Over the next couple of years, Indian businesses will have to follow two sets of accounting standards. One is the current Indian accounting standard which we are already used to – Accounting Standard 29 and the International Financial Reporting Standards (IFRS) converged accounting standard which will be known as IN AS.
As part of the first
While the above-mentioned entities will have to go in for IFRS compliance, other companies will continue to follow the current accounting standard until they are also included as part of the second phase. This phased implementation is aimed at making all companies go in for IFRS compliance by end of 2015. Only companies which are not listed and those with a networth less than Rs 500 crore will follow the existing standard.
While IFRS compliance promises a converged standard of global levels, the following points need to be considered with regard to the impact of its implementation:
1) Property, plant and equipment: The biggest impact of IFRS compliance will be felt on the way companies account for fixed assets. In the current system, exchange differences are capitalized. But according to the system that will be in vogue after IFRS compliance, on the date of transition to IFRS, companies need to identify the items which have been capitalized in the past (which are not permissible) and decapitalize them. Hence, the fixed asset block will come down on the date of transition and that adjustment will be made against your results.
After capitalization of assets, the next area to look at regarding IFRS compliance will be the way in which you depreciate assets. Most companies depreciate assets based on the rate of depreciation with regard to Schedule 14 of the Indian Government Act. But with IFRS compliance, depreciation should not be based on some artificial rate of depreciation provided by the company, instead it should be based on the management’s own assessment of the life of the asset. The third key area that is likely to get affected by IFRS compliance is component accounting.
2) Revenue: In India, most companies recognize sales when they dispatch goods from the factory. But according to IFRS compliance in addition to recognizing sales, companies have to look through risks and rewards of ownership that pass to the customers. Hence, IFRS compliance will require sales to be recognized not at the time of raising the invoice and dispatching of goods from the factory but at the time goods reach the customer.
3) Financial instruments: According to the old accounting standard (prior to IFRS compliance), classification of a debt and networth were based on the type of instruments. For example, let’s consider preference share. During the time of the standard prior to IFRS compliance, preference shares are shown as part of the company’s networth in the balance sheet since they are equity instruments that fall within the Company Act. But as per IFRS compliance, preference shares which are redeemable at the end of a particular period are no different from debentures. Therefore if an instrument is redeemable, then it is a liability and not an equity instrument. Therefore preferential shares which were a part of networth (till now) will become a liability.
In considering financial instruments with regard to IFRS compliance, the next thing is the foreign currency convertible bonds. They are a combination of a debt instrument, which is a bond, and an embedded conversion feature, which is a derivative. While, during the time of older standards, this was not broken into two parts. As per IFRS compliance requirements, the debt component is a separate aspect. The derivative’s value should be stripped out from this component and identified separately.
For IFRS compliance, the share premium cannot be played around with on the balance sheet. All costs related to redemption premium (even discount coupons) have to be charged to the profit and loss account every year when opting for IFRS compliance.
Another key area is accounting for investments. With IFRS compliance in place, investments will have to be done at fair value (market value). If the value is not quoted, then it has to be decided by the management. It necessarily does not have to go to the profit and loss account, but will definitely add to the networth after IFRS compliance.
4) Consolidation: Prior to IFRS compliance, companies were allowed to give standalone financial statements quarterly. But with IFRS compliance in place, you will have to report consolidated financial statements to your investor on a quarterly basis.
5) Acquisitions: Before IFRS compliance, most of the acquisition accounting used to be conducted through a system of court approved schemes. The court decides the type of required accounting. With IFRS compliance coming into place, this will depend on the fair value of the assets and liabilities acquired (with the difference being reported).
6) Employee stock options: When a company gives employee stock options, it does not record the cost in a profit and loss account (as per existing system). Options are given in the market price and date on which they are granted. But IFRS compliance will require companies to assign fair value to options which are a notional value.
7) Presentation and Disclosures: Prior to IFRS compliance, in all likelihood there are many disclosures which you may not have made. But with IFRS compliance, many of the disclosures will need to be made. For example, recently that is few months prior to IFRS compliance, Bharti announced its IFRS numbers. Even though there were no changes in the profits, what was different was the way segments were reported this year than earlier.
About the author: Jamil Khatri is Executive Director Head-Accounting Advisory Services, KPMG.
(The tip is an excerpt from the session IFRS is Coming - Are you Ready held at the Financial Excellence Track during SAP World Tour 2010. Collated by Anuradha Ramamirtham.).
This was first published in September 2010