Friday, January 16, 2015

The Challenges and Opportunities of IFRS

The Ministry of Corporate Affairs (MCA) has drawn up a revised road map for companies for implementation of the Indian Accounting Standards (Ind AS) converged with the International Financial Reporting Standards (IFRS) for companies other than banking companies, insurance companies and NBFCs. The road map envisages a two-phase implementation. All companies, listed and unlisted, with a net worth over ` 500 crore together with their holding, subsidiary, joint venture or associate companies are covered in the first phase, w.e.f.April 1, 2016.

The second phase covers all the other listed companies or those in the process of listing and all other unlisted companies with a net worth over ` 250 crore, w.e.f. April 1, 2017. The time line for Banking and Insurance Companies are under consideration of RBI and IRDA. The other companies and non-corporate businesses will continue to follow Historical Cost Based existing notified Accounting Standards.The IFRS Accounting Standards and Ind AS are based on fair value accounting of all assets and liabilities and have done away with Prudence as a basic accounting concept, permitting accounting for unrealized gains. The Central Board of Direct Taxes has also issued final draft of Income Computation and Disclosure Standards (ICDS) for computation of income from "Profit and Gains from Business and Profession" and "Income from Other Sources".

How Fair is the Fair Value

The Fair Value Accounting base IFRS permit/require all assets and liabilities including Fixed Assets, financial instruments, investments, debentures, bonds, securities, and other liabilities to be valued at fair value. The effect of increase or decrease in value is to be adjusted in "Statement of Comprehensive Income" (extended statement of profit and loss).The fair valuation is arrived at based on detailed Principles and a detailed international Standard on fair value determination. The existence of an active market and information in respect thereof is also crucial to ensure that fair value so calculated is not manipulated based on credit rating, market yield to maturity, risk free returns, risk estimate, estimated cash flows, alpha and beta factor and complex formulae. There were serious allegations of manipulations of fair values by hundreds of banks and institutions including Lehmann Brothers, which collapsed during 2008 to 2011 in US and Europe.

MCA and ICAI to take on responsibility:

We are quite hopeful that the Govt. of India and Institute of Chartered Accountants of India will together take responsibility of providing adequate checks and balances to undertake accounting on "Real Fair Value". It will be important to guide the Accountants, Auditors, Corporate as well as the tax department to understand complex accounting.
Fair Valuation Challenge: The Fair valuation in India is faced with many challenges


  • Shallow market: Indian markets are very shallow in securities, commodities and various other assets.
  • Impact Cost: The impact cost in the Indian market  range from 5% to 25% in case of most of the asset classes except Sen sex/Nifty shares.
  • Information: The information availability is very limited about actual transactions in the market, market yield, Alpha and Beta. The Arms' Length Transfer Pricing has already highlighted the absence.
  • Projections: The valuation being made on the basis of projected cash flows are based on estimates and assumptions. The risk of motivated perception and manipulations based on false projections could risk the entire truth and fairness of financial statements

Taxation Issues: The Income tax issues will be fairly complex as the ICDS announced by CBDT as well as current tax laws are based on historical cost. How the department will deal with complex issues:


  • Unrealized Income credited to Statement of Comprehensive Income or Profit and Loss Account
  • Liabilities write back and write up based on fair value
  • Assets write up and asset write off based on fair value
  • Disclosure of sales in financial statements based on mandatory discounting factors e.g. towards staggered payments (VAT, GST issues)
  • Fair valuation of derivatives and complex financial instruments
  • Adjustment of various Income and Expenses heads based on complex technical accounting estimates and transactions

The Government and specially Tax Department need to confirm its stand on the above. The taxation wing may be very happy to tax unrealized gains but may be reluctant to allow deductions of impairments; write offs and write downs impacting the Profit and Loss Statement and Statement of Comprehensive Income very substantially.

Tremendous Advantages: The challenges outlined above come with great opportunities:-

Accountants: The demand for learned Chartered Accountants and their value will multiply from 2 to 4 times. The transition years will require at least 10 times more of good Chartered Accountants, Semi qualified Accounting Technicians and basic level Accountants. Even international demand of Indian CAs will go up substantially.

Banks: The Fair value Accounting will push up fair value of all assets of banks and insurance companies, thereby increasing their net worth from 2 to 20 times. This will result in substantial saving of additional capital requirement as estimated based on BASEL III. As per an estimate, Public Sector Bank alone will have additional Net worth of ` 150,000 crores to ` 200,000 Crores, arising out of fair valuation. The NPA write offs and provisions will have to give way to fair value accounting and BASEL III norms.

Indian Corporate Sector: The value of Indian corporate sector will also multiply many times if all the assets are to be considered at fair value. The share market will see a new high, the borrowing power will go up and may fluctuate widely based on credit rating and market yield rates.

Gross Domestic Product(GDP): If value addition by private corporate sector is measured on fair value basis, the GDP of India will multiply to new levels. The Government may consider its own accounting on fair value based on Price Parity.

Interest Rates to be monitored and announced by RBI for Indian banking sector and Risk Free Govt securities will have a major bearing on valuations. Every reduction in interest rate will increase value of asset and decrease liability values. The net worth of business will move accordingly. Any increase in market interest rates will have a very severe negative impact on these figures. The challenges are many and opportunities are great. A comprehensive strategic plan, preparation and cautious management will ensure sustained success.


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