IFRS to be an expensive affair for SMEs

The Institute of Chartered Accountants of India (ICAI) has decided the strategy for adoption of International Financial Reporting Standards (IFRS) in India with effect from April 1, 2011.

At present over a 110 countries in the European Union, Africa, West Asia and Asia-Pacific regions either require or permit the use of IFRS. Even in the US, there is an ongoing debate regarding the adoption of IFRS replacing the US GAAP.

Now, the International Accounting Standards Board (IASB) that issues IFRS and the Financial Accounting Standards Board (FASB) that issues the US GAAP are cooperating and they have long term projects and short term projects to converge US GAAP into IFRS.

Indian corporates are likely to reap significant benefits from adopting IFRS. The European Union’s experience highlights many perceived benefits as a result of adopting IFRS.

There is adverse impact on small and medium size entities (SMEs) in India. Convergence to IFRS is a costly exercise that includes an overhaul of operational and IT processes apart from training costs. The SMEs cannot bear such huge costs. Therefore, a core panel constituted by the government on IFRS decided to exempt SMEs from the first phase of IFRS convergence falling due in 2011. The SMEs sector will continue to follow existing Indian Accounting Standards, which may be modified from time to time to make the sector more competent in the international arena.

However, it will have positive impact on big Indian corporates. These include:

Improvement in comparability of financial information and financial performance with global peers and industry standards.

IFRS enhances uniformity in the accounting principles.

Foreign investors rely only on IFRS financial statements, hence Indian financial statements will be liked by the foreign investors.

The adoption of IFRS is expected to result in better quality of financial reporting.

Low cost of raising funds in abroad.

Implementation of IFRS in India, will lead to increased trust and reliance placed by investors, analysts and other stakeholders in a company’s financial statements.

Better access to and reduction in the cost of capital raised from global capital markets arises as IFRS is now accepted as a standard financial reporting framework for businesses seeking to raise funds overseas.

The above cited benefits will accrue only to the big corporates in India. The SMEs sector will not benefit much as they do not have necessary set up to cope with the problems that may arise by switching to the more rigorous IFRS.

In December 2007, the US Securities and Exchange Commission (SEC) permitted foreign companies listed in the US to present financial statements in accordance with IFRS. This benefits Indian companies listed in the US, as they have to prepare only a single set of IFRS compliant financial statements, reducing financial and compliance costs.

However, the perceived benefits from IFRS adoption are based on the experience of IFRS compliant countries in a period of mild economic conditions. The current decline in market confidence in India due to big corporate failure (Satyam) as well as overseas, coupled with tougher economic conditions, may present significant challenges to Indian companies

Two separate sets of accounting standards under section 211(3c) of the Companies Act have been agreed upon by the core group for convergence of Indian Accounting Standards with IFRS. For banking and insurance companies there will be a separate roadmap.

The core group committee of the government finalised the road map for IFRS convergence in India. The ICAI said that all entities having net worth in excess of Rs 1,000 crore will have to follow IFRS. The list also includes all NSE and BSE-listed companies, insurance entities, mutual funds, venture capital funds and all scheduled banks having operations outside India.

In addition to the above, there are several impediments and practical challenges to adoption of and full compliance with IFRS in India.

Several laws and regulations governing financial accounting and reporting in India need to be amended. In addition to accounting standards, there are legal and regulatory requirements that determine the manner in which financial information is reported or presented in financial statements. For example, the Companies Act, 1956 determines the classification and accounting treatment for redeemable preference shares as equity instruments of a company, whereas these may be considered to be a financial liability under IFRS. There are certain sections in the Indian Companies Act that override the provisions of IFRS.

There is a shortage of professionals with practical IFRS conversion experience and therefore many companies will have to rely on external advisers and their auditors.

There is an urgent need to address these challenges and work towards full adoption of IFRS in India. The most significant need is to build adequate IFRS skills and an expansive knowledge base among Indian accounting professionals to manage the conversion projects for Indian corporates.