India Inc braces itself for Ind-AS, performance of companies to change dramatically

MUMBAI: Beginning April 2016 India Inc would undergo its first litmus test and many companies would look different as their profit, loss, assets and liabilities will be treated as per the new accounting standards.

Industry trackers say that while some companies would suddenly look more profitable others could see huge holes in their profits—all thanks to the new accounting standards. So next years’ result for most of the companies would look drastically different, say industry experts. So investors who were unable to compare companies even within a sector due to different accounting practices by companies; the new standards would give a fair idea and a rather apple to apple comparison.

India is changing its accounting standards from GAAP to Ind-AS, the latter is on a par with International Financial Reporting Standards or IFRS from April next year.

So any company, whether listed or unlisted, with a total net-worth of Rs 500 crore or above would have to follow Ind-AS. Many companies are bracing themselves for this major change as confusion continues to shroud the regulations.

Analysts point out that the accounting standards would have impact on company’s profits, goodwill, net-worth and in some cases even market capitalisation. Indian companies are also expecting increased tax demands and are even putting aside some funds for potential litigations.

“There are two major impacts; one is the impact on different sectors that Ind-AS would have and then within a sector there would be an impact on different companies depending on their current corporate governance standards in relation to revenue recognition and other aspects of accounting and reporting including application of fair values. Next year many companies’ results would look very different, as you would have different PE (price to earning) ratio you would have different debt to equity ratio and so on,” said Sandip Khetan, partner in a member firm of EY Global.

Industry trackers say that the biggest change would be on the way revenue recognition is done in the new accounting standards. The difference in the revenue recognition would also mean difference in net profit of the company and hence even different earning per share (EPS) say analysts.

Ind-AS would take time value of money in to consideration while calculating revenue which is absent under current standards. So if a company gets a contract from another company for supplying a product for next four years. And the seller receives a partial or full payment in advance.

The advance would be seen as a funding arrangement. So an interest component would be deducted from the total revenue and only the latter would be recorded as operational revenue. So for many companies, their operational income is set to reduce.

Experts also point out that many companies across the board would see a huge impact on their goodwill as well. While this would have many implications this is also affecting many companies looking for mergers and acquisitions.

“For most companies that engage in M&A activities, the goodwill recorded on acquisitions would reduce while there would be an increase in value of other intangible assets such as customer relationships, technology, etc, and unlike goodwill which isn’t amortised, these intangible assets have a finite life and would be amortised,” said Sai Venkateshwaran, partner and head of accounting advisory services at KPMG.

So if the customer or technology assets are written off over 3-7 years, it will impact the EPS for those periods and it would also reduce net worth over that period explained Venkateshwaran.

After the new standards set in, Indian companies would have to calculate their goodwill on fair value basis. Which means for some companies their goodwill would decrease but for some it could go up. While jump in goodwill may seem to be a positive development, some companies are worried about the same.

“For many companies the return on investment (ROI) would fall significantly as their net worth would increase significantly after their goodwill would be calculated on fair value basis. So while for some companies their goodwill would increase but ROI would come down, now whether the company looks at this change as positive or negative is a matter of their perception," said Ashish Gupta, partner, Walker Chandiok & Co.

While all sectors would be hit by the Ind-AS, some sectors could see more severe implications. Any company that has lot of subsidiaries or even special purpose vehicles (SPVs) could see their net worth going down substantially. “In a situation where the company has an SPV, where there is a private equity or strategic investor involved, who has a say in the operations of that SPV, it may be concluded that the control over that SPV is shared. And therefore, the assets and liabilities of that SPV would not be consolidated in the company’s balance sheet,” said Venkateshwaran of KPMG.

This could also happen the other way around for some companies, say industry trackers. If a company has a minority ownership in another company (including an SPV) but if it has a control over its operations, then despite being a minority stake holder, the accounts of such that other entity would be consolidated. Many companies deliberately keep some subsidiaries outside their structures as the subsidiaries have significant debt or are incurring losses. Under Ind-AS In such cases, the consolidated accounts may be adversely impacted.

“Major impact would be for sectors like real estate, infrastructure, financial services (subsidiaries of companies covered in phase I or II transition) and companies in the services sector,” said Khetan.

Industry trackers say that many banks and NBFCs would also see huge changes in their profitability. Banks and NBFCs are not required to follow the Ind-AS from 2016 as of now as RBI has not given a green signal however there is an implication there too, say experts. Some of the companies that have NBFC subsidiaries would have to follow Ind-AS.

However, the banks and NBFCs that have huge bad debts are going to see huge impact on their balance sheets. Because as per the new standards, while disbursing any loan, the average bad debt rate (in percentage) must be deducted. So if a bank has a 10% average bad debts over total loans given in last 10 years, only 90% of the loans that it disburses could be considered as its revenue.

Apart from that some of the financial instruments that are currently treated as equity would be treated as liability. So in a case where a PE firm (or any other investor) has invested in a company through convertible preference share or redeemable preference share it would go in to the company’s accounts as liabilities. Under GAAP it is considered equity. If the investor has a clause of assured return that would be considered as interest cost under Ind-AS.

And industry trackers say Ind-AS could have major ramification in India’s growth as well. “There would be a huge impact for many manufacturing companies due to Ind-AS and so there would be an impact on the Make in India concept as well. However, Ind-AS could see more foreign investments as foreign investors would have global common standards to compare Indian companies with the rest of the world's," added Gupta.