Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
ON IFRS
INTERNATIONAL
FINANCIAL
REPORTING
STANDARDS
RAMA KRISHNA VADLAMUDI
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More than 120 countries now require or permit the use of IFRSs or
are converging with the International Accounting Standards Board's
(IASB) standards.
The picture below shows the level of IFRS adoption at present. Blue
areas indicate countries that require or permit IFRSs. Grey areas are
countries seeking convergence with the International Accounting
Standards Board (IASB) or pursuing adoption of IFRSs.
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CONTENTS Page
1 Abbreviations used 3
2 Executive Summary 4
3 What is IFRS and its importance? 6
4 What are standard-setting bodies? 7
5 What are IASB and IASC Foundation? 7
6 What is the role of IOSCO? 8
7 Why do we need financial statements? 9
8 What are the objectives of Financial Reporting Standards? 10
9 What is the status of international adoption of IFRS? 11
10 What are the latest developments in IFRS? 11
11 What is global financial standards convergence? 12
12 What are the obstacles to global covergence? 13
13 Why is vital for investors to know about IFRS? 13
14 How does USGAAP compare with IFRS? 13
15 Does India need IFRS standards? 15
16 What is India's roadmap for IFRS convergence? 16
17 What are the issues involved in IFRS convergence in India? 17
18 How are Indian Banks preparing for IFRS? 19
19 What is the importance of new IFRS 9 on profits? 20
20 Some Important IFRS standards 21
1. ABBREVIATIONS USED
ADS : American Depository Share
CBDT : Central Board of Direct Taxes (of India)
FASB : Financial Accounting Standards Board (of the USA)
FCCB : Foreign Currency Convertible Bond
FIFO : First in, first out (a method used in inventory valuation)
FSA : Financial Services Authority (of the UK)
GDR : Global Depository Receipt
IASB : International Accounting Standards Board
IASC : International Accounting Standards Committee
IASCF : International Accounting Standards Committee Foundation
ICAI : Institute of Chartered Accountants of India
IFRS : International Financial Reporting Standards
IOSCO : International Organization of Securities Commissions
IRDA : Insurance Regulatory and Development Authority (of India)
LIFO : Last in, first out (a method used in inventory valuation)
MCA : Ministry of Corporate Affairs (India)
NACAS : National Advisory Committee on Accounting Standards (India)
RBI : Reserve Bank of India
SEBI : Securities and Exchange Board of India
SEC : Securities and Exchange Commission (of the US)
SOX : Sarbanes-Oxley Act
USGAAP : Generally Accepted Accounting Principles of the US
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2. EXECUTIVE SUMMARY
The financial year 2011-12 is going to be one of the most significant years since
the introduction of economic reforms in 1991 in india. Its significance can be
gauged from the fact that three important legislations are coming into effect from
April 1, 2011 as per the present indications and available information. They are:
These new acts are going to be very complex for ordinary investors. The
implications for companies are quite humungous. As such, investors need to be
well prepared for the changes that are going to happen in the next one year. All
these legislations and standards are going to be game changers in India.
Investors who overlook the impact are going to pay a heavy price for their
ignorance.
Ramesh Damani, a veteran broker from Bombay, has gone on record saying that
if the DTC implemented as per the draft released in August 2009, there is going
to be huge sell-off in the stock markets before the deadline of April 1, 2011 (DTC
proposes to eliminate the difference between long-term capital gains and short-
term capital gains on shares and mutual funds. Both LTCG and STCG will be
taxed at the rate of the individuals or others. At present, tax on LTCG is NIL and
tax on STCG is 15 per cent exclusive of surcharge and education cess.)
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The biggest economy US, however, is slow to move from its USGAAP to IFRS. It
has been trying to narrow down the differences between its USGAAP and IFRS
accounting standards. Still, there are significant differences between USGAAP
and IFRS in the following areas: Upward revaluation of fixed assets, LIFO/FIFO
inventory valuation, treatment of extraordinary items and others. There are big
inconsistencies in the treatment of dividend/interest received and
dividend/interest paid between USGAAP and IFRS cash flow statements. The
development of IFRS and its convergence are on an evolutionary phase.
Leading companies and banks in India are gearing up to meet the deadline of 1st
of April 2011 set by the Government of India. The country’s leading bank, State
Bank of India, has set up a separate team to migrate to IFRS. RBI and Indian
Banks Association have been working together to set IFRS guidelines to banks.
IFRS stands for International Financial Reporting Standards. IFRS standards are
set by an international body known as IASB. The objectives of IFRS are to
establish a single set of high quality global accounting standards that can be
adopted by several companies across countries and continents. More than 120
countries have already adopted or are at an advanced stage of implementing the
IFRS at their national level. Countries, like, Australia, the UK, countries in the
European Union and several countries in Africa have already moved toward
IFRS. Countries, like, Brazil, Canada and India are shifting their national
standards to IFRS in the next one year. The US has been making a slow
progress from its USGAAP standards to IFRS and it may take several more
years for complete convergence.
The IFRS standards are more transparent and easily acceptable to several users
of financial statements. Disclosure standards are very high under IFRS.
Comparability of companies’ balances sheets and income statements is much
more easier under IFRS.
The term IFRS refers to the new numbered series of pronouncements that the
IASB is issuing, as distinct from the International Accounting Standards (IASs)
series issued by its predecessor. More broadly, IFRS standards refer to the
entire body of IASB pronouncements, including standards and interpretations
approved by the IASB and IASs and SIC interpretations approved by the
predecessor International Accounting Standards Committee. IASs start from IAS
1 up to IAS 41; while IFRSs start from IFRS 1 up to IFRS 9. Some of the IASs
are superseded by other standards. All these IASs and IFRSs have been
effectively implemented except IFRS 9 which is slated to be implemented with
effect from 1st of January 2013. In addition, IASB has developed another IFRS for
SMEs (Small and Medium-sized Entities) which was implemented in 2009.
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The objective of the IASC Foundation and the IASB is to develop, in the public
interest, a single set of high-quality global accounting standards. In pursuit of this
goal, the IASB works in close cooperation with stakeholders around the world,
including investors, national standard-setters, regulators, auditors, academics,
and others who have an interest in the development of high-quality global
standards.
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The body is responsible for the cooperation among capital market regulators to
promote high standards of regulation in order to maintain just, efficient and sound
markets. The regulators exchange information and unite their efforts to establish
standards; effective surveillance of international securities transactions and
promote the integrity of financial markets around the world. It is also working for
the promotion of uniform regulation.
IOSCO works closely with IASB, IASC Foundation, other standard-setting bodies
and regulators for the global convergence of accounting standards.
A variety of users use the financial statements, like, balance sheet, profit and
loss account, cash flow statement and others of companies and other entities.
The body of users includes investors, creditors, credit rating agencies, bankers,
financial analysts, management, regulators, standard-setting bodies, auditors
and shareholders.
The financial statements are most important in security analysis and valuation. In
fact, these are the springboards to know about a company’s financial health and
the soundness of its operations.
With the help of financial statements, the users are expected to assess the
financial position of a company in terms of assets, liabilities and equity. In
addition, they can measure the financial performance in terms of income and
expenses.
Likewise, an analyst may want to find out the valuation of a listed company for
investment purposes; then she has to necessarily dissect the numbers given in
the financial statements of the company. These are only a few examples.
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According to IASB, the following are the necessary financial statements and
fundamental principles underlying their preparation:
As the financial statements are used by a large number of stakeholders, they are
to be prepared by accountants in such a uniform and consistent way so that all
the users of the statements understand them in a like manner. There should not
be any confusion among the users with regard to figures, statistics or
interpretation of the financial statements. There is a need to maintain consistency
in financial statements and to make them understandable to all in a simple and
similar way.
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The following table shows the status of IFRS adoption across continents:
(The list is only for information purpose. For accuracy of information, please refer to the
respective countries’ standard setting bodies:
AFRICA Egypt, Kenya, Malawi, South Africa and Tanzania have made it
mandatory for domestic companies to adopt IFRS
ASIA Japan is adopting IFRS in a phased manner wef 31st of March 2010.
India has made it compulsory for big companies to adopt IFRS from
1.4.2011. China has implemented IFRS for domestic companies.
Around 150 Chinese companies are listed on the Hong Kong Stock
Exchange and they are permitted to use IFRS or HK standards.
Singapore, Burma, Sri Lanka and Hong Kong have implemented
standards similar to IFRSs with some exceptions.
AUSTRALIA Australia and New Zealand have already adopted IFRS
CANADA It is adopting IFRS from 2011
EUROPE The European Union (EU) has already made it mandatory for EU
countries to adopt IFRS since 2005
RUSSIA It has introduced IFRS for banks and other companies in a phased
manner. But Russia's national standards differ from IFRSs significantly.
SOUTH Countries, like, Ecuador, Nicaragua, Peru and Venezuela have
AMERICA adopted IFRS in the past in a phased manner. Brazil is adopting IFRS
with effect from December 2010.
UNITED The US has in principle agreed to switch over to IFRS. The US is trying
STATES for convergence with IFRS but the process is slow and may take
several more years.
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The IASB and FASB have made progress towards substantial convergence
between IFRSs and USGAAP. Several memoranda of understanding were
signed since 2006 and in November 2009 the two boards issued a further
statement outlining steps for completing their convergence work by 2011.
Most recently, at their September 2009 meeting in Pittsburgh, US, the Group of
20 Leaders (G20) reaffirmed their commitment to global convergence in
accounting standards, calling for a single set of high-quality, global accounting
standards within the context of their independent standard-setting process, and
complete their convergence project by June 2011. Japan is moving towards IFRS
with effect from 31st of March 2011 in a phased manner. Brazil too is shifting
towards IFRS with effect from December 2010.
The degree of globalization has increased by several folds in the past two
decades. This calls for a need to have uniform and consistent set of regulations
that can be used by investors and analysts across the world. From the principles
of consistency, uniformity and correct interpretation of financial statements, there
is a vital need for adoption of single set of standards that are useful to all types of
global users of financial statements. As of now, more than 120 countries have
adopted IFRS standards at their national level – some partially and some fully.
The USA, the biggest country financially, is yet to adopt these standards creating
a need to unite their standards with those at the international level. As such,
IASB and FASB have been working together to move towards the goal of single
set of accounting standards accepted by the entire world. This is necessary to
achieve the objective of eliminating the differences between IFRS and USGAAP.
Towards this direction, both IASB and FASB came to an agreement in 2002
known as “Norwalk Agreement” setting out their commitment to the development
of compatible accounting standards that are useful to all. The FASB has been
working with IASB for convergence of USGAPP to IFRS and narrow the
differences. However, full alignment between IFRS and USGAAP, for a creating
a unique set of globally accepted accounting principles, may take much longer
time according to the present indications. A common set of high quality global
standards remains a priority for both the IASB and the FASB.
Accounting Scandals involving corporations, like, the Enron Corporation,
Worldcom and Arthur Andersen of the US in the early 2000s, have highlighted
the role of accounting standards in maintaining utmost integrity. These high
profile scandals have led to the introduction of Sarbanes-Oxley Act (SOX) in the
US in 2002 in order to strengthen investor protection laws. Even India suffered
corporate scandals from the likes of Satyam Computers in early 2009.
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Accounting standards are important for companies. For example, on March 31,
2009, Government of India diluted accounting standard AS-11, pertaining to
mark-to-market provisioning for foreign exchange-related gains and losses;
allowing foreign exchange losses to be deducted from the cost of fixed cost for
the financial year 2008-09 by postponing the implementation of AS-11 from
March 31, 2009 to March 31, 2011. This dilution has helped quite a few large
companies (like, Reliance Communications, Tata Motors, JSW Steel, Sterlite
Industries, M&M, Bharat Forge and Ashok Leyland) report a better profit picture
as on 31st of March 2009.
Likewise, the IFRS migration is going to impact the Indian companies in different
ways in terms of their profits, quarterly results, treatment of extraordinary items,
consolidated financial statements, etc. Only experts can fathom the impact on
profits and the size of the balance sheet. One can expect research reports from
brokerages, research houses and firms in the next one year, detailing the impact
of the newly developed accounting standards. Assessing the impact of IFRS
standards on holding companies with several subsidiaries – foreign as well as
local – is much more complex due to the enormity of IFRS standards and its
Framework. It will be a Himalayan task for analysts to decipher the ramifications
from a balance sheet and income statement perspective.
There are significant differences between IFRS and USGAAP. While calculating
financial ratios, analysts need to be aware of them. For example, USGAAP
allows LIFO method of inventory valuation which allows US companies to report
lower profits and consequently pay lower taxes in an inflationary environment.
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By using LIFO method, US companies will be able to show higher raw material
cost in the income statement which depresses the net income* and resulting in
lower taxes for them.
This will ultimately gets reflected in profitability ratios, like, Return on Equity
(RoE), etc. With lesser profits to declare, the companies will show lower RoE.
Historical data suggests that the difference in RoE for IFRS and USGAAP
calculations can be as large as 3 to 4 per cent in several cases.
(* The word ‘net income’ is used in the context of international terminology and followed in the US and
other countries. Net income is equal to net profit – the latter word is used in India for profit after tax. In
this article, whenever the word ‘net income’ is used, it is used in the context of net profit only.)
There are a large number of differences between the provisions of these two
standards. Presenting all of them is outside the scope of this article. Following
are some of the main differences:
IFRS USGAAP
Note: USGAAP allows LIFO method of inventory valuation, which allows US companies
to report lower profits and pay lower taxes during an inflationary period
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IFRS USGAAP
As can be seen from above, IFRS permits more flexibility in classifying cash flows
Even during the summit meeting of the Group of 20 leaders (G-20) held in
September 2009, India had committed itself to global convergence in accounting
standards and complete the convergence project by June 2011.
Several Indian companies and banks have created separate bodies for eventual
implementation of IFRS as per the roadmap for transition. IFRS-compliant
financial statements have a high brand value globally and the transition to IFRS
will allow Indian companies to list their shares on foreign bourses much more
easily. Companies may be able to get better credit rating from agencies.
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The Indian Government had on 22nd of January 2010 released the roadmap for
convergence of Indian Accounting Standards with the globally acknowledged
International Financial Reporting Standards (IFRS). The Core Group, constituted by
the Ministry of Corporate Affairs for convergence of Indian Accounting Standards
with IFRS from 1st of April 2011, that held its meeting on 11th of January 2010
had agreed for a clear roadmap. There will be two sets of accounting standards:
* When the accounting year ends on a date other than 31st March, the
conversion of the opening Balance Sheet will be made in relation to the first
Balance Sheet which is made on a date after 31st March.
If an Indian company's financial year is April to March, that company will have to shift
to IFRS with effect from FY 2011-12, if it falls under phase 1. Accordingly, the
company will have to reset its balance sheet for FY 2010-11 as per IFRS.
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The transition to convergence between Indian GAAP and IFRS is not going to be
smooth. As mentioned above, the transition is going to be done in a phased
manner in the next four years. The following are some of the issues that need to
be sorted out before the elimination of differences:
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With the Government deciding to implement IFRS with effect from 1st of April
2011 in a phased manner, RBI is expected to come with clarifications on how
IFRS will be implemented in Indian Banks. The regulator is a member of a
committee convened by the ministry of corporate affairs to finalize IFRS rules
that will be applicable in India.
Indian Banks Association (IBA), an industry body of Indian Banks, has set up a
committee to guide banks in shifting towards IFRS framework. A lot of issues
have to be addressed and banks have to adopt IFRS suitably to fit India’s need.
The following issues will have a big impact on banks while adopting IFRS:
1. Provisioning for NPAs will change radically. Indian Banks currently follow
RBI norms and Indian Accounting Standards according to which losses
due to non-performing assets is based on what is actually incurred. But
under IFRS, banks will have to make an estimation of all future NPAs
based on an expectation of losses leading to upfront recognition of losses.
2. Presentation of financial statements
3. Financial Instruments-Disclosures: The two main categories of disclosures
required by the new IFRS standard No. 7 are: (i). information about the
significance of financial instruments and (ii). information about the nature
and extent of risks (liquidity risk, market risk and credit risk) arising from
financial instruments. The IFRS 7 provides for extensive disclosures under
the above two categories and it will be a daunting task for the banks to
disclose all such information in their financial statements.
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Overview of IFRS 9:
The new standard IFRS 9 is expected to be implemented with effect from 1st of
January 2013. It will replace the existing IAS 39. According to IFRS 9, all
financial assets are initially measured at fair value plus, in the case of a financial
asset not at fair value through profit or loss, transaction costs.
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IFRS 9 divides all financial assets that are currently in the scope of IAS 39 into
two classifications – those measured at amortised cost and those measured at
fair value. The new IFRS 9 does away with the classification of Available for Sale
(AFS) and Held to Maturity (HTM) categories for financial assets (under the
existing IAS 39), which are extensively used by companies and banks now.
Debt instruments: A debt instrument that meets the following two conditions can
be measured at amortised cost (net of any writedown for impairment): 1. An
entity is holding the financial asset to collect the future cash flows and 2. The
contractual cash-flows are solely payments of principal and interest.
All other debt instruments must be measured at fair value through profit or loss
(FVTPL).
Equity instruments: All equity investments in scope of IFRS 9 are to be
measured at fair value in the balance sheet, with value changes recognised in
profit or loss, except for those equity investments for which the entity has elected
to report value changes in 'other comprehensive income'. There is no 'cost
exception' for unquoted equities.
'Other comprehensive income' option: If an equity investment is not held for
trading, an entity can make an irrevocable election at initial recognition to
measure it at fair value through other comprehensive income (FVTOCI) with only
dividend income recognized in profit or loss.
Derivatives: All derivatives, including those linked to unquoted equity
investments, are measured at fair value. Value changes are recognised in profit
or loss unless the entity has elected to treat the derivative as a hedging
instrument in accordance with IAS 39, in which case the requirements of IAS 39
apply.
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Sources:
1. www.iasb.org
2. www.iosco.org
3. www.iasplus.com
4. Press release of Ministry of Company Affairs
5. Newspapers and websites
6. www.cfainstitute.org
Disclaimer: The views of the author are personal. This research paper is prepared for
information purpose to the general reader only. For correct interpretation of the
provisions and tax-related matters, readers are advised to consult their recognized tax
consultants or qualified chartered accountants.
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