The Countdown to Ind-AS — careful evaluation of policy choices

• The near-final Ind-AS
  standard on revenue recognition has not adopted IFRIC 15 for revenue
  recognition from real estate development. Consequently, these agreements have
  been included in the scope of construction contracts, making it mandatory for
  real estate developers in India following Ind-AS to recognise revenue using
  the percentage completion method. This also means that Ind-AS financial
  statements of such real estate developers cannot be considered as
  IFRS-compliant.




• Ind-AS, in its definition
  of equity instruments, includes the equity conversion option embedded in a
  foreign currency convertible bond (FCCB). FCCBs will be considered compound
  financial instruments under Ind-AS and split between the liability and equity
  component at inception, as opposed to being split between liability and
  derivative component under IFRS. This would ensure that the issuer’s income
  statement is not volatile due to changes in value of the conversion option
  driven by changes in the market price of its own equity shares.




• Ind-AS requires that the
  measurement of fair value of financial liabilities designated at fair value
  through profit and loss at inception should not include fair value changes
  arising out of changes in the entity’s own credit risk. However, since the
  option to designate financial liabilities as at fair value through profit and
  loss at inception is not widely exercised, this is expected to impact only the
  few entities which exercise this option.




• Ind-AS requires the
  recognition of bargain purchase gain on day one accounting for a business
  combination in capital reserve, as opposed to profit or loss account under
  IFRS. This is also consistent with the existing principles under Indian GAAP
  enunciated in the current accounting standards on amalgamations and
  consolidation. Our experience indicates that such situations will be rare.




• Ind-AS requires the use
  of government bond rate as discount rate for measurement of employee benefit
  obligations, as opposed to a highly rated corporate bond rate required under
  IAS 19 (unless a deep corporate bond market does not exist). One of the key
  reasons for this deviation is in the argument that a deep bond market does not
  exist in India.




• IFRS 1 mandatorily
  requires a company to present comparative financial statements on first-time
  adoption. Ind-AS gives companies a choice in presenting comparative financial
  statements on first-time adoption. However, the choice to present comparatives
  for the prior year is also only on a memoranda basis and hence would not meet
  the IFRS 1 requirements. Clearly then, an Indian company’s first-time-adopted
  Ind-AS financial statements will not be IFRS 1-compliant financial statements.
  However, this specific carve-out will not impact Ind-AS financial statements
  beyond the first period of transition.

• Ind-AS 1 requires
  entities to present analysis of expenses in the profit and loss account only
  by nature of expenses, e.g., personnel costs, depreciation and amortisation,
  removing the option of reporting expenses by function under IFRS. This is
  expected to be further clarified by the format of financial statements in the
  revised Schedule VI.




• Ind-AS removes the choice
  of subsequently measuring investment property at fair values and requires
  these to be subsequently measured using only the cost model. This may not have
  a significant implication, since companies generally would be inclined to
  adopt the cost model to reduce the volatility in the income statement.




• Ind-AS requires the
  recognition of all actuarial gains and losses arising from employee benefits
  directly in equity, unlike the corridor approach or recognition directly in
  the profit and loss account which are also permitted by IFRS. This is a
  deviation from the current Indian GAAP practice of recognising these directly
  in the profit and loss account. This will reduce the volatility in the income
  statement due to fluctuations in various actuarial assumptions, such as
  discount rate, salary escalation rate, employee attrition rate, etc.

•     Ind-AS removes the option of deducting capital grants from the government from the cost of the underlying fixed asset and allows it only to be set up as deferred income. It also removes the option of initially measuring non-monetary government grants at their nominal value and requires such grants to be measured only at their fair value at inception. This will result in grossing up the balance sheet.

•     IAS 27 includes in its scope an exemption for entities from preparing consolidated financial statements if certain criteria are met. This exemption has not been included in Ind-AS, making it mandatory for all companies to present consolidated financial statements. Currently, under Indian GAAP, only listed companies are required to prepare consolidated financial statements. However, the scope of entities covered in this standard is much wider and covers all unlisted and private companies, including subsidiaries of listed companies.

Optional    deviations from application of IFRS:

•     Ind-AS gives a choice on first-time adoption whereby the carrying value as on the transition date for all property, plant and equipment capitalised before 1st April, 2007, can be the ‘deemed cost’ for first-time adoption of Ind-AS. This exemption entails that all depreciation adjustments to these assets would be applied from the date such deemed cost has been established. Since this is an option, companies may alternatively choose to restate their property, plant and equipment to comply with principles laid in Ind-AS on a retrospective basis, making adjustments for decapitalisation of preoperative expenses, foreign exchange differences and depreciation methods to ensure compliance with international IFRS as well. Entities choosing the carrying value exemption will need to make certain disclosures till the time significant value of the block of existing fixed assets is retained in the books of accounts.

•     Ind-AS gives entities a policy choice to defer the recognition of foreign exchange fluctuations on long-term monetary assets and liabilities over the period of their maturity in an appropriate manner. IAS 21 requires full recognition of such exchange differences in the income statement in the period when incurred. The option under Ind-AS is a one-time accounting policy choice with Indian entities on the date of transition. This policy choice needs careful evaluation, since this will also impact other aspects of accounting, such as capitalisation of borrowing costs and application of hedge accounting principles.

•     Derecognition provisions for financial assets can be applied prospectively from the transition date. Companies who choose to take this exemption will be non-compliant with IFRS till such time that the underlying financial assets continue in the books.

•     Ind-AS also gives an additional ‘impracticability’ exemption for financial instruments to be carried at amortised cost, i.e., if it is impracticable for the effective interest rate or impairment requirements under Ind-AS 39 to be applied retrospectively from the date of the financial instrument. In such a case, for financial assets, the fair value as on the transition date would be the deemed cost as on the transition date.

Additional guidance under Ind-AS where IFRS currently has no guidance:

•     Ind-AS gives additional guidance on accounting for common control transactions which are currently excluded from the scope of IFRS 3 — Business Combinations. Ind-AS requires accounting for these transactions as per the pooling of interest method and requires the acquisition to be accounted for at book values of the acquiree entity on the combination date. All reserves of the acquiree entity will be carried forward in the acquiring entity with any difference between the book value of net assets and consideration recorded as goodwill or capital reserve, as the case may be. Further, this transaction needs to be reflected from the beginning of the earliest period presented in the financial statements, and financial statements in respect of prior periods should be accordingly restated.

Since IFRS currently has no guidance on this topic, companies take the option of either accounting for such transactions at book values or at fair values under IFRS. However, this topic is currently an open project at the IASB level, and the deviation from IFRS would be clearly understood only when final guidance under IFRS is issued.

•     There is additional guidance under Ind-AS 33 Para 12, on earnings per share ‘Where any item of income or expense which is otherwise required to be recognised in profit or loss in accordance with Indian Accounting Standards is debited or credited to securities premium account/other reserves, the amount in respect thereof shall be deducted from profit or loss from continuing operations for the purpose of calculating basic earnings per share.’ This guidance has been added since Indian laws may continue to override accounting standards. Accordingly, if companies are permitted to account for income/expenses directly in reserves pursuant to any law, the impact of the same is appropriately captured in the EPS (a key performance metric for companies).

In summary, barring certain transactions summarised in part 1 of this discussion, Indian companies can choose to be compliant with IFRS through making optimal accounting policy choices on transition. It should be recognised that while the carve-outs discussed above would ease the transition process, the management of each company needs to give careful thought in deciding on accounting policy choices on transition to Ind-AS. The reporting strategy would depend on whether a company wishes to be fully compliant with IFRS on an ongoing basis and fully benefit from the advantages of convergence, i.e., achieve comparability with global peers, avoid dual reporting for raising capital overseas and move towards international quality of financial reporting.