Challenges for Implementation

The Chamber of Tax Consultants

18. 2. 2010

Dr. Paritosh. C. Basu

Discussion Flow
Striking Features of IFRS IGAAP to IFRS An Exciting Journey Transition to IFRS Significant Challenges and Impacts IT Enabled Solution Implementation Option to CFOs

Striking Features IFRS

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IFRS Striking Features vis--vis IGAAP

More similarities with IGAAP than differences Two striking differences from IGAAP are that IFRS is driven by Fair valuation of assets and liabilities resulting in unrealised gains and losses Arms length basis for assessment of transaction even between holding and subsidiary companies Becomes difficult at times to appreciate the combined impact of such fair valuations on financial results vis-a-vis actual business performance IFRS, therefore, suggests and demands Exhaustive disclosures of Accounting Policies Large number of clarificatory notes for almost every line item disclosed in Income Statement and Balance Sheet Sensitivity Analysis of certain elements that may affect results due to variations, e. g., rate of exchange, floating rate of interest on loan, etc. Disclosure of results out of Managements annual review of: Efficacy of risk hedging instruments Credit risks and so on Mandatory annual assessment of Useful Life of assets by management

IFRS Striking Features vis--vis IGAAP 2

Functional Currency may be the one of that country which significantly influences operations and financial results (IAS 21) Presentation of Financial Statements (IAS 1R) is significantly different from IGAAP Certain examples Clean segregation of Assets and Liabilities into Current and Non Current groups Statement of Other Comprehensive Income (SoCI)

Statement of Changes in Equity (SoCE) including Dividend

Functional grouping of expenses (generally preferred) Prohibition in disclosure of Extraordinary Item unlike AS 5 Disclosure of Critical judgment of management in applying accounting policies Key sources of estimation uncertainty that have significant risks Information that enables users to evaluate entitys objectives, policies and process of managing capital

Status of Adoption and Path Forward

Path Forward No blackout period expected from IASB in transition course up to 2014 Substantial changes expected in Standards - Revenue, Consolidation Def. Tax, Lease, Fin. Liabilities Uncertainties about schedule in the USA albeit expected by 2014 / 15 Implementation challenges Scarce resources and IT solution Change in mindset of all concerned - Substance over Form 6

Countries that have already adopted IFRS are shaded with blue Countries in the process of adoption of IFRS are shaded in grey (Source. www.iasb.org)

Need for Common Accounting Standard

Deutsche Bank group prepared its consolidated financial statements under US GAAP until Dec. 31, 2006. Due to the requirement of European Union, the group had to adopt IFRS from Jan. 1, 2007. Under US GAAP, for the year ended Dec. 31, 2006, the groups total assets were 1.126 billion Euros, while under IFRS they were 1.572 billion Euros. Such dissimilarities weaken the usefulness of financial statements and hence there is a case for uniform financial statement reporting standards.

Convergence Approach - Challenges

Management of variances and hurdles - A Rocky W a l k
1. Major modifications and amendments required
Legislations - Companies Act and Income Tax Act

Regulations and Regulators RBI, IRDA, SEBI

2. Rigorous application of repetitive Fair Valuations Limited availability of Tools and Professionals Psychological preparedness for accepting volatility by all stakeholders 3. Shortage of trained Accountants with requisite knowledge and skill set 4. Change in mindset of all concerned Substance over Form 5. Unlearn disclosures under Schedule VI Those stood the test of time 6. Functional Currency vs. General purpose currency and accounting 7. Replace Expert Advices, Guidance Notes by the likes of IFRIC and SIC 8. Protective confidentiality vs. complete transparency

10. Too many worksheets .. conversion Journal Vouchers

11. Management of options given under first time adoption
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Transition to IFRS Significant Challenges and Impacts

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Transition to IFRS - Significant Challenges

At every stage of accounting Measurement Transaction processing Recognition Disclosure
Conceptual

Four Frameworks Financial Statements of Accounting Institutional

Regulatory

Legal

In every aspect for reporting Accounting Policies Critical Accounting Judgments and Estimates * Income Statement Balance Sheet Statement of Other Comprehensive Income* Statement of Changes in Equity* Notes to Accounts Contingent Liabilities and Commitments

* New disclosure requirements under IFRS

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GAAP Conversion Brawl out Challenges at Each Step

Know your Financial Statements (FSs) more under IGAAP Study FSs under local GAAP in details for last three years Identify critical and major transactions including one-off kind List accounting under regulatory requirements Trace back all work sheets and valuations for measurement

Identify work content and assess time and resources

Identify GAAP differences vis--vis IFRS List items to be done / redone with owners for each work group Transactions, Measurements, Disclosures, Sensitivity Table Assess requirements, efforts in-house capabilities and external support with Plan B if required Brief top management and operating team for support required

Actions, Execution, and Monitoring

Identify a Mentor and set up a Steering Committee Prepare and monitor Action Taken Report Job description, Information inputs, Dependency, Timeline Review progress with focus for critical items Review draft accounts with iterative perfections

GAAP Conversion Brawl out Challenges at Each Step 2

Conversion process from IGAAP to IFRS - Points of Cautions
Certain first level changes leads to sympathetic reworking and revision Fair valuation of PPE - Depreciation and Lease Rent

Decapitalisation of expenses and Fx gain/ Loss - Depreciation and Expenses

Change in Depreciation and Expenses - Revaluation of Inventory Temporary differences due to revaluation - Deferred Tax Assets / Liabilities Whenever there is a change in treatment as above as far as practicable Reverse the effect under IGAAP in full Pass a new JV for the full value to bring in the effect of IFRS Maintain total caution about sympathetic changes that may emerge Avoid passing JVs for differential amounts Composite JVs for more than one conversion effect Create in course of time a second set of Fixed Asset Register in SAP added with value adjustments arising out of Fair valuation of Fixed Assets Decapitalisation of expenses and gain / loss of currency fluctuation

GAAP Conversion Brawl out Challenges at Each Step 3

Whenever effects are taken only for IFRS, which was not there under IGAAP Pass a separate JV with a new series of numbers

Be cautious about unwinding of liabilities or assets created under IAS 39

Keep all work sheets and JVs linked to each other with unique serial number, JV and line items for future reference A comprehensive list of all C/F adjustments after first adoption and / or new business combination to be kept handy to ensure Impacts are appropriately incorporated in Accounts of subsequent periods Preparation of a comprehensive list of impacts on Profit and Net Worth due to such C/F adjustments

Prepare three reconciliation statements from IGAAP to IFRS

Profit before Tax Net Worth Deferred Tax Assets and Liabilities arising from Balance Sheet approach

Significant Impacts Challenges in Measurement and Accounting

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Significant Impacts - Revenue Recognition

Technology, Media and Telecom Bundled service commitments with handsets / data cards deferred till delivery Retail, Motor Car, Airlines Deferment for Fair Value (FV) of Liability against loyalty programme, future delivery of commodity, services or extended warranty Incentive to be netted-off from Sales instead as selling expenses Advertisement Barter transactions Reliably measured FV of services received or provided Construction, Realty and Infrastructure Terms of agreement are critical for revenue recognition At backend on delivery or Proportionate completion basis
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Significant Impacts - Revenue Recognition .. 2

Banks Upfront fees income against loans to be amortised over loan period on effective yield basis Substantial reclassification and fair valuation of investments Capital Goods Unbundling of installation services and recognition on completion NPV differential against deferred payments treated as finance income Change in Nature of Revenue Manufacturing / Service nature to Leasing Income if IFRIC 4 is applied Manufacturing to Service Revenue Free service coupon by Motor Car Industry Sale of Goods Physical control and ownership change CIF Exports - Bill of Lading vs. delivery Domestic FOR Destination Contract - Lorry Receipt is not the criteria
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Significant Impacts - Income Statement

EBIDTA (Not recognised as a measured value in Income Statement) Automobile Component, Power Generation Arrangement
Charges for components under take or pay arrangement may attract IFRIC 4 and be treated as Depreciation under Financial lease

Banks
Provisioning against NPAs as per RBI directives to be replaced by Impairment of future cash flow based on objective evidence

Income Statement PBT & PAT Combined impacts of

Revenue and Cost recognitions

FV and Reassessed Life on Depreciation of Fixed and Intangible Assets

Functional Currency Change may impact all items in Income Statement

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Significant Impacts - Income Statement .. 2

Income Statement PBT & PAT (Contd.) Capital profit on business combination FV of investment property in Realty sector Interest cost against Preference Share on treatment as loan Amortisation of Upfront Fees for loans over door to door period

Deferred Tax Asset / Liabilities against all fair valuation gains / losses
Changes due to adjudged adjusting events post balance sheet date Provision for Contingent Liability Probable, Possible and Remote

Senior Executives may have to renegotiate Profit linked Variable Pay

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Significant Impacts - Balance Sheet and Net Worth

Reclassification of Loans as Current Liabilities, if waiver against covenant defaults not obtained within year end
Prescriptive provision and not substance over form May have implications on Going Concern assessment and report by Auditors

Replace Fixed Assets by Long Term Receivables if IFRIC 4 applies to Take or Pay or servicing contracts with specific assets Preference Shares reclassified as Debt FV of Inter-company Borrowings at concessional rate Split of Convertible Instruments into Debt and Equity FCCB, Debenture Effective Hedge Accounting for derivatives FV impact on Net Worth Adjusting Loans for Effective Interest Method and Upfront Charges Reassessment of effective Useful Life and Residual Value of Fixed Assets

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Significant Impacts - Balance Sheet and Net Worth .. 2

Functional Currency change Impact on Fixed Asset Valuation and CTR Current and Non Current approach towards Balance Sheet Goodwill - Amortisation vs. impairment Deferred Tax Provision with Balance Sheet approach Revaluation and FV of Fixed Assets
Business Combinations First Time Adoption Depreciation method

Changes due to assessed Adjusting Events post balance sheet date Provision for Contingent Liability Probable, Possible and Remote

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Additional Notes and Disclosures for More Transparency

Financial Risk Management - Objectives and Policies covering Credit Risk on Customers Currency Exchange Exposures Liquidity Risk - Maturity Profile for Loans, Creditors, Derivatives, Lease Commodity Price Risk Restricted Cash

Capital Management Policy - Objective, Debt, Equity

Tax Reconciliation and Analysis Reconciliation at Effective Rate Component-wise Analysis of Deferred Tax Sensitivity Analyses Interest Rate on Loan Portfolios with Reset Clauses or Floating Rate Exchange Variations on Financial Assets and Liabilities

Analyses of Contingent Liabilities - Probable, Possible and Remote

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Significant Impacts on Performance Indicators

Current Ratio - Mostly likely to be Adverse even Cash Equivalents may be Non Current Assets Fixed Assets to Loan - Movement may be Both Ways depending on FV, reassessment of Life and Residual Value Debt Equity Ratio - Likely to be Adverse due to Reclassification of Preference Share Convertible Instruments

Return on Net Worth - Combined effect may be Both Ways but likely to Improve
EBIDTA over Revenue (Not a Standard Measure, may be included in Notes) - Combined effect from revenue and cost recognition Debt Service Coverage Ratio - May have to be recast under IGAAP till Indian Banks takes a policy decision about IFRS application. Analysts to exercise caution while using and comparing such disclosures

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IT enabled solution Implementation Options before the CFO

(Stand Alone and Consolidated Accounts)

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IT Enabled Solution - Options before CFOs

Option - I
Native GAAP to IFRS using JVs - No Change in ERP 1. Prepare GL, Financial Statements using given ERP and native GAAP 2. Identify GAAP differences vs. IFRS 3. Calculate numbers for
a. Passing JVs for first adoption under IFRS - I b. Passing JVs to bridge GAAP differences c. Additional notes and disclosures

4. Recast TB with JVs in 3 above > Draw IFRS Accounts and Notes Implications / Challenges 1. Voluminous excel sheets with huge human efforts repetitive costs 2. Scope for human error, discretion, slippages in data security. 3. Use of non-standardised Master / Meta Data and processes 4. Conversion cannot start before Accounts under Native ERP is drawn

This may be the given scenario in corporate India till Statutes are changed and one converged GAAP is adopted
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IT Enabled Solution Options before CFOs .. 2

Option - II
IFRS to Native ERP using JVs Marginal change in ERP for Transaction Processing 1. Pass all JVs for first adoption of IFRS 2. Configure in existing ERP auto JVs or pass manual ones for additional entries required to bridge GAAP differences 3. Follow same steps of Option - I for conversion to native GAAP Implications / Challenges 1. Manual worksheets cannot be avoided for passing GAAP adjustment JVs 2. Others - same as in Option - I

Challenging option to implement without Comprehensive knowledge, stabilised processes and ERP support

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IT Enabled Solution - Options before CFOs .. 3

Option - III
Simultaneous Processing of General Ledger under IFRS and Native GAAP {Use FI-CO Modules of SAP (ECC 5 / 6)or Oracle} 1. GL - I : Used for Native GAAP 2. GL - II : Used for IFRS* 3. Configure in existing ERP auto JVs or pass manual ones for additional entries required to bridge GAAP differences in GL - II 4. Incorporate Changes in Opening balance for first adoption
(* Separate solution is required where Functional Currency is different)

Implications / Challenges 1. Huge time required to change the ERP to meet IFRS requirements 2. Manual Worksheets cannot be avoided for preparing numbers to pass JVs for GAAP conversion 3. Others: same as in Option - I Challenging option to implement without Comprehensive knowledge, stabilised processes and ERP support

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Further thoughts ..

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Thank you

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