Flaws in the present structure of IFRS

The implementation of International Financial Reporting Standard (IFRS), to be made mandatory in India for certain types of companies from April 1, has been postponed India being an important emerging global economy, the Ministry Corporate Affairs, made the commitment that the convergence of Indian Accounting Standard with IFRS will be in place with effect from April 1, 2011. Gradually, it will be made mandatory to the listed Companies having net worth of Rs 500 crore or less.

Indeed, this will bring uniformity and transparency in the financial reporting of the Indian companies and their performance can be compared with the foreign companies and could bring a lot of investment to India. Finally, the IFRS will play an important role in contributing to the economic development of India. That may be the reason for China to adopt IFRS at the very initial stage.

Now the question arises whether the proposed framework of IFRS will give the true financial picture to the investors or other stakeholders?

Major shift

If we analyse the IFRS, it can be concluded that the major shift is from historical cost to fair value of non-current items of the balance sheet. The companies have been given the freedom to go for the concept of fair valuation of its fixed assets and liabilities. In the absence of non-inclusion of the concept of fair value of current assets and liabilities in the proposed structure of IFRS, the question arises whether the financial results of a company will present a correct picture to the stakeholders.

Under IFRS regime, the companies will be required to follow the historical cost for preparation of Profit & Loss and current assets and liabilities; fair value concept, if adopted, for non-current items of balance sheet. In this process, if the property prices changes drastically, the difference has to be booked in Profit & Loss statement and the depreciation and insurance, worked out on the basis of fair value of fixed assets, will be booked in the Income Statement. Similarly, the gain or loss on investment, financial instrument, etc, due to fair value will be booked as a part of Profit & Loss.

Dual standards

In the entire new structure of IFRS, the concept of fair value has been adopted for non-current assets and liabilities and the same concept has been left out for current assets & liabilities. If we analyse this structure, the following issues have to be addressed:

(a)Whether this will give the true picture of the financial statement to the stakeholders;

(b) Whether this will give the correct picture of sustainability; and

(c)Whether a comparison can be made between the two companies, when one is following a concept of fair value and another is following cost concept for its non-current assets & liabilities

From the above, it is clear that the new structure will provide ample scope to the companies to manoeuvre their accounts, because it allows them to adopt the concept of fair value for non-current assets & liabilities as and when they feel.

In this process, the companies can select this scheme when planning for public issues and show the higher profits to the investors. Moreover, having a combination of two concepts, historical cost for current items and fair value for non-current items, will not give the true picture to the shareholders.

In order to give true value of the business based on current cost accounting, there should have been complete shift from historical cost to fair value concept under IFRS. The concept of fair value should have been introduced for all the resources including human resources accounting, social accounting, inflation accounting, etc, which would have given the correct picture to the shareholders and stakeholders. Such kind of reporting to shareholders would definitely have indicated the sustainability of business enterprise and have fulfilled one of the objectives of shifting from historical cost to fair value concept under IFRS.

By giving hybrid type of model to the presentation of accounts through new structure will create confusion in the mind of stakeholders. In addition, in the absence of valuation mechanism for certifying the current market price of fixed assets, the correctness of the fair value of assets will be suspected.

(The author is a Past President, ICWAI.)

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