India has proposed a set of 13 carve outs or divergences from the International Financial Reporting Standards (IFRS). A carve out essentially means that certain requirements of an accounting standard under IFRS will not be adopted. The demand for universal accounting language has been continuously increasing to facilitate comparability and transparency in financial statements. However, by introducing the carve outs in the IFRS, the ICAI has raised questions on whether the Indian Accounting Standards (Ind AS - the name used by the ICAI for IFRS standards with carve outs) will bring about comparability of financial statements of Indian companies with their international peers. Also, it is nt certain whether the carve outs will benefit Indian corporates.
This article summarises the impact of carve outs as proposed by the ICAI, and notified by the Ministry of Company Affairs (MCA), on industries, applicability, and disadvantages to Indian companies.
The following paragraph discusses the differences between Ind AS and IFRS.
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IFRS vs Ind AS
IFRS – the international standards that have been issued by the International Accounting Standards Board (IASB), which also includes interpretations of the International Accounting Standards (IAS), IFRS Interpretations’ Committee (IFRIC) and Standing Interpretations’ Committee (SIC).
Ind AS – the converged accounting standards which are in line with IFRS as issued by the IASB but subject to certain carve outs (differences) as notified by the MCA. Presently, there are 35 converged accounting standards with 13 identified carve outs. The Ind AS will be applicable to the entities in a phased manner at a future date as notified by the MCA.
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A carve out essentially means that certain requirements of an accounting standard under IFRS will not be adopted
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Indian GAAP – refers to the accounting standards that are applicable to companies registered in India and will continue to apply till the MCA notifies for convergence with Ind AS. However, the companies which do not fall in the phases of implementation of Ind AS will have the option to continue with Indian GAAP.
The following is a brief analysis of the carve outs notified by the MCA and their impact on Indian Industry.
Differences Impacting Specific Sectors
IFRIC 12 / SIC 29 (Ind AS 11)
Service Concession arrangements
A build operate transfer ( or a service concession agreement generally involves a government or public sector entity conveying to a private sector entity the right to provide services that gives the public access to major economic and social facilities for a certain period.
IFRS states that in the initial construction phase the operator will have to recognise revenue on construction contracts to the extent of the value of the services performed which is the cost of constructing the infrastructure asset with a reasonable margin. The revenue will be accounted by creating a financial asset or an intangible asset.
Hence the companies will experience an upfront booking of revenue in the initial years of construction.
However, on issuance of Ind AS by the ICAI, the applicability of the above standard has been deferred. The same may be examined and applied with or without modification later.
Impacted Sectors: Infrastructure and Power Sector
The entities which are in the initial stages of construction will have accounted for an upfront booking of revenue under IFRS, hence the turnover ratios will be high. India Inc will continue the percentage of completion method hence this will reduce the comparability with international infrastructure companies.
IFRIC 4 / Ind AS 17
Leases
IFRS states that an entity entering into an arrangement comprising a transaction, or a series of related transactions, that does not take the legal form of a lease, but conveys a right to use an asset in return for a payment or a series of payments, may be classified as a lease.
The applicability of the above clause has been deferred in Ind AS context. The same may be examined and applied with or without modifications later.
Impacted Sectors: Infrastructure, Power, Manufacturing, and any Capital Intensive Sector
IFRS 6 / Ind AS 106
Exploration and evaluation of Mineral resources
IFRS states that entities shall determine (choice is given to the corporates) an accounting policy specifying which expenditures are recognised as exploration and evaluation of assets, and apply the same consistently. Identifying such assets may be associated with finding special mineral resources.
Its applicability has been deferred and is under consideration.
India Inc will continue the percentage of completion method followed in the construction industry and hence, this will reduce the comparability with its global peers
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Impacted Sectors: Oil and Natural Gas and Metals and Mining
The comparison of profitability may not be comparable as the basis of determination of expense and capitalisation may differ with foreign companies adopting IFRS 6.
Ind AS 18 / IFRIC 15
Revenue / Agreement for construction of Real Estate
Construction of real estate shall be treated as sale of goods; hence revenue will be recognised when significant risk and rewards have been transferred to the customer.
As per Ind AS carve outs, the revenue from sale of real estate will be based on the percentage of completion method. No specific standard has been notified for recognition of revenue for real estate contracts.
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Impacted Sectors: Real Estate sector
As Indian companies follow the percentage of completion method, the revenue is booked in a phased manner based on the work completed. Hence Indian companies show sales even in periods before the asset is transferred to the buyer.
Applicability of IFRIC 15 will impact the profitability of Indian companies whose units are yet to be sold. Hence the profitability of Indian companies cannot be compared with foreign players which have adopted IFRIC 15, and foreign investors will not be able to judge the credibility of an Indian real estate company, leading to less capital flows and investment by foreign investors.
IAS 41
Agriculture
IFRS states that the measurement of biological assets, that is living animals and plants, are done at fair value and recognising gains and losses in the profit and loss account.
The standard has not been included by ICAI, and will be revised and not issued as it is.
Impacted Sectors: Life Science, Pharmaceuticals, and Agriculture
Ind AS 20
Accounting for Government grants and disclosure of Government assistance
IFRS states that non-monetary Government grants can be recognised at either fair value or nominal value. Grants related to assets including nonmonetary grants can be recognised at fair value in the balance sheet either by the deferred income approach, or reducing the grant from the carrying value of related asset.
However, based on the carve outs proposed in Ind AS, non-monetary government grants will be recognised only at their fair value. Grants related to assets can only be shown as deferred income.
Impacted Sectors: All Capital-intensive entities
IAS 40 / Ind AS 40
Investment Property
IFRS states that investment properties can be measured both by the cost model and the fair value model. However, Ind AS suggests that recognition only by cost model is permissible.
Impacted Sectors: Capital-intensive entities
Differences Impacting All Sectors
IAS 21 / Ind AS 21
The Effects of changes in foreign exchange rates
IFRS requires exchange differences arising on translation of monetary items directly in the profit and loss account. However Ind AS gives an option to the Indian corporates to recognise exchange differences on certain long-term monetary items directly in equity and amortised on an appropriate basis.
IAS 28 / Ind AS 28
Investment in associates
IFRS states that the difference between reporting periods of an associate and the investor should not be more than three months in any case.
Uniform accounting policies should be followed by the investor and the associate in the preparation of financial statements. This will be required for the purpose of applying equity method of accounting in the preparation of investors’ financial statements.
However as per Ind AS, if the situation as stated by IFRS is impracticable to implement the investor may adopt a different policy as the investor may not have control on the workings of the associate.
Difference Having No Major Impact
IFRS 3 / Ind AS 103
TBusiness Combination
IFRS recognises bargain purchase gains arising on business combination in the profit and loss account.
Whereas, Ind AS suggests to recognise the same in ‘Other Comprehensive Income‘ and accumulate in equity as capital reserve. Where there is clear evidence that business combinations are in the nature of bargain purchase, it will be recognised directly in equity as reserves.
TBusiness Combination
IFRS recognises bargain purchase gains arising on business combination in the profit and loss account.
Whereas, Ind AS suggests to recognise the same in ‘Other Comprehensive Income‘ and accumulate in equity as capital reserve. Where there is clear evidence that business combinations are in the nature of bargain purchase, it will be recognised directly in equity as reserves.
Impact: Comparability of financial statements of foreign players will not be possible. Hence India may lose out on attracting foreign investors due to lack of clarity and comparability of financial statements.
IAS 7 / Ind AS 7
Statement of Cash Flows
IFRS gives an option to classify interest paid and interest and dividends received as items of operating cash flows. Dividends paid can be shown as an item of operating activity.
Ind AS gives no option to the entities. Interest paid and interest and dividends received are treated as financing and investing activities. Dividend paid is to be classified as a part of financing activity.
IAS 19 (Ind AS 19)
Employee benefits
IFRS states that the rates used to discount post-employment benefits is determined only with reference to government bonds where there is no deep market of high quality bonds.
Ind AS suggests that the rate used will be determined with reference to market yield on government bonds.
IFRS gives various options for treatment of actuarial gains and losses for post employment defined benefits.
However, Ind AS states that both post-employment defined benefit plans and other long-term employment benefit plans will be recognised in other comprehensive income which will be immediately recognised in retained earnings and will not be reclassified to profit and loss in subsequent periods.
Conclusion
The major sectors where carve outs will impact comparability of financial information occupy a major part of the Nifty and the Sens*x.
As it is evident, some companies may be benefited by applying the existing Ind AS, over the IFRS. However, this benefit will result in them not being comparable with their International peers, which will, in turn, impact their fund-raising abilities.
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