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Convergence of Ifrs, US Gaap and Indian Gaap and Its Impact on Indian Companies Listing in U.s and American Companies Listing in India
Convergence of IFRS, US GAAP AND INDIAN GAAP and its impact on Indian companies listing in U.S and American companies listing in India
By SUNIL KEWALRAMANI
November 4, 2008
Consistent, comparable and understandable financial information is the lifeblood of commerce and investing. Presently, there are two sets of accounting standards that are accepted for international use--the U.S. Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS) issued by the London-based International Accounting Standards Board (IASB). Foreign subsidiaries of U.S. multinationals use U.S. GAAP. Many foreign companies, attracted to listing in the U.S. have to confront various problems like compliance with U.S. GAAP and the onerous Sarbanes-Oxley Act.
In search of a new financial order: one global standard for financial reporting makes sense.
Accounting Standards in India will undergo significant change from 1st April 2011, when the IFRS (International Financial Reporting Standards) come into force as per the recent proposal of The Institute of Chartered Accountants of India. Countries of the European Union, Australia, New Zealand and Russia have already adopted IFRSs for listed enterprises. China has decided to adopt IFRS from 2008 and Canada from 2011.
If 2011 is the year when we would be totally aligning our standards with the IFRS, then what would happen in terms of inter-period comparisons because the numbers that would emerge after convergence to IFRS would be based on different accounting principles than those based on Indian GAAP ?. In order to breathe meaning in the numbers and enable inter-period comparison, it is essential that similar accounting principles should have been used from one period to another. Besides, you would need IFRS-trained professionals in India for which the Institute of Chartered Accountants of India would need to impart special training to its students and members alike.
In India, the accounting standards or accounting-related requirements are issued not only by the ICAI(Institute of Chartered Accountants of India) but also by various other regulatory bodies, such as SEBI (Securities and Exchange Board of India), RBI (Reserve Bank of India) and the IRDA (Insurance Regulatory and Development Authority). They now not only need to be consistent with each other but also with the IFRS.
The Central Government in pursuance of Section 211 of the Companies Act 1956 has issued a notification prescribing accounting standards for companies, and these standards direct us to the Accounting Standards issued by the ICAI. Since ICAI is now leaning on implementing IFRS with effect from 1st April 2011, the Government would find it essential to treat complying with IFRS as satisfactory compliance with Section 211 of the Companies Act 1956.
Closing the GAAP
The demise of U.S. GAAP has accelerated this decade. While the SEC currently looks to FASB to set U.S. GAAP, it is the SEC that retains ultimate responsibility. U.S. GAAP has been extensively used since the 1930s, and until recently was widely used around the world. However, its shortcomings are also well known, including approximately 200 pieces of fragmented U.S. GAAP on revenue recognition, some of which are not based on consistent concepts.
U.S. GAAP has evolved over the years to become overly complex and onerous as evidenced by the large number of countries and companies abandoning it. One recent example is
NEC Corporation, the Japanese electronics giant. NEC announced on September 21, 2007, “that it was not able to complete a U.S. GAAP-required analysis relating to software, maintenance, and service revenues.” In essence, the company said it simply cannot figure out U.S. GAAP revenue recognition rules and will stop trying, resulting in suspended trading on the
NASDAQ
.
It is possible that companies listed in the U.S. could be allowed to report their financial results using standards set by IASB instead. Giving companies a choice of accounting standards might create an opportunity for forum shopping.
In India, one of the big impediments to implementation of IFRS in India is in the case of Mergers and Acquisitions where the High Court approval is required. The High Court has got the authority to stay application of accounting standards or to prescribe accounting requirements in the case of merger and amalgamation situations. All this would deter smooth transition to IFRS in India.
Besides, deferral of VRS cost or ESOP accounting being based on intrinsic method, though a departure from IFRS is essential bearing in mind the needs and requirements of the Indian economy.
In addition, Schedule VI of the Companies Act, 1956 is also not in complete compliance with the IFRS and they need to be reconciled as well.
The RBI also prescribes accounting requirements for banks, such as accounting for derivatives or provision for non-performing assets, and these requirements of the RBI are currently at variance with the IFRS.
Managements compensation, stock options, debt covenants, tax liability and distributable profits are all based on Indian GAAP and AS (Accounting Standards) at present. Now all the salary structure, compensation structure will have to be renegotiated by most senior employees who have variable methods of compensation. For example, the variable pay component of most TCS employees is about 30 % of the total compensation package and this variable pay being based on items of Profit/Loss Account which will be defined differently under IFRS, the entire compensation package will need to be revised.
Recently, the SEC (Securities and Exchange Commission) of the US eliminated the GAAP reconciliation requirement as a part of Form 20-F for foreign issuers. Almost simultaneously, the Commission issued a Concept Release that would enable U.S. issuers to drop GAAP and use International Financial Reporting Standards.
Statements of financial position, comprehensive income and cash flows
Perhaps the biggest potential change is a different look to financial statements. Although nothing has been decided, the IASB and FASB are striving to create a cohesive presentation of financial information that will likely do away with a single net income number, or “bottom-line.” Instead, the working proposal would require three separate statements: a statement of financial position, a statement of comprehensive income, and a statement of cash flows.
Companies would need to breakout in each financial statement information for business activities (including operating and investing activities), discontinued operations, financing activities, income taxes, and equity. This would result in a company classifying its assets, liabilities, and equity items into one of the prescribed categories or sections in the statement of financial position and then similarly classifying changes in assets, liabilities, and equity items in the statement of comprehensive income and the statement of cash flows. It is anticipated that the resulting standard will apply to all business entities (public and nonpublic), but not to not-for-profit organizations or defined benefit plans.
There are substantial differences between IFRS and U.S. GAAP. U.S. GAAP is largely rules-based meaning long and complex standards attempting to deal with all scenarios. Financial Accounting Standard No. 133 on derivatives is a fine example with over 800 pages of the standard and implementation issues.
On the other hand, IFRS is a principles-based accounting system, meaning it is objective-oriented allowing for more presentation freedom. Financial Accounting Standard No. 123R on share-based payments and the SEC executive compensation disclosure requirements are attempts to move toward principles-based standards.
One of the obvious benefits of accounting standards and particularly those that are adopted globally is comparability. We are heading towards, what we, in common parlance, call ‘apple-for-apple’ comparison, and not ‘apple-for-oranges’ comparison. Presumably, users of financial statements are in a better position to assess the prospects of one company versus another provided both the companies use the same set of rules to report similar transactions and events. The comparability issue was the prime reason for requiring the foreign issuers in the US to reconcile their statements to US GAAP.
SEC’S REASONS FOR ELIMINATING GAAP : It is ironical that although the purpose of adopting IFRS is ensuring greater comparability, how does eliminating requirement of reconciliation help when most issuers in the US come there because of greater liquidity, visibility and marketing in the American capital markets. These foreign issuers would be competing with the US entities who adopt US GAAP and it would be unrealistic to expect that these foreign issuers would forego the US GAAP. In fact, they will continue to use the US GAAP because this way, they can compare their financials with the listed US entities and show how they can fetch similar market capitalization for their entities.
To circumvent this problem, if the SEC allows US issuers to adopt IFRS, there will be little need for convergence, and the concept of comparability would be highlighted. The proposed move is said to be primarily intended to make it easier and cheaper for foreign companies to list on U.S. exchanges. There has been increasing concern that the competitiveness of the U.S. capital markets has been impaired by the onerous laws and additional compliance requirements put in place in the past five years – with the logical example being the Sarbanes-Oxley Act of 2002 and its Section 404 Internal Control Certification requirement. A popular example - regulators, lawmakers and other interested parties in the U.S. are concerned that domestic exchanges are losing market share in IPO listings to foreign exchanges that have “less cumbersome” listing requirements.
Is proposed elimination of U.S. GAAP reconciliation for foreign filers premature ? Due to a variety of reasons – some of which have only gained broad attention in recent weeks – it appears the proposed elimination of the U.S. GAAP reconciliation for foreign filers may be premature. One of the main reasons regularly cited – despite the progress in recent years by the FASB and IASB on its “convergence” project – there are still too many differences between the two sets of standards and still have considerable room to converge further. A classic example of this can be found with GlaxoSmithKline plc – a foreign filer with the SEC which prepares its financial statements using IFRS. Note 41 from GSK’s 2006 Form 20-F filing provides details on the company’s reconciliation to U.S. GAAP. The footnote is a whopping 13 pages long and discloses a long list of differences in reconciling shareholders’ equity under IFRS (£9.4 billion) to shareholders’ equity under U.S. GAAP (£34.7 billion). Although GSK may be an extreme example, I believe the U.S. GAAP reconciliation provides important visibility to investors on the material differences in a foreign company’s financial results between IFRS and U.S. GAAP. Eliminating the reconciliation would prevent investors from adequately assessing a company’s performance and performing peer comparisons.
A
paper
titled “Principles-based accounting standards” was issued by some of the world’s largest accounting firms including Deloitte, Ernst & Young, Pricewaterhouse Coopers, KPMG, Grand Thorton and BDO Seidman giving their overwhelming support for moving to single set of global accounting standards and specifically IFRS. They argued in the above paper that IFRS are more principles-based and in particular allow for “reasonable judgment”.
Many accounting experts argue that IFRS is of a lower quality and needs significant improvement. Certainly, the disclosures under IFRS are far less detailed than those required under US GAAP. Also, the moot point is does it make sense to allow companies to revalue property, plant and equipment considering that it is not for sale ? In addition, IFRS bans the use of LIFO flow of cost assumption as it relates to inventory. While the arguments for and against the various flow of cost assumptions are numerous, one has to submit that LIFO provides the users with information that is a better predictor of future results. Similarly, under IFRS 8, on Segment Reporting, a company can define a segment using its own discretion. Items such as segment revenue, segment asset, segment segment expense and current liabilities are left undefined. My question is how can differing definitions of what a segment is bring about comparable information for the users of financial statements. Or for that matter, useful information ? Even in India, as per AS 17, if the case of a vertically integrated segment meets the quantitative norms for being a reportable segment, the relevant disclosures are to be made. However, IAS 14 of IFRS encourages, but does not require, the reporting of vertically integrated activities as separate segments. According to the same IAS 14, a segment identified as a reportable segment in the immediately preceding period on satisfying the relevant 10 % threshold, shall be reportable segment in the current period also if the management judges it to be of continuing significance. (Note : The IASB has recently issued IFRS 8 on ‘Operating Segments’ which would supersede IAS 14 with effect from January 2009).
Besides, the IASB has not yet addressed important issues such as revenue recognition and lease accounting. Should we presume that revenue recognition is to be left to the auditor’s “reasonable judgment” and “to the best of his knowledge and belief” ?
Just like conversion to US GAAP, gave different lists; so has conversion to IFRS. Under European Union Law, 2007 was the first year that many foreign firms listed on U.S. exchanges were required to begin using IFRS. They have experienced varied results. For example, Diamler Chrysler’ first report using IFRS increased the automaker’s tax earnings by $ 819 Million to $ 5.2 Billion, while EPS (Earnings Per Share) increased by 68 cents. Operating Profit, or Earnings before interest and taxes, dropped by $ 38 Million to $ 7.5 Billion under IFRS. The switch also reduced the loss suffered by the company’s Chrysler division—the only unit to show a loss—from $ 1.5 Billion to $ 682 Million. The company attributed most of the above variation to the way pension obligations are booked under the IFRS. For example, retroactive pension-plan adjustments are immediately entered into the income statement under IFRS; whereas, under US GAAP, the adjustments are distributed over the remaining service period.
Fair value accounting of IFRS
One common criticism about IFRS is that it is heavily loaded in favour of fair valuation principles and these principles are very subjective and would result in significant volatility in periodic results. IFRS is fair-value driven and this often produces unrealized gains and losses. How will income tax treat these unrealized gains and losses ? Besides, can unrealized gains be distributed as dividends within the contours of Companies Act 1956 is the debatable point.
China Construction Bank, The Bank of China and The Industrial and Commercial Bank of China have launched mega-IPOs in the last couple of years. But after decades of rapid loan growth; they, along with other Chinese banks, state investment companies, credit co-operatives, are now sitting on record Non-Performing Loans (NPLs). The Chinese NPL market is one of the largest in the world with, according to one estimate, a total outstanding principal balance of over a trillion dollars, which is about 40% of China’s GDP. How are these NPLs to be reflected at fair value and at what point of time their diminution in value is to be recognized ?
In India, State Bank of India (SBI), ICICI Bank, Bank of Baroda (BOB) and Bank of India (BOI) are all set to book mark-to-market losses from 5 -10%. The exposure of these banks are $ 1 Billion, $ 1.5 Billion, $ 150 Million and $ 300 Million respectively to subprime loans. Here also, at what point of time these subprime losses are to be recorded as having crystallized ? Are we going to allow some time for these subprime losses to recover ? Or do we recognize them immediately on fair value principles as soon as it appears they are going sour ? And who’s call is this finally—that of the auditor, that of the management, or of both ?
Markets in complex pieces of paper such as CDOs (Collateralized Debt Obligations) and CDSs (Credit Default Swaps) are in disarray. If assets can be priced realistically, trading can resume. Yet in practice, fair value accounting, appears not to be delivering on its promise to help mitigate systemic risk. The problem seems to be arising over illiquid assets.
The US Financial Accounting Standards Board (FASB) has introduced a “three bucket” taxonomy to categorize marks to market.
Bucket # 1 is for assets that have observable market prices.
Bucket # 2 is for less frequently traded securities that can be priced by reference to similar assets.
Bucket # 3 is for assets with unobservable inputs where value is based on management assumptions. This where the CDS (Credit Default Swaps), CDOs (Collateralized Debt Obligations) and other exotic credit market instruments would lie. There will always be scope for friction here because company auditors, worried about their professional liability and using conservative accounting principles, may coerce management into adopting valuations close to fire sale valuations.
This will lead to a vicious circle. Because, if you mark down assets excessively, the solvency of the financial system could be eroded.
An unusual situation could arise where although on a fair value basis or mark-to-market basis, there could be loss but if the loss is expected to reverse itself over the life of the insured credit derivatives, as happened in the case of the monoliner MBIA which although threw up a pre-tax loss of $ 3.5 Billion on mark-to-market basis, expected to actually incur loss of only $ 200 Million.
If my loan accounts are marked-to-market under fair value accounting, it runs a predatory risk because by means of an hostile takeover, the predator can launch an assault on my firm. During the Latin American debt crisis of the 1980s, the world’s biggest banks would have been insolvent if their loan books had been valued realistically. But to stave off runs on banks by uninsured wholesale depositors in the protracted period needed to rebuild bank capital, the authorities allowed loans to remain at book value on the bank balance sheets. The ICAI (Institute of Chartered Accountants of India) should make sure that it is neither behind of the curve nor ahead of the curve. In the days of the Latin American debt crisis, provisioning against loans was progressive, permitting capital ratios to be maintained. This policy of regulatory forbearance would theoretically be possible today. Illiquid assets that are now flowing into the accountants’ third bucket could be kept on bank balance sheets at book value until maturity. But forbearance carries the risk of moral hazard. Hard look needs to be given to all these issues. The ICAI has always been very conservative in its accounting policies and this has stood it in good stead, and should be careful in adopting fair value method of accounting across-the-board and in situations.
At the end of the day, in the interests of globalization, convergence to IFRS is essential for India to align itself with the rest of the world; however the transition will not be smooth and we as members of the Chartered Accountancy profession need to put our heads together to ensure that foreign investors in our country do not get deterred by inconsistent policies and rules and regulations, which may get even more apparent as we move into the IFRS era.
Reference :
Concept Paper entitled “Convergence with IFRSs in India” issued by the Institute of Chartered Accountants of India
Note : Mr Sunil Kewalramani is a WHARTON BUSINESS SCHOOL MBA and CEO, GLOBAL CAPITAL ADVISORS.
EXECUTIVE SUMMARY :
A) THE CONVERGENCE AGREEMENT BETWEEN FASB (OF USA) AND IFSB, AND BETWEEN IAS (INDIAN ACCOUNTING STANDARDS) AND IFSB is significant and will have dramatic impact of Indian companies listing in US and American companies listing in India
B) THERE IS NO SINGLE PATH TO CONVERGENCE, but an open-minded pursuit of the highest quality guidance should result in standards that foster superior financial reporting
C) CONVERGENCE will require changes in US, Indian, International standards as well as those of countries who are trying to implement the convergence.
D) INTERNATIONAL STANDARDS may change to follow accounting standards in a particular country. For example, international accounting standards resemble U.S. standards in accounting for discontinued operations.
About the Author
Mr Sunil Kewalramani is a Wharton Business School MBA, a CPA, CA and a leading consultant for multinational companies on global asset management, strategic planning and cross-border mergers and acquisitions
Bad image on 42" LCD screen?
I have just upgraded and brought a 42" Sharp LCD screen. I used to have a 42" NEC plasma screen and that worked fine.
I get a brilliant image when im using a HD-MI cable from my DVD player and PS3 but when i connect a VGA from my desktop PC the image is not as good.
Im using 1360x768 resolution from my on board graphics card.
The image itself seems to be ok but when there is black/blue etc text on any background colour there seems a bright white glow from each piece of text. i kept the video settings on my PC the same as they were fine with the old Plasma (i have played with them but left them as i found then) and adjusted the back light, contrast and brightness on the LCD but i cannot seem to get a good image.
what could cause this?
and more importantly how can i resolve this?
Many thanks,
Char
Might've been a downgrade in fact. See, LCD just never shows colours as well as plasma... On the bright side, burn in will never bother you again!
Try a VGA-DVI cable or upgrade to an HDMI video card for your computer if you're sure it's the weak VGA support. For reasons beyond our comprehension, some TVs are in fact selectively horrid with VGA by design.
NEC Electronics Announces Four New Intelligent Power Devices for Automotive Lighting Applications
KAWASAKI, Japan & SANTA CLARA, Calif. & DUESSELDORF, Germany--NEC Electronics (TOKYO: 6723) announced today, four new intelligent power devices (IPDs), the µPD166017, µPD166019, µPD166020 and uPD166021. Each high-side IPD is applicable for automotive lighting and other critical vehicle loads. Designed for on-board electronic control units (ECUs) typically used in head- and fog-light applications ...
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