Get set for drastic changes in financial statements

Getting ready for the new accounting standard

The impact of Indian Accounting Standards (Ind-AS) on Indian companies will depend on their sectors, states, funding structure, how acquisitive they are, group structure, accounting policy choices and the strategic decisions and business models. Consequently, the extent of impact for different companies will be different, even if they belong to the same industry. Given that Ind-AS is a substantially different framework compared with Indian GAAP (generally accepted accounting principles), the impact is likely to be significant for many companies.

If a company is in the consumer sector space, they may have many sales incentive and sales promotion schemes. Unlike Indian GAAP, under Ind-AS, these schemes may either lead to a deferral (eg customer loyalty schemes) or reduction (eg cash and non-cash incentives) of revenues. On the other hand, under Ind-AS, the initial view of the standard setters is that excise duty is presented on a gross basis and may, therefore, increase the revenue number. For a real estate developer, the impact on the revenue numbers is likely to be insignificant, because both Indian GAAP and Ind-AS require the application of percentage of completion method.

Nonetheless, a real estate company may have funding structures that under Indian GAAP may have been accounted for as equity but are accounted for as liability under Ind-AS. For instance, redeemable preference shares that are accounted for as equity under Indian GAAP, would come under liability in Ind-AS. This will adversely affect the debt equity ratio, interest expense and earnings per share under Ind-AS.

Under Indian GAAP, the identification of subsidiaries is more substance-driven and based on assessing which investor has power over the relevant activities. Thus, options, defacto control and control through agents may result in consolidation or deconsolidation under Ind-AS. Under Indian GAAP, joint ventures are accounted for using the proportionate consolidation method. Under Ind-AS, it is through applying the equity method. To that extent, the balance sheet total and profit and loss statement (P&L) topline will reduce under Ind-AS. An infrastructure group, which operates through multiple joint ventures, may be significantly impacted.

Some major groups that have operations in developed countries may have a huge pension obligation. Under Indian GAAP, actuarial gains and losses are recognised in P&L, whereas under Ind-AS, they come under other comprehensive income (reserves). This will have the impact of reducing the P&L volatility under Ind-AS. Under Indian GAAP, acquisitions are accounted for using the book value, whereas under Ind-AS the accounting is based on fair values of assets and liabilities. Consequently, groups that are acquisitive may have larger intangibles and amortisation in the Ind-AS financial statements. However, goodwill number under Ind-AS would be comparatively lower than Indian GAAP. That would reduce P&L volatility under Ind-AS caused by any subsequent goodwill impairment.

The accounting policy choices on first time adoption and ongoing basis will also impact the Ind-AS financial statements. A company that chooses to use the first time adoption exemption under Ind-AS of stating fixed assets at fair value will have a larger equity and a higher P&L depreciation charge. On the other hand, a company that chooses to state fixed assets at previous GAAP carrying value will have a comparatively smaller balance sheet and a lower depreciation charge.

Conversion to Ind-AS is more than a mere technical exercise. The consequences are wider and extend to various business and regulatory matters, including debt covenants, tax outflow and modification of information technology systems. For many entities, financial statements and ratios may change dramatically. This will affect the perception of investors, analysts and bankers. A proper communication strategy could turn this event to one's advantage.

Leo Van Der Tas, Global leader, IFRS Services, EY
Dolphy D'Souza, Partner in Indian member firm of EY Global & IFRS leader, India