Moving toward a sustainable IND AS reporting regime
Partner, Assurance, EY India
Various companies that are in phase 1 are actively gearing up for IND AS reporting starting in the first quarter ended 30 June 2016. While it seems that most of companies will be able to successfully meet the timelines of declaring quarterly results in accordance with IND AS, the crucial question for managements is whether their organizations are ready to operate seamlessly in the IND AS environment?
A study of the GAAP conversion process indicates that the GAAP conversion strategy of most companies is currently focused only on the financial reporting work stream, with not enough focus on the impact of the transition in other work streams. While this short-term approach may help them in meeting the reporting timelines, it will not help them achieve their objective of sustainable IND AS reporting.
The transition to IND AS is not merely an accounting change. Its impact is pervasive across various work streams such as taxation, corporate governance, internal controls, stakeholder communication and inorganic growth strategies. To move toward sustainable IND AS reporting, companies need to address all the facets impacting them. Based on our GAAP conversion experience with companies globally, we have picked out the following key areas that require management focus:
• Internal control over financial reporting
Internal control has been one of the top agenda items for board members this year. The Companies Act, 2013 has mandated boards to certify that they have instituted robust systems and processes to ensure accuracy and completeness of accounting records, and timely preparation of reliable financial information. On transition to IND AS, companies will need to revisit their internal financial controls to ensure that they are geared up for reliable and timely IND AS financial reporting. The following are some examples of the changes that boards may be required to make in internal controls over financial reporting after transition to IND AS:
a. IND AS disclosure requirements are a lot more comprehensive than Indian GAAP, resulting in an estimated increase of 1.5 to 2 times in the size of financial statements over Indian GAAP. Companies will need to revisit or update the process of closing their financial statements to ensure reliability and completeness of disclosures.
b. Companies may need to update their accounting manual and group reporting package to ensure consistency in the accounting policies followed by subsidiaries, associates and joint ventures, as well as in data collation for the preparation of consolidated financial statements
• Manage regulatory compliances
Transition to IND AS may give rise to regulatory compliance risks. Companies need to ensure that they modify/update their systems and processes to manage compliances or proactively engage with regulators for appropriate solutions. Some areas where IND AS can lead to regulatory compliance risks are as follows:
a. IND AS 24 enhances the definition of a “related party.” Listed companies will need to consider this revised definition for related party transaction approval requirements as laid down in Clause 23 of the Listing Obligation and Disclosure Requirements issued by the Securities and Exchange Board of India.
b. The definition of “control” as per IND AS is based on substance rather than form. This can result in certain entities being considered as subsidiaries based on the rights available to them through contractual arrangements even though they do not own majority voting rights. In regulated industries such as insurance and retail, this can lead to a breach of FDI norms if the foreign partner is assessed as controlling the Indian entity.
c. In IND AS, the classification of debt and equity is based on contractual terms, not based on the form. This can result in certain instruments such as preference shares, share application money and perpetual instruments being classified as debt than equity. Consequently, the cost of these instruments will be classified into interest expense or dividend based on their classification as debt and equity. Further, the accounting for time value of money under Ind AS will result in an increase in the interest expense reported in the financial statements. This may result in a breach of the debt covenants, requiring proactive dialogues with bankers for either a waiver of such a breach or a renegotiation of the debt covenants.
• Modification of IT systems and processes
Certain data-collection efforts would change as a result of changes in accounting policies and financial statements’ disclosure requirements. As a result, the IT systems used to collect and report financial data may also need to be modified accordingly. It will be important to identify the specific effects on IT systems and to understand how easily changes can be made to a company’s existing systems. The age, flexibility and upgrade path of the current IT systems will be key factors in determining whether the existing systems can be enhanced or must be replaced. Some examples where modification will be required are as follows:
a. Modification of the chart of accounts
b. Modification of the fixed assets register to comply with component accounting, especially major inspection costs/ decommissioning liabilities
c. Modification of the treasury system to comply with the hedge accounting requirements.
d. Modification in MIS to align with the new segment reporting rules
IND AS might not directly impact the computation of direct taxes because it is based on the Income Computation and Disclosure Standards (ICDS). However there are many consequential impacts of IND AS on taxation that require careful evaluation. For example, the fair valuation of financial guarantees on initial recognition may not coincide with the fair valuation according to the transfer pricing regulations under the Income Tax Act. Recently, the MAT IND AS Committee instituted by the Central Board of Direct Taxes (CBDT) submitted its report, suggesting a framework for the computation of book profit for the purpose of the levy of the Minimum Alternate Tax (MAT) under Section 115JB of the Income Tax Act, 1961. The suggestions of the committee, if finalized, could have a significant impact on the MAT liability of the companies.
Managements should focus on addressing the issues arising on the transition to IND AS on all facets of organizations to move toward sustainable financial reporting phase. The clock has started ticking; have you chalked out your action plan?