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Why We Should Not Tamper With IFRS?

Published on Thu, Oct 09,2014 | 22:11, Updated at Thu, Oct 09 at 22:16Source : Moneycontrol.com 

By: Dolphy Dsouza, Partner In A Member Firm Of Ernst & Young Global

Most of the world is now reporting under International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB).  The last of the developed countries to adopt IFRS was Japan.  Earlier, China too has adopted IFRS, but retained only one difference between Chinese GAAP and IFRS. As of now, there are only two significant countries that do not use IFRS.  One is USA.  However, USA allows IFRS for foreign private filers.  It is also being hoped that US may ultimately allow US companies to voluntarily adopt IFRS in the future.  Besides since long, US and the IASB have been working together on numerous standards, which has resulted in US slowly inching towards US GAAP that is similar to IFRS.

The other significant exception to IFRS adoption is India.  India has announced a roadmap to IFRS (known as Ind-AS), but with numerous questions remaining unanswered.  In this article, the author is only dealing with one of these questions.  That question is should India really depart from IFRS as issued by IASB.  Secondly, if the answer is in the affirmative, why and to what extent should we depart?  At this stage these matters are being debated and the answers to these questions will be clear in the near future.

The most important thing to keep in mind is that accounting is an art, and not a precise science.  Primarily, financial statements should reflect and capture the underlying substance of transactions.  The accounting standards are drafted to ensure that underlying transactions are properly accounted for and also aggregated and reflected transparently in the financial statements.  But as already pointed out, this is not a precise science, and people may have different views on how to achieve this objective.  Also at times, countries depart from the basic objective of true and fair display, to help companies in difficulty and pursue other unrelated objectives.

The IASB is an independent standard setting body comprising of 14 full time members from different parts of the world.  The IASB is also responsible for approving interpretations of IFRS.  IFRS’s are developed through an international consultation process, the "due process", which involves interested individuals and organizations from around the world. The development of an IFRS is carried out during IASB meetings, when the IASB considers the comments received on the Exposure Draft. Finally, after the due process is completed, all outstanding issues are resolved, and the IASB members have balloted in favour of publication, the IFRS is issued.  This is a very time consuming process, but results in technically solid IFRS’s being issued.  It takes into consideration the needs and realities of different countries, and tries to balance them.  At times, some of these needs and realities could be conflicting, and it would be impossible to keep all countries happy all the time.  Nonetheless, the bottom line remains that the standards should be technically robust, one that would reflect the substance of the underlying business and transactions in a fair and transparent manner.

Most countries that have adopted IFRS, have adopted them as they are, i.e., without indigenizing them to their local GAAP.  There were many reasons for taking this approach.  Foremost, their local GAAP was developed to meet some regulatory objective such as taxes or investor protection or capital adequacy.  They did not reflect the true and fair picture and hence were not typically driven towards meeting the needs of the investors.  This had to change and investor needed to be given precedence if capital formation and growth objectives were important.

Most countries that did adopt IFRS as it is did so because it enhanced the credibility of the financial statements which resulted in low cost of capital.  As major groups have companies all over the world, using one accounting language helped them in preparing consolidated financial statements seamlessly.  Using one accounting language across their different companies in the world also meant that their management information systems and IT was consistent across the globe.  This made their lives much more predictable, consistent and easier.  Today most stock exchanges in the developed world either require or allow IFRS.  Also, investors around the globe understand IFRS and are very comfortable with it.  

Any country that departs from IFRS will not receive any of the above benefits.  Therefore if India were to implement IFRS with too many differences, it would be akin to moving from one Indian GAAP to another Indian GAAP.  It would not be possible for Indian companies to state that they are compliant with IFRS, and hence those financial statements will be treated as local GAAP financial statements.  In recent times, India’s corporate governance rating too has taken a beating because it has not implemented IFRS.

An interesting point to keep in mind is that in the future even if Ind-AS are completely aligned to IASB IFRS, companies would not be entitled to state that their financial statements comply with IASB IFRS.  This is because the opening balances would not be in accordance with IASB IFRS.  To state compliance with IASB IFRS, companies shall have to apply IFRS 1, convert all over again and will be treated as a first time adopter.

The other argument for not tampering with IFRS is one based on technical reasoning.  Take for instance, accounting for foreign exchange.  It is being proposed (under Ind-AS) that any gains or losses on foreign exchange on long term borrowings will be parked in a reserve account and amortized over the period of the loan.  This was based on the argument that sharp fall in foreign exchange rates are offset by sharp increases and in the long run volatility is evened out.  By following an amortization policy, stability can be introduced in the P&L account.

However, the reality is that in the long run, rupee does consistently depreciate vis a vis the US dollar.  This is not just based on a theoretical argument caused by different levels of inflation in the two countries, but can be practically checked (see table for 10 year chart).  By following a policy of amortization, the P&L impact connected with a substantial depreciation of the rupee is deferred to the latter years.  The best thing to do to reflect the true and fair picture would be to account for the foreign exchange changes in the financial statements as they happen, rather than amortizing it.  Amortizing current losses to future years, is like playing mind games into believing that the loss has not happened or hoping that the loss will reverse out, which may never happen.

 

 

 

 

 

 

 

India is now on the edge of a precipice from where it can either fall into a slumbering economy or rise like a phoenix from the ashes.  It has many hard choices to make; adopting IFRS is one such choice.  It may bring pain for a few entities, but in the long run, this is the way to go.  This is indeed a bold step which we are hopeful the new government would take.

 
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