Implementation of Ind AS and IFRS - Implications on Corporate Governance

1. CFO Summit, 2011 Implementation of Ind AS and IFRS - Implications on Corporate Governance October 20, 2011 Dr. Paritosh C. Basu

2. Discussion Flow • Corporate Governance Revisited • IFRS – The World Scenario • Challenges in Forward Path • Key Questions from Audit Committee and Board of Directors The Big Question - Is Good Corporate Governance GAAP Agnostic?

3. Corporate Governance Revisited

4. Accounting and Reporting in Changing Environment Challenges, Risks and Sustenance Pinnacle Frequency Reporting to Frameworks Functions • Critical documents • Risk Register and • Financial Reporting Procedure

5. Dimensions of Corporate Governance Risk and Performance Management Effectiveness of Audit Committee Functioning of Board of Directors Legal and Regulatory Boundaries Disclosure and Transparency Corporate Governance Independence and Value Orientation Business Practices and Ethics

6. Corporate Governance – Revisited Factors that Influence • Ownership structure – Co-existence of multiple categories * • Composition of Board of Directors and its Sub Committees • Independent Directors – Positions in too many corporate houses • Financial Structure – External debt vs. equity * • Socio-economic environment* • Effective Audit Committee • Risk Management * • Value - Maximise creation and minimise destruction * • Multiplicity of Tools* • Statutes, Rules, Regulations, Regulators • Discipline in Capital and Bond Market • Systemic problems related to investor friendly information • Demand / compulsive * • Monitoring costs • Dissemination – Accounting *, Financial * and Operational * *To be directly or indirectly impacted more by IFRS / IND AS

7. Corporate Governance – Revisited … 2 Issues and Controversies • Questionable ethics * • Behaviour and attitude at the top • True independence of the Board • Doctrine of Indoor Management – Lifting the corporate veil * • Aggressive earnings management* • Gaps and Ineffectiveness in accounting and reporting * • Faulty executive compensation practices * • Outdated rule based accounting disregarding substance * • People are important than process* • Senior management not responsible for control * • Lack of engagement on the part of shareholders *To be directly or indirectly impacted more by IFRS / IND AS Fishes start rotting from the head

8. Corporate Governance – Revisited … 3 Attributes and Facets of Good CG • Depends on the culture in which the corporate operates * • Honesty, integrity and transparency beyond regulation * • DNA and value system of the Group – Ethical code of conduct • Top management in a state for readiness to • Face challenge* • Deal with fear factor • Responsive to dynamic environment * • Good CG is philosophy and matter of attitude* • Non compromising, adaptable, and scalable * • Trustworthy for all stakeholders * • Sustainability * • Oriented towards ‘Tripple P Bottom Line’ *To be directly or indirectly impacted more by IFRS / IND AS Protect Existing + Enable Growth = More Results for Stake Holders

9. IFRS - The world scenario

10. Need for Common Accounting Standard Deutsche Bank group prepared its consolidated financial statements under US GAAP until Dec. 31, 2006. Due to the requirement of European Union, the group had to adopt IFRS from Jan. 1, 2007. Under US GAAP, for the year ended Dec. 31, 2006, the group’s total assets were 1.126 billion Euros, while under IFRS they were 1.572 billion Euros. Such dissimilarities weaken the usefulness of financial statements and hence there is a case for uniform financial statement reporting standards.

11. IFRS Implementation – World Scenario Countries that have already adopted IFRS are shaded with blue Countries in the process of adoption of IFRS are shaded in grey (Source. www.iasb.org) • No blackout period expected from IASB in transition course up to 2014 • Substantial changes expected in Standards - Revenue, Consolidation • Deferred Tax, Lease, Financial Liabilities • Uncertainties about schedule in the USA albeit expected by 2014 / 15 • Implementation challenges – Scarce resources and IT solution • Change in mindset of all concerned - Substance over Form

12. Corporate Governance (CG) and Properties of IFRS Adoption • Areas of Study in Europe • How CG associates with reporting quality and transparency with focus on three properties of IFRS adoption • The extent of disclosure on the restatement process itself. • Compliance and disclosure of specific standards which are identified to have the largest impact • Choice to early adopt IAS39 or to postpone its adoption around the time of IFRS adoption.  • Findings • European firms with strong CG engage in higher financial reporting quality • Firms with more independent and active Boards and especially with more effective Audit Committees disclose substantially more information about the impact of IFRS  • A corporate with strong governance  • Disclose more extensive on specific Standards • Use the timing adoption flexibility in a conservative fashion while • Weak ones tend to use this option in an opportunistic fashion. ArntVerriest, Tilburg University , Netherlands Ann GaeremynckCatholic University of Leuven, Belgium Daniel B. Thornton Queen's University, Canada November, 2009 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1266698

13. Style of Governance since the Economic Crisis – Strategy Formulation McKinsey Quarterly Survey – July, 2011 Source: Indian Management, August 2011

14. Challenges in Forward Path

15. Challenges in Forward Path • Information content • Protective confidentiality vs. complete transparency • Completeness vs. Invasion by analysts, who till recently knew IGAAP • More volatility in Income Statement • Relevance for stakeholders • Recognition and transaction processing with flexibility for • Corporate reporting – Substance over Form, • Tax Accounts and Return – Historical Cost vs. Fair Valuation • Least possible application of Regulatory framework of accounting • Test of ‘Functional Currency’ • Unlearning and relearning – Research, Reading, Benchmarking • Guidance of EAC of ICAI, RBI – Replaced by IFRIC, SIC and IND AS • Schedule VI and Regulatory Provisions – Revised • Revenue recognition – Retail, Automobile, Construction, Airlines, etc.

16. Challenges in Forward Path … 2 • Mandatory tests and measurements • Covenant compliance • Classification of Current liabilities • Test of Going concern • Debt and Interest - in Preference Shares and Quasi Equity Instruments • Modeling and valuation of Options and other Derivative contracts • ERP System under new standards • Automated process vs. Worksheets in excel with associated risks • Handling of GAAP differences for conversion • Annual Business Plan preparation under converged IFRS Standards • Emerging needs of Direct Tax Code and Goods and Service Tax “To be effective, governance standards need to be implemented in a way that fits the culture and organisation structure of the individual company” CFO, Tata Steel Source: Indian Management, August 2011

17. Challenges in Forward Path … 3 Socio Economic Impacts of IFRS – Some researched out thoughts “……. Introduction of IFRS should be re-examined from at least two distinct perspectives: • the use, misuse, and abuse of principle-based Fair Value Accounting (FVA) … in the wider arena of socio-economies … . FVA should be re-examined as a specific mode of information that changes the epistemic, operational and control frameworks of various organisations” • The long term consequence of adoption or convergence which would affect the ‘Sovereign Right’ and ‘National Strategy’ to control India’s socio-economy for the sake of sustainable growth …. The mode of international standards should be reexamined for whether it will affect the power balance between Indian Government and international organizations” (Page 3) “We are not concerned with isolated corporate scandals. .… concerned about the indirect , long term, mental impacts of the new accounting on the socio-economies in India.” (Page 114) Contd. ..

18. Challenges in Forward Path … 4 Socio Economic Impacts of IFRS – Some researched out thoughts “Countries such as China and India may require tight control of, for example insurance industry, for the protection of a large population that should not be subjected to the logic and power of international institutional investors whose main interests are investment return.” (Pages 114-115) “Once the global accounting standards are implemented, the performance of Indian companies and industries is likely to be compared with that of other countries without taking social needs and context into account.” (Page 115) “Convergence is a carefully crafted although it may not be commonly understood definition or the one desired by IASB.” (Page 115) “Chinese political leaders have treated accounting as a matter of national strategy …. Converted accounting as a governmental tool to transform communist business organisations into modern economic entities.” (Page 121) Source: Socio-Economic Impacts of IFRS on Wider Stakeholders in India TomoSujuki and Jaypal Jain, Said Business School, University of Oxford, 2010 [v.2.3.2]

19. Key Questions to be Answered For The Audit Committee and Board of Directors

20. Key Questions to be Answered for AC and BoD • Revenue Recognition and Accounting • Industry specific changes - Retail, Vehicle, Telecom, Constn. etc. • Approaches to revisit measurement and recognition • IT enablement of the process • Articulation of disclosure for policy and measurement • Fixed Assets – Institutionalised Process • Fair valuation on first adoption • Componentisation of assets • Annual review of useful life and residual value • Annual tests for impairment and accounting of outcomes • Instances of leases under ‘Take or Pay Arrangement’ (IFRIC 4) • Tax implications for all the above – Current and Deferred • Assets and Liabilities – Current & Non Current • Covenant compliances for Loans and consequent changes • Split Pref. Shares and Combined Instruments into Debt , Equity and Interest • Restricted Cash & Cash Equivalents

21. Key Questions to be Answered for AC and BoD… 2 • Business Combinations • Effects on transactions planned for future • Impacts of changes due to fair valuations of assets and liabilities • Future exit strategies • Investments in Associates and Joint Ventures • Changes in number of entities under ‘Equity Accounting’ method • Modifications required in Joint Venture agreements • Alignment of policies and procedures for measurement and accounting • Taxes • Deferred Tax – Balance Sheet based approach • Overall impact on Current IncomeTaxes • Effect on Indirect Taxes due to changes in Revenue accounting • Contingent Liabilities • Reassessment and categorise into Remote, Possible, or Probable • Provision requirement for probable cases • Transparent disclosures after detailed review

22. Key Questions to be Answered for AC and BoD… 3 • Financial Statement Presentation • Changes in Formats and Classifications • Functional vs. natural grouping of expenses • Volatility in Income Statement • EBITDA not a defined measurement • Additional – ‘Comprehensive Income’ and ‘Changes in Equity’ • Capital Management Policy – Objective, Debt and Equity • Assessed adjusting events post Balance Sheet date • Sensitivity Analyses – Currency Exchange Rate and Interest • Financial Risk Management • Credit to Customers • Currency Exchange Rate Exposures • Liquidity – Maturity Profile of Loans, Creditors, Derivatives • Commodity procurement • Communication strategy and presentation to Analysts

23. Additional Notes and Disclosures for More Transparency • Financial Risk Management - Objectives and Policies covering • Credit Risk on Customers • Currency Exchange Exposures • Liquidity Risk - Maturity Profile for Loans, Creditors, Derivatives, Lease • Commodity Price Risk • Restricted Cash • Capital Management Policy - Objective, Debt, Equity • Tax Reconciliation and Analyses • Reconciliation at Effective Rate • Component-wise Analysis of Deferred Tax • Sensitivity Analyses • Interest Rate on Loan Portfolios with ‘Reset Clauses’ or ‘Floating Rate’ • Exchange Variations on Financial Assets and Liabilities • Analyses of Contingent Liabilities - Probable, Possible and Remote Analysts to exercise caution while using and comparing such disclosures

24. Further Thoughts

25. Thank You