The Hindu Business Line : Awareness about IFRS needs to increase more rapidly

With the convergence of accounting standards across the globe gaining momentum, accounting bodies such as the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) have already initiated the groundwork on converging International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Standards (GAAP) in the US. The deadline for the convergence of Indian GAAP with IFRS is April 1, 2011.

Mr Jamil Khatri, Head, US GAAP & IFRS services in India of KPMG, who is one of the key persons in highlighting the challenges faced by the Indian banking sector along the path to convergence in the recent KPMG concept paper `IFRS: Developing a roadmap to convergence for the Indian Banking Industry', spoke about IFRS and India Inc.'s preparedness in an e-mail interview to Business Line.

Excerpts from the interview:

Do you think there is enough awareness among India Inc. about IFRS? With the ICAI (Institute of Chartered Accountants of India) asking for change in listing norms to facilitate IFRS, how prepared are companies?

Awareness about IFRS and implementation issues is gradually building up within corporate India. However, the awareness needs to increase more rapidly and across a wider section of India Inc. if we are to achieve the proposed timelines for convergence.

For example, a recent survey in Canada (which is also seeking a 2011 IFRS adoption) indicated that more than 80 per cent of companies had already understood the impact of IFRS adoption and had well laid-out plans to achieve implementation.

We expect that similar preparedness within corporate India would currently be less than 1 per cent. We are in the process of completing a similar survey in India that would give a better evaluation of preparedness and awareness.

However, as stated earlier, we are seeing awareness increasing in sectors such as banking (which would be most impacted) and at large multi-business conglomerates where IFRS implementation will take a long period of time.

We believe that one of the reasons for the slow pace of awareness and preparedness is lack of clarity on certain aspects of convergence with IFRS. For example, most other countries have shifted to IFRS through a methodology that is prescribed by IFRS 1 on First-time adoption that requires retroactive application of IFRS (subject to certain exemptions). It is unclear on whether this is the methodology that will be used for transition in India.

Similarly, corporate India is waiting to see further regulatory endorsement and a plan of proposed amendments to laws and regulations (including, for example, the Companies Act) to obtain clarity on the manner of IFRS implementation in India.

In what way does the IFRS differ from current accounting standards?

Though the ICAI is a full-fledged member of the International Federation of Accountants (IFAC), deviations from IFRS exist due to various reasons:

Differences due to the legal and regulatory environment: For example, while IFRS require depreciation of all assets over their estimated useful lives, Indian GAAP mandates that the depreciation rates cannot be lower than the rates prescribed under the law;

Differences due to the economic environment: For example, several IFRS that deal with investments, derivatives, other financial instruments and business combinations extensively use the fair value concept, while corresponding Indian standards are generally based on the cost/carrying value approach

Differences due to the level of preparedness: For example, accounting for deferred taxes under IFRS is based on the balance-sheet approach, but due to the fact that the concept of deferred taxes was newly introduced in India, the current Indian standard prescribes the income statement approach, which is easier to understand and implement; and

Conceptual differences: For example, the Indian standard on intangible assets is based on the concept that all intangible assets have a definite life, which cannot generally exceed 10 years, while IFRS acknowledge that certain intangible assets may have indefinite lives; also, useful lives in excess of 10 years are not unusual under IFRS.

Additionally, certain differences between Indian standards and IFRS reflect the fact that the Indian standards were initially based on international standards, which have been subsequently updated and modified.

Similarly, certain Indian standards eliminate and remove alternatives that are permissible under IFRS (for example, IFRS permit interest paid to be disclosed either as financing cash flows or as operating cash flows. Indian standards eliminate this alternative and require that interest paid be reflected as a financing cash flow).

Elimination of these differences on adoption of IFRS may have a significant impact for corporate India.

Even though the ICAI has been gradually issuing additional accounting standards and harmonising existing standards with IFRS, significant differences still exist between Indian GAAP and IFRS.

What are the important IFRS-related technical matters and industry-related issues that India Inc. should be aware of?

Application of IFRS would generally make the financial reporting process more complex than the past - for example, in several areas such as accounting for consolidation, stock options and financial instruments; current Indian GAAP prescribes accounting that requires limited judgment.

Application of IFRS will result in significant use of judgment, estimates and fair values that would make the financial reporting process more complex.

For example, under IFRS acquisitions are accounted for by the purchase method that requires intangible assets to be valued and separately recorded. This is a new and complex concept for most Indian companies.

Similarly, the rules on financial instruments have provisions for application of hedge accounting principles for certain derivatives. This is again a complex area.

The use of fair values for several financial instruments (including derivatives) would result in increased volatility in the income statement and reported profits. Estimating fair values for several financial instruments may also be a challenge given the lack of deep financial markets for several structured derivatives.

IFRS requires extensive disclosures. Several of these disclosures would require changes to existing systems and processes for collating the required information.

To make implementation of IFRS sustainable, several companies would need to change their existing processes and IT systems.

For example, investments are classified as trading, available for sale and held to maturity under IFRS. These classifications have to be decided at inception for each investment. Treasury systems would need to be modified to ensure that each investment is correctly classified at inception and the subsequent accounting is correctly reported.

In certain instances, application of IFRS may also change business practices.

For example, certain derivative contracts that are economic hedges may not qualify for hedge accounting under IFRS because of their nature (for example, leveraged options that are routinely used by several Indian companies). In such cases, if an entity wants to ensure that it wants to achieve hedge accounting (that prevents income statement volatility), it may decide to change the nature of the instruments (for example, to plain vanilla forward contracts) to ensure that the financial reporting matches the economic objectives.

Where does India stand vis-…-vis other nations?

Over the years, the use of IFRS has increased throughout the world. More than 100 countries now require or allow the use of IFRS, and many other countries are replacing their national standards with IFRS.

The European Union (EU), for example, under a regulation adopted in 2002, required companies incorporated in its member-states and whose securities are listed on an EU-regulated market to report their consolidated financial statements using IFRS beginning with the 2005 financial year.

It has been estimated that these requirements affected approximately 7,000 companies in the EU. In addition to financial statement issuers in the 27 EU member-states, these IFRS requirements apply in the three European Economic Area countries of Iceland, Lichtenstein and Norway. Other countries, including Australia and New Zealand, have similar requirements mandating the use of IFRS by public companies.

More countries have plans to adopt IFRS as their national accounting standards in the future. For example, Israel (2008), Brazil (2010), Canada (2011), Japan (2011) and Korea (2011). By 2011, the number of countries requiring or permitting IFRS is expected to reach 150.

Why do we need IFRS at all? What is its importance?

Key drivers of IFRS conversion across the world are as follows:

Better comparability and transparency of business performance and activities: IFRS provides more comparability among sectors, countries and companies. Due to its universal appeal it can both improve and initiate new relationships with investors, customers and suppliers across the globe since financial statements in accordance with IFRS cut across borders. As Indian businesses become more global in terms of their operations and investor base, IFRS would enable a comparison of Indian companies with global peers.

Reduced cost of capital and better access to global capital markets: IFRS eliminates barriers to cross-border listings as it is accepted as a global financial reporting framework and allows companies to seek admission to almost all of the world's bourses. Even in cases where listing on overseas exchanges is permitted using local (Indian) GAAP, international investors generally ascribe an additional risk premium if the underlying financial information is not prepared in accordance with international standards.

Thus, adoption of global standards such as IFRS may reduce the risk premium and, consequently, the cost of capital. Similarly, even companies raising capital and listed only on the local exchanges in India would be able to better attract international investors and reduce risk premium, by providing financial information that is more transparent and understandable for the international investor community.

Further, IFRS financial information can also result in more accurate risk evaluations by international lenders and lower risk premium for international debt offerings.

More cross-border transactions: By providing transparent and comparable financial information, IFRS reporting provides an impetus to cross-border acquisitions, enables partnerships and alliances with foreign entities, and lower the costs of integration in post-acquisition periods.

Eliminate multiple reporting: Currently, different entities within the group that reside in different jurisdictions may be required to prepare a dual set of financial statements for external financial reporting; one for local statutory financial reporting in the home country and second for reporting to the parent company (assuming that the parent company follows IFRS).

This increases the efforts of the finance function, introduces complexity in financial reporting and increases costs of the finance function. Group-wide adoption of IFRS will eliminate the need for such multiple reporting, if IFRS is accepted or required in all countries of operation.

Given that most of the world would move to IFRS by 2011, India cannot afford to be isolated and be one of the few countries that continue to use home-country GAAP.

Do you think India has enough professionals to handle IFRS related issues?

India has the second largest pool of accountants in the world. While substantially all of this resource pool is currently not familiar and trained under IFRS, there is a potential to train this pool and upcoming chartered accountants, through imbibing IFRS into the chartered accountancy curriculum.

We believe that the right approach would be for organisations to train core internal teams on IFRS-related issues that affect them. This can be achieved through use of external consultants who may have the benefit of international knowledge, skills and experience. This core trained internal team can then roll-out training to a wider group of people across organisations. This method has successfully been used in several other countries.

At KPMG, we have created a trained pool of more than 150 IFRS resources to enable our clients to leverage our global knowledge, skills and experience in IFRS implementation.

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