IFRS carve-outs wide-ranging

T. P. GHOSH | Updated on: May 22, 2011


The converged Indian Accounting Standards have about 69 major and minor carve-outs.

Converged Indian Accounting Standards are notified with some major carve-outs and deferrals of certain critical standards and interpretations to suit the local purposes apart from major departures for the first time convergence. The Ministry is reportedly open for more carve-outs if the industry requires.

The carve-outs originally suggested by the ICAI in the Exposure Draft were very minimal and restricted to the definition of related party disclosures whether to include brothers, sister, father mother of key individuals as close family members which was considered as matching with the social environment of India, and eliminating the ‘corridor approach' in accounting for post-employment benefit schemes.

Carve-outs in the finalisation stage range from presentation issues to fundamental IFRS accounting principles such as elimination of fair value option in investment property, deferral of lease interpretation and service concession arrangements, widening the scope of other comprehensive income, deferral of certain exchange fluctuation loss, adopting percentage of completion basis revenue recognition in real estate development business, to list a few.

Also there is a suitable first time adoption guidance that helps in smooth transition based on carrying amount of assets as on March 31, 2007. With about sixty nine major and minor carve-outs, still it got IFRS flavour! At least there are matching code numbers, sequence of IFRS paragraphs and clear demarcation of the carve-outs. It looks like IFRS. Now only there is another round waiting for the resolution of tax issues arising out of IFRS.

IFRS sans fair value

Fair value carve-out of investment property is a surprise element in Ind AS 40. IFRS offers cost alternative as well for those who prefer historical cost. This move may have approbation of ‘ conservative accountants,' but misses an important aspect of fair value advantage. Companies having land bank and wishing to unlock the value should not be able to demonstrate the fair value.

The prospective investor will remain handicapped to discover the fair value of such a company through financial analysts rather than looking through balance sheet lenses.

One of the critical advantage of fair value measurement is demonstration of ‘fair presentation' of the financial statements and thus to reduce the gap between speculative market valuation and fundamental fair value. Although real property market is quite volatile but financial asset like equity is no less volatile. If IAS 39 fair valuation becomes acceptable, then reservation for fair valuation of investment property is confusing. As against 28 per cent annual volatility of Nifty (as per NSE screen), annualised volatility of real property is just 4.5 per cent computed based on Makaan National Index). If balance sheet can tolerate 28 per cent volatility of equity assets, it could reasonably withstand 4.5 per cent volatility.

Real estate development

Real estate developers can now treat the agreement to construct real estate as construction contract without having any ‘agreement to construct' with any third party! All that they have are ‘ agreements to forward sale'. IFRIC 15 states it is not sale of goods unless the risk and reward of ownership passes to the buyer and revenue recognition is not possible. “Brick by brick” transfer approach is missing in such contracts. Ind AS 11 Construction Contracts may still embrace such ‘agreements to sale' as ‘agreements to construct'. Perhaps Ind AS 11 becomes riskier in its scope through carve-outs than IFRIC 15 allowing to recognise profit by stage of completion based on forward sale contracts. Whereas developer of investment property cannot opt for ‘fair value' model as Ind AS 40 carved out the fair value option. Such real estate developer has to follow cost model and can book profit only on sale of goods. This does not cocktail well.

Bargain purchase

Business acquisition profit is a fair value gain to be encashed over a period of time. No rational entrepreneur would like to sell business at less than the fair value. It normally arises because of forced sale and there in an inherent gain. Major concern against recognising bargain purchase gain as profit is possible misuse by intentional overstatement of fair value of assets, which the IASB did not wish to mitigate through accounting entries.Ind AS 103 Business Combinations carves out the accounting treatment of ‘fair value gain' and pushed to other comprehensive income. If there is overvaluation of asset acquired, then equity is overstated which is considered as less harmful in India.

(The author is Professor, Institute of Management Technology, Dubai.)

Published on May 15, 2011
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