The Hindu Business Line : It’s time to act on IFRS

The Institute of Chartered Accountants of India (ICAI), through its Concept Paper on convergence with International Financial Reporting Standards (IFRS), has indicated that public interest entities in India will start following IFRS for the accounting periods commencing on or after April 1, 2011.

It implies that an entity, which follows financial year as its accounting year, will have to draw its financial statements under IFRS for the accounting year 2011-2012. International Accounting Standards (IAS) 1 mandates that the financial statements have to be presented with one year comparative, which means that the reporting entity would need to present its 2010-2011 figures also under IFRS (in addition to the one under Indian GAAP). The date of transition to IFRS, therefore, would be April 1, 2010.

Retrospective application

IFRS 1, dealing with first-time adoption, generally demands retrospective application, that is, requirements of IFRS need to be applied assuming that the entity was following IFRS since inception. However, it grants certain optional exemptions from retrospective application in specified areas. These can also be termed as transitional provisions in common parlance. IFRS 1 also prohibits retrospective application of IFRS in some areas.

Retrospective application of IFRS poses a big challenge in accounting for property, plant and equipment (PPE), especially in the case of capital intensive entities. Keeping in mind the difference between Indian GAAP and IFRS, retrospective application will involve intense planning and preparation.

Application of IAS-16 requires capitalisation of PPE (fixed assets) for every major component. To cite an example, take the case of an aircraft, instead of capitalising the entire aircraft as one item, its major components such as engine, turbine, body, seats, etc., are capitalised separately.

This is more commonly referred to as “componentisation”. The depreciation of each component is to be based on its own useful life rather than the statutory life of the entire aircraft provided under Schedule XIV of the Companies Act, 1956 (presuming that the statutory life prescribed under Schedule XIV is lower than the useful life).

IAS 16 also requires that where the entity is obligated to incur decommissioning cost associated with an item of PPE, the discounted net present value of such liability is capitalised along with the cost of PPE and depreciated over the useful life of the asset.

Value matters

Moreover, the depreciable value of an item of PPE is its cost minus the residual value thereof. The residual value is the estimated amount that an entity would obtain currently from disposal of the asset, assuming that the asset were already of the age and in the condition expected at the end of its useful life, that is, assuming that the asset has already completed its useful life.

As a result, it leaves the management with a task to determine the residual value of the PPE on the date of transition assuming that the asset is already of the same condition as it would be at the end of the useful life.

Retrospective application of IAS 16 entails looking into the past and carrying out the componentisation and determination of useful life, determination of decommissioning liability as well as residual value as on the date of the original capitalisation of the asset and then to arrive at the written-down value (WDV) thereof on the date of transition. This requirement can become onerous for those entities which have been in existence for long periods and are capital intensive.

To address such issues in the area of PPE, IFRS 1 provides some relief in the form of optional exemption from retrospective application. As per the exemptions given, fair value on the date of transition can be taken as deemed cost under IFRS on that date.

(The author is a senior professional in a member firm of Ernst & Young Global.)

It means that the fair value on the date of transition would be considered to be equal to the written-down value (WDV) on that date had the entity followed IFRS since inception. This is one of the most significant exemptions given to a first-time adopter.

Getting the exemption

To get this exemption, certain exercises are required to be carried out by the reporting enterprise. It calls for active involvement of qualified valuers in determining the fair value. This also requires active involvement of the technical team of the entity who need to assist the valuers in identifying the individual components of the items of PPE.

Determining the fair value of each component throws its own challenge as the management might not have the cost break-up of each component thus identified. Furthermore, determination of useful life, decommissioning liability and residual value also require a good deal of estimates and judgments to be made by the management.

All this needs to be done to arrive at the fair value on the date of transition, that is, April 1, 2010. This is a mammoth exercise and requires time. Timely action will give ample opportunity to the management to plan. IT systems would also require consequential change to accommodate new fixed asset register and facilitate charge of depreciation under the new regime. Acting and preparing on time is the only way to achieve successful convergence. We are not too far from the impact date and, therefore, it’s time to start preparations and get cracking.

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