Financial
reporting in India is passing through very remarkable moments owing to adoption
of Indian accounting standards (Ind AS). For companies covered under Phase – 1
of mandatory Ind AS Financials, 31st March 2017 is first time
complete reporting period and June 2016 was first Quarterly result publication
date and we are months away from Phase 2 implementation. Ind AS Implementation has very wide impact on the
organization so companies should assess carefully impact on growth, strategies,
joint ventures and tax planning. There are many challenges in implementation of
Ind AS however this blog/ article focuses on 5 major challenges:
Challenges Ahead
Financial Instruments
Deferred Taxation
Revenue Recognition
Control for Group Accounting
Business Combination
Financial instrument (Ind AS 32,
109):-
There are no mandatory standards
applicable under Ind GAAP, Ind AS provide the detailed guidance on accounting
of classification, measurement, derecognition and impairment of financial
assets and financial liabilities.
The financial asset is classified based on entity’s business model for managing financial asset and contractual cash flow characteristics of the financial asset. Under an Indian GAAP, the classification of financial liability or equity is largely governed by legal form of the instrument and under Ind AS 32 the same is based on substance of the contractual agreement rather than its legal form. This may create the major changes in net worth as well as net income due to reclassification.
The financial asset is classified based on entity’s business model for managing financial asset and contractual cash flow characteristics of the financial asset. Under an Indian GAAP, the classification of financial liability or equity is largely governed by legal form of the instrument and under Ind AS 32 the same is based on substance of the contractual agreement rather than its legal form. This may create the major changes in net worth as well as net income due to reclassification.
- Classification of liability and equity in case of compound financial instruments like convertible bonds, redeemable preference shares, compulsory convertible debentures etc.
- Re-classification of dividend and interest in profit & loss account due to reclassification of liability and equity.
- Expected loss model for Impairment of financial assets
- All derivative instrument to be carried at fair value, unless hedge accounting requirements met
- Investments to be categorized – Fair value through profit or loss, Fair value through other comprehensive income and amortized cost
Impact:-
Accounting
Standards (AS) – 30, 31 and 32 were issued but not notified as there are
constant changes in the accounting of financial instruments in International
GAAP. ICAI has recently issued Guidance note on Accounting for derivatives
applicable for accounting period commencing after 1st April 2016 for
Non-Ind AS entities. However, there is a significant diversity in the practice.
The implementation of Ind AS 32, 109, disclosure requirements of Ind AS 107 and
applying fair value measurement of Ind AS 113 would be the most challenging
during Ind AS Implementation. As per various reports published after reviewing
June 2016 results, it is observed that Standards relating to Financial
Instruments are the most challenging standards.
Control /Consolidation (Ind AS 110) :-
Under
prevailing accounting standard control is assessed on the basis of more than
one-half of the voting power or control on the composition of board however as
Ind AS is principle based standard, it explains the control in detail and Ind
AS 110 provides a single control model.
As
per Ind AS 110, “An investor controls an investee if and only if the
investor has all the following:
(a)
power over the investee;
(b)
exposure, or rights, to variable returns from its involvement with the
investee; and
(c)
the ability to use its power over the investee to affect the amount of the
investor’s returns”
The
determination of who controls whom is the critical when we mover from existing
Indian GAAP to Ind AS. The universe of entities that get consolidated
could potentially different under both the frame works. The application of
control definition would change the line items of Consolidated financials in
Ind AS.
Key
Differences:
- Consolidation based on new definition of control
-Veto
right with minority share holders
-Potential
voting rights
-Structured
entities
-De
facto control
- Deferred tax on undistributed reserve
- Deferred tax on intercompany elimations
- Mandatory use of uniform accounting policy
Impact:-
With
the introduction of new definition several entities that are not currently
consolidated may get included and vice-versa and it will be a challenge for
Corporate India and professionals.
Revenue recognition (Ind AS 115) :- (Deferred till 2018-19)
Ind
AS 115, Revenue recognition from contract with customers, introduce a single
revenue recognition model, which applied to all type of contracts with
customers, including sale of goods, sale of services, construction
arrangements, royalty agreements, licensing agreements etc. In contrast under
existing Indian GAAP, there is separate guidance that applies to each of these type
of contracts. Ind AS brings five-step model which determines when and how much
revenue is to be recognized.
Key Differences:
- 5 step revenue recognition model
- Timing of recognition of revenue (Right of return, dispatch Vs. delivery) based on satisfaction of performance obligation
- Detailed Guidance on
- Incentive schemes
- Service concession arrangements
- Customer loyalty programs
- Time value of money to be considered
- Separation of contracts in case of linked transactions
Impact:-
India
has deferred to implement this standard in as it has not been implemented
internationally. NACAS had recommended to defer the application of Ind AS 115
and Ministry of Corporate Affairs announced the same on March 2016. Ind AS 18 and 11 has been notified in line
with IAS 11 and IAS 18.
Business combinations (Ind AS 103):-
Currently
there are no comprehensive standard which wholly addressing accounting for
business combination, currently it is done by form of transaction like Merger,
Acquisition etc. Under Ind AS 103, all business combinations are accounted for
using the purchase method that considers the acquisition date fair values of
all assets, liabilities and contingent liabilities.
Key
Differences:
- Acquisition date is the date when control is transferred – not just a date mandated by court or agreement
- Mandatory use of purchase method of accounting and fair value
- Post-acquisition amortization of asset based on the acquisition date fair values
- Transaction cost charged to the profit and loss account
- Goodwill to be tested at least annually for impairment
- Common control transactions are accounted using pooling of interest method
Impact:-
With
the adoption of new requirements on business combinations, it will result into
consistency over the period. Companies which are in progress of negotiation
regarding acquisition, need to pay kind attention to the requirement of the
standard. Fair valuation of asset on the date of acquisition and resultant
goodwill are major areas to look after under new Ind AS.
Deferred taxes (Ind AS 12) :-
As per Indian GAAP deferred taxes are
recognized on timing difference between accounting income and taxable income
for the year and it is known as income statement approach whereas under Ind AS,
deferred taxes are recognized for future tax consequences of temporary
differences between carrying value of assets and liabilities in their books and
their respective tax base and known as balance sheet approach.
Key
Differences:
- Ind AS is based on balance sheet approach whereas AS 22 is based on income statement approach
- Disclosure requirements are more detailed in Ind AS compare to AS
- Deferred tax on revaluation, undistributed profit by subsidiaries/associates, intercompany elimination
- The concept of virtual certainty does not exist in Ind AS 12
Impact:
Whole
method of calculation of deferred tax provision has changed so we have to
carefully assess the impact on the financial statement. On transition to Ind
AS, the deferred tax on reconciliation with Ind AS, deferred tax on components
of Other Comprehensive Income (OCI) and during consolidation will be
challenging during implementation.
The
above mentioned are some of the major challenges in implementation of Ind AS.
The other areas of challenges are application of Ind AS 101 First time
adoption, determination of functional currency under Ind AS 21, preparation of
Statement of Changes in Equity and accounting of components of Other
Comprehensive Income. Corporate India and professionals have to be cautious
while dealing with transformation process to ensure smooth and effective
convergence.
