IFRS: Disclosure Requirements for Preparation of Financial Statements By CS Komal Jain & CS Karuna Jain (K K Jain & Co.)


Introduction and Origin of IFRS: 

International Financial Reporting Standards (IFRS) are the set of global accounting principles and standards that are required to be followed while accounting for transaction and events in financial statements. The main objective behind IFRS adoption by International Accounting Standards Board (IASB) was to have uniform accounting standard across all countries. The IFRS conceptual framework is an attempt to determine nature and purpose of accounting. The purpose of IFRS is to provide information to determine how a particular transaction should be accounted.

Historical evidence indicates that in absence of conceptual framework, some accounting standard were in conflict with accounting principle of prudence and accrual, many standards were internally inconsistent and few standards were not consistent with other accounting standard. In many cases, the standard setting was based on individual concept of each participant of standard setting board. This led to development of rule based accounting, which is regarded as prescriptive and inflexible. So, to ensure that ‘principle based standard’ is developed to provide consistent accounting pronouncement over time. 

Benefits of Global Accounting Standard:
 
Due to emergence of Make in India concept, Modi Government is making all efforts to attract foreign Investments in our country. As a result of which many foreign companies are setting up their business in India. So in order to converge the Accounting Standard of that country, it is required to adopt some common standards which would be beneficial for the companies to disclose their financial statements in transparent & fair manner.
 
The following are the benefits of IFRS:

  1. Reduction in information cost to economy:
If the company is following local GAAP, the foreign investors perceive the presence of accounting risk in such statement. Accounting risk refers to risk involved in analyzing and interpreting financial statement that follows different GAAP. Thus, the financial statement prepared in different GAAP, affects the financial ratio, which is a key factors in lending decision by bankers and for compliance with debt covenant. If IFRS based standard are adopted, capital market regulators must be aware of only one set of accounting standard and the companies will experience efficiency in raising capital and reduced information processing cost.
 
  1. Effective Presentation of Financial Statement:
If IFRS is adopted, then it would provide consistent presentation of financial statement along with uniform measures for recognition, measurement and disclosures of financial transaction. It will lower complication in taxing global income, as the taxes are levied on the total income of the companies, and the company along with its foreign subsidiary.
 
IFRS cover a wide range of accounting activities. There are certain aspects of business practice for which IFRS set mandatory rules.

  • Statement of Financial Position: This is also known as a balance sheet. IFRS influence the ways in which the components of a balance sheet are reported.
  • Statement of Comprehensive Income: This can take the form of one statement, or it can be separated into a profit and loss statement and a statement of other income, including property and equipment.
  • Statement of Changes in Equity: Also known as a statement of retained earnings, this documents the company's change in earnings or profit for the given financial period.
  • Statement of Cash Flow: This report summarizes the company's financial transactions in the given period, separating cash flow into Operations, Investing, and Financing.
In addition to these basic reports, a company must also give a summary of its accounting policies. The full report is often seen side by side with the previous report, to show the changes in profit and loss. A parent company must create separate account reports for each of its subsidiary companies.
 
IFRS Developments in India:

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, pre-conditions 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.
 
Under the statutory mandate provided by the Companies Act, 2013 the Central Government of India prescribes accounting standards in consultation with National Advisory Committee on Accounting Standards (NACS) established under the Companies Act, 2013. 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.
 
Impact of IFRS on Financial Statements:
 
a.) Differences in the Balance Sheet: The accounting treatment of inventory, property & equipment, and goodwill etc shows differences while preparing financial statements as per U.S. GAAP and IFRS.
  1. Inventory:
Two inventory method standards normally used in the past were FIFO (first-in, first-out) and LIFO (last-in, first-out). However, LIFO is not allowed under IFRS, so firms that have used LIFO will have to change their inventory method to FIFO.

  1. Property and Equipment:
Property & equipment i.e. fixed assets are reported at their initial cost less the accumulated depreciation. U.S. GAAP does not allow any upward adjustments of property and equipment, whereas under IFRS they can. This can have a profound impact on a firm's reporting. For example, if equipment is marked down, it results in a loss on a firm's income statement. However, if the asset is then marked back up under IFRS from an increase in value, then the adjustment is recorded as a gain, up to the initial cost. Any further upward adjustment will be reported directly to equity.

  1. Goodwill
    An intangible asset, goodwill is reported on the balance sheet at the initial cost less accumulated amortization. Any downward revaluation will cause a loss on the income statement and if it is marked up, which is not allowed under U.S. GAAP, and then a gain is recorded up to the initial cost amount. Any adjustment beyond that will be reported directly to equity.
b.) Differences in the Income Statement: Some differences lie within how cost of goods sold is determined, the operating expenses, and construction contracts. The criteria for revenue and revenue recognition under U.S. GAAP and IFRS are slightly different.

  1. Revenue Differences in Regards to Construction Contracts:
Depending on the accounting method adopted, the revenue for construction projects can be affected. Under U.S. GAAP, if the outcome of a project cannot be estimated, then the completed contract method is required. However, under IFRS, if the outcome of a project cannot be estimated, revenue is recognized only to the extent of contract costs, and profit is only recognized at project completion.

  1. Cost of Goods Sold:
Since LIFO is not allowed under IFRS, LIFO firms have to convert their inventory into FIFO terms in the footnotes of the financials. This difference is known as the LIFO reserve, and is calculated between the COGS under LIFO and FIFO. The benefit in doing this is an increase in the comparability of LIFO and FIFO firms.
This has an effect on the financials of a firm. In particular, during periods of high inflation, a firm that uses LIFO will report higher COGS and lower inventory as compared to a firm that uses FIFO. Higher cost of goods sold results in lower profitability and lower profits results in lower income taxes. Lower profits will also result in lower equity for the firm, which affects retained earnings in a negative way. In contrast, in a low inflationary period, the effects mentioned are reversed. Something to keep in mind for analysts converting LIFO firms to FIFO.

  1. Operating Expenses:
IFRS does not differentiate between expenses and losses, but U.S. GAAP does. With IFRS, any losses that are due to a firm's main business are included in its operating expenses. 

Stages of IFRS Implementation:    
            
  1. Impact assessment:
Indian companies looking at International Financial Reporting Standards (IFRS) implementation will have to enable technology applications based on the impact assessment. The company which is adopting IFRS is required to establish proper team who will assess the areas wherein implementation will cause direct effect on financial statements.

  1. Planning and designing
Under planning phase, company is required to implement a policy change like configuration & up gradation of the IT systems, Risk mitigation and currency conversion and accordingly blue prints of the design should be prepared as IFRS implementation process.

  1. Realization and Data conversion:
In this phase of IFRS implementation, the configuration changes planned and agreed in the planning and design stage need to be realized or configured in the system. Post configuration changes, the company should test the solutions that aid in IFRS implementation with the current IT environment, End users need to be trained accordingly.

In the last phase of IFRS implementation, financial statements as per IFRS on the conversion date need to be prepared by an accounting team. Based on the converted financial statements, data conversions required in IT need to be identified.

IFRS implementation impacts asset accounting, revenue recognition, capital expense, or working capital; a company’s planning and budgeting policies will revolve around these. Hence, if there is a change in the accounting policy, the planning and budgeting should also be revised, accordingly.

Challenges towards implementation of IFRS:

  1. Transition Cost: The companies have to incur one time transition cost towards adjusting its accounting systems, updating internal control procedure and documenting it. Further, IFRS require companies to provide financial statement for at least one prior year or may be up to three years. In addition, the companies have to hire external consultant to train their employees and familiarize analysts and investors with IFRS.
  1. International Convergence: The listed companies of European Union State including UK, France and Germany, have adopted IFRS since 2005. Developed country like US has given an option its companies to voluntarily adopt IFRS Standard; Whereas Canada requires all listed entities to follow IFRS from January 01, 2011. Asian countries like China has converged its national standard to IFRS standard. The process of converging towards IFRS is still going on in India. 
  1. Compliance with IFRS: IFRS is a method of reporting financial transaction and presenting financial statement. Compliance with IFRS will reduce accounting risk associated with preparing financial statement as per local GAAP. However, the fair value concept advocated in IFRS may increase the subjectivity in accounting the value of asset that is not traded freely. So, if the value of such asset is not correctly arrived, the financial statement may distort its purpose. 
Conversion or Adoption of IFRS by Indian Company:

India today has become an international economic forum. Indian companies has surpassed in several sectors of the industry that includes, ITES, software, pharmaceutical, auto spare part to name a few. And to stay as a leader in the international market India opted the changes it need to interface Indian stakeholders', the international stakeholders' and comply with the financial reporting  in a language that is understandable to all of them. In response to the need several Indian companies have already been providing their financial statements as per US GAAP and/or IFRS on voluntary basis. But, however this is becoming more of a necessity then just being a best practice.

In the coming years, critical decisions will need to be made regarding the use of global accounting standards in India. Market participants will be called upon to determine whether achieving a uniform set of high-quality global accounting standards is feasible, what sort of investments would be required to achieve that outcome, and whether it is a desirable goal in the first place. This dialogue will be critical to the future of financial reporting and of fundamental importance to the long-term strength and stability of the global capital markets.

Conclusion:   

International Financial Reporting helps the regulatory agencies in benchmarking the accounting accuracy. Sufficient efforts by local accounting body are required to enable companies to adopt IFRS and the companies have to incur substantial cost in preparing statement as per IFRS. However, the Companies will derive long term benefit from using IFRS standard for reporting its financial transaction. Convergence of IFRS with Ind AS will facilitate the foreign companies to prepare their financials in accordance with the prevailing standards. This will also lead to reduction in the double disclosure on part of companies, thereby relaxing Corporates from burden of extra compliance. Harmonisation will have direct effect on cross border capital flows thereby growing number of foreign direct investments and mergers & acquisitions at international level.


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