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Ind AS: Taming the storm before the calm

For some firms, the topline gets impacted. For others, there is an impact on net income. For yet others, their balance sheet changes
Last Updated 26 April 2015, 15:47 IST

Sai Venkateshwaran

 is Partner and Head (Accounting Advisory Services) for KPMG in India. As a member of the National Advisory Committee on Accounting Standards (NACAS), he was closely involved in India’s efforts towards convergence with IFRS. He recently sat down for a discussion with Deccan Herald’s Umesh M Avvannavar about corporate India’s transition towards the recently notified Ind AS accounting standards.

Tell us about the Indian accounting standards (Ind AS)?
Indian companies currently follow Indian GAAP and the current set of standards are fairly outdated, in the sense that the last changes in the accounting standards were made 15 years back. Indian GAAP is not fully equipped to deal with all the changing complexities, and as a result, financial statements do not necessarily portray information in the best manner.

 This is why over the last 7-8 years efforts are being made to converge with IFRS and it has now become a reality with the Ind AS being notified. It is now a part of the corporate legal framework and companies will need to adopt the standards.  

What are the major changes in Ind AS from Indian GAAP?
There are three broad areas where we are making a significant leap. These include (i) revenue recognition; (ii) financial instruments; and (iii) standards around mergers and acquisitions (M&A).

For some of the companies, the topline gets impacted. For others, various elements of costs get impacted, so overall there is an impact on the net income. 
For yet others, their balance sheet characterisation undergoes a change — like equity becomes debt, fixed assets may probably become financial assets or intangible assets, etc.

Effectively, Ind AS would help better reflect the substance, rather than the mere legal form. For instance, if a company has raised money from private equity, using preference share capital or equity shares, today all that is classified as part of share capital but there are underlying obligations that the company has, including giving an assured return, or to buy back shares 3-5 years down the line, or provide an exit route, etc. 

With these kind of obligations involved, these shares are in effect not part of your equity, but instead should be part of your liabilities. So under the new standards these get covered under liabilities, instead of equity.

Similarly when you are doing an acquisition, there is very limited guidance under the existing Indian GAAP and again if you look at today’s activities lot of companies’ valuations are being driven because of the intangibles they have which could be their technology, their customers, or their unique relations, and these are not reflected in the financial statements. Under Ind AS, you recognise these as part of the balance sheet rather than put everything to goodwill. It will lead to more transparency on financial reports and performances.

From when is Ind AS applicable for companies?
It is already applicable. The companies that get covered under phase-I will need to be reporting for Financial Year 2016-17 under Ind AS, but when they do that they also need to give a comparison for the previous year, which is from April 1, 2015, onwards. 
So effectively for a listed company, from their June 2015 quarter onwards they need to be preparing quarterly information according to Ind AS. Therefore, the phase-1 companies are very much in the Ind-AS reporting framework. 
There’s also a possibility that some companies would do a voluntary early adoption for the year 2015-16 in which case they’ll also need to present their previous year, i.e 2014-15 according to the new standard for comparison, and so are they are already in their first reporting period.

Are these rules only for listed cos?
It covers unlisted companies as well. Broadly, the roadmap covers entities that have a net worth more than Rs 500 crore in phase-1 and the remaining listed companies and unlisted companies with net worth more than Rs 250 crore in phase-2. It is not just these entities, but also any other related group entities. For instance, you have a subsidiary with a Rs 10 crore net worth. 
That entity will also need to adopt these standards for their own statutory reporting. So it’s not just impacting the large company, but every individual small company within the group.

What are the big challenges you’ve seen in this?
One is dealing with the change in the financial reporting itself. For instance, today if you have a particular net worth, particular net income, etc., under the IFRS, those numbers could be very different. Then there are both internal and external changes that get triggered. Internal changes are how you go about generating those numbers: do you have enough information, do you need to look at external dependencies, do you need to train your people, etc. So a number of internal people issues, process issues, technology issues (you might need to change your ERP or do an ERP re-implementation), and so on. All these just to generate the information. Once the information is generated, then there’ll be external issues: for instance, does your banker understand what are these changes?  For example, your banker has given you a loan based on a particular covenant that you need to maintain a debt-equity ratio, let’s say 2:1. Now based on these standards, if your debt-equity ratio changed, what happens to your loan agreement?  Again, do your investors understand this information? For instance, you have been historically reporting a particular level of growth. With all these changes, if your EPS is going to be lower, do your investors understand that? Or are they going to assume that a lot of value has got eroded?  You need to educate the whole investor community as well. So there are a number of challenges before it gets to ‘business as usual’ for companies.

You said it is about 15 years since the last standards were issued?
Around 2000 was when the last set of standards (AS29) were issued.  If you look at Indian GAAP, there are around 29 standards. The last batch was released around early 2000.

Why has India been slow?
It could be because around 20 years back we had only about 15 accounting standards. And from there we did a quantum leap and introduced the additional 14 standards over 4-5 years. Around 5-6 years later we started talking about convergence with IFRS, i.e. 2007 onwards, and it was expected to be adopted from 2011. But that got derailed for a number of reasons. And because we were working on Ind AS standards we did not do anything about the existing standards. That is the reason it took time.

How different is IFRS from Ind AS?
We haven’t straightaway adopted IFRS standards. We picked those standards, made modifications to make them more suitable for India, and then adopted them.  

Which are the sectors that would get impacted?
There are a number of sectors that get impacted and each one gets impacted in a different manner. 

Technology.  The timing of revenue recognition could change.  They also get impacted by standards around stock options because technology companies typically use a lot of stock options for compensation. So that now results in a higher hit to the profit and loss (P and L) on a period-on-period basis, because it’s now going to be on the basis of the fair value of the option.  They also get impacted because of the standards around consolidation and M&A, because lot them tend to grow through inorganic means, they do acquisitions, etc. Today, a lot of the value paid for the acquisition is put into goodwill and going forward that goodwill will be broken down into certain finite and indefinite life intangibles or other tangible assets, all of which are recognised at their fair value, and, therefore, a higher amortisation would have to periodically recognised into the P&L rather than sit as an item of goodwill.

Real estate and infrastructure. Lots of their funding arrangements are complex. Lots of them have got these SPV (special purpose vehicle) level of funding with private equity funds or other investors, etc. A lot of them will get reclassified from currently being shown as equity to possibly debt type arrangement with the corresponding cost going to P&L. So significant impacts on their debt-equity ratio and their profitability ratio. There could also be cases where, since they are set up with complex SPV structure with different types of rights given to investors, etc., a lot of them will get consolidated going forward. Or some of them could be treated as a JV (joint venture), if the investors have the veto right on critical decisions. Therefore, the whole universe of what gets consolidated or not could change. There would also be situations where you have kept entities out of consolidation by keeping them at 49% shareholding. In substance, if you control these entities under the new standards you will actually be consolidating them. So there could be new entities getting consolidated, and vice versa.

Infrastructure. Some of the companies in public-private partnerships (PPP), the ones building airports, roads, power utilities so on. For them, the accounting may be very different. Liketoday, creating roads, airports, etc. are shown as fixed assets (FA) on their books. But going forward that FA will be replaced by intangible assets, if what they have is the right to collect fees from users. Like, every time you fly in and out of a new airport you are paying UDF, which is effectively the fee being collected for the use of the facility; or for instance each time you are going on a new highway, the toll you are paying to the various toll operators, which effectively is the right of the operator to collect the fees. So therefore, what is today classified as a fixed asset can actually become an intangible asset, because it’s an intangible right to collect fee from users. From that sense there could be re-characterisation of assets.

General manufacturing. For them, the capitalisation of costs on fixed assets could be very different. Under Indian GAAP, you have ended up capitalising a lot of overheads, indirect costs and foreign exchange fluctuations to fixed assets. Going forward, you will not be allowed to capitalise forex fluctuations, and you will not be allowed to capitalise the indirect overheads which get loaded on to the cost of the fixed asset. So in those periods when they are constructing the assets, there will be a greater hit to the P&L, and the total value you attribute to fixed assets and carry forward will be much lower. There will be a lot of other common issues like business combinations and complex funding arrangements.

Telecom. Under the new standards you will need to allocate your revenues differently for the handset, plan, etc. The way you recognise revenue and information of each of these would be very different.
Pharma and consumer products. Typically, a lot of these companies use third-party manufacturing facilities, which may be running on a dedicated basis and under long-term arrangements.  Whether this is a manufacturing arrangement or in substance a lease would be a key question to consider.

How can companies equip themselves for this transition?
The best way to manage is to start right now. We are already a month into the new framework. Companies need to first do an impact assessment, clearly understand the impact of the 39 standards that can come in. Essentially, a holistic study looking at overall impact on people, technology, processes, business related issues and of course the pure accounting change itself. Once this assessment is done, companies should look at getting the standards implemented over the next 12–18 months to ultimately make it business as usual.

How prepared is India Inc to adopt the new accounting standards?
Based on our interactions with companies and a recent survey done by us, companies feel a lot more prepared this time around compared with the 2011 experience. Having said that, many companies are still at the impact assessment stage and very few have started implementation. At least there is greater appreciation around the standards and its impact this time!

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(Published 26 April 2015, 15:47 IST)

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