The finalised roadmap for the convergence of Indian Accounting Standards with the International Financial Reporting Standards (IFRS), with respect to banking companies, requires all scheduled commercial banks to convert their opening balance sheets as of April 1, 2013. RBI has emphasised to banks that they need to gear up to adopt the new standards. Practical experience from other countries has proved that transition to IFRS can take 18-24 months to fully embed and implement. In particular, challenges related to information technology (IT) systems can often be underestimated. We have seen organisations attempt to manage their IFRS conversion with the use of manual spreadsheets. This can be extremely risky as spreadsheets may become cumbersome to manage when amalgamating a large quantum of information from disparate sources and systems. The key issue is to assess, at an early stage, whether the bank is looking at system updates or a major overhaul.
A solution to alleviate the risk of missing the deadline as well as to avoid costly mistakes, such as inadequate IT systems, is to incorporate a ?dry run? into the IFRS migration project plan. This methodology was followed by several large European and Australian entities in their conversion to IFRS, and in the Indian context would entail preparing dry-run financial statements for 2012-13. This should be carried out in four phases and its salient features, at a minimum, must include diagnostics, solution development, a dry run and finally the implementation of IFRS.
The diagnostic phase should be carried out in 2010-11 and assess the impact that IFRS would have on accounting, capital adequacy, IT systems, taxes and product design, amongst other issues. The organisation must develop a pan-organisation implementation strategy, understand data requirements and prepare data collation templates. The solution development phase to be carried out the following fiscal includes updating accounting and other policies in conformity with IFRS, conducting training across the organisation, data collation, preparation of skeleton accounts, reporting frameworks and building or changing financial instrument valuation models. The dry run slated for 2011-12, as the name suggests, should be used to prepare dry-run financial statements and review and modify policies, test the veracity of models and so on. The last phase, implementation, should bring with it no surprises and have post-implementation reviews in place in order to incorporate best practice.
An early start would also be beneficial for Indian banks to fully understand the implications of IFRS adoption on their business practices. To illustrate the forthcoming key standard IFRS 9, Financial Instruments: Classification and Measurement prescribes two options for the classification of financial assets, i.e. amortised cost or fair value. Amortised cost classification is only permitted if two conditions are met. First, the asset is held within a business model whose objective is to hold assets in order to collect contractual cash flow. Second, the contractual terms of the financial asset gives rise to cash flows on specified dates that are solely payments of principal and interest on the principal outstanding. When there are more than an infrequent number of sales in a portfolio held at amortised cost, the entire portfolio would have to be accounted for at fair value.
A key point to note is that a single entity may have more than one business model for managing its financial instruments, i.e. an entity may hold a portfolio of debt securities that it manages in order to collect contractual cash flows and another portfolio of similar debt securities that it manages in order to trade and realise fair value changes. Banks in India invest in government securities to comply with RBI?s statutory liquidity ratio prudential norms. As per current RBI rules, the majority of such investments are accounted for at amortised cost under the ?held to maturity? classification. Unless the bank has a clear strategy, sufficient expertise in their portfolio management and a demonstrable history of business models in place, it may well ?taint? an amortised cost portfolio with the result of having to measure the entire portfolio at fair value, causing undesired volatility in their financial statements.
There are strong arguments favouring the adoption of a migration timeline that incorporates a dry run. Even the banks that have already begun their IFRS conversion process, can take advantage of the extension in the timeline to develop best practice and experience with a dry run for the financial year 2012-13. Those entities that have not yet begun the conversion process would be well advised to start soon with their diagnostic effort so that they are fully aware of the extent of impact arising from IFRS conversion.
Amit Kabra is associate director, FS and Aman Bhargava is manager, FS at Ernst &Young. Views are personal
