International Financial Reporting Standards (IFRS) is gathering storm and most countries barring the US and a few others have either adopted IFRS or their national generally accepted accounting principles (GAAP) are converging to IFRS. Australia, New Zealand, China, Singapore, Japan, Middle East, Africa and the European Union have either adopted or are converging to IFRS. The eminent status to IFRS came about after the EU made it mandatory for all its listed companies starting 2005. Consequently, more than 8,000 EU-listed companies adopted IFRS in one go. US capital markets are losing their attractiveness as a result of what many view as excessive regulation. As a consequence, many believe that the predominance of US GAAP as a standard may be coming to an end. This could make large companies look at other capital markets, and in many of those capital markets IFRS are accepted. More than 1,100 Chinese companies have recently switched over to new accounting standards bringing their books in line with international norms. India follows Indian GAAP, which is inspired by International Accounting Standards (IAS). However, Indian GAAP has not kept pace with the changes that followed IAS’ metamorphosis to IFRS. The most important change in IFRS is the application of fair valuation principles. Key standards based on fair valuation principles that have not yet been rolled out under Indian GAAP relate to business combinations, financial instruments and investment properties. There are also several areas where there are critical differences between Indian GAAP and IFRS. The key questions for India are:
* Should Indian GAAP be converged with IFRS?
* What are the pros and cons?
* What are the hurdles and impediments in fully converging with IFRS?
* What are the precautions that need to be taken?
* Whether Indian GAAP should be converged with IFRS?
* Is there an option or alternative?
IOSCO requires all its constituents to converge to IFRS and therefore departing from IFRS is not a solution. Besides, India has globalised and if it has to invest abroad or attract inbound investments it must follow global standards. Seen from this perspective, the sooner we converge to IFRS the better. When most of the developed world follows IFRS, can we lag behind?
The accounting framework in India has been characterized by relatively less complex accounting guidance with a bias towards historical cost accounting and focus on the contractual form of the arrangement. Therefore, audit committee awareness of concepts around fair value recognition and measurement, reflecting the substance of the arrangement and applying relatively more complex accounting concepts and models is likely to be low. This would necessitate the need to create awareness among audit committee members on these concepts as it affects companies that they are involved with.
As compared to formal classroom-type training, a preferred approach in the Indian context would be for management to spend sufficient time in advance with audit committee members on key changes to accounting policies of the company and their implementation upon adoption of IFRS. This process should commence sufficiently in advance of the actual transition to enable audit committee members to familiarise themselves with IFRS accounting concepts and their implementation. Similarly, auditors would need to spend relatively more time with members of the audit committee educating them on IFRS interpretation and judgmental matters as they affect the company. A customised and company-specific approach is likely to be a good way to educate audit committees.
In the initial period, audit committees will likely rely more on both management and the external auditors to understand concepts and accounting models that are unique to IFRS and that represent a change from current accounting practice. During this initial period, audit committees will likely focus on sufficient debate between management and the external auditors on key judgement and interpretation issues and would focus on these areas as they evaluate the financial reporting process adopted by the company. Audit committees may question the manner in which such matters have been resolved, with a focus on whether the external auditor is satisfied in relation to the position adopted by management.
Fair value: In India, relatively few assets are traded on markets—primarily plain vanilla equities and bonds. How will the ‘fair value’ concept of IFRS be applied? Are there other challenges for audit committees in handling fair value?
Given the relatively less developed debt and asset markets in India, fair value determination will be a challenge for management, auditors and audit committees. There are no easy answers and management, auditors and audit committee members would need to work together closely to evaluate the process used by management for determining fair values.
Having said that, generally the assets and liabilities held/issued by Indian organizations are also relatively less complex and accordingly some of these valuation challenges may be addressed by extrapolating available information. It is likely that asset and financial markets in India will develop over time easing the process of fair value determination. In the initial period, management, auditors and audit committees may decide to place relatively more reliance on external independent valuation specialists.
Indian management and audit committees are also not familiar with managing the volatility that arises out of applying fair value concepts to financial instruments such as derivatives. The committees would need to devise and implement appropriate hedge accounting principles and policies to address such volatility or familiarize themselves with communicating such volatility to external stakeholders.
It not true that IFRS necessarily imposes any additional short-term, quarterly results-oriented views of corporate strategy. Indian corporations have been publishing quarterly results for quite some time now and adopting IFRS will not result in a change in financial reporting strategies. What will be needed is a will to change mindsets to get a better understanding of the financial results, along with a strategy to manage and communicate volatility that arises from applying the fair value principles.
The accounting framework in India is deeply affected by laws and regulation. In India we have multiple regulators of accounting standards. For example, if there is a listed bank, it has to follow the accounting norms prescribed by SEBI, RBI, ICAI, Companies Act and the Banking Regulation Act. Some of the accounting requirements may be inconsistent with each other and some are definitely inconsistent with IFRS.
The success of convergence to IFRS in India will depend on how well the regulators cooperate. At the moment, if the law conflicts with any requirement of an accounting standard, the law overrides the accounting standard. For instance, the presentation of financial statements as per the Companies Act, 1956 conflicts with the requirements of IFRS, and business combinations accounting is governed by the courts, which may conflict with IFRS. Besides the Companies Act, 1956, other regulators in India like SEBI, RBI and income-tax department will need to accept IFRS in lieu of their sets of rules of accounting. So, the Companies Act and related laws would need to be amended to ensure that the law does not conflict with the accounting framework that may be prescribed by the Institute of Chartered Accountants of India.
It’s a fait accompli, let us brace up for it
A recent notification from the Ministry of Corporate Affairs (MCA) confirms the International Financial Reporting Standards (IFRS) convergence/adoption agenda for India. The MCA states that it has adopted international norms established in IFRS’s issued by the International Accounting Standards Board to formulate Indian Accounting Standards after considering the requirements of Indian entities. This process would be continued by the Government with the intention of achieving convergence with IFRS by 2011.
While this is a welcome step, some questions remain unanswered. Considering that the MCA is looking at the harmonization process being implemented through notification of accounting standards, it seems the MCA believes that current accounting standards notified under Companies (Accounting Standards) Rules, 2006 are fairly consistent with IFRS. However, this is not the case as there are significant differences between India’s generally accepted accounting principles (GAAP) and IFRS. It is not clear how IFRS convergence would be achieved in India. Firstly, whether it would be convergence or adoption (adoption may result in nil or negligible departure from IFRS whereas convergence may result in significant departures from IFRS)? Secondly, whether appropriate amendments would be made to the Companies Act? Thirdly, whether exceptions to IFRS would be made so as to take care of India-specific issues in the rarest of rare circumstances? Fourthly, whether on adoption of IFRS, would IFRS standards continue to be notified under the Act? Lastly, what standards would apply to small- and medium-size enterprises and how would they be defined?
These and many other strategic issues in regards to IFRS adoption/convergence are not clear at this point in time. More importantly because law overrides accounting standards, full convergence with IFRS is not possible unless those laws are amended or an overriding section is enacted with regards to accounting standards. Some key examples are discussed below.
Companies Act, 1956 prescribes statutory depreciation rates. Companies are required to provide depreciation based on useful life of an asset or statutory rates, whichever is higher. In practice most companies apply statutory rates without regard to useful life. Under IFRS, depreciation is based only on the useful life of an asset. Accounting for amalgamation is done based on treatment prescribed by the High Court under an approved scheme, even though it may not be in accordance with accounting standards. Under IFRS, accounting for amalgamation is required to be done purely based on IFRS principles and hence may conflict with directions of the High Court.
Definition of subsidiary under Companies Act is not consistent with definition of subsidiary under IFRS. Further, section 78 of the Companies Act, 1956, permits writing off of preliminary expenses, underwriting commission paid or discount allowed on issue of debentures, premium payable on redemption of debentures etc. to be adjusted against securities premium account. Treatment of such expenses is different in IFRS and in many cases would result in a charge to the income statement.
Companies Act prohibits reopening of financial statements once accounts are approved in the AGM. This requirement will conflict with IFRS which requires comparatives to be restated to give effect to change in accounting policy and prior period items. Further, Schedule VI of the Companies Act prescribes specific disclosure requirement and format of balance sheet. These requirements are significantly inconsistent with the requirements of IFRS.
While the MCA notification clearly indicates that India will adopt IFRS, it does not lay down a comprehensive strategy for convergence or adoption. It would only be appropriate for the MCA to announce a strategy as soon as possible focusing on adoption rather than convergence, since if adopted Indian entities can claim that their accounts are prepared under IFRS which will give them a distinct advantage. If we converge and don’t adopt IFRS, Indian entities would not be able to claim that they are IFRS compliant, which will defeat the very purpose of embracing IFRS.
Apart from the MCA, tax authorities should consider IFRS implications on direct and indirect taxes and provide appropriate guidance from a tax perspective. The Institute of Chartered Accountants of India should make an all out effort to train and upgrade the profession in IFRS. These milestones need to be achieved at the earliest; else the whole convergence exercise could get trapped in a hopeless tangle causing immense waste of time, resources, capital and cause inconvenience for Indian entities. In any case, since IFRS in one form or the other is fait accompli, Indian entities should not take things lightly, and should prepare themselves for IFRS immediately.
* Should Indian GAAP be converged with IFRS?
* What are the pros and cons?
* What are the hurdles and impediments in fully converging with IFRS?
* What are the precautions that need to be taken?
* Whether Indian GAAP should be converged with IFRS?
* Is there an option or alternative?
IOSCO requires all its constituents to converge to IFRS and therefore departing from IFRS is not a solution. Besides, India has globalised and if it has to invest abroad or attract inbound investments it must follow global standards. Seen from this perspective, the sooner we converge to IFRS the better. When most of the developed world follows IFRS, can we lag behind?
The accounting framework in India has been characterized by relatively less complex accounting guidance with a bias towards historical cost accounting and focus on the contractual form of the arrangement. Therefore, audit committee awareness of concepts around fair value recognition and measurement, reflecting the substance of the arrangement and applying relatively more complex accounting concepts and models is likely to be low. This would necessitate the need to create awareness among audit committee members on these concepts as it affects companies that they are involved with.
As compared to formal classroom-type training, a preferred approach in the Indian context would be for management to spend sufficient time in advance with audit committee members on key changes to accounting policies of the company and their implementation upon adoption of IFRS. This process should commence sufficiently in advance of the actual transition to enable audit committee members to familiarise themselves with IFRS accounting concepts and their implementation. Similarly, auditors would need to spend relatively more time with members of the audit committee educating them on IFRS interpretation and judgmental matters as they affect the company. A customised and company-specific approach is likely to be a good way to educate audit committees.
In the initial period, audit committees will likely rely more on both management and the external auditors to understand concepts and accounting models that are unique to IFRS and that represent a change from current accounting practice. During this initial period, audit committees will likely focus on sufficient debate between management and the external auditors on key judgement and interpretation issues and would focus on these areas as they evaluate the financial reporting process adopted by the company. Audit committees may question the manner in which such matters have been resolved, with a focus on whether the external auditor is satisfied in relation to the position adopted by management.
Fair value: In India, relatively few assets are traded on markets—primarily plain vanilla equities and bonds. How will the ‘fair value’ concept of IFRS be applied? Are there other challenges for audit committees in handling fair value?
Given the relatively less developed debt and asset markets in India, fair value determination will be a challenge for management, auditors and audit committees. There are no easy answers and management, auditors and audit committee members would need to work together closely to evaluate the process used by management for determining fair values.
Having said that, generally the assets and liabilities held/issued by Indian organizations are also relatively less complex and accordingly some of these valuation challenges may be addressed by extrapolating available information. It is likely that asset and financial markets in India will develop over time easing the process of fair value determination. In the initial period, management, auditors and audit committees may decide to place relatively more reliance on external independent valuation specialists.
Indian management and audit committees are also not familiar with managing the volatility that arises out of applying fair value concepts to financial instruments such as derivatives. The committees would need to devise and implement appropriate hedge accounting principles and policies to address such volatility or familiarize themselves with communicating such volatility to external stakeholders.
It not true that IFRS necessarily imposes any additional short-term, quarterly results-oriented views of corporate strategy. Indian corporations have been publishing quarterly results for quite some time now and adopting IFRS will not result in a change in financial reporting strategies. What will be needed is a will to change mindsets to get a better understanding of the financial results, along with a strategy to manage and communicate volatility that arises from applying the fair value principles.
The accounting framework in India is deeply affected by laws and regulation. In India we have multiple regulators of accounting standards. For example, if there is a listed bank, it has to follow the accounting norms prescribed by SEBI, RBI, ICAI, Companies Act and the Banking Regulation Act. Some of the accounting requirements may be inconsistent with each other and some are definitely inconsistent with IFRS.
The success of convergence to IFRS in India will depend on how well the regulators cooperate. At the moment, if the law conflicts with any requirement of an accounting standard, the law overrides the accounting standard. For instance, the presentation of financial statements as per the Companies Act, 1956 conflicts with the requirements of IFRS, and business combinations accounting is governed by the courts, which may conflict with IFRS. Besides the Companies Act, 1956, other regulators in India like SEBI, RBI and income-tax department will need to accept IFRS in lieu of their sets of rules of accounting. So, the Companies Act and related laws would need to be amended to ensure that the law does not conflict with the accounting framework that may be prescribed by the Institute of Chartered Accountants of India.
It’s a fait accompli, let us brace up for it
A recent notification from the Ministry of Corporate Affairs (MCA) confirms the International Financial Reporting Standards (IFRS) convergence/adoption agenda for India. The MCA states that it has adopted international norms established in IFRS’s issued by the International Accounting Standards Board to formulate Indian Accounting Standards after considering the requirements of Indian entities. This process would be continued by the Government with the intention of achieving convergence with IFRS by 2011.
While this is a welcome step, some questions remain unanswered. Considering that the MCA is looking at the harmonization process being implemented through notification of accounting standards, it seems the MCA believes that current accounting standards notified under Companies (Accounting Standards) Rules, 2006 are fairly consistent with IFRS. However, this is not the case as there are significant differences between India’s generally accepted accounting principles (GAAP) and IFRS. It is not clear how IFRS convergence would be achieved in India. Firstly, whether it would be convergence or adoption (adoption may result in nil or negligible departure from IFRS whereas convergence may result in significant departures from IFRS)? Secondly, whether appropriate amendments would be made to the Companies Act? Thirdly, whether exceptions to IFRS would be made so as to take care of India-specific issues in the rarest of rare circumstances? Fourthly, whether on adoption of IFRS, would IFRS standards continue to be notified under the Act? Lastly, what standards would apply to small- and medium-size enterprises and how would they be defined?
These and many other strategic issues in regards to IFRS adoption/convergence are not clear at this point in time. More importantly because law overrides accounting standards, full convergence with IFRS is not possible unless those laws are amended or an overriding section is enacted with regards to accounting standards. Some key examples are discussed below.
Companies Act, 1956 prescribes statutory depreciation rates. Companies are required to provide depreciation based on useful life of an asset or statutory rates, whichever is higher. In practice most companies apply statutory rates without regard to useful life. Under IFRS, depreciation is based only on the useful life of an asset. Accounting for amalgamation is done based on treatment prescribed by the High Court under an approved scheme, even though it may not be in accordance with accounting standards. Under IFRS, accounting for amalgamation is required to be done purely based on IFRS principles and hence may conflict with directions of the High Court.
Definition of subsidiary under Companies Act is not consistent with definition of subsidiary under IFRS. Further, section 78 of the Companies Act, 1956, permits writing off of preliminary expenses, underwriting commission paid or discount allowed on issue of debentures, premium payable on redemption of debentures etc. to be adjusted against securities premium account. Treatment of such expenses is different in IFRS and in many cases would result in a charge to the income statement.
Companies Act prohibits reopening of financial statements once accounts are approved in the AGM. This requirement will conflict with IFRS which requires comparatives to be restated to give effect to change in accounting policy and prior period items. Further, Schedule VI of the Companies Act prescribes specific disclosure requirement and format of balance sheet. These requirements are significantly inconsistent with the requirements of IFRS.
While the MCA notification clearly indicates that India will adopt IFRS, it does not lay down a comprehensive strategy for convergence or adoption. It would only be appropriate for the MCA to announce a strategy as soon as possible focusing on adoption rather than convergence, since if adopted Indian entities can claim that their accounts are prepared under IFRS which will give them a distinct advantage. If we converge and don’t adopt IFRS, Indian entities would not be able to claim that they are IFRS compliant, which will defeat the very purpose of embracing IFRS.
Apart from the MCA, tax authorities should consider IFRS implications on direct and indirect taxes and provide appropriate guidance from a tax perspective. The Institute of Chartered Accountants of India should make an all out effort to train and upgrade the profession in IFRS. These milestones need to be achieved at the earliest; else the whole convergence exercise could get trapped in a hopeless tangle causing immense waste of time, resources, capital and cause inconvenience for Indian entities. In any case, since IFRS in one form or the other is fait accompli, Indian entities should not take things lightly, and should prepare themselves for IFRS immediately.
(Source: Economic Times)
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