This article has featured in ICAI's 1st IFRS e-Newsletter of October 2, 2014.
Introduction
IFRS convergence will bring in the
above differential characteristics in Indian entity’s financial statements and
make it comparable with International Peers.
While
hearing the budget speech by our Hon’ble Finance Minister of India Shri Arun
Jaitely in July 2014, I was enthused to hear that he actually spoke about IFRS
implementation in India. It shows India’s clear vision and positive approach
towards the long due IFRS implementation process in India.
He
proposed for voluntary adoption of IFRS in financial year 2015-16 and mandatory
from 2016-17. Institute of Chartered Accountants of India (ICAI) has played a
vital role in formulation of Ind ASs, giving comments to International Accounting
Standards Board (IASB) on Exposure drafts / Discussion papers, imparting training and
dissemination of knowledge on IFRS.
What
is IFRS?
As
the economy develops, it is exposed to International environment and commercial
transactions. There is a need to lay down standard principles of accounting for
making the financial statements comparable and bring them closure to the
substance of transaction. ‘IFRS’ which stands for International Financial
Reporting Standards, are these principle based standards that focus on
substance over form.
IFRS
broadly includes Reporting Standards, Accounting Standards and Interpretations
on Accounting and Reporting, apart from Conceptual framework and Preface to
IFRS.
The
effective pronouncements as on date comprises of 15 IFRSs, 28 International
Accounting Standards (IAS), 18 interpretations from International Financial
Reporting Interpretation Committee (IFRIC) and 8 interpretations of Standard
Interpretations Committee (SIC). This makes the tally to 43 Standards and 26
Interpretations under the framework of IFRS.
There
is a separate framework of IFRS for Small and Medium size Entities (SME), which
are referred as IFRS for Small and Medium Sized Entities.
So, are
we prepared for IFRS financial statements?
First
thing that I see as a prerequisite is change in approach of management in
perceiving the way the transaction will be measured, reported and disclosed in
financial statements. IFRS calls for transparency in financial statements for
readers, investors and stakeholders amongst others. It calls for a change in
perception and outlook of the readers as well, who have been accustomed to
Indian GAAP financial statements.
Differential Characteristics of
IFRS Financial Statement for the Preparers and Readers of Indian GAAP:
a.
Measurement:
i.
Cost v/s Fair value
Under Indian GAAP, we use the cost convention for recording transactions
as against IFRS which has a concept of day 1 P&L, which means that every
transaction has to be recorded at fair value at the date of its initial recognition.
Any value over or below fair value is passed through P&L.
Other than initial recognition, IFRS prescribes fair value measurement
for certain financial assets and liabilities such as Investments in equity
shares, debentures, etc for measurement at every reporting date, unlike Indian
GAAP which requires such items to be at cost.
ii.
Time value of money
It
is said that time is money, IFRS has rightly considered this substance in its
recognition and measurement principles. This has vital application in banking
and finance transactions, to make it simpler, an entity borrowing Rs 100 Crore
for 4 years @ 8% interest p.a with a clause asking upfront fees of Rs 6.5
crores, effectively leads to effective cost of borrowing to 10.05%. IFRS
requires to record borrowing at Rs 93.5 crores and recognize interest @10.05% i.e.
Effective Interest rate (EIR). Table 1 explains the discussed concept.
Table :
1
|
Coupon
|
8%
|
IRR / EIR
|
10.053%
|
Rs in Crs
|
|
Period
|
Principle
|
Upfront fees
|
Interest
|
Cash flows
|
Effective Int. Rt.
|
O/s Carrying Value
|
0
|
100
|
(6.50)
|
-
|
93.50
|
-
|
93.50
|
1
|
-
|
-
|
(8.00)
|
(8.00)
|
9.40
|
94.90
|
2
|
-
|
-
|
(8.00)
|
(8.00)
|
9.54
|
96.44
|
3
|
-
|
-
|
(8.00)
|
(8.00)
|
9.69
|
98.13
|
4
|
(100)
|
-
|
(8.00)
|
(108.00)
|
9.87
|
(0.00)
|
IRR
|
10.053%
|
iii.
Substance based
Here the transactions are recognized with careful assessment of the real
commercial substance, where trade and finance transaction are embedded in the
same invoice, similarly where the service revenue includes sale of goods
element. In these cases, it is important to split the embedded component and
recognize both the components separately at their fair value.
Take for example, Sale of goods at extended credit terms. Sale price
would include an interest element and hence the entity should record revenue at
fair value, which would lower, if goods are sold at market credit period. At
the same time separately accrue interest on the receivable to match the receipt
from customer at the end of the credit period.
Another
example would be say 10% discount vouchers for subsequent purchases by retailer
of electronic goods. The retailers will have to consider the impact of discount
on the first sale and book revenue accordingly instead of booking first sale at
full value and the second sale at 90%. Under IFRS, both, first as well as the
second sale will be booked at 95%, assuming that the customer will return for
the second sale.
iv.
Continuous involvement with assets
This is one of the principle test applied when an entity has to consider
whether it can book a sale or no. This is very commonly seen in factoring
arrangement i.e. discounting of bills receivables. If the discounting is done
with recourse, the entity cannot take the credit to receivable account, instead
it has to book the same as a short term loan. This is because, if the debtor
fails, the discounting bank will come to the entity for recovery of the
underlying receivable.
This test is applied before derecognition of assets as well as while
applying revenue recognition principles i.e. Goods sold but lying in godown on
behest of buyer.
b.
Disclosures:
i.
Critical Estimates, Judgments and Assumptions
While preparing financial statements, management is required to make
estimates for many things such as provision for expenses, virtual certainty for
deferred tax assets, net realizable value, cash flows for impairment testing,
useful lives of assets, etc.
Similarly, there are areas of judgments such as applying the Possible,
Probable and Remote test for contingent liabilities, in recognition and de-recognition of assets,
liabilities, expenses and revenue, etc. Critical estimates and Judgments are to
be disclosed separately after accounting policies.
Assumptions are the ones used in testing impairment, arriving at present
value of liabilities, etc. They are not only disclosed but a few critical ones
are also subject to sensitivity analysis. This means that if the assumptions
change by say 5% + or -, what would the impact on financial statements, commonly
seen in Goodwill impairment testing note in financial statements.
ii.
Exposure & Sensitivity Analysis
Entities are exposed to many variables which impact their performance and
profitability. These include foreign exchange rates, variable interest rates,
commodity prices, etc. For an entity that manufactures goods locally and
exports goods is exposed to foreign exchange rates. Thus if the exchange rate
goes up, the profitability will improve and if it goes down, it will reduce.
Since these variables are not going to be fixed, sensitivity of these variables
on entity’s profitability provides the reader with a fairer view on future
periods profitability and performance expectations.
Example: Table 2:
Carrying
amounts of the Entity’s financial assets and liabilities in different
currencies and sensitivity to income statement is as follows:
|
|||||
As at March 31,
|
20XX ($ million)
|
||||
Financial assets
|
Financial liabilities
|
Effect of say 5%
strengthening in foreign currency
|
Effect of say 5% weakening
in foreign currency
|
||
Indian Rupees (INR)
|
2,345
|
1,000
|
N.A.
|
N.A.
|
|
United States
Dollar (USD)
|
298
|
2,400
|
(105.10)
|
105.10
|
|
Euro (EURO)
|
201
|
765
|
(28.20)
|
28.20
|
|
Great Britain Pound
(GBP)
|
-
|
223
|
(11.15)
|
11.15
|
|
Others
|
12
|
-
|
0.60
|
(0.60)
|
Note: Entity will have to do sensitivity analysis for assets and liabilities
held in any currency other than its functional currency. In the above table 2,
INR is assumed to be the functional currency and USD is the Presentation
currency.
c.
Presentation of Financial Statements
Current & Non current presentation was the first difference noticed when
we compared any IFRS Balance Sheet and Indian Balance sheet. After Schedule VI
format was revised for making it in line with IAS 1, this difference has been
bridged. However, the preparers will
still be impacted when they converge to IFRS because there are still a few
differences that still exist between Revised Schedule VI and IAS 1. These
differences will drastically change the ratios such as debt to equity, current to
non-current and similar. Refer table 3 below for further insights.
Table 3: Few
differences between Revised Schedule VI & IAS 1
|
Revised Schedule VI
|
|
IAS 1 / Ind AS 1
|
1
|
Functional
classification in Profit & loss statement is not permitted.
|
|
Classification
using Functional as well as Nature approach is permitted.
|
2
|
Retirement
Benefits - Can be current as well as non-current.
|
|
Retirement
Benefits - Default Non current.
|
3
|
Share
application Money pending allotment - classified as Quasi Equity
|
|
It is
either Clear Equity or Liability
|
4
|
Interest
accrued on Borrowings - grouped under other liabilities.
|
|
Borrowings
- accounted using effective interest method and hence inclusive of interest.
|
5
|
Redeemable
preference shares - classified as Equity
|
|
Redeemable
preference shares - classified as Borrowings
|
6
|
Convertible
Bonds continue to be classified as Debt with disclosure of conversion terms.
|
|
Convertible
Bonds are split into Debt and Equity.
|
7
|
Contingent
assets are not part of Off balance sheet disclosures.
|
|
Contingent
assets are to be disclosed in notes
|
8
|
Continue
non-current classification if lender has not recalled the loan before
approval of FS
|
|
Need
unconditional right at the balance sheet date irrespective of action from
Bank
|
CA. Sanjay Chauhan