While standard accounting norms like IFRS are about creating a level global playing field, the freedom to differentiate each economy through reporting is also vital
The world is witnessing an integration of economies like never before. At the same time, political and economic volatility has also increased manifold and no country is immune to the resultant turmoil. Another consequence of this global economic integration is the rise of multinationals with transnational operations and subsidiaries in numerous countries and access to financial markets worldwide.
More than one-third of all financial transactions occur across borders and that number is expected to grow as the search for diversification and better investment opportunities expands. Different accounting standards mean different models. For example, a company may recognise profits under one set of national accounting norms and losses under another, which could ultimately have an impact on its reported financial performance and position. Without common accounting standards, cross-border activities were complicated in the past that resulted in adding cost, complexity and risk for both companies and investors using those financial statements to make economic decisions. In such an integrated but impulsive world economy, it is important to have a common business language that can help understand and compare businesses. Financial reporting is an important way through which companies communicate with external stakeholders and standardisation of such reporting processes worldwide to bring about uniformity is more valuable today than ever before.
With a view to improve corporate governance and increase free flow of capital across the globe, in 2001, the International Accounting Standards Board (IASB) developed the International Financial Reporting Standards (IFRS), a set of high-quality common accounting rules established to bring about consistency, transparency, reliability and comparability in the financial statements worldwide. They define the types of transactions with financial impact, their maintenance and reporting. This goal of a single set of high-quality global accounting standards is being supported by several nations, including G20 countries, several professional accounting organisations and investors worldwide.
IFRS norms support the three pillars of transparency, accountability and efficiency. Transparency in financial statements is brought about by improving the comparability and the quality of financial information internationally, thereby improving the decision-making capability of investors and other external stakeholders. As a source of globally-comparable information, IFRS norms are also of vital importance to regulators around the world. By reducing the information asymmetry between the providers and users of capital, they boost accountability. Improving capital allocation by helping investors to identify opportunities and risks across the world, these standards contribute towards better economic efficiency. The usage of IFRS has become quite widespread with approximately 120 nations partially requiring these standards for their domestic listed companies. However, as many as 90 countries have fully conformed with IFRS as promulgated by the IASB and include a statement, acknowledging such conformity in their audit reports. Even those countries that don’t apply the standards directly, like China, closely follow the rules that the IASB has established over the decades. According to a 2018 IFRS Foundation report, 27,000 domestically-listed companies on 88 major stock exchanges in the world use the standards. India’s convergence with IFRS started with its commitment to the momentum of growth in the G-20 summit held in 2009, following which the Ministry of Corporate Affairs formulated an action plan to implement the convergence of Indian Accounting Standards with International Financial Reporting Standards from April 2011.
However, after initial glitches, from 2016, India has implemented a new framework of the Indian Accounting Standards (Ind AS) that are based on and seek to substantially converge with IFRS, although not fully adopt them. Leasing, revenue recognition, foreign currency convertible bonds, current vs non-current liabilities, bargain purchases are among the areas where India has deviated from IFRS.
According to the Ind AS, from April 1, 2016, adoption of these standards has been compulsory for companies with a net worth upward of Rs 500 crore, which later expanded to every listed company from accounting period beginning on or after April 1, 2017. Even unlisted companies with a net worth greater than or equal to Rs 250 crore but less than Rs 500 crore came under its purview. Once any company starts following Ind AS, either voluntarily or on mandate, it cannot revert to its old accounting method. As on date, the Ministry of Corporate Affairs has notified 41 standards. Fair value and accurate reporting are given more importance, while computing financial statements in the new accounting standards and substance are recognised to reflect the most current picture of financials. It has also changed how the key financials such as revenue, net profit, book value, operating profit, goodwill and return on equity are computed. For instance, under the old rules, excise duty was deducted from sales. Conversely, as per the Ind AS, excise duty is now treated as a tax on manufacturing activity. Therefore, it is assumed to be a part of revenue, which thereby, increases the revenue of companies but depresses operating margin, without, however, affecting Earnings per share (EPS).
Several studies have been conducted worldwide to examine the usefulness of IFRS in realising the three pillars of transparency, accountability and efficiency and to help economic decision-makers and stakeholders alike to make informed decisions. In Germany, the impact of IFRS adoption was studied during 1998 to 2002 by Hung and Subramanyam where they concluded that the value of total assets and equity and variability of net earnings are significantly higher under IFRS compared to the German Accounting Standards. However, changes in financial ratios were not supported by their study.
Agca and Aktas conducted a pre and post-adoption study on impacts on financial ratios of 147 listed firms on the Istanbul stock exchange during 2004-2005 and found out that ratios that were majorly affected were the current and net asset turnover ratios. In contrast to other individual surveys by country, analysts Callao and Jarne, conducted two studies comparing results in Spain and the United Kingdom (UK).
The results revealed that the quantitative impact on financial ratios is significant in both countries and that it is higher in the UK. Blanchette, Racicot and Girard, in their research, examined various financial ratios of liquidity, leverage, coverage and profitability and their impact on the adoption of IFRS in companies operating in Canada and did not find any difference. Although survey results showed differences in means, medians and volatility in most financial ratios of companies but statistical significance could not be established in many cases. When they specifically evaluated their results by groups of companies who adopted IFRS at different dates, no significant variations were found in their results.
Arouri researched the IFRS impacts on return on equity (ROE) and value relevancy over 40 French listed firms in 2004 utilising the longitudinal analysis and found that ROE and net income are increased by decrease inequity value due to the concept of fair valuation. Also, they did not observe any evidence of improvement in transparency and value relevance. In India, Achalapathi and Bhanu Sireesha studied several firms and showed that IFRS adoption has led to an increase in most of the liquidity, profitability and valuation ratios, which were statistically significant and were able to conclude that an opportunity for capital maintenance and protection against failure risk may have been provided to companies due to the transition to IFRS. Although standardisation and harmonisation of financial reporting is important in this globalised world, complete integration may not be possible as there is an increasing focus among different stakeholders on the future. Therefore, in an environment that is highly volatile and ever-changing, it is rather difficult for companies to make accurate predictions. Thus, more flexibility is needed in this area and the possibilities of standardisation become limited. Besides, non-financial aspects, like Corporate Social Responsibility and Sustainable Development Goals, have started to play a major role in company reporting, the informative value of which may vary greatly from one industry to another and one country to another. The individual characteristics of each firm and their complex value chains must be taken into account here, as well as the industry, sector and country-specific requirements. Adequate flexibility is vital for coherent, stringent and appropriately-structured reporting. While standard accounting norms are all about creating a level global playing field, adequate freedom to differentiate each economy through our reporting is also vital.
(Writer: Hima Bindu Kota; Courtesy: The Pioneer)