Subscribe to BCA Journal Know More

November 2014

Ind-AS Carve Outs

By Dolphy D’Souza Chartered Accountant
Reading Time 10 mins
You may be aware that adoption of the converged Indian Accounting Standards (Ind-AS) has been prescribed under the Union Budget 2014-2015, voluntarily from the fiscal year 2015-16 and mandatorily from the year 2016-17. The Ind-AS are formed in alignment with the principles of IFRS as issued by the International Accounting Standards Board (IASB). In this article, the learned author points out an illustration of the Ind-AS 40 ‘Investment Property’, wherein some differences between Ind-AS and IFRS have been noted. The author explains therein, the necessity to keep the carve-outs to the bare minimum while finalising the Ind-AS, to ensure that there is global acceptability for financial statements that are prepared using these standards once thay are issued.

The Honourable Finance Minister during the Union Budget 2014-15 announced that Ind-AS would be applicable voluntarily from the year 2015-16 and mandatorily from the year 2016-17. To meet the roadmap, swift measures need to be taken. One key step is the notification of the final Ind-AS on a priority basis. This will help companies in timely preparation for Ind-AS adoption. The author is confident that the ASB and the ICAI will meet our expectations and ensure that the final Ind-AS are notified promptly.

A major part of the world is now reporting under the IFRS as issued by the International Accounting Standards Board (IASB). The last of the developed countries to adopt the IFRS was Japan. Earlier, China too has adopted the IFRS, but retained only one difference between Chinese GAAP and the IFRS. As of now, there are only two significant countries that do not use the IFRS. One is the USA. However, the USA allows the IFRS for foreign private filers. It is also being hoped that the US may ultimately allow US companies to voluntarily adopt the IFRS in future. Besides, for a long time, the US and the IASB have been working together on numerous standards, which has resulted in the US slowly inching towards the US GAAP that is closer to the IFRS. The other significant exception to the IFRS adoption is India.

The IASB is an independent standard setting body comprising of 14 full-time members from different parts of the world. The IASB is also responsible for approving interpretations of IFRS. IFRS’s are developed through an international consultation process, the “due process,” which involves interested individuals and organisations from around the world. The development of an the IFRS is carried out during the IASB meetings, when the IASB considers the comments received on the Exposure Draft. Finally, after the due process is completed, all outstanding issues are resolved, and the IASB members have balloted in favour of publication, the IFRS is issued. This is a very time consuming process, but results in technically solid IFRS’s being issued. It takes into consideration the needs and realities of different countries, and tries to balance them. At times, some of these needs and realities could be conflicting, and it would be impossible to keep all countries happy all the time. Nonetheless, the bottom line remains that the standards should be technically robust, one that would reflect the substance of the underlying business and transactions in a fair and transparent manner.

Most countries that have adopted the IFRS, have adopted them as they are, i.e., without indigenising them to their local GAAP. There were many reasons for taking this approach. Foremost, their local GAAP was developed to meet some regulatory and other objectives such as taxes or capital adequacy or protecting creditors. They did not often reflect the true and fair picture and hence were not typically driven towards meeting the needs of the investors. This had to change and investor needed to be given precedence if capital formation and growth objectives were important for that country.

Most countries that did adopt the IFRS as it is, did so because it enhanced the credibility of the financial statements which resulted in low cost of capital. As major groups have companies all over the world, using one accounting language helped them in preparing consolidated financial statements seamlessly. Using one accounting language across their different companies in the world also meant that their management information systems and IT was consistent across the globe. This made their lives much more predictable, consistent and easier. Today most stock exchanges in the developed world either

require or allow the IFRS. Also, investors around the globe understand the IFRS and are very comfortable with it. Any country that departs from the IFRS will not receive any of the above benefits. For example, in countries such as Singapore and Hong Kong, local standards are largely aligned to IFRS, but there are very few differences. This does not allow Singapore/Hong Kong entities to demonstrate compliance with IASB IFRS.

The Credit Lyonnais Securities Asia (CLSA) and the Asian Corporate Governance Association (AGCA) recently released their seventh joint report on corporate governance in Asia. Among other matters, the report ranks 11 Asian markets on macro Corporate Governance (CG) quality. A perusal of the report extracts indicate that amongst the 11 Asian countries, India has got the lowest rating on accounting and auditing matters as it has not implemented IFRS. Due to the same reason, India’s rating has also declined vis-à-vis previous periods. The chart given above depicts this.

The adoption of Ind-AS will resolve these issues and bring India at par with the world at large that has adopted IFRS. To achieve full benefit, it is imperative that Ind- AS’s are notified without any major difference from IASB IFRS. If India were to implement the IFRS with too many differences, it would be akin to moving from one Indian GAAP to another Indian GAAP. It would not be possible for Indian companies to state that they are compliant with the IFRS, and hence, those financial statements will be treated as local GAAP financial statements. More importantly if an Indian company wants to prepare IASB IFRS financial statements in the future, it will have to convert again from Ind-AS to IASB IFRS.

At the same time, it is appreciated that accounting is an art, and not a precise science. Primarily, financial statements should reflect and capture the underlying substance of transactions. The accounting standards are drafted to ensure that underlying transactions are properly accounted for and also aggregated and reflected transparently in the financial statements. But as already pointed out, this is not a precise science, and people may have different views on how to achieve this objective. Also at times, countries depart from the basic objective of true and fair display, to help companies in difficulty and pursue other unrelated objectives. Hence, a country may desire to have a few carve-outs in exceptional circumstances from IASB IFRS. To illustrate, it is believed that in the Indian scenario, classification of loan liability as current merely based on breach of minor debt covenant, say, few days delay in submission of monthly stock statement to bank, does not reflect the expected behaviour of the lender (who may ultimately condone the violation) and may create undue hardship for Indian corporates.

On the other hand, the proposed removal of the fair valuation option under Ind-AS 40 with respect to investment property, does not appear to be reasonable as can be seen from the arguments in the table below. This is not typically a carve-out, but certainly removes one option provided in the IFRS.

Ind-AS 40 Investment Property


IAS 40 allows entities an option to apply either the cost model or the fair value model for subsequent measurement of its investment property. If the fair value model is used, all investment properties, including investment properties under construction, are measured at fair value and changes in the fair value are recognised in the profit or loss for the period in which it arises. Under the fair value model, the carrying amount is not required to be depreciated.

Ind-AS 40 hosted on the MCA website does not permit the use of fair value model for subsequent measurement of investment property. It however requires the fair value of the investment property to be disclosed in the notes to financial statements. It is understood that the ICAI may now be proposing to retain fair valuation model for subsequent measurement of investment property. However, all changes in the fair value will be recognised in the OCI, instead of profit or loss. It is expected that the proposed fair valuation model may be similar to revaluation model under Ind-AS 16 Property, Plant and Equipment.

Technical perspective

Before issuing the IAS 40, the IASB had specifically considered whether there was a need for issuing separate IFRS for investment property accounting or should it be covered under the IAS 16 Property, Plant and Equipment. After detailed evaluation and consultation with stakeholders, the IASB decided that characteristics of investment property differ sufficiently from those of the owner-occupied property. Hence, there is a need for a separate IFRS. In particular, the IASB was of the view that information about fair value of investment property, and about changes in its fair value, is highly relevant to the users of financial statements.

An investment property generates cash flows largely in-dependently of other assets held by an entity. The generation of independent cash flows through rental or capi-tal appreciation distinguishes investment property from owner-occupied property. This distinction makes a fair value model (as against revaluation model) more appropriate for investment property.

The ICAI proposal for allowing fair valuation for investment property is unclear. Particularly, it is unclear whether a company will need to depreciate investment property. Since a company is not recognising fair value gain/ loss in P&L and on the lines of revaluation model in Ind-AS 16, it appears that companies may need to charge depreciation on investment property in profit or loss for the period. This means that while a company will charge depreciation on investment property to profit or loss; it will recognise fair value change directly in OCI. This may give highly distorted results.

In case of investment property companies, investors and other stakeholders measure performance based on rental income plus changes in the fair value. Under the ICAI proposal, no single statement will reflect such performance of an investment property company. A major global accounting firm had conducted a survey in India “IFRS convergence: an investor’s perspective.” Among the survey participants, 67% were in favour of allowing fair value model for investment property as an option to the cost model.

The author would therefore strongly support retaining the fair valuation option under IAS 40. India is at the threshold of introducing new structures such as REIT to provide a boost to the infrastructure and real estate sector. Fair valuation would be the most appropriate basis for investors to enter or exit out of these funds. Hence, retaining the fair valuation model under IAS 40 is imperative.

IASB IFRS may not necessarily provide the best answers in all cases, and there may be a few instances where the standards could have been much better. Nonetheless, the author believes that the standard setters and regulators will have to consider the benefit of these carve outs with the benefits lost as a result of departing from IASB IFRS. Ultimately, it is not about one-upmanship but aligning with the world. In my view, full adoption of IASB IFRS is a goal worth pursuing. At the same time the standards setters and regulators should engage with the IASB in resolving the Indian specific pain points amicably. As an alternative approach, the author suggests that companies should be allowed an option to adopt IASB IFRS, instead of Ind-AS, if they wish to.

In the long-run, the standard setters and regulators should work closely with the IASB so that any differences that arise are resolved more promptly. A mutually respectable relationship can be built with the IASB, where the IASB and the world can gain from India’s participation in the standard setting process and simultaneously India can also benefit from the process in improving its financial reporting framework.

You May Also Like