>Convergence with IFRS (CLSA)

There are significant differences in the accounting treatments proposed under Indian GAAP and IFRS. If the experience of the UK companies is anything to go by, convergence with IFRS can have a meaningful influence on the reported financial performance of certain sectors/companies. Our analysis suggests that banking, real estate, and infrastructure sectors in India are most sensitive to the changes in the accounting framework. Given that all listed companies will report their FY12 results under the IFRS provisions, we expect investors increasingly start considering its potential impact as we move closer to 2011.

Banking
■ Banks will have to distribute income and expenses related to acquisition of assets and liabilities over the expected term of assets/ liabilities.
■ Banks will be permitted to recognise MTM gains on assets (classified as AFS and HFT). MTM gains/ losses on AFS will be routed through reserves (presently through P&L) making quarterly earnings less volatile.
■ Recognition of impairment to assets and related provisioning will be based on management estimate of expected losses (after factoring likely recoveries). Banks will also be permitted to recognise income on impaired assets on accrual basis.
■ Indian Banks Association (IBA) has asked RBI to push transition to IFRS by a year due to inconsistencies in regulations, IT bottlenecks and lack of trained staff.

Real estate
■ IFRS can lead to delayed revenue recognition on sale of under-construction apartments as they are likely to qualify as sale of goods, in which case revenue is recognised only on completion of construction.
■ In a scenario of rising prices, valuing investment property at fair value (under IFRS) will increase profits of real estate developers.

Infrastructure
■ IFRS requires that in the case of service concession arrangements, a part of the overall profits should be recognised in the construction phase; and the infrastructure asset should be treated as a financial/intangible asset (rather than a fixed tangible asset).
■ Embedded derivatives in various contracts need to be recorded at their fair values.

Other sectors
■ Power: Under IFRS, some long term PPAs might be treated as leases; decommissioning obligations need to be recorded at their present values; embedded derivatives in long term fuel purchase contracts are to be recognised at their fair values; and components approach needs to be followed for fixed assets.

■ Extractive: According to IFRS, costs incurred on unsuccessful wells/mines cannot be capitalised; impairment needs to be tested at least annually on the basis of certain specified indicators; and abandonment costs are to be recorded as a liability at their present values.

■ Technology: Under IFRS, share-based payments need to be recorded on the basis of fair value method (intrinsic method is not permitted); and a higher proportion of product development expenses need to be expensed.

■ Telecom: Certain Indefeasible Rights to Use (IRUs) might be treated as leases; decommissioning costs need to be recorded at present values; multiple elements contract are to be split for revenue recognition; and components approach is to be followed for fixed assets.

■ Consumer/ Autos: Under IFRS, all retailer discounts and rebates are required to be subtracted from revenues; a higher proportion of R&D expenses needs to be expensed; certain contract manufacturing contracts might be required to be treated as leases; and component approach needs to be used for fixed assets.

■ Pharmaceuticals: Assets and liabilities of an acquired entity can be consolidated only at their fair values; and components approach needs to be followed for accounting for fixed assets.

To read the full report: MARKET STRATEGY