Accounting Globalization: Issues and Challenges of IFRS Implementation in Indian Banks Dr. Samiksha Ojha, Associate Professor, Finance, International Management Institute, New Delhi, India Dr. Deepak Tandon, Professor, Finance, Lal Bahadur Shastri Institute of Management, New Delhi, India ABSTRACT IFRS goal is to create comparable, reliable, and transparent financial statements that will facilitate greater cross-border capital raising, trade and better corporate governance practices. Thus acceptance of IFRS is gaining momentum across the globe. The Indian Banking industry is no exception and is stringently regulated wherein GAAP have been obviated. All the scheduled banks are required to convert their opening balance sheets as of 1st April 2013 as per the new reporting standards. Banks are currently following the prudential norms of Reserve Bank of India (RBI) and Institute of Chartered Accountants of India (ICAI), which are very prescriptive and require limited use of judgment. IFRS on the other hand requires a case by case assessment of the facts and circumstances regarding future cash flows. This clearly shows that convergence to IFRS will pose significant challenges for banks involving higher disclosures by banks.the conversion challenge for the sector is compounded since the main standard of concern, IAS39, is being replaced with a new standard, IFRS9, in three phases: Recognition and measurement, Impairment and Hedge accounting. The purpose of this paper is to analyze the impact of the new accounting system involving a major shift from prescriptive norms to the system involving greater judgment. The paper elaborates the preparedness on Indian Banks to adopt the new accounting system, the challenges before it and the areas on which the banks must focus on to adopt the system. Keywords: IFRS, Convergence to IFRS, challenges before Indian banks, financial reporting system I Introduction The impending work of IFRS implementation in India has given rise to a range of challenges for all the concerned authorities and regulators. The last deadline of April 2011 was not met and the target still looks far away. The present study is an attempt to analyse the conceptual framework of IFRS in the area of banking particularly public sector banks. It also analyses the various challenges and issues related to the implementation process and the efforts made by public sector banks in India in this direction. In India, the banks set the IFRS deadline as April 2013.All the commercial and co-operative banks with net worth of more than 300 Crores have to comply with the new accounting norms. 1.1 What is IFRS? IFRS or International Financial Reporting Standards are the sets of accounting standards developed by IASB (International Accounting Standard Board) to act as a uniform accounting standard around the world in the era of globalisation. 1.2 Why IFRS? Adoption of a uniform reporting practice such as IFRS would reap the following benefits: www.theinternationaljournal.org > RJEBS: Volume: 01, Number: 11, September-2012 Page 47
Similar reporting basis will facilitate comparison among sectors, countries and companies Global companies would benefit in the form of not having to prepare multiple set of accounting report and avoid significant adjustment for preparing consolidated financial statements. IFRS helps the company to raise capital abroad without the cumbersome process of conversion and filing procedures required by various stock exchanges across the world Besides it would also reduce the cost of raising funds abroad by reducing the accountant s fees and avoiding the preparation of dual financial statements. It can improve and initiate new relationships with investors, customers and suppliers across the globe. 1.3 IFRS & INDIAN ACCOUNTING STANDARDS: A COMPARATIVE ANALYSIS SUBJECT IFRS INDIAN GAAP First time adoption Components of Financial Statements Balance Sheet Full retrospective application of IFRS to PL and B/S. Reconciliation of P/L and B/S in respect of last year reported Numbers under previous GAAP. Comprises of Balance sheet, Profit and Loss A/c. Cash flow Statement, changes in Equity and accounting policy and notes to Accounts No particular format, a current/ non current presentation of Assets and liabilities is used. No need to prepare reconciliation on first time adoption Comprises of Balance sheet, Profit and Loss A/c. Cash flow Statement (if applicable), and Notes to Accounts As per Format Prescribed in Schedule VI for Companies, Adherence to Banking Regulation For Banks etc. As per Format Prescribed in Income No particular format Prescribed (IAS-1) Statement Schedule VI (AS-1) Cash Flow Mandatory for all entities (IAS-7) Level 3 entities are exempted Statement (AS-3) Depreciation Over the useful life of the asset. (IAS-16) Over the useful life of the asset, or schedule xiv rates, whichever is higher (AS-10) Cost of major repairs Revaluation Earnings per share Component accounting Intangible assets Recognized in carrying amount of the assets Revaluation (if done) to be updated periodically so that carrying amount does not differ from fair value at the end period. Revaluation to be done for entire class of assets (IAS-16) Disclosure to be made in only consolidated financials of the Parent Co. (IAS-33) Required each major Property Plant Equipment with a cost that is significant in relation to total Cost, should be depreciated separately (IAS-16) Intangible assets can have indefinite useful life and hence such assets are tested for impairment and not amortized. Expensed off. No specific requirement for Revaluation. Revaluation can be done on systematic basis like for one location leaving aside the assets of other location. (AS-10) Disclosure of EPS in both Consolidated and separate Financials. (AS-20) No such requirement (AS-10) There is no concept of indefinite useful life. Assets have definite life. (usually 10 years) www.theinternationaljournal.org > RJEBS: Volume: 01, Number: 11, September-2012 Page 48
Reporting currency Key management personnel (KMP) Uniform accounting policies Requires the measurement of Profit using the functional Currency. Entities may, however, Present financial statements in a different currency. (IAS-21) Includes Executive as well as non executive directors (IAS-24) Prepared using uniform Accounting policies across all entities in a group. (IAS-27) Schedule VI to the Companies Act, 1956 specifies Indian rupees as the reporting currency. (AS-11) Excludes non executive Directors. (AS-18) Policies may differ due to impracticability. (AS) Table 1: IFRS & Indian Accounting Standards: A Comparative Analysis Compiled from http://moneybol.com/comparison-of-ifrs-and-indian-accounting-standards/ II. REVIEW OF LITERATURE: 1. Mr. Sheshangiri (Jt. MD & Group CFO JSW Group), April 2010, Economics Times, has concluded that Indian corporate sectors particularly SMEs are not fully prepared to adopt IFRS due to various critical challenges, such as conflict between legislation and accounting standards resulting in multiple interpretations for a transaction; differences in the underlying conceptual framework and lack of trained people, etc. 2. Amarjit Chopra (President ICAI), in his article in Economics Times, April 2010, concluded that Indian companies are ready to adopt IFRS. IFRS-converged Indian accounting standards would not be too cumbersome. 4. Dr K. C. Chakrabarty (Address by Dr K. C. Chakrabarty, Deputy Governor, Reserve Bank of India at the Mint s Clarity Through Debate, Mumbai, on March 15, 2011), RBI Bulletin, April 2011, has concluded that, the convergence process would be from period beginning April 1, 2013, with a phased approach for urban banks and NBFCs. It has to be noted, however, that banks will be significantly affected by the Indian Accounting Standards (IAS) 39 replacement project and a number of other accounting developments including those relating to financial instruments, fair value measurement, financial statement presentation and consolidation. 5. Jayanthi Kumarasiri and Richard Fisher, Swinburne University of Technology, Australia & University of Canterbury, New Zealand, in their exploratory research study have made an effort to identify and examine the issues and challenges confronting auditors in a developing country context. These issues included: lack of technical knowledge, the prevalence of inactive markets in developing countries, difficulties associated with the variation in techniques used to ascertain fair values across different industries, general complexities in ascertaining fair values, and the incorporation of future events and conditions into valuations. The provision of adequate training and technical guidance were viewed as the primary means of mitigating these concerns. 6. International Journal of Business and Management Vol. 6, No. 3; March 2011, IFRS - Impact on Indian Banking Industry, CA. Mohammad Firoz (Corresponding author), Prof. A. Aziz Ansari, Kahkashan Akhtar.The study conducted by CA. Mohammad Firoz, Prof. A. Aziz Ansari and Kahkashan Akhtar shows that the implementation of IFRS shall have the major impact over the advances, financial instruments, investments. The tax authorities have not yet clarified the provision of the losses arising due to revaluation in such advances and instruments. Reserve Bank of India has also not clarified the compliances of the SLR and maintenance of the other reserve through the investments in the Government securities and their valuation in contradiction or compliances with IFRS.. 7. V K Gupta and Archana Patro concluded that the convergence of Indian GAAP with IFRS would various challenges on tax and regulatory funds, which companies, investors and regulators will have to grapple with. It is expected to have a significant impact on all www.theinternationaljournal.org > RJEBS: Volume: 01, Number: 11, September-2012 Page 49
stakeholders such as Chartered Accountants, regulators, financial analysts, economists, investors, industrialists and accounting professionals and so on. 8. P.S. Prabhakar has strongly opposed the mandatory implementation of IFRS for all the companies in India. He has a view that, it should be made optional for those who are willing to go for it. He is also of the view that since India has not adopted MTM in first place, therefore, IFRS is not required in Indian context. He has observed that, the banking and insurance regulators (RBI and IRDA) too are not too enthusiast by proposed introduction of IFRS. 9. Manoj Kumar Vijay has observed that convergence to IFRS is likely to pose significant challenges for banks as shown by global experience. Certain large Indian banks which have the benefit of going through the process of international GAAP such as US GAAP in the past, have recognized the challenges of convergence and have already started planning their detailed roadmap to achieve a smooth convergence. 10. Ernst and Young in its report have observed that banking sector would be affected most by the implementation of IFRS in India. As banking is highly regulated industry in India which has to comply with the accounting standards issued be ICAI as well as certain mandatory accounting principles prescribed by RBI. The prudential norms for banks set by RBI are not fully in compliance with IFRS. Apart from this banks have other extensive regulations to deal with such as Basel II requirements. All these factors collectively pose a serious challenge in front of baking industry in India as far as implementation of IFRS is concerned. 11. In their study, Mohd. Anam Akhtar and Dr. Ravinder Tripathy have discussed some notable efforts world wide to enforce IFRS. Besides they have also thrown light on need and benefits of IFRS for India and suggested the roadmap for its implementation. 12. Dr. Ravi Tripathy and Ms Shikha Gupta found that a successful transition requires a well thought of plan well in advance. However given the nature of accounting and peculiarities of the Indian economic environment, the process of convergence has its own set of challenges. 13. Thus, the above review of literature reveals that the convergence in to IFRS would aim at a uniform method of reporting globally. This will lead to a sea change in the method of calculating certain financial ratios and a dramatic change in the profitability of banking sector. OBJECTIVES OF THE STUDY : To analyse the theoretical framework of IFRS implementation in Banks in India To analyse the perception of bank officials related to implementation and successful convergence. To discuss various issues and challenges in of IFRS implementation To study the degree of preparedness of banks for IFRS implementation. METHODOLOGY: The present study is on primary as well as secondary data. Secondary data has been sourced from RBI Bulletin, Government budget document, Report on Currency and Finance (RBI), Economic survey of Government of India, various reports of committees, ICAI reports in journals and magazines etc. Primary data has been collected through a structured (close ended) questionnaire to analyse the perception of public sector bank officials regarding various issues related to implementation of IFRS in India as given below : The sample size was 100 consisting of respondents from various public sector banks working at deputy General Manager and General manager level of hierarchy in Delhi and NCR region. A sample survey of 50 banks with two employees from each bank was done. The respondants were chosen at DGM and GM levels as they would are aware of the challenges and issues in the implementation of IFRS. These were officials who are in the Finance and accounting department of the Banks. www.theinternationaljournal.org > RJEBS: Volume: 01, Number: 11, September-2012 Page 50
ANALYSIS: Questions Will Implementation of IFRS benefit in any way apart from the regulatory requirement What is the level of implementation of IFRS in your bank? List the benefits of implementation of IFRS in your bank List the issues and challenges related to implementation of IFRS in your bank List the top 5 IT challenges related to your bank List the top 5 technical accounting challenges for the bank due to IFRS implementation Does the bank have skilled resources for IFRS Convergence Do you agree that early implementation of IFRS has been/will be beneficial for your bank? List the HR challenges in implementation of IFRS in the bank Answers 30% of the respondents thought there would be significant benefits like standardization with global peers and also will be helpful in raising capital. 40% of the respondents felt there would be some benefits. No plan in the near future, 0% Planning to implement, 10% Planned but process has not yet started, 25% Into the process of implementation, 60% Are already following the IFRS, 5% Transparency in reporting Fair valuation of assets and liabilities Enhancement of brand value of the bank Better integration at global level Less time and efforts due to absence of dual reporting system Accounting challenges Compliance burden Tax reporting practices IT related challenges HR related challenges Absence of updated accounting software Challenges related to IT operation Lack of trained technicians High cost involved Obsolescence Loan/ investment impairment Fair value method Derivatives and hedge accounting De recognition of financial assets Consolidation 75% of the respondents said the bank would train the existing resources, 25% said they would recruit new. 55% of the respondents agreed to this, 25 % said no, and the rest had no opinion. Lack of trained professionals High training and development costs Optimal use of external advisors and specialists Effective knowledge transfer to the team members Resistance from the bank employees INTERPRETATION: The paper brings out a number of observations.the convergence of International Financial Reporting Standards shall change the entire scenario of the organization structure of the Banks. As per the respondents, top five technical accounting challenges for banks are Loan/investment impairment, Required use of fair value for more financial Instruments, Derivatives and hedge accounting, Derecognition of financial assets and Consolidation of entities. www.theinternationaljournal.org > RJEBS: Volume: 01, Number: 11, September-2012 Page 51
The respondents felt that a major issue relating to implementation of IFRS in Banks is that Indian Accounting Standards provides various norms and standards for valuation of financial instruments forming major part of capital structure in banking sector. In the case of financial instrument accounting the major difference between Indian Standards and IFRS pertains to investments, convertible debt and preference shares and derivative instruments. While under Indian Standards, investments are treated differently based on their classification into held to maturity, available for sale and available for trade, they are all mostly required to be treated under IFRS as available for sale and should be carried at fair value. This fair value is an exit price which is an estimate of its future value depending upon market interactions and hence needing expert's opinion. Another area, the respondents felt needed attention was, IFRS requires increased use of judgment and extensive use of unobservable valuation inputs and assumptions. The regulatory review process would need to be adjusted to acknowledge the inherent judgments involved in the application of IFRS. Another issue which the respondents stressed on was the adaptability and compatibility of existing IT solutions used by banks to the new requirements imposed by IFRS convergence. Software which has been written keeping in mind Indian standards requirements may have to be modified substantially to incorporate features of IFRS requirements. Similarly, compatibility between software and hardware would have to be addressed to take care of the new requirement Majority of banks have expressed a need for guidance on the above mentioned critical challenge areas. The RBI has set up a working group to help out banks with IFRS convergence. A large number of banks have still not started work on the convergence. Banks should atleast start assessing the impact IFRS would have on the IT systems, capital adequacy, taxes,etc. Almost all the banks surveyed perceived moderate benefits in implementing IFRS. The main reasons were ease in raising capital and comparability with global banks. WRT the difficulties the banks would face vis-a vis conversion a large number of banks considered disclosures as a problematic area. The data collection for disclosures would be a tough area. Another area of difficulty would be Investments. According to the respondents the challenges are compounded as the Indian banking sector must adhere to certain specific prudential requirements (e.g. SLR securities).in addition, there is a lack of an active and liquid market for most debt securities and, therefore, transaction evidenced mark-to market values are not readily available. The respondents mentioned that recruitment of skilled resources for IFRS is another challenge that banks are facing. Lack of proper trained staff is going to create problems for the banks. Therefore the banks plan to run their IFRS conversion project with assistance from an external consultant on specific issues. What should banks focus on to meet these challenges?. Banks should develop a data capture structure to see where the information will be collected, who will make the impairement assessment, storage systems etc. The loss forecasting mechanisms should be fine tuned alongwith the risk adjusted pricing for fresh loans being sanctioned by the banks. Collate and inventories the full set of entities where consolidation assessment need to be made and perform those assessments as early as possible including a consideration of non shareholding related factors that impact consolidation Ensure that common accounting policies are applied across the group Prepare for the impact of factors arising out of consolidation such as how disclosures at a group level can be collated and populated, chart of accounts, group reporting packages, reporting timelines.the fair valuation methods should be updated so that they are up to date with the current market conditions. Also trained personnel should be made responsible for significant areas. The budget areas should be fine tuned to incorporate volatility in the income statement due to fair values as a measurement attribute..the impact of transactions that would fail de-recognition should be assessed and the impact on capital adequacy and certain ratios should also be studied. Banks have to initiate action by themselves on some important aspects if not already done while RBI and GOI have to give needed guidelines and road map for a smooth and successful transition. Such www.theinternationaljournal.org > RJEBS: Volume: 01, Number: 11, September-2012 Page 52
aspect may include forming a core group for the identifying key areas of impact; discussing the issues at all the different levels in the bank; imparting necessary training to the employees on the risk management practices, systems and procedures and train the concerned staff on the new methods; and educating all the stakeholders regarding the impact and bank's position in the market. CONCLUSION In India, there will be a significant impact on banks especially the loan loss provisioning, financial instruments and derivative accounting. The banking industry will also be affected with an impact on the capital-adequacy ratio. Indian banks, being subject to the RBI's rules-based accounting would require to be converged towards principles-based accounting of IFRS. To conclude with, it can be said that the benefits derived from convergence to IFRS by banks are enormous; though it has got some challenges. It is imperative for the Indian Banks to improve their preparedness for adoption of IFRS and get the conversion process right because any error in such process would undermine the bank and consequently it will lose out on investor s confidence. The most relevant and pressing need is to build adequate skills and extensive knowledge amongst Indian accounting professionals and investors. The transition to IFRS is likely to be challenging for corporate India but if it is planned and managed successfully, it will enhance the quality and transparency of the financial reporting process and further align Banks in India to the global economy and global banking sector. There is also a need to improve awareness in general and build technical competence for the accounting and auditing profession on IFRS. The Institute of chartered accountants of India has already included a comparative study of Indian Accounting standards with international standards in its syllabus for CA Final Advanced Accountancy and is also offering courses and seminars for its members to update them in the field. The RBI too has been holding periodical seminars and workshops to educate its staff on IFRS provisions. Training, education and skill development is one of the cornerstones of a successful IFRS implementation. All the stakeholders including investors, accountants, auditors, customers, software and hardware vendors, rating agencies, analysts, audit committees, actuaries, valuation experts and other specialists would need to develop and understanding of IFRS provisions. References : 1. IFRS: Implementation challenges and approaches for Banks in India, KPMG India, 2008. 2. IFRS - Impact on banks, Chartered Financial Analyst, October 2009. 3.. Embracing IFRS by 2011: how geared are Indian banks?, Chartered Financial Analyst, October 2009. 4. S. Vijayalakshmi, IFRS Convergence for banks in India, The Accounting world, December 2009. 5.Dr. Ghosh T. P., (Jan 2010), IFRSs Adoption in India: A Review of Regulatory and Accounting Issues, Journal of Company secretary. 7. Ravi Tripathi and Ms. Shikha Gupta, international financial reporting standards : a way for global consistency, Australian Journal of Business and Management Research, pp 38-51,2011,ISSN No.:1839-0846 8. Manoj Kumar Vijay, http://economictimes.indiatimes.com/quickiearticleshow/3491946.cms 9. P.S. Prabhakar, http://cmaindia.informe.com/forum/ifrs-f26/why-ifrs-t2008.html A. 10. Jayanthi Kumarasiri and Richard Fisher International Journal of Auditing Volume 15, Issue 1, pages 66 87, March 2011 www.theinternationaljournal.org > RJEBS: Volume: 01, Number: 11, September-2012 Page 53