Richard Martin

The accounting standard IndAS109 which sets out the accounting treatment for financial instruments will need to be applied for the accounts beginning April 1, 2019, which is less than a year away. It is the equivalent of IFRS9 which was adopted internationally a year earlier from January 2018. That means that Indian companies have a year more still to get ready and that they can see something of the impact elsewhere beforehand.

The 2017 accounts of many IFRS companies have been published recently and these show something of the restatements on transition and of the new accounting policies that will be needed from now on. This article tries to highlight some of the main effects of the new standard and give some ideas from the international experience — limited though that is at present.

It is fair to say that the impact on banks will be greatest and most significant, given the predominance and scale of the financial instruments in their balance sheets. However, every company using IndAS will be affected to some extent, because the definition of financial instruments is very wide and covers trade debtors and creditors, cash, loans and investments for example.

Clearer balance sheets

IndAS109 has a clear categorisation which links the accounting treatment to the reasons why the instrument is being held.

Firstly, there is an amortised cost category which is to be used when the cash flows consist solely of payment of the principal and interest (SPPI), and the business model is to hold the item to collect those cash flows. They are not held to realise changes in their market value. This will apply to the loans and receivables from customers in banks but also to the trade debtors of other corporates.

The other main category will be fair value through profit or loss which is for trading or investment items where they are held for disposal — mostly for banks. But where corporates may hold equity shareholdings, perhaps for strategic business reasons, these will have to be at fair value.

If items are held to either collect those cash flows or maybe for sale and they meet the SPPI test then they should be at fair value with changes through Other Comprehensive Income (OCI). This means the income statement will be at historical amortised cost but the balance sheet will be at fair value. This would seem the best representation for investments in bonds that banks may hold to provide liquidity if needed.

The first wave of major European banks is showing some restatements from reclassifications — profits at HSBC and Royal Bank of Scotland, for example. But for others such as Barclays these have not been significant.

More provisions

For banks the biggest impact of IndAS109 is likely to be the change in the calculation of provisions against loan loss and the higher level of them. IndAS109 uses an expected loss model which inevitably includes more forward-looking information.

All loans have to include both those losses which have already occurred plus the effect of events expected over the next 12 months. If there has been significant credit deterioration then the full life-time losses have to be provided for right away. For banks with longer loans the step-up from 12 months to lifetime can be highly significant in the amounts to be set aside. For other corporates their trade receivables tend to be fairly short term and so there will be little difference here. This increase in provisions has generally been the major effect seen among the major European banks getting ready for IFRS9 — for example $2.2 billion at HSBC, over €3 billion each at Unicredit and BNP-Paribas.

Changes in reported profits

Making the loan loss provisions more forward-looking and the impact of moving debt portfolios from 12 months to lifetime expected losses could make future reported profits from banks more volatile as economic forecasts change. On equity holdings the full fair value stock market changes will impact profits in each period, unless the option is taken to treat the holding gains and losses through OCI.

Between now and April 2019 banks will need to finalise policies to deal with the details of IndAS109 and implement systems to provide the information needed. The different instruments need to be classified by business model and whether they qualify as SPPI. Expected loan losses involve forecasts of the future economic position.

The meaning of significant credit deterioration needs to be determined. The provisions have to be done on probability-weighted estimates of cash flows on reasonably supportable bases and discounted at the original effective interest rate.

European banks all stress the significance of the judgements required, of the complexity and extent of the system changes needed and the time that these have taken to put in place. Indian banks should take note.

Training and understanding

IndAS109 is complex. There is, therefore, the need for an understanding of it by different groups of people within a bank for example —clearly the finance and accounting team, those developing the systems and software needed. But importantly, it is the directors and others who will have to take responsibility for the policies and judgements, and speak on the implications.

Last but by no means least, external parties — credit rating agencies, regulators and investors need to be informed. IndAS and IFRS require that assessments of impact of new standards need to be explained.

All the EU banks have done this but some such as Unicredit and Deutsche Bank have chosen to publish detailed statements of the impact.

The writer is Head of Corporate Reporting, Association of Chartered Certified Accountants

comment COMMENT NOW