In recent years, the financial reporting framework in India has undergone a significant change with adoption of Indian Accounting Standards (‘Ind AS’) which are harmonized with globally accepted financial reporting standards, referred to as International Financial Reporting Standards (‘IFRS’), but with limited carve-outs/carve-ins.
The Ministry of Corporate Affairs (MCA), in 2015, had notified the Companies (Indian Accounting Standards (IND AS)) Rules 2015, which stipulated the adoption and applicability of IND AS in following phased manner beginning from the Accounting period 2016-17.
As the previous Indian GAAP (which is still valid for companies which do not meet the abovementioned thresholds) was divergent from IFRS, the companies had to face a lot of accounting issues on transition. Some of the key areas where companies experienced challenge while transitioning to Ind AS included:
- Accounting for financial instruments, underwent a comprehensive change, which affected the balance sheet ratios due to changes in classification of instruments as liability or equity and fair valuation of financial instruments. Certain operational performance measures were also affected due to recognition of fair value changes and adjustment to interest cost arising from effective interest rate method. Going forward Companies will need to be extremely cautious while drafting their financing contracts in order to avoid undesirable accounting implications.
- Accounting for business acquisitions became more challenging. Unlike present accounting practices, which involve the use of book values, Ind AS mandates recognition of assets acquired and liabilities assumed at fair values on acquisition date. Further, the new accounting standards require seeing through an acquisition transaction to identify hidden or unsaid elements therein which further complicate accounting. Given the complexity the companies typically have to engage valuers to identify and fair value assets (including hidden ones such as customer contracts, brand etc) and liabilities to meet the stringent requirements of the standards.
- Revenue recognition witnessed certain high-impact changes on transition. Whether it was accounting for multiple element arrangements or identification of principal-agent relationships, or accounting for rebates & incentives for customers. With implementation of Ind AS 115 Revenue with Contracts with customers which increases guidance on revenue recognition, revenue contracts will need to be carefully drafted to avoid unintended negative impacts on the income statements. Business development teams will have to work in tandem with the accounting and financial planning teams to ensure that there are no unintended consequences.
- Accounting for Leases by lessees, will change fundamentally from 1 April 2019 when Ind AS 116 Leases became effective. The new standard eliminates operating lease model for lessees and requires recognising all leases on the balance sheet as lease liability (similar to finance lease model today) with corresponding Right of Use (ROU) asset. The change impacts balance sheet and performance ratios due to recognition of additional liability and interest charge on such liability.
While the abovementioned roadmap only included corporates, there is a separate roadmap for Banks, Non Non-Banking Financing Companies (NBFC) and Insurance Companies.
NBFC started implementing Ind AS from April 1, 2018. In addition to above the key area of impact on transition comes from Ind AS 109 (equivalent of IFRS 9) which mandates a three-stage impairment model for computing expected credit losses on loans. As NBFC in India used regulatory norms/ guidelines as prescribed by Reserve Bank of India to loan loss provisioning, the challenge was developing an ECL model, which is compliant with Ind AS 109 yet at the same time would not unduly affect the bank’s financial performance.
Ind AS transition for Banks has been deferred until further notice and Ind AS transition for Insurance companies is deferred till 1 April 2020 to align with global adoption of IFRS 17.
While the Ind AS are largely converged IFRS, the Indian standard setters modified the requirements of IFRS, where necessary, to suit Indian conditions (referred to as ‘carve outs’). Key carve outs under Ind AS are listed below: