Accounting
Under IFRS, all derivatives are recognized on the balance sheet at fair values with changes in fair values being recognized generally in the income statement other than in the case of a qualifying cash flow hedge relationship. Application of hedge accounting does reduce the income statement volatility induced by the fair value measurement of derivatives but comes with significant strings attached in the form of documentation, hedge effectiveness testing and ineffectiveness measurement. 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.
De-recognition of Financial Assets
Under IFRS, de-recognition of financial assets is a complex, multi-layered area that follows the principle of transfer of risks and rewards. In the Indian context, this will impact mainly the securitisation activity. Securitsation transactions - where credit collaterals are provided or guarantee is provided to cover credit losses in excess of the losses inherent in the portfolio of assets securitised-may not meet the de-recognition principles enunciated in IAS 39. This will result in failure of de-recognition test under IFRS and lead to collapse of securitisation vehicles into the transferor's balance sheets. Banks will need to assess the impact and consider the potential impact on capital adequacy and ratios such as return on assets.
Consolidation of Entities
Under IFRS, consolidation is not driven purely by the ownership structure of an entity but will have to focus on the power to control an entity to obtain economic benefit. IFRS provides more rigorous consolidation tests and in practice can result in the consolidation of a larger number of entities as compared to under Indian GAAP. Banks will need to perform consolidation assessments as early as possible, particularly for non-shareholding related factors that impact consolidation, to assess its impact.
The Yin and Yang of Convergence to IFRS
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Convergence also entails maintaining consistency with legal and regulatory requirements prevalent in the country. Towards this end, amendments need to be made to existing laws and regulations, notably the Companies Act, 1956 provisions and schedules that detail the requirements of financial statements need to be harmonized with IFRS requirements and converged Indian Accounting Standards need to be notified under section 211 (3C) of the said Act. Additionally there are also issues relating to taxation under an IFRS converged environment.
There is also a need to improve awareness in general and build technical competence for the accounting and auditing profession on IFRS. The ICAI has already included a comparative study of Indian Accounting standards with international standards in its syllabus for CA Final Advanced Accountancy and is also offering courses and seminars for its members to update them in the field. The RBI too has been holding periodical seminars and workshops to educate its staff on IFRS provisions.
The IFRS convergence process will involve significant challenges for the banking system in general. Banks would need to upgrade their infrastructure, including IT and human resources, to face the complexities and challenges of IFRS. Some major technical issues arising for Indian banks during the convergence process would be differences between the IFRS and current regulatory guidelines on classification and measurement of financial assets, focus in the standard on the business model followed by banks and the challenges for management in this area, application of fair values for transactions where not much guidance is available in India in terms of market practices or benchmarks, and expected changes in impairment rules.
Global Financial Crisis and the Lessons learnt
One of the most destabilizing elements of the global financial crisis has been the pro-cyclical amplification of financial shocks through the banking system, financial markets and the broader economy. The tendency of the market participants to behave in a pro-cyclical manner has been amplified through a variety of channels, including through accounting standards for both mark-to-market assets and held-to-maturity loans, margining practices and through the build up and release of leverage among the financial institutions, firms and consumers. Failure to capture major on-and off-balance sheet risks as well as derivative related exposures, was also a key destabilising factor. 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 banking sector and NBFCs which deal primarily in financial instruments. IAS 39 includes provisions about classification of financial instruments, their ongoing measurement (including when impairment is required) and derecognition. The provisions of IAS 39 are currently applicable globally in respect of financial instruments.
In the backdrop of the developments after the global financial crisis, the Ministry of Corporate Affairs (MCA), GOI set up a high-powered Core Group under the chairmanship of Secretary (MCA) to study the impact of IFRSs and to understand the preparedness of the Indian companies for converging with IFRSs. The Road map towards IFRS convergence for corporates from April 1, 2011 has been finalized by the Ministry of Corporate Affairs in January, 2010.
Advantages of IFRS
IFRS is a principle based model as compared to rule based US GAAP. IFRS requires extensive use of fair valuations for measurement of assets and liabilities. The objective of IFRS is to set the Balance Sheet right, and hence a significant volatility may come in Profit & Loss statement.
a)Â Â Â Â Â Â Improved access to Global Market
Â Majority of the Stock exchange globally require financial information as per IFRS. If the financial information is as per Indian Accounting Standard then a risk premium is added in pricing.
b)Â Â Â Â Â Â Lower Cost of Capital
Convergence with IFRS means the Indian companies need not prepare two sets of Financial Statements to comply with the requirements abroad and this would lead to lower cost of administration, removal risk premium and hence pricing and the companies can approach any market for capital.
c)Â Â Â Â Â Â Â Benchmarking with Global Peers
Preparing accounts as per IFRS will give better understanding of performance relative to the Global peers / benchmarks. Targets and Milestones will be set based on global business environment instead of Local.Â
d)Â Â Â Â Â True Value of acquisition
In Indian GAAP except for a few exceptions net assets acquired is recorded on the carrying value instead of fair value. Hence the true value of the combination is not reflected. IFRS overcomes this flaw as it mandates accounting of business combinations at fair value.
Contemplations under IFRS
IFRS is an accounting-driven but it can drive major changes to IT systems as well as business processes and personnel.
Experience indicates that IT costs generally constitute more than 50 percent of IFRS conversion costs.
Organizations benefit when they identify and integrate the efforts of the IT team early in the IFRS conversion process.
IT efforts will comprise a mix of short- and long-term projects within the organization's overall IFRS initiative.
The IFRS conversion effort provides opportunities for achieving synergies with other IT projects and strategic initiatives.
Challenges in adopting IFRS
Regulatory endorsement and acceptance
Shortage of skilled resources
Huge cost of enhancement of IT systems
Acceptance by tax authorities
Managing market expectations and investor relationships
Managing day to day business issues - MIS, tax planning, performance indicators, mergers and acquisitions, etc.
The key divergences between Indian GAAP and IFRS have arisen due to:
Legal and regulatory requirements
Present economic conditions
Level of preparedness
Following the crisis, there was widespread criticism that the accounting standards, more so, fair value accounting significantly contributed to the financial crisis or at the very least exacerbated the severity of the crisis, in view of its failure to deal with illiquid markets and distressed sales.
The G 20 Working Group on "Enhancing Sound Regulation and Strengthening Transparency" recommended that accounting standard setters should strengthen accounting recognition of loan loss provisions by considering alternative approaches for recognizing and measuring loan losses that incorporate a broader range of available credit information. The G 20 Working Group also recommended that the International Accounting Standards Board (IASB) should enhance its efforts to facilitate the global convergence towards a single set of high-quality accounting standards by sharing the experience of countries that have completed this process and by providing technical assistance. Another significant recommendation was that accounting standard setters should accelerate efforts to reduce the complexity of accounting standards for financial instruments and enhance presentation standards to allow the users of financial statements to better assess the uncertainty surrounding the valuation of financial instruments.
In April 2009, in response to the input received on its work responding to financial crisis, and following the conclusions of the G 20 leaders and the recommendations of international bodies such as the Financial Stability Board, the IASB announced an accelerated timetable for replacing the principal standard for recognition and measurement of financial instruments- IAS 39. IAS 39 is sought to be replaced by IFRS 9 in three phases. 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. It is expected that IFRS 9 will replace IAS 39 in its entirety by June 2011.
Accounting standards setters and prudential supervisors should work together to identify solutions for promoting stability and improving transparency.
In 2007 the ICAI decided that India should converge towards IFRS in a definite time frame in the wake of developments taking place in other major jurisdictions which had set up time schedules for migrating towards IFRS.