Opportunities arise as standards converge

By Arun Balasubramanian, Linklaters

The International Accounting Standards Board recently reported the announcement by the Council of the Institute of Chartered Accountants of India (ICAI), at its July 2007 meeting, that Indian accounting standards will achieve full convergence with International Financial Reporting Standards (IFRS) for accounting periods commencing on or after 1 April 2011.

Arun Balasubramanian, Partner, Linklaters
Arun Balasubramanian

The proposal is an ambitious one, and presents opportunities as well as challenges to Indian companies subject to the convergence proposal that seek to issue securities in the international capital markets. This article, the first of two on the subject, examines the opportunities presented by the ICAI’s proposal.

Easier comparison

Presenting IFRS financial statements in offering prospectuses and periodic reports will enable analysts and investors to more accurately benchmark Indian companies against their peers overseas.

This should assist underwriters in pricing the offered securities more accurately and market participants in valuing the securities on a relative basis to comparable issuers in other markets.

IFRS also requires discussion of critical judgments made by management in applying accounting policies, which should aid more meaningful management’s discussion and analysis in prospectuses and periodic reports. Consequently, Indian companies should be able to raise international capital with greater efficiency and at lower cost.

Since over 100 countries have adopted IFRS and an additional 50 countries are expected to do so by 2011, Indian companies should be able to obtain easier access to overseas listings, including in Europe and the United States, where registrants may now conduct public offerings and produce periodic reports based on IFRS financial statements.

Greater visibility

Arguably the most significant change that IFRS convergence will bring to the financial statements of Indian companies is the adoption of fair market valuation principles. Under Indian GAAP, companies record assets at acquisition cost rather than fair market value, with limited exceptions.

This has the potential to present a company’s financial condition in a misleading light, particularly in sectors such as real estate, where rapidly appreciating asset values may not be fairly reflected on the balance sheet.

The recent listings on London’s AIM by several fund vehicles promoted by Indian real estate companies offer a stark example; by presenting asset values under IFRS, the promoters were able to obtain significantly higher purchase prices for the assets than those indicated by the Indian GAAP financial statements of those assets.

Under IFRS, Indian companies will also be required to account for market exposure and financial instruments rather than keeping them off-balance sheet, which should aid greater transparency as the growth of Indian companies subjects them to more exposure to interest rate, exchange rate, commodity price and other risks.

Overseas acquisitions

The convergence to IFRS will require Indian companies to follow acquisition accounting standards that include purchase method accounting, fair valuation of acquired assets and liabilities and testing goodwill for impairment. With Indian companies becoming increasingly acquisitive overseas, adoption of these accounting standards will enable them to better evaluate the financial condition of potential targets, assess synergies from business combinations and pay fair value for acquisitions.

Audit and assurance complications arising from the use of multiple accounting practices, and the resultant costs, should also be minimized as a consequence of convergence.

As a corollary to these opportunities, inward investment into India is also likely to benefit as overseas investors become more familiar with Indian companies and their financial statements and accounting practices. Importantly, the convergence with IFRS will place greater emphasis on transparency and clarity in disclosure of critical management decisions, which in turn should contribute to greater faith in the “true and fair” quality of the financial statements of Indian companies.

Of course, the convergence proposal presents a number of challenges, not least the possibility of earnings volatility that could result from fair valuation accounting, costs to issuers in reconfiguring information systems and disclosure controls, and the investment of management time to implement the transition. These and other challenges will be discussed in a future article.

Arun Balasubramanian is a partner at Linklaters. His practice is focused on India-related capital markets matters, and his recent transactions include the US$2.2 billion IPO of DLF, the US$1.9 billion IPO of Cairn India, the US$700 million AIM listing of Unitech Corporate Parks and Tech Mahindra IPO. His other transactions include the IPOs of TCS, NTPC and IDFC and the ONGC and IPCL disinvestments.

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