Come 2011, and audit committees and board members of Indian companies will have to deal with convergence of Indian GAAP (generally accepted accounting principles) with International Financial Reporting Standards (IFRS), which will have a key impact on their functioning, roles and responsibilities. The audit committees and board members will have to handle this challenge in an effective manner.
One of the basic features of IFRS is that it is a principle-based standard, unlike US GAAP, which is rule based. IFRS involves extensive use of judgement in selection of appropriate accounting policies and alternative treatments, including at the time of adoption. Also, IFRS requires valuations and future forecasts, which will involve use of estimates, assumptions and management’s judgements. It has been observed that the combination of all these factors can have a significant impact on the reported earnings and financial position of an enterprise. So far, audit committees and board of directors largely had an oversight role on accounting matters. With IFRS, this role is set to get enhanced considerably.
Therefore, in the next two years, audit committees and boards in India will have to specifically focus on how well companies are geared for the transition to IFRS. The members responsible for governance will have to spend considerable time in ensuring appropriate convergence of Indian GAAP with IFRS. They must be aware of the options available under IFRS, the choices made and the reasons for making these choices. Further, they must understand the impact of convergence on significant accounting matters and their likely effect on financial statements.
IFRS will not merely be a technical accounting conversion. Convergence will impact most business aspects, including structuring of contracts with customers and vendors, performance appraisal parameters and reward plans, and managing external investor relations and communication. Therefore, it will be imperative for governing members to have a detailed knowledge of the impact of IFRS on a company’s business. How will it impact business processes, including the IT system? Is the core team leading the IFRS conversion process adequately trained or not? How will the company communicate the impact of IFRS to its investors and lenders? Will this result in any tax or regulatory issues?
It will be most critical for boards to monitor the quality and robustness of the conversion process and the road map to IFRS. Essentially, IFRS will be a significant change that will need to be managed properly.
Under IFRS, prior years’ errors and omissions will have to be effected through restatement of previously declared results, which will be a critical change from prevailing practices in India. With IFRS, the complexities involved in preparing financial statements will increase manifold, thereby increasing the risk of errors and omissions. There is a strong likelihood that Indian companies will start restating accounts soon, much like their peers in the US do. As many as 1,538 restatements were filed in 2006 by US companies.
Usually, investors and regulators look at any restatement negatively, so audit committees and board members will need to manage and address this risk effectively. Moreover, restatements may be viewed with suspicion by tax authorities in India, who may not be able to understand the changes emanating from convergence with the IFRS reporting framework.
A survey of audit committees and board members of at least 176 US corporations carried out by Ernst & Young in 2006 disclosed some interesting facts. Only 25% of the respondents indicated that they have a formal plan for dealing with financial errors and irregularities, and merely 40% had a formal continuing education process, with the time spent annually being around 10 hours for most members. The state of preparedness in India is unlikely to be any better, but with IFRS kicking in, all of this needs attention and needs to change. Board members will have to be prepared to commit significant time and resources to deal with business and accounting issues arising out of convergence with IFRS.
The biggest challenge for members charged with governance will be to manage stakeholder expectations in terms of meeting targets and key performance indicators, declaring dividends and explaining variations and volatility in earnings on a quarterly basis. This is a challenging task even now, but with the arrival of IFRS, the challenge is set to assume a different dimension. Audit committees and board members should start preparing for this challenge now.
India will move to IFRS starting 2011. Navin Agrawal is a director with Ernst & Young India Pvt. Ltd. This is the third of a series that will analyse the impact of IFRS on industries and regulatory issues pertaining to its convergence with Indian GAAP.
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