International Financial Reporting Standards - IFRS - vrk100 - 08Sep2007

International Financial 

Reporting Standards - IFRS

AUTHOR: Rama Krishna Vadlamudi

MUMBAI

September 8th, 2007

The Institute of Chartered Accountants of India (ICAI) had, in July 2007, decided to fully converge Indian Accounting Standards (IAS) with International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB) with effect from April 1, 2011. Globalisation has changed the world of accounting. 

 

The migration of Indian GAAP (Generally Accepted Accounting Principles) to IFRS will facilitate Indian companies to raise money and attract foreign capital at low cost. The covergence will have far-reaching and salutary consequences for the Indian economy. 

 

As of now, many countries have adopted the IFRS standards and several more are in the process of adopting IFRS, thus creating a single set of accounting standards, that can be applied anywhere in the world, enabling Multi-National Companies to compare the performance of their international businesses in a better way. 

 

SALIENT FEATURE OF IFRS

GENESIS OF IFRS

International Financial Reporting Standards are standards adopted by the International Accounting Standards Board (IASB), a body earlier known as IASC (C for Committee). The London-based Board started its operations in 2001 for developing global accounting standards. IFRS came into limelight when the European Union decided to adopt it for all its member countries starting 2005.  

Since then, IFRS has spread swiftly all over the world. IFRS standards are principle-based whereas US GAAP standards are rule-based. Indian standards are basically modeled on the basis of IFRS.

COVERGENCE

Convergence means a coming together from different directions, especially a merging of groups that were originally opposed or very different. In the accounting standards parlance, convergence means alignment of national requirements with the international norms.

APPLICABILITY

As of now, 102 countries have either adopted or are converging to IFRS, including Australia, New Zealand, Pakistan, Singapore, China, West Asia, Japan, Africa and countries in the European Union (EU). Now, the ICAI, India’s premier accounting body, has decided to adopt IFRS with effect from April 1, 2011, for public limited companies and will be extended to other entities in a phased manner. 

 

The numero uno status to IFRS came about after the EU made IFRS mandatory for all its listed companies starting 2005. Consequently, more than 8,000 EU-listed companies adopted IFRS in one go.

In the USA, the Securities and Exchange Commission (SEC, akin to our SEBI) is proposing to eliminate, for IFRS foreign filers, the reconciliation requirement to US GAAP. In April 2007, SEC lined up proposals to allow companies listed in the US to choose betwen IFRS or US GAAP for reporting purposes to make a choice from 2009. 

BENEFITS OF IFRS

Immediate benefits of convergence are comparability of financial statements, portability of professional skills across countries, ease of Mergers & Acquisitions process, and doing away with the need to translate to different accounting norms. There are several more benefits with the convergence of the IAS with the IFRS. They are:

• This will greatly bolster the ability of Indian companies to raise and attract foreign capital at low cost

• Once Indian companies adopt IFRS, the global acceptability of them will be enhanced

• The adoption of IFRS is expected to increase transparency of financial statements

• Indian companies will be able to save on costs concomitant with reconciliation procedures

• The risk of being exposed to errors in reporting under different accounting frameworks for Indian multi-national companies will be eliminated

• Indian professionals trained under IFRS could be benefited immensely as they can scout for new clients around the globe

With the ongoing integration of Indian economy with the global economy, several Indian companies are becoming truly multi-national. Tata Steel has recently acquired Corus, UK, creating the fifth biggest steel producer in the world. 

Hindalco Industries has taken over Novelis Inc. Companies, like, Dr.Reddy’s, Aban Offshore, Sun Pharma,  and Bharat Forge have acquired foreign firms thus globalising the world.

DIFFERENCES BETWEEN INDIAN GAAP AND IFRS

Significant differences exist between the Indian GAAP and the IFRS. An example is accounting for amalgamations and mergers. Indian GAAP is very liberal in this respect whereas IFRS is rather stringent.

• As per Indian GAAP, while accounting for amalgamations, goodwill on acquisition has to be amortized over five years or so. That is, whether or not the goodwill is impaired, the company will have to charge it as expenditure in the financial statement affecting its profitability. However, IFRS provides for retaining the fair value of the intangible asset (goodwill) in the balance sheet.

• According to Indian GAAP, “Current Investments” are required to be valued at lower of cost and fair value. Thus, if the fair value of an investment is lower than the cost, the loss is recognized but the gain is ignored. However, IFRS requires firms to reckon both gains and losses for arriving at the profit. This means for investments held for trading (held for less than 12 months), both the ‘losses’ and ‘gains’, as the case may be, would have to be reflected in the profit and loss account. For a loss, provision to that extent is to be made. If it were a gain, the entity’s income tax liability would go up. This will have serious implications for the profitability of Indian firms, as the new standard will result in a situation wherein the tax liability will increase without any actual cash inflow.

• In India, fixed assets are valued at the price they were bought (historical cost) after allowing for depreciation. But this historical cost does not reflect the current fair market value of assets. Once IFRS is implemented, such anomalies will be removed.

• Some other areas of major differences are preparation of consolidated financial statements and exposures of firms to forward contracts on foreign currency transactions

IMPACT FOR THE TREASURIES

Indian companies, including banks, will have to gear up themselves for the deadline set by the ICAI for the implementation of IFRS. The proposed standards would mark a shift from the principle of conservatism and prudence in accounting to a regime of faithful representation. 

 

The proposed revision of standards would bring in refined measurement of assets and liabilities. The chain effects of differential interest rates, transfer pricing within corporate groups, directed lending (government-supported interest incentives) etc., would be recognized in balance sheets. RBI is likely to set up a committee to study the implications of the IFRS-compliant standards for the banking sector.

At present, State Bank Group has been reconciling its financial statements under Indian GAAP with US GAAP. In future, it will be mandatory for State Bank Group to adopt IFRS thus eliminating the need for reconciliation with the US GAAP. 

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Disclosure:  I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if any.

Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets. 

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