ACCOUNTING RISK A CHALLENGE TO IFRS (A CASE STUDY OF RELIANCE AND TCS)

KAAV INTERNATIONAL JOURNAL OF ECONOMICS,COMMERCE & BUSINESS MANAGEMENT ACCOUNTING RISK A CHALLENGE TO IFRS (A CASE STUDY OF RELIANCE AND TCS) BHARAT KUMAR MEHER Research Scholar Department of Commerce Dr.HarisinghGour Central University LATASHA MOHAPATRA M.Com IV Semester Department of Commerce Dr.HarisinghGour Central University Abstract With the increase in the export and import of goods there is a need of more foreign exchange to make the Indian currency stronger. But due to the fluctuations in foreign exchange it may be costlier for importing of goods. These fluctuations not only affect the economy but also affect the accounting statements of Multinational Companies (MNCs) as they trade goods to/from other countries. The extent to which the foreign exchange rate fluctuations affect the financial statements of an organization is known as Accounting Risk also called as accounting exposure or translation risk. India is in the stage of adopting International Financial Reporting System (IFRS) and there is a need to covert the figures of financial statements from Indian Currency to dollars while reporting the financial statements under IFRS. The accounting standard related to the Effects of Changes in Foreign Exchange Rates is mentioned in Indian Accounting Standard 11 and also in International Accounting Standard 21. The prevailing accounting system covers the method to covert the figures of Financial Statements from Indian currency to other foreign currency. The accounting standard suggest a proper treatment of the Effects of Changes in Foreign Exchange Rates so as to maintain the uniformity in treatment but it cannot eliminate the effect of exchange rate on final statements. The paper is an attempt to know how accounting risk affect the financial statements of two big companies of India (i.e. Reliance and TCS)? Can it be possible for IFRS to reduce the chances of occurring accounting risk after the complete adoption of IFRS in India? Key Words : Accounting Risk, IFRS, IAS 21 6

Introduction Due to Globalization, our close economy has been converted into open economy. In this globalisation our national economyis integrating withtheeconomyof other countries by spreading its trade and business activities outside the country. Contract Manufacturing, Foreign Direct Investments, Foreign Institutional Investors, Licensing, Joint Venture, Merger and Acquisition,Franchising and Business Outsourcing are some examples of international transactions in global business.but the problem is maintaining and reporting of accounting transactions differ in different countries as the different countries do not follow uniform accounting standards. Hence for the integrity of different county's business together in the world market it was necessary for the businessto adopt a common set of accounting standard, since accounting is the language of a business. For this purpose in1973, many professionals from different countries established the International AccountingStandard Committee. The main objective to this committee is to issue International Accounting Standards. Atpresent time Ministry of Corporate Affairs notified 35 International Accounting Standards. In 2001 InternationalAccounting Standard Committee are superseded as International Accounting Standard Board. Now theboard issues the International Financial Reporting Standard (IFRS) formerly known as International AccountingStandards. The use of common set of accounting standards throughout the world provides an easy way of comparability and transparency of financial information. Hence for the purpose of common set of accounting standards, International Financial Reporting Standards (IFRS) have been proposed. IFRS is a set of accounting standards developed by an independent, not-for-profit organization called the International Accounting Standards Board (IASB).It also reduces the cost of preparing financialstatements. A constant use of accounting standards provide higher quality information which enables theinvestors to make a better decision, indirectly fund will allocate in more efficient manner in the market andthe company can reduce its overall cost of capital. The prime goal of IFRS is to provide a global framework for how public companies prepare and disclose their financial statements. IFRS provides general guidance for the preparation of financial statements, rather than setting rules for industry-specific reporting. Under IFRS the financial statements are to be reported in two currency i.e. one is home currency and another one is international currency i.e. Dollars. For the conversion of figures from home currency into foreign currency the International Accounting Standard 21 (IAS 21) is to be followed. 7

This paper shows a clear picture of how the amount of financial statements items in functional currency is converted into international currency while reporting under IFRS. Do the converted figures in international currency reflects the same activity ratios as from the figures in functional currency? Moreover the study is also concerned in determining the ability of IFRS in reduction of Accounting Risk which rises due to the fluctuations in exchange rate. Objective of the Study To know whether conversion of figures of Financial Statements of two selected Companies affects the Activity s. To study upto what extent IFRS can reduce the Accounting Risk. Hypotheses of the Study H 0 : The Activity s from the figures of financial statements of TCS reported in home currency are equal to that of figures of financial statements reported in International Currency i.e. Dollars. H 1 : The Activity s from the figures of financial statements of TCS reported in home currency are not equal to that of figures of financial statements reported in International Currency i.e. Dollars. H 0 : IFRS can reduce the chances of occurring Accounting Risk. H 1 : IFRS cannot reduce the chances of occurring Accounting Risk. Research Methodology The study is empirical in nature. The study is totally based on Secondary Data collected from various websites, journals and newspapers related to Indian Accounting Standard, International Accounting Standard and International Financial Reporting System (IFRS). Two Big Companies of India i.e. Reliance Industries and Tata Consultancy Services are selected for the study. The period taken into consideration in this study, is two years i.e. 20014-15 and 2015-16. Activity s of both the companies of two years i.e. 2014-15 & 2015-16 are taken into consideration to examine the existence of Accounting Risk. For the purpose of calculating the significant difference, a rule of thumb has been set and the variation in percentage is calculated 8

between the figures of financial statements reported in Rs. and figures of financial statements reported in Dollors. Importance of the Study IFRS has already been adopted by many companies of India and there is much more possibility that all the companies in India, trading across the world, will have to follow the IFRS in the near future. Under IFRS it will be quite mandatory for the companies to report the figures in both the currencies i.e. Functional Currency as well as International Currency. Hence it is important to understand how the financial statements are to be reported and converted into International Currency i.e. US Dollars under IFRS. But while conversion of functional currency into international currency, there is always a possibility of rising accounting risk due to the fluctuations in foreign exchange. The paper attempts to study whether the IFRS can reduce the chances of occurring accounting risk. The study will also be helpful to know the problem and lacunas in implementing IFRS in India. Limitations of the Study The study is limited to two companies i.e. Reliance India Limited and Tata Consultancy Services. Only Activity s are taken into consideration to study the Percentage Variation of Figures reported in Dollars and in Rs. There are many regulations which are to be taken into consideration while converting the financial statements under IAS into IFRS. Due to the lack of information related to the realisable value of assets, the financial statements reported under IAS are very difficult to be converted under IFRS. About the Problem The extent to which the financial statements of companies can be affected by exchange rate fluctuations is known as Accounting Risk. Accounting Risk is also known as Accounting Exposure or translation risk. Such type of risk came into existence when the countries are exposed to globalisation. As there are many transactions taking place between countries, there is a need to record the transactions and report these in both functional and reporting currency. For this purpose the International Accounting Standard 21 is to be followed by the companies. The objective of IAS 21 i.e. The Effects of Changes in Foreign Exchange Rates is to prescribed :- How to include foreign currency transactions and foreign operations in the financial statements of an entity; and 9

How to translate financial statements into a presentation currency. In other words, IAS 21 answers 2 basic questions: What exchange rates shall we use? How to report gains or losses from foreign exchange rates in the financial statements? An entity is required to translate its results and financial position from itsfunctional currency into a presentation currency (or currencies) using the method required for translating a foreign operation for inclusion in the reporting entity s financial statements. The results and financial position of an entity whose functional currency is not the currency of a hyperinflationary economy shall be translated into a different presentation currency using the following procedures: a) assets and liabilities for each statement of financial position presented (ie including comparatives) shall betranslated at the closing rate at the date of that statement of financial position; b) income and expenses for each statement of comprehensive income or separate income statement presented(ie including comparatives) shall be translated at exchange rates at the dates of the transactions; and c) all resulting exchange differences shall be recognised in other comprehensive income. Any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to the carryingamounts of assets and liabilities arising on the acquisition of that foreign operation shall be treated as assetsand liabilities of the foreign operation. Foreign operation is an entity that is a subsidiary, associate, joint venture or branch of a reporting entity, the activities of which are based or conducted in a country or currency other than those of the reporting entity. On the disposal of a foreign operation, the cumulative amount of the exchange differences relating to that foreign operation, recognised in other comprehensive income and accumulated in the separate component of equity, shall be reclassified from equity to profit or loss (as a reclassification adjustment) when the gain or loss on disposal is recognised. Two companies are selected for showing the presentation of financial statements under IFRS. One is Reliance Industries and another one is Tata Consultancy Services. Both the companies are selected for the study as they are in the top 10 listed companies in India. Reliance Industries Ltd. is an Indian multinational conglomerate operating in various sectors in and outside India. Founded in 1966, RIL is based in Mumbai, Maharashtra. RIL deals in miscellaneous industries such as construction, energy, petrochemicals, communications, science 10

and technology, healthcare, textiles, retails, natural resources and logistics. The principal shareholders, the Ambani family, hold close to 45.34 percent shares in the company, while the rest of the shares are held by approximately three million shareholders. In May 2015, the market capitalisation of RIL amounted to Rs. 2,85,051.72crore. At present, Reliance Industries Limited is not following the IFRS. Hence to explain the process of converting the figures from Rs. to Dollors RIL would be a suitable company which engages in both production activities and providing services. The other company i.e. Tata Consultancy Services (TCS) is a global leader in IT services, digital and business solutions that partners with its clients to simplify, strengthen and transform their businesses. It ensures the highest levels of certainty and satisfaction through a deep-set commitment to its clients, comprehensive industry expertise and a global network of innovation and delivery centres. The purpose for selecting TCS for the study is that the company is presenting its financial statements under 3 types of standards i.e. US GAAP, Indian Accounting Standard and IFRS. Profit and Loss Statement of Reliance Industries for the year ended on 31 st March 2016 (Amt. in Millions) The US Dollar to Indian Rupee Exchange Rate on 1 st April, 2014 1 USD 59.938 INR The US Dollar to Indian Rupee Exchange Rate on 31 st March, 2015 1 USD 62.4018 INR The US Dollar to Indian Rupee Exchange Rate on 1 st April, 2015 1 USD 62.3152 INR The US Dollar to Indian Rupee Exchange Rate on 31 st March, 2016 1 USD 66.2491 INR Balance Sheet of Reliance Industries as on 31 st March 2016 (Amt. in Millions) 11

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Profit and Loss Statement of TCS for the year ended on 31 st March 2016. (Amt. in Millions) TCS Consolidated Income Statement as per IFRS - FY 14-15 Amt. Rs. FY 15-16Amt.Rs. FY 14-15Amt $ FY 15-16Amt $ Revenue Information Technology and Consultancy Services 9,27,017 0,86,462 15,154.79 16,901.46 Sale of Equipment and Software Licenses 19,467 318.24 - Total Revenue 9,46,484 10,86,462 15,473.03 16,901.46 Cost of Revenues Cost of Services Employee Cost 3,62,844 4,18,829 5,931.74 6,515.48 Fees to External Consultants 61,165 78,228 999.92 1,216.94 Cost of Equipment and Software Licenses 18,601 25,711 304.09 399.98 Depreciation 12,719 13,507 207.93 210.12 Travel 14,567 15,999 238.14 248.89 Communication 7,515 8,173 122.85 127.15 Facility Expenses 21,662 21,658 354.13 336.91 Other Costs 26,210 26,892 428.48 418.34 Total Cost of Revenues 5,25,283 6,08,997 8,587.28 9,473.81 Gross Profit 4,21,201 4,77,465 6,885.76 7,427.65 Operating Expenses Selling, General and Administrative Expenses Employee Cost 1,18,164 1,34,666 1,931.73 2,094.92 Fees to External Consultants 5,280 5,899 86.32 91.77 Provision for Doubtful Debts 1,605 1,347 26.24 20.95 Depreciation 5,980 5,373 97.76 83.58 Facility Expenses 10,175 12,404 166.34 192.96 Travel 9,452 10,630 154.52 165.36 Communication 3,045 2,900 49.78 45.11 Other Costs 13,256 16,346 216.71 254.29 Total Operating Expenses 1,66,957 1,89,565 2,729.40 2,948.94 Operating Income 2,54,244 2,87,901 4,156.36 4,478.71 Total Other Income/(Expense) 31,397 30,502 513.28 474.50 Income Before Income Taxes 2,85,641 3,18,403 4,669.63 4,953.20 Total Taxes 66,566 75,026 1,088.21 1,167.14 Net Profit After Taxes 2,19,075 2,43,376 3,581.42 3,786.06 Adjustments for Minority Interests Non Controlling Interest -2,114-1,227-34.56-19.09 Net Income Before Extraordinary Items 2,16,961 2,42,149 3,546.86 3,766.97 Net Income After Extraordinary Items 2,16,961 2,42,149 3,546.86 3,766.97 - - 13

Balance Sheet of TCS as on 31 st March 2016. (Amt. in Millions) If Reporting Under IFRS Amt $ Amt $ TCS Consolidated Balance Sheet as per IFRS - INR Mn 31-Mar-15 31-Mar-16 31-Mar-15 31-Mar-16 ASSETS Current Assets Cash and Cash Equivalents 18,622 62,953 298.42 950.25 Bank Deposits 1,63,829 527 2625.39 7.96 Accounts Receivable ( net of allowances ) 2,04,399 2,40,728 3275.53 3,633.69 Investments 15,009 2,24,540 240.52 3,389.33 Other Current Financial Assets 27,142 40,994 434.96 618.79 Unbilled Revenue 38,271 39,917 613.30 602.53 Current Income Tax assets 749 317 12.00 4.78 Other Current Assets 20,990 21,912 336.37 330.76 Total Current Assets 4,89,011 6,31,890 7836.49 9,538.09 - Non Current assets Bank Deposits 5,001 4,150 80.14 62.64 Other Non Current Financial Assets 23,156 33,817 371.08 510.45 Non Current Income Tax Assets 40,930 44,642 655.91 673.84 Deferred Income Tax Assets 26,150 28,819 419.06 435.01 Property, Plant and Equipment, net 1,15,716 1,17,900 1854.37 1,779.64 Goodwill, net 37,115 38,120 594.77 575.41 Other Intangible Assets, net 2,193 1,343 35.14 20.27 Investments 2,534 3,431 40.61 51.79 Other Non-Current Assets 9,064 7,767 145.25 117.24 Total Non-Current Assets 2,61,859 2,80,237 4196.34 4,230.06 LIABILITIES AND SHAREHOLDER'S EQUITY Liabilities Current Liabilities Total Assets 7,50,868 9,12,128 12032.79 13,768.15 Trade and Other Payables 88,318 75,408 1415.31 1,138.26 Short-term Borrowings 2,434 1,623 39.01 24.50 Other Current Financial Liabilities 11,878 23,148 190.35 349.41 Unearned and Deferred Revenue 10,623 13,589 170.24 205.11 Employee Benefit Obligation 13,561 16,353 217.32 246.84 Other provisions 1,030 1,148 16.51 17.33 Current Income Tax Liabilities 5,456 8,050 87.43 121.51 Accrued Expenses and Other Current Liabilities 13,415 16,373 214.98 247.14 Total Current Liabilities 1,46,716 1,55,691 2351.15 2,350.09 - Non Current Liabilities Long-Term Debt / Borrowings 1,143 825 18.32 12.46 Other Non Current Financial Liabilities 6,618 4,929 106.05 74.41 Employee Benefit Obligation 2,034 2,368 32.60 35.74 Other provisions 945 405 15.14 6.11-14

Deferred Income Tax Liabilities 5,473 8,051 87.71 121.53 Other Non-Current Liabilities 4,037 4,416 64.69 66.66 Total Non Current Liabilities 20,250 20,995 324.51 316.90 Total Liabilities 1,66,966 1,76,686 2675.66 2,666.99 0.00 Shareholders' Equity Common Stock - Par value / Share Capital 1,959 1,970 31.39 29.74 Additional Paid-in Capital / Share Premium 19,203 50,819 307.73 767.08 Accumulated Other Comprehensive Income/(Loss) 10,824 14,149 173.46 213.57 Retained Earnings 5,42,782 6,64,962 8698.18 10,037.29 Total Shareholders' Equity 5,74,767 7,31,899 9210.74 11,047.69 Non Controlling Interests 9,136 3,542 146.41 53.47 Total Liabilities and Shareholders' Equity 7,50,868 9,12,128 12032.79 13,768.15 Calculations of Activity s Activity s Inventory Turn Over Debtors Payables Fixed Assets Total Assets Working Capital Formula 2014-15 Rs Purchases Fees to External Consultants+ Cost of Equipment and Software Licenses 3358.58 4.8953 1.1104 3.6144 1.2605 2.4846 2015-16 Rs 2014-15 $ 2015-16 $ 3766.2152 3359.1300 3763.4807 4.8821 1.2698 3.8769 1.1911 2.2951 4.8990 1.1151 3.6872 1.2859 2.4847 4.8897 1.2676 3.9956 1.2275 2.3057 15

Capital Employed 1.7653 1.5867 1.8008 1.6352 Application of Rule of Thumb for testing the effectiveness of IFRS in controlling Accounting Risk. Hypotheses Validation Assuming :- ~If Percentage Variation of Figures in Dollars from Figures in Rs. is less than ±0.25% then IFRS is more capable in controlling the Accounting Risk.(H 0 Accepted) ~If Percentage Variation of Figures in Dollars from Figures in Rs. is more than ±0.25% but less than ±0.5% then IFRS is fairly capable in controlling the Accounting Risk.(H 0 Accepted) ~If Percentage Variation of Figures in Dollars from Figures in Rs. is more than ±0.5% then IFRS is not capable in controlling the Accounting Risk.(H 0 Rejected) Table showing the variation in percentage while converting from Rs. to Dollars. Activity s Inventory Turn Over Debtors Payables 2014-15 2014-15 Variation in Percentage 2015-16 2015-16 Variation in Percentage Rs $ Rs $ 3358.58 3359.13 0.016375968 3766.2152 3763.4807-0.07260605 4.8953 4.899 0.075582702 4.8821 4.8897 0.155670715 1.1104 1.1151 0.423270893 1.2698 1.2676-0.17325563 Decision More Capable as %variation is less than ±0.25% More Capable as %variation is less than ±0.25% Fairly Capable as %variation is more than ±0.25%but less than 16

±0.5% Fixed Assets Total Assets Working Capital Capital Employed 3.6144 3.6872 2.01416556 3.8769 3.9956 3.061724574 1.2605 1.2859 2.015073384 1.1911 1.2275 3.055998657 2.4846 2.4847 0.004024793 2.2951 2.3057 0.461853514 1.7653 1.8008 2.010989633 1.5867 1.6352 3.056658474 Not Capable as %variation is more than ±0.5% Not Capable as %variation is more than ±0.5% More Capable as %variation is less than ±0.25% Not Capable as %variation is more than ±0.5% In the above observation out of 7 activity ratios 4 activity ratios i.e. Inventory turnover, Debtors, Payables and Working Capital do not show any significant difference as the percentage variation is less than 0.5% hence, Null Hypothesis is accepted and IFRS is capable to control the accounting risk. Application of Paired T test To examine the impact of IFRS on the Activity s, Paired t test can be used which could represent the before-and-after effect. If t<1.943 then there is no effect of IFRS on Activity s (Null Hypothesis Accepted) Activity s Inventory Turn Over 3358.58 3359.13 Debtors 4.8953 4.899 2014-15 2014-15 After-Before Before IFRS After IFRS Rs If in $ d (d-d) 2 0.55 0.203503841 0.0037 0.009060375 17

Payables 1.1104 1.1151 Fixed Assets 3.6144 3.6872 Total Assets 1.2605 1.2859 Working Capital 2.4846 2.4847 Capital Employed 1.7653 1.8008 Total 0.0047 0.008871003 0.0728 0.000680479 0.0254 0.005400192 0.0001 0.009758674 0.0355 0.004017785 0.6922 0.241292349 n 7 t 1.304627188 0.200537756 As value of t<1.943 (5% level of Significance with 6 d.o.f.)hence, there is no effect of IFRS on Activity s and Null Hypothesis is Accepted. Activity s 2015-16 Before IFRS 2015-16 After IFRS Inventory Turn Over 3766.2152 3763.4807 Debtors 4.8821 4.8897 Payables 1.2698 1.2676 Fixed Assets 3.8769 3.9956 Total Assets 1.1911 1.2275 After-Before Rs $ d (d-d) 2 2.7345 5.641717553 0.0076 0.134593597 0.0022 0.127498985 0.1187 0.228455321 0.0364 0.156554749 Working Capital 2.2951 2.3057 Capital Employed 1.5867 1.6352 Total 0.0106 0.136803817 0.0485 0.166276373 2.5149 6.591900394 18

-0.906863678 n 7 1.048165095 As value of t<1.943 (5% level of Significance with 6 d.o.f.)hence, there is no effect of IFRS on Activity s and Null Hypothesis is Accepted. Conclusion From the above observation it is clear that IFRS is quite capable in controlling the accounting risk in most of the cases. Butthe major limitation should also be considered is that, only activity ratios of Tata Consultancy Services are calculated and compared. There is a possibility that if more companies for a larger period will be consider into study, then the result may vary. Again the activity ratios are taken because it deals with the items of both the balance sheet and profit and loss account. The variations in activity exist because of the two different foreign exchange rates used in converting the two different statements. If the ratios would be calculated by taking the two or more items from only one statement (i.e. either Profit or Loss statement or Balance Sheet)then no change or variation in the ratios would be observed. Again with the help of paired t test it is proved that there is no significant difference between the activity ratios after implementation of IFRS. Hence, reporting under IFRS by following IAS 21 in International Currency (Dollars) will not affect the ratios unless and until the items used in calculating ratio are taken from either of the statement. IFRS committee should also take few measures so that accounting risk can be reduced the extent that, those ratios which used items from both the statement should not be affected even after conversion of functional currency into reporting currency. References 1. Harris, P. (2016, January/February). A Case Study Of The Cash Flow Statement: US GAAP Conversion To IFRS. Journal of Business Case Studies, 12(1). 19

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