Chapter: 1 INTRODUCTION 1.1 PREAMBLE To make the world a global market International Accounting Standards Board (IASB) framed International Financial Reporting Standards (IFRS) for creating uniformity in Accounting all over the world. International Financial Reporting Standards (IFRS) adopted by International Accounting Standards Board (IASB) is a standardized format of financial reporting that is gaining momentum worldwide and is a single consistent accounting framework and is likely to become predominant GAAP in times to come. In this world of globalization in which Indian economy has also flourished, adopting IFRS would not only make Indian companies at par with other global companies but shall also increase India's marketability globally in terms of foreign investments. In general terms, convergence means to achieve harmony with IFRSs; in precise terms convergence can be considered to design and maintain national accounting standards in a way that financial statements prepared in accordance with national accounting standards draw unreserved statement of compliance with IFRSs. In this context, attention is drawn to paragraph 14 of International Accounting Standard (IAS) 1, Presentation of Financial Statements, which states that financial statements shall not be described as complying with IFRSs unless they comply with all the requirements of IFRSs. It does not imply that financial statements prepared in accordance with national accounting standards draw unreserved statement of compliance. 1.2 DIFFERENCE BETWEEN CONVERGENCE AND ADOPTION Adoption would mean full-fledged use of IFRS as issued by the IASB by the Indian public companies.
Convergence means that the Indian Accounting Standards (AS) and the International Financial Reporting Standards (IFRS) would, over time, continue working together to develop high quality, compatible accounting standards. 1.3 CONCEPTS OF HARMONIZATION AND CONVERGENCE Harmonization in accounting means the application of several methods for the accounting practices, for integration purposes among the accounting practices. In other words, harmonization means the identical accounting policies adopted by the enterprises all through the country 1. As the more rate of adoption of any of the policies used in the accountability increases, the harmonization of the accounting applications increases too accordingly. On the contrary, the harmonization level decreases. Harmonization can be analyzed in two parts; one is the legal harmonization the other one is the material harmonization. If accounting practices are affected by the regulations, it is called legal harmonization if not, the material harmonization occurs 2. As it is seen, the concept of harmonization relates directly to the accounting policies. The framework of the accounting policies is drawn through the legal regulations and/or standards. Therefore, the regulations that guide the applications in a country have great importance. Harmonization came into existence through the legal regulations forms the base of the legal harmonization. This can only be achieved through decreasing the number of accounting policies by taking into the care of the applications in other countries. The other harmonization concept namely, material harmonization, is related to the adoption of the accounting policies determined within the frame of the legal regulations and/or standards, by the enterprises. Application of different accounting policies by the enterprises has an effect on harmonization process in an increasing way. Nowadays the concept of harmonization is defined from a different point of view. According to this, there should be a leader or a follower standard setting bodies (country or organization) to mention about harmonization. The harmonization processes depend on harmonization of the national accounting standards with the standards of the leader standard setting body 3. The follower standard 2
setting body tries to harmonize its accounting standards to the standards of the leader standard setting body. On the other hand, there is no leader standard setting body for the concept of convergence. Convergence means the formation of high quality and the best accounting standards by the two standards setting bodies. After the highest quality standards are determined standard setting bodies change the standards accordingly. If there is no high quality standard among the existing, a new standard is formed. The similarity between the national and international standards is generally preferred. However, the principal is that the accounting standard makers should reach to an agreement for a single international standard in order to attain a quality standard set 4. 1.4 IFRS IN INDIAN SCENARIO The Indian GAAP is influenced by several standard setters and influenced by Statute, namely Companies Act, Income Tax Act, Banking Regulation Act, Insurance Act etc and directions from regulatory bodies like RBI, SEBI, IRDA. The legal or regulatory requirement will prevail over the IFRS requirement, in case of conflicts. Therefore, preconditions for IFRS adoption by India to be effective need amendments in required legislation and clarity on impact of IFRS adoption on Direct and Indirect taxes, especially transactions recorded at fair values. Institute of Chartered Accountants of India is actively promoting the IASB's pronouncements in the country with a view to facilitating global harmonization of Accounting Standards and ICAI has pronounced that Indian GAAP will converge into IFRS with effect from April 1, 2011. Under the statutory mandate provided by the Companies Act, 1956 the Central Government of India prescribes accounting standards in consultation with National Advisory Committee on Accounting Standards (NACAS) established under the Companies Act, 1956. The Central Government notified 31 Accounting Standards (AS 1 to 7 and AS 9 to 32) in the Form of Companies (Accounting Standard Rules) 2006. While doing so the Central Government had adopted a policy of enabling disclosure of company account in a manner at par with accepted international practices, through a process of convergence with the IFRS. The NACAS has 3
taken up initiative for harmonization of accounting standards with IFRS would be continued with an intention of achieving convergence with IFRS by 2011. Ministry of Corporate Affairs has also set up a high powered group comprising of various stakeholders under the Chairmanship of Mr. Anurag Goel, Secretary to discuss and resolve implementation challenges with regard to convergence of Indian Accounting Standards with IFRS from 2011. In November 2009 SEBI decided to provide an option to all listed entities with subsidiaries to submit their consolidated financial statements as per IFRS to be in line with objective of convergence to IFRS by 2011. On January 22, 2010, the Ministry of Corporate Affairs issued a press release which laid out a phased plan by which IFRS convergence will be achieved in India for companies other than Banking and Insurance Companies. This important announcement had cleared all clouds of IFRS convergence and provided the road map in phase manner for achieving convergence in India effective April 1, 2011. According to the above press release, there will be two separate sets of Accounting Standards under Section 211(3C) of the Companies Act, 1956. The two sets would be as described below: First set would comprise of the Indian Accounting Standards which are converged with the IFRS (IFRS converged standards). It shall be applicable to specified class of companies; Second set would comprise of the existing Indian Accounting Standards (Existing Accounting Standards) and would be applicable to other companies including small and medium companies (SMCs). In this changing scenario, India cannot cut off itself from the developments taking place worldwide. At present, the Accounting Standards Board (ASB) of the Institute of Chartered Accountants of India (ICAI) formulates Accounting Standards (ASs). Complex nature of IFRSs and the differences between the existing ASs and IFRSs, the ICAI is of the view that IFRSs should be adopted for the public interest entities such as listed 4
entities, banks and insurance entities and large sized entities from the accounting periods beginning effect from April, 2011. Convergence to IFRS would mean India would join a league of more than 100 countries, which have converged with IFRS. Converging to IFRS by Indian companies will be very challenging and on the contrary it could also be rewarding too. 1.5 PROGRESS OF WORK In 1949, Indian government to streamline accounting practices in the country established Institute of Chartered Accountants of India by passing ICAI Act, 1949. Accounting Standard Board was constituted by ICAI in 1977 with a view to harmonize the diverse accounting policies and practices in India. The other objectives of the Board are 6 : (i) conceive of and suggest new areas in which Accounting Standards are needed, (ii) formulation of Accounting Standards, (iii) examine how far IAS and IFRS can be adapted while formulating the accounting standards and to adapt the same, and (iv) Review the existing Accounting Standards and revise them regularly as and when necessary, among others. In 2006, a task force was set up by ICAI. The objective of the task force was to lay down a road map for convergence of IFRS in India. Based on the recommendation made by the Task Force and on the basis of outcome of discussions and public opinions on IFRS adoption procedure, a 3 step process was laid down by the Accounting Professionals in India. This three steps IFRS adoption procedure can be summarized as follows: Step 1 IFRS Impact Assessment In this step, the firm will begin with the assessment of the impact of IFRS adoption on Accounting and Reporting Issues, on systems and processes, and on Business of the firm. The firm will then identify the key conversion dates and accordingly a IFRS training plan will be laid down. Once the training plan is in place, the firm will have to identify the key Financial Reporting Standards that will apply to the firm and also the differences among 5
current financial reporting standards being followed by the firm and IFRS. The firm will also identify the loopholes in the existing systems and processes. Step 2 Preparations for IFRS Implementation This step will carry out the activities required for IFRS implementation process. It will begin with documentation of IFRS Accounting Manual. The firm will than revamp the internal reporting systems and processes. IFRS 1 which deals with the first time adoption of IFRS will be followed to guide through the first time IFRS adoption procedure. To make the convergence process smooth, some exemptions are available under IFRS 1.These exemptions are identified and applied. To ensure that the IFRS are applied correctly and consistently, control systems are designed and put in place. Step 3 Implementation This step involves actual implementation of IFRS. The first activity carried out in this phase is to prepare an opening Balance Sheet at the date of transition to IFRS.A proper understanding of the impact of the transition from Indian Accounting Standards to IFRS is to be developed. This will follow the complete application of IFRS as and when required. First time implementation of IFRS requires lot of training and some difficulties may also be experienced. To ensure a smooth transition from Indian Accounting Standards to IFRS, Continuous training to staff and addressing all the difficulties that would be experienced while carrying out the implementation is also required. 1.6 IDENTIFICATION OF INCONSISTENCY BETWEEN VARIOUS LAWS AND REGULATIONS In the concept paper of ICAI had expressed that on adoption of IFRSs, if certain IFRSs have certain requirements in conflict with the laws/regulations, the latter will prevail. However, on February 5, 2009 the technical directorate of ICAI has indicated that various steps are being taken for identification of inconsistencies between IFRSs and Companies Act SEBI regulations Banking laws & regulations Insurance laws and regulations 6
A draft schedule of IFRSs (to be made effective from 1 st formulated and sent to the ministry of corporate affairs. April, 2011) has been 1.7 NEED OF THE STUDY The Council of the Institute of Chartered Accountants of India, has decided to fully converge with International Financial Reporting Standards (IFRSs) issued by the International Accounting Standards Board from the accounting periods commencing on or after 1st April, 2011.With a view to ensure smooth transition to the IFRSs from April 1, 2011, the Institute of Chartered Accountants of India will take up the matter of convergence with IFRSs with the National Advisory Committee on Accounting Standards (NACAS) established by the Ministry of Corporate Affairs, Government of India, and various regulators such as the Reserve Bank of India, the Insurance Regulatory and Development Authority and the Securities and Exchange Board of India. There is also a Framework for the Preparation and Presentation of Financial Statements which describes of the principles underlying IFRS. A framework is nothing but the foundation of accounting standards. The framework states that the objectives of financial statements is to provide information about the financial position, performance and changes in the financial position of an entity that is useful to a wide range of users in making economic decisions, and to provide the current financial status of the entity to its shareholders and public in general. Some researches in USA & UK concluded in their research that due to changes in principles under IFRS there is a impact on profitability of companies and earnings available for equity shareholders and other benefits to all other beneficiaries. In the light of above discussion, the researcher has undertaken the study entitled, Convergence of Accounting Standards with International Financial Reporting Standards in India: Impact on Profitability of selected companies. 7
1.8 OBJECTIVES OF STUDY The objectives of a study are the ultimate goal which a researcher aspires to achieve. The real worth of any research depends on the objectives laid down for the same. In fact the objectives of the research are the goal which a researcher aspires to achieve. To carry out this study in scientific manner the researcher has considered the following objectives- 1. To compare Indian GAAPs with IFRS. 2. To study the challenges and risks specific to India in adoption of IFRS and an insight about the global financial reporting language i.e. IFRS. 3. To compare profitability of companies converging its accounts as per I.F.R.S. and accounts made on the basis of Indian GAAPs. 4. To give suggestions towards successful implementation of IFRS. In addition to above stated main objectives, we have made addition in objective 1; we have compared Indian GAAP, IFRS and Indian AS (newly framed by ICAI for implementation in India). 1.9 RESEARCH METHDOLOGY In addition to general research methodology adopted, the researcher has adopted the following specific objective wise research methodology:- Table 1: Objective wise methodology OBJECTIVES METHODOLOGY 1. To compare Indian GAAPs with IFRS. For attaining this objective researcher have compared thoroughly IFRS and Indian GAAPs quality wise and quantity wise. 2. To study the challenges and risks specific to India in adoption of IFRS and an insight about the global financial reporting language i.e. IFRS. For attaining this objective, the researcher have conducted interview and observe the risk and challenges on adoption of IFRS and give an 8
overview of IFRS. 3. To compare profitability of companies converging its accounts as per IFRS and accounts made on the basis of Indian GAAPs. 4. To give suggestions towards successful implementation of IFRS. For attaining this objective, the researcher have compared and observed effects in terms of financial ratios as a measurement of profitability as per IFRS and Indian GAAPs. For this purpose researcher have examined suggestions of accounting professionals, executives and members of ICAI in interviews. (i) RESEARCH METHDOLOGY Research methodology is a way to systematically solve the problem. It may be understand as a science of studying how research is done scientifically. It comprises of various steps that are generally adopted by the researcher in studying research problem along with the logic behind them. Research methodology not only includes research methods but also consider logic behind the methods researcher uses in the context of research study and explain why a particular method or technique has been used and why other have not used. So that research results are capable of being evaluated either by the researcher or other. Thus research methodology is the most vital ingredient of a research. Research methodologies have been classified into two sections for the sake of greater understanding viz. a) Analysis of the annual reports of selected companies to find out the changes in the profitability of companies on converging their accounts as per IFRS. b) Analysis of primary data collected from Chartered Accountants through interviews and questionnaire and draws a conclusion on convergence process. (ii) ANALYSIS OF PROFITABILITY OF COMPANIES 9
The research essentially attempts to evaluate and make a comparative study of the reporting practices of IFRS in Indian companies the researcher have gone through the following research methodology: 1.10 SAMPLE DESIGN Sampling design deals with the method of selecting sample from population which has to be observed for the given study. The sampling design used for selecting the companies who are reporting their annual reports in Indian GAAP as well as in IFRS whether in annual reports or separately or in form 20F of SEC filing. 1.11 SIZE OF SAMPLE For attaining the different objectives of the study, the researcher selected 30 companies based on BSE-SENSEX while 50 companies based on NSE-NIFTY, which are included because of market capitalization. BSE 30 SENSEX companies NSE 50 NIFTY companies List of sample companies Table 2: List of Companies LIST OF COMPANIES ON 31 LIST OF COMPANIES ON 31 MARCH MARCH 2011 2012 SENSEX COMPANIES NIFTY COMPANIES SENSEX COMPANIES NIFTY COMPANIES 1 ACC ABB ACC ABB 2 BHARTI AITEL ACC BHARTI AIRTEL ACC 3 BHEL AMBUJA CEMENT BHEL AMBUJA 4 DLF AXIS BANK DLF AXIS BANK 5 GRASIM INDUSTRY BHARTI AITEL GRASIM INDUSTRIES BPCL 10
6 HDFC BHEL HDFC BHARTI AIRTEL 7 HDFC BNAK BPCL HDFC BANK BHEL 8 HIDALCO CAIRN HERO HONDA CAIRN 9 HINDUSTAN UNILEVER CIPLA HINDALCO CIPLA 10 HINDUSTAN ICICI BANK DLF UNILEVER DLF 11 INFOSIS TECHNOLOGEY GAIL ICICI BANK GAIL (I) 12 ITC 13 JAI PRAKASH ASSOCIATES 14 L&T GRASIM INDUSTRY INFOSYS TECH GRASIM INDUSTRIES HCL HCL TECHONOLOGY ITC TECHNOLOGY JAIPRAKASH HDFC ASSOCITION HDFC 15 M&M HDFC BNAK L&T HDFC BANK 16 MARUTI SUZUKI HERO HONDA M&M HERO HONDA 17 NTPC HINDALCO MARUTI SUZUKI HINDALCO 18 HINDUSTAN HINDUSTAN ONGC UNILEVER NTPC UNILEVER 19 RANBUBAXY LAB. ICICI BANK ONGC ICICI BANK 20 COMUNICATIO N IDEA CELLULER COMMUNICATIN IDEA CELLULAR 21 INDUSTRY INFOSIS TECHNOLOGY INDUSTRY IDFC 22 INFRASTRACTU ITC INFRASTRACTUE INFOSYS TECH 11
RE 23 SBI L&T SBI ITC 24 STERLITE INDUSTRY M&M STERLITE JAIPRAKASH ASSOCITION 25 SUN PHARMA MARUTI SUZUKI SUN PHARMA JINDAL 26 TATA CONSULTANCY NATIONAL ALLUMINIAM TATA CONSULTANCY L&T 27 TATA MOTORS NTPC TATA MOTORS M&M 28 TATA POWER ONGC TATA POWER MARUTI SUZUKI 29 TATA STEEL POWER GRID TATA STEEL NTPC 30 PUNJAB WIPRO NATIONAL BANK WIPRO ONGC 31 RANBUBAXY LAB. PNB 32 CAPITAL POWER GRID 33 COMMUNICATIN RANBAXY LAB. 34 INDUSTRY CAPITAL 35 INFRASTRUCTUE COMMUNICATIN 36 PETROLEUM INDUSTRY 37 POWER INFRASTUCTURE 38 SAIL POWER 39 SBI SAIL 40 SIEMENS SBI 12
41 STERLITE INDUSTRY SIEMENS 42 SUJLON ENERGY STERLITE 43 SUN PHARMA SUN PHARMA 44 TATA COMMUNICATIN SUZLON ENERGY 45 TATA CONSULTANCY TATA MOTOR 46 TATA TATA MOTORS CONSULTANCY SERVICES 47 TATA POWER TATA POWER 48 TATA STEEL TATA STEEL 49 UNITECH UNITECH 50 WIPRO WIPRO In year ending on 31 st March 2011 and 31 st March 2012 there were 28 common companies listed on both stock exchanges hence profitability has been analysed for 52 companies out of which only 8 companies were reporting there financial data as per Indian GAAPs and IFRS both. List of 8 companies are as follows: (i) Infosys Ltd. (ii) Wipro Ltd (iii) Dr. Reddys Lab. Ltd. (iv) Bharti Airtel Ltd. (v) Sterlite Industires Ltd. (vi) Tata Motors Ltd. (vii) Seimens ltd. (viii) Tata consultancy Ltd. 13
1.11.1 SAMPLE DESIGN: A sample design is a definite plan for obtaining a sample from a given population. Population is the Indian companies in this research. Non probability Judgment sampling have been considered for selection the sample because in the first phase of the IFRS Conversion relates to opening Balance Sheet as at 1st April, 2011 for financial year commencing on or after 1st April, 2010, four types of the companies : a. Companies forming part of NSE -Nifty 50, b. Companies forming part of BSE - Sensex 30, c. Companies whose share or securities are listed in stock exchanges outside India and d. Listed or Non-listed companies having Net Worth in excess of Rs. 1000 Crores. Out of the above said groups all companies of two groups group (a) and group (b) have been selected for the research. Companies taken as sample which was a part of determine the BSE Sensex & NSE Nifty as on 31 March 2011 &31 March 2012 for the financial year (2010-2011) & (2011-2012) respectively. 1.11.2 Sample selection criteria: Table 3: IFRS Road Map in INDIA Phase I Conversion of opening Balance Sheet as at 1st April, 2011 for financial year commencing on or after 1st April, 2011* Type of Companies Group A- Companies forming part of NSE -Nifty 50 Group B- Companies forming part of BSE - Sensex 30 Group C- Companies whose share or securities are listed in stock exchanges outside India. Group D- Listed or Non-listed companies having 14
Phase II Conversion of opening Balance Sheet as at 1st April, 2013 for financial year commencing on or after 1st April, 2014 Phase III Conversion of opening Balance Sheet as at 1st April 2014, for financial year commencing on or after 1st April 2015 Net Worth in excess of R1000 Crores. Listed or Non-listed companies with a Net Worth exceeding R500 Crores but not exceeding R1000 Crores. Listed companies with a Net Worth of R500 Crores or less. *In early 2010, the Ministry of Corporate Affairs (MCA) issued various press releases on the IFRS roadmap and convergence plan for India specifying the convergence date to be 1 April, 2011, through 2014 for select Indian companies. Since the timeline in the roadmap is no longer valid for Phase I companies, the new implementation date for Ind AS is awaited from the MCA. It is unclear if the MCA will release a fresh roadmap or just amend the implementation date. 5 Indian companies will convert their accounts according to the above table. In the first phase they will have to use Conversion of opening Balance Sheet as at 1st April, 2011 for financial year commencing on or after 1st April, 2011. In the first phase four group s companies which are mentioned in phase I in above table converge their accounts. Out of the four groups of phase I, two groups Group A- Companies forming part of NSE -Nifty 50 & Group B- Companies forming part of BSE - Sensex 30 have been chosen for the study. 1.12 STATISTICAL DESIGN Statistical design concern with the question of how many items are to be observed and how the information and data gathered are to be analysed. The statistical designed used for the reporting practices of the IFRS in India are the following; 15
1.12.1 TYPES OF DATA USED To analyse the impact on profitability of Indian companies data from annual reports have been collected in tabular form. Figures representing the profitability and useful to calculate profitability ratios are taken from annual reports and form 20-F of companies. Primary data also used to find out challenges and suggestions about convergence with IFRS. 1.12.2 SOURCES OF THE DATA Data have been collected from the annual reports of the companies. The annual reports of the companies for both the financial years 2010-11 and 2011-12 have been downloaded from the website of the sample companies. Primary data through Questionnaire have also been collected from 50 Chartered Accountants. Questionnaires have been sent to 84 Chartered Accountants working in various national, multinational companies and CA Firms such as Ernest & young, KPMG, PWC, BHEL, MTS etc. Total 54 respondents reverted back the questionnaire out of which 4 have not been considered because they didn t have knowledge about IFRS. 1.12.3 PERIOD OF THE STUDY: For the purpose of the analysis of data annual reports of two years i.e. financial year 2010-2011 & 2011-2012 have taken into consideration from the view point of examining the impact on profitability of sample companies. 1.13 PROCESSING AND ANALYSIS OF DATA The information on the IFRS and IAS was presented with the help of the charts, table and Bar diagrams. Analysis of questionnaire has been presented in Pie charts for better and 16
easy understanding of responses received. For impact analysis various financial ratios have been used for calculating profitability ratios. 1.14 HYPOTHESIS One hypothesis was framed for the secondary data. The main hypothesis was H0: there is no significance difference in the profitability of the sample companies in the annual reports between 2010-11 and 2011-12. t test was used for testing this hypothesis at the 5% level of significance or 95% level of confidence. REFERENCES 1. Herman Don and W. Thomas (1995) Harmonization of Accounting Measurement Practice in the European Committee, Accounting and Business Research, XXV, 100, 254. 2. Van Der TAS, Leo (1998) Measuring Harmonization of Financial Reporting Practice, Accounting and Business Research, XVIII, 70, 158. 3. IASB SAC Meeting Agenda Paper 10, 2001. 4. Simga-Mugan C. ve Hosal-Akman N. (2003) Uluslararası Finansal Raporlama Standartları: Yakınsama Eğilimleri, XXII. Türkiye Muhasebe Eğitimi Sempozyumu, Muhasebe Eğitim: Eğilim ve Etkileşimler, 21 25 Mayıs 2003, Belek- Antalya, 76. 5. PWC news, IFRS in India. 6. Pawan Jain (2011) IFRS Implementation in India: Opportunities and Challenges World Journal of Social Sciences, Vol. 1. No. 1. March 2011. Pp.125 136. 17