In the age of globalisation, Indian Business has access to multiple markets enabling them to tap foreign sources of funding be it foreign inflow in India or fund raising by the Indian companies abroad. In both situations, foreign investors seek financial information under International Financial Reporting Standards (IFRS)

It is in this context, Institute of Chartered Accountants of India (ICAI) had initiated a convergence process with IFRS which is considered to be a globally accepted accounting standard, adopted by 140 countries across the world.

The above convergence process has finally led to the issuance of a roadmap by the Ministry of Corporate Affairs (MCA) on 2nd January, 2015 for adoption of the IFRS, christened as “Ind-AS” as below:

 

Phase I
Mandatory for accounting periods beginning on or after 1st April, 2016  

  • Listed/Unlisted Companies having a net worth of Rs 500 crore or more
  • Holding, subsidiary, joint venture or associate companies of companies

 

Phase II
Mandatory for accounting periods beginning on or after 1st April, 2017

  • Listed companies having a net worth of less than Rs 500 cr
  • Unlisted companies having a net worth of Rs 250 cr or more but less than Rs 500 cr
  • Holding, subsidiary, joint venture or associate companies of companies

 

 

Implementation Schedule for Banking, Insurance companies and NBFCs would be notified separately by the respective regulators and is not covered under the above roadmap. However, it is expected that notification under the relevant regulations would be issued to converge with Ind-AS

As most of the companies would be required to adopt the Ind-AS from the next financial year, the Financial Statements of these companies are going to see lot of changes. Some of the key standards having impact for Financial Services and Infrastructure Sector under the new regime are as under:

  • Consolidation - Larger Balance Sheet, Increased Complexity

 

Consolidation is based on the “Control”, as against “Risk & Reward” under the current Standard

Control is defined as when the investor is exposed or has right to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee irrespective of voting rights e.g. contractual arrangement would meet the above criteria

Concept of Investment Entity - Investment Entity not required to consolidate underlying Investment

 

Pass through of borrowing cost external borrowings used for equity investment in subsidiaries, in other words treatment of borrowing cost would be done on consolidated basis

Companies Act’ 2013 defines the Control based on the voting rights or right to appoint majority of the Board of Directors (Governing¬† Body)

 

Major relief to Private Equity Funds, Investment Managers

Higher profits on consolidated basis, as borrowing cost can be capitalised not permitted under the existing standard

 

  • Financial Instruments - Lower Net Worth, Higher Debt Equity Ratio

Follow “Substance over Form” Principle

 

Instrument with contractual obligation to repay, notwithstanding legal form shall be treated as Liability e.g. equity shares with written put option by Issuer. On the other hand instrument without the above obligation would be treated as Equity e.g. Compulsorily Convertible Debentures (CCDs)

 

 

All Investment other than Investment in Subsidiaries, Affiliates shall be recognised at Fair Value. Resultant difference between fair value and cost, if any should be treated as “first day gain or loss”

In respect of investment in debt or loan, application of expected loss model is required. This would require assessment of loss on the first day itself

Relevance of legal documents for accounting purpose?

Debentures considered as Debt under Companies Act’2013

Debentures convertible at Investor’s option considered ECB by RBI, in sync with
Ind-AS
Increased volatility in Income Statement

 

RBI Norms on NPA provisioning is based on Incurred Loss Model i.e. only on default

  • Revenue Recognition - Revenue Accrual Deferred, Cash Flow vs Accrual Mismatch

 

Revenue shall be accrued on completion of the Services under the contract, unless the contract contains multiple performance obligations. In such cases revenue on each performance obligation should be accrued separately. In other words “Percentage of Completion” Method done away

“Substance over Form” concept would mean even promise based on the customary business practices shall be considered to assess the completion of the performance obligation

 

All contracts need to be assessed to see whether the contracts pertain to transfer of goods or services or right to use. If the contracts pertain the right to use, it would not fall within the scope of this standard and shall be accounted under Ind AS 17 on “Lease”

Conflict with Service Tax rules which applies percentage of completion method for service tax incident

More likely to result into deferment of revenue on contracts mainly in case of services industry

Contract in infrastructure sector could be potentially considered as lease rather than Supply of Goods or Services

The adoption of Ind-ASs is going to change the way of Balance Sheet Structure of many Companies

For example Power Companies with PPAs with State Government may have to account for such contract as “Leases”; Annuity Agreement would require the arrangement to be accounted as Financial Assets. Balance Sheet in both the cases would be dominated by Financial Assets as against Fixed Assets under the current standards

Holding Companies which have written Put Option Agreement in respect of their Subsidiaries to facilitate Private Equity Investment would have to account for Financial Liabilities, completely changing the Debt-Equity Ratio thereby affecting Covenant Compliance further leading to consequences of breach

Many more changes are expected on the adoption of the Ind-AS and it would be difficult to provide details in just one article. Finally in the world of accounting complexities, I would like to conclude this article by saying:

Turnover is vanity, profit is sanity, but cash is reality

 

Nitesh Jain

Nitesh Jain is Assistant Vice President with Finance & Accounts team, IL&FS Financial Services ( IFIN ), based at Mumbai




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