The use of International Financial Reporting Standards (IFRS) globally is enabling companies to access capital markets more easily and at reduced cost, say ANDREW BUCHANAN, global head-IFRS at BDO, the global accounting and audit entity, and KEYUR DAVE, partner & leader of accounting advisory services at BDO India. A talk with Ashley Coutinho on the Indian transition to Ind-AS accounting standards, the closer domestic equivalent of IFRS. Edited excerpts:
What are the key benefits of shifting to Ind-AS?
Dave: New accounting standards are likely to bring more trust among Indian investors, as Ind-AS is better than GAAP in terms of disclosures and accounting issues coverage such as derivatives, embedded derivatives, hedge accounting, business combination and control parameters.
In India, we we will now have two sets of accounting standards. The first is the Ind-AS (rule 2015) for companies which are listed and have a net worth of more than ~250 crore. And, the second is the existing Indian GAAP (rule 2006) for all other companies. This could create confusion in the minds of investors, especially if two companies in the same sector issue their financial statements under a different framework of accounting.
Migration to Ind-AS is expected to increase banks’ provisioning requirements substantially. Would you agree?
Dave: Currently, the credit loss provision is rule-based for banks and nonbank financial companies. Implementation of expected credit losses (ECL) under Ind-AS 109 will bring in a significant change, impacting equity and increasing charges to the profit or loss account. Application of ECL has an all-pervasive effect, as it will influence many stakeholders like investors, regulators, analysts and even audit methodology for auditors.
An expected credit loss approach will depend mainly on the quality and availability of credit risk data. A lack of historical credit risk data will make application of Ind-AS 109 more challenging. Entities are required to continuously monitor credit risk and accordingly ensure proper classification of financial assets into specified stages, since accrual of interest and provisioning is directly linked with stage movement. Incorrect classification might have significant consequences.
The new credit impairment model not only considers historical data but also requires considering forwardlooking information. The latter are related to entities’ own estimate of their customers, like expected recovery patterns and probability of defaults, as well as macro economice factors like recession and unemployment. This will make the transition to Ind-AS difficult for banks.
How will the adoption of Ind-AS impact the way foreign investors look at India?
Buchanan: The fact that financial statements under Ind-AS are closer to IFRS than previous accounting standards will give foreign investors additional confidence. However, this confidence will be limited by the number of carve-outs from, and amendments to, IFRS. In other words, the amounts reported under Ind-AS will not be the same as if they were reported in accordance with IFRS.
What are the key learnings Indian companies could take from global firms which have already adopted IFRS?
Buchanan: IFRS has a mixed measurement model, with a combination of cost, amortised cost and fair value measurement. This is different from the cost model that Indian companies are moving from. Companies need to understand how and why the measurement requirements of IFRS differ, and to be able to explain what the different accounting requirements are and their effects.
Financial reporting has also needed to gradually be better integrated with a company’s ongoing operations. That is, there has been, and continues to be, a growing need to involve parts of the business that might not previously have liaised with the finance department. For example, sales teams need to understand the effects that different contractual terms in sales contracts will have on the amounts of revenue reported in financial statements.
In other jurisdictions, there is substantial focus on so-called ‘disclosure overload’. Financial statements have become long and complex, with many containing disclosures that are uninformative and ‘boilerplate’ in nature. They can contain a substantial amount of immaterial information, while at the same time failing to concentrate on more material items.
A number of initiatives are underway internationally, including the International Accounting Standards Board’s (IASB) Disclosure Initiative project, to improve the quality of financial reporting. Indian companies should take these into consideration in preparing their own financial statements. More widely, there are initiatives around the overall future of corporate reporting, including integrated reporting, aimed at increasing the relevance of a company’s annual report and its content. Again, Indian companies should monitor developments in this area.
What are some key advantages global companies have gained by adopting IFRS?
Buchanan: The key advantages include wider access to capital and reduced costs. The use of IFRS, an internationally recognised set of accounting standards, means investors get increased confidence on the amounts reported in financial statements. This has the potential to make it easier to raise equity and debt capital, and to reduce the associated costs.
Many international stock exchanges either require or permit companies to raise capital on the basis of financial statements prepared in accordance with IFRS. Consequently, the use of IFRS means companies can access those capital markets more easily, and at reduced cost, as there is no requirement for dual reporting under local GAAP and IFRS.
In the past, some countries have adopted elements of IFRS but have made changes to the accounting standards or have ‘carved out’ some of the requirements. In practice, companies in those jurisdictions have not seen the full benefits of adopting IFRS, as investors and lenders do not have the same level of trust in the amounts reported in financial statements. For this reason, some of those countries have subsequently adopted IFRS as issued by the IASB.