Basics of International Financial Reporting Standards

Background

Financial statements are the documents that indicate the financial condition of an entity. The financial statements prepared for the use by the shareholders, government, borrowers, creditors, customers, credit rating agencies etc., include a Balance Sheet, Statement of Profit and Loss, Statement of Cash Flows, Statement of Change in Equity, Significant Accounting Policies and Notes to Accounts. These are also called as general-purpose financial statements since it is prepared not for any specific purpose.

General purpose financial statements are prepared based on certain standards or framework to ensure uniformity in presentation, consistency in disclosure or presentation requirements, comparability between entities, etc., Therefore, these standards or framework is like a language in which the financial statements are prepared. Normally, every country has its law relating to management of corporate or non-corporate entities, like we have Companies Act 2013 for companies. Where a company has operation in multiple jurisdictions or geographies, it would naturally be difficult and challenging to prepare the financial under each of the country specific regulation. Yes, that meets the requirement of the regulator but from a business perspective, it cannot have a single view of the financial position since each financial statement is prepared in different accounting framework (GAAP - Generally Accepted Accounting Principles). Entities then would have to prepare consolidated accounts by converting each of the standalone financial into a common accounting framework, which is time consuming and may not much value. Hence, there was a thought why not have one single framework for preparing financial statements across the globe. Welcome to International Financial Reporting Standards ('IFRS'), the international language of financial reporting.

IFRS

The International Accounting Standards Committee ('IASC') was formed in 1973, by few accountancy regulating bodies. In 2001, the International Accounting Standards Board ('IASB') was born and all accounting standards issued was name prefixed 'IAS'. Later, this was renamed as International Financial Reporting Standards and accounting standards issued after renaming was prefixed with IFRS. Where any standards of IAS regime were withdrawn and reissued, it was renumbered under IFRS. For example, IAS 17 lease accounting was withdrawn and IFRS 16 was released.

International Recognition

In case of European Union ('EU'), from 1 January 2005 all consolidated accounts of the EU Listed companies should be following IFRS. Many other countries have also adopted IFRS. As per IFRS website, 120 nations and reporting jurisdiction permit or require IFRS for domestic listed companies, although approximately 90 countries have fully conformed with IFRS as promulgated by the IASB. The world's major economy i.e., United States of America ('USA') have not adopted IFRS till date. USA have their set of standards which is known as US GAAP. Though the SEC of US allows use of IFRS for the subsidiaries outside US, for the purpose of reporting US GAAP is the standard that needs to be complied with. US Financial Accounting Standards Board ('FASB') and IASB are continuously working to ensure the differences in the standards are minimized or bridged.

Indian Scenario

The Institute of Chartered Accountants of India ('ICAI') came up with a concept paper on convergence with IFRS in 2007. But after much delay, India did not adopt IFRS as it is, but had standards converged to IFRS, as required in Indian business or economic conditions and named it as Indian Accounting Standards or Ind AS ('Companies (Indian Accounting Standards) Rules, 2015'). Ind AS is predominantly IFRS minus carve-out (i.e., exceptions). Ind AS was made mandatory from 1^st April 2016 for all listed companies, unlisted companies with net worth of equal or more than Rs.500 Crores and included the parent, subsidiary, associate and joint venture of these companies / entities. (together called as 'group'). From 1^st April 2017 it was made applicable to all unlisted companies having net worth equal to more than Rs.250 Crores and the group companies / entities. For NBFC, Ind AS was made applicable from 1^st April 2018. Reserve Bank of India ('RBI') and Insurance Regulatory Development Authority ('IRDA') have deferred implementation of Ind AS to banks and insurance companies. However, if a company has a subsidiary which is a bank or insurance company, the accounts of these companies would have to be prepared under Ind AS only for the purpose of consolidation and not for regulatory reporting. The naming convention of Ind AS is very similar to IAS. For example, IAS 2 is denoted as Ind AS 2. IFRS 1 is denoted as Ind AS 101.

Further changes to the nomenclatures in Indian scenario are:

1. Statement of Financial Position is called as Balance Sheet;
2. Statement of Comprehensive Income includes both statement of profit and loss and other comprehensive income (which may be presented separately or as a single statement), however we have adopted it as Statement of Profit and Loss and Other Comprehensive Income as a single statement.

How different is Ind AS from the earlier standards?

Ind AS is very different from the standards we already had ('Companies (Accounting Standards) Rules 2006') or CAS 2006 or AS. Let's analyze predominant or some of the fundamental differences between the two:

1. Transition Standards - Ind AS 101 is the standard to be followed on transition to Ind AS. Earlier standards did not have a specific standard on transition. Ind AS 101 prescribes certain exceptions or exemptions to ease transition. These exemptions can be used only at the time of transition.
2. Standards on Financial Instruments - Ind AS brings in an elaborate accounting standard for financial instruments (receivables / payables / equity shares / preference shares / loans etc.,) which were absent before.
3. Fair Valuation - All our financial statements were prepared on historical cost basis. However, in Ind AS, fair valuation is mandatory for all the financial instruments, subject to of course applicability and materiality aspects. Further, there is a detailed disclosure required on the fair valuation methodology used, assumptions made, risk management framework etc.,
4. Prior Period Items - Ind AS does not permit accounting of prior period items. If you there is an accounting error discovered, then the entity has to prepare an opening financial statement, adjust the reserves accordingly.
5. Extra-ordinary items - Ind AS does not reckon any item as extra-ordinary in Statement of Profit and Loss.
6. Constructive obligation - An entity would require to make a provision for an obligation that originates from entity's action i.e., as a past practice or published policies or any statement made which indicates it will accept certain responsibilities and has created a valid expectation on the part of the other parties that it will discharge such responsibilities. This provision would be required even if there are no legal or contractual obligations.
7. Classification of subsidiary - Subsidiary relationship would be tested for whether the parent company has control over relevant activities and whether it can influence the returns of another entity by various means including the voting rights, agreements, and other factors; which is beyond the concept of concluding an entity to be subsidiary only by merely holding 51% or more of the ownership or composition of the board.
8. Revenue Recognition - Go beyond transfer of risk and rewards to adoptinga 5-step model requiring satisfying specific obligations and transfer of control to the customer.
9. Lease Accounting - Operating lease which was hitherto an off-balance sheet item, is now recognized and accounted as though it is a finance lease.

Impact on business

1. Net worth and profitability: Any changes at the transition point, is charged to the opening balance of reserves and surplus and hence, there could be either positive or negative impact considering the transition provisions. Further, standards on revenue recognition, lease accounting, etc., could either be favorable or unfavorable to the profitability.
2. Treasury and Finance: Changes in the accounting ratios and balances may impact compliance with loan covenants. There are have been cases where say, a preference share which hitherto was classified as share capital is treated as a debt and if this had not been redeemed in time, is a current financial liability. One can imagine the impact on the ratios of an item in capital turns out to be current financial liability.
3. Managerial Remuneration: Where the remuneration is indexed to performance and the parameters have changed, the evaluation of compensation would need to be reviewed.
4. Information Systems: To ensure that the current information system can take care of changes due to Ind AS, including from chart of accounts, classification, fair valuation changes, etc.
5. Internal Financial Controls: Significant impact on ensuring accuracy and completeness of data required. Redesign controls to ensure risks of misstatement in financial statements are mitigated.
6. Stakeholder awareness: Other stakeholders like creditors, shareholders, etc., should understand the requirements of the new standard and hence elaborate disclosures would be required.
7. Need of professional help: May require services of experts in valuation for complex financial instruments.
8. Taxation related: Income Computation and Disclosure Standards ('ICDS') are very different from Ind AS. There would be a need for more accounting and reconciliations because of difference in the standards. Similarly, revenue as per GST provisions are quite different from Ind AS.

Conclusion

The above are only some thoughts based on our experience with IFRS. Globalization is a reality and we have accepted this in the past. The carve-outs would also be removed (at least expected) over a period of time and we could surely see a time when the whole world uses a single accounting language.

The author, Aditya Kumar S is a qualified Chartered accountant with 20+ years of experience in his field. He carries immense knowledge in his areas of expertise and interest, namely statutory audit, internal audit and SOX audit gained through numerous and varied client assignments he has dealt with. He is a partner in South India's well known mid-size firm.