New accounting standards to impact corporates' fund raising strategy

Non-convertible preference shares will be classified as debt, stretching leverage ratios of companies

Offshore drilling company Aban Offshore would have seen its debt-to-equity ratio worsen to 4.12 if a new accounting standard, IND AS, were applied to its books in the last financial year. The reported ratio for the year was 3.75 by existing accounting practices.

The Union ministry of corporate affairs last month notified new accounting standards (IND AS) that converge with the International Financial Reporting Standards (IFRS) to be implemented in phases from 2016-17. This will affect fund-raising strategies through instruments such as non-convertible preference shares.

“The adoption is likely to significantly affect the reported net worth and the results of especially those having complex capital structures,” says Sumit Seth, partner and IFRS leader at PricewaterhouseCoopers.

Mandatory redeemable preference shares, which till now were shown as part of equity, will be classified as a liability under IND AS. Also the dividend and the dividend distribution tax on such capital will be recorded through the income statement as an expense instead of equity.

“It does not stop here and has a cascading effect. Companies that are expanding and incurring significant capital expenditure and also have outstanding preference share capital will now be required to capitalise such dividend costs as borrowing costs,” says Seth.

Of the BSE 500, excluding banks and financial services, there are 27 companies that have issued non-convertible preference shares and will face the impact of the changes under IND AS. These include JSW Steel, Wockhardt, Adani Port, United Breweries, and Godrej Properties.

“With the use of IND AS, the  key ratios are affected leading to a more leveraged positions of balance sheets. As a result, companies will lose one of the advantages of using preference shares as an instrument for fund-raising,” says Sai Venkateshwaran, partner and head of accounting advisory services at KPMG in India.

This will also help consider compulsorily convertible debentures as equity. “Such positive rationalisation is beneficial for corporates and reflective of the reality in the books,” says Prabal Banerjee, president for international finance at Essar Services India.

But preference shares are not going out of fashion. “It is more of an accounting classification and companies may not change strategy if trying to fund a high growth business,” says Sandip Khetan, partner with the India member firm of EY Global.