Significance of International Financial Reporting Standards (IFRS)

1. Significance of International Financial Reporting Standards (IFRS) NIRC - Conference on Accounting Standards and IFRS New Delhi 3 February, 2007 JITENDRA AGARWAL

2. The Reporting Landscape

3. The Reporting Landscape • Global Markets – the Services Revolution • Accountability • Cross border Capital flows • Bases for business decisions • Corporate Reporting failures • Corporate Governance • Regulatory Framework • Changes in Technology and Products

4. Accountability • A business enterprise receives capital from outside investors, lenders, and other creditors. • It is accountable to them – it has an obligation to keep them informed about performance, conditions, and prospects. • Also accountable to others who provide resources or environment in which to operate: Employees, government, community at large.

5. Bases for business decisions • Capital Market transactions • Mergers & Acquisitions • Employee Stock Options • Borrowing and Lending

6. Company failure – director failure !! January 31, 2002 October 16, 2001 March 28, 2002 June 20, 2002 Issue: Off-Balance Sheet Accounting and Financial Reporting Fraud Impact: $3 billion in undisclosed losses Issue: Financial Reporting Fraud through improper revenue recognition Impact: $12.4 billion in overstated earnings Issue: Financial Reporting Fraud and embezzlement Impact: $2.5 billion of hidden debt Issue: Financial Reporting Fraud Impact: $9 billion in unreported expenses

7. Corporate Governance Pillars Corporate Governance Primary characteristics D I S C I P L I N E D I S C I P L I N E T R A N S P A R E N C Y I N D E P E N D E N C E A C C O U N T A B I L I T Y R E S P O N S B I L I T Y F A I R N E S S S O C I A L R E S P. N T R A N S P A R E N C Y

8. Regulatory Framework • Sarbanes Oxley • Reporting in the financial services sector • Quotas, obligations, etc. • Taxation • Eligibility for business transactions

9. Changes in Technology and Products • Intangible Assets – Licenses, Rights, etc • Tangible Assets – component accounting • Barter transactions • Options and Swaps • Futures • Complex arrangements – BOOT, BOT, BOMT, Service concession agreements, etc

10. Relevant Transparent Reliable Comparable Accountability • This is what corporate accounting is all about. • Accounting standards help ensure the financial information is: Understandable

11. Evolution of Accounting Standards

12. Evolution of Accounting Standards • Historically accounting standards have evolved country by country. • Standards set by government, or accounting profession, or independent board. • In the USA:Independent board – Financial Accounting Standards Board (FASB) since 1973. Before that – accounting profession. • In Hong Kong:Accounting profession – Hong Kong Society of Accountants. • In China: Government – Ministry of Finance.

13. Evolution of Accounting Standards • National standards made sense when companies raised money in, and investors looked for investment opportunities in, only their home country. • But that is no longer the case.

14. Global Accounting Standards Are Needed • Big change in 4th quarter of 20th century: Globalisation of capital markets. • Now, investors seek investment opportunities all over the world. • Companies seek capital at the lowest price anywhere. • Cross-border mergers. • Accounting differences can completely obscure comparisons.

15. Cross border Capital flows

16. Global Accounting Standards Are Needed World: 51 stock exchanges, 2700 foreign (cross border listings) out of 40,000 companies

17. Global Accounting Standards Are Needed

18. Global Accounting Standards Are Needed

19. Globalisation of Capital Markets Capital inflows Capital Outflows Source: IMF Workpaper

20. Global Accounting Standards Are Needed • On many stock exchanges foreign listings are a large % of total - USA October 2006: • NASDAQ: 10% (329 cos., 36 countries). • NYSE: 20% (453 companies, 47 countries). • Foreign is 33% of market value. • US SEC total: • 1981: 173 foreign companies listed in US. • 1991: 439 foreign companies listed in US. • 2002:1,400 foreign out of 16000 total • 2004: 1,236 foreign companies from 53 countries • 2005: 1240 foreign companies from 55 countries

21. Global Accounting Standards Are Needed • Foreign companies that sell securities publicly in the US must either: • Prepare their financial statements using US Generally Accepted Accounting Principles (GAAP), or • Use their national GAAP and include a reconciliation of earnings and net assets to comparable US GAAP figures. • The 1,240 foreign companies registered with the SEC use about 55 GAAPs!

22. Global Accounting Standards Are Needed • Even with the reconciliation, perhaps 95% of the financial figures in a foreign company’s annual report are based on their national GAAP – not comparable to US GAAP. • Pity the poor investor who has to compare foreign GAAP companies with US investment alternatives. • Pity the SEC staff reviewer, too.

23. Global Accounting Standards Are Needed • Same problem all over the world. • And these exchanges do not even require a reconciliation to national GAAP. • London Stock Exchange (Jan 2006): • 17% of companies are non-UK. • 550 foreign companies, 65 countries. • 66% of market value is non-UK. • Euronext: 25% foreign (345 / 1,392) • Switzerland: 32% (132 / 419) • Germany: 21% (182 / 866)

24. Examples of Reconciling items USGAAP vs. Other GAAPs

25. Examples of Reconciling Items

26. Examples of Reconciling Items

27. Examples of Reconciling Items

28. Examples of Reconciling Items

29. Examples of Reconciling Items

30. Topics covered by IASs

31. Shortcomings of Old IASC • Weak relationships with national standard setters. • Lack of convergence of IAS and major national GAAPs. • Part-time Board, full-time work load. • Needed broader sponsorship than accounting profession. • Needed recognition by regulators. • Needed resources. Structure review 1999-2000. Results . . .

32. Topics Covered by Existing IASs

33. Topics Covered by Existing IASs

34. Topics Covered by Existing IASs

35. Topics Covered by Existing IASs • IFRS 1 First time adoption of IFRS • IFRS 2 Share based Payment • IFRS 3 Business Combinations • IFRS 4 Insurance Contracts • IFRS 5 Non-current Assets held for Sale and Discontinued Operations • IFRS 6 Exploration for and Evaluation of Mineral Resources • IFRS 7 Financial Instruments: Disclosures (issued 18 August 2005)

36. IFRS 8 Operating Segments • Issued [30 November] • Effective 1 January 2009 • Earlier adoption permitted • Replaces IAS 14

37. IFRS 8 • No significant changes from ED • Adopts FAS 131 approach to determining segments—’management approach’ • Focus on the information presented to the ‘chief operating decision maker’ • Vertically-integrated operations can have segments • Measurement • Based on measures reported to chief operating decision maker • No requirement for IFRS-based measurement

38. IFRS 8 • Disclosure • Enhanced from those in IAS 14 • Reconciliation to IFRS-based reporting required • IAS 34 disclosures amended

39. IFRIC developments • Group and Treasury Share Transactions – IFRIC 11 • Service Concession Arrangements – IFRIC 12

40. IFRIC 11 – Group share plans • Issues: • Share-based payments involving own shares • Share-based payments involving shares of the parent • Intra-group transfers • Share-based payments involving own shares • Will always be equity-settled if equity-settled under IFRS 2

41. IFRIC 11 (ii) • Share-based payments involving parent shares • Parent offers its shares to employees of the subsidiary • Always equity-settled • Subsidiary offers its employees shares of the parent • Cash-settled in the individual accounts of the subsidiary • Intra-group transfers—non-market vesting conditions

42. IFRIC 12 • IFRIC 12 Service Concession Arrangements • Approved, to be issued [30 November] • Effective date 1 January 2008 • Public-to-private arrangements only • Grantor controls or regulates what services are provided; to whom; and the price • Grantor controls any significant residual interest in the infrastructure • Whole life assets are within the scope if the Grantor controls services, intended customers and price • Operator’s pre-existing PP&E • Grantor accounting is not addressed

43. IFRIC 12 (ii) • Some significant issues • Arrangement consideration • Financial asset vs. intangible asset • Repairs, restoration and maintenance • Borrowing costs • Applicability of other IFRS • Amends IFRIC 4 • Scope exclusion for concession arrangements subject to IFRIC 12

44. The IFRIC’s agenda—status • Draft—comment period closed • D19 - The Asset Ceiling: Availability of Economic Benefits and Minimum Funding Requirements • D20 - Customer Loyalty Programmes • In development • IAS 18 - Real estate sales • IAS 18 - Initial fees received by a fund manager • IAS 18 - Identifying agency arrangements • IAS 38 - Advertising and promotional costs • IAS 41 - Recognition and measurement of biological assets

45. The IFRIC’s agenda (ii) • Early stages • IFRS 2 - Accounting for employee benefit trusts • IAS 11 - Allocation of profit in unsegmented contracts • IAS 17 - Sales and leasebacks with repurchase agreements • IAS 21 - Hedging a net investment • IAS 39 - various hedge accounting issues

46. Recent and Emerging Trends in International Accounting Standards • Greater use of fair values in measuring transactions: • Impairment recognition. • Prohibit poolings. • Non-monetary exchanges. • Fair values on balance sheet for both financial and non financial assets: • Financial Instruments. • Agriculture. • Investment property. • Commodity inventories.

47. Recent and Emerging Trends in International Accounting Standards • More unrealised components of income: • Performance reporting becomes key. • No income smoothing, cost deferrals, general provisions: • Remove corridor approach to pensions. • Balance sheet approach to deferred tax. • No accruals for future losses. • Rigorous hedge accounting rules.

48. Recent and Emerging Trends in International Accounting Standards • Eliminate off-balance sheet items: • Derivatives. • Special purpose entities. • Stock compensation. • More disclosure, especially judgements, plans, assumptions: • Judgement in applying accounting policies. • Risk management policies. • Sensitivity analyses. • Eliminate accounting choices. • Convergence with US GAAP.

49. “Endorsement” of IFRS in Past Few Years • International Organization of Securities Commissions: 100 securities regulators (including the US SEC). • Basel Committee: Global bank regulators (including the US Federal Reserve) • The World Bank and IMF. • The G7 Finance Ministers. • And many others. These are non-binding endorsements.

50. Use of IFRS around the world