Reflections on Indian industry’s transition to IndAS
The significant aspect of the transition to IndAS is how the impacted stakeholders, including regulators such as Sebi, deal with the issue
For large listed companies, the release of their first annual financial results under Indian Accounting Standards (Ind AS) was the culmination of a long transition that began several quarters ago and has had several ups and downs, both in the journey itself and in the numbers reported by companies.
The March 2017 annual results were particularly significant since it was the first time that all these companies published their consolidated financial results (as compared to just over half the BSE100 companies publishing their consolidated numbers in the earlier quarters), where the financial performance and position of these companies are presented as those of a single economic entity, thereby providing a better sense of the true impact of the transition.
As expected, the overall position as per these consolidated results is not entirely in line with the trends seen in the quarters where many of these companies had presented only their stand-alone results, with many ups and downs in the numbers, some in line with and some contrary to expectations. An analysis of the BSE100 companies shows that on average, companies have seen a reduction in their earnings and also significant changes on their balance sheet position, despite the fact that many of them used the first time adoption exemptions and choices to minimise the adverse impact on profitability or net worth under Ind AS.
On analysing the profit and loss (P&L) statements, it is evident that net profit as well as Earnings before interest, tax, depreciation and amortization (Ebitda) have seen a decline under Ind AS, indicating that there in an impact on the underlying business performance measures, with several items of cost showing an increase under Ind-AS for certain companies, and thereby impacting profitability.
Further, besides the obvious items, the impact of new requirements on consolidation is also quite interesting, with a two-way swing—several other companies have also shown either a decrease or an increase (in some cases, quite significant) in both their revenues and related cost line items and Ebitda, together with an impact, in most cases, on their share of profits from associates and joint ventures, and a comparatively lesser impact on their net profit. This seems to indicate that entities that were previously getting consolidated under the old Indian Generally Accepted Accounting Principles (GAAP) are no longer treated as subsidiaries and are now treated as joint ventures or associates or vice versa. And from the numbers, it appears that the impact of de-consolidation of entities seems higher than the impact of consolidation of new entities.
On the balance sheet as well, while the overall balance sheet size has shrunk under Ind-AS, companies have chosen to use the one-time exemptions and choices to boost their net worth. Despite the significant write-down in assets in many companies, the BSE100 companies have recorded an increase of approx. Rs1.16 trillion in their net worth (approx. Rs1.65 trillion after considering the reversal of proposed dividend liability of approx. Rs48,000 crore).
The most significant of these is the net upward adjustments to carrying values of fixed assets by approx. Rs89,000 crore. The recognition of financial instruments, including equity investments, at fair value has been the other significant contributor to the increase, whereas the recognition of higher income tax liability has offset some of that increase. However, despite all these adjustments to boost net worth, the total assets of these companies have shrunk by approx. Rs70,000 crore, indicating that had the fixed assets not been written up as a one-time adjustment, the shrinkage in the balance sheet size of these companies would have been even more pronounced.
The primary reason for the shrinkage in the balance sheet size seems to be the de-consolidation of entities that were previously consolidated as subsidiaries now being equity accounted (single line consolidation) as joint ventures or associates. Further, the changes in net worth may not always be directionally indicative of the underlying financial position or performance—for instance, some companies may reflect a decrease in net worth as part of its goodwill having been rightfully written down.
With all these changes taking place, the one area where there is a lot still left to be desired is quality of disclosure. Several companies that had significant changes to their key metrics such as revenue, costs, Ebitda, etc. don’t even make a mention of the reasons for changes of this magnitude in their results, and have only provided the bare minimum information on the reconciliations of profit and net worth.
A few companies have also changed their first time adoption choices in the last quarter, as clarity emerged on how it impacts their minimum alternate tax (MAT) liability, although some issues on MAT still need to be ironed out. Of course, a lot more will become evident as companies publish their annual reports, wherein many more disclosures will be required, which will provide investors a sense of the one-time and continuing impact of the transition to Ind-AS.
What is most important is not how the first lot of companies have dealt with the transition, but rather how the impacted stakeholders, including the regulators such as Securities and Exchange Board of India (Sebi) deal with it and also what the next lot of companies learn from this transition. Whether the learning from this experience leads to tighter regulations, stricter monitoring or better disclosures, only time will tell. Being eternal optimists, we can certainly hope for a better tomorrow.
Sai Venkateshwaran is partner and head of accounting advisory services, KPMG in India. The views and opinions expressed herein are those of the author and do not reflect the views and opinions of KPMG in India.