A STUDY ON IFRS AND ITS IMPACT ON THE BANKING INDUSTRY OF INDIA BACHELOR OF BUSINESS ADMISTRATION (BBA)

BIRLA INSTITUTE OF TECHNOLOGY (Deemed university U/S 3 of UGC Act 1956)

Submitted by: Nishchay Dhingra(BBA/4554/10) Saksham Taneja(BBA/4555/10) Akshay Chauhan(BBA/4582/10)

CONTENTS
1. Introduction 1.1 1.2 1.3 1.4 1.5 1.6 Background of IFRS Structure of IFRS Requirements of IFRS Challenges faced in adopting IFRS Advantages of IFRS Status of Indian Banking Industry

INTRODUCTION
IFRS are International Financial Reporting Standards, which are issued by the International Accounting Standards Board (IASB). Nearly 100 countries use or coordinate with IFRS. These countries or groups of countries include the European Union, Australia, and South Africa. International Financial Reporting Standards (IFRS) are standards and interpretations adopted by the International Accounting Standards Board (IASB). IFRSs are considered a "principles based" set of standards in that they establish broad rules as well as dictating specific treatments. The International Accounting Standards Board (IASB) and the International Financial Reporting Standards (IFRS) that they issue are very important for the future of accounting. With businesses turning global, it is important that investors are able to compare companies under similar standards. Likewise, it is important for businesses operating in multiple countries to be able to create financial statements that are understandable in all of the countries they operate in. Two of the main advantages of adopting IFRS are those of more transparency and a higher degree of comparability. Both of these will benefit investors and are essential to achieving the goal of an integrated global and financial market place. Companies will have greater access to world capital markets at lower costs of capital. Consumers (investors) will enjoy wider investment choice. IFRS allows a company to enhance the communication of its financial performance and position together with other performance. Another advantage of reporting under IFRS is the restructuring of internal management reporting systems which assist in financial accounting and financial statement generation and the provision of essential management information required for evaluating company and executive performance.

Objectives of IFRS
To develop, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require high quality, transparent and comparable information in financial statements and other financial reporting to help participants in the world's capital markets and other users make economic decisions; To promote the use and rigorous application of those standards; To take account of, as appropriate, the special needs of small and medium-sized entities and emerging economies. To bring about convergence of national accounting standards and International Accounting standards and IFRS to high quality solutions.

Scope of IFRS
1. IASB Standards are known as International Financial Reporting Standards (IFRSs). 2. All International Accounting Standards (IASs) and Interpretations issued by the former IASC and SIC continue to be applicable unless and until they are amended or withdrawn. 3. IFRSs apply to the general-purpose financial statements and other financial reporting by profit-oriented entities -- those engaged in commercial, industrial, financial, and similar activities, regardless of their legal form. 4. Entities other than profit-oriented business entities may also find IFRSs appropriate. 5. General-purpose financial statements are intended to meet the common needs of shareholders, creditors, employees, and the public at large for information about an entity's financial position, performance, and cash flows. 6. Other financial reporting includes information provided outside financial statements that assists in the interpretation of a complete set of financial statements or improves users' ability to make efficient economic decisions. 7. IFRS apply to individual company and consolidated financial statements. 8. A complete set of financial statements includes a balance sheet, an income statement, a cash flow statement, a statement showing either all changes in equity or changes in equity other than those arising from investments by and distributions to owners, a summary of accounting policies, and explanatory notes. 9. If an IFRS allows both a 'benchmark' and an 'allowed alternative' treatment, financial statements may be described as conforming to IFRS whichever treatment is followed.

10. In developing Standards, IASB intends not to permit choices in accounting treatment. Further, IASB intends to reconsider the choices in existing IASs with a view to reducing the number of those choices. 11. The provision of IAS 1 that conformity with IAS requires compliance with every applicable IAS and Interpretation requires compliance with all IFRSs as well.

Requirements of IFRS
IFRS financial statements consist of (IAS1.8) A Statement of Financial Position A Statement of Comprehensive Income or two separate statements comprising an Income Statement and separately a Statement of Comprehensive Income, which reconciles Profit or Loss on the Income statement to total comprehensive income A Statement of Changes in Equity (SOCE) A Cash Flow Statement or Statement of Cash Flows Notes, including a summary of the significant accounting policies Comparative information is required for the prior reporting period (IAS 1.36). An entity preparing IFRS accounts for the first time must apply IFRS in full for the current and comparative period although there are transitional exemptions (IFRS1.7). On 6 September 2007, the IASB issued a revised IAS 1 Presentation of Financial Statements. The main changes from the previous version are to require that an entity must: Present all non-owner changes in equity (that is, 'comprehensive income) either in one Statement of comprehensive income or in two statements. Components of comprehensive income may not be presented in the Statement of changes in equity. Present a statement of financial position (balance sheet) as at the beginning of the earliest comparative period in a complete set of financial statements when the entity applies the new standards. Present a statement of cash flow. Make necessary disclosure by the way of a note.

Difficulty in IFRS

Conversion to IFRS will often challenge fundamentally a company's existing business model. It will affect the way the company presents itself to investors and other users of its financial statements. It is vital that company managements recognize the far-reaching impact that IFRS will have on their businesses. Failure to do so could place their companies at a competitive disadvantage. IFRS conversion presents management with an opportunity to reconsider the business reporting model. For many companies, the impact of IFRS on investor relations will be considerable. Although entities are frequently required to adopt new accounting standards under their national Generally Accepted Accounting Principles (GAAP), adopting IFRS, an entirely different basis of accounting, poses a distinct set of problems: Information may need to be collected that was not required under the previous GAAP. practical experience of applying a principles-based system of financial Reporting standards such as IFRS does not exist in many entities. the requirements of individual standards will often differ significantly from those under an entity's previous GAAP; Indian accounting standards will converge fully with the International Financial Reporting Standards (IFRS) by 2011, The National Advisory Committee on Accounting Standards (NACAS) is reviewing AS-30, AS-31 and AS-32. Following this, AS-32 will become mandatory from April 2011,.It would be difficult for banks to follow IFRS.

Pronouncements of IFRS
International Financial Reporting Standards (IFRS) IFRS 1 IFRS 2 IFRS 3 IFRS 4 IFRS 5 IFRS 6 IFRS 7 IFRS 8 First-time Adoption of International Financial Reporting Standards Share-based payment Business Combinations (Revised) Insurance Contracts Non-current Assets Held for Sale and Discontinued Operations Exploration for and Evaluation of Mineral Resources Financial Instruments: Disclosures Operating Segments

Need OF IFRS
In the present era of globalization and liberalization, the World has become an economic village. The globalization of the business world and the attendant structures and the regulations, which support it, as well as the development of e-commerce make it imperative to have a single globally accepted financial reporting system. A number of multi-national companies are establishing their businesses in various countries with emerging economies and vice versa. The entities in emerging economies are increasingly accessing the global markets to fulfill their capital needs by getting their securities listed on the stock exchanges outside their country. Capital markets are, thus, becoming integrated consistent with this World-wide trend. More and more Indian companies are also being listed on overseas stock exchanges. Sound financial reporting structure is imperative for economic well-being and effective functioning of capital markets. The use of different accounting frameworks in different countries, which require inconsistent treatment and presentation of the same underlying economic transactions, creates confusion for users of financial statements. This confusion leads to inefficiency in capital markets across the world. Therefore, increasing complexity of business transactions and globalization of capital markets call for a single set of high quality accounting standards. High standards of financial reporting underpin the trust investors place in financial and non-financial information. Thus, the case for a single set of globally accepted accounting standards has prompted many countries to pursue convergence of national accounting standards with IFRSs. Amongst others, 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. In so far as US are concerned, Financial Accounting Standards Board (FASB) of USA and IASB are also working towards convergence of the US GAAPs and the IFRSs. The Securities & Exchange Commission (SEC) has mooted a proposal to permit filing of IFRS-compliant financial statements without requiring presentation of a reconciliation statement between US GAAPs and IFRS in near future. Appendix II contains list of countries which require or permit the use of IFRSs for various types of the entities such as listed entities, banks etc.

Benefits of IFRS
By adopting IFRS, we would be adopting a "global financial reporting" basis that will enable companies to be understood in a global marketplace. This helps in accessing world capital markets and promoting new business. It allows companies to be perceived as an international player. A consistent financial reporting basis would allow a multinational company to apply common accounting standards with its subsidiaries worldwide, which would improve internal communications, quality of reporting and group decision-making. In increasingly competitive markets, IFRS allows a company to benchmark itself against its peers throughout the world, and allows investors and others to compare the company's performance with competitors globally. In addition, companies would get access to number of capital markets across the globe.

Disadvantages of IFRS
Despite a general consensus of the inevitability of the global acceptance of IFRS, many people also believe something will be lost with full acceptance of IFRS. Further certain issuers without significant customers or may resist IFRS because they may not have a market incentive to prepare IFRS financial statements. Some other issuers may have to stick with existing GAAP because it is required for filings with other regulators and authorities, thus resulting in extra costs than currently incurred by following only existing GAAP. Another concern is that many countries that claim to be converting to international standards may never get to 100 percent compliance. Most reserve the right to carve out selectively or modify standards they do not consider in their national interest, an action that could lead to incomparability one of the very issues that IFRS seeks to address.

Indian Banking Industry

The adoption of IFRS has significant consequences on advances, Investments, financial instruments, hedge accounting valuation including regulatory compliances, information technology systems, tax calculations and other areas. At present, various bodies regulate accounting of the bank in India. Banks are also liable for the compliances with the Accounting Standards issued by Institute of Chartered Accountants of India (ICAI). In addition, the Reserve Bank of India (RBI) also prescribes certain mandatory accounting principles that have to be followed by bank. For example, Reserve Bank of India has prescribed accounting guidelines for investments and prudential norms for non-performing loans. Since RBIs guidelines are prescribed based on prudence as compared to fair presentation objective of IFRS, the guidelines issued by RBI are not in compliances with the IFRS.

In India, there are only seven out of 32 applicable accounting standards compliant with IFRS. There are 12 standards where there are conceptual differences and 10 standards where the regulatory changes are required. The International Financial Reporting Standards has given preference on consolidation of financial statements for reporting purpose. However in India, no such preference has been given in any accounting standards. The earlier issued Indian accounting standards on consolidation of financial statements is not mandatory whereas IFRS makes it mandatory. Its resultant all the banks in India is required to do consolidation of their subsidiaries. The International Financial Reporting Standards gives emphasis over the ratios shows the indication of financials and performances of the organization. It requires the disclosure of those ratios which are key indicators of the business performance and earnings. It also requires the disclosure of the managerial remuneration including any other benefits given to management personnel including bonus, ex gratia, commission or by whatever name called.

The statutory regulations prescribed by the Reserve Bank of India, Companies Act, 1956, Income Tax Act, 1961, and other laws of lands, now been discussed for amendments. The Institute of Chartered Accountants of India has already submitted the suitable amendments in the Companies Act, 1956 in the month of May, 2009 before the convergence of IFRS. The Institute of Chartered Accountants of India has suggested amendments in Section 78, Section 80, Section 100, Section 205, Section 208, Section 211, Section 394, Section 391 and Schedule VI of the Companies Act, 1956.

The convergence of IFRS is likely to create significant impact on the banking industry. It shall affect the reporting practices of net worth, capital adequacy, position of advances, valuation of derivatives, financial instruments and so on. It shall also affect the measurement of financial performance of the Indian banking industry.

Impact on Banking Industry

1. Compliances Burden

Banks and capital markets institutions have a number of local, national and international regulatory requirements that can trip up even the most sophisticated enterprise. All the policies regarding valuation of loans and advances, capital adequacy, net worth etc. are measured as per the rules prescribed by the Reserve Bank of India. Besides the compliances of the rules and regulations prescribed by the Reserve bank of India, the compliances of other laws shall also affect the Indian Banking industry. To illustrate, the International Financial Reporting Standards (IFRS) prescribes that the assets should be depreciated over the useful life of the assets. However the Indian Companies Act, 1956, prescribes the minimum rates of depreciation for the assets under different class of assets. Although the companies have the option to charge the higher rate of depreciation but no companies opt as such. At present, all companies are charging prescribed rates of depreciation on the assets only. The compliances burden shall enhance the non-operating costs of the banks. For example, the auditor or the consultants are required to certify the various categories of compliances such as compliances of IFRS, banking regulations, guidelines issued by the Reserve Bank of India, provisions under Income tax etc.

2. Tax Reporting Practices

The tax considerations associated with a conversion to IFRS, like the other aspects of a conversion, are complex. For banks, tax accounting differences are of great significance. However, the effects of a conversion go beyond these complex tax matters and also include matters such as pre-tax accounting changes on tax methods, global planning strategies, and tax information systems. If a conversion to IFRS is approached properly and well in advance of conversion. It has the potential to strengthen an entitys tax function by providing an opportunity from a detailed review of tax matters and processes. For differences that impact pre-tax accounting methods banks will need to consider the following questions: i. Is the new financial reporting standard a permissible tax accounting method under Income Tax Act, 1961? ii. Is the new book method is allowed under Income Tax Act, 1961? iii. Is it necessary to report changes in methods of accounting after conversion to IFRS? iv. Will there be modifications in the computation of permanent and temporary differences of Deferred Tax? v. Is the loss arises due to fair valuation allowed as expenditures under Income Tax Act, 1961?

3. Information Technology

IFRS is expected to have wide-ranging effects at different levels of the IT systems architecture. The realignment of the bankings information systems will pose a real challenge for their IT department (along with the rest of the organization). Virtually all applications and interfaces in the system architecture can be affected, from the upstream or source of data to the farthest end of the reporting tools. The information technology department of the bank will need to take into account external factors such as local and international regulations, financial consolidation of subsidiaries, stock markets, and external auditors. This business transformation cannot be considered as a one-step project. The updating of the information technology and information systems shall require an investment of bulky amount. The Indian banks have not made any such provisions for meeting out these investments. These investments shall have major impact over liquidity of the banks.

4. Financial Instruments The Institute of Chartered Accountants of India has issued AS 30, AS 31 and AS 32 respectively in parallel to International Accounting Standards 39 (IAS 39) on Financial Instruments. Financial Instruments: Recognition and Measurement is one of the typical standards for those organizations which use financial instruments in their financial statements especially banking industry. It shall have an impact over the income of the industry. To illustrate the forthcoming key standard IFRS 9, Financial Instruments: Classification and Measurement prescribes two options for the classification of financial assets, i.e. amortized cost or fair value. Amortized cost classification is only permitted, if two conditions are met. First, the asset is held within a business model whose objective is to hold assets in order to collect contractual cash flow. Second, the contractual terms of the financial asset gives rise to cash flows on specified dates that are solely payments of principal and interest on the principal outstanding. When there is more than one infrequent number of sales in a portfolio held at amortized cost, the entire portfolio would have to be accounted for at fair value. It is important to note that a single entity may have more than one business model for managing its financial instruments, i.e. an entity may hold a portfolio of debt securities that it manages in order to collect contractual cash flows and another portfolio of similar debt securities that it manages in order to trade and realize fair value changes. Banks in India invest in government securities to comply with RBIs statutory liquidity ratio prudential norms. As per current RBI rules, the majority of such investments are accounted for at amortized cost under the held to maturity classification. Unless the bank has a clear strategy, sufficient expertise in their portfolio management and a demonstrable history of business models in place. It may well taint an amortized cost

portfolio with the result of having to measure the entire portfolio at fair value, causing undesired volatility in their financial statements.

5. Human Resources

IFRS involves much more than reorganizing the chart of accounts. It represents a change that cascades well beyond the finance department. Consequently, human resources issues may be a major concern. A conversion project will place increase in demands of the trained and professional personnel, which may come at a time when they are able to handle it. It shall enhance the wages cost as percentage of the total expenses for the bank. To illustrate, State Bank of India & its associates has 17.03 percent wages of their total expenses in financial year 2009 - 2010 as compared to 15.06 percent and 15.89 percent in 2008 2009 and 2007 2008. This cost shall further increase after the appointment of the trained and professional staff for the implementation of the IFRS in the bank.

6. Impairment in Advances

IFRS recognize the impairment model for the assets of the organization. However, the banking industry, at present recognizes the provisioning and writes off method for the valuation of its advances as per the prudential norms of Reserve bank of India. This is the only guidelines that the Indian banking industry is required to comply. The auditor is required to provide comment on the compliances of these guidelines. The bank is required to examine each and every investment including advances on specific basis and shall require valuing them as per the method of present value after adopting the effective rate of interest for discounting. It is a tough work for the banking industry. However the IFRS specify the suitability of method for measurement of present value for group borrower and individual borrower. It specified the collective method and individual method for measurement of impairment of the assets of the organization. Under IFRS 9, loans and receivable portfolio are accounted on amortized cost basis, provided these loans do not contain any exotic embedded derivatives. Basic embedded derivatives, such as caps and floor or normal prepayment or extension terms, do not taint amortization accounting. However, amortization accounting is not possible if a loan has a contractual interest rate that is based on a term that exceeds the instruments remaining life. Similarly, a loan with a convertible option is not eligible for amortization accounting and will have to be accounted for on a fair value basis with changes taken to the income statement. Loan portfolio is accounted for on a fair value basis in cases where banks transfer/securities their loan portfolio. Amortization accounting is also not allowed for certain non-recourse loans, for example, when a loan to a real estate developer states that the principal and interest on the loan are repayable solely from the sale proceeds of a specific real estate. In such

cases, the contractual cash flow characteristics is not met and hence, such loans are accounted on a fair value basis.

7. Investments As per the existing Indian Accounting Standard 13 (AS 13) on Accounting for Investments, the Investments of the organization shall be valued on lower of cost or fair value. The calculation of fair value is simple or in other words the value, after deduction of expenditure for sale of such investments, at which it may sell in the open market. However under the IFRS, the measurement of fair value shall be different from the existing method. In India, the banks are required to maintain the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR). The banks maintain these ratios by investing in the Governments securities. Hence, these securities cover a major part of the investments of the banks in India. The investments of the Indian banks are approximately 50 percent of the total advances. Hence it shall also require a detailed evaluation during the convergence.

Under RBI norms, investment in equity instruments (other than subsidiaries and joint ventures), are marked to market. Net losses are recognized but net gains are ignored. Under IFRS 9, investments in equity instruments are fair valued. The gains or losses are either recognized in the income statement or in a reserve account. That choice is required to be made at the inception on an instrument by instrument basis, and is irrevocable. With regards to impairment of loans (not covered by IFRS 9), the IASB in a proposed standard is looking at a model that is based on expected losses rather than incurred losses. In other words, the proposed standard requires estimated credit losses to be included in the determination of the effective interest rate for the purposes of amortization accounting.

9. Consolidation of financial statements As per the Accounting Standard 23 (AS 23) on consolidation of Financial Statement of entities, the consolidation of financial statements are purely based upon the ownership and control over the another organization. As per the existing Accounting Standards, consolidation is not mandatory for all organization. However, as per IFRS, the consolidation is mandatory for all the organization. The measurement and test of ownership shall also be change in the IFRS. It has covered the potential voting rights other than the actual stakeholders. The potential voting rights includes all those whose debts or shares are required to be converted in to equity capital of the company. Indian industries are not practicing any such type of inclusions for examining the applicability of standards on consolidation of financial statements.