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A GUIDEBOOK ON IFRS
INTERNATIONAL FINANCIAL REPORTING STANDARDS
RAMA KRISHNA VADLAMUDI
www.scribd.com/vrk100
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vrk_100@yahoo.co.in
MARCH 28th, 2010
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IFRS A GUIDE BOOK ON TRANSITITION TO GLOBAL ACCOUNTING STANDARDS The article analyses the fundamentals of IFRS, the differences between USGAAP and IFRS and other related issues in a comprehensive manner.
IFRS ADOPTION AND USE AROUND THE WORLD
More than 120 countries now require or permit the use of IFRSs or are converging with the International Accounting Standards Board's (IASB) standards. The picture below shows the level of IFRS adoption at present. Blue areas indicate countries that require or permit IFRSs. Grey areas are countries seeking convergence with the International Accounting Standards Board (IASB) or pursuing adoption of IFRSs.
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CONTENTS
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Abbreviations used Executive Summary What is IFRS and its importance? What are standard-setting bodies? What are IASB and IASC Foundation? What is the role of IOSCO? Why do we need financial statements? What are the objectives of Financial Reporting Standards? What is the status of international adoption of IFRS? What are the latest developments in IFRS? What is global financial standards convergence? What are the obstacles to global covergence? Why is vital for investors to know about IFRS? How does USGAAP compare with IFRS? Does India need IFRS standards? What is India's roadmap for IFRS convergence? What are the issues involved in IFRS convergence in India? How are Indian Banks preparing for IFRS? What is the importance of new IFRS 9 on profits? Some Important IFRS standards
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3 4 6 7 7 8 9 10 11 11 12 13 13 13 15 16 17 19 20 21
1. ABBREVIATIONS USED
ADS CBDT FASB FCCB FIFO FSA GDR IASB IASC IASCF ICAI IFRS IOSCO IRDA LIFO MCA NACAS RBI SEBI SEC SOX USGAAP : American Depository Share : Central Board of Direct Taxes (of India) : Financial Accounting Standards Board (of the USA) : Foreign Currency Convertible Bond : First in, first out (a method used in inventory valuation) : Financial Services Authority (of the UK) : Global Depository Receipt : International Accounting Standards Board : International Accounting Standards Committee : International Accounting Standards Committee Foundation : Institute of Chartered Accountants of India : International Financial Reporting Standards : International Organization of Securities Commissions : Insurance Regulatory and Development Authority (of India) : Last in, first out (a method used in inventory valuation) : Ministry of Corporate Affairs (India) : National Advisory Committee on Accounting Standards (India) : Reserve Bank of India : Securities and Exchange Board of India : Securities and Exchange Commission (of the US) : Sarbanes-Oxley Act : Generally Accepted Accounting Principles of the US
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2. EXECUTIVE SUMMARY
The financial year 2011-12 is going to be one of the most significant years since the introduction of economic reforms in 1991 in india. Its significance can be gauged from the fact that three important legislations are coming into effect from April 1, 2011 as per the present indications and available information. They are: 1. Goods and Services Tax GST (a long-pending reform of indirect taxes) 2. Direct Taxes Code DTC (proposed to replace Income Tax Act) 3. Adoption of IFRS by companies in the Nifty 50 Sensex 30 indices and other companies with net worth exceeding Rs 1,000 crore These new acts are going to be very complex for ordinary investors. The implications for companies are quite humungous. As such, investors need to be well prepared for the changes that are going to happen in the next one year. All these legislations and standards are going to be game changers in India. Investors who overlook the impact are going to pay a heavy price for their ignorance. The valuations of companies and businesses are going to change in a substantial manner with effect from April 1, 2011. Stock markets are supposed to act ahead of time. As such, one can expect significant action on the bourses based on the news flows relating to the introduction and passing of these new legislations in Indias Parliament. Ramesh Damani, a veteran broker from Bombay, has gone on record saying that if the DTC implemented as per the draft released in August 2009, there is going to be huge sell-off in the stock markets before the deadline of April 1, 2011 (DTC proposes to eliminate the difference between long-term capital gains and shortterm capital gains on shares and mutual funds. Both LTCG and STCG will be taxed at the rate of the individuals or others. At present, tax on LTCG is NIL and tax on STCG is 15 per cent exclusive of surcharge and education cess.) As such, investors have to familiarize themselves with the provisions and implications of these new developments. To know about GST & DTC, just click:
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MY BLOG: www.ramakrishnavadlamudi.blogspot.com Direct Taxes Code-DTC-Its impact on individuals, etc www.scribd.com/doc/19542987 Direct Taxes Code-DTC-Its impact on Long-term capital gains and short-term capital gains of shares/MFs www.scribd.com/doc/23804443
This article discusses the significance of IFRS (International Financial Reporting Standards) and its likely impact on the balance sheets of Indian companies. The financial statements are extensively used by several groups of people including analysts, creditors and other stakeholders. Financial statements include balance sheet, income statement, cash flow statement and others. They provide useful information to users about the financial position and financial performance of the company. IFRSs are developed by International Accounting Standards Board (IASB), a global body headquartered in London. The IFRSs are expected to replace national standards of respective countries, like, the USGAAP in the US. They are uniform global accounting standards offering higher transparency and disclosure requirements.
On 22 January 2010, the Ministry of Corporate Affairs (MCA) in India issued a press release setting out the roadmap for International Financial Reporting Standards (IFRS) convergence in India. The roadmap requires IFRS to be made applicable in three phases starting from April 1, 2011. This is an historic step and will go a long way in improving transparency and disclosure requirements of financial statements.
Leading Indian companies and banks have already begun to plan the conversion to IFRS. The convergence to IFRS will have far-reaching implications for Indian companies in terms of initial public offers, disclosures, mergers and acquisitions, fair value of financial assets, publication of quarterly results, investors relations, debt offerings and raising foreign funds. These big companies have got a years time to migrate to IFRS from Indian GAAP. As of now, more than 120 countries use IFRS standards, including Australia, New Zealand, the UK, countries in the European Union and African countries. Japan, Brazil, Canada and India are moving towards IFRS in the next one year in a phased manner replacing their national standards. There are several benefits to Indian companies for implementing IFRS: 1. They can raise money abroad with favourable credit terms; 2. Indian companies will get international recognition and can avoid publication of financial statements based on multiple standards; 3. They can list on foreign bourses much more easily; 4. IFRS enhances the brand value of Indian companies abroad; and 5.
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India will be in line with the world in terms of its commitment as part of G-20 Group of nations to implement these uniform global accounting standards. The biggest economy US, however, is slow to move from its USGAAP to IFRS. It has been trying to narrow down the differences between its USGAAP and IFRS accounting standards. Still, there are significant differences between USGAAP and IFRS in the following areas: Upward revaluation of fixed assets, LIFO/FIFO inventory valuation, treatment of extraordinary items and others. There are big inconsistencies in the treatment of dividend/interest received and dividend/interest paid between USGAAP and IFRS cash flow statements. The development of IFRS and its convergence are on an evolutionary phase. Leading companies and banks in India are gearing up to meet the deadline of 1st of April 2011 set by the Government of India. The countrys leading bank, State Bank of India, has set up a separate team to migrate to IFRS. RBI and Indian Banks Association have been working together to set IFRS guidelines to banks.
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effect from 1st of January 2013. In addition, IASB has developed another IFRS for SMEs (Small and Medium-sized Entities) which was implemented in 2009.
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4. Taking care of special needs of small and medium entities (SMEs) and emerging market economies
More than 120 countries now require or permit the use of IFRSs or are converging with the International Accounting Standards Board's (IASB) standards.
The objective of the IASC Foundation and the IASB is to develop, in the public interest, a single set of high-quality global accounting standards. In pursuit of this goal, the IASB works in close cooperation with stakeholders around the world, including investors, national standard-setters, regulators, auditors, academics, and others who have an interest in the development of high-quality global standards. The IASB is the independent standard-setting body of the IASCF. IASB is supervised by the International Accounting Standards Committee Foundation. IASCF has got 20 trustees who promote the work of IASB and rigorous application of IFRSs. India is proud to have one of its leading businessmen, T V Mohandas Pai, Director and Member of the Board, Infosys Technologies Limited, Bangalore, as one of the Trustees. His term expires in December 2011. The IASC Foundation is an independent, not-for profit private sector organization, working in the public interest.
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The reduction of systemic risk The body is responsible for the cooperation among capital market regulators to promote high standards of regulation in order to maintain just, efficient and sound markets. The regulators exchange information and unite their efforts to establish standards; effective surveillance of international securities transactions and promote the integrity of financial markets around the world. It is also working for the promotion of uniform regulation. IOSCO works closely with IASB, IASC Foundation, other standard-setting bodies and regulators for the global convergence of accounting standards. SEBI, the capital markets regulator in India, is an ordinary member of IOSCO. Forwards Markets Commission (FMC), the commodities market regulator in India is as associate member of IOSCO. The FSA in the UK and the SEC in the US are ordinary members of IOSCO.
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According to IASB, the following are the necessary financial statements and fundamental principles underlying their preparation:
Financial Statements 1. Balance Sheet 2. Income Statement or Profit & Loss a/c 3. Statement of Cash Flows 4. Statement of changes in Equity 5. Notes to Accounting policies and others Fundamental Principles 1. Fair presentation 2. Going concern 3. Accrual basis 4. Consistency 5. Materiality
In order to understand the financial statements properly, there are four essential features that financial statements should satisfy. They are:
2. Relevant and timely information 3. Reliable information free from errors 4. Comparability of information across companies
As the financial statements are used by a large number of stakeholders, they are to be prepared by accountants in such a uniform and consistent way so that all the users of the statements understand them in a like manner. There should not be any confusion among the users with regard to figures, statistics or interpretation of the financial statements. There is a need to maintain consistency in financial statements and to make them understandable to all in a simple and similar way. The International Accounting Standards Board (IASB) has expressed the objective of Financial Reporting in a lucid way: The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity; this information should be useful to a wide range of users for the purpose of making economic decisions.
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Status of IFRS adoption Egypt, Kenya, Malawi, South Africa and Tanzania have made it mandatory for domestic companies to adopt IFRS Japan is adopting IFRS in a phased manner wef 31st of March 2010. India has made it compulsory for big companies to adopt IFRS from 1.4.2011. China has implemented IFRS for domestic companies. Around 150 Chinese companies are listed on the Hong Kong Stock Exchange and they are permitted to use IFRS or HK standards. Singapore, Burma, Sri Lanka and Hong Kong have implemented standards similar to IFRSs with some exceptions. Australia and New Zealand have already adopted IFRS It is adopting IFRS from 2011 The European Union (EU) has already made it mandatory for EU countries to adopt IFRS since 2005 It has introduced IFRS for banks and other companies in a phased manner. But Russia's national standards differ from IFRSs significantly. Countries, like, Ecuador, Nicaragua, Peru and Venezuela have adopted IFRS in the past in a phased manner. Brazil is adopting IFRS with effect from December 2010. The US has in principle agreed to switch over to IFRS. The US is trying for convergence with IFRS but the process is slow and may take several more years.
AUSTRALIA
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remaining major economies have established timelines for convergence with, or adoption of, IFRSs. The notable exception to convergence of IFRSs is the USA. The IASB and FASB have made progress towards substantial convergence between IFRSs and USGAAP. Several memoranda of understanding were signed since 2006 and in November 2009 the two boards issued a further statement outlining steps for completing their convergence work by 2011. Most recently, at their September 2009 meeting in Pittsburgh, US, the Group of 20 Leaders (G20) reaffirmed their commitment to global convergence in accounting standards, calling for a single set of high-quality, global accounting standards within the context of their independent standard-setting process, and complete their convergence project by June 2011. Japan is moving towards IFRS with effect from 31st of March 2011 in a phased manner. Brazil too is shifting towards IFRS with effect from December 2010.
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US in 2002 in order to strengthen investor protection laws. Even India suffered corporate scandals from the likes of Satyam Computers in early 2009.
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allows LIFO method of inventory valuation which allows US companies to report lower profits and consequently pay lower taxes in an inflationary environment. By using LIFO method, US companies will be able to show higher raw material cost in the income statement which depresses the net income* and resulting in lower taxes for them. This will ultimately gets reflected in profitability ratios, like, Return on Equity (RoE), etc. With lesser profits to declare, the companies will show lower RoE. Historical data suggests that the difference in RoE for IFRS and USGAAP calculations can be as large as 3 to 4 per cent in several cases.
(* The word net income is used in the context of international terminology and followed in the US and other countries. Net income is equal to net profit the latter word is used in India for profit after tax. In this article, whenever the word net income is used, it is used in the context of net profit only.)
There are a large number of differences between the provisions of these two standards. Presenting all of them is outside the scope of this article. Following are some of the main differences:
IFRS 1. Principles based approach 2. Upward revaluation of assets (property, plant & equipment) and intangible assets is allowed 3. Weighted average cost and FIFO are permitted for inventory valuation; LIFO is not permitted 4. IFRS does not allow any items to be classified as "extraordinary items" 5. While consolidating accounts for long-term investments, IFRS uses a voting control method for consolidation 6. Deferred tax assets and liabilities are classified net as NON-CURRENT on the balance sheet with additional disclosures USGAAP 1. A combination of principles and rules based approach 2. Upward revaluation of assets is not allowed 3. Weighted average cost, LIFO & FIFO are allowed for inventory valuation 4. Extraordinary items shall be reported in the income statement, net of tax, below income from continuing operations 5. USGAAP uses a dual model based on voting control and economic control for consolidation 6. Deferred tax assets and liabilities are classified as current or non-current, based on the classification of related tax asset or liability for financial reporting
Note: USGAAP allows LIFO method of inventory valuation, which allows US companies to report lower profits and pay lower taxes during an inflationary period
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As can be seen from above, IFRS permits more flexibility in classifying cash flows
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the Ministry of Corporate Affairs for convergence of Indian Accounting Standards with IFRS from 1st of April 2011, that held its meeting on 11 th of January 2010 had agreed for a clear roadmap. There will be two sets of accounting standards:
PHASE 2
Coverage Opening balance Companies (whether listed or not) not covered in sheet as at 1 April phase 1 and having net worth exceeding Rs 500 2013* crore, but not exceeding Rs 1,000 crore Date
PHASE 3
Coverage Opening balance Listed companies (not covered in phase 1 and 2) sheet as at 1 April having net worth of Rs 500 crore or less 2014* * When the accounting year ends on a date other than 31 st March, the conversion of the opening Balance Sheet will be made in relation to the first Balance Sheet which is made on a date after 31st March.
If an Indian company's financial year is April to March, that company will have to shift to IFRS with effect from FY 2011-12, if it falls under phase 1. Accordingly, the company will have to reset its balance sheet for FY 2010-11 as per IFRS.
Date
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According to an Economic Times estimate, IFRS will be adopted by about 400 Indian companies from 1st of April 2011 in the First Phase of implementation. This is highly significant from a stock market point of view.
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manner in the next four years. The following are some of the issues that need to be sorted out before the elimination of differences: INCOME TAX ISSUES: CBDT is working with ICAI to examine the direct tax issues arising out of the convergence between IFRS and Indian GAAP It remains to be seen whether CBDT will full adopt IFRS for taxation purposes The problem of income tax will get more complicated for Indian companies which have acquired several subsidiaries abroad, while preparing the consolidated financial statements Consolidated financial statements concern companies having joint ventures, subsidiaries and associates. According to IFRS norms, companies will have to present their interim financial statements (like quarterly results) also on a consolidated basis. Some experts contend the draft Direct Taxes Code (DTC) is very averse to IFRS and does not recognize fair value measurement Fair value accounting concept is the bedrock of IFRS IMPLEMENTATION and COMPLIANCE COSTS: The cost of implementation of IFRS convergence is going to be huge Training cost of making employees being aware of IFRS provisions and implications is also very big AMENDMENTS TO VARIOUS LAWS: Before implementation of IFRS, various laws need to be amended and approved in Indian Parliament Some of the laws that need to amended are Companies Act (specifically Schedule VI of the Act), Income Tax Act (or the proposed Direct Taxes Code), SEBI norms, banking laws like the Banking Regulation Act, insurance laws, etc INSURANCE COMPANIES: Under IFRS a large part of the premium of insurance companies is treated as investment liability (as against Indian GAAP treating it as revenue) as they have to return it to the investors. This will create a big dent in their financial statements. IRDA regulates financial reporting by insurance companies in India. IT AND ERP SYSTEMS: Convergence to IFRS requires companies to upgrade their IT and ERP systems in a robust manner
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There is a need to improve their Management Information Systems (MIS) The convergence to IFRS is a big opportunity for IT companies training institutions and tax consultants DIFFERENCES BETWEEN IFRS and Indian GAAP (Cash Flows):
IFRS 1. Interest received can be Operating or investing activity 2. Dividend received can be Operating or investing activity 3. Interest paid can be Operating or financing activity 4. Dividends paid can be Operating or financing activity Indian GAAP 1. Interest received is Investing activity. In case of a financial enterprise, it is operating activity. 2. Dividend received is Investing activity. In case of a financial enterprise, it is operating activity. 3. Interest paid is Financing activity. In case of a financial enterprise, it is operating activity. 4. Dividends paid is Financing activity
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financial instruments. The IFRS 7 provides for extensive disclosures under the above two categories and it will be a daunting task for the banks to disclose all such information in their financial statements. 4. Financial instruments and derivatives accounting: At present, valuation of investments by banks are classified as Helf for Trading (HTM), Available for Sale (AFS) and Held to Maturity (HTM). Under IFRS, all these investments are all mostly required to be treated as Held for Trading and they should be valued at fair value in the books. Fair value is defined as the amount at which an asset could be exchanged, or a liability settled, between willing and knowledgeable parties or market participants. When the asset or liability trades regularly, its fair value is usually readily available from its market price. All derivative instruments are to be recognized at fair value on the balance sheet under IFRS. State Bank of India, the countrys biggest commercial bank, has formed a separate team to work on a smooth transition from Indian GAAP to IFRS.
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financial assets are initially measured at fair value plus, in the case of a financial asset not at fair value through profit or loss, transaction costs. IFRS 9 divides all financial assets that are currently in the scope of IAS 39 into two classifications those measured at amortised cost and those measured at fair value. The new IFRS 9 does away with the classification of Available for Sale (AFS) and Held to Maturity (HTM) categories for financial assets (under the existing IAS 39), which are extensively used by companies and banks now. Debt instruments: A debt instrument that meets the following two conditions can be measured at amortised cost (net of any writedown for impairment): 1. An entity is holding the financial asset to collect the future cash flows and 2. The contractual cash-flows are solely payments of principal and interest. All other debt instruments must be measured at fair value through profit or loss (FVTPL). Equity instruments: All equity investments in scope of IFRS 9 are to be measured at fair value in the balance sheet, with value changes recognised in profit or loss, except for those equity investments for which the entity has elected to report value changes in 'other comprehensive income'. There is no 'cost exception' for unquoted equities. 'Other comprehensive income' option: If an equity investment is not held for trading, an entity can make an irrevocable election at initial recognition to measure it at fair value through other comprehensive income (FVTOCI) with only dividend income recognized in profit or loss. Derivatives: All derivatives, including those linked to unquoted equity investments, are measured at fair value. Value changes are recognised in profit or loss unless the entity has elected to treat the derivative as a hedging instrument in accordance with IAS 39, in which case the requirements of IAS 39 apply.
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7 8 9 Financial Instruments: Disclosures Operating Segments Financial Instruments: Classification and measurement of financial assets
Sources:
1. www.iasb.org 2. www.iosco.org 3. www.iasplus.com 4. Press release of Ministry of Company Affairs 5. Newspapers and websites 6. www.cfainstitute.org Disclaimer: The views of the author are personal. This research paper is prepared for information purpose to the general reader only. For correct interpretation of the provisions and tax-related matters, readers are advised to consult their recognized tax consultants or qualified chartered accountants.
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