The Hindu Business Line : Universal accounting will boost investor confidence

The use of a globally accepted set of accounting standards, not only for public reporting, but also for local or statutory purposes will attract potential investors.

Vijay Wadhwani

Global investors rejoice with the growing number of countries moving towards universal accounting standards — International Financial Reporting Standard (IFRS). Globalisation of the world’s capital market has led to the need for a universal accounting language. Currently, IFRS is used as an accounting language in more than 100 countries, and many others will follow suit in the coming years, including the US, Chile, Korea, Brazil, and Canada.

Seriousness of convergence can be seen from the Securities and Exchange Commission (SEC) ‘Roadmap’, which envisages the eventual use of IFRS by US companies. This roadmap is being circulated for public comments. The flexibility given by the SEC to Foreign Private Issuers (FPIs) in making financial statements without reconciling them with US GAAP has proved that the IFRS is indeed the “mother-tongue” of all financial reports.

India too has joined the bandwagon. This is truly beneficial from an investor’s point of view as the requirement of preparing the financial statements in accordance with Indian Globally Accepted Accounting Principles (GAAP) restricts global investors from investing in India.

Investors’ attempt to match these financial statements with IFRS sometimes results in misunderstanding and inefficiency in capital markets across the world. It also results in the additional cost of capital for Indian companies looking for global investors.

In India too, the convergence with IFRS has gained momentum. The Accounting Standard Board (ASB) of The Institute of Chartered Accountants of India (ICAI) had formed the IFRS task force in 2006.The main objective of the board was to lay down a roadmap to converge Indian accounting standards with IFRS.

Convergence in two years

Within a span of two years, the ICAI has decided to fully converge with IFRS for the accounting period commencing on or after April 1, 2011 for listed and other public interest entities such as banks, insurance companies, and large-sized organizations.

With the mandatory requirement of preparing the financial statements as per IFRS from April 2011, greater efficiency and uniformity is hoped for among the global investment community.

Convergence with IFRS will encourage global investments, with Indian entities eliminating the risk premium inbuilt in Indian GAAP financial statements. It will also allow investors to make informed investment decisions.

The basic principle of IFRS, being “fair value” accounting, is very different from Indian GAAP, which works on historical cost accounting. Potential investors will be able to assess the full value of acquisitions made by companies they are investing in and directors may be more accountable for ensuring value for money.

Substance over form, which is another key principle of IFRS, will make “off balance-sheet arrangements” such as special purpose entities, leasing arrangements, etc., as standards require recognition of assets and liabilities in such cases.

Practical roadmap

The use of globally accepted universal set of accounting standards, not only for public reporting, but also for local or statutory purposes, will attract potential investors. However, companies may tend to retain a local style for presentation and disclosure of financial statements, as IFRS is not as strict in this as local statutes such as Schedule VI. Therefore, investors may still find some difficulty in comparing financial statements. Nonetheless, the quality of information required to be disclosed in financial statements, including notes as per IFRS, is much higher and this is useful in making an investment decision.

Of course, transition to IFRS from Indian GAAP will not be entirely smooth. It will place significant pressure on human and financial resources. Companies need to consider the collateral effect such as impact on IT, human resources and taxes, to name a few. It is advisable for companies to analyse and implement the necessary steps required for a smooth transition.

In the coming years, convergence will bring with it a lot of challenges for companies seeking to make the transition. In the interim, it is imperative for investors to initiate discussions with company managements to understand the impact of IFRS adoption on their investments in India.

Further, there is need to consider management plans to mitigate any negative impact, such as renegotiating debt covenants. Investors would need to ensure that company managements take a proactive and pragmatic approach in preparing their roadmap for such a transition, as the process may take 12-18 months.

(The author is a senior professional in a member firm of Ernst & Young Global.)

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