Introduction
In accordance with the road map, phase 2
entities have started providing quarterly results under Ind AS starting from
the first quarter of 2017-18 with comparative Ind AS numbers for 2016-17. Under
Ind AS 101, the first time adoption choices are open and can be changed till
the preparation of the first annual financial statements for 2017-18. Also,
quarterly results do not include the disclosures required in the Ind AS annual
financial statements. It is therefore worthwhile for Phase 2 entities to learn
from Phase 1 Ind AS implementation. Below are some important tips.
Use the right people in the Ind AS conversion process
The existing accounting staff may not be Ind
AS literate, and therefore will need to be trained under Ind AS. However,
expertise does not come from mere training. Expertise comes from several years
of engagement in working on IFRS/Ind AS. Therefore, it will be worthwhile to
consider external help or recruit someone with Ind AS knowledge, expertise and
implementation experience.
Align all stake holders
Phase 1 entities have experienced that Ind
AS is not a mere accounting change, but has significant business impact.
Therefore, the CFO should be significantly involved in the Ind AS conversion
process, and also keep the CEO in the loop. The conversion process entails
taking numerous business decisions, which only the CFO or the CEO can take.
Other stakeholders that may need to be
aligned are regulators, investors and analysts, audit committee, board of
directors and various business heads of the organisation. In one particular
instance which the author is aware of, the Ind AS financial statements were
quite delayed, because the independent directors did not want to identify
themselves as key management personnel (KMP) in the financial
statements. It may be noted that independent directors are not KMPs under
Indian GAAP, but under Ind AS they would be disclosed as KMPs. It took the
CFO and the auditors quite some time to convince the Independent directors that
they were indeed KMPs for Ind AS disclosure purposes.
Consider impact on debt/equity ratio
Many
instruments that are classified as equity under Indian GAAP could be a
liability under Ind AS. Consider a simple scenario, where a PE firm has made
investments in the preference shares of a company, and has a put option of
those shares on the Company, if exit is not achieved within the specified
period through a successful IPO. This instrument would be classified by the
Company within the shareholder’s fund under Indian GAAP. However, under Ind AS
such an instrument is classified as financial liability, because the issuer
Company has no unconditional right to avoid payment of cash, if the IPO is not
successful. Further, a successful IPO is beyond the control of the issuer
Company as it is dependent on numerous factors, which the issuer Company cannot
change, for example, the stock market condition. This is a case where equity
under Indian GAAP is reclassified as loan under Ind AS.
In this
scenario, some Phase 1 companies have changed the arrangements with the PE,
such that the put option is not on the Company, but on the promoters of the Company.
In such a case, the financial liability is that of the promoter and not of the
Company. However, this change could be a very time consuming process as the PE
investor would need to be convinced. Therefore, it is important for Phase 2
companies to start early, in order to avoid last minute hiccups.
Consider income tax implications
One of the biggest impact areas of Ind AS
conversion is income-tax, which could be either positive or negative. Consider
a company that is restructuring its debts with the bank, wherein the bank takes
a hair-cut. The sacrifice the bank makes, is a gain for the borrower company,
and will be credited to the profit and loss account. A huge credit to the
P&L account, may result in a MAT liability even for a company that was otherwise
making book losses.
Besides the impact of Ind AS on income tax
on an ongoing basis, the Company also needs to consider the impact of first
time adoption adjustments. Phase 2 entities have a clear advantage over phase 1
companies in this regard. Phase 2 entities have a clear visibility on the
various requirements, which were available to phase 1 entities only at the last
minute. This is elaborated in the following paragraph. Phase 2 entities should
therefore have a clear plan and not waste any time in making the right first
time adoption choices.
Finding the sweet spot was not easy for
phase 1 entities. Consider a company which wants to reflect a better net worth
and therefore, used the Ind AS deemed cost option of fair valuing the fixed
assets. As MAT provisions were not clear at that point in time, these companies
were afraid of what the MAT implications would be, and hence the choice of fair
valuation was only tentative. Eventually, fair valuation of fixed assets on
first time adoption was made MAT neutral in the budget, which led to the
tentative decision becoming a final decision. Next, phase 1 Companies wanted to
fairvalue only land, since it does not entail any depreciation, and avoid higher
depreciation due to fair value uplift on plant and machinery. However, as per
Ind AS 101 selective fair valuation was not allowed, though there is a proposed
amendment to allow selective fair valuation which may help phase 2 companies.
Phase 2 companies should take benefit of the same. However, it is important
that all these choices are made in time and after careful consideration and
planning.
Presentation AND Disclosures can be a big
hurdle
Ind AS presentation and disclosures are
numerous running into several more pages than Indian GAAP. Many phase 1
companies were more focused on the Ind AS adjustments, and left presentation
and disclosures towards the end. These companies struggled to publish their Ind
AS financial statements on time.
The presentation and disclosure requirements
under Ind AS are highly onerous and time consuming, particularly the fair value
and various risk disclosures under Ind AS 107 Financial Instruments:
Disclosures. Consider, for example, the liquidity risk disclosures. Companies
have to provide a maturity analysis of their financial liability based on a
worse-case scenario. To provide these disclosures on a worse-case basis,
companies will have to consider potential debt covenant violation, treat demand
liabilities as immediately payable, etc.
Companies have to disclose sensitivity
analysis for each significant risk (for e.g. foreign exchange) applicable to
them. In providing these disclosures, entities operating in multiple currency
environment, will have more difficulty because of the correlation between the
various foreign currencies. Companies will also have to ensure that an
appropriate control process is in place to prepare and review such information,
including a formal process for audit committee review.
Phase 2 companies should therefore prepare
in advance and not delay their effort on presentation and disclosures till the
eleventh hour.
Conclusion
Phase 2 entities should use the benefit of
lessons learnt in Phase 1 implementation and avoid any pitfalls. Part 2 of this
article, will be included in the next edition. _
