The Hindu Business Line : IFRS 1: First time adoption

Converting from local GAAP to a new accounting framework can be quite an onerous task. The most critical aspect is to restate the opening balance sheet as if the new accounting framework was always followed. This can make things very difficult.

Take for example, accounting for fixed assets. Four significant differences between Indian GAAP and IFRS in this area are:

Schedule XIV depreciation rates are generally applied in practice rather than determining depreciation based on useful lives;

Residual values are not revised on an ongoing basis under Indian GAAP but is required under IFRS;

Capitalisation of exchange differences was allowed under Indian GAAP but not under IFRS; and

Component accounting followed under IFRS but not under Indian GAAP.

Exemptions allowed

If the approach is to restate fixed assets according to IFRS ab initio, then for most first-time adopters, this could be practically impossible. Fortunately, IFRS 1 First Time Adoption of IFRS allows certain exemptions such as in the case of fixed assets, these could be fairly valued as of the opening balance sheet date (date of transition) and the same would constitute a deemed cost under IFRS. Once the fixed asset value is plugged as of the opening date, going ahead, all the requirements of IFRS would need to be complied with.

IFRS 1 also allows exemptions in regards to accounting of business combinations. This is important in the Indian context, since business combinations are accounted at historical cost under Indian GAAP, whereas under IFRS business combinations are accounted for on the basis of fair valuation principles.

Under IFRS 1, if an entity so chooses, it need not restate the business combinations that have taken place prior to the opening balance sheet date.

However, business combinations after that date are to be accounted for in accordance with IFRS.

Under Indian GAAP all actuarial gains and losses are recognised according to AS-15.

Under IAS 19 Employee Benefits, an entity may elect to use a corridor approach that leaves some actuarial gains and losses unrecognised. Retrospective application of this approach requires an entity to split the cumulative actuarial gains and losses from the inception of the plan until the date of transition to IFRSs into a recognised portion and an unrecognised portion.

However, a first-time adopter may elect to recognise all cumulative actuarial gains and losses at the date of transition to IFRSs, even if it uses the corridor approach for later actuarial gains and losses.

Two methods

In the case of employee share-based payments, under Indian GAAP, both the intrinsic method and the fair-value method are allowed. Under IFRS, employee share-based payments are required to be accounted for using the fair value method.

However, a first-time adopter is not required to apply IFRS 2 share-based payment to equity instruments that were granted after November 7, 2002, that vested before the later of the date of transition to IFRS and January 1, 2005.

While IFRS provides exemptions, in a few cases, it also prohibits retrospective application of IFRSs. Such is evident in the case of hedge accounting, at the date of transition an entity shall:

Measure all derivatives at fair value and;

Eliminate all deferred losses and gains arising on derivatives that were reported under previous GAAP, as if they were assets or liabilities.

As of the opening balance sheet date an entity, if it desires to, should re-establish a hedging relationship, provided, it complies with the requirements of IAS 39.

Through numerous exemptions and a few exceptions, IFRS 1, makes it practical for a converting company, to change from Indian GAAP to IFRS. Other than the exemptions and exceptions, an entity shall in its opening balance sheet recognise all assets and liabilities whose recognition is required under IFRSs and not recognise items as assets and liabilities, if IFRSs do not permit such recognition.

Further, entities are required to reclassify items that it recognised under previous GAAP as one type of asset, liability or component of equity; but are a different type of asset, liability or component of equity under IFRSs and apply IFRSs in measuring all recognised assets and liabilities.

Adopting IFRS

It may be noted that the ICAI has already announced the transition date of 2011 for the adoption of IFRS. This date actually means 2010, since comparables would be required under the IFRS. The Ministry of Corporate Affairs too has made its intention to adopt/converge to IFRS.

It is recommended that Indian entities start preparing themselves for converting to IFRS. As a first step, they may consider performing a diagnostic to identify high level differences between the two GAAPs to be followed by a detailed implementation strategy. It may be noted that adoption of IFRS will not only have accounting implications, but will have significant business consequences as well.

Consequently, those that approach IFRS adoption as a mere technical exercise will not be able to fully optimise on the benefits of adopting IFRS.

(The author is Partner, Ernst & Young. The views are personal.)

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