Carve Outs from IFRS

N. VENKATRAM | Updated on: Apr 17, 2011

India has chosen to converge with IFRS as opposed to adopting IFRS as this gives the standard setters the latitude to modify accounting standards to better reflect the local economic environment.

As the capital markets become increasingly global in nature, convergence of accounting standards towards a common set of high-quality accounting principles is a move in the right direction. Therefore, when the Institute of Chartered Accountants of India issued the “Concept Paper on Convergence to IFRS” (the Concept Paper) in 2007, it was well received by the industry and the accounting profession. The final IFRS converged standards, referred to as Ind ASs, have now been “notified” on the Web site of the Ministry of Company Affairs. However, there is a requirement for the Government to prescribe these standards in the Official Gazette, and also set the date these standards come into effect, before these officially become part of the Companies Accounting Standard Rules.

In the meantime, there has been scepticism in some quarters on the quality of the new accounting standards, and critics cite illustrations of carve-outs that have been made. A balanced review of carve-outs is necessary to enable an understanding of the rationale behind them. We need to recognise that India chose the conversion route over adoption of IFRS without change, in order to be in a position to deal with certain situations in India which could arguably render international standards either difficult to apply or which could even lead to results not intended by the standard setters.

This is not unusual, and several countries initially carved out areas in which they apply their own standards that are distinct from IFRS, in view of the overriding need to ensure that the IFRS pronouncements are fit for application in their specific-country environment. This was based on the premise that accounting standards cannot be viewed in isolation or based on their utility to a single set of users.

What is a carve-out? Simply put, a carve-out is a divergence from the practices and principles as set out in the international standards. India has chosen to converge with IFRS as opposed to adopting IFRS. This gives the standard setters the latitude to modify accounting standards to better reflect the local economic environment and this leeway has been utilised by the standard setters while formulating the Ind ASs. Currently, differences between IFRS and Ind ASs can be classified into four categories:

(1) elimination of options provided under IFRS

(2) addition of options not available under IFRS

(3) inclusion of additional guidance in Ind AS not found in IFRS and

(4) prescription of accounting rules that are different as compared to IFRS

Eliminating options and providing additional guidance usually would not render financial statements non-compliant with IFRS. As regards the second category, where the Ind ASs provide alternative policy choices, preparers may choose a policy that is available under IFRS to ensure that they are compliant with IFRS. Thus, if the first three categories above are excluded, we are really left with very few carve-outs where the accounting rules prescribed by the Ind ASs are different from IFRS.

Real estate

Now let us discuss the carve-outs. A carve-out that met with mixed reactions is on the recognition of profit or loss by real estate developers. The fundamental question that determines accounting is whether the developer is selling a product (goods) – the completed apartment or house – or is selling a service – a construction service as a contractor engaged by the buyer. Under IFRS, as per the requirements of IFRIC 15 Agreements for the Construction of Real Estate, revenue from agreements for construction of real-estate will generally be recognised on completion of the contract. Percentage of completion method to recognise revenue is applied for such contracts only if such contracts meet certain specified criteria. Adopting IFRIC 15 would result in a shift for real estate developers from recognising revenue as construction progresses to recognising revenue at a single time – at completion upon or after delivery which would create a lot of volatility in profit or loss. Consequently a few countries, including India, characterised by a tremendous amount of construction activity have chosen not to adopt or to defer the implementation of IFRIC 15.

Business combinations

The next carve-out relates to the standard on business combinations. IFRS 3 Business Combinations requires the excess of fair value of identifiable net assets acquired over the purchase consideration to be recognised in profit or loss as bargain purchase gain. Ind AS 103 Business Combinations requires that the acquirer should first establish whether there was indeed a bargain purchase i.e. assess whether there are any circumstances which indicate that the acquirer made a bargain purchase for example, a distress sale in which the seller is acting under compulsion. If such evidence exists the acquirer recognises the resulting gain in other comprehensive income on the acquisition date and accumulates the same in equity as capital reserve. However, if no circumstances exist to classify the business combination as a bargain purchase, the excess is recognised directly in equity as capital reserve.

Unrealised exchange differences

The third carve-out pertains to the gain or loss on the translation of a foreign currency borrowing where Ind AS 21, The Effects of Changes in Foreign Exchange Rates, provides an additional option as compared to the international standard. Under IFRS, generally all exchange differences are recognised immediately in profit or loss. Over the last few years, several Indian companies have borrowed funds overseas- typically in US dollars or euros or more recently yen, being the preferred currency of global investors. Translating these foreign currency borrowings into rupees at each period end creates a huge volatility in the profit and loss account of the current period even though the borrowing is repayable after a specific period of time. Therefore Ind AS 21 provides an option to recognise unrealised exchange differences arising on translation of long-term monetary assets and liabilities either directly in equity or in profit or loss. If recognised directly in equity, the amount so accumulated is required to be transferred to profit or loss over the period of maturity of such long-term monetary items. Accordingly, an exemption for first-time adopters of Ind AS has also been added to provide that the aforesaid option may be exercised either retrospectively or prospectively and if elected prospectively, such unrealised exchange differences on said items may be deemed to be zero on the date of transition.

FCCB conversion option

As an increasing number of companies are issuing bonds in foreign currency, there is another important exception from IFRS - the accounting for the conversion option embedded in foreign currency convertible bonds. Under IFRS, a conversion option to acquire fixed number of equity shares for fixed amount of cash in entity's functional currency is treated as equity. Therefore, a conversion option embedded in foreign currency convertible bonds is treated as an embedded derivative, and accordingly fair valued through profit or loss at every reporting period end. Again this causes a great deal of volatility in profit or loss which is unintended. Therefore, the definition of a financial liability has been modified in the Indian standard so that the conversion option to acquire fixed number of equity shares for fixed amount of cash in any currency (entity's functional currency or any foreign currency) is treated as equity and accordingly, is not required to be remeasured at fair value at every reporting date.

Fair value of liabilities

The next carve-out we discuss is on the fair value of liabilities. Under IFRS, in determining the fair value of the financial liabilities including those designated as at fair value through profit or loss upon initial recognition, any change in fair value due to changes in the entity's own credit risk are considered. In India, it was decided that in determining the fair value of the financial liabilities designated as at fair value through profit or loss upon initial recognition, any change in fair value due to changes in the entity's own credit risk will be ignored. Internationally too, many investors and others have felt that volatility in profit or loss resulting from changes in fair value of a financial liability due to changes in an entity's own credit risk is counter-intuitive and does not provide useful information. This caused the IASB to add requirements for classification and measurement of financial liabilities to IFRS 9 in October 2010 whereby an entity choosing to measure a liability at fair value will present the portion of the change in its fair value due to changes in the entity's own credit risk in other comprehensive income.

Investment property

There is a difference between IFRS and Ind AS on investment property, where the additional option to use the fair value model after initial recognition under IAS 40 Investment Property has been deleted in the Ind AS. Ind AS requires investment property to be measured using the cost model only, though the IFRS disclosure requirements of fair value are retained in the Ind AS. This was done primarily due to the difficulty in assessing the fair value in an industry where the prices may include a cash component.

First-time adoption

There are a few differences between the first time adoption standard in India and IFRS 1 First-time Adoption of International Financial Reporting Standards. Under IFRS, a first-time adopter may elect to measure an item of property, plant and equipment at the date of transition to IFRS at its fair value and use that fair value as its deemed cost at that date. In addition to using the fair value as deemed cost, the Ind AS 101 First-time Adoption of Indian Accounting Standards permits preparers to continue with the carrying value for all its property, plant and equipment as recognised in the financial statements at the date of transition as per previous GAAP and use that as its deemed cost. Under IFRS 1, entities are required to present comparatives. In India, entities will not be required to present comparative information; however, entities will have an option to present memorandum comparative information based on deemed transition date as of the beginning date of immediately preceding financial year. Irrespective of the option elected for presentation of memorandum Ind AS comparatives, the first time adopter is required to present latest corresponding previous period's financial statements prepared as per the previous GAAP; such previous GAAP financial statements being reclassified to the extent practicable.


With regard to preparation of the statement of profit and loss, IFRS provides an option either to follow the single statement approach or to follow the two statement approach. Ind AS 1 Presentation of Financial Statements allows only the single statement approach. IAS 1 Presentation of Financial Statements requires preparation of a statement of changes in equity as a separate statement whereas Ind AS 1 requires the statement of changes in equity to be shown as a part of the balance sheet. IFRS also permits entities to present an analysis of expenses in profit or loss using either nature-wise or functional classification, whichever provides information that is reliable and more relevant. Ind AS 1 mandates such presentation using nature-wise classification only. Indian GAAP also differs from IFRS as regards the presentation of cash flows from interest and dividend.

Employee Benefits

On employee benefits, IAS 19 Employee Benefits provides three alternatives to account for actuarial gains and losses for defined benefit plans: recognition of all actuarial gains and losses immediately in profit and loss, other comprehensive income or use of the corridor approach. The international standard is under review and the exposure draft of IAS 19 eliminates the corridor method that allows deferral of some of the actuarial gains or losses. Ind AS 19 Employee Benefits has eliminated the options currently available under IFRS and all actuarial gains and losses have to be recognised in other comprehensive income. The discount rate used to discount employee benefit obligations is not the same - the rate on government bonds is used in India whereas such rate is used under IFRS only if there is no deep market on high quality corporate bonds.

Government Grants

As regard government grants, IFRS gives an option to present the grants related to assets, including non-monetary grants at fair value in the balance sheet either by setting up the grant as deferred income or by deducting the grant in arriving at the carrying amount of the asset. Ind AS requires presentation of such grants in balance sheet, only by setting up the grant as deferred income.

‘Not permitted' list

A mention must also be made of the three accounting standards that will not be issued at all in India at present- standards equivalent to IAS 26 Accounting and Reporting by Retirement Benefit Plans, IAS 41 Agriculture and IFRS 9 Financial Instruments. The standard on agriculture is not being issued in view of difficulties in assessing the fair value in the agricultural sector. IFRS 9 which is effective from 1 January 2013 with early adoption permitted will replace the existing IFRS standard on financial instruments with the project being carried out in three phases, dealing with classification and measurement, impairment methodology and hedge accounting. The first phase is complete and exposure drafts have been issued for the second and third phases. Since the second and third phase have not yet been finalized, entities that choose to early adopt IFRS 9 would have to fall back on IAS 39 Financial Instruments: Recognition and Measurement for matters not covered by IFRS 9; a situation that could lead to some inconsistencies in accounting for financial instruments. The Indian standard setters have therefore chosen to not permit the early adoption of IFRS 9. IFRS 6 Exploration for and Evaluation of Mineral Resources and certain interpretations like arrangements in the nature of a lease and service concession arrangements are proposed to be notified at a later date.

Though we all agree that carve out from IFRSs may not be looked upon favourably by the international accounting community and global investors as comparability of financial information then becomes an issue, as discussed earlier, certain carve outs are necessary keeping the Indian situation in mind. We have come a long way from 2007 when the Concept Paper was issued, to today, where all the converged standards have been issued. So instead of criticising the Ind ASs, let us concentrate our efforts on implementing these standards at the earliest. Hopefully as international standard setters acknowledge and address the unique problems of developing economies in adopting certain standards, the differences between Indian GAAP and IFRS will narrow down over a period of time.

(The author is a Partner with Deloitte Haskins & Sells.)

Published on April 14, 2011
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