The Hindu Business Line : IFRS calls for decisive shifts in strategic management

But to accountants, who are in the professional loop, the abbreviation stands for International Financial Reporting Standards, the global yardstick that will soon come into vogue, in the world of business numbers closer home. And, in pockets, the serious accountants are already at work, preparing the ground for the switchover.

To those who worry whether as a country we are focused in effectively dealing with the change, it should be comforting to hear that "we have made a good beginning," as opines Mr Kaushik Dutta, the leader of IFRS practice of PricewaterhouseCoopers. He draws our attention to the concept paper issued by the ICAI (Institute of Chartered Accountants of India) which clarifies a lot of doubts and gives a clear roadmap towards IFRS convergence.

"Indian companies, based on the categorisation done, can start identifying areas which will get impacted the most, for instance, consolidation on basis of control, revenue recognition, leasing arrangements, financial instruments, taxation, future mergers and acquisitions, etc," urges Mr Dutta.

Citing some of the recent statements made by the officials of the Ministry of Corporate Affairs, he expects that the Government may go in for quick amendments to the existing company law rather than wait for the new company law to get legislative accord so that the country meets the April 2011 deadline for convergence with IFRS.

As you may be aware, the Ministry has stated its intention to converge the country's accounting standards with IFRS, in a move to reassure regulatory bodies abroad that the Indian Government is committed to harmonisation of accounting standards.

Mr Dutta is however of the view that we still have a long road to home, given that 10 standards of IFRS will need regulatory changes for them to be applied, and 12 standards have conceptual differences with the Indian GAAP - combined with legal and regulatory requirements of taxation, SEBI, Companies Act, etc.

"But we can reach on time, if we can get our act together," he hopes, during a recent email interaction with Business Line.

Excerpts from the interview:

What is the magnitude of change that we have to be prepared for?

Indian GAAP convergence into IFRS will create a new accounting paradigm from 2011 onwards and we will have a new set of reporting and accounting principles and rules which is currently followed in over 120 countries. The key changes are holistic and they transform businesses and their processes, systems and controls and not just accounting.

There will be changes in future earnings forecast, effect on debt or loan covenants need to be evaluated as profits or ratios will change under IFRS, key performance ratios will be different and there will be effect on distributable reserves, earnings per share, taxation, especially those taxes which are calculated based on book profits, etc.

That's a lot!

And there's more. Together with the above elements, combine the new world term of `fair value' accounting - a hint of which we have seen lately in India in the `mark to market' losses of hedges and other financial instruments in the last two quarterly results in India.

The business combinations of mergers and acquisition, leases, consolidation and transition disclosures will witness a significant change in the way we report. In short - the effect is a quantum leap of faith and not an incremental change of elements.

Where are the gaps that the Government, the regulators, and the ICAI need toplug?

I think, while all the stakeholders like the ICAI, the regulatory bodies and the Ministry of Company Affairs are making some progress in their individual roles, what we need now is a more coordinated effort from all the stakeholders, maybe through a joint working group.

There are so many aspects relating to IFRS convergence which still need to be clarified, such as IFRS first time adoption standard, compliance of comparative previous period figures with IFRS, changes required to the Companies Act to comply with IFRS, changes to the Income-Tax Act, the Reserve Bank of India's requirements for banks, etc.

The earlier we clear all the ambiguities, the smoother will be the transition and we will have time to bridge the gap. But speed is of essence.

Is the change to IFRS good for India? Will we stand to benefit?

The change to IFRS is good for everybody - the economy, investors, industry and users of financial statements. The Indian economy will benefit from the growing internationalisation of business and increased foreign investment. Internationally, insofar as cross-border investments are concerned, a non-IFRS compliant country is perceived as an additional risk factor.

Convergence to IFRS means that investors will not have to go through expensive and time-consuming conversion processes and will contribute to understanding and improving confidence in financial statements of Indian entities.

It will further help our industry to raise capital from foreign markets at a lower cost, save on costs of preparing separate set of financial statements and benchmark with competitors globally. It also allows multinational groups to apply common accounting across their subsidiaries, which can improve internal communications, and the quality of management reporting and group decision-making.

Our accounting professionals will also be able to compete with quality services with experts in different parts of the world and thus will become part of the global IFRS resource pool. It is beneficial for all.

Can you explain how the change goes beyond accounting and impacts the business holistically?

It is tempting for companies contemplating the adoption of IFRS to view the change simply as an accounting exercise, something their staff can do in their spare time. After all, as a company executive remarked, "All we have to do is change the numbers." But this assumption is dangerous.

It is not just the CFO who has to understand IFRS. The board and the audit committee also need to understand IFRS to be able to discharge their duties of giving direction to business and governance respectively.

IFRS conversion is a change in primary GAAP, which means that everyone in the organisation must learn a new language, a new way of working. This is a new performance measurement system that needs to be taken on board throughout the organisation. The whole basis of reporting to the market will be different.

For many companies, this will mean fundamental changes - changes that can ripple right across their business operations from investor relations to everyday procedures, changes that can affect the viability of some products and even the reported profitability of the business itself.

So, in summary, it will change the way people need to work and could require decisive shifts in strategic management.

Are there specific standards in IFRS which are so different from Indian GAAP, which will affect earnings and results?

IFRS numbers can look very different. Indian standards as of now do not have concepts such as fair valuation, multiple element contracts, customer loyalty programmes, consolidation based on control and not just ownership, lease accounting based on substance and not form, etc., and the present systems and processes used by Indian companies are also not designed to make the related calculations.

The biggest differences are expected to be in accounting for financial instruments (be it accounting for investments, derivatives, loan loss provisioning, or borrowings), deferred taxation, business combinations, revenue recognition, leases, employee benefits, disclosures, etc.

Are there takeaways from other countries that have managed the transition to IFRS?

Most of the companies in more than 100 countries that have already converged to IFRS faced similar problems like significant differences between local GAAP and IFRS, availability of comparable data for fair valuations, lack of knowledge base on IFRS, interpretation differences, differences between local regulations and IFRS, and lack of planning in advance by companies for managing the change. We, in India, would also face similar challenges. And, since the challenges are the same, the solutions would be similar, i.e., plan in advance, start with desktop reviews to find out areas of differences, assess business impact, plan changes to systems that generate data, train all stakeholders, and robust project management.

Do you foresee that the IFRS transition will affect corporate governance including the Clause 49 compliance?

The Clause 49 of the Listing Agreement requires all listed companies, and companies seeking listing for the first time, to have an audit committee. All members of such audit committees are required to be "financially literate", which is defined as the ability to read and understand basic financial statements.

Once India moves on to IFRS, audit committee members and the Board need to be `IFRS literate' and at least one has to be an `accounting expert'. This would now mean that the audit committee should have an understanding of the transition from Indian GAAP to IFRS and at least one director who is an expert in IFRS - the new GAAP.

Audit committees will also have the onerous responsibility of oversight of IFRS transition of the companies. Thus, those charged with governance cannot leave it to CFO only.

A country-wide change in GAAP in three years will need a huge investment in training and knowledge sharing. How is India readying itself for this?

The transfer of knowledge has to happen both at the executive and operational levels. All of us have to make huge investments in trainings on IFRS to meet the training needs of CEOs, CFOs, board members, members of the audit committees, tax authorities, students, and regulators.

The ICAI needs to make changes to the curriculum to include IFRS training, business schools will have to initiate certificate courses on IFRS and companies will have to include staff training as one of the key steps in the overall convergence strategy. I would also recommend inclusion of IFRS concepts even at the University-level education so that the basic knowledge can then be topped up with specialised training. Many practitioners say that Indian GAAP is very similar to IFRS and the incremental change is not significant.

Only two Accounting Standards of India can be adopted to IFRS in the current form. There are 22 standards which are either conceptually different or need regulatory changes to comply with the IASB's version of IFRS. Also, changes to the Companies Act, and to SEBI and RBI requirements need to be made to help converge with IFRS. These changes are too many and fundamental to be not taken seriously.

As I have already pointed out that some of the biggest differences are expected to be in accounting for financial instruments (be it, accounting for investments, derivatives, loan loss provisioning, or borrowings), deferred taxation, business combinations, revenue recognition, leases, employee benefits, consolidation, etc.

Your advice to corporates on managing the transition and the change.

The transition, in my view, will take considerable time to plan, to make the necessary changes and to integrate them fully across the organisation, while continuing business operations as effectively as usual.

There is lot to learn from countries such as the UK and in Europe, which experienced the challenges of transition from local GAAP to IFRS. Most of the companies in these countries have tackled change to IFRS in three parallel areas of activity, that is, changing the numbers, changing the business, and project management.

Changing the numbers revolves around understanding the differences and collecting all the data required for IFRS reporting. Changing the business involves anticipating changes required in management information systems, accounting policies and upgrading skills of people across all levels.

An effective project management all through the transition process will ensure removal of roadblocks, compliance with deadlines and will not allow transition process to impact normal functioning of business. Therefore, a well planned transition is the key to success.

D. MURALI

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