Ind-AS is still a moving goal post’: IFRS Expert
India is well on its way to adopting the globally accepted International Financial Reporting Standards (IFRS) with the first phase already rolled out. The imminent second phase includes banks and financial institutions. Here ETCFO’s Vartika Rawat puts a few questions to Saket Modi, the founder and director of Square Mile Global Consulting, a specialist financial training and consulting company based out of London. In addition to being a Chartered Accountant (India), Saket is also a CFA® charterholder and specialises in matters relating to Financial Reporting and Analysis (IFRS).
Q: Ind-AS is like a new era of accounting in India. How should companies prepare for this dynamic accounting change?
Saket Modi: Ind-AS (or IFRS equivalent standards) is a positive change for India Inc. It places India on the global IFRS map alongside over 100 countries including Canada, Japan, Hong Kong, Korea and the whole of the European Union. The adoption of these standards is not just an accounting change which impacts earnings and net worth, but also affects IT systems, operational processes and controls, information presentation and disclosure, and most importantly business decisions. Large Indian companies with net worth over Rs.500 crores have converged to IFRS in 2016-17. It is not yet business as usual as we have new standards on revenue, financial instruments, leases and insurance contracts to deal with in the next few years. IFRS (and Ind-AS) is still a moving goal post and like any other change, it is important for companies to do an impact assessment of each standard to enable them to plan in advance. The CFOs in charge of implementing from 2017-18 onwards could take lessons from the learnings of the early adopters in India as well as other countries.
Q: What are the challenges that CFOs need to deal with in IFRS 9 Financial Instruments?
Saket Modi: IFRS 9 (effective for periods beginning on or after 1 January 2018) will in some form or the other affect every organisation that has adopted or is moving towards IFRS. IFRS 9 has a significant impact on banks and similar financial institutions as it requires impairment provisioning based on a forward looking approach called expected credit loss model. This is different from the current incurred loss model and requires continuous assessment of changes in credit risk including incorporating macro-economic factors like GDP, unemployment, house price index etc. into the loss provisioning. There are many challenges including creating impairment models with the correct forward looking inputs, continuously updating models based on revised or new estimates and compliance with actual presentation and disclosure requirements. The key questions for CFOs in banks are – what is the impact of transition to IFRS 9 on loss provision? How does it affect the regulatory capital position and would the new impairment requirements affect pricing of the products in the future? IFRS 9 introduces a principles-based approach to classification of financial assets. This is based on the business model in which the financial assets are held and the nature of cash flows. Banks and similar financial institutions could be required to make some significant reclassifications between amortised cost and fair value categories. In its 2017 interim results, Royal Bank of Scotland has estimated an increase in asset values of £1 billion before tax in respect of changes on classification and measurement. This may not however be the case with all banks and the adjustment could be less significant. The IFRS 9 hedge accounting changes may be beneficial for corporates as it makes hedge accounting widely available and aligns it more closely to risk management practices. I have seen some commodity companies early adopt IFRS 9 hedge accounting (there was an option in IFRS 9 to adopt the standard in phases) for these reasons. It would be useful for CFOs to assess whether there are hedging opportunities in IFRS 9 that currently do not exist and which may be beneficial for the company to adopt. With IFRS 9, the challenges are not restricted to transition only. There will be ongoing work required to comply with IFRS 9, be it classification of financial assets, impairment provisioning or hedge accounting, and all this will also ultimately affect management decisions.
It is important for CFOs to assess the impact on the ratios and whether this would breach any bank covenants for loans. The impact of the standard should be clearly communicated to the various stakeholders.
Saket Modi, Founder & Director, Square Mile Global Consulting
Q: Do IFRS 15 dealing with Revenue from Contracts with Customers and IFRS 16 dealing with Leases also entail similar challenges?
Saket Modi: Both IFRS 15 (effective for periods beginning on or after 1 January 2018) and IFRS 16 (effective for periods beginning on or after 1 January 2019) may or may not have significant impact on companies as this depends on the nature of transactions and type of contracts entered into. Even if there is no significant measurement impact, these standards require additional disclosures for the benefit of the users of financial statements. IFRS 15 may have a significant impact on companies that enter into contracts with multiple deliverables (performance obligations). This would include, for example, some telecom companies that provide multiple services to retail customers. This standard requires revenue to be recognised as each performance obligation is satisfied which could be at a point in time or over time. The core principle of revenue recognition is revised in IFRS 15, and with the application guidance on specific matters, the companies may need to revise their revenue recognition policies. This may affect how revenue from existing contracts is recognised in the future and the management forecasts. IFRS 16 introduces a single model for recognition of leases by the lessee irrespective of operating or finance lease. The transition may lead to a significant increase in asset and debt if the company currently has operating leases likely to continue beyond 2019. It is important for CFOs to assess the impact on the ratios and whether this would breach any bank covenants for loans. The impact of the standard should be clearly communicated to the various stakeholders. The other challenges include judgements required around determination of a lease, estimation of the lease term, determining the appropriate discount rate and capturing relevant data including updates to calculate the lease liability.
Q: What are your observations on financial and other disclosures in annual reports? Are they adding value or taking a toll on the companies?
Saket Modi: Having advised and trained finance professionals from over 50 countries in areas relating to IFRS, I have often explained that one of the biggest challenges in adopting IFRS or a new standard is for the preparers to find the most effective way to meet the presentation and disclosure requirements. This has often helped clients to think about realigning their systems accordingly. There is no doubt that the annual reports these days are packed with lots of financial and other disclosures. This makes it challenging for users to identify and analyse relevant information. The International Accounting Standards Board (IASB) has received feedback that there are three main concerns about information disclosed in the financial statements:
- Financial statements not including enough relevant information
- Financial statements including too much irrelevant information
- Information being communicated ineffectively
- There is a current project about possible principles of disclosure that could help the board develop better disclosure requirements and help companies communicate information more effectively to the users of financial statements. The Discussion Paper Disclosure Initiative – Principles of Disclosure is available on the IASB website (ifrs.org). In summary, disclosures – both financial and non-financial are important for the users and are here to stay though they could be made more effective. It is important for companies to communicate the key points in their story clearly.