Published on Mon, Sep 15,2014 | 20:45, Updated at Mon, Sep 15 at 20:45Source : Moneycontrol.com
By: Keyur Dave, Director - Grant Thornton India
The world is getting smaller and flatter. Globalisation has made it possible to accept that the world is one market. For better understanding of the business reporting and consistency in accounting policies, there was an urgent need to align to one global accounting language. Application of a single set of accounting requirements would increase the comparability of different entities' accounting numbers. This is the main reason for more than 120 countries to follow global accounting standards, i.e., International Financial Reporting Standards ("IFRS").
India, one of the most prominent emerging markets is also converging to the IFRS. The Ministry of Corporate Affairs (MCA), based on the recommendation of the Institute of Chartered Accountants of India (ICAI), has issued 35 converged Indian Accounting Standards (Ind-AS). Recently, the Finance Minister in his budget speech proposed to make Ind-AS mandatory from FY 16-17 & stressed on the necessity and urgency of convergence with global standards. With ICAI already submitting a Ind-AS implementation roadmap to MCA, awaiting its final nod.
Ind AS is not "adoption" of IFRS and includes certain modifications to the IFRS as issued by International Accounting Standard Board (IASB), generally referred as 'carve-outs'. Notably, owing to the carve-outs companies will not be able to make a compliance statement i.e. financial statements comply with IFRS as per IASB. However, from the international stakeholders perspective, Ind-AS will provide a significant leap from the existing standards and can be made IFRS compliant much quicker than moving from the current standards, basically, eliminating the effects of "carve-outs" Let us now discuss about these "carve-outs" and my perspective thereon.
Major carve-outs:
- Foreign exchange fluctuations:
Ind-AS provides an option to recognise exchange differences arising on translation of certain long-term monetary items directly in equity. Under IFRS, such exchange difference is charged to the income statement. This carve-out was obligatory during the period of 2010-2011under Indian context, since volatility between exchange rates for commonly traded currencies such as US Dollar, Euro, Pounds, etc. was at its peak and companies' statement of profit and loss would reflect unnecessary movement of such currencies and in substance created volatility without any true change in underlying business.
Since then, as demonstrated in the chart above, exchange rates have become quite stable[1]. MCA and ICAI may consider eliminating this carve-out, given that such accounting treatment will not have any acceptance under any globally recognised GAAP. It is imperative to understand other countries' accounting treatment to justify such carve-out which may represent adequate accounting treatment for countries experiencing extreme exchange rate volatility.
- Foreign currency convertible bonds (FCCB):
IFRS provides guidance that where the conversion of bond into equity shares is fixed, but since exercise price for such conversion is defined in currency other than the functional currency of the entity, the conversion aspect is to be accounted as embedded derivative. Under Ind-AS, it is stated that where the exercise price for the conversion of the FCCB is fixed, irrespective of any currency, it is to be classified as an equity rather than embedded derivative. Indian Companies have issued significant amount of FCCBs' and this carve-out may provide significant gap in recognition, measurement and disclosure as compared to IFRS. From the period August 2013 till July 2014, Indian companies have issued 812 million USD[2] (Approximately INR 48 billion) worth of FCCBs. This is quite a significant number which might impact acceptability of Ind-AS.
- Financial liabilities at Fair Value Through Profit and Loss (FVTPL):
Ind-AS provides exemption from recognition of change in fair value due to entity's own credit risk. Indeed, recognition of own credit risk was a debatable issue and IASB had a detailed discussion to firm up its view on its recognition. Finally, IASB had issued IFRS 9 "Financial Instruments" which suggest that entity should recognise change in fair value due to its own credit risk in other comprehensive income. This carve-out also challenges the methodology of fair value of the financial liability, since by not recognising own credit risk the fair value of the instrument would not reconcile from the perspective of the market participants. Indian companies' instruments would not be comparable with global parameters of fair value.
Guidance not issued under Ind-AS:
Keeping in mind the Indian practices and its adverse impact on reporting, regulators have not issued guidance relating to agreements for the construction of real estate (IFRIC 15). The concept of transfer of significant risk and reward under construction contract and sale of completed contracts are critical to understand under such guidance. Accounting under IFRIC 15 was a debatable issue. Arguments were floated with respect to when an entity satisfies a performance obligation, like when did obligation for transfer of land accounted? When did obligation for underlying construction of property on that land was accounted? I must say, it is worth to understand the arguments before any act and appreciate the obstacles faced by emerging economies.
Agricultural accounting (IAS 41) has not been adopted due to difficulties in determining the fair value of the biological assets. However, Exposure draft on Ind-AS 41 has been issued. It is a surprising element that there is no guidance of agricultural accounting in an agricultural country.
Guidance deferred under Ind-AS:
Ind-AS coverage has deferred few relevant guidance, like IFRIC 4 and IFRIC 12.
- Determining whether an arrangement contains a lease (IFRIC 4) issued by Interpretation committee is an extended arm of standard on "Leases". This interpretation assists in identifying an arrangement which is in substance leases but not in form. Deferment of such guidance under Ind-AS would certainly scope out such arrangement from lease accounting and they might be accounted in the same form as they are accounted currently under Indian GAAP.
- Service Concession Arrangements (IFRIC 12) issued by interpretation committee usually applies to infrastructure entities engaged in public-to-private partnerships arrangements that are on Build-own-operate-transfer (BOOT). As a consequence of application of IFRIC 12 the entity is required to recognise an intangible asset or a financial asset or both based on its right to collect revenue over the period of the arrangement. Since the ownership gets transferred to the grantor at the end of the arrangement, control cannot be established and thus PP&E is not recognised in the financial statement. Deferment of such guidance may result in recognition of PP&E as compared to financial asset or an intangible asset. This would be a bigger challenge on acceptance from framework perspective, given that "control" is not yet established, while entity recognises PP&E in the financial statement.
Major Carve-outs relevant for first-time adoption:
- Presentation of Comparatives and Reconciliations:
At transition, IFRS mandates entities to present the comparatives and reconciliation. However, Ind AS 101 requires an entity to provide comparatives as per the existing notified Accounting Standards. Entities have an option to present Ind-AS comparatives on a memorandum basis. Entities which do not exercise this option, they need not provide reconciliation at transition but are expected to disclose significant differences pertaining to total comprehensive income. However, entities that provide comparatives would have to provide reconciliations. Interesting to observe that entities which prepare the comparatives, they need to provide justification of transition by reconciliation. Is this adequate approach towards transition? This might tend all the entities not to prepare comparatives under Ind-AS and avoid reconciliation. Though, ICAI road map to MCA suggested having comparatives under Ind-AS.
- Property plant and equipment (PP&E):
To facilitate smooth convergence with Ind-As and to reduce operational difficulties on first time adoption, Ind AS 101 provides the option to carry forward the existing carrying values of all the items of PP&E as opening balances under Ind AS. Indian companies might have added foreign exchange movement to the cost of asset under existing notified accounting standards, which will get depreciated over the remaining useful life of the asset. This might be a smooth starting point for Ind-AS, however this would not certainly be a good indicator to represent Ind-AS as a global standard with such carve-out.
New standard:
IASB has issued IFRS 9 and also permitted its early application. Regulator might consider accepting similar standard under Ind-AS. Considering the cost-benefit analysis, it may provide options to transit directly to standard similar to IFRS 9 or to Ind-AS 39. This might save cost of transiting initially to Ind-AS 39 and later to standard similar to IFRS 9. Regulator may think of accommodating similar stand for IFRS 15 "Revenue from Contracts with Customers".
One more step:
There is no doubt that we are moving towards better accounting standards which would certainly enhance the reporting which is based on substance. Indian companies financial would positively attract the global investors and raise its bar to the global standards; however carve-outs might act as hurdles. Many companies would not be able to gain the advantage of dual compliance and they might need to provide further adjustments to comply with IFRS. It is in favour of Indian companies; if we can narrow down the gap between Ind-AS and IFRS, so that at one go companies may get dual compliance.
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