Convergence between Indian GAAP and IFRS

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Convergence between Indian GAAPand IFRS Sudhir
Soni
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International Financial Reporting Standards (IFRS)
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What is IFRS?

• IASB
• Private Sector Organisation
• IASB develops IFRS
• International Accounting Standards (IAS) issued
  by IASC, predecessor body of IASB, continue to be
  applicable
• Interpretations of Standard Interpretations
  Committee (SIC), predecessor body of IFRIC,
  continue to be applicable
• IFRS Comprises
• 8 IFRSs and 31 IASs
• 12 IFRIC and 11 SICs
• IFRS - Economic Model focussing on Balance Sheet
• IFRS Moving towards
• increased use of fair values and
• getting the balance sheet right

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IFRS A Truly Global Accounting Standard
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Global Fortune 500
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Why IFRS in India?

• One language
• Comparability enhanced
• Understanding enhanced
• One set of books
• Access to Global capital markets
• Low cost of capital
• Attract foreign investment
• Elimination of multiple reports
• Reflect true value of acquisitions
• Schedule VI in todays environment

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Convergence with IFRS

• ICAI has set up a Task Force on Convergence with
  IFRS
• The task force has decided date of adoption of
  IFRS as April 1, 2011
• This means that date of transition is April 1,
  2010
• All public interest entities are required to
  adopt IFRS

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Public Interest Entities

• Listed companies
• Banks, insurance companies, and financial
  institutions
• Turnover in preceding year gt Rs 100 crores
• Borrowing in preceding year gt Rs 25 crores
• Holding or Subsidiary of the above

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IFRS conversion dimensions more than a change
in accounting policy

• Whats Involved ?
• The scope and complexity involved in the
  conversion to IFRS should not be underestimated
• The new standards involve changes in
  presentation, new valuation rules, and additional
  disclosure requirements
• A successful conversion must plan and manage
  change across business processes, technologies,
  and the organization impacting both the group and
  business unit levels
• ERP configurations will likely be impacted across
  multiple modules
• Financial system architectures may require
  substantive modifications

IFRS conversion will impact all levels of
accounting in a business, a top level conversion
to IFRS will not be sufficient
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Overview of key differences
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Key differences include.

• Assets Liabilities
• Revenue Expenses
• Acquisition and Consolidation
• Differences related to Presentation Disclosure
• Others

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Assets and liabilities related
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IAS 16 - Property, plant and equipment

• Component accounting Key impact on Capital
  intensive industries
• In-depth analysis required to identify
  significant components that make up a plant
• Each significant component to be depreciated over
  its own useful life
• Application would require technical knowledge
• Experience of other countries indicates that
  there is considerable disparity in identification
  of components
• Major repairs and overhaul expenditure are
  capitalized as if it is a separate component in
  IAS 16
• Replacement costs

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IAS 16 - Property, plant and equipment (contd.)

• Depreciation Useful life as against Schedule
  XIV rates
• Depreciation on revalued portion cannot be
  recouped out of revaluation reserve. However,
  transfer of revaluation reserve directly to
  retained earnings is required
• Site restoration
• Revaluation frequency need to update frequently
• Arrangement in nature of lease covered by IFRIC 4

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IAS 40 Investment property

• Investment property may include property interest
  held by a lessee under an operating lease
• If accounted for at Fair Value under IAS 40
• IAS 40 overrides IAS 17 for classification of
  lease and the lease be recorded as finance lease
• Disclosures required
• Model used (Cost or Fair Value) Indian GAAP
  allows Depreciated cost model only
• If Fair Value model is applied state whether, and
  in what circumstances, property interest held
  under operating lease is classified and accounted
  for as investment property
• Detailed guidance on Transfer to/ from Investment
  property
• Revaluation - Allowed in IAS 40 for some
  non-financial assets

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IAS 38 - Intangible assets

• Revaluation Discounting - permitted for
  intangibles with active markets
• Rebuttable assumption
• Impairment testing
• Amortisation of Intangibles having indefinite
  life
• No amortisation required under IAS 38, only
  impairment testing
• Indian GAAP silent, however, amortisation
  required
• Intangible Asset held for sale
• Under IAS 38, amortisation should be stopped
• No guidance under Indian GAAP

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IAS 37 - Provisions, contingent liabilities and
contingent assets

• Discounting - Not permitted in Indian GAAP
• Restructuring Provision IFRS based on
  constructive obligation whereas Indian GAAP based
  on Legal obligation
• Disclosure of contingent assets not permitted
  under Indian GAAP
• Best Estimate Measurement
• AS 29 does not contain any such guidance and
  relies on judgment of management
• IAS 37 provides certain basis and statistical
  methods to be followed for arriving at the best
  estimate of the expenditure for which provision
  is recognised
• Present and Possible obligation not defined under
  IAS 37 (No impact on the financials)

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What discount rate should be used ?

• The discount rate should be a pre-tax rate that
  reflects the current market assessments of the
  time value of money and the risks specific to the
  liability
• It should not reflect risks for which future cash
  flow estimates have been adjusted.
• No guidance given in IAS 37 regarding whether
  real or nominal rate of discount should be used.
• Use of discount rate will depend on manner in
  which cash flows are estimated
• if future cash flows are expressed in current
  prices, real rate should be used (which excludes
  inflation effect)
• If future cash flows are expressed in expected
  future prices, in which case nominal discount
  rate should be used (which includes return to
  cover expected inflation)
• IAS 37 indicates that where discounting is used,
  the carrying amount of a provision increases in
  each period to reflect passage of time and this
  increase is recognised as borrowing cost

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Site restorations costs

• Site restoration costs related to construction of
  mine is capitalised
• Unwinding of discount taken to PL account
• Changes in estimates capitalised / decapitalised
• If increases carrying value, test for impairment
• Change will not result in negative carrying value
• If change happens when carrying value is zero,
  take effect of change in PL

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IFRS 5 - Non-current assets held for sale and
discontinued operations

• Scope
• IFRS 5 sets out requirements for the
  classification, measurement and presentation of
  non-current assets held for sale
• Also includes classification and presentation of
  discontinued operations.
• Indian GAAP - no specific standard which
  prescribes classification, measurement and
  presentation for all non-current asset held for
  sale except for AS 10 which requires assets held
  for sale to be measured at lower of cost and net
  realisable value.
• AS 24 deals with disclosures relating to
  discontinuing operations
• Period of disposal for Non-Current Assets Held
  for Sale
• IFRS 5 - Completed within a year, with limited
  exceptions.
• Indian GAAP - No time-frame specified
• Measurement principles under IFRS - Lower of
  carrying value or fair value less costs to sell.
• Presentation requirements of the discontinued
  operations

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Revenue and expenses related
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IAS 18 Revenue recognition

• Measurement
• Fair value / charges to customer
• Discounting
• Service income - AS 9 allows completed service
  contract method or proportionate completion
  method however, IAS 18 allows only percentage of
  completion method.
• Interest income Recognition at applicable rate
  or effective interest method
• Multiple Element Contracts
• IFRIC 12 Service concession arrangements
• Real Estate Sales

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Real estate sales

• Under Indian GAAP, ICAI GN deals with the matter
• Significant risks and rewards of ownership are
  considered to transferred to the buyer based on
  legally enforceable agreement for sale if
• price risk has been transferred to the buyer
  and
• the buyer has a legal right to sell or transfer
  his interest in the property, without any
  material impediment.
• Subsequent recognition based on percentage of
  completion method
• To cover the matter under IFRS, IFRIC I5 has
  recently been issued
• Percentage of completion method only if IAS 11
  criteria are met or the seller is providing only
  construction services.
• In case of sale of goods, if criteria for sale
  are met on continuous basis, percentage of
  completion is applied
• If the entity transfers to the buyer control and
  the significant risks and rewards of ownership of
  the real estate in its entirety at a single time
  (e.g., at completion, upon or after delivery), it
  shall recognise revenue only when all the
  criteria of IAS 18 are satisfied

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IFRIC 12 Service concession agreement

• In India, private sector companies participate in
  the development, financing, operation and
  maintenance of public-service infrastructure (PPP
  Public-private partnership)
• Scope
• Operator cannot recognise infrastructure as PPE
• Recognition and Measurement of Arrangement
  Consideration
• Construction or Upgrade
• Intangible assets and financial asset

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IAS 12 Income taxes

• Basic approach Timing difference (income
  statement approach) as against temporary
  difference (balance sheet approach) in IAS
• DTA on unabsorbed depreciation and carry forward
  losses recognised based on convincing evidence
  and not virtual certainty
• Deferred tax determined on temporary differences
  like
• a) Revaluation of fixed assets
• b) Business combinations
• c) Consolidation adjustments
• d) Undistributed profits
• e) Foreign currency translation adjustment
• Fringe Benefit Tax
• Dividend distribution tax appropriation against
  tax expenditure

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IAS 19 - Employee benefits

• Corridor approach AS 15 does not permit
  corridor approach in respect of actuarial gains
  and losses
• Termination benefit legal obligation as against
  constructive obligation
• VRS deferral Not permitted under IAS
• AS does not permit recognition of terminal
  benefit as a liability merely on the basis of a
  detailed formal plan

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IAS 21 - The effect of changes in foreign
exchange rates

• Framework for accounting for foreign operations -
  AS-11 is based on the concept of integral and
  non-integral operations while IAS is based on
  functional currency
• Concept of functional currency

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Acquisition and Consolidation
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IFRS 3 Business combinations

• Comprehensive standard applicable in situation of
  change in control
• Purchase method of accounting
• Fair value of consideration, assets, liabilities
  and contingent liabilities acquire
• Identification of intangible assets
• Negative goodwill
• Deferred tax asset on losses of acquiree
• Acquisition Date control v/s. date of
  amalgamation in acquisition scheme
• Minority interest at acquisition
• Step Acquisitions
• Reverse acquisition Based on Substance or Legal
  form
• Accounting of Goodwill - amortisation is
  prohibited and impairment test is mandatory

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IAS 27 - Consolidated financial statements

• Presentation of Consolidated financial statements
  (CFS)
• CFS includes all subsidiaries
• SIC 12 states that a Special Purpose Entity (SPE)
  should be consolidated when the substance of the
  relationship between an entity and the SPE
  indicates that the SPE is controlled by that
  entity
• Definition of control
• As per AS, ownership of more than one half of the
  voting power or control of the composition of
  board of directors
• IAS - it is the power to govern financial and
  operating policies of an entity so as to obtain
  benefit from its activities.
• Effects of potential voting rights for
  determination of control
• Uniform accounting policies

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IAS 27 - Consolidated financial statements
(contd.)

• Consolidation based on Non-coterminous period -
  Maximum gap of 6 months is allowed as against 3
  months under IAS
• Minority Interest - Disclosed separately from
  liability and equity under AS
• Goodwill determination - Based on carrying value
  for AS, while at fair value for IAS
• IAS 28 Investment in Associates conceptual
  differences like control, uniform accounting
  policies applies

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IAS 31 - Investment in joint ventures

• Method of Accounting for joint ventures -
  Proportionate consolidation under AS, while
  equity method is also allowed in IAS
• Accounting for subsidiary where joint control is
  established Under AS, in case of contractual
  agreement if investors share is greater than 50
  accounted as subsidiary

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Differences related to Presentation and Disclosure
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IAS 1 Presentation of financial statements

• Format for disclosure
• No standard format in IGAAP, Schedule VI format
  followed
• IAS prescribes minimum structure on financial
  statements and contains guidance on disclosure
• No extra-ordinary items classification
• Statement of Changes in Equity
• SME exemptions for applicability of AS in IGAAP
• Disclosure of
• Critical judgments made in applying accounting
  policies
• Key sources of estimation uncertainty causing a
  risk of material adjustment to carrying amounts
  of assets and liabilities within the next
  financial year
• Information to evaluate the entitys objectives,
  policies and processes for managing capital
• Reclassification disclosed separately

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Presentation of financial statements

• Components of financial statements
• statement of financial position as the end of the
  period
• statement of comprehensive income for the period
• statement of changes in equity for the period
• statement of cash flows for the period
• schedules
• statement of financial position at the beginning
  of the earliest comparative period
• Current and Non-current distinction or Liquidity
  approach
• presentation of current and non-current assets
  and current and non-current liabilities as
  separate classification
• subsequent events not to be considered for
  classification of liability

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Statement of comprehensive income

• Statement includes all items
• recognised in profit and loss statement and
• of income and expenses not recognised in profit
  or loss as required or permitted by other
  Accounting Standards
• Other Comprehensive income comprises items of
  income and expense not recognized in profit or
  loss
• changes in revaluation surplus (AS 10)
• gains and losses arising from translating the
  financial statements of a foreign operation (AS
  11-revised 2003)
• gains and losses on remeasuring
  available-for-sale financial assets (AS 30)
• effective portion of gains and losses on hedging
  instruments in a cash flow hedge (AS 30)
• actuarial gains and losses on defined benefit
  plans recognized in accordance with AS 15

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IAS 8 Changes in accounting policies, estimates
and prior period errors

• Changes in accounting policy retrospective
  effect to be given by adjusting retained
  earnings, where retrospective effect is not
  possible, to give effect from the year in which
  it is practical
• Change in method of depreciation - change in
  accounting estimate in IFRS
• Prior period definition covers PL and balance
  sheet
• IAS 8 requires retrospective restatement of prior
  period figures by restatement of opening balances
  of assets, liabilities and equity for the
  earliest period practicable
• Disclosure and estimation of possible impact on
  adoption required for accounting pronouncement
  yet to come into effect

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IAS 10 Events occurring after balance sheet date

• Proposed dividend - Provision prohibited in IAS
  as against mandatory requirement in IGAAP
• Non-adjusting events, which are material,
  required to be disclosed in the financial
  statements under IAS. Disclosure required in the
  report of the approving authority in IGAAP
• Specific disclosure required in financial
  statement relating to authorisation date for
  issue of financial statement. No such requirement
  in IGAAP

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IAS 3 - Cash flow statements

• Exemptions to SMEs
• Bank overdrafts - AS 3 is silent. Generally
  considered in cash flow from financing activity
  whereas bank overdrafts are to be treated as a
  component of cash/cash equivalents under IAS 7
• Interest and Dividend disclosure
• IAS 7 prohibits separate disclosure of
  extraordinary items
• AS 3 does not deal with cash flows relating to
  consolidated financial statements

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IAS 14 Segment reporting

• IASB issued IFRS 8 - Operating Segments
• IFRS 8 will supersede IAS 14, applicable from
  January 1, 2009
• Difference between AS 17 and IFRS 8
• IFRS 8 - Identification of operating segments on
  basis of internal reports that are regularly
  reviewed by the entity's chief operating decision
  maker
• Accounting policies management approach
• Restatement in case an entity changes structure
  of internal organisation vis a vis reportable
  segment
• Change in accounting policy - Prior period
  segment information to be restated
• AS 17 silent on the aspect of treatment of
  associates and JVs in CFS

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IAS 24 Related party transactions

• Definition of Key Management Personnel (KMP) -
  IAS 24 provides for including non-executive
  directors and also any person who has indirect
  authority and responsibility for planning,
  directing and controlling the activities of the
  enterprise, be treated as a KMP
• Under AS 18, the term relative is defined under
  Companies Act whereas the definition of related
  party under IAS 24 includes close members of the
  families of KMPs as well as persons who exercise
  control or significant influence
• Definition of Control Restrictive in IAS power
  to govern the financial and operating policies of
  the management of the entity
• IAS - No concession in making disclosures based
  on confidentiality requirements as per statute or
  regulatory authority

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Others
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IAS 33 Earnings per share

• Disclosures Requirements in case of
• Discontinued Operations
• Anti-dilutive instruments
• Face value of shares
• Extra-ordinary items
• Treatment of written put options and forward
  purchase contracts
• Treatment of application money held pending
  allotment
• Changes in Accounting Policy
• IAS 33 requires changes in accounting policy to
  be given retrospective effect for computing EPS,
  which means EPS to be adjusted for prior periods
  presented

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Financial instruments

• Financial instrument classified as liability or
  equity in accordance with substance
• AS 30, AS 31 and AS 32 will bridge differences
  between IFRS (IAS 32, IAS 39, IFRS 7) and IGAAP
• Differences due to legal and regulatory
  environment
• Derivatives based on an enterprises own equity
  instruments and buy back of shares by enterprise
  itself for issuance to employees under ESOPs not
  permitted under present legal framework
• Disclosure of redeemable preference shares debt
  instrument/equity instrument

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Others

• Corresponding AS for IAS 41 - Agriculture, IFRS 4
  - Insurance Contracts, IFRS 2 - Share based
  payments under preparation
• GN by ICAI on Accounting for Oil and Gas
  Producing Activities covers IFRS 6 -
  Exploration for and Evaluation of Mineral
  Resources

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IFRS Impact
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IFRS has potential to impact many areas of the
business
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Changing face of the financial statements
Efforts

• The efforts will necessarily shift to record
  both underlying business transactions and unique
  IFRS valuation and measurement principles

Financial Instrument Valuation
Accounting for BusinessCombinations
Appropriatenessof Hedge Accounting
Share-basedPayment Valuations
Asset Impairment Selection of CGUs
Identification of Embedded Derivatives
Reasonableness of Asset ImpairmentModels
Intangible AssetIdentification
Time for preparation of financial statements
Pension Plan Deficiencies
Research andDevelopment Costs
Selection of Functional/Presentation Currency
Restructuring Provisions
Non-Amortisation Of Goodwill
Impact on Opening IFRS Balance Sheet
Low Impact
Medium Impact
High Impact
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IFRS conversion program
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Practical implications for companies

• Converting to IFRS is more than a technical
  exercise it presents many business challenges
  and opportunities
• Major conversions can take 18 months to
  complete
• Senior management will need the time to
  understand the full impact of IFRS on the company
  and to develop the right messages for the
  marketplace

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Global experience in implementing IFRS

• Lack of guidance on IFRS conversion
• Entity specific issues requiring detailed
  analysis of facts and circumstances to apply IFRS
• Untrained staff
• Time spent for converting to IFRS was under
  budgeted
• Collating the data required for conversion
• Use of experts for valuations
• IFRS application involves management to exercise
  judgment and estimations in many areas, since it
  is a principle based framework and not rule based

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Global experience in implementing IFRS

• Being the initial years, IFRS was interpreted
  differently by different people
• Increased communication was required for keeping
  analysts and stakeholders informed about the
  implications of IFRS conversion
• In some cases, IFRS dictated the business
  decision due to significant accounting impact
• Conversion exercise was handled casually, leading
  to critical problems as the target date drew
  closer
• Regulatory requirements are not in compliance
  with IFRS

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Expected challenges

• IFRS is significantly different from Indian GAAP
  in the areas of financial instruments, business
  combinations, and group accounts.
• IFRS knowledge, resources, and literature is
  scarce in the country
• Difficulties in fair valuation due to
• Very few valuers have expertise to perform
  valuations required by IFRS
• Lack of data for the valuers to perform valuation
• Non-availability of statistical models
• Non-availability of competitors data

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Expected challenges

• Legislative Conflicts
• Preference capital
• Section 78
• Changes in accounting policies
• Depreciation rates
• Definition of control
• HC orders
• SEBI Clause 41, ESOPs

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Thank You